What is the Depreciation and Amortization of a Company?

Depreciation and Amortization: The Basics

Depreciation is the method by which a company allocates the cost of a physical asset over its useful life, while amortization is the process of expensing the cost of an intangible asset over its useful lifespan.

Depreciation and Amortization usually fall under under the category of operating expenses.

Depreciation = (Cost of Asset - Salvage Value) / Useful Life of Asset

Amortization = (Intangible Asset Cost) / Useful Life of Intangible Asset

A Deeper Dive into Depreciation and Amortization

Expanding on the basic understanding, depreciation and amortization are non-cash expenses that reduce the value of an asset over time due to use, wear and tear, or obsolescence. These costs are important to record as they have tax implications and influence a company's balance sheet and income statement.

Depreciation is applicable to physical assets such as buildings, machinery, and equipment. The method of depreciation might differ based on the asset's type and usage patterns. Common methods include straight-line, reducing balance, and sum of years' digits method.

Amortization, on the other hand, relates to intangible assets like patents, trademarks, software, and goodwill. These are assets that don't physically exist but hold significant value for a company. Amortization is typically carried out using the straight-line method.

Real-world Examples

A Manufacturing Company - Ford Motor Co.

For Ford, depreciation would be calculated on its physical assets like manufacturing plants, machinery, and vehicles. The cost of these assets would be spread over their useful life.

A Technology Company - Adobe Systems

Adobe Systems would amortize the cost of intangible assets such as software and patents. The cost of these assets would be spread over their legal or useful life, whichever is shorter.

A Pharmaceutical Company - Pfizer Inc.

For Pfizer, both depreciation and amortization come into play. Depreciation would be calculated on their lab equipment and buildings, while the cost of patents and trademarks would be amortized over their effective lifespan.