How to Calculate Depreciation – A Guide to Understanding Depreciation and Amortization

Depreciation (Depreciation) You Need to Know

Depreciation is the process of reducing the value of tangible assets over time. Accountants use this method to allocate the cost of expensive assets across their useful years without having to pay the full amount upfront in cash.

When a company acquires machinery, vehicles, or office equipment, these assets gradually lose their value. Depreciation helps ensure that accounting accurately reflects this reality. It is also related to amortization, which is a similar concept but applied to intangible assets.

Factors Affecting Depreciation Calculation

Depreciation calculation depends on several key factors:

Useful Life – The period during which the asset is expected to be usable. For example, a laptop might have a useful life of about 5 years, while large machinery could last over 10 years.

Salvage Value – The estimated residual value of the asset at the end of its useful life. If you buy a car for 100,000 THB with a 5-year lifespan and expect to sell it for 20,000 THB, the difference of 80,000 THB is the depreciable amount.

Calculation Method – There are various ways to allocate this amount, depending on the asset’s nature and company policy.

Assets That Can and Cannot Be Depreciated

Assets that can be depreciated:

• Vehicles and automobiles
• Buildings and structures
• Machinery, equipment, furniture
• Computers and electronic devices
• Patents, copyrights, software

Assets that cannot be depreciated:

• Land (Considered non-depreciable assets)
• Collectibles (Art, coins, souvenirs)
• Short-term investments and debt securities
• Personal property
• Assets with a useful life of less than 1 year

How Many Methods Are There for Depreciation – Comparing All 4 Methods

1. Straight-Line Method (Straight-Line Method)

This is the simplest and most commonly used depreciation method.

Principle: Divide the asset’s cost equally over its useful life.

Formula: Annual Depreciation = (Cost of Asset - Salvage Value) ÷ Useful Life

Example: A company buys a car for 100,000 THB with a salvage value of 20,000 THB and a 5-year lifespan.

• Annual Depreciation = (100,000 - 20,000) ÷ 5 = 16,000 THB per year

Advantages:

• Easy to understand and apply
• Suitable for small businesses
• Reduces calculation errors

Limitations:

• Does not account for higher depreciation in the initial years
• Does not reflect the increasing maintenance costs as the asset ages

( 2. Accelerated Depreciation Methods )Accelerated Depreciation###

This method allows companies to record higher depreciation expenses in the early years, decreasing over time.

Double-Declining Balance Method:

A form of accelerated depreciation that uses twice the straight-line rate.

Principle: Each year, depreciation is calculated at double the straight-line rate on the remaining book value, not the original cost.

Example: A vehicle costing 100,000 THB, lifespan 5 years.

• Straight-line rate = 1 ÷ 5 = 20%
• Double-Declining rate = 20% × 2 = 40%
• Year 1: 100,000 × 40% = 40,000 THB (Remaining 60,000)
• Year 2: 60,000 × 40% = 24,000 THB (Remaining 36,000)

Advantages:

• Greater tax deductions in early years
• Reflects the reality that many assets lose most of their value early on
• Helps offset increasing maintenance costs later

Limitations:

• More complex calculations
• If the company incurs losses, it may not benefit from depreciation deductions

( 3. Sum-of-Years Digits Method )Sum-of-Years Digits###

An accelerated depreciation method that assigns a higher depreciation expense in the early years.

Principle: The depreciation fraction is based on the sum of the years’ digits, with the numerator decreasing each year.

Example: Asset lifespan of 5 years.

• Sum of digits = 5 + 4 + 3 + 2 + 1 = 15
• Year 1: 5/15 of the depreciable amount
• Year 2: 4/15, and so on

Advantages:

• Larger depreciation in the first years, but less aggressive than double-declining
• More equitable than straight-line

( 4. Units of Production Method )Units of Production Method(

This method links depreciation to actual usage rather than time.

Principle: Calculate depreciation based on actual production or usage, such as hours operated or units produced.

Example: A machine can produce 500,000 units over its lifespan, costing 500,000 THB with a salvage value of 50,000 THB.

• Depreciable amount = 450,000 THB
• Cost per unit = 450,000 ÷ 500,000 = 0.90 THB per unit
• If 50,000 units are produced this year, depreciation = 50,000 × 0.90 = 45,000 THB

Advantages:

• Suitable for businesses with variable production levels
• Accurately reflects actual asset usage

Limitations:

• Requires precise tracking of usage
• Can be complicated in practice

What Is Amortization )Amortization(?

Amortization is the process of allocating the cost of intangible assets )such as patents, copyrights### or debt repayment over time.

(Difference Between Depreciation and Amortization

) Example of Amortization

Patent amortization: Patent for machinery costing 10,000 THB with a 10-year lifespan.

• Amortization = 10,000 ÷ 10 = 1,000 THB per year

Loan amortization: Loan of 10,000 THB repaid with 2,000 THB annually.

• Amortization per year = 2,000 THB

Relationship with EBIT and EBITDA

Depreciation and amortization play roles in calculating key financial metrics:

EBIT ###Earnings Before Interest and Taxes( – Income before interest and taxes.

• EBIT includes depreciation and amortization expenses.
• EBIT = Net income + Interest + Taxes

EBITDA )Earnings Before Interest, Taxes, Depreciation, and Amortization(

• EBITDA excludes depreciation and amortization.
• EBITDA = EBIT + Depreciation + Amortization

Choosing which metric to use depends on the analysis purpose. Companies with many fixed assets tend to have high depreciation, which can lower EBIT but increase EBITDA.

Summary: How Many Methods Are There for Depreciation?

The choice of depreciation method depends on business type, asset characteristics, and accounting policies.

Small businesses often prefer the straight-line method for simplicity.

Asset-heavy companies seeking maximum tax deductions may opt for accelerated methods like Double-Declining Balance.

Businesses with variable production might choose units of production.

As for amortization, the straight-line method is most common because contractual or legal periods are usually fixed.

Understanding depreciation and amortization methods helps investors and business owners analyze financial statements accurately and make informed investment decisions.