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 generates economic returns and revenue for the business over the life of the asset. But each asset comes with life. It must be depreciated or amortized in the books of accounts 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. The assets are physical assets that are reduced each year due to the wear and tear in them. This amount is chargeable to the income statement.
Amortization, on the other hand, is also the expense of the asset over its useful life. However, amortization applies to intangible assets over the life of the asset. This amount is also chargeable 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.
- The critical 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 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
|A technique to calculate the reduced value of the tangible asset is known as depreciation.||A technique to measure the reduced worth of 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
Examples of Depreciation asset are
|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 be the same if considered from the perspective of depreciation
- Declining Balance Method– Under this method of depreciation, the depreciation amount is charged in the income statement is charged in the closing balance of the previous year of the asset. I.e., Asset value- depreciation for an earlier 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 significant expense is charged to the income statement
In most of the cases, the methods used for depreciation are also utilized for amortization unless it is the amortization of loans and advances. In that case, the above methods of amortization schedule of loans are used.
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 is crucial and paramount. These two are often identical terms and are commonly used interchangeably, but they are both governed by different accounting standards.
A business should realize the importance of these two accounting concepts and how much money should 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.
This article has been a guide to Depreciation vs. Amortization. Here we discuss the top differences between them and their methods along with infographics and comparative table. You may also have a look at the following articles –