Analytical Issues Related to Depreciation and Amortization
There are three components involved in computing depreciation expense: depreciation method, depreciable life, and salvage value. Managers can influence the reported expense based on how they estimate each component. Choosing an accelerated method rather than straight-line depreciation will result in lower earnings in the early years but a faster earnings growth rate over time. However, if the company continuously purchases new fixed assets, the early-year earnings pressure will persist. With respect to the depreciable life of an asset, a shorter life will result in higher depreciation (lower earnings) in the early years. A low salvage value will likewise increase depreciation expense and reduce earnings.
Again, companies are often reluctant to share much of this information with external financial statement users. However, they must disclose the estimated depreciable life for general categories of equipment. Here are those disclosures for Japanese telecom provider NTT:
And for U.S. counterpart AT&T:
Given the differences in the classes of equipment shown, it can be difficult to compare the two companies. However, we can probably assume that the 50-year life for AT&T relates to “conduit” as opposed to cable and wiring. NTT only depreciates its tubes and tunnels for 27 years, which will result in a higher depreciation expense and lower earnings for NTT based on the same asset.
Investors can at least determine whether a company appears aggressive or conservative relative to its peers. They can also monitor the same company’s disclosures over time. For example, if NTT’s latest report came out with an estimation of 6-10 years for digital switch equipment astute investors would notice that they had chosen a longer depreciable life, which would increase their reported earnings.
For more information, see all articles on: Accounting, Financial Statement Analysis, Fundamental Analysis See also:
The Intelligent Investor: The Classic Text on Value Investing
Financial Statement Analysis: A Practitioner's Guide, 3rd Edition
Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)
