Is Depreciation an Operating Expense?

Is Depreciation an Operating Expense

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Is Depreciation an Operating Expense

Yes, depreciation is considered an operating expense. Operating expenses are the costs associated with a company’s normal business operations. They include rent, utilities, salaries, and depreciation.

Depreciation refers to the systematic allocation of the cost of a tangible asset over its useful life. It’s an accounting method used to account for the reduction in value of assets like buildings, equipment, machinery, or vehicles that are used in the company’s day-to-day operations.

When a company purchases an asset, instead of recognizing the entire cost of the asset as an expense in the year it’s purchased, the cost is spread out over the expected useful life of the asset. This way, the company’s income statements more accurately reflect the cost of using the asset to generate revenue over time.

In the income statement, depreciation is usually included under operating expenses, often within a line item called “Depreciation and Amortization.” This expense is subtracted from the company’s gross profit to arrive at operating profit (also known as operating income or EBIT).

Remember that even though depreciation is an expense on the income statement, it’s a non-cash expense, meaning it decreases net income but doesn’t involve an actual cash outlay. Instead, it represents the cost of using an asset over time.

Example of: Is Depreciation an Operating Expense

Let’s look at an example to illustrate how depreciation works as an operating expense.

Let’s say that XYZ Company purchases a machine for its factory for $100,000. The machine has a useful life of 10 years and no salvage value (the value of the machine at the end of its useful life). Using straight-line depreciation (a method that spreads the cost of the machine evenly over its useful life), XYZ Company would record a depreciation expense of $10,000 each year for 10 years ($100,000 cost / 10 years).

On its income statement for the first year after purchasing the machine, XYZ Company would report a $10,000 operating expense for depreciation. This expense would be deducted from the company’s gross profit (revenue minus cost of goods sold) to help calculate operating income.

Here’s a simplified version of what XYZ Company’s income statement might look like:

Revenue: $500,000
Cost of Goods Sold (COGS): -$200,000

Gross Profit: $300,000

Operating Expenses: Salaries: -$100,000
Rent: -$50,000
Depreciation: -$10,000

Total Operating Expenses: -$160,000

Operating Income (Gross Profit – Total Operating Expenses): $140,000

So, you can see that depreciation is included as part of the operating expenses, reducing the operating income. However, remember that the $10,000 depreciation expense didn’t involve an actual cash outflow—it simply represented the cost of using the machine for one year.

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