Few assets last forever, according to business expert Douglas Battista. While there are many foundational principles of accrual accounting, perhaps the most frequently misunderstood concepts are amortization and depreciation. Battista clarifies the two and offers insight on their practical application in the following Q & A.
Q: What is amortization?
Douglas Battista: Amortization is the method by which accountants spread an intangible asset’s cost over its anticipated useful life. For example, an inventor owns a patent on a piece of sports equipment. The patent itself has a “life span” of 20 years. The costs associated with manufacturing that equipment is divided across each year the patent is active. Each portion is recorded on the company’s income statement as an annual expense.
Q: How is that different from depreciation?
Douglas Battista: Depreciation refers to the process of prorating a tangible asset’s cost over its expected lifetime. You will hear the term depreciation often used to describe automobile value in terms of age and condition. A car that cost $20,000 brand-new is not going to resell for that much in 10 years. The difference between the initial cost and what the vehicle is worth at the end of its anticipated lifespan is its depreciated value.