Businesses incur a cost in various forms. It is always a balance between the cost and revenue that makes a business run successfully.
The revenue that is got is also due to the expenditure done on various fronts. The calculated costs that are incurred to get a profitable revenue is a business strategy.
Of course, keeping people in good harmony, money management, productivity increase all comes to one picture. But there is something more than that to be considered for the businesses to run for a very long time.
It is the control and safeguarding and repurchasing of assets. This also comes with a cost, they can be manpower revamp, purchase of new machinery or renewal of a patent or a copyright license.
The value of a particular purchase keeps reducing day by day for many reasons. What remains constant is value reduction.
Businesses calculate it meticulously as they remain the prime part of the industry functionality too. The value reduction of a particular asset is categorized into two types; Depreciation and Amortization.
Depreciation vs Amortization
The main difference between Depreciation and Amortization is the reduction of cost of the tangible fixed assets over its time of lifespan which is directly proportional to the use of the asset for a specific year while Amortization is the reduction of cost of intangible assets over its lifespan.
Comparison Table Between Depreciation and Amortization (in Tabular Form)
| Parameter of Comparison | Depreciation | Amortization |
|---|---|---|
| Meaning/Definition | It is the reduction of the cost of tangible assets over its lifespan which is proportionate to the usage of the asset in a specific year. | It is the reduction of the cost of intangible assets over a lifespan. |
| Applicable to | It applies to tangible assets like Machines, Equipment, Furniture, Building. | It applies to intangible assets like patents, licenses, copyright, agreements. |
| Implementation method | Depreciation can be done using the straight-line method (SLM) or accelerated depreciation method. | Amortization can be done using the Straight Line Method. |
| Salvage Value | Depreciation has salvage value for the items which have their costs reduced. | Amortization does not have any salvage value to it. It has to be completely remade with the new cost. |
| Expense and Benefits | Depreciation can be used for taxation purposes however rapid depreciation can be highlighted as higher expense in initial years of service. | Amortization also helps in taxation purposes and can never be shown higher expense in any future years to come by. |
What is Depreciation?
Depreciation is the reduction of cost of the tangible assets available in the company over its lifespan which is proportionate to the usage of the same asset in a specific year. Depreciation applies to assets like building, machines, equipment, furniture.
Depreciation can be used as a straight-line method or accelerated depreciation method. Accelerated depreciation is used to show higher expenses in the initial years of the erection of a machine or a building or a piece of equipment.
It represents the amount of assets’ value has been used every year. The assets which depreciate, of course, earn revenue and a part of the revenue is allocated as a cost to maintain the asset to produce revenue the next year too.
The companies can very well take tax reductions on depreciating items. As such that will not come under taxable income too.
It is also widely understood that the depreciating costs must be widely spread over some time for taxation purposes. The rules are strict when it comes to tax reductions. An asset that is depreciating has its own cost over some time. The sum of all depreciation occurred in the asset’s life span is called accumulated depreciation.
What is Amortization?
Amortization is the reduction of cost for the intangible items over its life span. Amortization applies to patents, licenses, rental agreements, copyrights.
Amortization refers to two things, one is clearing the debts through strict installments and the other is the spreading of expenses which is related to the intangible assets over some time. The period shall be normally the entire lifespan of the intangible asset.
Amortization can be used for taxation purposes too. It can be used as the Straight-line method.
The amortization is a cost tied up with the intangible asset which must be adjusted with the revenue generated by the tangible assets. The value of the intangible assets keep reducing every year.
Amortization is majorly connected with the debt that the company has. The greater percentage of amortization goes towards the principal amount in the loan, the rest is the interest being paid.
Amortization assets cannot get any benefit from the salvage value as it cannot be resold. Amortization is simply considered as an expense to the company, In the balance sheets, the record of amortization shall be done as a portion of the cost and not the entire cost. This is done in each accounting period of a financial year.
Main Differences Between Depreciation and Amortization
- The main difference between depreciation and amortization is, depreciation is the reduction of cost on the tangible asset over its lifespan which is proportionate to the usage of the asset in a specific year, while amortization is the reduction of cost of the intangible assets over a lifespan.
- Depreciation applies to tangible assets like furniture, equipment, building, machinery while amortization is applicable to license, patents, copyrights, trademarks.
- Depreciation can be used as a Straight-Line Method or accelerated depreciation method whereas AMortization can be used as a straight line method only.
- Depreciation has the salvage value of the asset as it can be resold while amortization does not have the benefit of salvage value.
- There are taxation benefits for both depreciation and amortization, however, depreciation has higher benefits as higher expenses can be shown through accelerated depreciation in the initial years of service whereas no such benefit is available for amortization.
Conclusion
The businesses incur a lot of costs and the cost can also help in benefits. It is the strategy to work under the law to look at these benefits which are on offer. While tangible assets are required for generating revenue, intangible assets are required for security and market branding.
They both have to be incurred for the successful running of a business cycle. The role played by both in the industry requires knowledgeable auditors and account personnel to work on the numbers. After all, taxation is connected to the government, and producing the right papers for the cost incurred must be legitimate.
References
- https://academic.oup.com/qje/article-abstract/69/2/191/1873131
- https://www.ebr.edu.pl/pub/2014_2_63.pdf