Amortization vs. Depreciation

Amortization vs. Depreciation

Amortization

Amortization is the practice of allocating the value of an intangible asset over the useful life of that asset. Intangible assets are not in themselves physical assets. Examples of intangible assets that are amortized may include:

Patents and trademarks

Franchise agreements

Patented processes such as copyright

The cost of issuing bonds to raise capital

Organizational costs

Unlike depreciation, depreciation is usually spent straight-line, ie the same amount is spent in each period during the useful life of the asset. In addition, depreciable assets generally do not have the value of resale or recovery, unlike depreciation.

It is important to pay attention to the context when using the term depreciation, as it has a different meaning. The amortization schedule is often used to calculate a series of loan payments, consisting of both the principal amount and interest on each payment, as in the case of a mortgage.

 The term depreciation is used both in accounting and in lending with completely different definitions and uses.

Wear and tear

Depreciation is the cost of a fixed asset over its useful life. Fixed assets are tangible assets, ie they are physical assets that can be touched. Some examples of fixed or tangible assets that are normally depreciated include:

Houses

Equipment

Office furniture

Vehicles

Land

Cars

Because tangible assets may have a certain value at the end of their lives, depreciation is calculated by deducting the value of the asset or the resale value from its original value. The difference is depreciated evenly over the years of the expected useful life of the asset. In other words, the amortized amount spent annually is a tax deduction for the company until the useful life of the asset expires.

For example, an office building can be used for many years before it becomes worn out and sold. The cost of the building is distributed over the estimated life of the building, with part of the costs spent for each reporting year.

Depreciation of some fixed assets can be accelerated, which means that most of the value of the asset is spent in the first years of life of the asset. For example, vehicles are usually depreciated on an accelerated basis.

Special considerations

Depletion is another way to determine the value of economic assets. It concerns the distribution of the value of natural resources over time. For example, an oil well has a limited service life before pumping all the oil. Therefore, the cost of installing an oil well is distributed over the estimated life of the well.

The two main forms of depletion aid are the percentage of depletion and the depletion of costs. The method of percentage depletion allows businesses to assign a fixed percentage of depletion to gross income derived from the extraction of natural resources. The cost reduction method takes into account the basis of the property, the total recoverable reserves and the number of units sold.

Taking into account depreciation, amortization and depletion, all three methods are non-cash costs without cash costs over the years of their costs. It is also important to note that in some countries, such as Canada, the terms depreciation and amortization are often used interchangeably to refer to both tangible and intangible assets.