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FINANCIAL ACCOUNTING

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The terms depreciation and amortization have various meanings in finance and investing. For example, depreciation can refer to the devaluation of a currency, and amortization can be used to describe the payment structure in a common type of loan (What is the difference between Depreciation and Amortization? 2003). Depreciation is charged to tangible assets, whereas amortization is charged to intangible assets. Fixed or tangible assets are those assets of the organization, which last more than one year, for example: furniture, buildings and machinery. Intangible assets are invisible assets that incur cost to the company, in terms of brand recognition, intellectual property and goodwill. Both amortization and depreciation are non cash cost of the industry and they cause reduction in the earning, whereas, on the other hand, they lead to an increase in the cash flow. The reason for recording depreciation as a cost is to increase the early purchase cost of the fixed asset more than its useful life. Whenever an industry makes its financial statements, it records a cost of depreciation to assign the loss in price of equipment, machines and other fixed assets it has purchased. On the other hand, unlike other costs, depreciation is a non-cash charge. This means that no money is actually paid at the period in which the expenditure is incurred. The function of depreciation is to match the price of a creative asset to the incomes earned from using the asset. Since it is difficult to observe a direct relation to revenues, the asset’s price is usually assigned to the years in which the property is used. Depreciation systematically allocates or moves the asset’s cost from the balance sheet to expense on the income statement over the asset’s useful life. In other words, depreciation is an allocation process in order to achieve the matching principle. it is not a technique for determining the fair market value of the asset (What is the Purpose of Depreciation, 2004). The International Accounting Standard Board (IASB) states that it is appropriate for plant and machinery to be depreciated and intangible assets to be amortized by employing a revenue-based amortization or depreciation method. A revenue based amortization or depreciation process is one that is derived from the transaction between price and units, and this considers the possible future fluctuations in price as the basis of depreciation distribute the quantity of an asset that is to be amortized or depreciated. Tax benefits are also likely to arise along with depreciation. While depreciation stands for non-cash payments in the income statement, it does decrease the industry’s net income. Lesser net income will result in a lesser tax liability. To expand this benefit, industries frequently utilize an accelerated depreciation process. According to the International Accounting Standards Committee, depreciation is the part of the depreciable price of an asset more than its expected useful life. Depreciation for the accounting period is charged to income either directly or indirectly. Thus, it is clear from the above definition that depreciation is a loss arising on account of circumstances, some of which are known whereas others are not (Need Help with Accounting Assignment? 2002). The Internal Revenue Service provides organizations with an