Difference Between Amortisation and Depreciation Explained
Amortisation vs depreciation is a core topic in accounting and commerce. Both concepts describe how the cost of assets is allocated over time in a business. Understanding the differences is important for school and competitive exams, as well as for making smart decisions in business and financial reporting.
| Basis | Amortisation | Depreciation |
|---|---|---|
| Asset Type | Intangible assets (patents, copyrights, goodwill) | Tangible assets (machinery, buildings, vehicles) |
| Calculation Method | Straight-line method (mostly) | Multiple methods (straight-line, reducing balance, units of production, etc.) |
| Salvage Value | Not deducted | Deducted from asset cost before calculation |
| Contra Asset Account | Usually does not use contra assets | Uses accumulated depreciation as contra asset |
| Examples | Amortisation of a patent over 10 years | Depreciation of a car over 5 years |
Difference Between Amortisation and Depreciation
Amortisation is the systematic allocation of the cost of intangible assets over their useful life. Depreciation is the process of reducing the recorded value of tangible assets as they get used. Both help businesses match expenses with revenues for accurate profit calculation.
What is Depreciation?
Depreciation is an accounting method used for tangible assets such as machines, buildings, and vehicles. It spreads the asset’s cost across its estimated useful life, reflecting wear and tear due to usage, age, or obsolescence. Depreciation is vital for preparing accurate final accounts and is tested in commerce exams.
Common Methods of Depreciation
- Straight-Line Method: Equal expense each year
- Reducing Balance Method: Higher expense in early years
- Units of Production: Based on asset's usage (e.g., kilometres, hours)
- Sum-of-the-Years-Digits: Accelerated depreciation in early years
Example
Suppose a machine costs ₹50,000, has a salvage value of ₹5,000, and a useful life of 5 years. Annual depreciation using the straight-line method is (₹50,000 - ₹5,000) ÷ 5 = ₹9,000 per year.
Depreciation Journal Entry
Depreciation A/c Dr
To Accumulated Depreciation A/c
(Being depreciation charged for the year)
For more on depreciation, see Depreciation and Methods of Depreciation.
What is Amortisation?
Amortisation relates to intangible assets like patents, trademarks, copyrights, or goodwill. It allocates the asset’s cost evenly over its useful life, most often with the straight-line method. This accounting treatment helps reflect gradual consumption of intangible asset benefits.
Features of Amortisation
- Only for intangible assets
- No salvage value deducted
- Generally uses only the straight-line method
- Ensures expense recognition matches benefit period
Example
A company acquires a patent for ₹20,000, valid for 10 years. The annual amortisation expense is ₹2,000 (₹20,000 ÷ 10 years) per year.
Amortisation Journal Entry
Amortisation Expense A/c Dr
To Intangible Asset A/c
(Being patent amortised for the year)
Explore more on intangibles in Classification of Goodwill or Non-Current Assets.
Key Differences Table
| Amortisation | Depreciation |
|---|---|
| Intangible assets (patents, goodwill) | Tangible assets (plants, machinery) |
| Straight-line method only | Several methods available |
| No salvage value involved | Salvage value is deducted |
| Charged as "Amortisation Expense" | Charged as "Depreciation Expense" |
| Does not use contra assets | Uses "Accumulated Depreciation" |
Examples and Journal Entries
Amortisation Example
A company pays ₹40,000 for software, usable for 4 years. Each year, it charges ₹10,000 as amortisation expense in the Profit & Loss account. The journal entry is:
Amortisation Expense A/c Dr ₹10,000
To Software A/c ₹10,000
Depreciation Example
If a company buys a vehicle for ₹5,00,000 with a salvage value of ₹1,00,000 and useful life of 4 years, the annual depreciation is (₹5,00,000-₹1,00,000)÷4 = ₹1,00,000.
Depreciation A/c Dr ₹1,00,000
To Accumulated Depreciation A/c ₹1,00,000
For deeper practice, see Depreciation and Amortization Journal Entry and Accounting Concept of Depreciation.
How to Identify: Amortisation or Depreciation?
If the asset you are dealing with is physical—like a computer, building, or vehicle—use depreciation. If the asset is non-physical, like a trademark or copyright, use amortisation. Accounting standards (GAAP, IFRS) and exam questions often mention asset type as a clue.
Why Knowing the Difference Matters
Understanding amortisation vs depreciation helps students answer MCQs and case studies in exams correctly. In business, applying the right method makes financial reports accurate and helps with better decision-making. This knowledge is also useful when analysing company accounts or preparing final accounts in class projects.
Vedantu provides step-by-step guides on topics like Cost of Assets for Calculating Depreciation and Accounting Standards for more learning support.
When and Where to Apply (Exam & Real Life)
- School/Board/Competitive exams: MCQs, short/long answers, and project work
- Business: Accurate profit calculations and tax filings
- Assignments: Journal entries and schedules in final accounts
Page Summary
Amortisation vs depreciation explains how asset cost allocation differs for intangible and tangible assets in business accounting. Amortisation uses the straight-line method for intangible assets, while depreciation offers more methods for physical assets. Both ensure accuracy in profit reporting, aiding in exams and business decisions. For more details, Vedantu provides connected resources and guides for thorough learning.
FAQs on Amortisation vs Depreciation: Meaning, Examples, and Differences
1. What is the main difference between amortisation and depreciation?
Amortisation and depreciation are both methods of allocating the cost of an asset over its useful life, but they apply to different types of assets. Depreciation is used for tangible assets (physical assets like machinery), while amortisation is used for intangible assets (non-physical assets like patents).
2. What is an example of amortisation?
A common example of amortisation is the systematic expensing of a patent's cost over its legal life. If a company purchased a patent for $100,000 with a 10-year useful life, they would amortise $10,000 each year. This is a common expense allocation method for intangible assets.
3. Is software amortised or depreciated?
Whether software is amortised or depreciated depends on how it's classified on the company's balance sheet. If treated as an intangible asset, it's amortised. If treated as a tangible asset (e.g., physical media), it might be depreciated. Accounting standards (GAAP/IFRS) guide this classification.
4. Can you depreciate buildings and amortise loans?
Buildings are depreciated because they are tangible assets that lose value over time. Loans, however, are not assets; they are financial liabilities. The repayment of a loan is amortised, meaning the payments are spread over time. This is a key difference in accounting treatments.
5. Does amortisation use salvage value?
No, amortisation generally does not consider salvage value. Unlike depreciation, which accounts for the asset's estimated value at the end of its useful life, amortisation typically spreads the initial cost evenly over the asset's life. This simplifies the cost apportionment process.
6. What is the difference between amortization and Amortisation?
There is no difference; amortisation and amortization are simply alternative spellings of the same accounting concept. Both refer to the systematic allocation of the cost of an intangible asset over its useful life. This applies equally to accounting exam preparation and real-world applications.
7. What is amortization with an example?
Amortization is the systematic reduction of an amount over time. A common example is the amortization of a loan, where the payments are spread out over the loan's term, systematically reducing the principal balance. Another example is the amortization of an intangible asset's cost.
8. Do you amortize or depreciate buildings?
Buildings are depreciated, not amortised. Depreciation is the systematic allocation of the cost of a tangible asset (like a building) over its useful life. The choice of depreciation method (e.g., straight-line, reducing balance) impacts the annual expense recognised.
9. What is the difference between amortization and depreciation?
The key difference lies in the type of asset. Amortization applies to intangible assets (patents, copyrights), while depreciation applies to tangible assets (machinery, buildings). Both methods spread the cost over the asset's useful life but differ in calculation methods and accounting treatments. This is a crucial distinction for financial reporting and exam MCQs.
10. What is the difference between amortisation and depreciation in accounting?
In accounting, amortisation allocates the cost of intangible assets (like goodwill or patents) over their useful life. Depreciation does the same for tangible assets (like equipment or buildings). The key difference is the type of asset and, sometimes, the depreciation method used. Understanding this is vital for accurate financial statements.
