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 revaluation amount of the asset. Depreciation amounts to distributing the cost of assets to the income statement over the useful life of the asset.

Depreciation expense is a non-cash operating activity which is the result of qualitative wear and tear in the use of asset but it has been quantified by the use of 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 expenses.

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

The historical value of the asset is reduced by this accumulated depreciation so as 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 expense. Implicit costs are opportunity costs that arise when a company use 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 it.

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 of his say 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 income statement in financial statements.

Conclusion

Depreciation is recognized expense. Although it has the feature of been incurred like implicit cost, however, depreciation represents the ongoing wear and tear of asset that has to be distributed over the number the years. In fact, depreciation is recognized as explicit cost and not implicit cost.