What is the purpose of depreciation expense?

The purpose of depreciation expense is to allocate the cost of tangible assets over their useful lives. When a company acquires a physical asset, such as machinery or a building, this asset does not provide its benefits all at once; instead, it generates value over an extended period. Depreciation expense systematically reduces the carrying amount of the asset on the balance sheet while also recognizing a portion of the asset's cost as an expense on the income statement. This allocation aligns with the matching principle of accounting, which states that expenses should be recognized in the same period as the revenues they help to generate.

This approach reflects a more accurate financial picture of the company’s profitability and operational performance over time. By depreciating an asset, a firm can recognize the wear and tear and the economic consumption of the asset, rather than showing the entire cost upfront.

In contrast, ensuring liquidity relates to the ability of a company to meet its short-term obligations, which isn't directly tied to how depreciation is calculated or allocated. Calculating net income indeed involves accounting for depreciation, but that is a byproduct of the depreciation expense rather than its primary purpose. Lastly, depreciation does not increase asset value; in fact, it reduces the book value of the asset on the balance sheet as