Understanding the Difference between Amortization and Depreciation
Amortization and depreciation are two of the most common ways to calculate the value of a company’s assets. Although both of them serve similar purposes to report the expenses for each accounting period, there are some clear differences between the two – learning that would help a business determine which process would be the best one for their needs. Below is a quick look at amortization and depreciation to understand them better.
This method uses spreading the cost of an intangible asset over its use and life span. Note that the term “amortization” could also be used to express loan payments that include both the principal and the interest amount. Therefore, understanding the context is very necessary to understand how it works in accounting.
In accounting, amortization calculates the asset’s value in a straight-line technique, by keeping the amount same throughout the useful life of the asset. Usually, amortization is used to evaluate those assets that normally cannot be resold or salvaged. The most common non-physical assets that are evaluated through amortization include trademarks and patents, cost of issuing bonds, organizational costs, as well as proprietary assets like copyrights and franchise agreements.
This method is used to evaluate tangible assets such as the company building, financed equipment and machinery, office furniture, vehicles, etc. As such physical assets can be resold or salvaged after they have served their purpose for the company, depreciation calculates the value of these assets by subtracting their expected resale or salvage value from its original worth. This difference is spread out evenly across the expected useful life of the fixed asset.
Note that depreciation of some tangible assets can be done on an accelerated basis; company vehicles are usually depreciated this way. This refers to expensing a greater portion of the depreciation value of the asset in its preliminary useful years.
What is Depletion?
Just like amortization and depreciation, the depletion method can also be used to evaluate the value of a business’ assets. However, this approach is mostly used to determine the cost of natural resources in mining, petroleum, timber, and other similar companies.
For instance, for a petroleum company, the depletion method would be used to calculate the value of oil for the company’s operations. To do that, it takes the life of the oil resource (well) into consideration and spreads the costs of its yield across the life and usability of the resource. This can then help the petroleum company in easier tax reporting.