The short answer is yes: depreciation is an operating expense.
Depreciation is an accounting method that allocates the loss in value of fixed assets over time. And since these fixed assets are essential for day-to-day business operations, depreciation is considered an operating expense.
Let’s break down what all of that means by explaining both depreciation and operating expenses in detail.
Read on to learn about:
- What Is Depreciation?
- What Is an Operating Expense?
- Is Depreciation An Operating Expense?
- Depreciation FAQ
- Automate Depreciation with Accounting Software
What Is Depreciation?
When businesses purchase long-term fixed assets, they can either choose to deduct the entire cost of the asset right away or to write it off for several years, until the item is no longer of use.
This second method of expensing fixed assets is known in accounting as depreciation. With depreciation, you spread out the cost of the fixed asset over its useful life.
There are four methods for calculating depreciation:
- Declining balance
- Sum-of-the-year digits
The most commonly used calculation method is the straight-line formula, which separates the cost of the asset evenly over its expected useful life.
For instance, say company ABC purchases a delivery van for $20,000, with an expected useful life of 4 years. Using the straight-line method, the depreciation expense for the van would be $5000 ($20,000/4 years) per year.
Although the $5000 is recorded as an expense, no payment is actually made at the time of recording - the cash is solely an estimate that helps recognize expenses when they occur.
That’s why depreciation is considered a non-cash expense, and it has no impact on cash flow.
Just like every other type of expense, depreciation is recorded in the income statement, under the Expense section.
Now, not all assets can be depreciated. Low-cost items, such as office supplies that don’t last longer than a year, are expensed right away. Assets that last many years, such as land, also can’t be decreased in this manner.
With that being said, furniture, machinery, equipment, buildings, and anything else that lasts the business over a year, is considered a depreciable asset.
What Is an Operating Expense?
Operating expenses are expenditures that businesses make during their regular daily activities.
They include all operating costs of the business, besides the cost of goods sold, and capital expenditures.
The cost of goods sold is related to the direct costs of production, like materials and labor used to produce merchandise. While capital expenditures are large investments that provide value for a business for over a year.
Both of these costs are not included in operating expenses.
Any other expense associated with a business’s daily operations falls under operating expenses. Operating costs include maintenance, utility, rent, payroll, sales, research, insurance, and depreciation expenses.
Is Depreciation an Operating Expense?
Now that we went through all of the necessary background information on depreciation and operating expenses, we can fully answer our question.
Depreciation deals with devaluing fixed assets, which businesses can’t operate without.
And although depreciation expenses are only recorded monthly, quarterly, or yearly, assets get consumed by the minute, every time they are used.
That’s why depreciation is considered an operating expense, even if it doesn’t cost the business any money when it is recorded. It’s still an expense that directly relates to the day-to-day operating activities of a company.
#1. Is Depreciation a Fixed Cost?
Usually, yes, but that’s not always the case.
If a business calculates depreciation using the straight-line method, then it’s considered a fixed cost, since the depreciated amount remains the same in every accounting period.
However, some companies go for a usage-based depreciation method, such as the unit-of-production (UOP) method.
With UOP, depreciation is determined based on the number of units produced in the year.
So, basically, the depreciation cost varies from year to year, depending on the market and the number of units needed for sale.
In this scenario, depreciation is considered a variable cost, rather than a fixed one.
#2. What’s the Difference Between Depreciation and Accumulated Depreciation?
Accumulated depreciation represents the amount of depreciation that has been gathered, since the very beginning of the depreciation of an asset. It’s a contra asset account, and it appears in the balance sheet.
While depreciation expense is a non-cash expense within the income statement that recognizes depreciation for just one accounting period.
Another difference between the two is that accumulated depreciation has a credit balance, whereas depreciation is a debit.
If you want to learn how to record debits and credits, head over to our guide on double-entry bookkeeping for small businesses.
Automate Depreciation with Accounting Software
Use a cloud accounting platform like Deskera to automate accounting and set up a Depreciation Schedule within seconds!
Simply select the asset name, financial year, method of depreciation, and the time period you want to schedule it for, and press Post.
The software will automatically post the correct journal entry, with the corresponding debit and credit balances.
You can give Deskera a try out yourself right away, with a free trial. No credit card details required.
And that’s a wrap!
We hope our guide was helpful in understanding the basics of depreciation, and why it’s considered an operating expense.
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