In financial terms, what does depreciation and amortization do to a company's asset base?

Depreciation and amortization represent methods of allocating the cost of tangible and intangible assets over their useful lives. These processes reduce the book value of assets on a company's balance sheet over time.

When a company acquires an asset, it records that asset at its initial cost. As the asset is used, it depreciates (in the case of physical assets) or amortizes (for intangible assets), reflecting wear and tear or the consumption of the asset's value. This allocation of cost results in a reduction of the recorded value of these assets over time, effectively shrinking the total asset base on the balance sheet.

By applying depreciation and amortization, a company's financial statements more accurately reflect the current economic value of its assets, acknowledging that they are not worth their original purchase price over time. This reduction in asset value is significant for accounting and tax purposes, as it can affect profitability and financial ratios important to investors and creditors.