For accounting purposes, it is generally acceptable to amortize or deplete the asset and reflect the cost of the asset in the determination of net income. The objective of amortization, for financial statement accounting purposes, is to match the cost of producing the revenues to net income. Little attempt is made to compute the present value of the asset for the balance sheet, although the principle of conservatism requires that capital assets presented on the balance sheet do not exceed the market value of the asset or the present value of estimated future cash flows.

For tax purposes, the accounting methods of amortization are rejected because of the various alternative methods that may be selected. The capital cost allowance system is strict and leaves few, if any, alternative choices in the computation of a capital cost allowance claim.

For accounting rules versus tax rules are summarized here. There are a number of differences between the accounting amortization rules and the tax depreciation rules. Remember that the policy objectives supporting the tax system of depreciation are

• To allow taxpayers to amortize, on the same basis, similar assets used in similar business;

• To spread the cost of capital properties over their useful life; and

• In certain cases, to promote investment in particular economic or social activities, such as manufacturing and pollution control.

The CCA system in Canada separates capital property into three general categories.

Non-depreciable property is not defined in the Act; it represents inventory, receivables, and other capital property such as land, investments, personal-use property, and listed personal property. Since this property, except for personal-use property, is not used up or worm out over time in the production of income, non-depreciable property is not eligible for capital cost allowance.

Eligible capital property generally includes intangibles such as good will, patents, unlimited franchises and incorporation costs. When an eligible capital expenditure (ECE), that is, the cost, is incurred, 75% of the cost is included in a single common pool referred to as cumulative eligible capital (CEC) and is subject to a rate of tax depreciation of 7%. The deduction, which is provided for in paragraph 20(1)(b), is referred to as cumulative eligible capital amount or CECA. This will be discussed in the latter part of this chapter.

Depreciable property is defined in subsection 13(21) as property acquired by the taxpayer where CCA has been allowed or will be allowed. Since depreciable property is also treated as capital property (section 54), a capital gain may arise. Conversely, a capital loss can never arise on the disposition of depreciable property. Paragraph 20(1)(a) of the Act permits a deduction from net income to reflect the wear and tear of depreciable property based on the capital cost allowance system.