Depreciation (Depreciation) in English: A Guide for Entrepreneurs

In the accounting and finance industry, the term depreciation is a fundamental concept that every manager and investor must understand. Most companies have significant fixed assets, whether equipment, vehicles, or buildings. These assets decrease in value over time, and depreciation accounting is the systematic way to reflect this loss of value. Understanding depreciation not only helps you read financial statements better but also impacts tax decisions and financial planning for the business.

What is depreciation? Meaning according to accounting principles

Depreciation refers to allocating the cost of a fixed asset over its useful life. Each year, the company records a depreciation expense in the income statement, representing the asset’s loss of value during that year.

It’s important to understand that depreciation has two key meanings. First, the asset’s value decreases naturally over time, such as a car purchased for 100,000 THB becoming less valuable after two years of use. Second, depreciation accounting involves spreading the original cost over the estimated useful years. For example, if a car is expected to last five years, its depreciation should be allocated across those five years.

Calculating depreciation isn’t arbitrary; it requires estimating the asset’s useful life. Typically, a vehicle might have a lifespan of about 5 years, a computer 3-5 years, and a building 30-50 years. Machinery depends on the type. These estimates involve some assumptions, but they are reasonable estimates.

Why is depreciation important for analyzing EBIT and EBITDA?

Investors and financial analysts often use two metrics—EBIT and EBITDA—to compare company performance. The difference between them lies in depreciation.

EBIT (Earnings Before Interest and Taxes) is calculated by subtracting costs, including depreciation, from revenue. When a company has many fixed assets, depreciation expenses are substantial, which can make EBIT appear lower compared to companies with fewer assets.

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) adds back depreciation to EBIT, reflecting the company’s core earning power without the influence of investment policies.

For example, Company A and Company B both have revenues of 1 million THB, with additional expenses of 200,000 THB. Company A has significant fixed assets with annual depreciation of 100,000 THB, while Company B has fewer assets with only 20,000 THB depreciation. EBIT for Company A will be lower, but their EBITDA will be similar. This is why some investors prefer using EBITDA for comparison.

Which assets can be depreciated?

Not all assets are eligible for depreciation under tax law. Generally, four conditions must be met:

1. The asset must belong to the company, purchased or acquired by any means.
2. It must be used in the business to generate income—such as machinery, trucks, or buildings leased out.
3. The useful life must be reasonably determinable; assets without a definite lifespan are not depreciable.
4. The asset is expected to be used for more than one year; assets with a lifespan of one year or less are not depreciable.

Assets eligible for depreciation include vehicles (cars, trucks), factory machinery, office space, furniture, computers and IT equipment, production tools, and intangible assets like patents, copyrights, and certain contractual rights—these are amortized.

Assets that cannot be depreciated include land (which does not deteriorate), collectibles (art, rare coins), financial investments (stocks, bonds), personal property (personal cars, homes), and assets with a lifespan under one year.

Main methods of calculating depreciation

Companies can choose from several depreciation methods, each with different calculations and results:

1. Straight-line method

This is the simplest and most common method, dividing the asset’s cost evenly over its useful life. For example, if a machine costs 100,000 THB and is expected to last 5 years, annual depreciation is 20,000 THB (100,000 ÷ 5).

Advantages: Easy to calculate, consistent annual expense, simplifies planning.
Disadvantages: Doesn’t reflect the actual loss of value, which is often higher when the asset is new; ignores increased maintenance costs as the asset ages.

2. Double-declining balance method

This accelerated method records higher depreciation in the early years. For example, with a 5-year lifespan, the straight-line rate is 20%. Doubling that gives 40%. Depreciation is calculated on the reducing book value each year.

Advantages: Suitable for assets that lose value quickly early on, offers higher tax benefits upfront.
Disadvantages: More complex, may not suit all asset types.

3. Declining balance method

Similar to double-declining but allows for different rates (e.g., 1.5 times the straight-line rate). It offers flexibility to adjust depreciation based on asset usage.

4. Units of production method

Depreciation depends on actual usage, not time. For example, if a machine is expected to produce 1 million units over its life and costs 100,000 THB, depreciation per unit is 0.10 THB. If 100,000 units are produced in a year, depreciation is 10,000 THB.

Advantages: Reflects actual wear and tear, suitable for manufacturing assets with variable usage.
Disadvantages: Requires detailed tracking of usage, estimates of total production may be uncertain.

How does amortization differ from depreciation?

Besides depreciation, accounting also uses amortization for intangible assets or loans.

Amortization refers to spreading the cost of intangible assets (like patents, trademarks, software) or loan principal over time. For example, purchasing software for 60,000 THB with a 6-year useful life results in 10,000 THB amortization per year. For loans, amortization involves paying down the principal over time, including interest.

The main difference: depreciation applies to tangible assets (buildings, machinery), while amortization applies to intangible assets (patents, trademarks) and loan repayments.

Another difference: depreciation can be calculated using various methods, whereas amortization typically uses the straight-line method because intangible assets do not deteriorate from use like tangible assets.

Both depreciation and amortization impact EBIT similarly and are added back in EBITDA calculations.

Applying depreciation in business decision-making

Choosing the appropriate depreciation method is a strategic decision affecting taxes and financial reporting.

• To reduce taxable income early on, companies may prefer double-declining balance.
• For stable and straightforward financial statements, straight-line is common.
• Larger companies with complex operations might use units of production to match actual usage.

When comparing companies, investors should note which depreciation methods are used, as different methods affect reported earnings and EBIT. Using EBITDA helps normalize these differences for better comparison.

Summary: depreciation, amortization, and asset management

Depreciation is a vital accounting concept that systematically measures the value of fixed assets over time. Selecting the right depreciation method benefits tax planning, budgeting, and financial statement accuracy.

Understanding the difference between depreciation and amortization enhances your ability to analyze financial statements, assess EBIT and EBITDA, and make informed investment and financial planning decisions.