How to Calculate Depreciation: A Practical Guide for Business Owners

How Do Assets Actually Lose Value

When you purchase equipment or machinery for your business, it gradually depreciates over time, not all at once. This is the basis of depreciation accounting — spreading the asset’s cost over multiple years according to usage.

Simple example: A company buys a car for 100,000 THB, expected to be used for 5 years. Instead of deducting the full 100,000 THB in the first year, it deducts only 20,000 THB per year for 5 years. This is the essence of depreciation.

Why Is It Important for Accounting and Taxes

Depreciation has two parallel meanings: First, it reflects the reality that assets actually lose value. Second, it allows companies to allocate costs over time and reduce taxes accurately.

Companies with many fixed assets (such as factories, machinery) will have higher depreciation expenses, resulting in lower reported profits. This is normal and important for accurate financial analysis.

We see this difference when comparing EBIT and EBITDA:

• EBIT (Earnings Before Interest and Taxes): Does not include depreciation in calculation.
• EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): Adds depreciation back to show the true operating profit.

Which Assets Can Be Depreciated

Not everything can be depreciated. Assets must meet three conditions:

1. Owned by you — The company owns and uses the asset in operations.
2. Have a determinable useful life — Not assets with indefinite lifespan.
3. Remain for more than 1 year — Must be a long-term asset.

###Assets that can be depreciated: Vehicles, buildings, office equipment, computers, machinery, patents, copyrights, software.

###Assets that cannot be depreciated: Land, collectibles (art, coins), investments (stocks, bonds), personal property, assets with less than 1-year lifespan.

4 Main Methods of Depreciation

1. Straight-Line Method (Straight-Line) — The simplest

Divide the asset’s value by the number of years of usage. The result is the amount deducted each year.

Advantages: Very simple, few errors, suitable for small businesses.

Disadvantages: Does not account for assets losing value faster in early years or increased maintenance costs as they age.

2. Double-Declining Balance Method (Double-Declining Balance) — Accelerated depreciation

Deducts more depreciation in the early years, less over time.

Advantages: Helps businesses recover costs faster, increases tax deductions in initial years, offsetting higher maintenance costs.

Disadvantages: Less beneficial if the business is already operating at a tax loss.

3. Declining Balance Method (Declining Balance) — Accelerated depreciation

Similar to double declining but uses a lower rate. The depreciation amount decreases each year.

4. Units of Production Method (Units of Production) — Based on actual usage

Calculates depreciation based on actual usage of the asset, not time, such as hours worked or units produced.

Advantages: Highly accurate, reflects actual usage.

Disadvantages: Difficult to implement; requires consistent tracking of usage.

What Is Amortization (Amortization)?

While depreciation applies to tangible assets, amortization applies to intangible assets and loans.

Amortization has two meanings:

First: Summarizing the reduction in value of intangible assets (such as copyrights, patents, trademarks) over a period.

Second: The process where borrowers repay loans in regular installments, each covering interest and principal.

###Example for intangible assets A company has a patent worth 10,000 THB with a useful life of 10 years. Annual amortization is 1,000 THB (10,000 ÷ 10).

###Example for loans A 10,000 THB loan repaid annually with 2,000 THB per year. The amortization expense is 2,000 THB.

In auto or home loans, each monthly payment is split between interest and principal. Initially, interest payments are higher; over time, principal payments increase. Eventually, the loan is fully repaid.

Key Differences Between Depreciation and Amortization

Tips for Choosing the Appropriate Depreciation Method

Choose straight-line if: Small business, simple accounting system, assets lose value steadily.

Choose accelerated depreciation if: Need to recover costs quickly, want higher tax deductions in early years.

Choose units of production if: Asset lifespan depends on usage, with good tracking systems.

Summary

Depreciation and amortization are essential accounting tools. They not only reflect the actual decline in asset value but also help reduce taxes and improve financial planning. The appropriate method depends on the nature of the asset and your business needs.