Amortization Vs. Depreciation: What’s The Difference?

Business Terms

While amortization sounds like a term in the funerary industry, it’s actually a business and accounting term, like depreciation. Both have to do with how a business determines its value and categorizes its assets. Amortization and depreciation relate to assets that a company owns and the value derived from them.

The difference between them is that they describe different types of assets. Most companies have physical assets – such as vehicles, office space, and furniture – and intangible assets, like patents and proprietary software.

Amortization is used to describe intangible assets. Most intangible assets don’t have any resale or salvage value, meaning that the amortization is typically the fees required to keep the asset for the business. This can include fees to keep a patent up to date, maintain copyright, or maintain a brand’s image.

Depreciation is used for assets a company owns that are tangible, such as equipment, vehicles, and property. These types of assets usually have a resale value as well. Depreciation determines their value and how it changes as time passes, and the item is used for its intended purpose.

Key Takeaways:

Amortization	Depreciation
Intangible assets’ value is determined through amortization.	Tangible or physical assets’ value is determined through depreciation.
Amortization is calculated like a straight-line depreciation.	Deprecation can be calculated in five different ways: straight line, declining balance, double declining balance, the sum of the years’ digits, and units of production.
Amortized assets’ value are difficult or impossible to determine.	Depreciated assets usually have a set resale or salvage value used to determine their deprecation value.
Intangible assets include intellectual property, software, trade secrets, and customer relations.	Tangible assets include vehicles, equipment, office furniture, property, and computers.

What Is Amortization?

Amortization is a way to determine the value and costs of intangible assets. Intangible assets are valuable things a business possesses that don’t take up physical space and can’t be touched. That makes them very difficult to value – sometimes even impossible – but no less important to a business’s efficacy.

Examples of intangible assets include

Copyrights
Trademarks
Software
Trade secrets
Employee experience

The relationship with the public can be included as well, which means that you can include:

Customer goodwill
Brand recognition
Customer loyalty

All of these can be amortized, mainly by determining how much is spent on them, as their value can be subjective.

Determining amortization is typically calculated like a straight-line depreciation. Depreciation is usually a more complex calculation due to the fact that the value of different types of assets shifts differently over time. A straight-line depreciation just means that you pay a certain amount each period, as most items that are amortized are going to have a flat fee to keep up.

Some others will be more complicated, such as the money spent on keeping up goodwill or brand recognition, but those are more often categorized as marketing or public relations in a budget.

What Is Depreciation?

Depreciation is a way to calculate the value of a company’s physical assets. Most often referred to as tangible assets, these are assets a company has that have an immediate resale or salvage value. They include;

Property, such as buildings
Vehicles
Equipment
Office furniture
Computers
Tools

Because these assets typically have some value following the end of the lifespan. That value is usually deducted from the asset’s original cost in order to determine its depreciation value.

Depending on the type of asset it is, and what you use it for, there are several different types of depreciation. Different accounting firms will use different ones, but it will depend on the asset and its lifetime.

Straight line method. This is the simplest method, where the company just depreciates the asset by the same amount each year – or selected term – of its lifetime. The base is arrived at by reducing the salvage value by a set amount each year.
Sum of the years’ digits method. This method takes the sum of the digits in the asset’s life. Therefore, if it’s expected to be useful for five years, you add up each number, one through five. Then you take a fraction of the sum, dropping it a bit each year.
Declining balance method. The idea behind this one is that some assets – such as cars – depreciate more quickly at the beginning than later. However, this one is calculated by multiplying the current value by a fixed depreciation rate that doesn’t change over time.
Double declining balance method. This is similar to the above method (hence the name) but is instead calculated by doubling the rate under the straight-line method early in the asset’s life.
Units of production. In this method, the company sets a baseline of how much the asset is expected to be used. Then it’ll compare the actual usage to the estimate in order to determine the proportion of depreciation.

Amortization vs. Depreciation FAQ

How do I know whether to depreciate or amortize an asset?

The rule of thumb is that intangible assets are amortized, and tangible assets are depreciated. However, the Generally Accepted Accounting Principles (GAAP) will have guidance on how to categorize different assets. If you’re unsure whether an asset should be amortized or depreciated, you should refer to the guidelines.
How do I include amortization and depreciation in my business tax return?

IRS form 4562, depreciation and amortization will help with the calculations for the year. If you have assets to depreciate or amortize, then this form must be added to your tax submission for the year. Such tax forms have instructions on how to fill them out and how to do the necessary calculations.

If it’s affordable or reasonable for you, business accounting firms will be able to help you with your taxes as well. They can either file them for you or advise you on how to make sure that the tax rules and regulations are followed when you file with the IRS.
Why do we amortize a loan instead of depreciating a loan?

The reason a loan is amortized rather than depreciating a loan is that it’s an intangible asset. That being said, amortization in finance has a different meaning and usage than it does in business.

Many loans have an amortization schedule, which is a way to calculate a series of loan payments. Such payments consist of both payments on the principal and interest – most often used in mortgages, though it isn’t exclusive.

Business Terms

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Author

Di Doherty

Di has been a writer for more than half her life. Most of her writing so far has been fiction, and she’s gotten short stories published in online magazines Kzine and Silver Blade, as well as a flash fiction piece in the Bookends review. Di graduated from Mary Baldwin College (now University) with a degree in Psychology and Sociology.

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