Is depreciation a direct or indirect expense?
September 28, 2014
Most businesses use fixed assets which are typically depreciated. Such depreciation can be classified as direct or indirect expense. How can one distinguish between the two? In this article we will discuss this question and provide examples.
Main assets of a manufacturing company are usually property, plant and equipment (PPE). Such assets are expensive by nature and capitalized when purchased or constructed internally.
Non-current assets, such as PPE, are intended to be used and bring economic benefits to a company for a definite period of time. For instance, a packaging machine of a chemical plant may be expected to be used for ten years and then be replaced due to deterioration of its parts. It is possible to assume that the machine cost should be written off (expensed) at the end of its useful life. However, doing so will have a significant negative impact on financial performance of the company and make it unfair, because the machine benefited the company during a number of periods (i.e., ten years), not just the last year of its useful life. It is here where depreciation becomes relevant, since it allows the cost of the asset to be written off over a number of periods.
Accounting standards define depreciation as the systematic allocation of the depreciable amount of an asset over its useful life.
Allocating the cost of fixed assets (i.e., the recording of depreciation expense) to the periods of their use helps match revenues with related expenses.