Amortisation vs Depreciation: Key Differences Explained

Highlights:

• Understand how depreciation applies to tangible assets while amortisation applies to intangible assets under Ind-AS and the Companies Act, 2013
• Learn why both concepts reduce asset values on the balance sheet and affect reported profits without consuming cash
• Discover how EBITDA adds back both depreciation and amortisation to reveal underlying cash generation
• Explore tax treatment under Section 32 of the Income Tax Act and how to locate depreciation & amortisation schedules in company annual reports for investment analysis

Introduction

When a company buys a factory or acquires a patent, those assets do not retain their full value indefinitely. Depreciation and amortisation are the accounting mechanisms that systematically reduce asset values over time, reflecting real-world wear, consumption, and obsolescence.

In India, these are governed primarily by Schedule II of the Companies Act, 2013 (for useful lives of tangible assets) and Ind-AS 16 / Ind-AS 38 (for measurement and amortisation). Understanding both helps you read financial statements of NSE/BSE-listed companies more accurately and evaluate earnings quality more meaningfully.

What is Depreciation?

Depreciation allocates the cost of tangible assets over their useful life. Tangible assets like plant & machinery, vehicles, buildings, computers, and furniture have a finite productive lifespan. Rather than expensing the full purchase cost in one year, accounting standards require spreading that cost across the asset’s useful years.

Example: A manufacturing company buys machinery for ₹50 lakh with a 10-year useful life and residual value of ₹2.5 lakh (5% of cost). Using the straight-line method, annual depreciation = (₹50 lakh – ₹2.5 lakh) / 10 = ₹4.75 lakh. This reduces both the asset’s net book value on the balance sheet and reported profit on the income statement.

Key Indian rules (Companies Act / Schedule II):

• Useful lives are prescribed in Part C of Schedule II (e.g., general plant & machinery – 15 years, factory buildings – 30 years, computers – 3 years, motor cars – 8 years).
• Residual value shall not ordinarily exceed 5% of original cost (higher residual value requires technical justification and disclosure).
• Companies may use the Straight-Line Method (SLM) or the Written Down Value (WDV) method.
• Component accounting is required where a significant part of an asset has a different useful life.
• Schedule II explicitly states that “depreciation includes amortisation.”

Common methods produce different profit patterns, which is why investors check the method and useful lives disclosed in the accounting policy note when comparing peers.

What is Amortisation?

Amortisation applies the same principle to intangible assets: patents, trademarks, software licences, customer relationships, technical know-how, and licences. These assets have value but no physical form. Amortisation systematically reduces their carrying value over their estimated useful life.

Example: A pharmaceutical company acquires a drug patent for ₹100 crore with a 20-year remaining life and residual value of zero. It amortises ₹5 crore annually under the straight-line method. This reduces reported profit each year even though no cash leaves the business, an important distinction for cash-flow analysis.

Key Indian rules (Ind-AS 38):

• Intangible assets with finite useful lives are amortised. The method should reflect the pattern in which economic benefits are consumed; if the pattern cannot be determined reliably, the straight-line method is used.
• Residual value is assumed to be zero unless there is a commitment by a third party to purchase the asset at the end of its useful life or an active market exists.
• Goodwill arising from business combinations is not amortised. It is tested for impairment annually under Ind AS 36.
• Certain intangibles (e.g., toll roads under BOT/BOOT/PPP projects) may use revenue-based amortisation as permitted under Schedule II.

Amortisation vs Depreciation: Key Differences

The difference between amortisation and depreciation centres on asset type:

Both are non-cash expenses. Both reduce reported profit without consuming cash. This is why EBITDA adds both back to show cash generation independent of these accounting allocations.

Tax Treatment in India

Indian tax law treats depreciation and amortisation differently from book accounting.

Under Section 32 of the Income Tax Act:

• Depreciation is allowed on tangible assets (buildings, machinery, plant, furniture) and on specified intangible assets acquired on or after 1 April 1998: know-how, patents, copyrights, trademarks, licences, franchises, or any other business or commercial rights of similar nature.
• These intangibles form a single block and attract 25% depreciation on written-down value (WDV).
• Goodwill of a business or profession is specifically excluded from depreciable assets with effect from Assessment Year 2021-22 (Finance Act 2021). Pre-amendment goodwill may still get transitional treatment in some cases, but new goodwill is not depreciable.
• Tax depreciation is computed on the block-of-assets method (WDV), not asset-by-asset. Most assets use WDV rates; only power generation undertakings can opt for SLM.

Book vs Tax difference: Companies report “depreciation and amortisation debited to the profit and loss account” and then compute “depreciation allowable under the Income-tax Act” (Section 32(1)(ii) and 32(1)(iia) for additional depreciation). The difference creates temporary timing differences that lead to deferred tax assets/liabilities under Ind-AS 12.

In income-tax returns, this is captured in Schedule DPM (Plant & Machinery), Schedule DOA (Other Assets), and the summary Schedule DEP. Book depreciation is adjusted when arriving at taxable income.

Why It Matters for Investors

Both depreciation and amortisation directly affect the earnings metrics used to evaluate Indian stocks.

• Capital-intensive sectors (manufacturing, telecom, infrastructure, power) show heavy depreciation. A company with strong EBIT but thin EBITDA often signals high asset intensity.
• Technology, pharma, and consumer companies frequently carry significant amortisable intangibles (software, patents, brands, customer relationships). Post-acquisition amortisation arising from Purchase Price Allocation (PPA) under Ind-AS 103 can depress reported profits for several years even when the underlying business is healthy. Analysts therefore look at cash earnings or adjusted profit after adding back acquisition-related amortisation.
• Accumulated depreciation reduces the net book value of tangible assets, which lowers book value per share and affects Price-to-Book (P/B) ratios, a key valuation multiple in India.
• Useful-life and residual-value choices (and any deviation from Schedule II) are disclosed in the accounting policies note. Differences across peers can distort comparability.

Where to find the data:

In the annual reports filed with NSE and BSE, look at:

1. Note on Property, Plant and Equipment
2. Note on Intangible Assets
3. Accounting Policies note (methods and useful lives)
4. Notes to the Statement of Profit and Loss (break-up of depreciation & amortisation)

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