Updated July 19, 2023
Definition of Non-Cash Expenses
Non-cash expenses refer to expenses that are recorded as expenses in the financial statements but do not involve any cash outflow during the current accounting period.
These expenses may have been incurred in previous accounting periods or are expected to be incurred in the future. Non-cash expenses do not involve the writing off of any recognized assets and are reflected in the company’s profit and loss account.
Explanation
Non-cash expenses are the cost/ expenses incurred/ charged by the company which does not involve cash outflow during the current accounting period in which it is recognized as an expense. These expenses also form part of the company’s profit and loss A/c but do not affect the cash balance. Organizations often seek to play down the importance of non-cash expenses significantly one after another to adjust earnings to evacuate the impact on financial figures.
How Does It Work?
Non-cash expense is a charge against the earnings of the company which does not involve cash outflow. An organization incurs non-cash expenses against balance sheet non-cash items. These non-cash items are charged as expenses in the income statement. Debtors are the money of the business that is owned by the company but has not been received.
The companies need to record non-cash expenses; however, it is also important to note that most of these transactions require estimates. For example, various products require maintenance by the company. Therefore, to accompany the maintenance cost, the company sets aside an allowance which is a non-cash item. A higher estimate for the allowance lower will be the income of the business. In comparison, a lower estimate can create a problem in the future for meeting future obligations in the case where actual expenditure exceeds planned. Therefore, management needs to be very careful while recording non-cash items.
On one side, non-cash expenses reduce generated profit figures; on the other side, it may also lead to a reduced or lower asset balance. For example, writing off debtors will have a negative impact on P&L A/c on the one hand and a reduction in the value of debtors from the balance sheet on the other hand. The company may use non-cash expenses as a medium of window dressing.
Examples of Non-Cash Expenses
Below are some examples of non-cash expenses.
1. Depreciation
Depreciation is the most common example of non-cash expenses. It is a method of writing off the cost of a physical or tangible asset over its useful life and represents how much an asset has been used till now. Charging depreciation helps businesses to charge off the cost of a relevant asset according to its usage. If it is not taken into account, it can significantly affect profits. The business charges depreciation on long-term assets for both tax and accounting purposes. The internal revenue system states that while depreciating the asset, the cost must be proportioned over its useful life. Long-term assets split their cost as expenses over their useful life period because they are expected to generate economic benefits for more than one accounting period.
2. Amortization
Amortization is a process of spreading the cost of an intangible asset over its useful life. It is a non-cash expense. Examples of amortized assets are franchise contracts, organizational costs, patents, and trademarks, cost of issuing bonds.
3. Unrealized Gains and Unrealized Losses
There are always two sides to every situation- one being a positive one and another being the negative one. The market price of an investment as on the balance sheet may be different date from its initial purchase price. If the market price on the balance sheet date is higher than its purchase price, it’s a situation of unrealized gain. In real terms, there is no cash profit; it is only paperwork until the investment is sold and the position is closed. While on the other hand, the same is for unrealized losses; where the market price of investment falls below its purchase price, it becomes a case of unrealized loss.
Non-Cash Expenses on Income Statement
In accounting terms, items such as depreciation and amortization are included in the net income of a business. Still, these expenses do not impact working capital i.e. cash flows. However, these transactions do not impact the cash flow of the business but have a significant impact on the bottom line of the income statements, i.e.reduces, the profits reported. Non-cash expenses are the same as other write-downs, which results in the lowering of reported earnings.
Advantages of Non-Cash Expenses
Some of the advantages are:
- As non-cash expenses do not involve cash, they do not affect its working capital requirement.
- Non-cash expense help in saving tax by deducting expenses from revenue.
- Non-cash expenses facilitate writing off of tangible and intangible assets over a period of time.
- It helps investors determine the amount of money earned or lost during the year.
Disadvantages of Non-Cash Expenses
Some of the disadvantages are:
- These are only paper expenses and have no connection with the actual flow of cash.
- It must be adjusted for financial analysis.
- The Non-cash expense reduces the profit of the company.
- Proper estimates are required to charge non-cash expenses as they are spread over a period of time.
Conclusion
The company records and recognizes non-cash expenses in its books of accounts under income statements. These expenses can be either paid in a previous financial year or accrue as expenses to be paid in the future. Non-cash expenses can also arise due to asset write-offs and other similar events. Such expenses reduce the amount of profits generated and have a negative impact on its profitability. Management should analyze and accurately record such non-cash expenses as there exists room for window dressing by under/ over-stating such expenses in the company’s Income Statement.
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