Estimating Practice Exam

What do we call the process of allocating the cost of the item over its useful life?

1. Amortization

2. Depreciation

3. Escalation

4. Allocation

The correct answer is: Amortization

The process of allocating the cost of an asset over its useful life is known as depreciation. Depreciation applies specifically to tangible assets such as buildings, machinery, and vehicles, reflecting the wear and tear that these assets experience over time. It allows businesses to match the cost of an asset with the revenue it generates, providing a more accurate picture of financial performance. Amortization is similar but pertains to the allocation of costs associated with intangible assets, like patents or trademarks, over their useful lives. Escalation refers to the adjustment of costs due to inflation over time, while allocation generally refers to the distribution of costs or expenses among various departments or projects, rather than the specific process for writing down an asset’s value. Therefore, the correct answer is depreciation, as it specifically captures the concept of accounting for the decrease in value of tangible assets over their working life.