Amortization vs.

Depreciation: An Overview
An asset acquired by a company may have a long useful life. Whether it is a
company vehicle, goodwill, corporate headquarters, or a patent, that asset
may provide benefit to the company over time as opposed to just in the
period it is acquired. To accurately reflect the use of these assets, the cost
of business assets can be expensed each year over the life of the asset. The
expense amounts are then used as a tax deduction, reducing the tax
liability of the business.

Amortization and depreciation are the two main methods of calculating the
value of these assets, with the key difference between the two methods
involving the type of asset being expensed. There are also differences in the
methods allowed, components of the calculations, and how they are
presented on financial statements.

KEY TAKEAWAYS

 Amortization and depreciation are two methods of calculating the value

for business assets over time.
 Amortization is the practice of spreading an intangible asset's cost over
that asset's useful life.
 Depreciation is the expensing a fixed asset as it is used to reflect its
anticipated deterioration.
 Amortization and depreciation differ in that there are many different
depreciation methods, while the straight-line method is often the only
amortization method used.
 The two accounting approaches also differ in how salvage value is
used, whether accelerated expensing is done, or how each are shown
on the financial statements.

Amortization
Amortization is the accounting practice of spreading the cost of an intangible
asset over its useful life. Intangible assets are not physical but they are still
assets of value. Examples of intangible assets that are expensed through
amortization include patents, trademarks, franchise agreements, copyrights,
costs of issuing bonds to raise capital, and organizational costs.12

Amortization is typically expensed on a straight-line basis. That means that

the same amount is expensed in each period over the asset's useful life.
Assets that are expensed using the amortization method typically don't have
any resale or salvage value.3

The term amortization is used in another, unrelated context. An amortization

schedule is often used to calculate a series of loan payments consisting of
both principal and interest in each payment, as in the case of a mortgage.
Though different, the concept is somewhat similar. As a loan is an intangible
item, amortization is the reduction in the carrying value of the balance.

The term amortization is used in both accounting and in lending with

completely different definitions and uses.

Depreciation
Depreciation is the expensing of a fixed asset over its useful life. Fixed assets
are tangible objects acquired by a business. Some examples of fixed or
tangible assets that are commonly depreciated include buildings, equipment,
office furniture, vehicles, and machinery.4

Unlike intangible assets, tangible assets may have some value when the
business no longer has a use for them. For this reason, depreciation is
calculated by subtracting the asset's salvage value or resale value from its
original cost. The difference is depreciated evenly over the years of the
expected life of the asset. In other words, the depreciated amount expensed
in each year is a tax deduction for the company until the useful life of the
asset has expired.5

For example, a business may buy or build an office building, and use it for
many years. The business then relocates to a newer, bigger building
elsewhere. The original office building may be a bit rundown but it still has
value. The cost of the building, minus its resale value, is spread out over the
predicted life of the building, with a portion of the cost being expensed in
each accounting year.

Depreciation of some fixed assets can be done on an accelerated basis,

meaning that a larger portion of the asset's value is expensed in the early
years of the asset's life. Vehicles are typically depreciated on an accelerated
basis.6

The definition of depreciate is to diminish in value over a period of time.

Depreciation Methods

Companies often have several options when choosing their depreciation

method. The most common depreciation methods include:

 Straight-Line Method: A company depreciates the asset equally over

the term of its useful life. The depreciable base is determined by taking
the asset's cost and reducing the salvage value. The same amount of
depreciation is recorded each year.7
 Declining Balance: A company depreciates an accelerated amount of
depreciation earlier in the asset's useful life. This is done by multiplying
the current book value of the asset by a fixed depreciation rate that
does not change over the life of the asset.8
 Double Declining Balance Method : A company depreciates an
accelerated amount of depreciation earlier in the asset's useful life by
doubling the rate under the straight-line method. This rate is then
applied to the current book value.9
 Sum-of-the-Years' Digits Method : The digits of the asset's useful life
are summed (i.e. an asset with a useful life would add up to 5+4+3+2+1
= 15 years). Then, a company depreciates a proportion of costs based
on the corresponding digit (i.e. 5/15 for Year 1, 4/15 for Year 2).10
 Units of Production: A company assesses a baseline of anticipated
usage. For example, a company buys a company vehicle and intends
to drive it 100,000 miles. Each year, it assesses its actual use (i.e.
17,000 miles driven in year one) to determine what proportion to
depreciation (i.e. 17% of the depreciable base in year one).11

Key Differences
Now that we've highlighted some of the most obvious differences between
amortization and depreciation above, let's take a look at some of the more
specific factors that make these two concepts so distinct.

Applicability

By definition, depreciation is only applicable to physical, tangible assets

subject to having their costs allocated over their useful lives. Alternatively,
amortization is only applicable to intangible assets.

General Philosophy
The term depreciate means to diminish in value over time, while the term
amortize means to gradually write off a cost over a period. Depreciation is
recorded to reflect that an asset is no longer worth the previous carrying cost
reflected on the financial statements.

Amortization, on the other hand, is recorded to allocate costs over a specific

period. Both methods appear very similar but are philosophically different.

Options of Methods

Almost all intangible assets are amortized over their useful life using the
straight-line method. This means the same amount of amortization expense
is recognized each year. On the other hand, there are several depreciation
methods a company can choose from.

These options differentiate the amount of depreciation expense a company

may recognize in a given year, yielding different net income calculations
based on the option chosen.

Timing (Acceleration)

Of the different options mentioned above, a company often has the option of
accelerating depreciation. This means more depreciation expense is
recognized earlier in an asset's useful life as that asset may be used heavier
when it is newest.

Tangible assets can often use the modified accelerated cost recovery system
(MACRS).12 Meanwhile, amortization often does not use this practice, and
the same amount of expense is recognized whether the intangible asset is
older or newer.

Use of Salvage Value

The formulas for depreciation and amortization are different because of the
use of salvage value. The depreciable base of a tangible asset is reduced by
the salvage value. The amortization base of an intangible asset is not
reduced by the salvage value.

This is often because intangible assets do not have a salvage, while physical
goods (i.e. old cars can be sold for scrap, outdated buildings can still be
occupied) may have residual value.
Use of Contra Account

Depending on the asset and materiality, the credit side of the amortization
entry may go directly to to the intangible asset account. On the other hand,
depreciation entries always post to accumulated depreciation, a contra
account that reduces the carrying value of capital assets.

Amortization vs Depreciation: Key Differences

Amortization Depreciation
Applies only to intangible assets Applies only to physical assets
Philosophically spreads an asset's cost Philosophically reduces and asset's value
Generally is only done using the straight-line Has many different methods a company
method may choose from
Often results in the same amount recorded May result in accelerated, inconsistent
each year amounts recorded each year
Doesn't incorporate salvage value when May incorporate salvage value when
determining amortization base determining depreciation base
May not always use contra assets Always uses contra assets

Special Considerations
Depletion

Depletion is another way that the cost of business assets can be established
in certain cases. It is relevant only to the valuation of natural resources. For
example, an oil well has a finite life before all of the oil is pumped out.
Therefore, the oil well's setup costs can be spread out over the predicted life
of the well.

The two basic forms of depletion allowance are percentage

depletion and cost depletion. The percentage depletion method allows a
business to assign a fixed percentage of depletion to the gross income
received from extracting natural resources. The cost depletion method takes
into account the basis of the property, the total recoverable reserves, and the
number of units sold.13

Cash Flow

One of the primary similarities between depreciation and amortization (and

depletion) is the recognition of an expense without the associated cash flow.
For this reason, depreciation and amortization are both very misleading
expenses that may be omitted from certain reports to better clarify operating
needs.

For example, a company often must often treat depreciation and amortization
as non-cash transactions when preparing their statement of cash
flow.14 Without this level of consideration, a company may find it more
difficult to plan for capital expenditures that may require upfront capital.

Example of Amortization vs. Depreciation

As part of its 2021 annual report, Amazon (AMZN) included full-year
comparative financial statements accompanied by financial statement notes.
As shown on the company's statement of cash flow, Amazon aggregated
depreciation and amortization, reporting $34,296 of combined activity.15
Amazon, 2021 Annual Report (Select Information).
As is standard in financial statement disclosures, Amazon explained how it
approaches depreciation and amortization. For both, the company uses the
straight-line method. However, it uses a wide range of useful lives depending
on the underlying asset.16
Amazon, 2021 Annual Report (Select Information).
At the end of 2021, Amazon reported $238.8 billion of gross property and
equipment. Of this, only $78.5 billion of total accumulated depreciation and
amortization was recognized. This means that roughly one-third of the
company's fixed assets were depreciated. In addition, you'll note that land
was included in this section, which is non-depreciable. At the end of the year,
Amazon reported $160.3 billion of net property and equipment.17
Amazon, 2021 Annual Report (Select Information).
Amazon provided additional details regarding its intangible assets. It
classified its intangible assets as either finite-lived or in-process used
in research and development (R&D) . Most of the company's intangible assets
were finite-lived, with most of them being either marketing-related or contract-
based. At the end of 2021, the company had almost $7 billion of intangible
assets, though the company had accumulated amortization of over $1.8
billion.18
Amazon, 2021 Annual Report (Select Information).
Correction—Jan. 20, 2022: An earlier version of this article erroneously listed
land as an asset that could be depreciated. Land can never be depreciated,
according to the IRS.19
What Is an Example of Amortization?
A company may amortize the cost of a patent over its useful life. Say the
company owns the exclusive rights over a patent for 10 years, and the patent
is not to renew at the end of the period. The company may amortize the cost
of the patent for the decade, recognizing 10% of the expenses each year.
Through amortization, the carrying value of the trademark decreases.

What Is an Example of Depreciation?

The sum-of-the-years digits method is an example of depreciation in which a
tangible asset like a vehicle undergoes an accelerated method of
depreciation. Under the sum-of-the-years digits method, a company
recognizes a heavier portion of depreciation expense during the earlier years
of an asset's life. In theory, more expense should be expensed during this
time because newer assets are more efficient and more in use than older
assets.

Why Do We Amortize a Loan Instead of Depreciate a

Loan?
Loans are amortized because they are intangible. A loan doesn't deteriorate
in value or become worn down over use like physical assets do. Loans are
also amortized because the original asset value holds little value in
consideration for a financial statement. Though the notes may contain the
payment history, a company only needs to record its currently level of debt as
opposed to the historical value less a contra asset.20

How Do I Know Whether to Amortize or Depreciate an

Asset?
Generally speaking, there is accounting guidance via GAAP on how to treat
different types of assets. Accounting rules stipulate that physical, tangible
assets (with exceptions for non-depreciable assets) are to be depreciated,
while intangible assets are amortized.

Is It Better to Amortize or Depreciate an Asset?

It is neither better to amortize or depreciate an asset. Instead, there is
accounting guidance that determines whether it is correct to amortize or
depreciate an asset. Both terminologies spread the cost of an asset over its
useful life, and a company doesn't gain any financial advantage through one
as opposed to the other.

The Bottom Line

Two common techniques are used to reflect the benefit of an asset and its
associated costs over a period of time. Both depreciation and amortization
reduce the carrying value of assets and recognize expenses as assets are
used over time. However, depreciation is used for physical assets, while
amortization is used for intangible assets. In addition, there are differences in
the methods available, acceleration options, how salvage value is used, and
how contra accounts are used.

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