What is the difference between depreciation and amortization?
The conditions of depreciation and amortization have different meanings in finance and investment. For example, depreciation may apply to currency devaluation and amortization can be used to describe the structure of payments in a common loan type. However, words are directly comparable only when used in accrual accounting. In this area, they both describe the method of allocation of initial assets of the asset about its useful life, so in each period the income from the asset may be associated with part of its costs. They differ in the types of assets on which they are used. Both include estimating the life of an asset or period over which it will generate profit. The life of the physical asset that must be depreciated is the time for which the asset must be replaced; The assignment of costs smoothly in this period requires an accounting period in which the asset will cease to be valuable. The amortization is somewhat easier because the life of an intangible asset ends in the expiry date. For example, patents usually last for 17 years, so the price for obtaining a patent canthat be evenly distributed in this period.
Accountants use depreciation and amortization to distribute the cost of asset. The share of the value of the asset that is depreciated or amortized in a given year is equal to the share of a lifelong profit of an asset that is expected to be realized during this year. One of the reasons for this practice is that the accountants can write off part of the costs for each year. Another reason is that depreciation and amortization can avoid scary investors with high initial expenses.
If the company could not postpone its investments, its accounting statement could show Sharp reduces profits whenever it replaced expensive machines. This could discourage investments. However, the total profitability of the company would be constant because the machine generates sufficient profit to justify the initial costs, so the depreciation of the cost of the machine would more evidence of the potential of the investor's company.
The company's accounting statement does not reflect exactly how much money the company has at hand for depreciation and amortic procedures. A large purchase in one year could leave a company that is unable to fulfill its obligations, even if its accounting statement shows that it should have sufficient funds. Cash flow statements reflect the reality of society shares.
Depreciation and amortization only apply to assets whose values are expected to be reduced. If the company decorates its headquarters with an image that is expected to appreciate value, it may not divide the costs on its accounting sheets the image will not depreciate over time. The soil does not have to be depreciated because it has an endless life. Similarly, unmarted trademarks may not be amortized because they could become more valuable. The conditions are also unusable for natural resources: they are used in a process known as exhaustion.