Introduction to Depreciation and Amortization in Accounting

Depreciation and amortization are employed as accounting (Also see The Importance of Accounting Procedures) techniques to apportion the expenses of assets over their anticipated periods of productivity. If you find the concepts of Depreciation and Amortization unfamiliar, it is advisable to consult an accounting firm in Johor Bahru for professional assistance. Here’s a brief explanation of each:

Depreciation:

Depreciation is a systematic allocation of the cost of tangible assets over their estimated useful lives. Tangible assets are physical assets that a business uses to generate revenue or support its operations, such as buildings, machinery, vehicles, furniture, and equipment.

The main purpose of depreciation is to match the cost of an asset with the periods during which it contributes to generating revenue. By spreading the cost over the asset’s useful life, depreciation helps to recognize the expense in a way that reflects the asset’s consumption or wear and tear over time.

Depreciation methods:

There are various depreciation methods, but two common approaches are:

• Straight-line depreciation: This method evenly allocates the cost of an asset over its estimated useful life. It assumes that the asset’s benefits are consumed at a constant rate over time. To compute straight-line depreciation, the formula used is: (Initial cost of the asset – Estimated residual value) divided by the estimated useful life.
• Accelerated depreciation: Accelerated depreciation is an approach that acknowledges greater depreciation expenditures during the initial stages of an asset’s lifespan, gradually decreasing in subsequent years. It acknowledges that many assets are more productive or valuable in their initial years. Accelerated depreciation methods include the declining balance method (e.g., double declining balance) and the sum-of-the-years’ digits method.

Amortization:

Amortization is the process of systematically allocating the cost of intangible assets or financial assets over their estimated useful lives. Intangible assets lack physical substance but possess value and are essential to a business’s operations or generate economic benefits. Examples of intangible assets include patents, copyrights, trademarks, licenses, and goodwill.

Similar to depreciation, the purpose of amortization is to match the cost of an intangible asset with the periods over which it provides value or generates revenue.

Amortization methods:

The most commonly used method for amortization is straight-line amortization. It spreads the cost of the intangible asset evenly over its estimated useful life. To compute straight-line depreciation, the formula used is: (Initial cost of the asset – Estimated residual value) divided by the estimated useful life.

It’s important to note that the estimated useful life, salvage value (or residual value), and choice of depreciation or amortization method depend on factors such as industry practices, legal requirements, accounting (Also see Types of Accounting Errors and Ways to Avoid Them) standards, and company policies. These factors can influence the determination of an asset’s useful life and the method chosen for allocating its cost.