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Depreciation vs Amortization: What's the Difference?

When it comes to business accounting, there are a lot of terms that get thrown around. Two of those terms are depreciation and amortization. And while they may sound similar, there is a big difference between the two.

What is Depreciation?

Depreciation is an accounting method used to spread the cost of a physical asset over its useful life. This is done by recording a depreciation expense on the income statement, which reduces the book value of the asset on the balance sheet.

There are two main methods of depreciation: the straight-line method and the declining balance method. The straight-line method is the most commonly used, and it simply spreads the cost evenly over the asset's useful life. The declining balance method, on the other hand, accelerates the depreciation expense in the early years of the asset's life.

What is Amortization?

Amortization is an accounting method used to spread the cost of an intangible asset over its useful life. Like depreciation, this is done by recording an amortization expense on the income statement, which reduces the book value of the asset on the balance sheet.

There are two main types of intangible assets: goodwill and patents. Goodwill is created when one company buys another company for a price that is higher than the fair market value of the assets. This premium is recorded as goodwill on the balance sheet. Patents are intellectual property rights that give the owner the exclusive right to produce and sell a product or process for a certain period of time.

The Difference Between Depreciation and Amortization

The main difference between depreciation and amortization is that depreciation is used for physical assets and amortization is used for intangible assets. Other than that, the two accounting methods are very similar.

How to Calculate Depreciation

There are two main methods of calculating depreciation: the straight-line method and the declining balance method. The straight-line method is the most commonly used, and it simply spreads the cost evenly over the asset's useful life. The declining balance method, on the other hand, accelerates the depreciation expense in the early years of the asset's life.

How to Calculate Amortization

Amortization is calculated in much the same way as depreciation. There are two main methods of calculating amortization: the straight-line method and the declining balance method. The straight-line method is the most commonly used, and it simply spreads the cost evenly over the asset's useful life. The declining balance method, on the other hand, accelerates the amortization expense in the early years of the asset's life.

Conclusion

Depreciation and amortization are two accounting methods used to spread the cost of an asset over its useful life. The main difference between the two is that depreciation is used for physical assets and amortization is used for intangible assets. Other than that, the two methods are very similar.

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