That’s the big fuss over amortization and depreciation? Amortization and depreciation are wonky and arcane topics in the world of accounting and business finance. If you’re a small business owner or entrepreneur terms like this can be incredibly intimidating and complex.
Depreciation
Basically amortization and depreciation are ways of accounting for things declining in value naturally over time. A great example is the rusted tractor shown above. At one point in time the tractor was an asset on the farm’s balance sheet. The tractor was basically paid for with cash and a new line item on the balance sheet was created. Note that this is a capital good, so it did not affect the income statement or expenses side of the accounting equation. Over time, the tractor rusted and became useless, but it was still on the balance sheet as an asset. In order for the balance sheet to accurately reflect the assets of the farm or organization, an accountant needs to depreciate the value of the tractor over time by creating expenses that remove it gradually from the assets. This accounting method accurately.
Amortization
Amortization is the same exact thing as depreciation, except that it refers to the process in which intangible assets lose value over time. A great example is a brand name that was acquired by a company. Over time the goodwill or intangible value over book value paid for the company needs to be written off. This process of amortization is the same in every way as depreciation but goes by a different name. There you have it! Fairly simple and straightforward.
