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Difference Between Depreciation And Amortization

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Every business invest in some equipment’s, furniture, machinery, vehicles, building, land, patents etc in order to operate. Major assets last for more than one year, but will not last indefinitely. Major assets that will be used in your business for more than a year are known as “capital assets” and are subject to special treatment under the tax laws. Most importantly, you generally can’t deduct the entire cost of acquiring(purchasing) such an asset in the year you acquire it. To accurately measure a business’s gross income, expenses, and net income (earnings) during a given period of time, usually a year.

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Depreciation

An asset, say, a car or a machine, will never have the same value throughout its lifetime. As time passes, the asset loses value known as Depreciation. The term depreciation is used with reference to tangible fixed assets. The assets which we can see and touch can depreciate; like machinery and building. It is a non-cash expense that reduces the value of an asset as a result of wear and tear, age or obsolescence. Most assets lose there net value over time (In other worlds, they depreciate), and must be replaced once the end of there useful life is reached.

For example, a company purchases a Rs 450,000 piece of equipment that is expected to have a useful life of five years and a salvage value(Market value of asset at the end of its useful life) of Rs 50,000 at the end of that time. It would not be appropriate to record the entire Rs 450,000 (or even Rs 400,000) as an expense on the income statement in the year of purchase because the equipment will be used to generate revenues over its useful life of five years. Therefore, the cost of the equipment should be allocated over its useful life of five years. This allocation process is termed as depreciation.

There are many methods for calculating Depreciation. This is one of the example to make you understand the concept of Depreciation.

YEAR 2011 2012 2013 2014 2015 Salvage Value
Cost Of Equip 4,50,000 3,60,000 2,70,000 1,80,000 90,000
Depreciation (-) 90,000 (-) 90,000 (-) 90,000 (-) 90,000 (-) 90,000 50,000
NAV 3,60,000 2,70,000 1,80,000 90,000 0

Amortization

Amortization is the same process as Depreciation, but it is concerned with intangible assets. An intangible asset is something of value to a business that does not have a physical presence. The assets which we cant see or touch like patents and copy rights come under intangible assets. Amortization usually refers to spreading an intangible asset’s cost over that asset’s useful life. For example,ABC Company spent Rs 48 million on a Car engine technology and the patent on the engine lasts for 12 years, this mean that Rs 4 million will be accounted each year as an amortization expense.

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Difference Between Depreciation And Amortization

  • Depreciation is used on tangible assets amortization on intangible asset

One comment

  1. Great article.. I could never understand Amortization. Your example makes it very clear. Thanks !!

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