31/8/18 Amortization vs. Depreciation
What’s the difference between amortization and depreciation?
The cost of business assets can be expensed each year over the life of the asset. The expense amounts are subsequently used as a tax deduction reducing the tax liability for the business.
Because very few assets last forever, a finite number of years is calculated which is called the asset’s useful life. In this article, we’ll review three common methods used by business to spread out the cost of an asset. The key difference between all three methods involves the type of asset being expensed.
Depreciation is the expensing of fixed assets over its useful life. Fixed assets are tangible assets meaning they are physical assets and can be touched. Some examples of fixed or tangible assets that are commonly depreciated include:
- Office furniture
Depreciation of some fixed assets can be done on an accelerated basis, meaning that a larger portion of the asset’s value is expensed in the early years of the assets’ life. For example, vehicles are typically depreciated on an accelerated basis.
Amortization is the practice of spreading an intangible asset’s cost over that asset’s useful life. Intangible assets are not physical assets per se. Examples of intangible assets that are expensed through amortization might include:
- Patents and trademarks
- Franchise agreements
- Proprietary processes like copyrights
- Cost of issuing bonds to raise capital
- Organizational costs
Unlike depreciation, amortization is typically expensed on a straight-line basis, meaning the same amount is expensed in each period over the asset’s useful life. Also, assets that are expensed using the amortization method typically don’t have any resale or salvage value, unlike with depreciation.
In our next e-Lesson, we’ll analyze the term: “Depletion”