Question

Analysis of the concepts of basis and adjusted basis and cost recovery;

depreciation,

amortization,

and depletion.

Discuss the use of IRS Form 4562, Depreciation and Amortization.

please answer by the way typing, please do not answer me by handwriting because I can not understand what you write. Thanks

Answer 1

Depreciation

The fixed assets are long-term assets. They help in the production of goods and services. However, when an asset is in use its value decreases due to the normal wear and tear, efflux of time and obsolescence. This reduction in the value of a fixed asset is known as depreciation. Let’s understand the concept of depreciation.

The assets which are held by a business for the production and supply of goods and services, expected to be used for more than an accounting year and have a limited useful life are known as Depreciable Assets.

On purchasing a fixed asset we record it at its original cost or purchase price in the books of accounts. An organization uses this fixed asset to earn or generate revenues for a number of accounting years until it sells or discards the asset.

Hence, it becomes necessary to allocate a part of the purchasing cost or the acquisition cost to every accounting year until we use it. We call this allocation of cost as Depreciation. Depreciation is an expense of an organization

For example, Setu enterprises purchases machinery for ₹2000000 and it sells it after using it for 10 years for ₹400000. Therefore, the cost of machinery for its use in business will be ₹1600000 (₹2000000 – ₹400000). Now, we need to allocate this cost of ₹1600000 as an expense of the business for each of the 10 accounting years for which we have been using the machine. This expense is depreciation which comes to ₹160000 (1600000/10).

In other words, the concept of depreciation is the cost of obtaining services from the use of an asset. We need to match the depreciation cost of the fixed asset against the revenues of the years over which we use it. Thus, we charge depreciation as an expense to the Profit and Loss A/c.

Amortization

Amortization is an accounting term that refers to the process of allocating the cost of an intangible asset over a period of time. It also refers to the repayment of loan principal over time.

Let's assume Company XYZ owns the patent on a piece of technology, and that patent lasts 15 years. If the company spent $15 million to develop the technology, then it would record $1 million each year for 15 years as amortization expense on its income statement.

Alternatively, let's assume Company XYZ has a $10 million loan outstanding. If Company XYZ repays $500,000 of that principal every year, we would say that $500,000 of the loan has amortized each year.

The length of time over which various intangible assets are amortized vary widely, from a few years to as many as 40 years. As a general rule, an asset should be amortized over its estimated useful life, or the maturity or loan period in the case of a bond or a loan. If an intangible asset has an indefinite life, such as goodwill, it cannot be amortized.

It is important to note that the term amortization refers to intangible assets; the term depreciation refers to tangible assets, and the term depletion refers to natural resources.

Depletion

Depletion also lowers the cost value of an asset incrementally through scheduled charges to income. Where it differs is that it refers to the gradual exhaustion of natural resource reserves, as opposed to the wearing out of depreciable assets or the aging life of intangibles.

Depletion expense is commonly used by miners, loggers, oil and gas drillers, and other companies engaged in natural resource extraction. Enterprises with an economic interest in mineral property or standing timber may recognize depletion expenses against those assets as they are used. Depletion can be calculated on a cost or percentage basis, and businesses generally must use whichever provides the larger deduction for tax purposes.

EXAMPLE

Let’s say a lumber company purchases land to forest and sell timber to consumers. The timber company bought the land for $1,000,000 (cost of resource), and they estimate the land is capable of producing 1,000,000 individual trees (resource units) over the entire useful life of the reserve. Going back to our unit formula, the purchase cost of the land divided by the estimated number of resource units available calculates the cost per unit extracted ($1,000,000 cost / 1,000,000 units = $1.00 per unit).

Now, we use the $1.00 expense per unit as the basis of our total expense calculation. Let’s assume that the lumber company cuts down 8,500 trees this year. It would record depletion expense of $8,500 (8,500 trees x $1 per unit) for the year.