Depreciation vs Amortization

Difference Between Depreciation and Amortization

Depreciation is the reduction in the value of the fixed assets due to normal wear and tear, normal usage or technological changes, etc and it is applicable on the tangible assets, whereas, amortization refers to the process under which the cost of the different intangible assets of the company, etc are expensed over the specific period of time and is thus applicable only on the intangible assets of the company.

Assets are the backbone of any business. No business can run without owning an asset. As the asset is the one who has the capacity to generate economic returns and revenue for the business over the life of the asset. But each asset comes with life and must be depreciated or amortized in the books of accounts in order to recognize the true value of the asset. Companies use methods like depreciation or amortization to depreciate the asset over its useful life.

Depreciation refers to the expenses of an asset which are fixed and are tangible in nature. The assets are physical assets that are reduced each year due to the wear and tear in them. The amount is charged to the income statement.

Amortization, on the other hand, is also the expense of the asset over it’s useful live but amortization is applied to intangible assets over the life of the asset. This amount is also charged to the income statement of the company.

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Depreciation vs Amortization Infographics

Let’s see the top differences between depreciation vs amortization.

Key Difference

The key difference is that the asset that is an expense in depreciation are tangible assets and the assets that are expensed in amortization are intangible in nature
In amortization there is usually no salvage value is involved whereas in depreciation there is a salvage value most of the cases
There are various methods used by the business to calculate depreciation however amortization there is the only method which is generally used by companies
The objective of depreciation is to prorate the cost of the asset over the useful life of the asset, on the other hand, the objective of amortization is to capitalize the cost of the asset over the useful life of the asset
The only similarity in depreciation vs amortization is that they are both non-cash charges

Depreciation vs Amortization Comparative Table

Depreciation		Amortization
A technique to calculate the reduced value of the tangible asset is known as depreciation		A technique to measure the reduced worth of the intangible assets is known as amortization
Allocation of the cost principle		Capitalization of the cost principle
The different methods of depreciation are a straight line, reducing balance, Annuity, Sum of years, etc.		The different methods to calculate the amortization is to Straight Line, Reducing Balance, Annuity, Increasing Balance, Bullet, etc.
Applies over tangible assets		Applies over intangible assets
The governing accounting standard of depreciation is AS-6		The governing accounting standard of amortization is AS-26
Examples of Depreciation asset are • Plant • Machinery • Land • Vehicles • Office Furniture		Examples of Depreciation asset are • Patents • Trademark • Franchise Agreements • Cost of issuing bonds to raise capital • Organizational costs • Goodwill
The cost of depreciation is shown in the Income statement		The cost of amortization is also shown in the income statement
Non-cash item		Non-cash item

Methods of Depreciation & Amortization

#1 – Depreciation

Straight-line method– Under this method the same amount of depreciation expense is charged in the income statement over the useful life of the asset. Under this method, the profit over the year will the same if considered from the perspective of depreciation
Declining Balance Method– Under this method of depreciation the depreciation amount in charged in the income statement is charged in the closing balance of the previous year of the asset. I.e. Asset value- depreciation for a previous year= Closing balance. Under this method of depreciation, the profit for the year will be lesser in the initial years and more in the later years when considered in light of depreciation
Double Declining Balance method (DDB) – This is the most accelerated method of depreciation that counts twice as much of the asset’s book value each year as an expense compared to straight-line depreciation. The formula for this method is 2 * straight-line depreciation percent * Book Value at the beginning of the period

#2 – Amortization

Bullet- Under this method of amortization the amount of amortization of the intangible is charged to the income statement of the company all at once. This method recognizes the expense all at one go which generally firms does not adopt this method as it affects the numbers of profit and EBIT largely in that year
Balloon Payments– Under this method, the amount which is deducted at the beginning of the process is less and the end of the period large expense is charged to the income statement

In most of the cases, the methods which are used for depreciation are also used for amortization unless the amortization of loans and advances. In that case, the above methods of amortization schedule of loans are used.

Final Thoughts

Both processes are a non-cash expense but need to be created like a provision as assets have a particular life and need to be replaced in due course of time if the business does not want to lose their labor productivity.

That is why the use of these two accounting concepts are very important and are paramount in nature. These two are often identical terms and are often used interchangeably but they are both governed by different accounting standards.

A business should realize the importance of these two accounting concepts and should be analyzed which most importance on how much money needs to be set aside to purchase an asset in the future. Also, assets of the business should always be tested for impairment at least annually which helps the business to know the real market value of the asset. The impairment of assets also helps the business to forecast the cash requirement and at which year the probable cash outflow should occur.