อย want to understand the concept of depreciation (Depreciation) more deeply? Let's see how important this is for business

Depreciation is the method used in accounting to record the loss of value of an asset over time. Imagine a company buys a car for 100,000 baht, expected to be used for 5 years. Each year, the car loses some value. Depreciation helps the accounting to spread this cost evenly over the 5 years, which is about 20,000 baht per year.

Why is depreciation necessary? Because without it, the company would appear to incur a large loss in the first year, making the financial picture unclear. Depreciation smooths this out and reflects the true situation more accurately.

Another thing to know is that depreciation is included in the calculation of EBIT, which is earnings before interest and taxes. This affects how companies within the same industry are compared. If a company has many fixed assets, its depreciation will be higher, resulting in a lower EBIT.

However, when looking at EBITDA, which adds back interest, taxes, depreciation, and amortization, the figures differ. EBITDA shows the company's true earning power without being affected by accounting choices.

Assets that can be depreciated must be owned by you, used in the business, have an estimated useful life, and are expected to last more than 1 year, such as cars, buildings, furniture, computers, machinery, software, patents, copyrights—all of these can be depreciated.

Assets that cannot be depreciated include land, collectibles (art, coins), stocks and bonds, personal property, or assets used for less than 1 year.

Let's look at how to calculate depreciation; there are 4 main methods:

The first is the Straight-line method, which is the simplest. It divides the cost equally each year. Its advantage is simplicity and low error, but the downside is it doesn't account for assets losing value faster in the early years, and maintenance costs increase as assets age.

The second is the Double-declining balance method. It calculates higher depreciation in the early years and decreases over time. This is suitable for businesses wanting to recover costs quickly to increase cash flow. It helps offset rising maintenance costs and allows for higher tax deductions in the initial years.

The third is the Declining balance method, an accelerated method that depreciates assets at up to twice the rate of the straight-line method, resulting in higher expenses early on, then decreasing over time.

The fourth is the Units of Production method, which calculates depreciation based on actual usage, such as hours used or units produced. It is suitable for machinery. Its advantage is accuracy based on real usage, but it is more complex to track and calculate.

Now, let's discuss Amortization, which is similar to depreciation but applies to intangible assets like copyrights, patents, trademarks.

Amortization is also used for loan repayments, e.g., borrowing 10,000 baht and repaying 2,000 baht annually. The amortization expense is 2,000 baht per year. For example, a patent costing 10,000 baht with a useful life of 10 years has an amortization expense of 1,000 baht per year.

The difference between depreciation and amortization is that depreciation applies to tangible assets (touchable), while amortization applies to intangible assets (untouchable). Depreciation has multiple methods, whereas amortization typically uses the straight-line method only.

In summary, depreciation and amortization are essential tools in financial analysis, helping to provide a clearer picture. Whether you're a business owner, accountant, or investor, understanding how depreciation and amortization are calculated will help you make better decisions.