What Is the Difference Between Depreciation and Amortization? 

6 min read | Posted on: January 14, 2025

The financial picture of your small business requires applying accounting concepts around expenses. There are two main categories — depreciation and amortization. These are two are separate categories. The better you understand amortization vs. depreciation, the more informed your decision-making can be. 

In this guide, you’ll learn what amortization and depreciation are. Additionally, we’ll explain their key differences, when to use each, and the benefits they offer your business.  

Then, we’ll wrap up with key tips for using each concept within your business. 

What Is Amortization? 

Amortization is a business accounting practice focused on intangible assets. Intangible assets are non-physical, but they still hold value. You amortize to spread the cost of an intangible asset over its useful life.  

Examples of intangible assets include: 

  • Franchise agreements 
  • Trademarks, copyrights, and patents 
  • Software and digital asset 
  • Intellectual property (IP) 

Even though these aren’t physical assets, they do lose value over time. For example, your technology may become obsolete and no longer be of use. Companies use amortization to accurately represent the decrease of these intangible assets over time. 

The information from practicing amortization can provide insights into financial performance related to expenses you incur from using and maintaining these assets. 

There are several possible calculations for amortization: 

  • Straight-line method: It’s a uniform option to reduce the value of the asset each year until its useful life is over. It’s the simplest way to amortize. 
  • Declining balance method: This approach accelerates the value amount, with higher numbers at the beginning, which then taper off. You’d use this when you want to recognize more expense now or for assets used more intensely in their early years. 

FROM OUR PARTNERS: 42 Common Accounting Terms All Business Owners Should Know 

What Is Depreciation? 

Depreciation is similar to amortization. It also systematically allocates the cost of an asset over its useful life. However, it relates to physical assets.  

Depreciation represents how much of an asset’s value has been used up or consumed during a specific period. Typically, this reflects wear and tear, obsolescence, or aging.  

Examples of physical or fixed assets include: 

  • Equipment 
  • Property 
  • Vehicles 
  • Hardware. 

There are several terms you’ll need to know when making depreciation calculations. First, the asset cost is an expense in your accounting records. You’re simply extending the expense across its useful life. 

The second is understanding its importance in your finances. It provides you with profitability insights, as it indicates the decline in the value of the asset. It reduces the book value of the asset, which is necessary in tax calculations. 

So, what methods are usable for determining depreciation? The most common is the straight-line method and declining balance, as defined above.  

Other calculations are: 

  • Double-declining: You can use this to accelerate the deprecation amount by doubling the rate used in the straight-line method. 
  • Units of production: In this option, you find the value of income-producing assets before they deteriorate. It’s a good option for items that operate considerably over time, like equipment or vehicles. 
  • Sum-of-the-years’ digits depreciation: You could use this method for assets that are more valuable and useful in their early years. It works for things that depreciate quickly. 

RELATED ARTICLE: How to Use Profitability Ratios to Improve Financial Performance 

Key Differences Between Amortization and Depreciation 

As you can see, deprecation vs. amortization have some overlap and similarities. However, they are unique, separate, and not interchangeable. 

What is the difference between depreciation and amortization? Let’s look at the key differences between the two concepts. 

They Cover Different Asset Classes 

Amortization applies only to intangible assets. Depreciation is usable with fixed and physical items you purchase for your business. 

Additionally, amortization assets often have a much longer useful life. Some could be open-ended. They typically lose value due to technological innovation, the expiration of a legal attribute (e.g., trademarks end), or greater competition in the market. 

Depreciation assets all have a finite useful life. They’ll become less valuable with usage. They can also become obsolete when something better becomes available. 

Calculation Methods 

Amortization tends to be simpler in calculations. For example, if your company invests in a trademark costing $10,000 over five years, the amortization value is the cost of the patent divided by its useful life. 

In this example, the amortization expense is the same each year. 

Depreciation may be more complex. It really depends on the type of asset and its usage. Depreciation expense is more likely to be dynamic each year depending on the calculation method. 

Impact on Financials 

Another difference between amortization and depreciation is how it impacts your accounting records and taxes. 

Amortization helps you spread the cost of the asset over time. Depreciation enables you to recover a physical item’s expense over time, gradually decreasing the carrying value on your balance sheet. 

Acceleration Options 

You can accelerate depreciation, especially if the asset will be in heavier use in its early years. Amortization would rarely accelerate. 

Physical assets often use the modified accelerated cost recovery system (MACRS). This approach lets you recover the cost basis of a deteriorating asset. MACRS can be beneficial for tax purposes, giving you a greater expense early. 

Salvage Value 

Salvage value is an essential term related to assets. It’s the estimated book value of an asset after depreciation is completed. 

You can reduce the depreciable base of a physical asset by its salvage value. You cannot do this with an intangible asset. Only rarely would one have a salvage value. 

The end of an intangible asset’s life leaves you with accumulated amortization. It’s the total expense you’ve recorded for that asset over time. 

Contra Account Usage 

Another difference to note revolves around contra accounts. A contra account is one within a general ledger that reduces the value of a related account when you net two together. 

A contra account holds a balance that’s the opposite of the related account. For instance, if the related account has an asset with a debit balance, its contra will have a credit balance. 

Amortization may not use a contra, but depreciation always does. 

Benefits of Understanding Amortization and Depreciation for Your Business 

Knowledge of deprecation vs. amortization provides insights into costs and profitability. They are vital for visibility into your finances. You can realize the benefits below. 

They’re both deductible on your taxes as business expenses. For small businesses with minimal budgets, they can be a huge tax advantage. 

You can use amortization indefinitely until the asset is no longer usable. It’s an annual deduction as long as you’re using it. 

Depreciation also reduces your tax burden since it can be an expense for multiple years. 

You’ll have clarity around an asset’s true value. You can compare its role as a revenue generator to its costs. This insight could help you make better purchasing decisions. 

Amortization and deprecation also support asset valuation. You can then be more precise in reporting an asset’s net book value. 

Knowing when to use each method ensures you’re applying the correct formulas in accounting, too. 

When to Use Amortization vs. Depreciation in Accounting 

When should you use amortization vs. depreciation? The first and most obvious answer is that amortization is for intangible assets. Depreciation accounts for physical assets.  

Here are some specific examples: 

The Purchase of Software Applications 

With this expense, you’ve bought a digital asset, such as invoicing software. You determine you’ll use it for at least five years without needing an upgrade. You’d amortize here, dividing the cost by useful life. 

Computer Hardware Expenses 

Computer hardware is technology, but it’s a real asset like a monitor screen or laptop. You’d use deprecation in this instance. You would divide its cost by the expected useful life. 

Items With Salvage Value 

Any asset that has a probable salvage value will most likely go into the depreciation class. For example, computer hardware or equipment may be able to be refurbished and resold. 

You purchase a machine for $10,000 and plan to use it for three years. After that time, its salvage value is $500. So your depreciation expense is: ($10,000 – $500) divided by three years. 

When unsure about depreciation vs. amortization, consult the Generally Accepted Accounting Principles (GAAP). The GAAP offers advice and guidance on handling and categorizing assets. 

Generally, the GAAP dictates that tangible assets follow depreciation, and intangible assets use amortization. 

Is it better to depreciate or amortize an asset? One isn’t better than another. Instead, it depends on the asset and its application in your business. 

What’s most crucial is that you use one or the other for every asset in your accounting and tax filings. 

RELATED ARTICLE: Cost Accounting 101: A Guide for Small Businesses 

Key Takeaways for Amortization vs. Depreciation 

As a recap of amortization vs. deprecation, keep these tips in mind: 

  • Amortization spreads the cost of an asset, while depreciation reduces its value. 
  • Amortization and depreciation both affect your impact statement. They are expenses but in different categories. 
  • Depreciation and amortization reduce the book value of fixed or intangible assets. As a result, you have a more accurate view of asset value across your business. 
  • Both expenses should be included in your tax returns. Failure to include these would decrease your deductions. 
  • You’ll treat amortization and deprecation as non-cash add-back on your cash flow statement. 

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