Depreciation and Amortization: Understand the Differences and How They Work

Depreciation and amortization are accounting concepts that help reflect the loss of value of assets over time. Depreciation applies to physical assets such as machinery and real estate, while amortization is used for intangible assets like patents and licenses.
These methods are essential for evaluating a company’s financial standing and are recorded in the Income Statement (DRE). Both help to understand how the cost of assets is spread over their useful life.

How Does Depreciation Work?
To illustrate depreciation, imagine a company buys a machine for R$ 500,000 with a useful life of 10 years. Instead of recording the entire cost in the year of purchase, the company distributes that value over the 10 years, resulting in an annual expense of R$ 50,000.
Depreciation starts being accounted for when the asset is in use. This means the value is allocated annually until the end of the asset’s useful life, reflecting wear and tear and obsolescence.

How Does Amortization Work?
Amortization is similar to depreciation but applies to intangible assets. For example, if a company acquires a software license with a useful life of 5 years, the cost will be amortized over that period.
Companies dealing with public service concessions, such as energy and sanitation, often use amortization to manage their intangible assets.

Relationship Between Depreciation, Amortization, and EBITDA
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is an important metric. It measures a company’s operating profit before accounting for depreciation and amortization, providing a clear view of operational performance without considering non-cash expenses.
Investors should pay attention to how depreciation and amortization affect EBITDA, as these factors influence a company’s ability to reinvest and maintain its assets.

Conclusion
While there are many other aspects to consider on this topic, such as tax issues, obsolescence, etc., the purpose here is to understand the difference between depreciation and amortization and how this understanding is vital for investors seeking to evaluate a company’s financial health and asset management. These concepts provide a detailed view of how a company handles its resources, helping to make more informed investment decisions.