Is Depreciation a Cash Expense?

Depreciating concerns corporate fixed assets, such as trucks.

Public officials generally encourage policies that spur economic growth in the short and long terms, focusing on fiscal legislation that's likely to increase corporate investments. Depreciation is a "sweetener" policy that allows government --- through accounting rules --- to stimulate long-term investments in the economy. Indeed, companies are more likely to purchase fixed assets if depreciation policies are economically favorable.

Identification

Depreciation is an accounting practice that enables a company to spread the costs of its operating assets over several years. In addition to its accounting nature, depreciation has fiscal implications because the Internal Revenue Service (IRS) also allows companies to depreciate assets. An asset is an economic resource that a company owns. Only long-term assets, also known as fixed or capital resources, are subject to depreciation. Depreciation is an expense, as it reduces corporate net income. However, it's not a cash expense because a company doesn't pay for depreciation, unlike salaries, rent, insurance and interest.

Significance

Depreciation is an important piece of fiscal legislation that allows companies to invest in long-term assets. Without this policy, organizations may be reluctant to devote substantial sums to purchase tangible resources, according to Accounting Study Guide, an online accounting resource.

Accounting and Reporting

To record depreciation expense, a corporate accountant debits the depreciation expense account and credits the accumulated depreciation account. Depreciation expense is an income statement item; accumulated depreciation is a balance sheet line. A balance sheet is also known as a statement of financial position or statement of financial condition.

Illustration

Assume a car manufacturer has total fixed assets amounting to $50 million. The assets' average useful life is 10 years, meaning the company intends to use the assets in its operating activities over 10 years. The corporate controller wants to depreciate the resources with a straight-line method, which allows for an even distribution of costs over the assets' useful life. Annual depreciation expense is equal to $5 million --- $50 million divided by 10. The company's operating-income-before-depreciation at the end of the year is $100 million, and the corporate combined tax rate is 20 percent. The company's income after depreciation is $95 million --- $100 million minus $5 million --- and its tax liability is $19 million, or $95 million times 20 percent. As a result, net income for the year is $76 million, or $95 million minus $19 million. Needless to say, the company didn't pay for depreciation, but depreciation expense clearly reduces its fiscal debt.

Considerations

In the corporate context, another set of accounting entries bears similarity with depreciation entries. These entries concern intangible assets, such as corporate patents and copyrights. Instead of depreciation expenses, accountants use the term "amortization" to describe the process by which they spread the costs of intangible assets over several years.

References

• Labyrinth, Inc.: Depreciation Expense
• Oblivious Investor: How to Calculate Depreciation Expense
• Accounting Study Guide: Depreciation Methods