Definition:

Depreciation & Amortization Expense refers to the allocation of the cost of tangible and intangible assets over their useful lives. Depreciation applies to tangible assets like machinery, while amortization applies to intangible assets like patents.

Examples

Examples of depreciation include the gradual reduction in value of a company's fleet of delivery trucks. Examples of amortization include the systematic write-off of the cost of a patent over its legal life.

Formula:

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

Amortization Expense = Cost of Intangible Asset / Useful Life

How to use the metric:

Depreciation and amortization expenses are used to allocate the cost of assets over time, impacting both the income statement and the balance sheet. They help in assessing the true profitability of a company by matching expenses with revenues.

Limitations:

These expenses are based on estimates of useful life and salvage value, which can be subjective and may not reflect actual asset usage or market conditions. They do not involve actual cash outflows, which can sometimes mislead stakeholders about a company's cash position.

Applies to:

Depreciation and amortization are applicable across various industries, especially those with significant investments in physical assets (like manufacturing) or intangible assets (like technology and pharmaceuticals).

Doesn't apply to:

These metrics are less relevant in industries with minimal asset bases, such as service-oriented sectors like consulting, where human capital is the primary asset.

Summary:

Depreciation & Amortization Expense is a crucial accounting concept that helps allocate the cost of tangible and intangible assets over their useful lives. While it provides insights into asset utilization and profitability, its reliance on estimates can limit its accuracy. It is widely applicable across asset-intensive industries but less so in service-based sectors.