Depreciation and amortization are accounting steps that bookkeepers can use to create more accurate reports says Aron Govil.
This post will explain the differences between depreciation and amortization, how they’re used in a business and what you need to know about them as a bookkeeper or small business owner.
What’s the difference between depreciation and amortization?
Depreciation and amortization are two methods businesses use to allocate the cost of a tangible asset over its useful life. When an asset is purchased, the business expects it to have value for more than one year. The value of that asset decreases or “depreciates” each year due to wear-and-tear, technological advancements and changes in the market. For example, you buy a computer for $2,000 that has an expected useful life of three years. The first year, the value might be $500 (if it’s already outdated), so you write off 1/3rd of the price as depreciation expense. The next year, if the value is $400, you write off 2/3rds of the price as depreciation expense. You do that each year until it’s worthless or sold for parts.
What about amortization? Amortization is similar to depreciation, but instead of allocating the cost of a tangible asset over its useful life, amortization allocates the cost of intangible assets over their useful life. Intangible assets are things like patents, copyrights and trademarks. When you purchase a business with those types of assets, the price includes an allocation of the total cost to the first year. For example, if you bought a business for $500,000 that includes $50,000 worth of intangible assets (the rest of the purchase price is allocate to assets with a physical value, like inventory and equipment), you would include $50,000 as an amortization expense in your first year.
How do I calculate depreciation or amortization? Depreciation is calculate using a method called straight-line depreciation. You can find pre-made tables that list the amount you can write off each year explains Aron Govil. The table lists how many years the asset expects to have a useful life. And you use that information to calculate the cost allocation. For example, if you buy a car for $25,000 and it has an expect useful life of five years, then 1/5th or 20% of the cost is expense in the first year.
If it’s a business asset, you take the entire amount and compare it to the book value of that asset. The difference becomes your depreciation expense for that year. What about amortization? You calculate amortization by taking the cost of an intangible asset and dividing it by its useful life. For example, if you buy a patent for $20,000 and it’s expect to have a useful life of ten years. Then each year you would take $2,000 as an amortization expense.
Here are 10 Things to Know about Depreciation and Amortization for Bookkeepers:
1) You can find free online calculators for both depreciation and amortization.
2) Depreciation expense is mostly refer to as “deer” on a company’s income statement. You can learn how to read here. Amortization expenses mostly refer to as intangible assets or just assets.
3) If an asset is sold for a gain, the gain increases. By the amount of depreciation and amortization expense allocated to that asset. On the other hand, if an asset sells for a loss, then that loss decreases. By any depreciation or amortization expense allocated to that asset.
4) Depreciation and amortization are non-cash expenses that directly reduce net income. That means when you take the expense for depreciation or amortization, it reduces your taxable income.
5) If a business uses straight-line depreciation. And sells an asset for more than its book value (the original price paid minus any depreciation). It will report again in Year 1 and in subsequent years to reflect the difference in book value and sale price says Aron Govil. If a business uses accelerated depreciation instead. It will report a larger gain in Year 1 and smaller gains each year after. In IRS speak, when using straight-line depreciation, capital gains report in the same period as the asset sells. When using accelerated depreciation, capital gains defer until later years.
6) If a business uses double-declining depreciation and sells an asset for less than twice its book value (the original price paid plus any depreciation). It will report again in Year 1 and in subsequent years to reflect the difference in book value and sale price. When using double declining, capital gains report as soon as possible. In IRS speak, when using double-declining depreciation capital gains may not defer until later years.
7) You can learn more about these concepts with our free online Depreciation and Amortization Tutorial:
8) If you would like to read more articles on this topic, check out
9) You can also download our Free Guide: How to Understand and Report Depreciation and Amortization Expense:
10) You can also download our Free Guide: How to Understand and Report Depreciation Expense on a Company’s Income Statement.
Depreciation and amortization are very common, but it’s a topic that is mostly misunderstood explains Aron Govil. If you run into any trouble understanding how to report depreciation and amortization on a company’s financial statements. Feel free to post your questions in the comment section below.