Every business owns assets — machines, vehicles, buildings, patents, and natural resources — that help it generate revenue. But these assets don’t last forever. Over time, they lose value as they are used, age, or become obsolete.
Accounting standards require companies to systematically record this loss in value through three key processes: depreciation, amortisation, and depletion.
Although these terms are often used together, they apply to different kinds of assets. Understanding their differences is crucial for accounting students, finance professionals, and anyone seeking to interpret a company’s financial statements accurately. This article breaks down each concept, explains how it works, and uses real-world examples to make these ideas easy to understand.
What Is Depreciation?
Depreciation refers to the systematic reduction in the cost of a tangible (physical) asset over its useful life. Tangible assets are items a business can touch and use — such as machinery, buildings, computers, furniture, or vehicles.
Every time a business uses one of these assets, it gradually loses value. Depreciation helps record that loss in a structured, measurable way. Instead of charging the full cost of the asset in the year it’s purchased, the company spreads that cost over the asset’s useful life.
Let’s take an example of Tata Motors, which purchases machinery worth ₹10 crore to produce car engines. The expected useful life of the machinery is 10 years, and it is expected to have a scrap value (residual value) of ₹1 crore at the end of its life.
The total depreciable amount = Cost – Residual Value = ₹10 crore – ₹1 crore = ₹9 crore.
If Tata Motors uses the straight-line method (SLM) of depreciation, it will charge ₹90 lakh (₹9 crore ÷ 10 years) as depreciation expense each year.
On the balance sheet, the machinery’s value will reduce by ₹90 lakh each year, while on the income statement, this depreciation expense will reduce the company’s profit.
What Is Amortisation?
Amortisation is similar to depreciation but applies to intangible assets — assets that have no physical form but still hold value. Examples include patents, trademarks, copyrights, goodwill, and software licenses.
Intangible assets also lose value over time, either as they get used or as they approach expiration. Amortisation allocates their cost systematically over their estimated useful life.
Let’s assume Infosys develops proprietary software at a cost of ₹20 crore. The software’s useful life is estimated at 5 years, after which it will need a complete upgrade.
Amortisation expense per year = ₹20 crore ÷ 5 years = ₹4 crore per year (assuming the straight-line method).
Each year, Infosys records ₹4 crore as an amortisation expense, reducing both its net income and the software’s book value on the balance sheet.
What Is Depletion?
Depletion applies to natural resources such as oil, coal, timber, minerals, and gas. These assets are physically extracted from the earth, so they lose value as resources are removed and sold.
Depletion is the process of allocating the cost of natural resource assets over the period in which they are consumed or extracted.
Suppose Oil and Natural Gas Corporation (ONGC) buys a piece of land with oil reserves for ₹100 crore. Based on geological surveys, ONGC estimates the total oil capacity at 10 million barrels, with no residual value.
If ONGC extracts 1 million barrels in the first year, the depletion expense is calculated as:
Depletion per barrel = ₹100 crore ÷ 10 million barrels = ₹10 per barrel.
Depletion expense for Year 1 = 1 million barrels × ₹10 = ₹10 crore.
This ₹10 crore becomes an expense on ONGC’s income statement, and the remaining asset value on the balance sheet reduces to ₹90 crore.
Conclusion
Depreciation, amortisation, and depletion are three pillars of accounting that ensure financial statements reflect the true cost of using long-term assets.
- Depreciation applies to physical assets like machines and buildings.
- Amortisation applies to intangible assets like patents or software.
- Depletion applies to natural resources extracted from the earth.
Though different in application, all three share one goal — to spread an asset’s cost over the period it helps generate revenue.
Understanding these concepts helps students grasp not just accounting mechanics but the deeper business logic behind them: assets are investments, and every investment has a life cycle. Recording that life cycle accurately is what transforms numbers into meaningful financial insight.
