Sources for Figuring Depreciation & Amortization

Both amortization and depreciation use inexact numbers based on prior precedent.

Amortization is an accrual accounting procedure, in which an intangible asset has its value deducted across the multiple time periods of its useful lifespan. In comparison, depreciation is an accrual accounting procedure in which a tangible long-term asset has its value deducted over time, as its usefulness decreases through its usage. Although separate, both concepts are similar and use similar methods to account for them. As with much else in accrual basis accounting, amortization and depreciation use estimation for their figures.

Depreciation and Amortization

Over time, an asset's usefulness for its intended purpose decreases until its usefulness becomes nil, and renders it no more than scrap suitable for disposal. Accrual basis accounting requires that costs incurred in the production of revenues be recorded in the same time period as those revenues. As such, depreciation and amortization, both of which are incurred as their base assets are used, are recorded in each of the multiple time periods that constitute the base assets' useful lifespans.

Sources of Depreciation and Amortization

Four main sources of depreciation and amortization exist. First and most prominent is the wear and tear on assets incurred through their usage, impairing the assets' efficacy and efficiency until they become so impaired as to be useless. Second is the depletion of natural resources that an asset is reliant upon to be of economic use. Third is the expiration of certain assets with mandated legal lifespans, like copyrights and patents. Fourth is obsolescence, the decrease in an asset's value over time as newer versions come out with better performance, reducing older models' values by comparison.

Straight-Line Method

The total decrease in an asset's value upon the end of its usefulness can be determined by selling it for scrap and then subtracting the amount received from its original purchase price. This is the total amortizable/depreciable value, allocated across the asset's useful lifespan as amortization/depreciation expense. Doing the same in order to calculate an asset's decrease in value in each period incurs more costs than the superior information collection is worth. Instead, amortization/depreciation formulas are used to estimate the expense in each period. For example, the straight-line method allocates an equal portion of the total amortizable/depreciable value to each period in which the asset is useful.

Declining-Balance Method

In contrast to straight-line method, the declining-balance method is a more accurate and widely used depreciation/amortization method. It deducts a set percentage of total amortizable/depreciable value in each period of the asset's usefulness. Since this set percentage can be adjusted for separate classes of assets, declining-balance method is also more versatile than straight-line method.

References

• IAS Plus: IAS 1, Presentation of Financial Statements
• IAS Plus: IAS 16, Property, Plant, and Equipment
• IAS Plus: IAS 38, Intangible Assets