## Why Companies Need to Understand Depreciation and Amortization

When a company owns assets in use, managers and accountants must recognize one fundamental truth: the value of those assets decreases over time. This issue leads to two key accounting methods: depreciation and amortization. Both are essential tools for financial analysis. If a company's assets are not properly accounted for, it may make poor decisions or even face operational problems.

## What is (Depreciation) and Why Is It Important?

**Depreciation** is the process accountants use to allocate the cost of a fixed asset over its useful life. This concept has two important aspects:

First: The value of the asset gradually decreases as it is used, due to natural wear and tear.

Second: The initial cost of expensive assets is divided over the expected years of use so that each year's expense aligns with the revenue generated in that year.

For example, a company's laptop has an estimated useful life of about 5 years, or a large machine that can operate for 10-15 years. These periods depend on the asset type and its design.

## How to Calculate Depreciation Accurately

### Conditions for Asset Depreciation

The Revenue Department and international accounting standards clearly specify: assets must belong to the company, be used in operations or generate income, have measurable useful life, and be expected to last more than one year.

Assets generally eligible for depreciation include: vehicles, buildings, office equipment, computers, machinery, furniture, and even intangible assets such as patents, copyrights, and software.

###Assets Not Subject to Depreciation

Some assets do not deteriorate or lose value over time, so depreciation cannot be applied: land, collectibles (art, coins, souvenirs), investments (stocks, bonds), personal property, and any assets used only once or for less than a year.

## Common Methods of Depreciation: The Four Most Used

### 1. Straight-Line Method(

This is the simplest method: divide the asset's cost by its useful life. The result is the same amount recognized each year.

**Example:** A company purchases a car for 100,000 THB, expected to last 5 years. Annual depreciation = 100,000 ÷ 5 = 20,000 THB.

Advantages: Easy to calculate, minimal errors, suitable for small businesses.

Disadvantages: Does not account for rapid loss of value in the first year or increasing maintenance costs as the asset ages.

) 2. Double-Declining Balance Method###

This method results in higher depreciation expenses in the early years and lower later, reflecting the reality that assets tend to lose value faster when new.

Advantages: Helps offset increasing maintenance costs, provides greater tax deductions in the first year.

Disadvantages: More complex, may not be suitable for companies with many assets.

( 3. Declining Balance Method)

An accelerated depreciation method. While the straight-line method depreciates evenly, this method accelerates depreciation, resulting in higher expenses in the initial years and decreasing over time.

### 4. Units of Production Method(

Depreciates based on actual usage: the more the asset is used, the higher the depreciation. Calculated according to hours used or units produced.

**Example:** A machine can produce 1 million units over its lifespan. If it produces 100,000 units this year, depreciation is 10% of the asset's total value.

Advantages: Reflects actual usage accurately, suitable for manufacturing equipment.

Disadvantages: Difficult to predict total units the asset will produce.

## Relationship Between Depreciation, EBIT, and EBITDA

When accountants prepare financial statements, depreciation is included in the calculation of **EBIT** )Earnings Before Interest and Taxes###, affecting investor analysis.

**EBIT** = Profit before tax + interest expense

**EBITDA** (Earnings Before Interest, Taxes, Depreciation, and Amortization) differs by adding back depreciation and amortization to net income.

This difference is crucial for investment decisions: comparing companies with many fixed assets to those with fewer, the high depreciation of the former reduces reported EBIT, especially if the company has high debt, leading to higher interest expenses.

## What is Amortization (?

**Amortization** is the process of allocating the cost of intangible assets )such as patents, copyrights( or loans over time.

In the case of loans: borrowers make periodic payments consisting of principal and interest. Initially, most of the payment goes toward interest, but over time, the proportion shifts toward principal.

**Example:** A car loan of 10,000 THB paid monthly over 5 years. If the principal repayment is 2,000 THB per year, amortization is 2,000 THB )plus the calculated interest(.

) Types of Amortization

**1. Loan Amortization:** Helps borrowers systematically reduce debt. Whether a mortgage, car loan, or personal loan, monthly payments remain fixed, but the proportion of principal and interest changes over time.

**2. Intangible Asset Amortization:** Companies acquiring other businesses or patents must allocate the cost over several years. Example: a patent for machinery costing 10,000 THB with a 10-year useful life, amortized at 1,000 THB per year.

## Key Differences Between Depreciation and Amortization

| Aspect | Depreciation | Amortization |
|---------|--------------|--------------|
| **Asset Type** | Tangible assets (machines, buildings) | Intangible assets (patents, copyrights) or loans |
| **Calculation Method** | Multiple methods: straight-line, declining, units of production | Usually only straight-line |
| **Residual Value** | Considers salvage value | Usually none or zero |
| **Usage Period** | Based on asset’s useful life | Based on loan term or contract duration |

## Why Is It Important to Understand These Concepts?

Understanding **depreciation** and amortization helps:

- Investors compare companies fairly, especially those with different levels of fixed assets.
- Managers make informed decisions when purchasing machinery or expensive assets.
- Ensure net profit reflects true costs rather than distorted figures.

These methods are not just accounting procedures but fundamental to proper financial analysis. If a company's assets are valuable but depreciation is not properly calculated, reported profits may be overstated, potentially misleading investors.