Depreciation and amortization
Amortization and Depreciation Comparing depreciation and amortization
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- You'll often hear the words "depreciation" and "amortization" used together.
- And what I want to do in this video is understand a little bit better
- why they are similar and the slight difference between the two.
- So in our previous examples we've done depreciation
- so you can imagine, in period 0 we buy a truck for $60,000
- and instead of just expensing it in period 0,
- instead of putting $60,000 expense right over here,
- we capitalize it.
- We say that we have a $60,000 asset.
- So this is right at the end of period 0, or the beginning of period 1
- And what we do is we spread out this expense over the period of time
- that we're actually going to use the truck.
- So in period 1, we depreciate the truck by $20,000.
- We're assuming we have a 3-year life of this truck,
- and we're just going to do what's called
- "Straight Line Depreciation"
- We're just going to take the cost of the truck, and divide it by its life.
- There are other ways to depreciate it.
- Maybe you could imagine that it depreciates faster in the first year.
- But this is the simplest type, and is actually used by a lot of companies.
- Just Straight Line Depreciation.
- So after we use $20,000
- we depreciate the truck by $20,000
- we expense it in that year, so this is literally an expense.
- Then at the end of period 1, it is now on our books for $40,000
- Then in period 2, we depreciate it by another $20,000
- it's going to be a $20,000 expense in period 2.
- Now on our books, at the end of period 2, it's going to be worth $20,000
- Then in period 3, we expense another $20,000 on our income statement
- and then, at least for this truck, assuming we hadn't bought a new one yet
- We've completely written it off.
- It is now worth $0 on our books, because, based on what we assumed, it's not useful anymore.
- We kind of have to scrap this truck.
- That's depreciation.
- Now imagine if, to run our trucking business,
- we also had to pay some type of license fee.
- And let's say that the license fee was $4000
- and we get to use it over 4 years.
- So once again, you could've just put a $4,000 expense right over here,
- but that's not really accurate, you're not just using that fee in that period.
- That fee is going to be useful over the next 4 years.
- So once again, you would put down the asset, you know, the paid license fee,
- or maybe the prepaid license fee, depending on how you view it,
- and then you would amortize that cost.
- Which is essentially the same thing mathematically. You say
- "Oh look! I'm going to use this over the next four years
- essentially $1,000/year." So my license fee amortization in year 1
- I'd say is $1,000
- and then on my books I would carry the license fee for $3,000
- and then I'd amortize another $1,000, and it would go down to $2,000
- then amortize another $1,000, and at the end of period 3 it's now worth $1,000 on my books
- Period 4, amortize another $1,000, now I've completely written it off
- and I probably have to get another license at the point.
- So mathematically, they're the same thing
- even philosophically they're the same thing
- The idea that, instead of expensing those expenses all at once,
- you say "Look, they have some useful life, let me spread out the expense over their useful life."
- The difference between the two, and you might have already realized this,
- Is the appreciation is when you have hard assets
- If you have a building, or a truck, or some type of equipment you would depreciate that asset
- If you have a non-hard asset, or a financial asset
- or something that's less tangible, then you would amoritze it.
- It's just a different word depending on how tangible the asset is.
- So if it's a license fee, or some other type of fee,
- or some type of, maybe intellectual property, you would amortize the cost
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