Minus Zero: Concepts in Accounting, Essay Example

Depreciation

Depreciation accounting is the practice of reduction in the value of a product arising from use or abuse, wear and tear. Not a method of valuation but of cost allocation, it can be classified according to a number of factors but is always time estimated according to warranty or other legal stipulation, and those terms are traditionally based upon the ‘economic life’ or more typically called the ‘product life’ of those assets. Determined to be a line item in cost allocation during an accounting period, only items that are categorized to devolve in terms of use value over time can be depreciated (Investopedia, 2010).

Durable personal property, services (i.e. unless to be rendered consecutively or in dependent upon third factor), and real property (i.e. land) cannot depreciate in the classical sense in that it can always be put to use.  A proximate measure employed by natural resource companies is ‘depletion,’ and should not be confused with depreciation. Depletion is the only time that carry-over of land assets deemed to be a reduction to profits due to inventory status is allowable (FASB, 2010).

Methodological consideration in application of depreciation in accounting practice is denoted by either: 1) Straight-line Depreciation; or 2) Accelerated Depreciation (Investopedia, 2010). Straight-line presents the simplest and most commonly used approach to calculation of depreciation. Salvage value is subtracted from the purchase or acquisition price of an asset, and then divided by the total ‘productive years’ that the asset can reasonably be expected to benefit the owner.

The major benefit of using accelerated depreciation is the tax shield is provides; enabling filers to obtain additional write offs which in turn promotes faster reductions in earlier years (FASB, 2010). Reduction in income is sometimes preferable to a large tax burden, and the latter method allows actual mitigation of those obligations by way of showing depreciation on the financial statement.

Amortization

Distinct from designation of losses to tangible assets (i.e. depreciation), amortization refers to intangible assets, and most specifically loan debt (FASB, 2010). The application of amortization in accounting is typically seen in installment agreements to pay off those assets. A complete schedule of amortized installments includes periodic blended loan payments. Negative Amortization results when a payor fails to cover interest due on a loan, with increase in the principal balance of the monies borrowed is in response to agreement. The terms can also mean the deduction of capital expenses over time as value is consumed by the asset, as in payment on copyright related intangibles (Investopedia, 2010).

References

CFA Class1 (2010). Investopedia. Retrieved from: http://www.investopedia.com

Financial Accounting Standards Board: FASB Issues Proposed Accounting Standards Update on Amendments for Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (2010). Investment Weekly News, 17 July 2010, 304.