Telestrat is a worldwide leader in continuing education seminars. Our Telestrat MBA Seminar Series has brought the world of finance, accounting, and business strategy to professionals in the U.S. and Europe.

Depreciation - one of the most interesting topics in Accounting. Of course, by interesting we mean “Accounting” interesting, not necessarily “interesting” interesting… Depreciation is interesting because there are many ways to think about it. And it’s a lot more than just an Accounting or Tax fiction.

Let’s back up for a moment. Recently we talked about the fact that buying assets isn’t an expense. In addition to coming from paying for some service (utilities, rent, etc), expenses come from using up our assets (selling inventory or using some of the useful life of equipment). But the portion of the life of an asset (or inventory) that we haven’t used yet remains and has not become an expense. As we use up the life of the asset, we recognize that it has (at least theoretically, perhaps) lost some market value, and so we recognize it as a Depreciation expense.

Notice something about how this works. We pay the cash now for an asset (yes, we might be financing it, but from an Accounting perspective the loan is independent from the actual purchase) and we expense it over the life of the asset, which may be 20 years or more (depending on the schedule used for this “asset class”). So most of the expense will happen long after we actually paid for the asset – it will be a non-cash expense. That doesn’t make it a fiction (though the schedule may be somewhat subjective) - it just means that instead of recognizing the whole cost as an expense immediately, for all the reasons above, we’re spreading out that cost over the expected life of the asset.

Speaking of spreading things out over time, that’s what amortizing means (think of amortizing a loan – we spread out the repayments over time). Some of the assets that we amortize are tangible, so that the spreading out of the costs is at least potentially related to its loss of value in the market. Intangible assets such as licenses and other contracts are also amortized, but since we don’t relate these expenses to some reduction in market value, we refer to them simply as Amortization, not Depreciation, but they work exactly the same way.

“Interesting?” Then why miss out on so much more fun? Sign up for one of our in-person, live online, or on-demand seminars!

This entry was posted on Friday, September 18th, 2009 at 3:39 pm by Max Minkoff and is filed under Accounting. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.