Assets acquired by a company might nave a long, useful life. They may provide benefits to the company over years, not just during the accounting period in which they are acquired. Amortization and depreciation are two main methods of calculating the value of these assets such as company vehicles, goodwill, and office buildings (except for land).

The cost of these assets can be expensed each year over the estimated useful life of the assets to accurately reflect their use. The expense amounts can then be used as a tax deduction, reducing the tax liability of the company.

The main difference between amortization and depreciation involves the type of asset being expensed. There are also differences in the methods allowed. Components of the calculations and how they're presented on financial statements also vary.

Amortization

Amortization is the accounting practice of spreading the cost of intangible assets over their estimated useful life. Intangible assets aren't physical but they're still assets of value. They include patents, franchise agreements, copyrights, costs of issuing bonds to raise capital, and organizational costs.

Amortization is generally expensed on a straight-line basis. The same amount is expensed in each accounting period over the asset's useful life. Assets that are expensed using the amortization method usually have no resale or salvage value.

Depreciation

Depreciation is the expensing of fixed assets over their estimated useful. Fixed assets are tangible objects acquired by a business. Examples of fixed or tangible assets that are commonly depreciated include buildings, (not including land), equipment, office furniture, vehicles, and machinery.

Tangible assets usually have some value when the business no longer has a use for them. Depreciation is therefore calculated by subtracting the asset's salvage value or resale value from its original cost.

Depreciation Methods

Companies usually have several options when selecting a depreciation method. The most common 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.
• Declining balance: A company depreciates an accelerated amount of depreciation earlier in the asset's useful life by multiplying the current book value of the asset by a fixed depreciation rate that doesn't change over the life of the asset.
• 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.
• Sum-of-the-years digits method: The digits of the asset's useful life are summed. An asset with a useful life would add up to 5+4+3+2+1 = 15 years. A company then depreciates a proportion of costs based on the corresponding digit such as 5/15 for year one and 4/15 for year two.
• Units of production: A company assesses a baseline of anticipated usage. It might buy a company vehicle and intends to drive it 100,000 miles. It assesses its actual use each year such as 18,000 miles driven in year one to determine what proportion to depreciate. It would work out to 18% of the depreciable base in year one in this example.

 

Depreciation Expense - Accounting

Cost Accounting

Tax Shelters