Amortization vs. Depreciation

Accountancy Resources

Amortization vs. Depreciation

Business Author: Admin


In accounting, the terms amortization and depreciation are both used a great deal and it can be difficult for non-accountants to follow exactly what they’re referring to. While technically there are differences, which will be discussed below, in practice amortization and depreciation are used interchangeably. The technical difference is more of an academic one, with companies using amortization or depreciation in reference to the reduction in the value of assets completely interchangeably.

So what do they both mean in practice?

Amortization and depreciation refers to the concept that most assets have a useful life and over time their value will go down.

For example, a car is bought new and after 1 year of use it is worth less than it was new, and after 1 year more it is worth a little bit less, and a little bit less until you have essentially no value aside from any salvage value.

So each year a company holds an asset it needs to reduce the value of that asset and recognize it as an expense, this expense being the amortization or depreciation expense. So if an asset has five years of use before its worthless each year 20% of the value will be expensed to the income statement, and the value on the balance sheet will decline by 20% also.

Amortization for Academics

In a technical, but not business practice, perspective amortization is applied to intangible assets. Intangible assets are patents or goodwill (from acquiring another business) and are not actual physical assets held by a company. A patent can be worth millions of dollars, but you don’t have anything more than a piece of paper to really show the value. As such these assets are considered intangible. Intangible assets often still have a useful life, say a patent that is valid for 10 years, and the value of the patent will be expensed evenly over that time period

Depreciation for Academics

From a technical perspective, depreciation is the same concept but applied to tangible assets. Tangible assets are physical assets, i.e. buildings, cars, machinery, that have a set useful life after which they are no longer of value or would need to be replaced. A company would recognize a depreciation expense related to the decline in value of these assets over the years until the assets’ effective life is done.

Amortization vs. Depreciation

As said above amortization and depreciation are more academic concepts as opposed to what’s really done in real life. Large publicly listed companies that only have tangible assets will still have an amortization expense on their income statement. For use in business, anyone can feel free to use the two words interchangeably.