Is Depreciation Included in SG&A Expenses?

Financial statements provide a comprehensive overview of a business’s financial performance and position. They enable stakeholders to assess financial health and make informed decisions. Proper categorization of expenses is fundamental for clear financial reporting, allowing for a detailed understanding of resource utilization and contributing to accurate profitability analysis.

Defining SG&A Expenses

Selling, General, and Administrative (SG&A) expenses represent the operational costs a company incurs that are not directly tied to the production of goods or services. These expenses are often referred to as overhead, encompassing the day-to-day costs required to keep a business running. SG&A is typically presented as a line item on the income statement, appearing below the Cost of Goods Sold (COGS).

Common examples of SG&A expenses include salaries for administrative staff, executive compensation, and human resources department costs. Marketing and advertising expenditures, such as campaign costs, digital marketing efforts, and promotional events, also fall under this category. Additionally, general office expenses like rent for office spaces, utilities, office supplies, and business insurance are classified as SG&A.

SG&A costs support overall business operations, even without direct contribution to manufacturing. While many SG&A expenses, such as rent, tend to be fixed regardless of sales volume, some, like sales commissions or distribution costs, can be variable. Managing these expenses helps assess a company’s operating leverage and profitability.

Understanding Depreciation

Depreciation is an accounting method used to systematically allocate the cost of a tangible asset over its estimated useful life. This practice reflects the gradual wear and tear, consumption, or obsolescence of an asset as it is used to generate revenue. The primary purpose of depreciation is to align the expense of using an asset with the revenues it helps produce, adhering to the accounting matching principle.

This accounting entry is considered a non-cash expense, meaning it does not involve an actual outflow of cash in the period it is recorded. While the initial purchase of an asset requires a cash outlay, depreciation spreads that cost conceptually across multiple accounting periods. To calculate depreciation, accountants consider the asset’s original cost, its estimated useful life, and its salvage value.

For instance, if equipment costs $10,000, has an estimated useful life of 5 years, and a salvage value of $0, the annual depreciation expense might be $2,000 using the straight-line method. This allocation provides a more accurate representation of a company’s financial performance over time.

Depreciation’s Placement on the Income Statement

The placement of depreciation expense on a company’s income statement depends primarily on the function of the asset being depreciated. Depreciation is categorized based on whether the asset contributes to the production of goods or supports selling, general, and administrative activities. This functional classification helps financial statement users understand the underlying cost structure of the business.

Depreciation is included within SG&A expenses when it relates to assets used for selling, general, or administrative purposes. For example, the depreciation of office buildings, administrative equipment, or vehicles used by sales staff would be classified under SG&A. These assets support overall business operations but are not directly involved in manufacturing.

In contrast, depreciation on assets directly involved in the production process is included in the Cost of Goods Sold (COGS). This applies to manufacturing machinery, factory buildings, and other equipment essential for creating products. Including such depreciation in COGS ensures the full cost of producing goods is accounted for before calculating gross profit.

Some companies with substantial depreciation expenses may present it as a separate line item on the income statement. Alternatively, it might be included within a broader “Operating Expenses” category. Depreciation expense is recognized as an operating cost that reduces taxable income.