The main difference between depreciation and amortization is that while depreciation is used in charging off the cost of a tangible asset, amortization normally charges off cost of an intangible asset. Examples of tangible assets are furniture, motor vehicle and office equipment. An intangible asset is an asset which is not physical and has a useful life that exceeds one year. Examples of intangible assets are goodwill, trademarks, customer lists, motion pictures, franchise agreements, and computer software.
If a business uses money to purchase an asset, the asset may have a useful life beyond the tax year. Such expenses are referred to as capital expenditures and costs are written off or recovered over the asset’s useful life. For tangible assets, this is known as depreciation and if it is intangible like in the case of goodwill or patent, this is known as amortization.
To amortize is to write off costs or to pay debts off while to depreciate is to lose value over a certain time period. Both are used in reflecting the expiration, consumption, obsolescence or any other decline in an asset’s value as a result of time passage. This commonly applies to tangible assets which are prone to wear and tear. Therefore, intangible assets require a corresponding technique for spreading out the cost over a certain time period. Intangible property that is subject to amortization in the U.S has to be described in U.S.C 26. Under Â§ 197, this has to be property held for use in business, trade or for income production. Most intangible assets that are acquired are usually ratably amortized over a period of 15 years. Under Â§ 197, if the intangible does not qualify for amortization, the tax payer may depreciate the asset if there is evidence of the useful life of the asset.
The other aspect differentiating the two concepts is that amortization is usually carried out on a straight line basis so that the amortization amount is shown as an expense in each period of reporting. On the other hand, depreciation is commonly shown on the basis of acceleration such that a significant depreciation amount is recognized at earlier periods of reporting compared to later periods of reporting.
Another difference is that when calculating amortization, the salvage value is never incorporated because an intangible asset is never considered to be having a resale value upon the expiration of the useful life. Contrariwise, a tangible asset may have salvage value; an amount which in most cases will be included in the calculation of depreciation.
All in all, amortization and depreciation have got similar characteristics. These include:
- Non- cash expenses- Amortization and depreciation are both expenses that are non-cash and upon recording these expenses, the company will not suffer reduction in cash.
- Reporting- In the balance sheet, amortization and depreciation are both treated as reductions from long term fixed assets and for purposes of reporting, these may be an exaggeration
- Impairment- Tangible assets and the intangible ones are subjected to impairment which means that their carrying value may be written down. If this happens, the remaining amortization or depreciation charges will decrease as there is a remaining small balance to offset.
Depreciation is calculated using the straight-line method or the reducing balance method. The main objective behind depreciation is spreading the cost over the useful life of the asset or during the life where the asset generates revenue for the business. More often than not, there is no direct link between the changes in levels of revenue and the cost of the fixed asset. The asset’s useful life is simply estimated on the depreciation basis. Salvage value is the amount expected to be received by the company after it disposes off a fixed asset. Useful life is the period expected over which a fixed asset will be used by the company.
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