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Current time:0:00Total duration:7:45

Video transcript

in the depreciation video we saw that if a company had to buy some equipment for its factory let's say at the beginning of 2007 just based on the cash that went out of the door there might have been this temptation to say okay in 2007 we had in it I don't know let's call an equipment expense say EQ expense and they could have just wrote let's say that equipment cost fifty thousand dollars so they would have just put a 50 thousand dollar expense right in 2007 I write it a negative number just because I like to remember it's an expense although I don't know if that's that's actually not normally people just write it as a positive expense but I always like to put a negative for expense to know that it's going to subtract from your revenue so they would do that they would put that cash expense there in 2007 and then in future years maybe 2008 2009 2010 they would have no expense until maybe they had to replace that machine or buy a new one and we saw that that I guess is one way to account for things but it really doesn't reflect the reality of the business the fact that this machine right here that cost fifty thousand dollars is used for in this example in the depreciation video we it was usable for two years let's say in this example it's usable for four years so what they do is instead of just expensing the cost of the machine when the machine is bought on the balance sheet at the beginning of 2007 they say we now have an asset they now have an asset called a machine I'll just call it m4 machine that's $50,000 $50,000 asset at this point right here right when we bought the machine remember balance sheets are snapshots in time and then instead of having an equipment expense instead of having that expense they'll have an a let's call it an equipment depreciation expense equipment depreciation expense and the difference here is just instead of saying that we the entire expense was that machine in just the first period they're saying no we're using some of the machine in that period and let's say we do a straight-line depreciation which means we essentially depreciate the asset evenly over the over its lifespan so in this case we're assuming it's a four year lifespan let me draw that out it's a four year lifespan so they the asset should linearly go to zero over these four years so essentially in the first year our expense would be what it's twelve thousand if you divide fifty thousand divided by four it's twelve thousand five hundred dollars so it'd be minus twelve thousand five hundred dollars in each year depreciation expense minus twelve thousand five hundred minus twelve thousand five hundred and we would account for it on the balance sheet because remember income statements are just telling you how do you get from one balance sheet to another so expenses reduce the the value of your asset so example in this one at the beginning of the period before the 2007 income statement the asset was worth fifty thousand dollars we depreciated twelve thousand five hundred from it so at this point in time the balance sheet as of the end of 2007 or the beginning of 2008 we're going to say that our machine is now twelve thousand five hundred less of forty seven thousand five hundred and then at the end of 2008 beginning of 2009 our balance sheet on under the assets the machine if they gave us that level of granularity would be twelve thousand five hundred less than that so that's what thirty five thousand so the machine would be thirty five sorry this is thirty seven thousand thirty seven thousand five hundred so then the machine is twenty five thousand and then another twelve thousand five hundred on the books it'll say the machine is worth twelve thousand five hundred and then at the end of 2010 it'll say the machine is worth nothing and if we did our depreciation schedule right or if the lifespan of this machine really is four years and it's time to go buy another machine and start doing this all over again and this is all a review of the depreciation video amortization is the exact same thing but it deals with intangible assets what's an intangible well it's some things you can't see touch feel smell eat obviously a machine you can't do all of those things to it but you can at least touch it and and possibly smell and taste it so an intangible asset is some you can't do any of that stuff to but it's the exact same idea for example let's say we are some type of light I mean whatever we could still be a widget company and let me write down the years 2007 2008 2009 and 2010 and let's say that if we just did it from a cash point of view let's say we have to buy a patent in order to make our widgets so we could add we could have said oh we have to buy our you know patent expense we have to buy a patent from some brilliant investors inventor someplace patent expense we could just say oh you know what the patent it costs $4,000 so we could just put that there even though the useful life of the patent might be four years and so it doesn't reflect the fact that we still are using that patent in these years and we just take the hit here and so this income will look unusually low while these will these will look unusually high that's not reflective of the fact that you're using this patent that has four years left on it so instead of doing that what you do is at the beginning of the period so you don't do this at the beginning of the period you say we have acquired a patent an asset that is worth four thousand dollars and then every year over the life of the patent we'd amortize 1/4 of it since it has a four year life so it would be patent amortization patent amortization and there's all sorts of intangible assets that you might amortize and amortize is really just means spreading out the cost of this asset just like depreciation was spreading out the cost of a physical asset so patent amortization would be a thousand and this year a thousand and this year a thousand and this year and a thousand and this year and then at the our snapshot or our balance sheet at the end of 2007 will have honors assets of patent that's now worth three thousand and then at the end of 2008 it'll have a patent that's now worth two thousand end of 2009 I think you get the point you'll have a patent worth 1000 and the end of 2010 probably because the patent is now expired and anyone can go out and and produce whatever was that that that invention that was patented without having the patent we then say that the patent is worthless this could actually you know a very relevant thing is if you are a drug company and you were buying the patent to some pharmaceutical that had four years left so that you can have exclusive rights to develop that drug and and at this point all of a sudden now anyone can develop the drug so that patent is worthless so the balance sheet is really trying to capture what your asset is worth at that point in time at this point in time your patent is arguably only worth a thousand dollars because you paid four thousand for four years and I only have a year left but that's all amortization is nothing nothing fancy letme amortization I didn't write it out nice and neatly in case you want to know how to spell it it really in my mind it's very similar depreciation depreciation is tangible amortization is intangible and it could be patents it could be licenses it could be fees associated with a financing let's say you have some debt that you took from a company and the debt is going to last for ten years and you have to pay a one-time lump-sum fee to the bank well that one one-time lump-sum fee should probably be spread over the life of the debt so you would amortize that expense over its life anyway see in the next video