What Does the Term “Amortization” Mean?
Amortization is known as the process of disbursing an intangible asset’s purchase price throughout the asset’s useful life. Physical assets are not intangible assets.
Amortization is usually deducted on a straight-line basis, which means that the same amount is deducted each period during the asset’s useful life. Therefore, contrary to depreciation, assets expensed via the amortization technique typically have little salvage or resale value.
The following are examples of intangibles that are expensed through amortization:
- franchise contracts
- proprietary methods, such as copyright
- Patents and Trademarks
- Costs of organization
- Bond issuance fees when raising funds
It’s crucial to consider the context when using the word amortization because it has two meanings. First, as with a mortgage, a series of loan installments that include the principle and interest in each installment is calculated using an amortization plan. As a result, the term “amortization” has distinct meanings when used in lending and accounting.
What Does the Term “Depreciation” Mean?
Depreciation is charging costs to a fixed asset throughout its useful life. This is because fixed assets are observable, touchable, tangible objects.
Fixed or physical assets that are subject to depreciation include:
- Office equipment
Depreciation is computed by deducting the asset’s salvage value or resale value from its original cost since tangible assets may still have some worth at the end of their useful lives. Over the asset’s anticipated life, the difference is depreciated equally. In other words, until the asset’s useful life has passed, the corporation may deduct the depreciation expense each year from its taxes.
An office building, for instance, may be occupied for several years before becoming dilapidated and being sold. The building’s cost is divided up throughout its anticipated lifespan, with a portion of it being written down in each accounting year.
Some fixed assets can depreciate more quickly, meaning that more of the asset’s value is incurred in the first few years of its period. An illustration of rapid depreciation is an automobile.
Depreciation is used for tangible assets, whereas amortization is used for intangible assets. Another significant distinction is that while depreciation can be applied using either the straight-line or accelerated methods, amortization is nearly typically applied using the straight-line approach. A salvage value, an asset’s expected resale cost at the end of its useful life, is not present for amortized assets because they are intangible. Contrarily, depreciated assets may have a salvage value. The amount that an asset may be depreciated must be calculated by deducting its cost from its salvage value.
Salvage value usage, whether accelerated expensing is employed, and how each is depicted on the financial statements are other differences between the two accounting techniques.
The assets are what matter most.
When a business buys assets, such assets typically have a price. The cost of assets must be spent appropriately depending on their employment period, though, as most assets only endure for a while. Therefore, the cost of corporate investment is prorated throughout its helpful life via amortization and depreciation.