Depreciation & Amortization
Definition
Depreciation and amortization are accounting methods for spreading the cost of an asset over its useful life. Depreciation applies to tangible assets like equipment and furniture, while amortization applies to intangible assets like patents and capitalized software development costs.
Overview
Depreciation allocates the cost of tangible assets (computers, furniture, vehicles) over their expected useful life. Amortization does the same for intangible assets (patents, trademarks, capitalized R&D). Both are non-cash expenses: they reduce reported income without an actual cash outflow in the period recorded.
For SaaS startups, the most common amortization scenario involves capitalized software development costs. Under ASC 350-40, certain internal-use software development costs must be capitalized and amortized, typically over 3 to 5 years. This can create a disconnect between cash spending (which happened earlier) and reported expenses (which are spread over time).
These non-cash charges matter for metrics like EBITDA (which adds them back) and for tax planning. Accelerated depreciation methods like Section 179 or bonus depreciation allow businesses to deduct a larger portion of asset costs upfront, reducing taxable income in early years when cash preservation is critical.
Example
A $15,000 laptop fleet depreciated over 3 years creates a $5,000 annual depreciation expense, reducing taxable income without any additional cash outflow.
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