Difference Between Amortization And Depreciation

Accounting is one of the skills that everyone needs to have regardless of their background. The goal is none other than to help each individual become more skilled and wise in financial management

The realm of accounting skills that are owned for daily personal interests certainly does not need to be as complex as those of accountants or similar professionals in a company.

One of the fundamental skills that need to be possessed is to understand some basic accounting terms such as depreciation and amortization.

Depreciation and amortization are accounting processes that both have a depreciation effect on asset values. However, they both have different concepts. For more details, see the following explanation.

Understanding Assets

The difference between depreciation and amortization lies in the type of asset. The simple definition of assets in accounting is all wealth owned by individuals or companies and can be measured using currency units. In everyday life, assets are more commonly known as assets.

Grouping of assets based on their form is divided into two, namely tangible assets (also called fixed assets) and intangible assets (also called intangible fixed assets).

  • Tangible Assets

These assets have physical forms that can be observed such as land, buildings, vehicles, furniture, and so on.

  • Intangible Assets

On the other hand, these assets do not have a physical form. Intangible assets are privileged and have a certain value. Some examples of intangible assets are goodwill, patents, copyrights, trademarks, leases, and franchises.

Definition and Examples of Depreciation

Depreciation is the allocation of depreciation expense to tangible assets over a certain period. The specified period is the expected time span for the utilization of these assets.

This needs to be done because basically the value of tangible assets fluctuates when purchased and when sold or no longer used. The calculation of depreciation will affect the financial statements, including the taxable income of a company.

The calculation of depreciation requires three main components, namely cost, estimated economic life, and estimated residual value. For example, you buy a building for $2,000,000 and sell it 20 years later. The estimated residual value of this type of building is $ 500.000. Thus, the amount of building depreciation is:

= (Cost cost – Estimated residual value) : Estimated economic life

= ($ 2,000.000 – $ 500.000) : 20

= $ 1,500.000,00 : 20

= $ 75,000

For the record, the calculation of depreciation can be done by various methods. The example above is a calculation using the straight-line method. The weakness of this simplest method is the assumption that the economic usefulness of assets every year is the same.

You can find other methods to calculate depreciation from this post.

Definition and Examples of Amortization

Amortization is the depreciation of the value of an intangible fixed asset over a certain period (economic life) without any residual value. If an intangible asset has an indefinite economic life, then amortization is not necessary.

For example, your company managed to get a patent for the creation of an application. The acquisition price of the patent is $ 30,000,000 and will be depreciated within a period of 10 years. Thus, the amount of amortization of patent rights per year is = $  30,000,000.00 : 10  = $ 3,000,000.00

Amortization can also be defined as a method of paying debts in stages over a predetermined period of time. The simplest examples are monthly payments for vehicle installments, mortgage loans, unsecured credit, and so on.

Also read:  Easy Steps to Calculating Amortization.

Apart from depreciation and amortization, another accounting term related to depreciation is depletion. In general, depletion has similarities with depreciation, namely reducing the economic benefits of a tangible asset. However, the condition for the asset object referred to in depletion is that it cannot be replaced if it has run out such as natural resources (forest wood, iron ore, and so on). The term depletion is more widely used in mining company accounting.

Depreciation and amortization are two accounting terms that refer to the depreciation of an asset. The basic difference between depreciation and amortization lies in the type of assets, namely tangible assets for depreciation and intangible assets for amortization.


Trending in Accounting

Leave a Comment