One bad month, on paper only
Expensing it all at once makes a healthy month look like a crisis.
Volume 07, Chapter 11
Depreciation and Capital Expenditure
The cash leaves all at once, the day you buy. The cost is then spread out over the years the machine is actually used.
The Golden Rule
If something will help the business for years, don't count its whole price as one month's expense. Spread it over the years you will use it.
That spreading is called depreciation. It keeps each month's profit honest, instead of making the month you buy a machine look like a disaster and every month after it look better than it really was.
Everyday expenseUsed up quickly. Record it as an expense now.
Capital expenditure (CapEx)Used for many years. Record it as an asset first.
DepreciationSpread that asset's cost over the years it is used.
Needs an Asset Register
Depreciation requires a purchase date, cost, and useful life for every asset.
The cash leaves only once
The money goes out the day you buy. Depreciation just counts the cost slowly after that, no more money leaves.
A fairer profit picture
Spreading the cost evenly matches it to the years the asset is actually used.
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Definition
MANIAC MINDZ buys a new industrial sewing machine for ₦2,400,000. The money leaves the bank account today, all at once.
Here's the question a beginner actually asks: if the money is gone today, why can't I just count the whole ₦2,400,000 as this month's expense and be done with it?
Because the machine did not only help the business today. That same machine will keep making clothes for years. If you recorded the entire ₦2,400,000 as this one month's cost, this month's profit would look far worse than it really was, and the next few years would look better than they really were, because those years would carry no cost at all for a machine they were still using every day. That would not be a fair picture of the business.
Capital expenditure (CapEx)
is money spent buying something that will keep helping the business for years, a machine, a vehicle, a building. Depreciation is the method that spreads that cost across the years the thing is actually used, instead of counting the whole cost in the single month it was bought.
In One Sentence
Buy a ₦2,400,000 sewing machine that will last about 5 years, and it would be misleading to say the business "lost" ₦2,400,000 in that one month, the machine still has years of use ahead of it. Depreciation spreads that cost across those years, so each year's profit carries only that year's fair share of the machine wearing out.
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Two Kinds of Spending
Before you can record a purchase correctly, you have to know which of two kinds it is.
Everyday Expense
Something the business uses up quickly: thread, fabric, electricity, fuel, this month's rent. Recorded as an expense straight away, in full.
Capital Expenditure (CapEx)
Something that will help the business for many years: a sewing machine, a delivery van, a computer, factory equipment. Recorded as an asset first, not an expense, then its cost is spread over its useful life through depreciation.
| Everyday Expense | Capital Expenditure (CapEx) | |
|---|---|---|
| Buys | Something used up quickly | Something used for many years |
| Examples | Thread, fabric, electricity, fuel, rent | Sewing machine, delivery van, computer, factory equipment |
| Recorded as | An expense, immediately, in full | An asset first, then depreciated over its life |
| Lives in | The expense ledger | The Asset Register |
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Straight-Line Depreciation, Worked
The simplest and most common way to spread the cost is called straight-line depreciation. It assumes the machine loses the same amount of value every year. Here is how to read it, one step at a time:
- Start with the cost, what you paid for the machine.
- Subtract the salvage value, what you expect to sell it for at the end of its useful life.
- Divide by the useful life, the number of years you expect to use it.
Written as one line, that is:
Annual depreciation = (Cost − Salvage Value) ÷ Useful Life (in years)
Now let's put in real numbers for a MANIAC MINDZ industrial sewing machine.
| Item | Value |
|---|---|
| Cost (what we paid) | ₦2,400,000 |
| Salvage value (what we expect to resell it for at the end) | ₦400,000 |
| Useful life (how long we expect to use it) | 5 years |
Step 1, work out how much value the machine will lose over its whole life:
₦2,400,000 − ₦400,000 = ₦2,000,000
So the business expects the machine to lose ₦2,000,000 of value while it is being used.
Step 2, spread that loss evenly across the years:
₦2,000,000 ÷ 5 years = ₦400,000 per year
So instead of treating the machine as a ₦2,400,000 expense in the single month it was bought, the business counts ₦400,000 of depreciation each year for five years. That gives a much fairer picture of how much of the machine has been "used up" each year.
Why go to this trouble? Imagine two businesses buy the same machine on the same day.
Business A: counts it all at once
Records the full ₦2,400,000 as one month's expense. That month looks terrible, and the next few years look unusually profitable, even though the machine is still working every day.
Business B: uses depreciation
Counts ₦400,000 each year. Every year's profit shows that the machine is still being used to earn money. Business B's accounts tell the more accurate story.
Memory Trick
The cash leaves once. The machine works for years. So the cost is spread over the years the machine is used. Buying the machine moved money out of the bank one time. Depreciation moves no extra money at all, it only decides how that one cost is shared across the years.
Remember
Depreciation changes profit, not cash. The cash for the machine left the day you bought it; depreciation only decides how its cost is shared out across the years that follow.
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Example Story: The Machine That Looked Like a Disaster
Here's the full version of the story from the start of this chapter.
The month MANIAC MINDZ bought that ₦2,400,000 sewing machine, a new bookkeeper recorded the full ₦2,400,000 as that single month's expense. On paper, it looked like the business had made a huge loss.
But nothing was actually wrong. The machine was still there. It was making clothes every day. The problem wasn't the business, it was the bookkeeping.
Switching to depreciation fixed it. The machine's cost was spread across the years it would be used, ₦400,000 a year, and the accounts finally matched reality: one fair share each year, instead of one terrible month followed by months that looked better than they truly were.
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Across Industries
Rapid Auto Works
CapExA vehicle diagnostic machine
Useful life5–7 years
Golden Crust Bakery
CapExA commercial oven
Useful life8–10 years
Green Fields Farm
CapExAn irrigation system
Useful life10–15 years
| Business | A Capital Expenditure | Typical Useful Life |
|---|---|---|
| Rapid Auto Works | A vehicle diagnostic machine | 5–7 years |
| Golden Crust Bakery | A commercial oven | 8–10 years |
| Green Fields Farm | An irrigation system | 10–15 years |
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Common Mistakes
Common Mistake #1: Expensing the Full Cost in One Month
Distorts that month's profit dramatically and understates every following month, see the example story.
Common Mistake #2: Forgetting Depreciation Isn't a Cash Movement
The cash already left when the asset was purchased; depreciation is an accounting entry, not a new cash outflow. Don't double-count it in a cash flow forecast.
Common Mistake #3: No Asset Register to Depreciate Against
Depreciation needs a purchase date, cost, and useful life for every asset, exactly what Volume 04, Chapter 6's Asset Register already tracks.
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Quiz Yourself
Quiz 1
A machine costs ₦1,500,000, has an estimated salvage value of ₦300,000, and a 4-year useful life. What's the annual straight-line depreciation?
(₦1,500,000 − ₦300,000) ÷ 4 = ₦300,000/year.
Quiz 2
Why shouldn't the full cost of a machine be expensed in the month it's bought?
Because the machine will keep providing value for years, expensing it all at once distorts that month's profit and understates every following month.
Quiz 3
Is depreciation a cash outflow?
No, the cash already left when the asset was purchased. Depreciation is an accounting entry spreading that cost over time, not a new cash movement.
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Practice Exercise
- List your major fixed assets from your Asset Register.
- For each, estimate useful life and salvage value, and calculate annual straight-line depreciation.
- Confirm your monthly profit figures reflect depreciation, not the full purchase cost in a single month.
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Quick Summary
Quick Summary
- A capital expenditure (CapEx) buys something used for years; an everyday expense is used up quickly.
- Depreciation spreads an asset's cost evenly across its useful life, so profit reflects a fair share each period, not a single distorted month.
- Straight-line formula: (Cost − Salvage Value) ÷ Useful Life.
- Depreciation is an accounting entry, not a new cash outflow, the cash already left at purchase.
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