Depreciation translation: Understanding depreciation and its importance in financial analysis

What is depreciation and why is it important for investors

When you own a business, the assets you purchase gradually lose value over time, whether it’s a car, building, or machinery. This phenomenon is called (Depreciation), which is a key concept in accounting and financial analysis.

Depreciation refers to the process where accountants allocate the cost of a fixed asset over its expected useful life. This allows companies to reflect the decrease in asset value in their financial statements reasonably.

For investors, understanding depreciation is essential because:

• It affects the net profit reported in the income statement
• It is related to the calculation of EBIT and EBITDA
• It helps us compare companies fairly

How depreciation works

Asset value decreases over time

The main points of depreciation are:

1. Actual value decline - Over time, physical assets lose value due to usage, wear and tear, or obsolescence.

2. Cost allocation for income matching - If you buy machinery for 100,000 THB to be used over 5 years, allocating 20,000 THB per year links the cost to the income generated each year.

Useful life: a key factor

The estimated useful life of an asset depends on its nature. Examples include:

• Laptop: approximately 5 years
• Car: 5-10 years
• Building: 20-40 years
• Office furniture: 5-10 years

Depreciation and financial analysis

Relationship with EBIT and EBITDA

Depreciation is a non-cash expense, so it influences financial metrics:

• EBIT (Earnings Before Interest and Taxes) = profit before interest and taxes after deducting depreciation
• EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) = EBIT plus depreciation and amortization

This difference is important when comparing companies with different asset structures. Businesses with more fixed assets (such as manufacturing) tend to have higher depreciation, while lighter businesses (like software) may have none.

Types of assets that can be depreciated

Depreciable assets

The Revenue Department and international accounting standards specify that assets must have the following characteristics to be depreciable:

• Tangible assets - Have a physical form (not intangible assets)
• Used in business - To generate income
• Have a determinable useful life - Not resources with indefinite lifespan
• Expected to be used for more than 1 year - Short-term expenses are recorded differently

Examples of depreciable assets:

• Vehicles
• Buildings and structures
• Machinery and equipment
• Furniture and fixtures
• Computers and electronic devices
• Intangible assets (patents, copyrights, software)

Non-depreciable assets

Some assets do not decrease in value or have an indefinite useful life and cannot be depreciated:

• Land - Considered to have perpetual value
• Collections - Art, coins, souvenirs (may sometimes appreciate in value)
• Investments - Stocks, bonds (do not depreciate with usage)
• Personal property - Personal residences
• Current assets - Usable within less than 1 year

How to calculate depreciation

There are four main methods in accounting, each with its advantages and disadvantages:

1. Straight-Line Method(

This is the simplest and most commonly used method, where depreciation expense is the same each year.

Formula: Annual depreciation = )Asset cost - Salvage value( ÷ Useful life

Example: A company buys a car for 100,000 THB, with an expected salvage value of 10,000 THB after 5 years.

• Annual depreciation = (100,000 - 10,000) ÷ 5 = 18,000 THB per year

Advantages:

• Easy to calculate
• Reduces errors
• Suitable for small businesses

Disadvantages:

• Does not reflect actual wear and tear, as assets may depreciate faster in early years
• Does not account for increasing maintenance costs over time

) 2. Double-Declining Balance Method(

Accelerates depreciation, resulting in higher expenses in the initial years and decreasing over time.

Principle: Calculate depreciation at twice the straight-line rate, then multiply by the remaining book value.

Example: Asset worth 100,000 THB, useful life 5 years

• Straight-line rate = 20% per year
• Double-declining rate = 40% per year
• Year 1: 100,000 × 40% = 40,000 THB
• Year 2: 60,000 × 40% = 24,000 THB
• Year 3: 36,000 × 40% = 14,400 THB

Advantages:

• More accurately reflects actual depreciation, especially for assets that lose value quickly initially
• Helps reduce taxable income in early years
• Suitable for businesses seeking faster cash flow recovery

Disadvantages:

• More complex calculations
• May not provide tax benefits if the company is already operating at a loss

) 3. Declining Balance Method###

Similar to double-declining but uses a fixed rate different from 40%.

This method balances between straight-line and double-declining, providing higher depreciation in early years but less than double-declining.

( 4. Units of Production Method)

Depreciates based on actual usage rather than time.

Principle: Suitable for equipment with measurable output, like factory machinery.

Formula: Depreciation = ###Asset cost ÷ Total estimated units( × Units produced in the year

Example: Machinery costing 100,000 THB, expected to produce 50,000 units over its lifespan.

• Year 1: 10,000 units produced, depreciation = (100,000 ÷ 50,000) × 10,000 = 20,000 THB

Advantages:

• Links depreciation directly to usage
• Most realistic reflection of asset consumption

Disadvantages:

• Difficult to track and calculate
• Requires precise usage records

What is Amortization?

) Concept: After depreciation, there is amortization

Many confuse Depreciation with Amortization, but both are similar concepts applied to different assets.

Amortization is an accounting process where the value of intangible assets or loans decreases over time.

Types of amortization

(# Loan Amortization)

Borrowers repay loans in installments, including interest and principal.

Example: A loan of 10,000 THB at 5% annual interest over 5 years.

• Initially, most payments go toward interest
• Over time, the principal portion increases, interest decreases
• At maturity, the loan is fully paid off

(# Intangible Asset Amortization)

Applied to intangible assets like patents, copyrights, trademarks.

Example: A company purchases a patent for 10,000 THB to be used over 10 years.

• Annual amortization = 10,000 ÷ 10 = 1,000 THB

Differences between Depreciation and Amortization

Summary

Depreciation is a fundamental accounting concept that helps companies record the reduction in asset value over time.

For investors, understanding depreciation is beneficial:

• It enables deeper financial analysis
• It allows fair comparison across industries
• It supports smarter investment decisions

Whether it’s depreciation or amortization, both are essential tools companies use to reflect the true value of assets and help us understand a company’s financial health more clearly.