Depreciation in spirit is similar to?

The correct option is 2. Amortization.

Depreciation in spirit is similar to Amortization because both depreciation and amortization have the same characteristics except that depreciation is used for tangible assets and amortization for intangible assets.

To make it clear, intangible assets are those assets that cannot be touched i.e. they are not physically present. For example, goodwill, patent, trademark, etc. Hence, these assets are amortized over their useful life and not depreciated.

Example for Amortizing intangible assets: A manufacturing company buys a patent for Rs 80,000 for 8 years. Assuming that the residual value of the patent after 8 years to be zero.

The depreciation to be written off will be

Yearly Depreciation = Cost of the patent – Residual value / Expected life of the asset.

= 80,000 – 0 / 8

= Rs 10,000 every year.

Whereas, tangible assets are those assets that can be touched i.e. they are physically present. For example, building, plant & machinery, furniture, etc. Hence, these assets are depreciated over their useful life and not amortized.

Example of Depreciating tangible asset:  A manufacturing company bought machinery for Rs 8,10,000 and its estimated life is 8 years, scrap value being Rs 10,000.

The depreciation to be written off will be

Yearly Depreciation = Cost of machinery – Scrap value / Expected life of the asset.

= 8,10,000 – 10,000 / 8

= 8,00,000 / 8

= Rs 1,00,000 every year.