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Video transcript

you'll often hear the words depreciation and amortization used together and what I want to do in this video is to 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 and so you can imagine in period 0 we buy a truck for $60,000 and instead of just expensing it in period zero instead of putting $60,000 expense right over here we capitalize it we say that we have a $60,000 asset and so this is right at the end of period zero or at the beginning of period one 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 one we depreciate the truck by $20,000 we're assuming we have a three 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's other ways to depreciate it maybe you could imagine that it appreciates faster in the first year but this is the simplest type and it's actually used by a lot of companies just straight 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 one it is now on our books for $40,000 then in period two we depreciate it by another $20,000 it is going to be an expense a $20,000 expense in period two now on our books at the end of period two it'll be worth 20 then period three we expense another $20,000 on our income statement and then on at least four just this truck assuming we haven't bought a new one yet we've completely written it off it is now worth zero on our books because it has know just what 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 have to pay some type of license fee so what does let me call this a license a license fee and let's say that the license fee was $4,000 and we get to use it over four years so once again you could have just put a $4,000 expense right over here but that doesn't that's not really accurate you're not just using the fee in that period that fee is going to be useful over the next four years so once again you would put down the asset that 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'd say oh look I'm going to use this over the next four years essentially a thousand dollars a year so my license fee amortization in year one I'd say is one thousand dollars and then on my books I would have carried the license fee for three thousand dollars then I'd amortize another thousand dollars then it'd go down to two thousand dollars and were ties another 1000 dollars then at the end of period three is now worth one thousand on my books period for amortize another thousand now I've completely written it off and I probably have to get another license at this point so mathematically they're the same thing even philosophically this they're the same thing the idea that instead of expensing these expenses all at once you're saying 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 kind of realized this is depreciation is when you have hard assets if you have a building or a truck or some type of equipment that would you would 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 you would just amortize it that's just the kind of 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 it may be intellectual property you would amortize the cost if you have a truck or a building or whatever you would depreciate it