Amortization vs depreciation: What's the difference?
Among the most common questions we get from customers is, “What’s the difference between amortization vs depreciation?” These two accounting terms might sound complicated but are really just about spreading out the cost of your business purchases over time. If you've been scratching your head about when to use which one, you're not alone.
Let's put amortization and depreciation into plain English, so you can manage your books like a pro while hopefully saving some money on taxes.
What is amortization?
Amortization is how we handle things you can't touch or feel. Got a patent for your amazing invention? Software licenses for your team? That's where amortization comes in. It helps you spread out these costs instead of taking one big financial hit.
When to use amortization
You'll use amortization for assets like:
Patents (they last about 20 years)
Trademarks (usually good for 10 years)
Copyrights (time varies)
Software licenses (however long your subscription lasts)
Calculating amortization
Here's an example of straight-line amortization:
Let's say you purchase a patent for $100,000 that lasts 20 years. The calculation is simple:
Take the total cost: $100,000
Divide by useful life: 20 years
Annual amortization = $5,000
So you'll write off $5,000 each year over the 20-year period. Unlike depreciation, there's no salvage value to consider since you can't sell or reuse a patent after it expires.
What is depreciation?
Depreciation is like amortization, but for physical stuff. In other words, it’s tracking how your tangible assets lose value over time. You know that delivery van you bought last year? Or those shiny new chairs? Instead of writing off the entire cost when you buy them, depreciation lets you spread that expense across the years you'll actually use them.
When to use depreciation
You'll want to use depreciation for any business items that:
Cost you $2,500 or more
Will last longer than a year
Lose value as time goes by
Think about things like:
Office chairs, desks, and file cabinets
Your company's delivery vehicles
The fancy coffee machine in the break room
Calculating depreciation
While there are several ways to calculate depreciation, let's look at the two most common methods.
Straight-line depreciation
Unlike straight-line amortization, straight-line depreciation considers salvage value. You take what you paid, subtract what it'll be worth when you're done with it, then divide by how many years you'll use it.
Let's say you buy manufacturing equipment for $100,000 that will be used for 10 years and be worth $20,000 after those ten years. Here's how you would calculate depreciation using the straight line method.
Take the total cost: $100,000
Subtract salvage value: $20,000
Divide by useful life: 10 years
Annual depreciation = $8,000
So you'll write off $8,000 each year over the 10-year period.
Double declining balance
This method frontloads the depreciation — perfect for things that lose value quickly, like computers or vehicles.
The double declining balance method applies twice the straight-line rate to the remaining book value each year. Here's an example:
Let's say you have a $50,000 van with a 5-year useful life:
Calculate the straight-line rate: 1/5 = 20%
Double it: 40% (this is your DDB rate)
Apply it each year to the remaining value:
Year 1: $50,000 × 40% = $20,000 depreciation
Year 2: $30,000 × 40% = $12,000 depreciation
Year 3: $18,000 × 40% = $7,200 depreciation
Year 4: $10,800 × 40% = $4,320 depreciation
Year 5: $6,480 × 40% = $2,592 depreciation
Benefits of amortization and depreciation
Understanding and properly implementing depreciation and amortization isn't just about following accounting rules — it's about making smarter business decisions. These methods offer significant advantages that can impact everything from your daily operations to your long-term business strategy.
Here's what's in it for you:
Tax benefits through systematic deductions that reduce your taxable income
Financial planning advantages that improve cash flow management
Asset management benefits for better equipment and resource planning
Financial statement impacts that show a more accurate picture of your business health
Business valuation benefits when seeking investors or planning an exit
Regulatory compliance advantages that keep you in good standing
Making the right choice
Choosing between depreciation and amortization doesn't have to be complicated. If you've got intellectual property or other intangible assets, amortization is your go-to method. For physical business assets, depreciation gives you more flexibility in how you write off the costs.
The key is understanding how these methods affect your business's financial picture. Proper asset management can help you:
Time major purchases strategically
Plan for equipment replacements
Make smarter decisions about leasing versus buying
Keep your books audit-ready
Want to manage your books more effectively? Learn more about our bookkeeping services for small businesses.