Are depreciation, depletion and amortization similar?

Companies have a few options when managing the carrying value of an asset on their books. Many companies will choose from several types of depreciation methods, but a revaluation is also an option. There are two methods to calculate the depletion charge for a business. There are four major types of costs for calculating the depletion charge. Depreciation for tax purposes requires the estimation of the useful life of an asset. Businesses using different classes of assets can estimate different depreciation rates as well.

To calculate depletion, you subtract the cost of extracting resources or a percentage of the cost of mining from the asset’s value. The IRS does not allow you to take the deduction until you produce income and as you deplete the asset. Another definition of amortization is the process used for paying off loans. The loan amortization process includes fixed payments each pay period with varying interest, depending on the balance.

What is the difference between depreciation, amortization and depletion?

In accounting, amortization refers to a method used to reduce the cost value of a intangible assets through increments scheduled throughout the life of the asset. Companies take depreciation regularly so they can move their assets’ costs from their balance sheets to their income statements. Neither journal entry affects the income statement, where revenues and expenses are reported. The term depreciation refers to an accounting method used to allocate the cost of a tangible or physical asset over its useful life. It allows companies to earn revenue from the assets they own by paying for them over a certain period of time. Both depreciation and depletion are cost allocations and thus non-cash expenses as they do not impact the cash flow of the entity.

This affects the value of equity since assets minus liabilities are equal to equity. Overall, when assets are substantially losing value, it reduces the return on equity for shareholders. Depreciation  is a type of expense that when used, decreases the carrying value of an asset.

Final Advice on the Difference Between Depletion vs. Depreciation

Of the different options mentioned above, a company often has the option of accelerating depreciation. This means more depreciation expense is recognized earlier in an asset’s useful life as that asset may be used heavier when it is newest. Tangible assets can often use the modified accelerated cost recovery system (MACRS). Meanwhile, amortization often does not use this practice, and the same amount of expense is recognized whether the intangible asset is older or newer.

• Because companies don’t have to account for them entirely in the year the assets are purchased, the immediate cost of ownership is significantly reduced.
• For example, expenses and income get recorded in the period concerned instead of when the money changes hands.
• Different companies may set their own threshold amounts for when to begin depreciating a fixed asset or property, plant, and equipment (PP&E).
• It is based on what a company expects to receive in exchange for the asset at the end of its useful life.

In practice, depletion is also the same concept as depreciation and amortization. However, it is particularly linked with the cost allocation process of natural resources. A business will first calculate the total value of intangible assets. Estimating the useful life of an intangible asset is harder than for tangible assets. Businesses can estimate a reasonable useful life and adjust from time to time.

What is the Journal Entry to Record Amortization of an Intangible Asset?

Cost depletion is calculated by taking the property’s basis, total recoverable reserves and number of units sold into account. The property’s basis is distributed among the total number of recoverable units. As natural resources are extracted, they are counted and taken out from the property’s basis.

As assets like machines are used, they experience wear and tear and decline in value over their useful lives. The double-declining balance (DDB) method is another accelerated depreciation method. After taking the reciprocal of the useful life of the asset and doubling it, this rate is applied to the depreciable base—its book value—for the remainder of the asset’s expected life.

depletion

After five years, the expense of the vehicle has been fully accounted for and the vehicle is worth $0 on the books. Depreciation helps companies avoid taking a huge expense deduction on the income statement in the year the asset is purchased. Depreciation spreads the expense of a fixed asset over the years of the estimated useful life of the asset. The accounting entries for depreciation are a debit to depreciation expense and a credit to fixed asset depreciation accumulation. Each recording of depreciation expense increases the depreciation cost balance and decreases the value of the asset.

Without this level of consideration, a company may find it more difficult to plan for capital expenditures that may require upfront capital. The dollar amount represents the cumulative total amount of depreciation, depletion, and amortization (DD&A) how to prepare a post closing trial balance from the time the assets were acquired. Assets deteriorate in value over time and this is reflected in the balance sheet. Section 179 deductions allow you to recover all of the cost of an item in the first year you buy and start using it.

Depreciation, depletion and amortization are also described as noncash expenses, since there is no cash outlay in the years that the expense is reported on the income statement. As a result, these expenses are added back to the net income reported in the operating activities section of the statement of cash flows when it is prepared under the indirect method. Depletion refers to an accrual accounting technique commonly used in the natural resources extracting industries such as mining, petroleum, timber, among others.