A:

Because very few assets last forever, one of the main principles of accrual accounting requires that an asset's cost is proportionally expensed based on the period over which the asset was used. Both depreciation and amortization (as well as depletion) are methods that are used to prorate the cost of a specific type of asset over the asset's life. It is important to mention that these methods are calculated by subtracting the asset's salvage value from its original cost.

Amortization usually refers to spreading an intangible asset's cost over that asset's useful life. For example, a patent on a piece of medical equipment usually has a life of 17 years. The cost involved with creating the medical equipment is spread out over the life of the patent, with each portion being recorded as an expense on the company's income statement.

Depreciation, on the other hand, refers to prorating a tangible asset's cost over that asset's life. For example, an office building can be used for many years before it becomes run down and is sold. The cost of the building is spread out over the predicted life of the building, with a portion of the cost being expensed each accounting year.

Depletion refers to the allocation of the cost of natural resources over time. For example, an oil well has a finite life before all of the oil is pumped out. Therefore, the oil well's setup costs are spread out over the predicted life of the oil well.

It is important to note that in some places, such as Canada, the terms amortization and depreciation are often to used interchangeably to refer to both tangible and intangible assets.

For more information, see Appreciating Depreciation.

RELATED FAQS
  1. What are the differences between amortization and impairment?

    Learn the differences between amortization and impairment as they relate to intangible assets held on a company's balance ... Read Answer >>
  2. What are some examples of fixed assets?

    Learn the difference between fixed tangible assets and fixed intangible assets, and review examples of these two types of ... Read Answer >>
  3. What are some examples of the main types of capital expenditures (CAPEX)?

    Learn about different expenses with acquiring assets that are considered capital expenditures and should be depreciated over ... Read Answer >>
  4. What is the difference between tangible and intangible assets?

    Discover the difference between tangible assets and intangible assets and the types of assets that are in each. Additionally, ... Read Answer >>
  5. What happens to accumulated depreciation when you sell an asset?

    Learn what happens to a company's accumulated depreciation when it sells an asset. Understand why accumulated depreciation ... Read Answer >>
  6. Which consumer goods do Americans buy the most of?

    Explore the various factors that influence estimations of a tangible asset's useful life, as well as standard estimations ... Read Answer >>
Related Articles
  1. Investing

    Amortization

    Amortization and depreciation are two ways to prorate the cost of an asset's life. Learn more about the former and how it it's calculated.
  2. Investing

    Explaining Amortization In The Balance Sheet

    Amortization is important to account for intangible assets. Read to find out more about amortization.
  3. Managing Wealth

    What's a Tangible Asset?

    Tangible assets are property owned by a business that can be touched -- they physically exist. Examples include furniture and fixtures, computer hardware, delivery equipment, leasehold improvements ...
  4. Investing

    Goodwill vs Other Intangible Assets: What's the Difference?

    "Intangible" assets don't possess physical substance. Yet they are quanitfiable, and of great importance to any business.
  5. Managing Wealth

    Comparing Tangible and Intangible Assets

    Tangible assets are physical assets such as land, vehicles or equipment.
  6. Managing Wealth

    How to Calculate Your Tangible Net Worth

    Your net worth can be calculated with a simple equation.
  7. Managing Wealth

    Explaining Net Tangible Assets

    Net tangible assets is a company’s total assets subtracting both intangible assets (such as goodwill and intellectual property) and total liabilities.
  8. Managing Wealth

    What's an Asset?

    An asset is a resource with economic value.
  9. Investing

    What's Salvage Value?

    Salvage value is the amount a company expects to receive from the sale of an asset at the end of that asset’s useful life. Salvage value plays a part in the depreciation calculation of an asset, ...
RELATED TERMS
  1. Straight Line Basis

    A method of computing amortization (depreciation) by dividing ...
  2. Amortization

    1. The paying off of debt in regular installments over a period ...
  3. Accumulated Depreciation

    The cumulative depreciation of an asset up to a single point ...
  4. Depreciation

    1. A method of allocating the cost of a tangible asset over its ...
  5. Economic Life

    The expected period of time during which an asset is useful to ...
  6. Useful Life

    An estimate of how long one can expect to use an income-producing ...
Hot Definitions
  1. Trickle-Down Theory

    An economic idea which states that decreasing marginal and capital gains tax rates - especially for corporations, investors ...
  2. North American Free Trade Agreement - NAFTA

    A regulation implemented on Jan. 1, 1994, that eventually eliminated tariffs to encourage economic activity between the United ...
  3. Agency Theory

    A supposition that explains the relationship between principals and agents in business. Agency theory is concerned with resolving ...
  4. Treasury Bill - T-Bill

    A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations ...
  5. Index

    A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical ...
  6. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a comparative measure typically used by analysts to identify companies that generate ...
Trading Center