Amortization vs. DepreciationDifferences You Need to Know Between the Two!

Lisa Borga

Businesses can expense the cost of their assets every year of the asset’s useful life.

They can then use this expense as a tax deduction, thus decreasing their tax liability.

The two primary methods of expensing assets over time are amortization and depreciation.

There is another method called depletion; however, it is not as common.

The main difference in these methods is the asset that is being expensed.

Amortization

Amortization is used in accounting to spread out the cost of a business’s intangible assets over their useful life.

Intangible assets are assets that have value but no physical substance.

Some examples of these assets that businesses expense through amortization are: franchise agreements, organizational costs, copyrights, trademarks, and patents.

When businesses use amortization to expense an asset, the straight-line method is typically used.

Therefore, the amount charged to expense each year remains the same over the useful life of the asset.

Assets that businesses expense through amortization generally do not have a salvage or resale value.

The word amortization is also used in association with loans.

In this context, an amortization schedule is made that shows a payment schedule for a loan that includes the principal and interest for every payment.

The term amortization, when used in lending, has a different meaning than it does when used in accounting.

Amortization of Intangibles

Depreciation

Depreciation is used by companies to expense fixed assets over their useful lives.

Fixed assets are tangible items that a business purchases.

Some tangibles assets that businesses typically depreciate are equipment, vehicles, buildings, machinery, and office furniture.

Tangible assets may still have resale value or salvage value when a business chooses to dispose of them.

Because of this, a business will need to subtract this value from the original cost when depreciation is computed.

Then this difference will be divided by the asset’s useful life to determine the amount of depreciation to be expensed each year.

The amount of depreciation that is expensed can be deducted from the business’s taxes to lower its tax liability.

As an example, suppose a business buys a piece of equipment, and it intends to use it for a few years, then replace it with newer equipment.

The equipment may still have some resale value when the business decides to replace it.

When calculating the depreciation for the equipment, the business needs to subtract the estimated resale value of the equipment from the purchase price and then expense this amount evenly over the asset’s useful life.

The same amount will be expensed each accounting year.

There are some fixed assets that can be depreciated using an accelerated depreciation method.

This will allow a greater portion of the value of the asset to be expensed in the early portion of the useful life of the asset.

Accelerated depreciation methods are commonly used for vehicles.

depreciation expense

 

Special Circumstances

For the valuation of certain finite resources, particularly natural resources such as coal, oil, or lumber, neither amortization nor deprecation may be applicable.

Instead, depletion is used to reduce the value of such an asset as its resources are exhausted.

For example, consider an area of forest that is purchased by loggers.

There are a finite number of trees on the land, and as each is cut down, the value of the land decreases.

Depletion allows a company to account for this decrease in value and record it over several accounting periods.

There are two methods to calculate this, percentage depletion and cost depletion.

Cost depletion counts upon the basis of the asset and applies a proportionate amount based on the number of resources that were consumed in the accounting period.

In contrast, percentage depletion will assign a certain percentage based upon the particular resource and multiply it by the gross income a business acquired from the asset in the accounting period.

What These Accounting Techniques Have in Common

What amortization, depletion, and depreciation all have in common is that they are considered to be non-cash expenses.

This means that though they are recorded as expenses, they will never result in a transfer of cash in the period in which they are expensed.

Additionally, all of these concepts are used to reduce the value of an asset on the balance sheet and will often be aggregated for financial reporting.

Finally, in certain countries, depreciation and amortization are used interchangeably regardless of whether an asset is tangible or intangible.

Key Highlights

  • There are two primary methods of determining the value of a company’s assets over a period of time. These are depreciation and amortization.
  • Businesses calculate the amount of depreciation and amortization so that they can claim the resulting expense as a tax deduction, thus reducing their tax liability.
  • Amortization spreads the cost of intangible assets over their useful life.
  • Depreciation is a method businesses use to expense the cost of a fixed asset over its useful life.
  • Another method businesses can use to expense their assets is the depletion method. This is an accrual accounting method and is useful for businesses that have assets that are natural resources.

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  1. Cornell Law School "26 CFR § 1.178-1 - Depreciation or amortization of improvements on leased property and cost of acquiring a lease." Page 1 . March 30, 2022

  2. California State University Northridge "Depreciation, Amortization, Depletion" Page 1 . March 30, 2022