Amortization and depreciation are sometimes used as interchangeable terms for the same concepts in accounting. But in the main, depreciation refers to distributing the costs of tangible assets over their useful lifespans, while amortization refers to spreading the costs of intangible assets over their useful lifespans. Whether software is depreciated or amortized depends on whether the software was purchased for use or developed for sale.
Depreciation refers to the decrease in value of assets incurred as a result of their usage in business activities. In accounting, depreciation expense is distributed over time periods in accordance with the assets' rate of decrease of value. This is done to avoid distortions of incomes and losses due to all expenses associated with assets coming due in a single period.
Amortization in accounting refers to the gradual writing-off of capitalized expenditures. Capitalized expenditures are expenses that have been recorded as assets due to their being used to produce revenues across many periods, rather than simply the one in which they were incurred. Such assets tend to be intangible and include items such as patents.
Software Purchased For Use
Software purchased for use is considered a fixed asset. Fixed assets are long-term assets such as plant, property and equipment. Fixed assets are depreciated over time as their residual values drop due to their usage in business activities.
Software Developed For Sale
Software developed for sale have their development costs recorded as an asset. Such an asset is considered an intangible asset due to its immaterial existence and amortized because it has an useful lifespan due to obsolescence and other causes. Its value is gradually written off period by period until there is none left by the end of its usefulness.
Alan Li started writing in 2008 and has seen his work published in newsletters written for the Cecil Street Community Centre in Toronto. He is a graduate of the finance program at the University of Toronto with a Bachelor of Commerce and has additional accreditation from the Canadian Securities Institute.