Depreciation and amortization
By SuperdayReps · Wharton MBA · ex-Greenhill · investment banking interview coaching
5 min read · updated July 2, 2026
Here's the whole idea in one line: when a company buys something that lasts for years, it doesn't expense the whole cost the day it pays. It spreads that cost across the years the asset actually earns its keep. That spreading is depreciation and amortization (D&A).
Depreciation is for tangible assets: buildings, machines, trucks, servers. Amortization is the same mechanic for intangible assets: patents, customer lists, software, licenses. Different words, identical logic. Buy the asset once, expense it slowly.
Why spread the cost at all?
Because expensing a $500 machine all at once would make the year you bought it look terrible and every year after look fantastic. Neither is true. The machine helps produce revenue for, say, five years. So accounting matches the cost to the revenue it helps generate. That's the matching principle, and it's the reason the income statement shows a slice of the cost each year instead of the full hit up front.
Simple example. A $500 machine with a 5-year life, straight-line, no salvage value:
So $100 shows up as an expense on the income statement every year for five years. The cash left the building on day one. The expense arrives in installments.
D&A is an accounting expense, not a cash expense. The company already paid for the asset. Depreciation is just the bookkeeping that recognizes the cost over time. That single fact drives everything else in this lesson.
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Frequently asked
- What is depreciation and amortization?
- Depreciation and amortization spread the cost of a long-lived asset across the years it earns its keep, rather than expensing it all at purchase. Depreciation covers tangible assets like machines and buildings; amortization covers finite-life intangibles like patents and software. Different words, identical logic: buy once, expense slowly.
- Why is depreciation added back on the cash flow statement?
- Because it is a non-cash expense. The company already paid cash for the asset years ago, so this period's depreciation is just an accounting allocation. It lowered net income on the income statement, but no cash actually left, so you add it right back to get to real cash movement.
- Walk me through the three statements when depreciation increases by 10 dollars.
- At a 25% rate: pre-tax income falls 10, taxes fall 2.50, so net income falls 7.50. On the cash flow statement, net income is down 7.50 but you add back the full 10, so cash rises 2.50. On the balance sheet, cash is up 2.50, PP&E down 10, retained earnings down 7.50, and it balances.
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