Any asset which a company acquires whether tangible or intangible has some life i.e. they do not last forever and has a cost attached to it. The cost gets proportionately expensed in due course of its life. In this case, amortization and depreciation comes into the picture where they portray the cost of the business assets over the due course of time.
When the cost of an intangible asset is spread throughout its useful life, we consider it is as amortization. By the intangible, we mean something which cannot be touched. Thus, intangible assets are non-physical assets that are important to a company. It includes patents, trademarks, and copyrights. The purpose of amortizing assets is to match the expense to the revenue which is generated by these intangible assets.
A company purchases a license worth $10,000 which will get expired in 10 years. Since the license is an intangible asset, we will be using the method of amortization to find out the cost to an expense at a consistent rate over time. For calculating amortization, using the straight-line method, the amortization expense of the license will be $1000 which is calculated by dividing the cost of the intangible asset by the number of years by which the license will get expired. In this case, license cost is $10,000 and expiration term in 10 years.
Like we have amortization for intangible asset, we have depreciation for the tangible asset. When the cost of a tangible asset is spread throughout its useful life, we consider it is as depreciation. By the word tangible, we mean anything which can be felt or touched like physical assets. It includes manufacturing equipment, business vehicles, and computers etc. Through Depreciation one can identify how much the physical asset is being used up at a given point of time. Also, depreciation is used for tax deductions.
Suppose a company purchases a piece of equipment worth $100,000 with an estimated useful life of 10 years. Through the straight-line method, the annual depreciation expense each year can be calculated by dividing the total equipment cost by the expected life of the asset, which will be $10,000 in this case. Depreciation is also calculated using an accelerated depreciation method. In this method, the amount of depreciation in the consecutive year of the asset will be higher than its previous year’s depreciation until the estimated life of the asset.
How does Amortization differ from Depreciation?
Although both calculate the cost of an asset during its useful life, there are certain differences as well. Amortization is used for intangible asset whereas depreciation is used for a tangible asset. Amortization can be calculated using the straight-line method whereas depreciation uses both the straight-line methods and accelerated method to calculate each year’s expense. The intangible asset does not have any resale value. On the other hand, the tangible asset does have a resale value. Depreciation can also be calculated by subtracting the salvage value of that asset from the actual cost of the asset.
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