Depreciation, Amortization, Depletion, and Impairment
- Depreciation is the process of allocating the cost of tangible assets to expense in a rational and systematic manner in the periods that the assets provide benefits.
- Amortization is the process of allocating the cost of intangible assets to expense in a rational and systematic manner in the periods that the assets provide benefits.
- Depletion is the process of recording the extraction of natural resources (wasting assets) to expense.
- Impairment is the process of recording the cost of an asset whose value lessoned to expense.
In order to follow the matching principle, long lived assets are not expensed in the year that they are purchased. A punch press machine may have a useful life of twenty years. If the business wrote off the entire cost of the machine in the year purchased, that years’ revenue would be artificially reduced because the machine still has many useful years of service left in it. The following years revenue would be artificially enhanced as the dollar cost of the machine would have been recognized in an earlier year.
So instead of expensing the punch press, we capitalize it by adding an asset that matches the money spent to acquire the machine. Then each year of service we expense it by adding to a contra account attached to the asset account call accumulated depreciation. No money is spent, yet we recognize the cost to match the revenue generated by the asset.