Depreciation vs Amortization vs Depletion
"Three ways to spread costs - each for different types of assets."
All three concepts involve allocating cost over time, but they apply to different types of assets.
The Big Picture
1. Depreciation
Definition: Systematic allocation of cost of tangible fixed assets over their useful life.
Applies To:
- Machinery & Equipment
- Buildings
- Vehicles
- Furniture & Fixtures
- Computers
NOT Applicable To: Land (doesn't deplete)
Methods: SLM, WDV, Units of Production
Example:
- Machine cost: ₹10,00,000
- Life: 10 years
- Annual Depreciation (SLM): ₹1,00,000
2. Amortization
Definition: Systematic write-off of intangible assets over their useful/legal life.
Applies To:
- Patents: 20 years (legal life)
- Copyrights: Author's life + 60 years
- Trademarks: 10 years (renewable)
- Goodwill: Over expected benefit period
- Software: 3-5 years
- Preliminary Expenses: Written off over 3-5 years
Method: Usually Straight Line (equal amounts over life)
Example:
- Patent cost: ₹20,00,000
- Legal life: 20 years
- Annual Amortization: ₹1,00,000
3. Depletion
Definition: Reduction in value of natural resources due to extraction.
Applies To:
- Coal Mines
- Oil & Gas Wells
- Quarries
- Forests (timber)
- Mineral Deposits
Method: Units of Production method
Formula:
Depletion per unit = (Cost - Residual Value) / Total estimated units
Total Depletion = Depletion per unit × Units extracted
Example:
- Coal mine cost: ₹50,00,000
- Estimated coal: 1,00,000 tons
- Depletion per ton: ₹50
- If 10,000 tons extracted: Depletion = ₹5,00,000
Detailed Comparison
| Basis | Depreciation | Amortization | Depletion |
|---|---|---|---|
| Asset Type | Tangible Fixed Assets | Intangible Assets | Natural Resources |
| Cause | Use, time, obsolescence | Time, legal expiry | Extraction/consumption |
| Examples | Machinery, Building, Vehicle | Patent, Goodwill, Software | Coal mine, Oil well |
| Common Method | SLM or WDV | Straight Line | Units of Production |
| Shown in B/S | Asset less Accumulated Dep. | Asset less Amortization | Asset less Depletion |
| Reversal | Generally not reversed | Impairment can be reversed (except Goodwill) | Not reversed |
| Scrap Value | Usually has scrap value | Usually zero | May have land value |
Journal Entries
Depreciation
Depreciation A/c Dr. ₹1,00,000
To Machinery A/c ₹1,00,000
(Being depreciation charged on machinery)
Amortization
Amortization A/c Dr. ₹50,000
To Patent A/c ₹50,000
(Being amortization of patent)
Depletion
Depletion A/c Dr. ₹5,00,000
To Coal Mine A/c ₹5,00,000
(Being depletion charged on extraction of 10,000 tons)
Real-World Case Studies
📋 Case Study: Reliance Industries - All Three in Action
Special Cases
Goodwill Amortization
AS-10 (Old): Goodwill was amortized over useful life (max 5 years).
Ind AS-38 (Current): Goodwill is NOT amortized. Instead, tested annually for impairment.
Example:
- Company A buys Company B for ₹100 Cr
- Net assets of B: ₹70 Cr
- Goodwill: ₹30 Cr
- Treatment: Test annually, write down if impaired (no systematic amortization)
Software - Depreciation or Amortization?
Depends on nature:
| Type | Treatment | Reason |
|---|---|---|
| Software License (Oracle, SAP) | Amortization (3-5 years) | Intangible asset |
| Software integral to hardware | Depreciation (with hardware) | Part of tangible asset |
| Internally developed software | Amortization or immediate expense | Depends on capitalization |
Tax Perspective
Income Tax Act allows:
- Depreciation: Yes, at prescribed rates (machinery 15%, building 10%, etc.)
- Amortization: Yes, for certain intangibles (patents, copyrights)
- Depletion: Yes, special provisions for mining/extraction industries
Key: Only WDV method allowed for tax purposes (not SLM).
Memory Trick
Easy to Remember:
- Depreciation = Desk, Drill machine (Tangible with D!)
- Amortization = App, Agreements (Intangible with A!)
- Depletion = Diamond mines, Drilling oil (Natural resources, D again!)
Quiz: Depreciation vs Amortization vs Depletion
Test Your Knowledge
Question 1 of 5
1. Cost allocation for patents is called: