Depreciation refers to the decline in the book value of fixed assets due to gradual wear and tear, consumption, effluxion of time or obsolescence due to technology or market related factors.
Depreciation is charged every year so that the burden of the decline in the value of assets do not fall in any one year. It evenly distributes the amount of asset in each accounting period during the expected useful life of the asset.
Depreciation differs slightly from the concept of depletion and amortisation. However, due to their similar accounting treatment sometimes these words are used interchangeably. As in layman’s language, depreciation and other similar terms indicate the decline in value of assets.
What is Depletion ?
Like depreciation is associated with fixed assets, depletion is used in reference to extraction of natural resources mines, quarries, etc. It refers to the reduction in availability of the quantity of the material or asset.
For example – Consider a business enterprise which is engaged into a mining business and due to that enters in an agreement to purchase a coal mine for Rs. 50,00,000. Therefore, with use the value of coal mines continues to decline. This fall in the value of coal mines is known as depletion.
Thus, the nature of two terms vary as depletion is used to indicate towards the exhaustion of economic resources whereas the word depreciation points towards the usage of fixed assets.
Although, there is a clear difference between the two terms, they have the same treatment in accounting.
What is Amortisation?
Amortisation can be referred to as depreciation of intangible assets. Amortisation comes into play when one has to write off any intangible asset, just like depreciation which is used to write off fixed assets.
For eg – amortisation means to write off intangible assets like goodwill, patents, copyrights, trademarks etc.
For example – Consider a business enterprise that buys a patent for Rs. 10,00,000 and its estimated useful life is calculated to be 10 years. Therefore, it means that the business entity shal amortise Rs. 100,000 every year for next 10 years.
Although depreciation and other similar terms like depletion and amortisation all indicate a reduction in the book value, they are used in reference of different assets. These should be used carefully to avoid any confusion.