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Depreciation is used in accounting practices to spread out the cost of purchasing a tangible asset (whether property, plant, or equipment) over several years by reducing the value of the asset over the course of the asset's life span (as the asset loses value from usage, wear and tear, or obsolescence). Different methods of depreciation are used depending on the type of asset purchased. Land has the longest life span (and has many factors if used for its natural resources or simply as the grounds where buildings and machinery are kept for the purpose of running a business), so the 150% declining-balance method is most commonly used for this purpose. Buildings, where business is conducted, have a fairly lengthy life span (depending on how old the building is when purchased), so the straight-line depreciation method is used for this example. For assets whose life span may not be as long, such as machinery or equipment used to generate revenue, the double-declining depreciation method is used.

Businesses are taxed on any revenue they generate after they have accounted for any expenses they have incurred to accumulate these earnings (so expenses are deducted as the costs of doing business). Depreciation helps to spread out the taxes that are paid each year on the earnings from services rendered, and is tax deductible based on the fact that assets lose value over time from everyday usage. If a business were to be taxed on the revenue generated the year a major asset was purchased (for example, a piece of machinery for $1M to help create products that will be sold for a profit), the asset would be deducted as an expense, so the IRS would only be able to tax the business on the earnings after the expense was deducted. A $1M expense would mean the IRS wasn't collecting taxes on a large portion of the businesses revenue. The next year, however, the business would be taxed on all of the revenue it generated. The next year's revenue would be significantly higher, so the amount paid in taxes would reflect that. In order to minimize (and even out) the taxes paid each year, depreciation of the asset will control this.

Plant and Machinery