Depreciation (Depreciation) and Amortization (Amortization) - Tools that accountants need to know

Why Understanding Depreciation and Amortization Matters

When your business purchases assets, their value doesn’t just disappear because costs increase; instead, their value gradually declines over the years. The question is: how do you record this expense in your financial statements? That’s where depreciation and amortization come into play.

Both tools help companies to:

• Systematically record asset costs
• Match revenue with actual expenses each year
• Calculate net profit more accurately
• Properly deduct taxes

If your business doesn’t use these methods, profits may appear higher in the first year, but in reality, you’re hiding the true costs of operations.

What is (Depreciation)?

Depreciation is an accounting process that allocates the cost of tangible assets over their useful life.

Imagine this: a company buys a computer and laptop for 50,000 THB, expected to last 5 years, with a residual value of 5,000 THB. The annual depreciation will be (50,000 - 5,000) ÷ 5 = 9,000 THB.

Important point: depreciation is not actual cash. It’s an accounting entry only. You pay the full amount upfront but expense it over the years.

###Real-world example of depreciation

Scenario: A company imports machinery costing 100,000 THB, with an expected useful life of 5 years and a salvage value of 0 THB.

• Year 1: record depreciation of 20,000 THB
• Year 2: record depreciation of 20,000 THB
• Years 3-5: similarly

After 5 years, the asset’s book value becomes 0, even though the machinery may still be usable.

Which Assets Are Depreciable?

Assets that can be depreciated:

• Vehicles (Cars, trucks)
• Buildings and constructions
• Machinery and equipment
• Computers and electronics
• Furniture and office supplies

Assets that cannot be depreciated:

• Land (Value does not decrease)
• Collectibles (Art, coins)
• Stocks and bonds
• Personal property
• Assets with a useful life of less than 1 year

Four Methods to Calculate Depreciation

1. Straight-line Method (Straight-line) - The simplest

Calculates the same depreciation expense each year over the asset’s useful life.

Formula: (Asset cost - Residual value) ÷ Useful life

Advantages:

• Easy to calculate and record
• Suitable for small businesses

Disadvantages:

• Ignores increased maintenance costs as assets age
• Does not reflect actual depreciation for some assets

2. Double Declining Balance Method (Double-declining Balance)

Also called “accelerated depreciation” — higher depreciation in the first year, less in subsequent years.

This method is suitable for assets that rapidly lose value from the start, such as vehicles or tech equipment.

Advantages:

• More realistic reflection
• Greater tax deductions in early years
• Compensates for increased maintenance costs over time

Disadvantages:

• More complex calculations
• May overstate remaining value at the end

3. Sum-of-the-Years-Digits Method (Sum-of-the-years-digits)

An accelerated depreciation method that uses the remaining useful years to determine depreciation proportionally.

For example, for an asset with a 5-year life:

• Year 1: 5/15 of the total depreciation
• Year 2: 4/15
• and so on

4. Units of Production Method (Units of Production)

Depreciates based on actual usage, not time.

Example: A machine designed to produce 100,000 units. If it produces 20,000 units this year, depreciation = (20,000 ÷ 100,000) × total cost.

Advantages:

• Reflects actual usage
• No depreciation if not used

Disadvantages:

• Requires tracking actual usage, which is complex
• Difficult to predict lifespan

What is (Amortization)?

While depreciation applies to tangible assets, amortization is used for intangible assets.

Intangible assets include:

• Licenses and patents
• Trademarks
• Goodwill (Goodwill)
• Franchise rights

(Example: Amortization of an asset

A company purchases a patent for 10,000 THB, usable for 10 years.

Annual amortization = 10,000 ÷ 10 = 1,000 THB/year

)The difference between depreciation and amortization in debt repayment

Loans, such as mortgages or car loans, also involve “amortization,” but with a different meaning.

Example: Borrow 100,000 THB, repay over 5 years.

If each payment is 20,000 THB, this is called “loan amortization,” which includes:

• Principal ###Principal###
• Interest (Interest)

Important: Initially, most payments are interest. Over time, principal repayment increases. For example:

• Year 1: interest 8,000 THB + principal 12,000 THB
• Year 5: interest 1,000 THB + principal 19,000 THB

Key Differences

Relationship with EBIT and EBITDA

Depreciation and amortization impact accounting profit calculations and are key examples:

( EBIT )Earnings Before Interest and Taxes - Earnings before interest and taxes###

EBIT = Revenue - Total expenses (Including depreciation and amortization) + Interest

Simple formula:

1. Start with net income
2. Add back interest expense
3. Result = EBIT

( EBITDA )Earnings Before Interest, Taxes, Depreciation, and Amortization###

EBITDA = EBIT + depreciation + amortization

Differences:

• EBIT: subtracts depreciation and amortization
• EBITDA: adds back depreciation and amortization

( Why is this important?

Compare two companies:

• Company A: Has high depreciation of 10 million THB/year due to factory assets
• Company B: Service company with low depreciation of 1 million THB/year

Looking at EBIT, Company A seems less profitable, but EBITDA reveals that both are actually performing similarly.

Investors often look at EBITDA to compare operational efficiency across businesses with different capital structures.

Summary and Practical Tips

Depreciation and amortization are accounting tools that do not involve actual cash flow but are crucial for:

• Accurate profit and loss reporting
• Comparing companies
• Tax deductions

For investors: Don’t focus solely on EBIT. Check EBITDA to understand the company’s true operational performance.

For business owners: Choose depreciation methods suitable for your business. Straight-line is simple but may not be ideal for assets that lose value quickly.