Financial Accounting
Depreciation & Amortization
5 question(s)
What is depreciation?
Beginner
The systematic allocation of the cost of a tangible fixed asset over its useful life, reflecting the wearing out or consumption of the asset.
Machine cost 10,000, life 5 years -> 2,000 expense per year (straight line)
Real-world example
Spreading a delivery van's cost over the years it helps generate revenue.
How does the straight-line method work?
Intermediate
It charges an equal amount each year: (cost - residual value) / useful life.
(10,000 - 1,000) / 5 = 1,800 per year
Real-world example
Used for assets that give even benefit over time, like fixtures.
How does the reducing-balance method work?
Intermediate
It applies a fixed percentage to the asset's carrying (net book) value each year, giving higher charges early on.
Cost 10,000 at 20%: Yr1 2,000; Yr2 20% of 8,000 = 1,600
Real-world example
Suits assets that lose value fast early, like vehicles or IT equipment.
What is the journal entry to record depreciation?
Intermediate
Debit depreciation expense and credit accumulated depreciation (a contra-asset), leaving cost untouched.
Dr Depreciation Expense 1,800
Cr Accumulated Depreciation 1,800
Real-world example
Net book value = cost - accumulated depreciation on the balance sheet.
What is the difference between depreciation, amortization and impairment?
Advanced
Depreciation spreads the cost of tangible assets, amortization spreads intangibles (e.g. patents, software), and impairment is a one-off write-down when an asset's recoverable amount falls below its carrying value.
Machine -> depreciation; Patent -> amortization; Sudden value drop -> impairment
Real-world example
Writing goodwill down after a failed acquisition is an impairment, not depreciation.