What Are Depreciation and Amortization?
Depreciation and amortization are accounting methods for allocating the cost of long-lived assets over the periods they generate economic benefit. Depreciation applies to tangible assets (PP&E), while amortization applies to intangible assets (patents, trademarks, customer relationships).
Why D&A Matters in Finance
D&A is a non-cash expense. When a company buys a $10M machine, the entire $10M cash outflow occurs at purchase (capex). The income statement spreads the cost over the asset's useful life. Each year's depreciation charge reduces reported earnings but does not involve additional cash leaving the company.
This has two implications. First, D&A creates a tax shield — by reducing taxable income, D&A lowers the tax bill and preserves cash. Second, when calculating cash flow, D&A must be added back to net income because it was deducted as an expense but did not consume cash.
Depreciation Methods
Straight-line depreciation allocates the same amount each year. Accelerated methods (double-declining balance, MACRS) front-load the expense. Straight-line is typical for GAAP reporting; accelerated methods are used for tax purposes, creating deferred tax liabilities.
Amortization of Intangibles
Amortization applies to intangible assets with finite lives: patents, customer lists, technology. Indefinite-lived intangibles (goodwill, certain trademarks) are not amortized but are tested annually for impairment.
In M&A, purchase price allocation creates significant intangible assets that generate substantial amortization for the acquirer.
D&A in Financial Models
In DCF models, D&A is added back in FCF but capex is subtracted separately. If D&A significantly exceeds capex, the company may be underinvesting. If capex exceeds D&A, the company is investing for growth.
D&A vs. Impairment
D&A is systematic and scheduled. Impairment is an unscheduled write-down triggered by a decline in fair value below carrying value. Impairments are one-time charges usually excluded from adjusted metrics.