Matching of Costs and Revenue

The central idea of depreciation is rooted in the matching principle of accounting. A business buys fixed assets — machinery, buildings, vehicles — not to resell them, but to use them over several years to earn revenue. Each year that the asset is used, it contributes to the income of that year. But it also suffers wear and tear, obsolescence, or a simple loss of value from being used. That loss of value is a real cost of using the asset, just like the salary paid to the worker who runs the machine or the electricity bill that powers it.

If a business ignored this loss of value, it would be overstating its profit for the year. It would be matching the full revenue earned from the asset against only the out-of-pocket expenses (like repairs and wages), while ignoring the fact that the asset itself is being consumed. This would violate the matching concept, which states that all expenses incurred to earn revenue for a period must be deducted from that revenue to arrive at the true net profit. …