Amortization vs Depreciation: Key Differences With Examples
Amortization vs depreciation explained: which assets each applies to, methods, journal entries, tax rules like Section 197, and a worked example that balances.
Quick answer: Amortization vs depreciation comes down to the type of asset. Depreciation spreads the cost of tangible assets, like equipment and vehicles, over their useful lives. Amortization does the same for intangible assets, like patents, software licenses and customer lists. Both are non-cash expenses; amortization is usually straight-line with no salvage value.
If you have bought a laptop, a van or the client list of a retiring competitor, you have assets whose cost should be spread over the years they help your business earn money. Understanding amortization vs depreciation helps you record those costs correctly, read your financial statements, and talk to your accountant about tax deductions. This guide compares the two side by side, explains the methods and tax rules, and works through an example with journal entries that balance. For the mechanics of the depreciation side, see our guide on how to calculate depreciation.
On scope: the free invoice generator on this site creates PDF invoices but does not keep fixed asset registers. You will record these entries in your accounting software or with your accountant. This article is general information, not tax or accounting advice.
What is depreciation?
Depreciation allocates the cost of a tangible, long-lived asset over its useful life. The IRS describes depreciation in Publication 946, How to Depreciate Property as an annual deduction that lets you recover the cost or other basis of certain property. To be depreciable for tax, property generally must be owned by you, used in your business or income-producing activity, have a determinable useful life, and be expected to last more than one year.
Typical depreciable assets include computers, machinery, vehicles, office furniture, tools and buildings. Land is not depreciated, because it does not wear out.
The point of depreciation is matching. A $12,000 piece of equipment used for five years helps generate revenue in each of those years, so charging the whole cost to the year of purchase would make that year look unusually poor and the next four look unusually good. Spreading the cost gives a fairer picture of profit in every year, which is what lenders, buyers and you as the owner actually need when judging how the business is performing.
What is amortization?
Amortization allocates the cost of an intangible asset over its useful life. Intangibles have no physical form but still provide value over several years: think patents, copyrights, licenses, franchise rights, non-compete agreements, purchased customer lists and acquired software.
For accounting purposes, intangibles with a finite useful life are amortized, usually on a straight-line basis, and with no residual value in most cases. Intangibles with an indefinite useful life, and goodwill for most companies, are not amortized but are tested for impairment instead. Under IFRS, the equivalent rules sit in IAS 38 for intangibles and IAS 16 for property, plant and equipment.
Amortization vs depreciation: side-by-side comparison
| Feature | Depreciation | Amortization |
|---|---|---|
| Asset type | Tangible: equipment, vehicles, buildings, furniture | Intangible: patents, licenses, customer lists, goodwill (in some cases) |
| Common methods | Straight-line, declining balance, units of production | Mostly straight-line |
| Salvage or residual value | Often estimated | Usually zero |
| Contra account | Accumulated depreciation | Accumulated amortization (or a direct credit to the asset) |
| US tax system | MACRS recovery periods, with Section 179 and bonus options | Section 197 intangibles generally over 15 years |
| Tax form (US) | Form 4562 | Form 4562 |
| Cash effect in the year | None (non-cash expense) | None (non-cash expense) |
| Not applied to | Land | Indefinite-life intangibles; goodwill for public companies under US GAAP |
Methods: how each is calculated
Straight-line (both)
Annual expense = (Cost minus Salvage value) divided by Useful life
This is the default for amortization and the most common method for small business depreciation, because it is simple and gives the same expense each year.
Declining balance (depreciation)
Accelerated methods charge more expense in early years. Double-declining balance applies twice the straight-line rate to the remaining book value each year. For a five-year asset, the straight-line rate is 20%, so the double-declining rate is 40%. On a $12,000 asset, year one depreciation would be $4,800, leaving a book value of $7,200.
Units of production (depreciation)
Expense follows usage, such as miles driven or units produced. It suits vehicles and machines whose wear depends on activity rather than time.
Choosing a useful life
For your books, useful life is a judgment about how long the asset will actually serve your business, not how long it could physically last. A laptop may work for eight years, but if you replace laptops every four, four years is the better estimate. For intangibles, look at legal or contractual limits first: a license that expires in three years cannot have a five-year life. For a purchased customer list, consider how quickly clients typically leave; if most of the acquired clients will be gone within five years, a five-year life is reasonable.
For tax, you do not choose freely. Depreciable property follows the recovery periods set out by the IRS, and acquired section 197 intangibles follow the fixed 15-year period. That is the main reason book and tax schedules diverge, and why keeping both is normal rather than a sign of error.
How to record depreciation and amortization
- Capitalize the asset. Record the purchase as an asset, not an expense, if it has a useful life of more than a year and is above your capitalization threshold.
- Classify it. Decide whether it is tangible (depreciate) or intangible (amortize), and whether an intangible has a finite life.
- Estimate useful life and residual value. Base the book life on how long the asset will realistically serve the business.
- Choose a method. Straight-line for most intangibles; straight-line or accelerated for equipment.
- Post the periodic entry. Debit the expense and credit the accumulated account monthly or annually.
- Track tax separately. Tax rules can differ from book rules, so keep a separate tax schedule or let your accountant maintain one.
- Review for impairment if an asset's value drops sharply, for example when software is abandoned or a customer list loses key clients.
Worked example: equipment and a purchased customer list
A bookkeeping firm makes two purchases at the start of the year:
- Office equipment (servers and scanners) for $12,000, expected to last five years with a $2,000 salvage value.
- A customer list bought from a retiring bookkeeper for $30,000, expected to generate client revenue for five years with no residual value.
Depreciation of the equipment
Straight-line: ($12,000 minus $2,000) divided by 5 = $2,000 per year.
| Year | Depreciation expense | Accumulated depreciation | Book value at year end |
|---|---|---|---|
| 1 | $2,000 | $2,000 | $10,000 |
| 2 | $2,000 | $4,000 | $8,000 |
| 3 | $2,000 | $6,000 | $6,000 |
| 4 | $2,000 | $8,000 | $4,000 |
| 5 | $2,000 | $10,000 | $2,000 |
After five years, the book value equals the $2,000 salvage value, exactly as planned.
Amortization of the customer list
Straight-line: $30,000 divided by 5 = $6,000 per year, with no salvage value.
Year-end journal entry
| Account | Debit | Credit |
|---|---|---|
| Depreciation expense | $2,000 | |
| Accumulated depreciation: equipment | $2,000 | |
| Amortization expense | $6,000 | |
| Accumulated amortization: customer list | $6,000 | |
| Total | $8,000 | $8,000 |
After year one, the balance sheet shows equipment at $12,000 minus $2,000 = $10,000 and the customer list at $30,000 minus $6,000 = $24,000, a combined carrying amount of $34,000. The income statement shows $8,000 of non-cash expense. Our debits and credits cheat sheet explains why accumulated accounts carry credit balances.
Selling the equipment early
Suppose the firm sells the equipment at the end of year three for $5,000. From the schedule, accumulated depreciation is $6,000 and book value is $12,000 minus $6,000 = $6,000. Selling for $5,000 produces a $1,000 loss on disposal. The entry removes both the cost and the accumulated depreciation:
| Account | Debit | Credit |
|---|---|---|
| Cash | $5,000 | |
| Accumulated depreciation: equipment | $6,000 | |
| Loss on disposal of equipment | $1,000 | |
| Equipment | $12,000 | |
| Total | $12,000 | $12,000 |
If the sale price had been $7,500 instead, the firm would record a $1,500 gain (a credit) rather than a loss. Remember to issue the buyer an invoice for the sale and charge sales tax where your state requires it; the sales tax calculator helps with the figures.
The tax view is different
For US federal tax, a customer list acquired as part of buying a business is generally a section 197 intangible. The IRS guidance on amortizing intangibles says you must generally amortize the capitalized costs of section 197 intangibles over 15 years. So the same $30,000 list would produce $2,000 a year of tax amortization ($30,000 divided by 15), versus $6,000 a year on the books. The equipment, meanwhile, may qualify for faster tax write-offs; our comparison of Section 179 vs bonus depreciation explains those options. Book and tax differences like these are normal; your accountant tracks them separately.
Where they show up in your financial statements
- Income statement: depreciation and amortization appear as expenses, reducing operating profit. Our sibling comparison of the income statement vs balance sheet explains how the two reports connect.
- Balance sheet: assets appear at cost minus accumulated depreciation or amortization. See our small business balance sheet guide.
- Cash flow statement: both are added back to net income in operating activities, because no cash left the business when the expense was recorded. The cash left when the asset was bought, which shows under investing activities. Our cash flow statement guide walks through the add-back.
Because both expenses are non-cash, lenders often look at EBITDA (earnings before interest, taxes, depreciation and amortization) as a rough proxy for operating cash flow. They also reduce reported profit, which affects measures such as net margin; see our sibling guide on how to calculate profit margin.
Goodwill, software and other special cases
| Item | Book treatment (typical) | Notes |
|---|---|---|
| Goodwill (public company, US GAAP) | Not amortized; impairment testing | IFRS also prohibits goodwill amortization |
| Goodwill (private company, US GAAP) | May elect to amortize straight-line over 10 years or less | Election under the private company accounting alternative |
| Purchased software license | Amortized over expected use | Subscriptions (SaaS) are usually just operating expenses |
| Trademark with indefinite life | Not amortized; impairment testing | Amortize if the useful life becomes finite |
| Building | Depreciated | Split purchase price between land and building first |
| Leasehold improvements | Depreciated (often called amortized) over the shorter of life or lease term | Terminology varies; the mechanics are the same |
A final note on the word itself: "amortization" also describes paying down a loan in scheduled installments. Loan amortization splits each payment between interest (an expense) and principal (a reduction of the liability). It is a different concept from amortizing an intangible asset, even though the word is the same.
Common mistakes to avoid
- Expensing a multi-year asset immediately on the books without a capitalization policy, which distorts profit between years.
- Depreciating land or forgetting to split a property price between land and building.
- Assuming book and tax lives match. They often do not, especially for section 197 intangibles.
- Treating software subscriptions as intangible assets. Monthly SaaS fees are normally ordinary expenses; group them correctly using a clear set of business expense categories.
- Forgetting the asset when it is sold or retired. Remove both the cost and the accumulated balance, and record any gain or loss.
Keep the paper trail for every asset
Whether an asset is depreciated or amortized, the starting point is the same: a clear purchase record showing the date, description, cost and seller. Keep supplier invoices with your fixed asset register, and when you sell equipment or services yourself, issue clean, numbered invoices with the invoice generator. Choose a layout from our invoice templates, and your records will be ready for your accountant at year end. Every invoice exports as a PDF, so it looks the same on your client's phone, laptop or printer.
Frequently asked questions
What is the main difference between amortization and depreciation?
Depreciation spreads the cost of tangible assets, such as equipment, vehicles, furniture and buildings, over their useful lives. Amortization spreads the cost of intangible assets, such as patents, customer lists, software licenses and purchased goodwill, over their useful lives. Both are non-cash expenses that reduce profit gradually instead of all at once. The main practical differences are the type of asset, salvage value and the methods normally used.
Is amortization the same as depreciation?
They follow the same idea, allocating an asset's cost over the period it helps earn revenue, but they are not the same term. Depreciation is used for physical assets and amortization for intangible ones. Amortization is usually straight-line with no salvage value, while depreciation can use straight-line, declining balance or units of production methods and often allows for a residual value at the end of the asset's life.
What assets are amortized?
Intangible assets with a finite useful life are amortized. Common examples include patents, copyrights, trademarks with a set term, franchise agreements, purchased customer lists, non-compete agreements and acquired software licenses. For US tax purposes, section 197 intangibles bought as part of acquiring a business, including goodwill, are generally amortized over 15 years. Intangibles with an indefinite life are usually tested for impairment instead.
Is goodwill amortized or depreciated?
Goodwill is never depreciated, because it is not a physical asset. Under US GAAP, public companies do not amortize goodwill; they test it for impairment. Private companies can elect an accounting alternative to amortize goodwill on a straight-line basis over 10 years or less. IFRS does not allow goodwill amortization. For US federal tax, purchased goodwill is a section 197 intangible generally amortized over 15 years.
Is land depreciated?
No. Land is a tangible asset, but it is not considered to wear out or be used up, so it is not depreciated for book or tax purposes. When you buy property, you must split the purchase price between the land and the building. Only the building portion, and land improvements such as fences, driveways or landscaping where allowed, can be depreciated over the applicable recovery period.
Where do depreciation and amortization appear on financial statements?
On the income statement, they appear as expenses, either as separate lines or combined as depreciation and amortization. On the balance sheet, the asset is shown at cost minus accumulated depreciation or accumulated amortization, giving its carrying amount. On the cash flow statement, they are added back to net income in the operating section, because they reduce profit without using cash in that period.
What is the journal entry for amortization?
Debit amortization expense and credit accumulated amortization, or credit the intangible asset directly, which some businesses do. For a $30,000 customer list with a five-year useful life and no residual value, the annual entry is a $6,000 debit to amortization expense and a $6,000 credit to accumulated amortization. After one year, the carrying amount is $24,000. The entry for depreciation follows the same pattern.
Why does amortization also refer to loans?
The word has two common meanings. In asset accounting, amortization spreads the cost of an intangible asset over time. In lending, an amortization schedule shows how each loan payment is split between interest and principal until the balance reaches zero. Loan amortization does not create an expense for the principal portion; only the interest is an expense. The context usually makes clear which meaning is intended.
Invoice Creator Editorial Team
Guides on invoicing, cash flow and small-business finance from Invoice Creator, operated by Next Software Development Company. Content is reviewed for accuracy against the fields our own invoice generator produces.
Try the invoice generator