## What Does Depreciation Mean? Understanding Asset Write-Down Systems Correctly

When talking about **depreciation**, it refers to the decrease in value of assets over time. Many people might think it’s just a number on financial statements, but it is a crucial process that affects net profit and company valuation. Today, we will delve into what depreciation is, how it relates to EBIT and EBITDA, and why businesses need to understand it deeply.

### The Relationship Between Depreciation, EBIT, and EBITDA

**Depreciation** is an expense recorded by accountants when the value of fixed assets decreases over time. It is deducted from revenue to calculate EBIT (Earnings Before Interest and Taxes)

On the other hand, EBITDA is a different indicator because it adds back depreciation and amortization to income. This approach helps investors compare companies across different sectors more fairly, as companies with more fixed assets will have higher depreciation, which could distort actual performance figures.

EBIT can be calculated from the income statement by starting with profit before tax and then adding back interest expenses. Conversely, depreciation and amortization are not added back.

### The Four Main Methods of Calculating Depreciation

Choosing the appropriate depreciation method depends on the nature of the asset and the company's accounting policies. The main methods are:

**Straight-line Method (Straight-line Method)** is the simplest and most common. It divides the asset’s cost equally over its useful life. For example, if a car costs 100,000 THB and has a useful life of 5 years, the annual depreciation will be 20,000 THB. This method is suitable for small businesses seeking simplicity. However, its downside is that it does not account for assets losing value faster in the early years.

**Double-Declining Balance (Double-Declining Balance)** is an accelerated depreciation method. It allows businesses to deduct more in the initial years and less later. This is useful when assets lose value quickly or for maximizing tax benefits in the short term, as it can offset increasing maintenance costs over time.

**Declining Balance (Declining Balance)** is similar to the double-declining method but with a lower depreciation rate. The asset’s value is depreciated at a consistent rate but at a faster pace than straight-line. It offers flexibility to adjust the rate according to actual circumstances.

**Units of Production (Units of Production)** calculates depreciation based on actual usage, such as hours operated or units produced. This method is suitable for equipment whose lifespan depends on output. Its advantage is accuracy and fairness, as depreciation aligns with actual use, but it is more complex to implement due to the need for precise usage tracking.

### Which Assets Can Be Depreciated?

Assets eligible for depreciation must have these characteristics: owned by the company, used to generate income, have a determinable useful life, and expected to last longer than 1 year.

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

Assets that cannot be depreciated include land, antiques, financial investments, personal property, and assets with a useful life of less than 1 year.

### Amortization: The Write-Down of Intangible Assets

**Amortization (Amortization)** is a process similar to depreciation but applies to intangible assets and loans. For intangible assets like copyrights or patents, if the initial cost is 10,000 THB and the useful life is 10 years, the amortization expense will be 1,000 THB per year.

Loan amortization differs, as payments are divided into interest and principal. Initially, the interest portion is high, but over time, the principal repayment increases. Payments remain fixed, but the components change.

### The Main Difference Between Depreciation and Amortization

**Depreciation** applies to tangible assets like buildings and machinery, while **amortization** applies to intangible assets and loans.

The calculation methods differ: depreciation may use straight-line or accelerated methods, whereas amortization typically uses straight-line for consistency and ease of tracking.

The valuation basis also differs: depreciation considers the residual value after use, while amortization reduces the asset’s book value to zero within its useful life.

### Why It’s Important to Understand Asset Write-Down Systems

A proper understanding of depreciation and amortization benefits investors, managers, and accountants by helping to:

- Assess the company’s true profit-generating ability without large depreciation expenses skewing decisions
- Fairly compare company performances using EBITDA, which reflects core operational efficiency
- Plan taxes and finances effectively, as choosing suitable depreciation methods can reduce tax liabilities or improve debt-to-equity ratios
- Forecast future cash flows, recognizing that depreciation is a non-cash expense and must be added back during cash flow analysis

Knowledge of depreciation as a concept and the use of amortization enables executives and investors to make well-informed financial decisions, enhances transparency, and increases the credibility of financial statements.