Depreciation

IAS 16 defines depreciation as ‘the systematic allocation of the depreciable amount of an asset over its useful life. The depreciable amount equals the purchase cost of the asset less the salvage value or other amount like the revaluation amount of the asset. Depreciation amounts to distributing the cost of assets to the income statement over the asset’s useful life.

Depreciation expense is a non-cash operating activity resulting from qualitative wear and tear in the use of assets. Still, it has been quantified by using accounting principles and assumptions in line with the enterprise’s own accounting policies.

Depreciation is computed using various methods. Popular methods include the straight-line method and accelerated depreciation methods.

Presentation in Financial Statement:

Income Statement: The asset cost less salvage value is spread over the useful life of the asset. The amount of depreciation needs to be calculated each year and is debited to Income Statement like any other operating expense.

Balance Sheet: Depreciation reduces the value of assets over time. Depreciation cumulatively rises over time and hits the cost less salvage value in the final year of useful life.

This accumulated depreciation reduces the historical value of the asset to arrive at the written-down value of the asset.  Written down value is computed after charging depreciation accumulated over the years to the initial cost, i.e., historical cost.

Implicit costs

These are the costs that have already been incurred. These are, however, not reported as separate expenses. Implicit costs are opportunity costs that arise when a company uses internal resources toward a project without any explicit compensation for the utilization of resources.

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When a company allocates a resource, it has to forgo the ability to earn from other techniques or allocating elsewhere. In a nutshell, it comes from the use of assets but not from renting or buying them.

Example of implicit cost

When a tech company hires new tech employees, there are implicit costs to train that employee. If the senior manager takes the opportunity to train these new employees, he has to allocate some hours to 8 hours per week.

The implicit cost here in this scenario would be the hourly wage rate of senior managers multiplied by 8 hours. This is because the hours could have been allocated toward the senior manager’s current role in the top-level management.

Are implicit costs shown in financial statements?

No implicit costs are not relevant to accounting as it does not involve the movement of money. These are just notional costs. Hence, these implicit costs are not recorded in financial statements.

Implicit vs Explicit

Explicit costs are defined costs in running the business. It includes expenses such as wage, rent, materials, depreciation, amongst others. Unlike implicit, these costs are real and presented in the income statements in financial statements.

Conclusion

Depreciation is a recognized expense. Although it has the feature of being incurred like implicit cost, depreciation represents the ongoing wear and tear of assets that have to be distributed over several years. In fact, depreciation is recognized as an explicit cost and not an implicit cost.