The Difference between Amortization and Depreciation

For those business
assets, amortization and depreciation are two methods of calculating value. Each
year over the life of the asset, the cost of business assets can be expensed.
To reduce the tax liability for the business, the expense amounts are
subsequently used as a tax deduction. Amortization, depreciation, and one more
common method used by businesses to spread out the cost of an asset will be
reviewed in this article. The involvement of a type of asset being expensed is
the key difference between all three methods.

Amortization

The practice of
spreading an intangible asset’s cost over that asset’s useful life is called
amortization. Physical assets are not intangible assets, per se. Intangible
assets that are expensed through amortization might include the following
examples:

  • Patents
    and trademarks
  • Franchise
    agreements
  • Proprietary
    process, such as copyrights
  • Cost
    of issuing bonds to raise capital
  • Organizational
    costs

Amortization is
physically expensed on a straight-line basis, meaning the same amount is
expensed in each period over the asset’s useful life, unlike depreciation.
Additionally, unlike with depreciation, assets that are expensed using the
amortization method typically don’t have any resale or salvage value.

When using the
term amortization since it carries another meaning, it is important to note the
context. As in the case of a mortgage, to calculate a series of loan payments
consisting of both principal and interest in each payment, an amortization
schedule is often used.

Depreciation

The expense of a
fixed asset over its useful life is called depreciation. Physical assets that
can be touched are fixed assets or tangible assets. Fixed or tangible assets
that are commonly depreciated includes some of these examples.

  • Buildings
  • Equipment
  • Office
    furniture
  • Vehicles
  • Land
  • Machinery

Depreciation is
calculated by subtracting the asset’s salvage value or resale value from its original
cost since tangible assets might have some value at the end of their life. The
expected life of the asset over the years is when depreciation is evenly
different. In other words, a tax reduction for the company until the useful
life of the asset has expired for the depreciated amount of expensed in each
year.

An example, an
office building can be used for many years before it becomes run down and is
sold. With a portion of the cost being expensed in each accounting year, the
cost of the building is spread out over the predicted life of the building.

A large portion of
the asset’s value is expensed in the early years if the asset’s life, meaning
the depreciation of some fixed assets can be done on an accelerated basis.

Special Considerations

Another way the cost of business assets can be established is by depletion. the allocation of the cost of natural resources over time is what it refers to. All three methods are a non-cash expense with no cash spent in the years they are expensed—depreciation, amortization, and depletion. The terms amortization and depreciation are often used interchangeably in other countries to refer to both tangible and intangible assets, which is an important thing to note.

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