What is Depreciation?

Depreciation is a planned, gradual reduction in the recorded value of an asset over its useful life by charging it to expense. Depreciation is applied to fixed assets, which generally experience a loss in their utility over multiple years. The use of depreciation is intended to spread expense recognition over the period of time when a business expects to earn revenue from the use of an asset.

Is Depreciation a Fixed or Variable Expense?

Depreciation is a fixed cost, because it recurs in the same amount per period throughout the useful life of an asset. Depreciation cannot be considered a variable cost, since it does not vary with activity volume. However, there is an exception. If a business employs a usage-based depreciation methodology, then depreciation will be incurred in a pattern that is more consistent with a variable cost.

For example, a logging machine is depreciated based on the number of hours that it is used, so that depreciation expense will vary with the number of trees cut. If these trees are then sold to generate revenue, then it can be said that the related depreciation behaves more like a variable cost than a fixed cost. However, usage-based depreciation systems are not commonly used, so in most cases depreciation cannot be considered a variable cost.

If depreciation is considered a fixed cost, then it is included in the numerator of the formula used to calculate the break even sales of a business, which is:

Total fixed expenses ÷ Contribution margin % = Break even sales

If depreciation is considered a variable cost, for which a case can be argued if usage-based depreciation is employed, then it is instead used to reduce the amount of the contribution margin percentage in the denominator of the equation.