Understanding Non-Cash Charges: Accounting Explained

A non-cash charge is an accounting expense that does not involve any cash outflow. Unlike a transactional expense that uses cash, a non-cash charge is only considered as an accounting expense on the income statementIncome StatementThe Income Statement is one of a company's core financial statements that shows their profit and loss over a period of time. The profit or.

Non-cash charges can include expenses such as depreciationDepreciation ExpenseWhen a long-term asset is purchased, it should be capitalized instead of being expensed in the accounting period it is purchased in., amortization, and depletion. In all the cases mentioned, there is an accounting expense on the income statement, but no cash is involved in the transaction.

For example, if an office laptop depreciates by $100 every year, it will be accounted for as an expense on the income statement, even though there is no actual cash leaving the company’s account.

Summary

• A non-cash charge is an accounting expense that does not involve any cash outflow.
• Non-cash charges can include expenses such as depreciation, amortization, and depletion.
• Since non-cash charges are still included as expenses, they will be accounted for as deductions in the income statement and lower overall earnings.

Understanding Non-Cash Charges

To put it simply, non-cash charges are expenses that do not involve any cash outflow. Non-cash charges are typically a reduction in value attributed to an asset that has already been purchased.  These assets are periodically written down to reflect wear and tear or declining value.

As the product continues to depreciate, no further cash transactions are occurring, so the depreciation expenses are recorded as non-cash charges. In some cases, non-cash charges can also be referred to as non-cash expenditures or non-cash transactions.

Accounting for Non-Cash Charges

Non-cash charges are important because they lower the overall earnings of a corporation. Since non-cash charges are still included as expenses, they will be accounted for as deductions in the corporation’s net income but do not affect the overall cash flow.

In the case of non-cash charges such as depreciation, it can be difficult to predict how assets will depreciate or change over time, so they are recorded as estimates. Since the expense itself does not involve any cash, non-cash charges are a way of adding the expense back into the income statement.

Types of Non-Cash Charges

1. Depreciation

Depreciation occurs when the value of an asset decreases due to factors like obsolescence and wear and tear. When accounting for depreciation, the yearly reduction in value is included as a non-cash charge on the income statement.

Depreciation is included as a non-cash charge every year until the value of the asset is reduced to its salvage value.

2. Depletion

Depletion is a way for corporations to account for reductions in the quantity of a product’s natural reserves and is most commonly used in resource sectors such as mining, timber, or natural gas. As a product’s reserves are depleted, the cost of the depleted resources is recorded as a non-cash charge.

3. Amortization

Amortization refers to the cost of intangible assets such as trademarks, copyrights, or patents. When accounting for amortization, the cost of the asset is allocated over time and recorded as a non-cash charge on the income statement.

Although the above are the most common types, other expenses such as stock-based compensationStock Based CompensationStock Based Compensation (also called Share-Based Compensation or Equity Compensation) is a way of paying employees and directors of a, deferred income taxes, and inventory write downs are also examples of non-cash charges.

Examples of Non-Cash Charges

1. A technology company purchases brand new laptops for 200 employees, and each laptop depreciates at a rate of $100 per year. After the first year, the company will include a non-cash charge of $20,000 (200 x $100) on its income statement. The expense will be included every year until the value of the laptop becomes zero. It is an example of a depreciation non-cash charge.
2. A Canadian petroleum company purchases an oil reserve containing 150,000 barrels of oil that was purchased for $50,000. If the company extracts 5,000 barrels, the company will report a non-cash charge of $1,667 ($50,000 x 5,000 / 150,000). It is an example of a depletion non-cash charge.
3. A pharmaceutical company purchases a patent for a new drug at $500,000. If the patent is valid for 25 years, the company will include a non-cash charge of $20,000 (500,000 ÷ 25) for 25 years. It is an example of an amortization non-cash charge.

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