Amortization and Depreciation

Depreciation is required for tangible capital assets such as machineries, equipment, furniture and renovations. The purpose of depreciation is to spread out the asset cost usually over a period of its useful life. Machinery and equipment, including furniture, are often depreciated over a period of 3 to 5 years. Vehicles can be depreciated over as long a period as 10 years. For reasons such as taxes in certain countries, personal computers, notebooks, tablets and mobile phones may be depreciated over a 1-year period. Often, the depreciation period for renovations is tied to the length of the lease of the premises. They can therefore range from 2 to 5 years or more.

There are several ways to depreciate an item. However for the basic version of the StartBizUp app, the straight line method  will be used. Basically, the straight line method divides equally the asset cost over the depreciation period by months. As a simple example, take a machine which costs $36,000. Say you want to depreciate it over a 3-year period or 36 months. Using the straight line method, your monthly depreciation is $36,000 divided by 36 (see figure below). This works out to be $1,000 a month. If you decide to depreciate it over a 6-year period, then the monthly depreciation drops by half to $500 a month. At the end of the day, the deciding factor in most cases is the estimated useful life of the asset to be depreciated.

 

Besides incurring large sums of capital in purchasing tangible assets, one may also spend similar amounts on intangible assets. These can include paying for the rights for the use of patents, copyrights, trademarks, licences, franchises etc over a period of time. Similar to tangible assets, the costs of intangible assets have to be spread out over a period of time. However the costs of intangible assets are not depreciated but amortized over the period of their useful life. Usually the amortization period corresponds to the contractual period for the rights of use of the intangible asset. For the basic version of the app, the straight line method is used for amortization.

 

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