Accurately tracking a company’s assets is essential for determining its net worth. Assets are things owned by the business. There are current assets like cash that can be easily liquidated. There are long-term assets like an office building that are not easily used for immediate needs. Depreciation occurs to tangible assets like equipment and furniture. Amortization is for intangible assets like patents. Both need to be calculated and considered an expense to your accounts. Both account for the wear and tear and decrease in value of an asset.
Depreciation and amortization is used to account for a major purchase that will be used for a period of years. It shows the decrease of an assets value over time. “If you’d declared the total cost as an expense (the year you purchased it) you’d have an understatement of your company’s profit that year, and an overstatement of profit in the following years” (Accounting Savvy For Business Owners p.204).
There are many exceptions to the way depreciation and amortization accounts can be calculated. These regulations have been established by the IRS, the state and through court decisions. Look into the specific laws that apply in your area.
When entering the depreciation or amortization into the journal, you reduce the value of the asset by posting a credit to the contra-asset account. At the same time, you increase expenses by posting a debit to the depreciation and/or amortization expense account. The company receives a tax deduction against the loss in value of the asset.
You may choose to create specific asset accounts to show accumulated depreciation for each type of fixed asset and separate asset accounts for the amounts of the original purchase price. Or, you may choose to have only one account for each asset category. In this case, when depreciation is posted, the single asset account balance is reduced.