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Amortization and depreciation

Comparing depreciation and amortization. Created by Sal Khan.

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  • blobby green style avatar for user Jaeson Bang
    why is home loan amortizied? it is a property, so shouldnt it be considered depreciation?
    (21 votes)
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  • blobby green style avatar for user nick
    For License fee amortization, why does it not start on period 0, as you get to use it as soon as you bought it?
    (9 votes)
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  • blobby green style avatar for user Logan Seidl
    What happens on the books when the company sells the truck after three years? Where to they claim that money on the balance sheet?
    (7 votes)
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    • aqualine ultimate style avatar for user Rahul Chindaliya
      When the company sells the truck after three years, (remember the book value of the truck is ZERO) Whatever will be the selling price is considered as a profit, it wouldn't affect the Machinery account as its already written off. The company will book the profit(if any) and record the increase in cash.
      That will help hopefullly
      (10 votes)
  • blobby green style avatar for user Luke Chang
    What does it mean to write-off an asset?
    (8 votes)
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    • blobby green style avatar for user Gerald Matthews
      To write off an asset means to charge it as an expense immediately instead of depreciating it as planned. For example, if the truck in the video got into a serious accident at the end of Year 1 and couldn't be repaired, the remaining $40K could written off by expensing it immediately. This would be proper accounting because the truck wouldn't be used in Year 2 and Year 3.
      (6 votes)
  • orange juice squid orange style avatar for user spidy
    Why is depreciation considered an 'expense'? Is it because i bought it at $60 and now its only worth 40... so i've 'lost' 20?
    (2 votes)
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  • blobby green style avatar for user Mathew952
    What if I have a building expense, but I'd like to count that building as an asset? Let's say a bank builds a new branch; depreciating the building to 0 would make it seem as though they no longer have the building. On the balance sheet, would I simply put both an expense of 150,000 and an increase in equity of 150,000 (since the building is hopefully worth what we paid for it)?
    (1 vote)
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    • blobby green style avatar for user W.Coulby
      He is correct, you would increase assets by 150,000 and decrease cash by 150,000 (or record a liability, which is likely a mortgage). There would be no increase in equity as you have not gained anything. The purpose of amortization is to match the expenditure to the revenue that it helped earn. The amortization period should match the useful life of the building, which as stated above could be a long period such as 40 years.
      (3 votes)
  • blobby green style avatar for user Tom Pringle
    Due to the concept of materiality, isn't it more often that businesses just expense items rather than amortizing them? Is amortization reserved mostly for high-dollar liabilities?
    (2 votes)
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  • blobby green style avatar for user dapelta
    A truck could be sold to realise its value. Usually, a license cannot, so does a licence have a value as an asset?
    (2 votes)
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  • mr pants teal style avatar for user ericp
    Can the License Fee be sold in the market?

    Can you have assets that are not worth anything if you try to sell them? Would that make it just an expense?
    (1 vote)
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    • leaf yellow style avatar for user Erik Carlson
      To comply with accounting principles, all capital assets (both tangible and intangible) must be recorded at cost, and subsequently amortized over their useful lives. If you subsequently sell the asset for less than or greater to the net book value (which could be zero), a gain or loss would be recorded on sale of the capital asset. For example, a gain is equal to the proceeds on sale less the net book value. It would be difficult to sell a license fee asset since the license originally arose from a contract or agreement between the buyer and the seller. So if a license is not fully used up over its useful life, the net book value amount remaining is recorded as a loss if it's determined that future economic benefits cannot be obtained.
      (3 votes)
  • piceratops ultimate style avatar for user JR . MATUSE
    can khan academy help with accounting
    (1 vote)
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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 could imagine in period zero 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 depreciates faster in the first year, but this is the simplest type. And it's 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 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 in period three, we expense another $20,000 on our income statement. And then on, at least for 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 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 let me call this 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'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, 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, look, I'm going to use this over the next four years, essentially $1,000 a year. So my license fee amortization in year one I'd say is $1,000. And then on my books I would carry the license fee for $3,000. Then I'd amortize another $1,000. Then it would go down to $2,000. Amortize another $1,000. Then at the end of period three, it's now worth $1,000 on my books. Period four, amortize another $1,000. 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, 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, 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 just amortize it. This is just 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 maybe intellectual property, you would amortize the cost. If you have a truck or a building or whatever, you would depreciate it.