Amortization vs. Depreciation: What's the Difference?

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Amortization and depreciation do the same basic job: they spread the cost of a long-lived asset over the years it helps the business earn revenue, instead of expensing the full price when it is bought. The difference is the type of asset. Depreciation applies to tangible, physical assets such as buildings, machinery, vehicles and office furniture. Amortization applies to intangible assets such as patents, copyrights, trademarks with a finite life, franchise agreements and certain capitalized costs. The two also differ in the methods typically used, whether salvage value reduces the cost base, and how the reduction is recorded on the balance sheet.

What Is Amortization?

In accounting, amortization is the systematic write-off of an intangible asset’s cost over the period the asset is expected to provide economic benefits. Intangible assets have no physical form but still carry value. Common examples include patents, copyrights, trademarks with a defined term, franchise and license agreements, customer lists, non-compete agreements and software. Certain capitalized costs, such as bond issuance costs and some organizational costs, are also amortized.

The guiding idea is matching. A company that pays $200,000 for a license it will use for five years receives the benefit across all five years, so the expense is spread across them rather than recorded in one year. Each year’s charge appears on the income statement as amortization expense, and the asset’s carrying value on the balance sheet falls by the same amount.

Under US GAAP, the amortization method should reflect the pattern in which the asset’s benefits are used up. When that pattern cannot be determined reliably, which is the normal situation for most intangibles, the straight-line method is required. In practice, then, amortization usually means equal charges each period.

The useful life of an intangible is not automatically its legal life. A patent may have years of legal protection remaining, but if the technology it protects is expected to become obsolete sooner, the shorter economic life governs the amortization period.

The lending meaning of amortization

The word is also used for loans. An amortization schedule shows how each payment on a mortgage or term loan is split between interest and principal, and how the principal balance falls to zero over the term. The shared idea is gradual reduction, but the two uses are otherwise unrelated: accounting amortization allocates the cost of something the company owns, while loan amortization describes repaying something the company owes. Accounting also amortizes some financing items, such as bond premiums and discounts, which adjust interest expense over a bond’s life.

That split is the usual answer to the question of the “two types” of amortization in accounting: amortization of intangible assets, and amortization of debt (loan principal and related premiums, discounts and issuance costs).

What Is Depreciation?

Depreciation is the allocation of a tangible fixed asset’s cost over its useful life. Fixed assets (also called property, plant and equipment) are physical items a business acquires to use, not to resell: buildings, factory equipment, computers, furniture, vehicles and machinery.

Unlike most intangibles, tangible assets often keep some value when the business is finished with them. A delivery van can be sold used; old equipment can be sold for parts or scrap; a building can still be occupied by someone else. That leftover amount is the salvage value (or residual value). Depreciation is calculated on the depreciable base, which is cost minus salvage value.

Consider an office building a company uses for many years before moving to a larger site. The old building is worn but still worth something. The amount the company actually consumed is the purchase price minus what the building is expected to be worth when it leaves, and that consumed amount is what gets spread across the years of use.

Depreciation methods

Companies can choose among several depreciation methods for financial reporting, as long as the method reasonably reflects how the asset’s benefits are used:

• Straight-line: (Cost minus salvage value) ÷ useful life. The same expense each year.
• Declining balance: A fixed rate is applied to the asset’s current book value each year, so the expense shrinks over time.
• Double-declining balance: The declining-balance rate is set at twice the straight-line rate (for a 5-year asset, 2 × 20% = 40%), applied to the current book value. Depreciation stops once book value reaches salvage value.
• Sum-of-the-years’ digits (SYD): The years of useful life are added (for 5 years: 5 + 4 + 3 + 2 + 1 = 15). Year one expense is 5/15 of the depreciable base, year two is 4/15, and so on.
• Units of production: Expense follows actual use. If a vehicle is expected to be driven 100,000 miles and is driven 17,000 miles in year one, 17% of the depreciable base is expensed that year.

Declining balance, double-declining balance and SYD are accelerated methods: they record more expense in the early years. The rationale is that a new asset is often used most heavily and is most productive when it is new.

Amortization vs. Depreciation: Key Differences

Applicability

The deciding question is whether the asset is physical. Equipment is depreciated; a patent on the process the equipment runs is amortized. A purchased software license is amortized; the server it runs on is depreciated.

General philosophy

To depreciate is to diminish in value over time. To amortize is to write off a cost gradually over a set period. Depreciation carries the sense of an asset wearing out or becoming less useful, so its carrying amount no longer matches what was paid. Amortization is more purely an allocation: a license with a fixed term delivers its benefit across that term, and the cost is assigned to those periods. The mechanics look alike, but the reasoning starts from different places.

Choice of methods

Because amortization is usually straight-line, two companies amortizing similar intangibles over similar lives will report similar annual charges. Depreciation gives management a real choice of method, and that choice changes reported expense and net income year by year. Over the full life of the asset, total depreciation is the same under every method (cost minus salvage value); only the timing differs.

Acceleration

Depreciation can be accelerated for financial reporting, and US tax rules for tangible property use the Modified Accelerated Cost Recovery System (MACRS), which front-loads deductions for many asset classes. Amortization rarely uses acceleration: the same charge is recognized whether the intangible is new or old.

Use of salvage value

Salvage value is subtracted from the cost of a tangible asset before depreciation is calculated. Intangibles are generally amortized to zero because they seldom have a resale value at the end of their useful life. Under IFRS, an intangible’s residual value is assumed to be zero unless a third party has committed to buy it or there is an active market for it.

Use of a contra account

Depreciation is credited to accumulated depreciation, a contra-asset account that sits beneath the asset’s original cost. Amortization may be credited to accumulated amortization or, depending on the asset and materiality, directly to the intangible asset account, so the original cost may not stay visible.

Example: Depreciating a Machine and Amortizing a Patent

Hypothetical example for illustration. A manufacturer buys a machine for $50,000. It expects to use it for 5 years and sell it for $5,000 at the end. In the same year, it buys a patent for $120,000. The patent has 10 years of legal protection left, but management expects the product it covers to be commercially relevant for only 8 years.

Depreciating the machine. The depreciable base is $50,000 − $5,000 = $45,000.

Straight-line: $45,000 ÷ 5 = $9,000 per year.

Double-declining balance (40% rate applied to book value, stopping at the $5,000 salvage value):

Sum-of-the-years’ digits: $15,000, $12,000, $9,000, $6,000, $3,000 (5/15 through 1/15 of $45,000).

All three methods expense $45,000 in total. Straight-line records $9,000 in year one; double-declining balance records $20,000. In year one, the accelerated method lowers reported profit by $11,000 more than straight-line, and later years are higher by the same total.

Amortizing the patent. The patent is amortized straight-line over its 8-year useful life, not its 10-year legal life, with no salvage value: $120,000 ÷ 8 = $15,000 per year.

Journal entries for year one (straight-line):

• Dr Depreciation expense $9,000 / Cr Accumulated depreciation $9,000
• Dr Amortization expense $15,000 / Cr Accumulated amortization (or Patent) $15,000

Balance sheet presentation at the end of year one. Accumulated depreciation is shown as a deduction from cost in the statement of financial position (or in the notes):

• Machinery, at cost: $50,000
• Less accumulated depreciation: ($9,000)
• Machinery, net: $41,000

The patent is shown at $105,000 net, either as $120,000 less $15,000 accumulated amortization or simply as a net figure if amortization was credited directly to the asset.

Exceptions That Change the Answer

The tangible-versus-intangible rule settles most cases, but several situations change whether, or how, cost is spread.

Land is not depreciated

Land is tangible, yet it is not depreciated under GAAP or US tax rules, because it is not considered to be used up. When a company buys a building with its land, the purchase price is split: the building portion is depreciated and the land portion stays on the books at cost.

Goodwill and indefinite-lived intangibles

Not every intangible is amortized. Under US GAAP, public companies do not amortize goodwill; they test it for impairment at least annually and write it down if its value has fallen. Private companies may elect an alternative that allows goodwill to be amortized on a straight-line basis over 10 years or less. Intangibles with indefinite lives, such as a trademark the company expects to renew indefinitely, are also not amortized and are tested for impairment instead. IFRS likewise prohibits amortizing goodwill and indefinite-lived intangibles.

Tax rules differ from book rules

The figures in financial statements and on a tax return often differ. For US federal tax, most tangible business property is depreciated under MACRS, which assigns recovery periods by asset class rather than by the company’s own useful-life estimate. Many acquired intangibles, including goodwill bought in a business acquisition, fall under Section 197 and are amortized straight-line over 15 years for tax purposes, even though goodwill is not amortized in a public company’s GAAP accounts. Additional rules such as Section 179 expensing and bonus depreciation can let a business deduct some asset costs immediately; the limits and percentages are set by law and change over time.

IFRS terminology and options

Outside the US, IFRS uses “amortisation” (British spelling) for intangibles under IAS 38 and “depreciation” for property, plant and equipment under IAS 16. The meaning is the same. IFRS also permits a revaluation model in some cases, under which assets can be carried at fair value rather than cost less accumulated depreciation or amortization.

Depletion for natural resources

Natural resources, such as oil wells, mines and timber, are subject to depletion, a third method of allocating cost. An oil well holds a finite quantity of oil, so its cost is spread over the reserves extracted. Cost depletion divides the property’s basis by total recoverable reserves and applies that rate to the units extracted and sold in each period. Percentage depletion, a tax method, applies a fixed percentage set in tax law to the gross income from the property.

Depreciation and Amortization in the Financial Statements

Depreciation, amortization and depletion share one feature: they record an expense without any cash going out at the time. The cash left when the asset was bought; the annual charge is an allocation of that earlier outlay. This is why depreciation and amortization, along with provisions (estimated liabilities such as warranty or legal reserves), are described as non-cash items. Each reduces profit in the current period without a matching payment in that period.

On the cash flow statement prepared using the indirect method, depreciation and amortization are added back to net income in the operating section, because they reduced profit without reducing cash. The original purchase appears separately as a capital expenditure in investing activities. Many companies combine the two into a single “depreciation and amortization” (D&A) line. Amazon’s 2024 annual report, for example, presents them as one combined figure on its cash flow statement and states that it uses the straight-line method for both, with useful lives varying by asset.

D&A also explains why analysts look at metrics such as EBITDA (earnings before interest, taxes, depreciation and amortization), which strips these charges out to show operating performance before the cost of long-lived assets. The trade-off is that ignoring D&A can hide how much a business must keep spending to replace equipment and technology. A company with heavy capital needs can look strong on EBITDA while its assets are wearing out. The interaction between profit, D&A and cash is covered further in revenue vs. profit, and D&A assumptions feed directly into cash-flow-based business valuation.

The Risks: Where Judgment Affects the Numbers

Because both charges depend on estimates, they can move reported earnings without any change in the underlying business.

• Useful life estimates. Extending an asset’s estimated life lowers the annual charge and raises reported profit. A change in estimate is applied going forward, but it can noticeably shift results in the year it happens.
• Salvage value assumptions. A higher assumed salvage value shrinks the depreciable base and the annual expense.
• Method choice. Straight-line and accelerated methods produce the same total expense but very different year-by-year profit, which affects comparisons between companies using different methods.
• Impairment. Goodwill and indefinite-lived intangibles that are not amortized can sit on the balance sheet at cost for years and then be written down in a single large charge when an impairment test fails.
• Classification. Recording a cost as a capitalized asset rather than an immediate expense, or treating an intangible as tangible, changes both the timing and the method of expense recognition.

Reading the accounting policy notes in a company’s annual report shows the methods and useful lives it uses, which is the basis for comparing its D&A with peers.

FAQs

The Bottom Line

Business owners, accountants and investors reading financial statements need to know which assets are depreciated, which are amortized, and which, like land and goodwill, follow other rules. Both charges reduce reported profit without using cash, and their size depends on estimates of useful life, salvage value and method. The accounting policy notes in an annual report show those choices and make a company's D&A comparable with its peers.