Depreciation and amortisation

A machine bought for ₹10 crore and used for ten years is not a ₹10 crore expense in year one. It is consumed gradually, and depreciation is the mechanism that spreads the cost over the periods that benefit.

Depreciation for tangible assets; amortisation for intangibles — software, licences, patents. Same idea, different word.

It is an allocation, not a valuation

The most common misunderstanding. Depreciation does not attempt to track what the asset is worth.

A fully depreciated machine with a book value of zero may still be running and still be worth crores. A newly depreciated building may have appreciated. The carrying amount after depreciation is cost minus accumulated allocation, and that is all it is.

Nor does depreciation set aside money. It is a non-cash charge — which is exactly why chapter 14 adds it back when building the cash flow statement.

The two estimates that decide everything

Useful life. How long will the entity use it? Not how long it could physically last.

Residual value. What will it be worth at the end of that life?

$\text{Annual charge (straight line)} = \frac{\text{Cost} - \text{Residual value}}{\text{Useful life}}$

Neither input is observable. Both are management estimates, both are reviewed at least at each financial year end, and a change to either flows straight into profit.

Work the problem. A ₹10 crore asset with no residual value over 10 years charges ₹1 crore a year. Extend the life to 15 and the charge becomes ₹67 lakh — ₹33 lakh of extra pre-tax profit, every year, from changing an assumption.

A legitimate reason exists: better maintenance, a genuine change in how the asset is used, new evidence about its life. The test is whether anything about the asset changed or only the assumption. A life extension announced in a weak quarter, with no operational explanation in the notes, is the pattern worth noticing.

Methods

Straight line charges the same amount each year. Simple and most common.

Reducing balance charges a fixed percentage of the declining carrying amount, so the charge is large early and small later.

Units of production charges by output, which matches consumption best for assets that wear with use.

The standard requires the method to reflect the pattern in which the asset's economic benefits are consumed. So this is a judgement rather than a free choice — but it is a judgement, and switching methods changes the profile of reported profit without changing a single rupee of cash.

Impairment is different

Depreciation is planned consumption. Impairment is an unplanned loss of value, recognised when the carrying amount exceeds what the asset can recover — through use or through sale.

Impairment is tested when there is an indication of it, and for goodwill at least annually. It is a lumpy, immediate charge, and it is the mechanism by which a bad acquisition eventually shows up in the accounts, often years after the decision.

Two things are worth watching. A large impairment is usually an admission about a past decision rather than news about the present. And impairments cluster in bad years, which is chapter 15's "big bath".

Why this matters for comparison

Two identical companies can report materially different profit purely through depreciation policy:

	Company A	Company B
Useful life	10 years	15 years
Method	Reducing balance	Straight line
Early-year charge	High	Low
Early-year profit	Low	High

Neither is wrong. Neither is comparable to the other without reading both policy notes, which is why chapter 18 of the Company analysis subject prefers EV/EBITDA when comparing companies with different asset policies — it removes depreciation from the comparison entirely, at the cost of pretending capital assets are free.

The point

Depreciation allocates the cost of a long-lived asset across the periods it serves; it is not a valuation and it sets aside no money. Two unobservable estimates — useful life and residual value — decide the charge, and extending an assumed life from 10 years to 15 adds a third of the charge straight to profit with no operational change. Impairment is the separate, unplanned write-down that is how bad acquisitions eventually surface.