Depreciation Vs. Loss on Disposal of Assets and EBITDA
Some items in accrual accounting that are strictly accrual accounting entries. Depreciation is one of them. Depreciation is a confusing topic in accounting because it is an accounting entry and not a cash expense. Still, it is commonly used in such calculations as the loss on disposal of assets and EBITDA.
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Depreciation
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Capital expenditures are costly and for accounting purposes are not allowed to be expensed as a whole in the year they are bought. The right way to receive a tax break and account for the capital expenditures for financial statement purposes is through deprecation. Depreciation is the gradual expensing of long-lived assets over the life of the asset. For example, say a company purchases a computer for $1,000 and there is a five-year useful life for it according to accounting standards. The company would then claim a depreciation expense of $200 over the next five years to properly account for the purchase. The $1,000 would not be seen as an equipment expense the year the item is bought.
Loss on Disposal of Assets
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The loss on disposal of assets occurs when a company sells an asset for less than book value. A sale for less than book value can happened for many reasons, including differences between real market deprecation and the accounting deprecation. For example, say a company has equipment on its books for $10 million and sells it for $8 million because it is upgrading its factory. On the income statement, the company would record a loss of $2 million on the disposal of assets.
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EBITDA
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EBITDA stands for earnings before interest, taxes, depreciation and amortization. Analysts prefer to use it over net income because it gives a better idea of the cash flow-generating power of a company. For example, interest and taxes are heavily affected by a company's choice of capital structure. Interest is high for companies with high debt. Interest is deductible on income taxes. Comparing companies of different capital structure by net income would unfairly punish the company with higher debt. Depreciation and amortization are non-cash charges, as the cash outlays have already been made. Removing the effects of depreciation and amortization gives an analyst a better idea of where the cash flow stands because they are non-cash charges.
Difference
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The three terms, depreciation, loss on disposal of assets and EBITDA all are somewhat related to each other. Depreciation is the gradual expensing of long-lived assets. The loss on disposal of assets is a way to calculate the loss on an asset. It uses accumulated depreciation to calculate the book value of the asset, which then helps it calculate the related loss. EBITDA is a valuation measure for companies and excludes depreciation for its purpose to help investors get an idea of cash flow excluding the effects of capital structure and non-cash items.
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References
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