## Depreciation (Depreciation) Explained Simply and Practically

If you are a business owner or investor, you’ve probably seen the term **depreciation** many times, but may not fully understand how it works or why it is calculated.

In short, depreciation (Depreciation) is an accounting process used to gradually reduce the value of tangible assets (such as buildings, machinery, vehicles) over time as they are used. Because these assets wear out or become obsolete, their value decreases, similar to an old car whose price drops over the years.

### Why is depreciation accounting necessary?

For companies, depreciation is not just a number in the ledger. It affects profit calculations (EBIT, EBITDA) and also impacts tax filings.

For example, if you buy machinery for 100,000 baht and expect it to last 5 years, depreciation helps spread out this cost. Instead of recording a loss of 100,000 baht in the first year, you record 20,000 baht per year, making the overall financial picture more reasonable.

### The importance of EBIT and EBITDA in a company

**EBIT** (Earnings Before Interest and Taxes) is profit before deducting interest and taxes – depreciation is included in this calculation.

**EBITDA** (Earnings Before Interest, Taxes, Depreciation, and Amortization) is profit before deducting interest, taxes, depreciation, and amortization – depreciation is added back in.

This difference is important when comparing companies with many assets versus those with few.

## Types of Assets and Which Assets Can Be Depreciated

### Assets that can be depreciated

If an asset has the following characteristics, you can depreciate it:

- **Owned by you** – not leased or borrowed
- **Used in business** – to generate income
- **Has a clear useful life** – e.g., 5 years, 10 years (not for lifetime)
- **Lasts more than 1 year**

Typical examples: vehicles, office buildings, desks, computers, machinery, patents, copyrights, software

### Assets that cannot be depreciated

Not everything that is an asset can be depreciated:

- **Land** – land does not wear out; its value often appreciates over time
- **Collectibles** – art, coins, amulets
- **Stocks and bonds** – financial investments
- **Personal property** – not a business asset
- **Assets used less than 1 year**

## How to Calculate Depreciation: How Many Methods Are There?

Companies have many options for calculating depreciation, but the most common methods are four:

### 1. Straight-line Method(

**Simple and widely used**

Calculate directly: Asset cost ÷ number of years = depreciation per year

**Example:** Buy a car for 100,000 baht, useful life 5 years

Depreciation = 100,000 ÷ 5 = **20,000 baht per year**

**Advantages:** Very simple, accurate, suitable for small businesses

**Disadvantages:** Does not account for faster loss of value in early years or increased maintenance costs as it ages

) 2. Double Declining Balance###

**Used for assets that lose value quickly**

This method calculates higher depreciation in the first year, then decreases over time – similar to a new car’s big initial depreciation.

**Example:** For a computer that becomes obsolete quickly

Year 1: High depreciation, about 40% of value

Years 2-5: gradually decreasing

**Advantages:** Reflects reality well, helps reduce taxes in the first year

**Disadvantages:** More complex, less suitable for simple accounting

( 3. Declining Balance)

**Accelerates depreciation**

Similar to double declining but not as fast – depreciation is twice the straight-line rate.

Year 1: high depreciation

Subsequent years: decreasing depreciation

**Advantages:** Balances simplicity and realism

**Disadvantages:** Still more complex than straight-line

### 4. Units of Production(

**Based on actual usage, not time**

Instead of calculating by years, base depreciation on how many units or hours the asset is used – e.g., hours worked or units produced.

**Example:** Machinery expected to produce 1,000,000 units in its lifetime

If this year produces 100,000 units, depreciation is 10% of the asset’s value

**Advantages:** Accurate for machinery and equipment with irregular usage

**Disadvantages:** Harder to track in real life; requires detailed usage records

## What is Amortization )Amortization###?

**Amortization** is similar to depreciation but applies to **intangible assets** such as:

- **Licenses and patents** – decrease over time
- **Loans** – repaid in installments
- **Other intangible assets** – e.g., goodwill purchased during mergers (Goodwill)

( Examples of amortization

**Intangible assets:**

Patent for machinery = 10,000 baht, useful life 10 years

Amortization = 10,000 ÷ 10 = **1,000 baht per year**

**Loan:**

Loan of 10,000 baht, repaid annually with 2,000 baht

Amortization = **2,000 baht per year**

) Types of amortization

**Loan amortization** – when you repay a loan (such as a mortgage or car loan), each payment is split into:

- Interest portion
- Principal reduction

Initially, more of the payment goes toward interest; over time, more goes toward reducing the principal.

**Intangible asset amortization** – uses straight-line method, spreading the asset’s cost over its useful life, e.g., licenses.

## Comparing Depreciation vs Amortization

| Aspect | Depreciation | Amortization |
|---------|----------------|--------------|
| **Definition** | Reduces the value of tangible assets | Reduces the value of intangible assets or loans |
| **Calculation methods** | Straight-line or accelerated | Mostly straight-line |
| **Applicable to** | Buildings, machinery, vehicles | Licenses, patents, loans |
| **Time frame** | Based on physical useful life | Based on contract or set period |

## Summary

Depreciation and amortization are essential accounting tools that help to:

1. **Spread costs** – instead of recording all expenses as losses in the first year
2. **Provide a realistic financial picture** – reflecting the true value of assets
3. **Plan taxes** – depreciation is a common method for tax deductions
4. **Compare companies** – understanding differences between EBIT and EBITDA

For investors, understanding how companies calculate depreciation ###which methods they use and why### can deepen financial analysis and improve investment decisions.