Depreciation, depletion, amortization - American businessDepreciation, depletion, and AMORTIZATION are accounting techniques associated with the long-term ASSETS of a firm. When a long-term asset that is used in the course of business helps to generate revenue, a portion of its purchase cost is systematically apportioned to expense to satisfy accounting’s matching principle. The systematic apportionment from cost to expense for the firm’s man-made, tangible assets is called depreciation. The systematic apportionment from cost to expense for the firm’s natural resources in depletion, and for the firm’s intangibles it is amortization. When a long-term asset is purchased, this is a CAPITAL EXPENDITURE, and an asset account is debited for the purchase.
When that asset is then used in the generation of revenue, a part of that purchase cost must be transferred to expense, a revenue expenditure. Thus the accounting for long-term assets requires an understanding of both capital and revenue expenditures.
Contra asset accounts are created when depreciation, depletion, or amortization expense is recorded as accumulated depreciation, accumulated depletion, and accumulated amortization. These contra asset accounts serve to systematically reduce the book (carrying) value of the long-term assets over their useful lives. When the BOOK VALUE of a long-term asset declines to the level of its residual (salvage) value, then the asset is considered to be fully depreciated, depleted, or amortized.
See also RESIDUAL VALUE.