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# Depreciation and amortization

IFRS allows a company to carry its fixed assets either at cost (under the cost model) or revalued amount (under the revaluation model), but US GAAP requires application of the cost model.

Under the cost model, PPE is carried at historical cost less accumulated depreciation and accumulated impairment losses, and intangible assets with finite useful lives are carried at cost less accumulated amortization and accumulated impairments.

The amount at which a long-lived asset is reported on the balance sheet is called its carrying amount (also called carrying value or book value).

## Depreciation methods

Depreciation is the process through which the cost of a tangible fixed asset is charged to the income statement. Popular depreciation methods include the straight-line method, accelerated depreciation method, and units of production method.

### Straight-line method

Under the straight-line method, equal depreciation expense is charged in each period. Depreciation under the straight-line method can be calculated as follows:

$Straight‐line\ Depreciation=\frac{DA}{L}=\frac{C – R}{L}$

Where DA is depreciation amount, the excess of cost over salvage value, C is cost, R is residual value, and L is useful life.

### Accelerated depreciation methods

Under the accelerated methods, such as the declining balance method, higher depreciation expense is charged in earlier periods. Depreciation expense in a period under an accelerated depreciation is calculated by applying the depreciation rate to the opening carrying amount (not to the depreciable amount), and depreciation ceases when carrying amount equals the salvage value.

### Units of production depreciation method

Under the units of production method, depreciation expense in a period equals depreciable amount (which equals cost less salvage value) multiplied by the units produced during the period (U) divided by total productive capacity (TU) of the asset.

$Units\ of\ Production\ Depreciation=(Cost – Salvage Value)×\frac{U}{TU}$

### Tax accounting implication of depreciation methods

When there is a difference between the depreciation method used for financial reporting and depreciation method allowed under the tax code, it results in temporary differences that may require recognition of deferred tax assets or liabilities.

### Component depreciation

Charging depreciation requires estimating useful life and residual value. Longer useful life and higher residual value would reduce depreciation expense. IFRS requires companies to depreciate each component of an asset separately, and US GAAP allows (but does not require) it.

Depreciation expense of assets used in production is capitalized as part of inventories and charged to the income statement as cost of sales, and depreciation expense of non-production assets is charged to the income statement directly under operating (or selling, general and admin expenses).

## Depreciation vs amortization

Amortization is the process through which the cost of intangible assets with a finite useful life, such as copyrights, patents, etc. is charged to the income statement. It is calculated using acceptable depreciation methods. Intangible assets with indefinite useful life are not amortized. Just like depreciation, amortization involves estimating useful life, residual value, etc. which is driven by legal, contractual, regulatory and economic factors.