When a business acquires assets, those assets usually come at a cost. However, since most assets do not last forever, their cost should be expensed proportionally based on the period in which they are used. Amortization and depreciation are methods of prorating the cost of a company’s assets over their useful lives.
Depreciation is a method of spreading the cost of an intangible asset over a specific period of time, which generally corresponds to its useful life. Intangible assets are non-physical assets that are nonetheless essential to a business, such as patents, trademarks and copyrights. The goal of depreciating an asset is to match the acquisition expense with the income it generates.
Let’s say a company spends $ 50,000 to obtain a license, and the license in question will expire in 10 years. As the license is an intangible asset, it must be amortized over the 10-year period preceding its expiration date. Using the straight-line depreciation method, which is a method of charging a cost to an expense at a constant rate over time, the company’s annual depreciation expense for the license will be $ 5,000 (or $ 50,000 $ / 10 years), which means that the asset will decline in value by $ 5,000 each year.
Like depreciation, depreciation is a method of allocating the cost of an asset over a specified period of time, typically the useful life of the asset. The purpose of depreciation is to match the expense of obtaining an asset with the income it helps a business earn. Depreciation is used for tangible assets, which are physical assets such as manufacturing equipment, commercial vehicles, and computers. Depreciation is a measure of how much of an asset’s value has been depleted at any given time.
Suppose a company purchases new equipment with an estimated useful life of 10 years for the price of $ 100,000. Using the straight-line method, the company’s annual depreciation expense for the equipment will be $ 10,000 ($ 100,000 / 10 years). This is important because depreciation charges are recorded as a tax deduction. It is also possible for a business to use an accelerated depreciation method, where the amount of depreciation it takes each year is higher during the first years of an asset’s life.
The key difference between depreciation and depreciation is that depreciation is used for intangible assets, while depreciation is used for tangible assets. Another major difference is that depreciation is almost always implemented using the straight-line method, while depreciation can be implemented using the straight-line or accelerated method. Finally, because they are intangible, depreciated assets have no salvage value, which is the estimated resale value of an asset at the end of its useful life. Impaired assets, on the other hand, often have salvage value. The salvage value of an asset should be subtracted from its cost to determine the amount at which it can be depreciated.
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