Depreciation vs Amortisation in CISI Corporate Finance: Net Book Value & Straight-Line Method

In CISI Corporate Finance, depreciation and amortisation are essential because they connect the balance sheet to the income statement. They explain why buying an asset does not automatically create a one-year expense equal to the purchase price—and why profit can differ from cash.

This lesson covers depreciation (for many tangible non-current assets), amortisation (for certain intangibles), net book value (NBV), and the straight-line method. These are common exam targets because they test your understanding of accrual accounting and asset measurement.

In real corporate finance analysis, these concepts affect EBITDA vs EBIT, capital intensity assessment, and how you interpret asset values and reinvestment needs.

Where this topic sits inside CISI Corporate Finance

This belongs to the statement of financial position and income statement interpretation. It supports analysis of operating profit, non-cash charges, and the quality of earnings. It also links to cash flow statements where depreciation is added back as a non-cash item.

The concept explained in plain English

When a company buys a long-term asset (e.g., machinery), it expects to use it over several years. Instead of charging the full cost as an expense immediately, accounting spreads the cost across the asset’s useful life. This is depreciation.

The asset’s balance sheet value after depreciation is called net book value (NBV):

NBV = Cost − Accumulated depreciation

Amortisation is similar but typically applies to certain intangible assets (e.g., licences, patents) that are used over time.

Salvage value is the estimated amount an asset can be sold for at the end of its useful life, and it is considered when calculating depreciation (conceptually, you depreciate the depreciable amount: cost minus expected salvage value).

Not all assets depreciate: for example, freehold land is often not depreciated because it does not wear out in the same way (subject to policy and jurisdiction).

How it works step-by-step

1. Identify the asset type: tangible (depreciation) vs intangible (amortisation, for eligible intangibles).
2. Set the useful life: based on expected economic benefit period (e.g., computers might have a short life; industrial plant longer).
3. Estimate salvage value: expected value at end of life (if relevant).
4. Choose a depreciation method: this lesson focuses on straight-line (equal charge each year).
5. Record the expense: depreciation/amortisation reduces profit in the income statement.
6. Update the balance sheet: accumulate depreciation and reduce NBV over time.
7. Link to cash flow: depreciation is non-cash, so it is added back in operating cash flow reconciliation.

Practical examples

• Straight-line illustration: A machine costs 100, has salvage value 10, and useful life 5 years. Depreciable amount is 90; annual straight-line depreciation is 18 per year (conceptual example).
• Profit vs cash: Buying the machine uses cash immediately (investing cash outflow), but profit is reduced gradually via depreciation over the asset’s life.
• Amortisation example: A licence purchased for 60 with a 3-year useful life could be amortised at 20 per year straight-line (if the accounting policy treats it as amortisable).

Exam focus: how this is tested

• Definitions: depreciation, amortisation, NBV, salvage value.
• Knowing where depreciation appears: as an income statement expense and as reduced asset NBV on the balance sheet.
• Understanding why depreciation exists: matching the asset’s cost to periods benefiting from its use.
• Straight-line method: equal annual charge (often simplified calculations).

Common pitfalls and how to avoid them

• Pitfall: Treating depreciation as a cash payment.
  Avoid: It is a non-cash accounting allocation, not a cash outflow.
• Pitfall: Forgetting salvage value in basic calculations.
  Avoid: Depreciable amount is typically cost minus salvage value (if given).
• Pitfall: Depreciating assets that typically are not depreciated (e.g., freehold land).
  Avoid: Remember some assets may not be depreciated due to indefinite life characteristics (subject to policy).
• Pitfall: Confusing amortisation with impairment.
  Avoid: Amortisation is systematic allocation over time; impairment is a write-down due to loss of recoverable value.

Self-test (original questions)

1. Question: What is net book value (NBV)?
   Answer: Cost less accumulated depreciation.
   Explanation: It is the carrying amount on the balance sheet for many depreciated assets.
2. Question: Depreciation is mainly associated with which asset type?
   Answer: Tangible non-current assets with a limited economic life.
   Explanation: Examples include plant and equipment.
3. Question: Amortisation is mainly associated with which asset type?
   Answer: Certain intangible assets with a finite useful life.
   Explanation: Examples include licences and patents.
4. Question: Why do companies depreciate assets instead of expensing the full cost immediately?
   Answer: To allocate the cost over the periods that benefit from the asset (matching concept).
   Explanation: It provides a more meaningful profit measure over time.
5. Question: Define salvage value.
   Answer: The estimated amount an asset can be sold for at the end of its useful life.
   Explanation: It reduces the depreciable amount if relevant.
6. Question: A computer costs 30, has zero salvage value, and a 3-year life. Straight-line depreciation per year?
   Answer: 10 per year.
   Explanation: 30 ÷ 3 = 10.
7. Question: Where does depreciation show up in the cash flow statement reconciliation under the indirect method?
   Answer: Added back to operating profit (as a non-cash expense).
   Explanation: It reduced profit but not cash.
8. Question: True/False: Depreciation increases the cash balance.
   Answer: False.
   Explanation: It is an accounting expense, not a cash inflow.
9. Question: Name one reason an asset might not be depreciated.
   Answer: It has an indefinite life or does not wear out in the same way (e.g., freehold land).
   Explanation: Policies vary; focus on the principle described in the workbook.

Note for candidates in Jersey

For CISI Corporate Finance Jersey candidates, make depreciation and amortisation “automatic marks” by practising quick, tidy calculations: write the formula (cost − salvage) ÷ life, then do three 2-minute examples per week. A strong scheduling tip is to link this to cash flow study: every time you see depreciation, remind yourself it is added back in operating cash flow under the indirect method. When arranging your exam sitting, build a buffer for administration and verify with CISI/exam provider for the latest booking steps, deadlines, and any permitted materials guidance.

FAQs

• Is depreciation the same as a fall in market value?
  Not necessarily. It’s an accounting allocation based on useful life, not a guarantee of market price movement.
• Why is depreciation shown as an expense?
  Because using assets is part of generating revenue; depreciation allocates that cost over time.
• Does depreciation affect cash flow?
  Not directly. It affects profit, but it’s non-cash and is added back in operating cash flow reconciliations.
• What’s the difference between depreciation and amortisation?
  Depreciation is typically for tangible assets; amortisation for certain finite-life intangibles.
• What is accumulated depreciation?
  The total depreciation charged to date, used to calculate NBV.
• Can useful life estimates change?
  Yes, companies may revise estimates; the exam usually uses simplified fixed-life assumptions unless otherwise stated.
• Is land depreciated?
  Often no for freehold land, because it doesn’t wear out; policies can vary—verify if needed.
• How does depreciation relate to EBIT and EBITDA?
  Depreciation reduces EBIT; EBITDA adds it back (conceptually) to focus on operating earnings before non-cash charges.

Next step

To practise depreciation, cash flow linkages, and exam technique across reporting topics in CISI Corporate Finance, study with Tadawul Academy here: CISI Corporate Finance Technical Foundations.

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Quick Quiz

1. Net book value (NBV) is best defined as:
   • A. Market value of the asset
   • B. Cost minus accumulated depreciation
   • C. Cost plus depreciation
   • D. Salvage value only
2. Straight-line depreciation means:
   • A. Depreciation increases each year
   • B. Depreciation decreases each year
   • C. Equal depreciation charge each year
   • D. No depreciation is charged
3. Amortisation most commonly applies to:
   • A. Land
   • B. Tangible plant and machinery
   • C. Finite-life intangible assets
   • D. Trade receivables

Answers

• 1: B
• 2: C
• 3: C