What is Amortization / Depreciation?

[tennis123]

I understand the calculations behind it and how to do it, but don't really know the meaning.

Example I purchase a car for 20,000 and expect it to last 10 years with 0 residual value.

Using straight line method, i would have a depreciation expense of 2,000 a year for 10 years.

What is the purpose of this though? The original entry would be
Dr. Car
Cr. Cash

Why do I need an expense every year for it? It's not an "actual" $2,000 expense right?

Thanks

[noman]

its not expense.....

u are using 2000 worth of car in a year.......so the actual expense was one time....but u gain benefit over the periods....so u divide the expense over the period

[faizee]

Dear Tennis,Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. In accounting we depreciate fixed assets because of the accounting concept (Matching Concept).

In your eg, 2,000 is the amount of depreciation for one year which means the life of an asset have been reduced by 1 year and we have derived the economic benefit from that asset, so according to matching concept same year revenues should match with same year exenses.That's the the purpose of this concept.Hope you understand it.

Regards,
Faizan

[Pyara]

The term depreciation is used for tangible assets,
and amortization for intangibles, (at least that's how I've seen them used to date)
whereas the basic operation, as you said you know it,
is the same for both.

Apka Pyara. . .

[tennis123]

ok but depreciation expense doesnt effect cash at all right? i would pay the 20k cash upfront for the car?

[noman]

yes

[mudassar2704]

By not depreciating the car actualy you are booking it as expense for the 1st year. And by expensing means we have used the car and its benefits totaly in the first year.

But you have to use the benefits of the car for 10 years. So we should divide the cost of car over 10 years. In this way we can have the right picture of the net income or benefits from the car for every year. This is also required by the Matching concept of the accounting.

There will be no effect of this yearly depreciation of 2,000 on cash and entry will be

Depreciation Expense 2,000 Dr
To Car 2,000 Cr

And this depreciation expense will resultantly decrease the profit for the year not cash etc.