The Difference Between Depreciation & Amortization

Depreciation and Amortization are accounting methods that devalue or "write-down" assets over time. Accountants use both techniques to reduce a company's tax liability by decreasing its net income. Depending on the asset that is being devalued, income tax laws and company rules determine the method that will be used.

Basic Accounting Principles

A company's assets lose their value over time. This loss is accounted for as an expense to the company which it notes in its general ledger. At the end of every month, general ledger expense totals are transferred to the company's income statement which decreases its net income. The expense totals are then transferred to the balance sheet resulting in a decrease of the company's net worth.

Why Devalue a Company's Assets?

A company saves money when it pays fewer taxes. It does so by offsetting its revenues against its asset losses. As such, asset devaluations are non-cash expenses that increase a company's cash flow while decreasing its revenues. Since taxes are paid on a company's profits, an aggressive asset write-down can lower its profits sufficiently enough to also lower its tax liability even during sales increases.

Tangible and Intangible Assets

Assets that a company devalues are categorized as either tangible or intangible. The former are physical items that can be seen and touched and that lose their value over time. In contrast intangible assets cannot be seen or touched but are as valuable to a company as its tangible assets. Examples include a company's patents, trademarks, licenses, agreements and goodwill.

What is Depreciation?

Depreciation which is also known as "capital or cost recovery" is the accounting method used to devalue tangible assets. Computers, for example, become obsolete and unusable to a company over a prescribed number of years. Their original costs are written off, or depreciated, over their useful life until they have no value. The company can then purchase new computers with the money it saved by paying fewer taxes because of the write-down.

What is Amortization?

In contrast to depreciation, amortization is the devaluation of intangible assets. United States patents, for instance have a life span of 17 years. A company can recoup the total costs of research and development, production and commercialization of its patents by writing down, or amortizing them over the 17 years. As with depreciation, amortization lowers a company's tax liability which saves it money.