Depreciation reserves are funds established by a business for expensive items that depreciate overtime and must be replaced. The business puts money into the reserve every year according to the amount the item depreciates and its salvage value. This allows the business to have the funds available to replace expensive equipment as it must be replaced. Many businesses have equipment that is essential to their operation but can cost much more than the businesses can afford in a single year. Depreciation reserves allows the business to slowly prep for the cost and do so in a way that avoids taxes. As an example of how this operates, if a cruise company must replace its new ship which cost $100,000,000 in twenty years and the ship can be salvaged for $10,000,000 at the end of that twenty year period, the business would allocate $4,500,000 each year into a reserve account to pay for the new ship ($100,000,000 - $10,000,000 = $90,000,000 /20 = $4,500,000).
[Last updated in January of 2022 by the Wex Definitions Team]