Why is depreciation an expense?One objective of the income statement is to measure a company's success in selling a good or service. To do that the income statement matches revenue with expenses, which is known as accrual accounting.
Consider the image below, which shows the purchase of a large piece of equipment for a business, in this case a crane. Let's assume that the crane has a useful life of five years.
The image shows two income statements. The first (top) demonstrates what the income statement would look like if the purchase was expensed all at once (note: not an accurate income statement).
The second, titled "Income Statement" to reflect accrual accounting, shows the cost of the crane spread out over its useful life (depreciation).
Now imagine that your business generates $10M of revenue in each period. Expensing $5M in period 1 and $o in the following four periods would not accurately reflect the earnings of the business since you are using the crane in each of the five periods.
Finally in the last image you will see how the cash flow statement adjusts for this non-cash item to arrive at the company's cash balance.