Why Understanding Depreciation is Crucial for finance Directors

Recently, our company welcomed a new finance Director, a position that should instill confidence and expertise in managing our financial strategies. With her extensive background—including over 20 years in corporate finance, experience with a Big 4 firm, and an MBA from a well-respected institution—one might assume that she possesses a solid grasp of fundamental Accounting principles. However, our experiences over the past few weeks have raised significant concerns about her understanding of basic financial concepts, particularly regarding depreciation.

During a recent walkthrough of our monthly closing process, she posed an unexpected question: “Why do we seem to waste money every month on depreciation expenses when we’re not actually incurring any out-of-pocket costs?” Initially, I thought she was testing my knowledge. After all, depreciation—which allocates the cost of tangible assets over their useful lives—is a cornerstone of proper Accounting practices. I attempted to clarify that the purpose of depreciation is to match expenses with the revenues generated from those assets over time.

To my surprise, her response indicated a fundamental misunderstanding. She argued, “But we already paid for the equipment. Why do we need to expense it again?” When I referenced the Generally Accepted Accounting Principles (GAAP)—the standard framework of guidelines for financial accounting—she requested a step-by-step breakdown, labeling the process as “unnecessarily complicated.” I found myself spending a good half-hour explaining concepts typically covered in an introductory accounting course.

Furthermore, when we discussed our newly acquired $50,000 server, she suggested that we simply expense the entire amount to maximize our tax write-off in the current fiscal year, rather than spreading the cost out as depreciation suggests. As I introduced the notions of capitalization thresholds and differentiating between assets and expenses, she seemed unconvinced and recommended consulting our tax adviser, as she felt something was amiss.

What’s more concerning is that she is slated to review our financial statements, ensuring their accuracy before they are presented to the board next week.

For context, our company is a well-established manufacturing entity with a revenue of $15 million—not a small startup where one might expect a lax approach to accounting practices.

Adding to my astonishment, she also inquired about why our cash flow statement didn’t align with the profit and loss (P&L) statement, expressing genuine confusion when I explained the fundamental difference between net income and cash flow.

This situation leads me to question how someone can navigate the finance sector for