The document discusses the accounting concepts of amortization, depreciation, and depletion. Amortization refers to allocating the cost of intangible assets over their useful lives, while depreciation refers to allocating the cost of tangible assets. Depletion allocates the cost of natural resources. Key differences are that amortization applies to intangible assets and loans, while depreciation applies only to tangible assets.
The document discusses the accounting concepts of amortization, depreciation, and depletion. Amortization refers to allocating the cost of intangible assets over their useful lives, while depreciation refers to allocating the cost of tangible assets. Depletion allocates the cost of natural resources. Key differences are that amortization applies to intangible assets and loans, while depreciation applies only to tangible assets.
The document discusses the accounting concepts of amortization, depreciation, and depletion. Amortization refers to allocating the cost of intangible assets over their useful lives, while depreciation refers to allocating the cost of tangible assets. Depletion allocates the cost of natural resources. Key differences are that amortization applies to intangible assets and loans, while depreciation applies only to tangible assets.
The document discusses the accounting concepts of amortization, depreciation, and depletion. Amortization refers to allocating the cost of intangible assets over their useful lives, while depreciation refers to allocating the cost of tangible assets. Depletion allocates the cost of natural resources. Key differences are that amortization applies to intangible assets and loans, while depreciation applies only to tangible assets.
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Because
very few assets last forever, one of the main principles of accrual accounting
requires that an asset's cost be proportionally expensed based on the time period over which the asset was used. Depreciation and amortization (as well as depletion) are methods that are used to prorate the cost of a specific type of asset to the asset's life. It is important to mention that these methods are calculated by subtracting the asset's salvage value from its original cost.
Amortization usually refers to spreading an intangible asset's cost over that asset's
useful life. For example, a patent on a piece of medical equipment usually has a life of 17 years. The cost involved with creating the medical equipment is spread out over the life of the patent, with each portion being recorded as an expense on the company's income statement.
Depreciation, on the other hand, refers to prorating a tangible asset's cost over that asset's life. For example, an office building can be used for a number of years before it becomes run down and is sold. The cost of the building is spread out over the predicted life of the building, with a portion of the cost being expensed each accounting year.
Depletion refers to the allocation of the cost of natural resources over time. For example, an oil well has a finite life before all of the oil is pumped out. Therefore, the oil well's setup costs are spread out over the predicted life of the oil well.
It is important to note that in some places, such as Canada, the terms amortization and depreciation are often to used interchangeably to refer to both tangible and intangible assets.
Amortization vs depreciation
Amortization and depreciation are two words that are often used synonymously. Quite often, such interchanging of terms is harmless because both accounting charges are quite alike. However, there are some major differences related to the two, which must be borne in mind. Amortization is writing off of loans or intangible assets in equated annual/monthly installments over a scheduled period. Depreciation is writing off of tangible asset as consumed on pro-rata basis, for estimated pre-defined life of the asset.
Both can be calculated in straight-line and diminishing balance methods:
Both reduce the values of assets in the books to zero. Both are accounting charges. The two can also co-exist. For example, a business buys a car by taking a loan. The loan will be amortized, and the car will be depreciated. Here it would be wrong to say that car is amortized.
Equated installment of an amortization loan has two components, i.e., the interest component and the component of loan that is being repaid. Unlike it, depreciation charge cannot be segregated into two components.
Loans that are being amortized are generally obtained by mortgaging the property, which continues as long as any part of the loan remains outstanding. The same is not true for depreciation. If an asset is acquired by taking a loan, and as a security, this asset is mortgaged, then amortization of loan, and depreciation of asset will go on simultaneously. If, however, the loan is repaid much before the life of asset is exhausted, then, the asset continues to be depreciated, whereas amortization aspect of it ceases.
Another crucial difference is that quantum of loan installments influence purchase
decisions. That is, amortization of loans becomes a primary concern due to variables like interest rate, tenure, quantum of loan, etc. If the installment is higher, the borrower may opt to defer or forego the purchase. It is, however, unlikely that a business enterprise will forego its decision to purchase an asset because of higher depreciation charges. If at all, such higher depreciation is likely to result in tax savings.
Depreciation is essentially asset value reduction through an annual accounting charge.
Unlike it, amortization reduces both assets and liabilities, i.e., it is applicable to intangible assets, which are assets, and loans, which are are liabilities.
Tax benefits related to amortization differ from those related to depreciation, especially in cases of home loans. The interest component from home loan installments is allowed as expense for purposes of tax. The principal component from these installments, however, does not entitle the borrower to any tax benefits. Unlike it, entire amount of depreciation is expensed for tax purposes.
International Accounting Standard 36 and 38 lay down the principles and rules for accounting amortization. On the other hand, International Accounting Standard 16 and 36 cover depreciation rules. Within United States, Generally Accepted Accounting Principles (GAAP)'s Statement of Accounting Standard No.142 is the one that lays down the method for accounting amortization. In case of depreciation, it is Accounting Standard No.6, which lays down the rules.
