Define 'depreciation'.

Depreciation refers to the process of allocating the cost of a tangible asset over its useful life. This accounting method allows businesses to match the asset's cost with the revenue it generates over time. By systematically reducing the asset's recorded value on the balance sheet, depreciation reflects the wear and tear or loss of value that occurs as the asset is used.

In this context, recognizing depreciation is essential for accurately representing financial performance and position. It provides a more realistic view of a company’s profit margins by ensuring that expenses are associated with the revenue they help to generate, adhering to the matching principle of accounting. Additionally, this practice aids businesses in tax deductions, as depreciation can reduce taxable income.

Understanding depreciation is critical for financial reporting, as it affects both the income statement and the balance sheet, influencing decisions made by investors, creditors, and management alike.