Fixed Assets: Depreciation, Amortisation & Depletion

Fixed vs. Current Assets

Current assets = short-term (expected to convert to cash or be consumed within ≤1 yr).
Fixed assets (a.k.a. non-current, long-term) = resources that will serve the firm for periods >1 yr.
Key property of fixed assets: they lose value over time and/or through use.

Major Categories of Fixed Assets

Financial investments (long-term): bonds, shares, equity participations, pension fund assets, long-term obligations, etc.
Property, Plant & Equipment (PP&E): tangible, physical operating resources—buildings, machinery, vehicles, land, etc.
Natural resources: mineral deposits, mines, forests, oil & gas fields—assets whose value is tied directly to extractable/harvestable units.
Intangible assets: non-physical rights such as patents, trademarks, logos, software, licences, and goodwill.

General Loss-of-Value Equation

At any date:
$\text{Book (Actual) Value} = \text{Purchase Cost} - \text{Accumulated Loss of Value}$
Loss of value may arise from:
• Time/obsolescence (e.g., tech becomes outdated)
• Physical use/consumption (wear-and-tear, extraction).

Depreciation of PP&E (Example: Company Car)

Key inputs (often prescribed by tax-authority tables)

Purchase price: €25 000.
Useful (expected) life: 5 yrs.
Salvage (residual) value at end of life: €5 000.

Straight-Line Depreciation Formula

$\text{Annual Depreciation} = \frac{\text{Purchase Price} - \text{Salvage Value}}{\text{Useful Life}}$

Car: $\frac{25\,000 - 5\,000}{5} = 4\,000$ per year.
Same amount expensed each year; most widely accepted & simplest method.

Balance-Sheet Presentation (selected years)

• Cost (Vehicles) account stays fixed at €25 000.
• Accumulated Depreciation (contra-asset) rises annually.
• Net Vehicles (book value) declines correspondingly.

End Yr 1 → Accumulated €4 000 → Book €21 000.
End Yr 2 → Accumulated €8 000 → Book €17 000.
…
End Yr 5 → Accumulated €20 000 → Book €5 000 (matches salvage estimate).

Disposal Illustration

Sale price €10 000 (Yr 5): Gain = €10 000 – book €5 000 = €5 000 → taxable profit.
Sale price €3 000 (Yr 5): Loss = Book €5 000 – €3 000 = €2 000 → tax-deductible.

Ethical/Practical note: Manipulating salvage values or useful lives can distort reported profits; auditors and tax authorities scrutinise these assumptions.

Amortisation of Intangible Assets (Example: 20-Year Patent)

Cost of patent: €1 000 000.
Useful life: 20 yrs (equals legal life in example).
Salvage value: €0 (typical—patent expires).

Annual Amortisation

$\text{Annual Amortisation} = \frac{1\,000\,000 - 0}{20} = 50\,000$

Straight-line again produces equal yearly charges.

Balance-Sheet Flow

Patent (cost) remains €1 000 000.
Accumulated Amortisation climbs €50 000/yr.
Net Patent value declines to €0 after 20 yrs.

Special Intangible: Goodwill

Arises only in business combinations when purchase price > fair/book value of acquired net assets.
Scenario: Company A acquires Company B.
• Book value of B’s identifiable assets: €10 000 000.
• Purchase price paid: €13 000 000 (financed via 10-yr loan → liabilities rise by €13 000 000).
• Goodwill recognised: €13 000 000 – €10 000 000 = €3 000 000.
Goodwill is an intangible asset subject (in many jurisdictions) to automatic 10-year straight-line amortisation.
$\text{Annual Amortisation (Goodwill)} = \frac{3\,000\,000}{10} = 300\,000$
Year-end balances (selected):
• Purchase year: Goodwill €3 000 000; Accumulated €0 → Net €3 000 000.
• End Yr 1: Accumulated €300 000 → Net €2 700 000.
• End Yr 10: Accumulated €3 000 000 → Net €0.

Philosophical/ethical angle: Goodwill embodies expectations of future earnings, brand reputation, customer loyalty; over- or under-estimating can mislead investors.

Depletion of Natural Resources (Example: New Oil Field)

Establishing Initial Asset Value

Pre-production costs (prospecting, conditioning): €100 000 000.
Estimated extractable reserves: 2 000 000 000 barrels (value captured implicitly through expected revenue; example folds reserve value into the asset base).
Combined capitalised amount used in example: €2 100 000 000 (costs + valuation of reserves).
Useful extraction life: 10 yrs.

Depletion Calculation (Straight-Line)

$\text{Annual Depletion} = \frac{2\,100\,000\,000}{10} = 210\,000\,000$ per year.

Each year, oil extracted reduces the carrying value of the field by €210 000 000.

Balance-Sheet Tracking

Oil Field (cost) stays €2 100 000 000.
Accumulated Depletion increases €210 000 000/yr.
Net Field value declines to €0 at end of Yr 10.

Practical notes

In practice, depletion often uses units-of-production method (per-barrel charge) rather than straight-line, aligning expense with actual extraction volumes.
Estimating reserves involves geological uncertainty → periodic revisions required.

Cross-Method Comparison & Connections

Depreciation (tangible PP&E), Amortisation (intangibles), and Depletion (natural resources) are conceptually analogous mechanisms for systematically allocating asset cost over periods benefiting from their use.
All reduce reported profit annually but do not involve cash outflows when recorded (non-cash expenses).
They protect matching principle in accounting—aligning expense recognition with revenue generation.
Consistent methods enhance comparability across periods and firms; changes must be justified & disclosed.

Regulatory & Tax Dimensions

Useful lives, salvage values, and permissible methods are often dictated or limited by tax codes and financial-reporting standards.
Over-aggressive depreciation lowers taxable income (tax planning tool), but may attract regulatory scrutiny.
Goodwill amortisation period fixed by law (10 yrs in example jurisdiction); IFRS currently mandates annual impairment testing instead of systematic amortisation—highlighting differences across frameworks.

Key Formulas Recap

• Annual Straight-Line Depreciation $= \frac{\text{Cost} - \text{Salvage}}{\text{Useful Life}}$
• Book Value at time t $= \text{Cost} - \text{Accumulated}\ (\text{Depreciation | Amortisation | Depletion})$
• Gain/Loss on Asset Sale $= \text{Sale Proceeds} - \text{Book Value}_{\text{date of sale}}$