What does 'depreciation' refer to in financial accounting?

Depreciation in financial accounting refers to the systematic allocation of the cost of a tangible asset over its useful life. This process allows businesses to match the cost of an asset with the revenue it generates over time, which is consistent with the matching principle in accounting. By spreading the cost of the asset across its useful life, companies can reflect a more accurate financial picture in their income statements, as it accounts for the wear and tear or obsolescence of their assets.

This approach ensures that the financial statements represent the consumption of the asset's value as it is utilized in the business operations, rather than recognizing the entire expense at the time of purchase. Therefore, understanding depreciation is crucial for accurately preparing financial statements and assessing a company's financial position.