Depreciation & Amortization

According to one major brokerage firm, “Depreciation is the process by which a company gradually records the loss in value of a fixed asset [which after its acquisition is capitalized on your balance sheet]. The purpose of recording depreciation as an expense over a period is to spread the initial purchase price of the fixed asset over its useful life.

Each time a company prepares its financial statements, it records a depreciation expense to allocate the loss in value of the machines, equipment or cars it has purchased. However, unlike other expenses, depreciation expense is a "non-cash" charge. This simply means that no money is actually paid at the time in which the expense is incurred.”

Still, depreciation does have cash consequences, because it decreases your corporate tax base and thus the amount of corporate income tax that you have to pay into federal and state budgets. Therefore, it is very important to adopt the most efficient (but legally sound) depreciation schedule in terms of its tax implications.

It is also important to note that depreciation is an accounting charge which reduces the book value of the asset in question. Which may (and often does) have little to do with its market value. The latter can be either lower or higher than the book value. This difference obviously must be recorded somewhere in comments to your financial statements to reflect the true financial value of the object in question.

‘Depreciation’ usually refers to tangible (physical) assets; while amortization – to the same process applied to an intangible one (e.g., a patent on a piece of medical equipment).

Another related term is depletion. It refers to the allocation of the cost of natural resources over time. For example, an oil well has a finite life before all of the oil is pumped out. Therefore, the oil well's setup costs are spread out over the predicted life of the oil well.

However, it is important to note that in some countries, such as Canada, the terms ‘amortization’ and ‘depreciation’ are often used interchangeably and refer to both tangible and intangible assets.