Depreciation Is the Only Expense That Never Leaves the Bank

Three years of life is worth 1,500 a year of profit

Stretch the same van from five years to eight and the annual charge falls from $4,000 to $2,500 — $1,500 a year of extra reported profit produced by nothing but a change of opinion about how long a van lasts. The cash position is identical in both versions, the tax bill may not be, and neither number is more truthful than the other until the van is actually sold. This is the reason accounting standards constrain the choice rather than leaving it open, and the reason a lender reads the depreciation policy in the notes before believing the profit on the front page. When a company's useful lives lengthen from one year to the next, that is a question to ask, not a detail to skip.

Straight line is a convention, not a measurement

Nothing loses value in equal annual slices. A van drops a large fraction of its price the moment it is registered and then declines gently, which is why declining-balance methods exist and why a five-year-old vehicle is usually worth more than the straight-line schedule says. The convention survives because it is simple, predictable and hard to manipulate mid-life, not because it tracks the second-hand market. Use it for the accounts, and use an actual resale estimate when the question is whether to replace the vehicle now or run it another year — those are different questions and the straight-line figure answers only the first.

Frequently asked questions

Is depreciation the same as the tax allowance?

Rarely. Most tax systems set their own rates and lives for capital allowances, and they need not match what the accounts show — a country may allow the whole cost in year one to encourage investment while the accounts still spread it over five. The gap between the two is where deferred tax comes from, which is why the line exists on balance sheets that otherwise look simple. For planning purposes keep the two calculations separate: one tells you what the accounts will report, the other what the tax return will claim, and confusing them produces a cash forecast that is wrong in both directions at once.

What if I sell for more than the residual I assumed?

The difference lands in the year of sale as a gain, and it is a correction of past estimates rather than fresh trading income. Selling the van for $6,000 when the books carry it at $4,000 produces a $2,000 gain, which flatters that year's profit and tells you the previous five years were charged $400 a year too much. Nobody restates the earlier accounts for this, so the pattern to watch in a set of results is a company whose profit is repeatedly helped by asset disposals — that is depreciation coming back, not the business improving.