Tangible vs. Intangible Depreciation
It is an important rule in accounting that revenues should be recorded in the same time periods as the expenses that were incurred in order to produce them, much as expenses should be recorded in the same time periods as the revenues that their occurrence helped produce. Compliance ensures that financial statements are more accurate and faithful to the business’s actual circumstances. Since most assets lose their usefulness, and thus value, through their usage in business operations, that lost value must be recorded as an expense in each period of their usage.
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Tangible and Intangible Assets
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Depreciation and amortization are similar but not quite the same process applied to long-term, tangible and intangible assets with impermanent existence. Long term means that the asset is expected to exist longer than one year, while tangible and intangible refers to whether the asset is a physical object. Only assets with impermanent existence are depreciated or amortized because their usefulness is limited.
Nomenclature
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Both depreciation and amortization see the asset’s value expensed across the time span during which it is used, in order to represent its usage in business operations. Mathematical formulas are used to calculate the value to be expensed in each time period that passes until the asset’s usefulness is at an end and its value is exhausted. Although depreciation and amortization are sometimes used as interchangeable terms, in strictest usage, depreciation describes this process applied to tangible assets while amortization describes the same or a similar process applied to intangible assets.
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Depreciation
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Different mathematical formulas create different patterns of value loss and are used to better suit different classes of assets. For example, the simplest method -- and thus one of the most popular -- is the straight-line method. This allocates an equal portion of the asset’s value as depreciation expense in each time period in which it is expected to be used. Others, such as the declining-balance and sum-of-year methods, record higher depreciation expense in the earlier periods, and thus, lower expense in later periods. As depreciation expense is recorded, it is collected in accounts called accumulated depreciation, representing the value of each depreciable asset that has been accounted, thus far.
Amortization
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Amortization is performed using the same principle, and even the same mathematical formulas, as depreciation. In some cases though, amortization expense is deducted from the asset’s value rather than collected in an accumulated amortization account. For example, a patent that is being charged $800 in amortization expense might record that as $800 in amortization expense and a direct deduction of $800 from the patent asset account. Other intangible assets use the same procedure as depreciation, albeit under different names.
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References
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