Depreciation vs. Amortization

Depreciation and amortization both spread the cost of a long-term asset over its useful life, but they apply to different asset types. Depreciation covers tangible assets such as equipment, vehicles, and buildings. Amortization covers intangible assets such as patents, copyrights, and software licenses. Understanding when to use each method is essential for accurate financial reporting and tax compliance.

Both processes serve the same accounting goal: matching the expense of an asset to the periods in which it generates revenue, consistent with the matching principle under GAAP.

What Is Depreciation?

Depreciation is the systematic allocation of a tangible asset's cost over its useful life. When a company buys a piece of equipment, it does not expense the entire cost in the year of purchase. Instead, a portion of the cost is recognized each year until the asset reaches its salvage value.

Common Tangible Assets That Are Depreciated

• Buildings and leasehold improvements
• Machinery and manufacturing equipment
• Office furniture and fixtures
• Vehicles (cars, trucks, forklifts)
• Computers and servers

Land is the notable exception -- it is not depreciated because it does not wear out or become obsolete.

Straight-Line Depreciation Example

A landscaping company buys a mower for $18,000. It expects the mower to last six years and have a salvage value of $3,000.

Annual depreciation = ($18,000 - $3,000) / 6 = $2,500 per year

Each year, the company records a $2,500 depreciation expense on the income statement and increases accumulated depreciation on the balance sheet by the same amount.

Year	Depreciation Expense	Accumulated Depreciation	Book Value
1	$2,500	$2,500	$15,500
2	$2,500	$5,000	$13,000
3	$2,500	$7,500	$10,500
4	$2,500	$10,000	$8,000
5	$2,500	$12,500	$5,500
6	$2,500	$15,000	$3,000

Accelerated Depreciation

Accelerated methods such as double-declining balance front-load the expense, recording larger amounts in the early years of an asset's life. This approach can be useful when an asset loses value quickly -- vehicles and technology hardware are common examples.

The IRS also provides accelerated options through Section 179 expensing and bonus depreciation under the Modified Accelerated Cost Recovery System (MACRS), which can allow businesses to deduct the full cost of qualifying assets in the year of purchase.

What Is Amortization?

Amortization is the process of expensing an intangible asset over its useful life. Unlike most tangible assets, intangible assets typically have no salvage value, so the full cost is amortized.

Common Intangible Assets That Are Amortized

• Patents (typically amortized over their legal life, often 20 years)
• Copyrights
• Trademarks with a finite legal life
• Software development costs (capitalized under FASB ASC 350-40)
• Franchise agreements
• Licensing agreements

Goodwill is an intangible asset, but under current U.S. GAAP it is not amortized by public companies -- it is tested for impairment annually. Private companies may elect to amortize goodwill over a period of up to ten years under ASC 350-20.

Amortization Example

A software company acquires a patent for $50,000 with a remaining legal life of 10 years.

Annual amortization = $50,000 / 10 = $5,000 per year

Account	Debit	Credit
Amortization Expense	$5,000
Accumulated Amortization -- Patent		$5,000

After 10 years the patent's book value reaches zero.

Key Differences at a Glance

Feature	Depreciation	Amortization
Asset type	Tangible (physical)	Intangible (non-physical)
Salvage value	Often has a residual value	Usually none
Methods available	Straight-line, declining balance, units of production, MACRS	Almost always straight-line
Balance sheet contra account	Accumulated Depreciation	Accumulated Amortization
Tax treatment	MACRS, Section 179, bonus depreciation	Section 197 (15-year amortization for acquired intangibles)

How Both Affect the Financial Statements

Income Statement

Both depreciation and amortization appear as operating expenses, reducing net income. Because they are non-cash charges, they lower taxable income without reducing the cash balance in the current period.

Balance Sheet

Each period's expense increases the corresponding contra-asset account (Accumulated Depreciation or Accumulated Amortization), which reduces the net book value of the asset. Over time the asset's carrying amount declines toward its salvage value (tangible) or zero (intangible).

Cash Flow Statement

Neither depreciation nor amortization involves a cash outflow in the period recorded. Both are added back to net income in the operating activities section when preparing the cash flow statement using the indirect method. The actual cash outflow occurred when the asset was purchased, and that appears in the investing activities section.

You can review these entries alongside your invoices and other transactions in your financial records to ensure consistency.

Choosing the Right Method

For most small businesses the decision is simple:

• Tangible asset? Use depreciation. Start with straight-line unless your tax advisor recommends an accelerated method for tax benefits.
• Intangible asset? Use amortization, almost always straight-line over the asset's legal or contractual life.
• Not sure about useful life? Consult FASB ASC 360 for tangible assets or ASC 350 for intangibles. Your CPA can help determine an appropriate period.

Related Articles

• How To Calculate Depreciation
• What Are Intangible Assets?
• Is Equipment a Current Asset?
• Straight-Line Depreciation