Why is depreciation important to your business accounting?

Actually, many accountants and business owners still do not fully understand the difference between depreciation and amortization, or how these relate to their net profit. If you do not handle these correctly, it could affect your business valuation. Let’s look into the details.

What is depreciation, and how does it impact your business?

When breaking down depreciation, there are two main aspects:

First: The value of the asset you own gradually decreases over time. For example, a car purchased for 100,000 THB will likely not sell for the same full price after four years.

Second: The initial cost paid for the asset is allocated over its useful life on an annual basis. The benefit of this approach is that your accounting reflects the true cost each year.

Depreciation is calculated based on the estimated useful life of the asset. For example, laptops typically have a lifespan of about 5 years, while cars may last around 10 years. Assets that can be depreciated include various types such as equipment, furniture, machinery, and even patents.

Why are depreciation and EBIT calculation related?

When accountants prepare annual budgets, depreciation is deducted as a fixed cost (unless using methods where depreciation varies each year), and depreciation is included in the calculation of EBIT.

Why is this important? Because comparing two companies—one with many machines and another in the service industry—depreciation will reduce the profit of the first, affecting their EBIT even if both are equally profitable.

This is why EBITDA (which is profit before depreciation) is a popular metric among analysts. Let’s see the difference:

• EBIT: Profit after deducting depreciation and amortization, but before interest and taxes.
• EBITDA: Profit before deducting depreciation, amortization, interest, and taxes.

Which assets can be depreciated, and which cannot?

The Revenue Department has clear guidelines on which assets can be depreciated:

Assets eligible for depreciation:

• Owned outright
• Used in business operations or income generation
• Have measurable useful life
• Expected to last longer than 1 year

Examples: vehicles, buildings, office equipment, computers, machinery, patents, copyrights, software.

Assets not eligible for depreciation:

• Land (not depreciable)
• Collectibles (art, coins, souvenirs)
• Investments (stocks, bonds)
• Personal property
• Assets with a useful life of less than 1 year

Common methods of depreciation calculation

In practice, there are four main methods:

1. Straight-line method (- the simplest

This is the most widely used method, dividing the asset’s cost evenly over its useful life.

Example: Buying a car for 100,000 THB, with a 5-year lifespan → depreciation of 20,000 THB/year.

Advantages: Simple, easy to calculate, owner pays the same amount each year.

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

) 2. Double declining balance method ###

This method results in higher depreciation in the first year, decreasing over time.

Advantages: Helps recover costs faster, provides greater tax deductions in early years.

Disadvantages: More complex, less suitable for businesses still incurring losses.

( 3. Declining balance method )

Similar to double declining but with a slower rate of depreciation. Higher in the first year, lower in subsequent years.

4. Units of production method (

Depreciation based on actual usage, such as hours, number of cycles, or units produced.

Ideal for equipment with measurable output, like manufacturing machinery.

Advantages: Reflects actual wear and tear, precise calculation.

Disadvantages: Requires ongoing tracking of usage, more complicated.

What is amortization?

While depreciation applies to tangible assets, amortization refers to intangible assets.

Amortization has two main forms:

)Loan amortization

When you borrow money, each payment is split into:

• Interest portion
• Principal repayment

Example: Borrow 10,000 THB, repay 2,000 THB/year → amortization is 2,000 THB/year ###including interest and principal(

Initially, most payments go toward interest, but over time, the principal portion increases.

)Intangible asset amortization

For example, patents, copyrights, trademarks.

Example: Patent costing 10,000 THB with a useful life of 10 years → amortization of 1,000 THB/year.

How do depreciation and amortization differ?

Both are methods of reducing the value of assets over time, but they differ clearly:

Summary: Why is understanding this important?

Depreciation and amortization are not just accounting figures; they impact:

• Reported profit: Higher depreciation reduces profit.
• Tax liabilities: Greater deductions lower taxable income.
• Business valuation: Investors analyze these figures to assess company health.
• Loan decisions: Banks consider these numbers when approving credit.

Proper management of depreciation helps your accounting accurately reflect your business’s true financial position.