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Depreciation is the process of systematically reclassifying the cost of an asset from the balance sheet to the income statement over its useful life — a topic I discuss at length in Chapter 12. A few different methods of depreciation are allowed by GAAP, so unless you know which method the company is using, you can’t effectively compare one company to another.

Consider an example. For the same asset, here is the amount of depreciation a company can take for the asset’s first year of use depending on which commonly used depreciation method it employs:

 Straight-line depreciation: $54,000

 Double-declining balance depreciation: $120,000

The difference between the two methods is a whopping $66,000 ($120,000 – $54,000)! Now imagine depreciating equipment that costs in the millions of dollars; the effect on the company’s bottom line net income of choosing one depreciation method versus another would be even more astonishing.

Luckily for the financial statement users, to aid in comparability, the depreciation method in use by a company must be disclosed in the notes to the financial statements. For much more info about depreciation, jump to Chapter 12. For the scoop on what financial statement notes are, head to Chapter 15.

Consistency is crucial when it comes to depreciation. If the company lacks consistency —for example, it uses different depreciation methods when accounting for the same asset in different years — you cannot create truly useful financial statements.