Where to Find Depreciation and Amortization on Financials?

Depreciation and amortization are fundamental accounting concepts businesses use to allocate the cost of long-term assets over their useful lives. These processes reflect the systematic reduction in an asset’s value due to wear and tear, obsolescence, or consumption. Depreciation specifically applies to tangible assets, such as buildings, machinery, and vehicles. Amortization, conversely, is used for intangible assets, including patents, copyrights, and trademarks. This allocation allows companies to match the expense of using an asset with the revenues it helps generate, providing a more accurate representation of financial performance over time.

On the Income Statement

Depreciation and amortization appear on the income statement as non-cash operating expenses. While they reduce a company’s reported profit and taxable income, these expenses do not involve an actual outflow of cash in the current period. Businesses include these expenses to reflect the portion of an asset’s cost consumed during the accounting period.

The placement of depreciation and amortization on the income statement can vary depending on the asset’s function within the business. For assets directly involved in manufacturing, such as factory machinery, depreciation is often included within the “Cost of Goods Sold” (COGS). This treatment ensures that the expense is directly tied to the production of goods.

Alternatively, for assets used in general business operations, like office equipment or administrative buildings, depreciation and amortization typically appear as a separate line item or are embedded within “Selling, General, & Administrative Expenses” (SG&A). This approach categorizes the expense as an overhead cost not directly linked to production.

On the Balance Sheet

The balance sheet reflects the cumulative impact of depreciation and amortization through contra-asset accounts. These specialized accounts, known as “Accumulated Depreciation” and “Accumulated Amortization,” reduce the original cost of an asset to arrive at its current book value.

Accumulated Depreciation specifically lowers the book value of tangible assets classified under “Property, Plant, and Equipment” (PP&E). Similarly, Accumulated Amortization reduces the value of intangible assets. The balance shown in these accounts represents the total amount of depreciation or amortization charged against those assets since their acquisition, not just the current period’s expense.

Presenting assets at their original cost alongside their accumulated depreciation or amortization provides transparency to financial statement users. It allows for an understanding of both the historical investment in assets and their remaining carrying value. This method helps stakeholders assess the age and remaining economic life of a company’s asset base.

On the Cash Flow Statement

Depreciation and amortization play a distinct role on the cash flow statement, particularly when using the indirect method for preparing the operating activities section. Since these are non-cash expenses that reduce net income, they must be added back to net income to reconcile it to cash flow from operations. This adjustment is necessary because net income is calculated using accrual accounting, which recognizes expenses when incurred, not when cash is paid.

The cash flow statement aims to show the actual cash generated or used by a company’s operations. Adding back depreciation and amortization effectively reverses their impact on net income, as no cash changed hands for these expenses in the current period.

By adding back these non-cash charges, the cash flow statement provides a clearer picture of a company’s operational liquidity. This adjustment helps users understand how much cash the business truly generated from its core activities before considering non-cash accounting entries. The initial cash outlay for the asset’s purchase is accounted for in the investing activities section of the cash flow statement.

In the Notes to Financial Statements

The notes to financial statements provide detailed, supplementary information about a company’s depreciation and amortization policies. These disclosures help understand how these non-cash expenses impact the financial figures. The notes typically specify the depreciation and amortization methods used for various asset classes.

Common depreciation methods include the straight-line method, which spreads the cost evenly over an asset’s useful life, and accelerated methods like the declining balance method, which recognize more expense in earlier years. For intangible assets, the straight-line method is most frequently applied for amortization. The notes also disclose the estimated useful lives assigned to different categories of tangible and intangible assets, which can range from a few years for technology to several decades for buildings.

The notes often include a roll-forward schedule for Property, Plant, and Equipment and intangible assets. This schedule reconciles the beginning and ending balances of these assets, showing additions, disposals, and the total depreciation and amortization expense recognized for the period. Such detailed breakdowns offer valuable context regarding a company’s investment activities and its accounting judgments.