While depreciation applies to physical (tangible) assets, amortization is the process used to spread the cost of intangible assets over their useful life. These are assets that have no physical form but still provide value to the business.

“Amortization is the gradual reduction in value of intangible assets, allocated evenly across their useful life.”

It ensures that the cost of non-physical assets like licenses or copyrights is accounted for properly over time.

Intangible assets are non-physical items that still hold significant value for a business. Examples of intangible assets include patents, which grant legal rights to inventions; copyrights, which protect creative works like books or music; trademarks, which secure branding elements such as logos or names; franchise agreements that allow businesses to operate under an established brand; and software licenses that provide legal access to digital tools. Although these assets can't be physically touched, they provide ongoing benefits to the business. Because many of them have a limited useful life, their value is gradually reduced through amortization.

Most businesses use the straight-line method for amortization, meaning the asset’s cost is divided equally over its useful life.

Example: You purchase a software license for $10,000 with a 5-year term.
Annual amortization = $10,000 ÷ 5 = $2,000 per year

Each year, $2,000 is recorded as an expense, and the asset’s value on the Balance Sheet decreases accordingly.

Depreciation and amortization serve similar purposes but apply to different types of assets. Depreciation is used for tangible assets, such as machines, vehicles, or equipment—items that have a physical form. In contrast, amortization applies to intangible assets, like patents, trademarks, or software licenses, which do not have a physical presence. When it comes to method, depreciation can be calculated using multiple options, such as straight-line or declining balance methods. Amortization, however, is typically done using the straight-line method, spreading the cost evenly over the asset's useful life.