You may have heard of the terms amortisation and depreciation. But do you know the difference between the two and how they are shown on your financial statements?

Most of us can have a stab at the definition of depreciation (probably along the lines of how the value of a brand new car plummets the moment we drive off the dealership forecourt) But amortisation? That’s much trickier …

Depreciation

“A reduction in the value of an asset over time, due in particular to wear and tear.” Depreciation is an accounting entry that reduces the value of a fixed asset over the course of its useful life. Its an estimate of the value of usage that a business is deriving from the asset. Although shown as an expense on the Profit and Loss account alongside items such as heating and lighting, depreciation is a non-cash expense. So the figure could relate to an item bought years ago – a car, for example, or computer equipment, both of which naturally deteriorate over time. Depreciation therefore spreads the cost of the asset across several years in your Profit and Loss account. It matches that cost to the periods in which you are using the asset and generating revenues from it. This ensures that your profits are not unfairly distorted by taking the cost all in one go.

Amortisation

Amortisation has the same effect as depreciation. But it is an accounting entry that reduces the value of intangible (or non-physical) assets such as patents and goodwill over the period of their use in order to give a fair reflection of profits. This is in contrast to depreciation, which applies to tangible fixed assets such as premises and vehicles. The Profit and Loss account includes amortisation figure as an overhead cost. Just like depreciation it is an operating cost of the business. Both also reduce the overall value of a company’s assets in the Balance Sheet. Because both are non-cash expenses, they are stripped out, or excluded, from the EBITDA measure of profitability. You can learn more about accounting terms such as these in our financial literacy training courses. Far from boring, they’re interactive and fun, increasing understanding so you can run your business more efficiently. Colour Accounting™ is our financial literacy course. Discover more about how to add great finance skills to your toolkit. [traininglist slug=”colour-accounting-normal”]  ]]>