Question

Why it is necessary to depreciate long-term tangible assets and amortize intangible assets with finite lives? Which principle do these practices (depreciation and amortization) satisfy?

Answer 1

Long-term tangible assets have its definite life and hence should be reduced to the approx value of life reduction due to normal wear and tear and reduction to the estimated useful life. according to US GAAP, we provide depreciation to record and shows the assets as near residual value in the balance sheet so that the balance sheet and books of accounts show true and fair view and the actual position of the company.

Intangible assets are non-monetary assets which cannot be seen or touched or physically measured. for example, patent, copyright, know-how, trademarks. it has a definite life and hence should be amortized according to US GAAP over the estimated life of the assets. Hence we amortize these assets by dividing the amount by the expected estimated useful life of the assets. so that it should reflect the actual useful value of the assets to the balance sheet date.

According to the fundamental principle of accountancy, we should maintain the accrual principle to record the transaction when they actually occurred and recorded in books of accounts. so that the books of accounts shows the correct position of income and expenditure and the assets/ liabilities of the organization. Depreciation and amortization is provided to satisfy the accrual principle of accountancy.