What is the difference between Depreciation, Amortization, and Depletion?

Depreciation applies to tangible fixed assets, amortization to intangible assets, and depletion to natural resources - all methods of allocating asset costs over useful lives.

Depreciation, Amortization, and Depletion

All three are methods of allocating asset costs over their useful lives, but they apply to different types of assets.

Key Differences:

Depreciation: For tangible fixed assets
Amortization: For intangible assets
Depletion: For natural resources
All follow matching principle in accounting

Common Purpose:

Allocate cost of long-term assets to expense over periods benefiting from their use.

Detailed Comparison

1. Depreciation

Definition: Systematic allocation of tangible fixed asset cost over useful life.

Applies to: Physical assets with limited useful life
Examples: Buildings, machinery, vehicles, equipment
Methods: Straight-line, declining balance, units of production
Journal Entry: Dr Depreciation Expense, Cr Accumulated Depreciation
Example: Machine cost $100,000, 10-year life: $10,000 depreciation per year

2. Amortization

Definition: Systematic allocation of intangible asset cost over useful life.

Applies to: Non-physical assets with finite useful lives
Examples: Patents, copyrights, trademarks, software
Methods: Usually straight-line only
Journal Entry: Dr Amortization Expense, Cr Accumulated Amortization
Example: Patent cost $50,000, 10-year legal life: $5,000 amortization per year

3. Depletion

Definition: Systematic allocation of natural resource cost as resource is extracted.

Applies to: Natural resources being consumed
Examples: Oil wells, mines, timber forests, quarries
Methods: Usually units of production based on extraction
Journal Entry: Dr Depletion Expense, Cr Accumulated Depletion
Example: Mine cost $1,000,000, estimated 100,000 tons: $10 per ton depletion

Key Differences Summary

Aspect	Depreciation	Amortization	Depletion
Asset Type	Tangible fixed assets	Intangible assets	Natural resources
Physical Form	Physical existence	No physical form	Physical, but extracted
Common Methods	SL, DB, UOP	Usually straight-line	Units of extraction
Residual Value	Usually has	Often zero	May have after extraction
Industry	All industries	Tech, pharma, media	Mining, oil, timber
Account Used	Accumulated Depreciation	Accumulated Amortization	Accumulated Depletion

Special Cases:

Land - No Depreciation:

Land has indefinite life, so not depreciated (unless contains natural resources).

Goodwill - No Amortization:

Tested for impairment annually instead of amortized.

Indefinite-Life Intangibles:

Trademarks, perpetual licenses - not amortized, tested for impairment.

Accounting Standards:

Depreciation: IAS 16 - Property, Plant and Equipment
Amortization: IAS 38 - Intangible Assets
Depletion: Specific guidance in mining/oil accounting

Practical Examples:

Manufacturing Company:

Depreciation: Factory building, production machines
Amortization: Patents on manufacturing processes
Depletion: None (unless owns mineral rights)

Mining Company:

Depreciation: Mining equipment, offices
Amortization: Mining licenses, exploration rights
Depletion: Coal mine, oil reserve

Software Company:

Depreciation: Office equipment, servers
Amortization: Software licenses, patents
Depletion: None

Important Notes:

All three methods allocate cost, not measure market value
Different from impairment (unexpected loss in value)
Must review useful lives and methods periodically
Tax rules may differ from accounting treatment
Proper classification affects financial ratios
Disclosure required in financial statements

Financial Statement Impact:

Income Statement: All three are expenses reducing profit
Balance Sheet: Reduce asset carrying value through contra accounts
Cash Flow: Non-cash expenses added back in operating activities

Key Points to Remember:

Depreciation = tangible assets, Amortization = intangible assets, Depletion = natural resources
All follow matching principle
Methods differ based on asset type and usage pattern
Regular review of estimates required
Affects both financial reporting and tax calculations
Essential for accurate profit measurement