Differentiate depreciation and amortization.

• A. Depreciation applies to tangible fixed assets; amortization applies to intangible assets with finite useful lives.
• B. Depreciation applies to intangible assets; amortization applies to tangible assets.
• C. Both depreciation and amortization apply to the same asset types.
• D. Depreciation is a cash flow concept; amortization is not.

Answer: (B)

Depreciation and amortization are the way we allocate the cost of assets over time. The main distinction is the type of asset involved: tangible fixed assets—buildings, machinery, vehicles, equipment—are depreciated, while intangible assets with finite lives—patents, licenses, software, franchise rights—are amortized. Indefinite-life intangibles, like goodwill, aren’t amortized; they’re tested for impairment instead.

In both cases the expense is non-cash, reducing reported income, and it creates a tax shield that can affect cash flow. For example, if you buy a machine for a fixed amount with a finite useful life, you’d depreciate it over that life (often straight-line or another systematic method). If you buy a patent or software with a definite life, you’d amortize the cost over the asset’s useful life. Understanding this helps you distinguish which assets fall into each category and how their costs are recognized in financial statements.