The price of corporate assets can depreciate year after year over the asset’s lifetime. The ways of calculating value for those business assets are amortization and depreciation. The cost amounts are then used as a tax deduction, lowering the company’s tax burden. In this post, we are going to examine amortization, and depreciation used by corporations to spread out the expense of an asset. The type of asset being expensed is the main distinction between the two techniques.
It is the process of offsetting the cost of an intangible asset over its useful life. Intangible assets are not the same as tangible assets. The following are some examples of intangibles that are incurred through amortization:
- Patents and trademarks are two types of intellectual property.
- Agreements on franchising
- Copyrights and other proprietary processes
- Issuing bonds to raise capital costs a lot of money.
- Costs associated with the organization
Amortization is normally expensed in a straight line during the asset’s useful life, meaning the same amount is expensed in each cycle. Furthermore, unlike depreciation, items that are expensed using the amortization technique often have little resale or salvage value.
When using the phrase amortization, it’s vital to remember the context because it has a different connotation. In the case of a mortgage, an amortization schedule is frequently used to compute a sequence of loan installments that include both principal and interest in each payment.
Expensing a fixed asset throughout its life span is known as depreciation. Fixed assets are tangible assets, which means they can be held. The following are some examples of commonly depreciated fixed or tangible assets:
- Equipment for Buildings
- Vehicles and office furnishings
- Land and Machinery
Depreciation is computed by deducting the asset’s salvage value or resale value from its initial cost, because tangible assets may have some worth at the end of their lives. The distinction is depreciated proportionally over the asset’s estimated life. In other words, until the asset’s service life has expired, the depreciated amount expensed each year provides a tax credit for the corporation.
An office space, for instance, can be used for many seasons before becoming dilapidated and being sold. The property’s cost is spread out over the building’s expected life, with a percentage of the value expensed in each financial year.
Certain fixed assets can have their depreciation hastened, which means that a substantial number of the asset’s value is expensed in the early years of its life. Vehicles, for example, are often depreciated at a faster rate.
Particular Points to Consider
Depletion is another method for determining the cost of corporate assets. It relates to the cost of natural resources being allocated through time. Before all of the oil is drained out, for example, an oil well has a finite life. As a result, the oil well’s set up expenditures are spread out over the expected well life.
Percentage depletion and cost depletion are the two most common types of depletion allowance. The percentage depletion approach allows a company to apply a defined proportion of depletion to the gross revenue from natural resource extraction. The cost depletion technique considers the property’s initial value, total recoverable reserves, and the quantity sold.
Depreciation, amortization, and depletion are all non-cash expenses that do not require any cash in the year they are expensed. It’s also worth noting that the phrases amortization and depreciation are frequently used alternately in some countries, such as Canada, to refer to both tangible and intangible assets.