Depreciation vs Amortisation: What's the Difference?
Understand how depreciation and amortisation work, what types of assets each applies to, and how they affect your financial statements.
Key Takeaways
- Depreciation applies to tangible assets like equipment and vehicles, while amortisation applies to intangible assets like patents and software licences.
- Both spread the cost of an asset over its useful life rather than expensing it all at once, matching the cost to the revenue it generates.
- Understanding these concepts helps African business owners plan asset purchases, manage tax obligations, and present accurate financial statements.
What is depreciation?
Depreciation is the systematic allocation of the cost of a tangible asset over its useful life. Physical assets like machinery, vehicles, buildings, and equipment lose value through use, wear, and obsolescence. A delivery van purchased by a Cape Town logistics company for 400,000 ZAR with a ten-year useful life might be depreciated at 40,000 ZAR annually. This annual charge appears on the income statement as an expense, reducing reported profit without any actual cash outflow.
What is amortisation?
Amortisation serves the same purpose as depreciation but applies to intangible assets. These include patents, trademarks, copyrights, software licences, and goodwill acquired through business purchases. A Rwandan tech company that spends 50 million RWF developing proprietary software might amortise that cost over five years at 10 million per year. Like depreciation, amortisation is a non-cash expense that reduces reported income and reflects the gradual consumption of an asset's value.
Key differences
The core difference is the type of asset: depreciation covers physical assets, amortisation covers intangible ones. Depreciation methods include straight-line, declining balance, and units of production. Amortisation is typically straight-line over the asset's legal or estimated useful life. Tangible assets may have residual or salvage value at the end of their useful life, while intangible assets often amortise to zero. Tax treatment varies, with different African jurisdictions offering different capital allowance rates for each category.
When to use each
Apply depreciation when you purchase physical business assets like vehicles, computers, or manufacturing equipment. Apply amortisation when you acquire or develop intangible assets like software, patents, or brand licences. Both reduce taxable income, which is valuable for tax planning. African businesses investing in technology and intellectual property should work with qualified accountants to establish appropriate amortisation schedules that comply with local accounting standards and tax regulations.