Depreciation and Amortization

Depreciation and amortization are non-cash charges that spread the cost of an already-acquired asset across its useful life, depreciation covering tangible property such as vehicles, equipment, and leasehold improvements, and amortization covering intangibles such as acquired customer lists, goodwill, and loan costs. Because depreciation and amortization consume no cash in the period they are recorded, both are added back in full when historical earnings are recast to seller's discretionary earnings or EBITDA.

Also called D&A, Depreciation & amortization, Depreciation, amortization and depletion · Last updated 2026-08-07 · All 24 terms

Where the numbers actually live

On a small-business tax return the two charges are not always where a reader expects them, and a recast built only from the face of the return will understate the add-back. The lines worth checking:

Form 1120-S line 14: depreciation not claimed on Form 1125-A or elsewhere on the return
Form 1065 lines 16a through 16c: total depreciation, less the portion reported on Form 1125-A and elsewhere, then the balance
Schedule C line 13: depreciation and the Section 179 deduction for a sole proprietorship
Form 4562: the supporting detail for both, including the Section 179 election and Part VI for amortization
Form 1125-A, other costs: depreciation charged into cost of goods sold, which has no labeled line of its own. This is the one that gets missed. A manufacturer running machine depreciation through COGS shows a smaller face-line depreciation number, and the difference can be six figures.
The 'other deductions' statement: on an 1120-S, amortization usually appears here rather than on a labeled line

Book depreciation and tax depreciation will not agree

Section 179 and bonus depreciation are the usual reason. A seller who elects Section 179 on a $96,000 machine writes it off entirely in the year of purchase, showing a collapsed profit that year and inflated profit in the four years after, on the tax return only, while the machine wears out at the same rate the whole time. Neutralizing that timing distortion is why the depreciation add-back is the least contested line in a recast: no buyer disputes that the charge consumed no cash in the period it was recorded.

The same divergence is why a multi-year recast should carry the fixed asset detail alongside the earnings. One year in which a large Section 179 election lands can move reported net income by more than the owner's entire salary, and a buyer reading only the bottom line will misread the trend as a downturn followed by a recovery.

Worked example: the inputs

Take an illustrative S corporation over one full fiscal year on tax-basis statements, with the following figures.

Reported net income: $310,000
Depreciation: $145,000, of which $96,000 is a Section 179 election on a machine purchased that year
Amortization: $18,000 on a customer list acquired in a prior tuck-in
Interest expense: $42,000
Owner's W-2 salary: $150,000
Owner's health insurance and related payroll taxes: $16,000

What the add-back does to earnings

Seller's discretionary earnings is $310,000 + $145,000 + $18,000 + $42,000 + $150,000 + $16,000 = $681,000.

Strip the two owner items back out and the figure is $515,000, being $310,000 of net income plus $42,000 of interest plus $163,000 of depreciation and amortization. That is EBITDA on these facts, because an S corporation pays no federal entity-level income tax and there is no tax add-back to make. Industry convention then builds adjusted EBITDA by adding back owner compensation only to the extent it exceeds what a hired manager would cost. At a $110,000 fully loaded market cost for that manager, the excess is $56,000, being $166,000 of owner salary and benefits less $110,000, giving adjusted EBITDA of $571,000. The $110,000 gap between $681,000 of SDE and $571,000 of adjusted EBITDA is exactly that market cost, which is the conventional relationship between the two measures and the reason an owner-operator buyer quotes SDE while a buyer who will hire a manager quotes EBITDA.

Definitions vary here and it is worth saying so. Adjusted EBITDA has no authoritative definition: some buyers add back the full owner compensation, some add back only the excess over a market rate as above, some also normalize related-party rent, and diligence providers and software each apply their own rule. Ask what went into any adjusted EBITDA figure before comparing it with another one.

Depreciation and amortization of $163,000 is 24 percent of SDE in this example. On an equipment-heavy business the D&A add-back is frequently the single largest line in the recast, larger than owner compensation, which is why it draws more diligence than its uncontested status would suggest.

Depreciation is not capital expenditure

The add-back is arithmetically correct and economically incomplete, and every experienced buyer raises the same objection. A trucking company with $145,000 of annual depreciation on a fleet it must actually replace does not have $145,000 of surplus cash. The charge is non-cash in the period, but the asset it describes wears out.

Lenders handle this by deducting a capital expenditure allowance or replacement reserve from earnings before testing debt service coverage. Sophisticated buyers handle it by asking for the fixed asset schedule with in-service dates and remaining lives, then comparing five years of depreciation against five years of actual equipment purchases. If the business spent $60,000 a year against $145,000 of depreciation, the depreciation is running off assets bought in an earlier expansion and the gap is real cash. If it spent $190,000 a year, the add-back is funding a treadmill the buyer inherits.

None of this changes whether the add-back belongs in the recast. SDE and EBITDA are earnings measures, not cash flow measures, and both are defined to exclude depreciation and amortization. The capital expenditure question belongs in the debt sizing and in the multiple, not in the add-back schedule. What a broker can do is anticipate it: put the fixed asset schedule and the last five years of equipment purchases in the data room before the buyer asks.

What practitioners get wrong

Comparing an owner to a lessee. A company that leases its equipment reports lease expense, which is not added back; a company that buys reports depreciation, which is. Two operationally identical businesses produce different SDE, and neither recast is wrong. The comparison is.
Double counting COGS depreciation. Form 4562 reports total depreciation including amounts charged to cost of goods sold. Adding the Form 4562 total to a separately identified COGS depreciation line counts the same dollars twice.
Adding back loan cost amortization and the related interest twice. Debt issuance costs are commonly amortized into interest expense, so confirm the fee amortization is not already inside reported interest before adding both.
Treating goodwill amortization from a prior acquisition as suspicious. It is the purest non-cash charge on the statement, it relates to a purchase the seller already paid for, and it adds back.
Missing depletion. Extractive, quarry, and timber businesses report depletion, which behaves like depreciation for recast purposes and belongs in the same add-back.
Adding back finance lease amortization and interest while ignoring the payment. On GAAP statements a finance lease splits into amortization and interest, both technically addable, while the cash payment continues at full size. The form is correct but the buyer still writes that check, so disclose the payment alongside the add-back.