Amortization VS Depreciation

AMORTIZATION VS DEPRECIATION

Capital expenses are either amortized or depreciated depending upon the type of asset acquired through the expense. Tangible assets are depreciated over the useful life of the asset whereas intangible assets are amortized.

Comparison chart

Differences — Similarities —

	Amortization	Depreciation
What is it?	A way to "recover costs" i.e. account for capital expenditures.	A way to "recover costs" i.e. account for capital expenditures.
Use for	Intangible assets e.g. patents	Tangible assets e.g. machinery

Contents: Amortization vs Depreciation

·         1 Cost Recovery ·         2 Depreciation or Amortization Schedule o    2.1 Straight Line Depreciation o    2.2 Accelerated Depreciation ·         3 References

1.Cost Recovery

When a business spends money to acquire an asset, this asset could have a useful life beyond the tax year. Such expenses are calledcapital expenditures and these costs are "recovered" or "written off" over the useful life of the asset. If the asset is tangible, this is called depreciation. If the asset is intangible; for example, a patent or goodwill; it's called amortization.

To depreciate means to lose value and to amortize means to write off costs (or pay debt) over a period of time. Both are used so as to reflect the asset's consumption, expiration, obsolescence or other decline in value as a result of use or the passage of time. This applies more obviously to tangible assets that are prone to wear and tear. Intangible assets, therefore, need an analogous technique to spread out the cost over a period of time

Amortization vs. Depreciation

2. Depreciation or Amortization Schedule

As an example, suppose in 2010 a business buys Rs.100,000 worth of machinery that is expected to have a useful life of 4 years, after which the machine will become totally worthless (a residual value of zero). In its income statement for 2010, the business is not allowed to count the entire Rs.100,000 amount as an expense. Instead, only the extent to which the asset loses its value (depreciates) is counted as an expense.

Straight Line Depreciation

The simplest way to depreciate an asset is to reduce its value equally over its life. So in our example, this means the business will be able to deduct Rs.25,000 each in the income statement for 2010, 2011, 2012 and 2013.

Accelerated Depreciation

Accelerated depreciation methods provide for a higher depreciation charge in the first year of an asset's life and gradually decreasing charges in subsequent years. This may be a more realistic reflection of an asset's actual expected benefit from the use of the asset: many assets are most useful when they are new. A popular accelerated method is the declining-balance method. Under this method the depreciation is calculated as:

Annual Depreciation = Depreciation Rate * Book Value at Beginning of Year

In our example, let's say the business decides to use a depreciation rate of 40%.

Book value at beginning of year	Depreciation rate	Depreciation expense	Accumulated depreciation	Book value at end of year
Rs.100,000 (original cost)	40%	Rs.40,000	Rs.40,000	Rs.60,000
Rs.60,000	40%	Rs.24,000	Rs.64,000	Rs.36,000
Rs.36,000	40%	Rs.14,400	Rs.78,400	Rs.21,600
Rs.21,600	40%	Rs.8,640	Rs.87,040	Rs.12,960
Rs.12,960	Not applicable (last useful year)	Rs.12,960	Rs.100,000	Zero