In financial statements, what does the term 'depreciation' refer to?

Depreciation refers to the process of allocating the cost of tangible assets, such as machinery, buildings, or equipment, over their useful lives. This concept reflects the idea that an asset loses value as it is used over time and as it ages, and it allows businesses to match expenses with the revenues generated from the asset. This allocation is crucial for accurately assessing the financial performance and position of a business over its accounting periods.

By systematically recognizing depreciation, businesses can ensure that their financial statements provide a more realistic view of the value of their assets and help stakeholders understand the true earning capacity of the company. This approach also aligns with accounting principles that require costs to be matched with associated revenues within the same fiscal periods.

The other options do not accurately describe depreciation. While the increase in asset value over time refers to appreciation, the recognition of total sales revenue pertains to revenue recognition rather than asset management. Additionally, capital gains relate to profits made from selling an asset at a price higher than its purchase cost, which is distinct from the concept of depreciation.