State BPA Fundamental Accounting Practice Exam

Which accounting term describes the reduction of an asset that occurs when it is used or consumed?

1. Liability

2. Depreciation

3. Amortization

4. Expenditure

The correct answer is: Depreciation

Depreciation is the accounting term that describes the reduction in value of a tangible asset over time due to wear and tear, usage, or obsolescence. This process allocates the cost of an asset over its useful life, which reflects its consumption and gradual loss of value as it is utilized in business operations. Businesses account for depreciation to match the expense of using the asset with the revenue it generates, adhering to the matching principle in accounting. This concept is essential for accurately portraying a company’s financial position and performance, as the recorded value of assets on the balance sheet needs to reflect their current value after considering their usage. By applying depreciation, companies are also able to account for the replacement costs of assets when they eventually need to be replaced due to their diminished value. Other terms listed do not accurately describe this specific process. Liability refers to obligations or debts a company owes to outside parties. Amortization refers specifically to the gradual reduction of intangible assets, such as patents or copyrights, rather than tangible assets. Expenditure refers to the outflow of funds for goods or services but does not specifically address the reduction of an asset's value over time.