Depreciation vs Amortization

Difference Between Depreciation vs Amortization

Depreciation vs Amortization both are tools to reallocate the cost of the Company’s Assets over the lifespan of specific assets which results in the reduction in the cost of an asset over its lifespan.  All the assets used by Companies in their business to generate revenue have a certain lifespan and the cost of assets are reallocated over their lifespan for accounting and tax purposes.

Depreciation

Depreciation refers to the reduction in the cost of the tangible fixed assets over its lifespan which is proportionate to the use of the asset in that specific year. The example of tangible assets which are depreciated is the plant, equipment, machinery, building, and furniture.

Depreciation of the tangible assets can be done by using either a straight line method or accelerated depreciation method.

Amortization

Amortization refers to the reduction in the cost of the intangible assets over its lifespan. The example of intangible assets which are amortized are patents, trademarks, lease rental agreements, concession rights, brand value etc.

Amortization of the intangible assets is mostly done using the straight-line method.

Head To Head Comparison Between Depreciation vs Amortization(Infographics)

Below is the top 9 difference between Depreciation vs Amortization

Key Differences Between Depreciation vs Amortization

Both Depreciation vs Amortization are popular choices in the market; let us discuss some of the major Difference Between Depreciation vs Amortization:

1. Depreciation is used to distribute and expense out the cost of Tangible Asset over its useful life. However, Amortization is used to expense out the value of Intangible assets over its useful life.
2. Tangible Assets are depreciated using either the straight-line method or accelerated depreciation method. However, amortization of intangible assets is mostly done using only the straight-line method.
3. Tangible assets carry some salvage value which is used in the calculation of depreciation. Intangible assets don’t have any salvage value.
4. Both depreciation and amortization are used in the finance industry for accounting and tax purposes.
5. Both depreciation and amortization are recognized as an expense in profit and loss statement of the Company for taxation purpose.
6. Taxation advantage is more significant in the case of depreciation in comparison to amortization as an accelerated method of depreciation can be used in case of tangible assets.
7. Journal entries for both depreciation vs amortization is the credit to Accumulated Depreciation/Amortization account and a debit to depreciation/amortization expense account.
8. Depreciation is applicable to assets such as plant, building, machinery, equipment or any tangible fixed assets. However, amortization is applicable to intangible assets such as copyrights, patent, collection rights, brand value etc.

Depreciation vs Amortization Comparison Table

Below is the 9 topmost comparison between Depreciation vs Amortization

Examples of Depreciation vs Amortization

Example of Depreciation

A Company purchased a machine at $100 million. The life of the machine is 5 Years. The salvage value of the machine is 10% of the purchase value. The depreciation as per the straight-line method is as below:

• Cost of Machine= $100 million
• Salvage Value= 100*10%= $10 million
• Depreciable value = Cost of Machine –Savage Value
• Depreciable value = 100-10= $90 million
• Life of the Machine= 5 Years

Now we will find out the Annual Depreciation for the machine by using the Annual Depreciation formula.

Annual Depreciation for the Machine = Depreciable value/life of the machine

Annual Depreciation for the Machine = 90/5

Annual Depreciation for the Machine = $18 million

Calculation of depreciation year on year and reduction in asset value is provided in below table:

Example of Amortization

A Company involved in construction, development, and operation of roads and highways has been granted a toll collection right of $800 million by the highway ministry to be collected over 20 Years.

Amortization expenses which the Company can claim under the straight-line method are as under:

Annual Amortization Expense = (Value of Toll Collection Right-Salvage Value)/Useful Life

Annual Amortization Expense = (800-0)/20 Years

Annual Amortization Expense = $40 million

Note: Generally, Amortization is implemented using a straight-line method and salvage value of intangible assets are zero.

Conclusion – Depreciation vs Amortization

Depreciation vs Amortization both are used to distribute the cost of an asset (be it tangible or intangible) over its useful life. Depreciation is more precisely used for tangible assets and amortization is used for intangible assets. Both Depreciation vs Amortization are recognized as expenses in the revenue statement of the Companies and used for taxation purpose. Both Depreciation vs Amortization broadly serves the purpose of taxation and accounting.

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