most businesses own assets that are used
for several years when a company acquires a vehicle or builds a plant it
is reasonable to expect that the asset will be part of its business operations
for the next 5 10 or 20 years at the same time it’s clear that these assets
won’t be used indefinitely as they will become old and obsolete during each
period a portion of the cost of these assets is being used up the portion
being used up is called depreciation the economic meaning of depreciation is that
year after year the asset becomes older and loses some of its market value
depreciation is shown as an expense in the income statement because the asset
has been used by the business and this is a cost that should be accounted for
when calculating the company’s profitability imagine that a firm buys a
vehicle for \$30,000 the vehicle has an estimated useful life of 8 years how
much should be charged as an expense this year we know that \$30,000 has been
paid for the vehicle but only a portion of this sum can be attributed to the
current period right instead the following will occur the firm will
register an asset that costs \$30,000 on its balance sheet and will decrease its
cash by \$30,000 then year after year the value of the asset will decrease because
it becomes older and obsolete the firm will have to implement a depreciation
method in order to calculate by how much the value of the asset will be reduced
each year two main methods can be used to calculate depreciation straight-line
depreciation and depreciation based on use the straight-line depreciation
method does the following it considers the initial cost of the asset and its
salvage value which is how much will the asset be worth at the end of its useful
life let’s say that in our example the salvage value of the asset will be
\$6,000 then we will calculate the difference between \$30,000 and \$6,000
which would give us the amount that will be depreciated throughout the useful
life of the asset \$30,000 – \$6,000 equals
\$4,000 given that the asset will be used for eight years and we will apportion
the depreciation expense equally we will have \$24,000 divided by eight so the
annual depreciation calculated with the straight-line depreciation method will
be \$3,000 very well now let’s look at the activity-based method the firm can
estimate that the vehicles useful life will be 200 thousand miles and assign it
a salvage value of six thousand dollars right so \$30,000 minus six thousand
dollars equals twenty four thousand dollars let’s divide this number by the
vehicles useful life we have twenty four thousand dollars divided by two hundred
thousand miles which equals twelve cents per mile if we hypothesize that at the
end of the current year the vehicle will have 30 thousand miles on it so domitor
the company will have to use this number to obtain the depreciation expense that
will be registered in the income statement it will be equal to thirty
thousand miles multiplied by zero point one two which equals three thousand six
hundred dollars by using this method the company agrees to calculate the vehicles
depreciation according to the number of miles that it has been driven we will
have a similar picture for intangible assets assets such as software brands
goodwill and artistic assets are called intangible due to the fact that they are
not physical in nature the equivalent of depreciation for intangible assets is
amortization depreciation is always used for tangible assets while amortization
is used for intangible assets the two are almost always grouped together and
commonly refer to as DNA we should bear in mind that only intangible assets with
finite lives such as software licenses are subject to amortization intangible
assets such as a firm’s brand are not amortized given that they have an
indefinite life in this lesson we learned more about depreciation and
amortization and their impact on tangible and intangible assets thanks
for watching