In order to include depreciation on an income statement, it is necessary to know the cost of the asset or assets in question and to have an idea of their expected lifespan. Then the cost of each asset is divided among the years it is expected to be in use. The amount for each year is then entered into the income statement for the anticipated years of use.
To account for depreciation on an income statement, the cost and matching principles must be considered. The first dictates that the value of the asset should be reported as the price at the time of purchase, rather than the replacement cost at the end of the depreciation period or current market value of the asset at any point during that period. Matching principle is simply the process of dividing the cost of the asset so that it matches annual profits.
Depreciation on an income statement is recorded as a no-cash charge. This is a condition where an expense is accounted for during a period where no payment is made for that asset. The method is best used for one-time or extremely occasional expenses such as for equipment, technology, and vehicles. The estimated lifespan of the asset may not necessarily match the actual period the item is in use.
When accounting for depreciation on an income statement, the goal is to create an accurate picture of the organization’s overall financial condition. This is distinct from the company’s cash flow, which shows an accurate picture of status, but not performance. The financial condition provides a picture of the organization that is appropriate for educating investors as to the overall status of the company over the long-term, while tracking the underlying cash flow is an important aspect of maintaining accurate records in the short-term. This is primarily because it proves that there are sufficient reserves for paying immediate expenses.
Recording depreciation on an income statement enables an organization to match the benefit an asset provides an organization with its cost. The primary reasons for including depreciation on an income statement are taxes and overall annual accounting. By using depreciation, an organization can spread out the tax responsibility for the asset. It can also provide a more accurate picture of the company’s performance. This is because if the entire cost of the asset is accounted for in one year, the cost may create the appearance that the company did not do well. If that cost is evenly distributed over the asset’s life span, then it can be easier to more accurately gauge performance over those years.