Any assets that your company has come at a cost. Assets tend to lose their function over time, so they need to be expensed against your profits for the time you’re using them. The method of distributing the cost of having these assets throughout their useful life is called amortisation and depreciation.
This guide will cover:
- What assets are and how they’re affected
- What depreciation is
- What amortisation is
- The difference between depreciation and amortisation
- How Countingup can help you understand your finances better
What are assets?
An asset is a valuable item you own or lease that helps you run your business, including cash or something you can sell for cash. Business assets can be anything from equipment (like a laptop) and machinery (like a bakery oven) to bank balances and stock. Amortisation and depreciation affect different kinds of assets, as explained below.
Depreciation affects tangible assets, which are fixed (long-term) physical resources that often are essential for small businesses. Examples of tangible assets include inventory, property and equipment.
Amortisation affects intangible assets. These are nonphysical resources that still add value to your company, such as your brand name, patents, established processes, and copyrights.
How do amortisation and depreciation affect these assets? To help you understand, we need to dig into each component individually.
What is depreciation?
Depreciation is when you expense a tangible asset over its useful life. These assets may still have value at the end of their life, so you calculate their depreciation by subtracting their resale value from their original price. Learn more about business expenses here.
The difference is then depreciated evenly every year as a tax reduction for the company for the assets’ useful life. Let’s look at an example:
Imagine you buy a large oven for your little bakery. This oven will likely last a good few years before you need to sell it and buy a new one. The cost of the oven is spread out over the length of time you expect to use it, deducting a portion of the cost as an expense each accounting year.
Some fixed assets, like a company vehicle, can be depreciated at an accelerated rate. This means you expense a larger portion of the asset’s value in the early years of the asset’s life cycle.
The following methods are used for calculating depreciation:
- Straight-line method: The most common method, which is used to spread out the asset depreciation evenly over time.
- Declining balance: An accelerated accounting method that shows how the depreciation value decreases as you use a fixed asset.
- Double-declining balance: Another accelerated depreciation method where the asset value depreciates at twice the rate a straight-line method does.
- Units of production: This method accounts for the number of units an asset produces instead of focusing on the number of years you’ve used it.
- Sum-of-years-digits: Another way to calculate accelerated depreciation, which factors in the asset’s original cost, resale value and its useful years of life.
What is amortisation?
Amortisation refers to the practice of spreading the cost of an intangible asset over its useful lifetime. Typically expensed on a straight-line basis, amortisation distributes the same amount in each accounting period as long as the asset is useful.
Unlike depreciated assets, assets that are using amortisation usually don’t have a resale value. The word amortisation also has a double meaning, so make sure you note what context you’re using it in. Amortisation applies in accounting and lending situations but has completely different meanings in each context.
In lending, an amortisation schedule is used to calculate loan repayments of both the standard amount and the interest in each payment.
Amortisation vs depreciation: what’s the difference?
Are you still wondering what the difference is between amortisation and depreciation? Let’s see if we can clear things up.
While the two have similarities, the key difference is that depreciation applies to tangible assets and amortisation to intangible assets.
Additionally, you almost always conduct amortisation using the straight-line basis, charging the same amount of amortisation to expense in every accounting period. On the flip side, it’s more common to calculate depreciation on an accelerated basis, meaning more depreciation is charged during earlier reporting periods.
Another difference between amortisation and depreciation is that the amortisation calculation usually doesn’t incorporate any resale value. This is because intangible assets like a brand name or copyrights likely won’t have any value at the end of their lifecycle.
Tangible assets might still have resale value, which is why it’ll more likely be included in a depreciation calculation.
How are they similar?
There are some ways that amortisation and depreciation are similar. For example, both components are non-cash expenses, meaning your company doesn’t lose any cash when the expenses are recorded. Instead, these expenses are taken from your profits.
Amortisation and depreciation are also similar when it comes to reporting. Both are treated as reductions from fixed assets in your balance sheet (learn more about balance sheets here). You might even combine them for reporting purposes.
Another similarity is that both tangible and intangible assets are subject to impairment. This means that you can write down their carrying amounts. If you record the carrying amount, there will be a smaller remaining balance to offset. As a result, the remaining depreciation or amortisation charges will decline.
Now that we’ve answered the whole “amortisation vs depreciation” question, we hope you’ll have the knowledge you need to confidently track and manage your assets’ value in the future.
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