Difference Between Amortisation vs Depreciation Explained

Amortisation and depreciation are crucial accounting concepts that allow companies to expense their tangible and intangible assets, respectively. Read on to know more about amortisation vs depreciation in terms of differences and similarities.

The accounting practice of spreading out or expensing asset costs over its normal operating life comes under the amortisation process. It involves intangible assets like trademarks, patents, licenses, etc.

The primary objective of undertaking amortisation is to match the cost of acquiring the said asset with expected revenue generated from the same. Amortisation allows accountants to shift these intangible assets to the profit and loss statement from the balance sheet.

This allows companies to consider these as deductible expenses, thereby lowering their overall tax liability. Let’s understand amortisation with an example:

Company XYZ undertook research and development activities so as to develop a product. After successfully developing a product and completing all the trials related to it, they applied for a patent of the product. The total cost of research and development, as well as acquiring the patent, was $500,000, and validity of the patent was for 10 years.

Therefore, Company XYZ will undertake amortisation of the patent across 10 years of its operation. Under the straight line method of computing amortisation, the company will spread out the cost at a uniform rate over 10 years. This way, the annual amortisation cost for the patent will be:

$500,000 (Total Cost of intangible asset) / 10 years (Validity or useful life) = $50,000

This signifies a fall in the value of patents by $50,000 every year.

Depreciation is a process of expensing the cost of a tangible asset like plant and machinery, buildings, etc. over its operating life cycle. This process reduces an asset’s value on an annual basis.

Companies calculate depreciation by subtracting the original cost of an asset from its resale value. This value is then uniformly spread out over its useful life, and that asset is recorded in the income statement rather than considering it as capital investment on the balance sheet.

Moreover, the expensed value is claimed as a tax-deductible item, thereby reducing the overall tax liability of the company. Suppose a company buys a building to operate it as its headquarters for a transaction amount of $800,000, and lifespan of the building is presumed at 50 years.

Using straight line method of depreciation, the per year depreciated value of the building will be:

$800,000 (Total cost of tangible asset) / 50 years (Lifespan of the asset) = $16,000

$16,000 will be recorded in the income statement for 50 years.

Amortisation and depreciation are similar on some parameters as well, which have been discussed below:

• Both of the concepts come under the non-cash expenses of a company. They do not incur any reduction from their reserves.
• Another similarity is that both these concepts have to undergo impairment. The carrying value of both amortisation and depreciation gets written off, leading to a consequent decline in their values over time. This happens because there is a smaller remaining balance which needs to be offset.

To simply explain amortisation vs depreciation, to depreciate means to lose value and to amortise means to decrease the cost of an asset over time. However, the primary difference between amortisation and depreciation is that the former is applied to intangible assets, and the latter is related to tangible assets.