Understanding Amortization and Depreciation
Managing your assets in terms of taxes can seem intimidating at first glance. A simple mistake can cause significant damage to your business. However, understanding concepts like depreciation and amortization can help avoid potential issues in the future. This guide explains the various aspects of amortization and depreciation to help navigate your assets.
What is Amortization?
Some may believe that amortization involves complex factors in its calculations, but it can be rather simple once understood. Amortization can be defined as an accounting technique used to periodically lower the book value of a loan or intangible asset over a set period of time. For example, if something is amortized over three years, simply take the cost and divide by three, and that is your annual amortization.
What is Depreciation?
Depreciation can be defined as an accounting method of allocating the cost of a tangible or physical asset over its useful life or life expectancy. In simpler terms, it is essentially a way to write off the value of an asset. Depreciation is not a business choice, rather it is a required way to expense the capitalized assets that you purchase.
This means that you can spread out the original cost of an asset and gain value from it, which can be a wise business choice if executed properly. Depreciation can also be sped up or slowed down, depending on the status of your business income. The vital business decision is whether to fully depreciate in one year or to spread it out.
In addition, there are different types of depreciation, which include straight line, double declining balance, units of production, and sum of years digits. Annual depreciation occurs yearly to a depreciated fixed asset. When looking into the different types of depreciation, be sure to find the one that works best for your company.
When to Use Amortization and When to Use Depreciation
Some may mistake amortization and depreciation as two accounting techniques to be chosen between. However, there is no choice between the two. Instead, simply use the one that you are required to based on which asset you purchased. The general rule of thumb is to use depreciation on physical assets and amortization on non-physical assets. Depreciation works best with physical, tangible assets. Amortization is often used for non-tangible assets, as it is tailored for loans and patents. Stick to the general rule of thumb and try to keep things as simple as possible.
Unsure About Things Like Annual Depreciation? Contact a Tax Professional
The IRS is not an enemy you want to wrestle with. It will often win and you will have wasted time. Time makes your business thrive.
Before using annual depreciation or amortization for your assets, contact a tax professional.
Core Group believes that a CPA should do more than just help you with taxes. They should strive to help your company grow.
The focus of your business should be on making a difference in the world. Complicated tax and financial matters only distract from that. Let the passionate and talented experts at Core Group US put your mind at ease.
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