What is depreciation in English? A practical guide for investors

Why You Need to Understand Depreciation

A company’s assets do not retain their value forever. Over time, machinery, buildings, and equipment will depreciate. This is where depreciation comes into play. It is an accounting process that helps companies systematically calculate and record the loss of value of these assets.

Investors who want to assess a company’s financial health need to understand depreciation and how it affects profit calculations.

Two Perspectives on Understanding Depreciation

Depreciation can be viewed from two main angles:

First perspective: Value reduction Tangible assets lose value over time. Vehicles, office equipment, and computers all depreciate.

Second perspective: Cost allocation Depreciation is the process of spreading the cost of purchasing an asset over the useful life of that asset. For example, IT equipment like laptops, which typically have an estimated useful life of 5 years.

Estimating Useful Life: The Key

Determining how many years an asset will be used is crucial because it influences how much depreciation is recorded each year. For example, if a company purchases a car for 100,000 THB and estimates its useful life at 5 years, the straight-line depreciation will be 20,000 THB per year.

Which Assets Can Be Depreciated?

The Revenue Department has specific criteria for assets eligible for depreciation. Assets that meet the following conditions can be depreciated:

• Owned by the company
• Used to generate income or support business operations
• Have a determinable useful life
• Expected to be used for more than 1 year

Common depreciable assets include vehicles, buildings, personal equipment, machinery, and even intangible assets such as copyrights, patents, and software.

Assets That Cannot Be Depreciated

Some asset types are not eligible for depreciation:

• Land (considered to appreciate or maintain value)
• Collectibles (art, coins, souvenirs)
• Investments (stocks, bonds)
• Personal property
• Assets used for less than 1 year

Four Methods of Calculating Depreciation

( 1. Straight-line Method)

The simplest and most popular method. You just divide the asset’s cost by its useful life. The result is the same amount recorded each year.

Advantages: Easy to calculate, fewer errors, companies can clearly plan annual expenses.

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

2. Double-declining Balance Method(

This method allows you to record higher depreciation in the early years of the asset’s life, decreasing over time. Suitable for businesses that want to recover cash quickly.

Advantages: Compensates for increasing maintenance costs, reduces taxable income in the first year.

Disadvantages: More complex calculations, may not be beneficial if the company is experiencing tax losses.

) 3. Declining Balance Method###

An accelerated depreciation method where the asset is depreciated at twice the straight-line rate. The main feature is high depreciation in the first year, decreasing in subsequent years.

( 4. Units of Production Method)

Suitable for equipment with a clear production capacity. Depreciation is based on the number of units the machinery can produce, rather than time.

Advantages: High accuracy, reflects actual usage.

Disadvantages: Requires close tracking of usage, more difficult to account for in real-world scenarios.

What Is Amortization?

Amortization is the process of gradually reducing the value of intangible assets or loans over time or as payments are made.

Example: If a company acquires a patent for machinery costing 10,000 THB and expects to use it for 10 years, the amortization expense would be 1,000 THB per year.

Loan Amortization

When you or your company take out a loan, each payment consists of two parts: interest and principal. Initially, you pay more interest than principal, but over time, this ratio shifts until the loan is fully repaid.

( Amortization of Intangible Assets

Companies amortize intangible assets such as copyrights, patents, trademarks to spread their costs over the period they provide benefit to the organization.

The Difference Between Depreciation and Amortization

Depreciation in English and Financial Analysis

) EBIT and Including Depreciation

EBIT ###Earnings Before Interest and Taxes( refers to profit before interest and taxes. Depreciation is deducted from revenue when calculating EBIT. When comparing two companies, a company with more fixed assets may have a lower EBIT due to higher depreciation.

) EBITDA Adding Back Depreciation

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) adds depreciation and amortization back. Investors can better compare the earning capacity of different companies.

Why Is This Important for Investors?

When comparing companies, if one has newer equipment and another has older equipment, the first may have a lower EBIT even if their actual revenue-generating ability is similar. Understanding depreciation helps you see a clearer picture.

Summary: Why Understanding Depreciation Matters

Depreciation and amortization are essential tools not only for accountants but also for investors and managers. Understanding depreciation helps you read financial statements more accurately.

Whether you study the straight-line method or accelerated depreciation, the key is to understand how assets lose value and how companies calculate this loss. This directly impacts company valuation.