Decoding Depreciation: The Hidden Force Shaping Financial Statements

By Pavit Kaur

Let’s face it, “depreciation” sounds like one of those dry, accounting textbook words that makes you want to zone out. But hang on a second. If you’ve ever owned a car, a laptop, or even a smartphone, you already understand what depreciation means in real life.

Your shiny new phone loses value the moment you unbox it. Give it a year, and it’s worth half of what you paid. That slow decline in value? That’s depreciation. Now imagine that on a corporate scale: with factories, equipment, office buildings, and machinery. Suddenly, it’s a big deal.

So today, let’s break it down together.

What exactly is depreciation?

Depreciation is how businesses account for the wear and tear or obsolescence of their assets over time.

Let’s say a company buys a ₹10 lakh machine. It won’t last forever, it might be useful for, say, 10 years. Instead of treating that ₹10 lakh as an expense all at once, they spread it out over its useful life. That’s depreciation.

So every year, the company records ₹1 lakh as a non-cash expense on its income statement.

Why does this even matter?

Depreciation impacts a lot of things:

• Profits – Since it’s an expense, it reduces net income.

• Taxes – Less profit = less tax to pay.

• Cash Flow – It's non-cash, so it doesn’t actually reduce the cash in hand.

• Asset Values – It slowly lowers the value of stuff a company owns on its balance sheet.

So yeah, depreciation plays behind the scenes, but it changes how we view a company’s performance.

Types of Depreciation (Yes, there’s more than one!)

There’s no one size fits all. Here are some of the popular methods companies use:

1. Straight Line Method

• Most common and simplest.

• Equal amount of depreciation every year.

• Think of it like slicing a cake into even pieces.

2. Declining Balance

• More depreciation in early years, less later.

• Good for tech gadgets or anything that loses value quickly.

3. Double Declining Balance

• An even more aggressive version of the above.

4. Units of Production

• Tied to how much the asset is used.

• A delivery truck that drives 10,000 km vs. one that drives 50,000 km? The second depreciates faster.

5. Sum-of-the-Years' Digits

• Sounds scary, but it’s just a slightly fancy way to front load depreciation.

Depreciation, Taxes & Trickery

Here’s where things get interesting.

Since depreciation reduces profits, it also reduces taxes. That’s why companies (legally) play around with depreciation methods to maximize tax benefits. In India, businesses follow rules set by the Companies Act and Income Tax Act, which can differ.

This leads to different depreciation figures in financial statements vs. tax filings. Fun, right?

Quick Side Note: Don’t Confuse These!

How Investors Use Depreciation to Read Between the Lines

Let’s say you’re an investor or analyst.

You don’t just look at net profit, you look at EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). Why? Because depreciation is non cash. It’s not money leaving the company, it’s just accounting.

But here’s the twist: if depreciation is too high, it could mean the company has outdated or overvalued assets. If it’s too low, maybe they’re not reinvesting enough in new tech or infrastructure.

Also, compare depreciation to CapEx (Capital Expenditure). If CapEx < depreciation year after year, that could mean shrinking operations.

Wrapping It Up

Depreciation may not be flashy, but it’s incredibly powerful. It influences profit, taxes, valuations, and investor decisions. If you're into financial analysis or company research, understanding depreciation isn’t optional, it’s essential.

Next time you look at a company’s financials, don’t skip over that tiny “Depreciation & Amortization” line, it’s doing a lot more than you think!!