Depreciation vs. Amortization: What's the Difference?

Updated October 13, 2023

Depreciation and amortization are methods that determine the reduction or decline in the cost of tangible and intangible assets over a specific period. When buying property or investing in business-related assets, it's important to understand these two accounting concepts. Learning about the differences between these principles may help you make better financial decisions that save time and money.In this article, we define depreciation and amortization, explain their differences and provide examples of these two accounting methods.Key takeaways:

Depreciation and amortization are ways to calculate asset value over a period of time.
Depreciation is the amount of asset value lost over time.
Amortization is a method for decreasing an asset cost over a period of time.

What is depreciation?

Depreciation is a method of reduction that breaks down the expenses linked to a fixed asset's long-term costs. These fixed assets are physical or tangible assets that decrease in value over a specific time frame. Numbers relating to depreciation help businesses determine the expense of an item in relation to the income it provides. Examples of fixed assets include:

Land
Vehicles
Buildings
Equipment
Office furniture
Machinery
Computers
Tools

It's common for tangible assets to have some value at the end of their life span. This is the asset's salvage or resale value deductible from its original cost. In accounting and reporting statements, companies must deduct the depreciated amount expensed throughout the asset's useful life. Several methods determine a tangible item's depreciated value over time. These include:

Straight-line method

This is the most common method for spreading out the depreciation of an asset evenly over time. It allows businesses to determine an asset's loss of value in a certain period. Businesses mainly use the straight-line method when there's no set pattern on how to use an asset.Related: What Is Straight-Line Depreciation? Definition, Formula and Examples

Declining balance

The declining balance method is an accelerated accounting method that shows how depreciation's value decreases with a fixed asset. This method assumes that the tangible asset remains valuable in the early years and loses value later. The declination continues over time to its salvage value.Related: 4 Common Depreciation Methods and Applications

Double-declining balance

The double-declining balance method is a method that determines an asset's value by doubling the amount of its deprecation in the first years. This accelerated depreciation method considers that the value of an asset depreciates at twice the rate of a straight-line method. You can use this method for assets that lose their value early. The formula for a double-declining balance is:

Depreciation = 2 x (Straight-line depreciation percent x Beginning period book value)

Units of production

This method of depreciation accounts for the number of units an asset produces rather than focusing on the number of years in use. It compares an asset's initial value to its depreciation. You may use this method for assets with extensive operations over a period. Here's the units-of-production formula:

Units of production depreciation = [(Original value − Salvage value) / Estimated production capability] x (Units per accounting period)

Sum-of-years-digits

The sum-of-years-digits method is another way of calculating accelerated depreciation for an asset. It factors in the asset's original cost, salvage value and useful years of life. The method yields higher depreciation expense in the first years and depreciates in coming years.

What is amortization?

Amortization is the decreasing cost of an intangible item over a certain period. Examples of intangible items include:

Patents
Trademarks
Copyrights
Franchise agreements
Organizational costs
Trade names
Customer lists
Employee relations

Amortization may refer to debt payments and payments for long-term loans. People with mortgages, student loans and auto loans follow an amortization schedule that outlines the details of the principal and the interest amount applicable through monthly installment payments. The bulk of the monthly payment usually applies to interest in the early stages of the loan.Amortization can also refer to the distribution of intangible assets relating to capital expenses over a specific time. Accountants commonly calculate it using the straight-line method.Related: Amortization Schedule: Definition, Tips and Loan Benefits

Depreciation vs. amortization

Amortization and depreciation are methods of calculating business assets over time. The two concepts present some differences, which include:

Value

Depreciation considers and determines the value of a tangible item after its usage. It's also known as the salvage value. Amortization determines the decreasing value of intangible assets over a specific period using the straight-line method.

Calculation method

Depreciation uses the straight-line method or the accelerated depreciation method to determine its values. Amortization only uses the straight-line method. This is because it decreases the value of the intangible asset over a given period.Related: Intangible Assets: Definition and Examples

Application

Depreciation only applies to tangible assets, like buildings, machinery and equipment. This is vital when determining the disposal value of such assets. Amortization only applies to intangible assets, like copyrights and patents, and mostly applies when acquiring an existing business.Related: What Is Asset Disposal? Definition, Benefits and Examples

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Examples of depreciation and amortization

Here are examples of depreciation methods to help you understand how they function:

Straight-line method amortization example

Derby Business Solutions acquired a special machine to make filing forms more efficient. The estimated life of the machine is 10 years, and the salvage value is 10% of the purchase value. The business determines the depreciation value using the straight-line method:

Machine cost: $500,000
Salvage value: $50,000
Depreciated value: $450,000
Machine life: 10 years

The annual depreciation for the machine is equal to the depreciated value or the machine's life cycle. Derby Business Solutions completes the following calculation:Annual machine depreciation = $450,000 / 5 = $90,000This means that the annual depreciation for the machine is $90,000.

Declining balance depreciation example

Gravity Jump purchases a snow blower for $1,700 to ensure easy access to its building during the winter months. The manager estimates that a snow blower has a useful life of 10 years and a residual value of $200.The rate of depreciation is 20%. For the first five years, the declining balance depreciation is at its highest. Here's the estimated depreciation amount resulting from projected wear and tear:

Year	Depreciation equation	Yearly depreciation amount	End-of-year value
1	20% x ($1,700 - $200)	$300	$1400
2	20% x ($1,400)	$280	$1120
3	20% x ($1,120)	$224	$896
4	20% x ($896)	179.20	$716.80
5	20% x ($716.80)	$143.36	$573.44
6	20% x ($573.44)	$114.69	$458.75
7	20% x ($458.75)	$91.75	$367
8	20% x ($367)	$73.40	$293.60
9	20% x ($293.60)	$58.72	$234.88
10	20% x ($234.88))	$46.98	$187.90

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