John has purchased the red Mercedes last year. Due to some reasons he wants to sell it off but to his surprise, he was getting much less amount that what he had purchased. Like many of us, he was also confused because he does not know that the value of the car purchased today won’t remain same after few year of its use. The commonly used term to deduct the particular amount before re selling the car is Depreciation and amortization. On first look they may look same but they are not same. I am going to explain the basic differences between depreciation and amortization below. You can take a quick overview to make out the right difference of both!
Depreciation is concerned with Tangible assets. The assets which we can see and touch can depreciate; like machinery and building among others. Their costs are spread over the number of years. Depreciation takes into account the wear and tear of the tangible assets. The moment you own or use the assets, it starts depreciating. There are at least 10 methods in accounting to take into account the depreciation. The income tax laws and company laws decide which method to use and how to use it.Suppose, a company buys a machine for $12 million and expects it to have a useful life of 12 years, its cost will be depreciated over 12 years. In each accounting year, the company will write off $1 million (according to straight-line depreciation method), money depreciated would help company to make more money by that time.
Amortization is concerned with intangible assets. The assets which we can’t see or touch but we can feel like patents and copy rights come under intangible assets. It is the part of capitalized expenditure and preliminary expenditure which is usually distributed over the number of years. It is also fixed by company’s law and it can rapidly change. Basically, in amortization the intangible assets are written off over the number of years.
For example ABC Company spent $48 million US dollars on a Car engine technology and the patent on the engine lasts 12 years, this will mean that $4 million will be accounted each year as an amortization expense.
Both depreciation and amortization are non cash expense of the company and they decrease the earning while increasing the cash flow.