Depreciation and amortisation both meant to reduce the value of the asset year by year, but they are not one and the same thing. The difference between the two must be appreciated. Writing off tangible assets for the period is termed as depreciation, whereas the process of writing off intangible fixed assets is amortization.
Fixed assets refers to the assets, whose benefit is enjoyed for more than one accounting period. Fixed assets can be tangible fixed assets or intangible fixed assets. The value of fixed asset tends to decrease over time. As per matching concept, the portion of asset employed for creating revenue, needs to be recovered during the financial year, so as to match the expenses for the period. And for this purpose, depreciation and amortization is applied, on the fixed assets.
So, take a read of the article given below, which describes the difference between depreciation and amortization in detail.
Content: Depreciation Vs Amortization
|Basis for Comparison||Depreciation||Amortization|
|Meaning||Depreciation is a technique used measure the decrease in the value of the asset due to age, wear and tear or any other technical reason.||Amortization is a method of allocating the depreciable amount over the life of the intangible fixed asset.|
|Governing Accounting Standard||AS - 6 for Depreciation||AS - 26 for Intangible Assets|
|Applies on||Non-current Tangible Asset like machinery, vehicle, computers etc.||Non-current Intangible Asset like copyright, patent, goodwill etc.|
|Purpose||To prorate the cost of the asset over its life years.||To capitalize the cost of the asset over its life years.|
|Methods||Straight Line, Reducing Balance, Annuity, Sum of years digit, etc.||Straight Line, Reducing Balance, Annuity, Increasing Balance, Bullet etc.|
|Type of Expense||Non-Cash||Non-Cash|
Definition of Depreciation
A technique used to determine the loss in the value of the long-term fixed tangible asset due to usage, wear and tear, age or change in market conditions is known as depreciation. Long term fixed tangible assets mean the assets which are owned by the company for more than three years, and they can be seen & touched. The depreciation is charged as a capital expenditure against the revenue generated from the asset during the year i.e. matching concept.
For the purpose of calculating the depreciation, the cost of the asset is taken into consideration, from which the salvage value is deducted, and then the amount obtained is divided by the estimated number of life years as per Straight Line Method of Depreciation. Now, the amount obtained is charged as an expense every year in the Profit & Loss Account and simultaneously deducted from the value of an asset in the Balance Sheet. Salvage Value means the value obtained when the asset is resold at the end of its lifetime.
There are two very popular methods of depreciation, i.e. Straight Line Method and Written Down Value Method (Reducing Balance Method). An organization may opt any method of depreciation, but it should be applied consistently in every financial year. If an organization wants to change the method of depreciation, then the retrospective effect is to be given. Any surplus or deficit arising on account of such change in the method of depreciation shall be debited or credited to the profit & loss account as the case may be.
Definition of Amortization
Amortization is a method of measuring the loss in the value of long-term fixed intangible assets due to the passage of time, to know about their decreased worth is known as amortization. Long term fixed intangible assets are the assets which are owned by the entity for more than three years, but they do not exist in its material form like computer software, license, franchises, etc. Similarly, like depreciation, the amount of amortization is also shown on the assets side of the Balance Sheet as a reduction in the intangible asset.
Various methods of amortization are given like Straight Line, Reducing Balance, Bullet, etc. The cost of the asset is reduced by the residual value, then it is divided by the number of its expected life, the amount obtained will be the amount of amortization, this is a Straight line method.
There are cases when the amortization is charged in a lump sum, i.e. in the year in which the intangible asset is acquired, which is incorrect, as the benefit from that asset will be received over a long time so it should be apportioned on the life of the asset, this method is known as Bullet Method. Sometimes the pattern for charging amortization is also given in which the amount is charged every year on a proportionate basis.
Amortization is not charged as an expense on the assets which are internally generated or on the assets which have infinite life years.
Key Differences Between Depreciation and Amortization
The major differences between depreciation and amortization are as under:
- A technique used to calculate the reduced value of the tangible assets is known as Depreciation. Amortization is a measure to calculate the reduced worth of the intangible assets.
- Depreciation applies to tangible assets i.e. the assets which exist in physical form like plant and machinery, vehicle, computer, furniture, etc. Conversely, Amortization applies on intangible assets i.e. the assets which exist in their non-physical form like royalty, copyright, computer software, import quotas, etc.
- The primary objective of depreciation is to allocate the cost of assets over its expected useful life. Unlike amortization, which focuses on capitalizing the amount of the cost of an asset over its useful life.
- Methods for calculating depreciation are Straight Line, Reducing Balance, Annuity, etc. On the other hand, the method for calculating amortization are Straight Line, Reducing Balance, Annuity, Bullet, etc.
Depreciation and Amortization are typically identical terms the only difference is that depreciation applies to tangibles while amortization applies to intangibles. Both are non-monetary capital expenditure and hence shown in the assets side of the Balance Sheet as a reduction in the value of the asset concerned. However, these two terms are governed by different accounting standard