Non-cash expense items are expenses recorded on a company's income statement that do not involve actual cash outflow during the accounting period. These expenses are accounted for to represent the cost of using or consuming an asset over its useful life or to adhere to accounting principles such as the matching principle, which states that expenses should be matched to the revenues they help generate. Non-cash expenses provide a more accurate picture of a company's operational costs and profitability by including the cost of assets that are not paid for in cash at the time they are consumed.
Check out these accounting templates. Also, in the startup financial models and integrated 3 statement model templates you will find across this site, I most often deal with logic for a few of the below, mostly depreciation and inventory-related items (via cost of goods sold).
Here are five examples of non-cash expense items along with scenarios for each:
Depreciation: This is the systematic allocation of the cost of a tangible asset over its useful life.
- Scenario: A company purchases a piece of machinery for $100,000, expected to last 10 years. The company uses straight-line depreciation, recognizing a non-cash expense of $10,000 annually to reflect the machinery's usage and wear over time.
- Debit: Depreciation Expense account (Income Statement) for $10,000
- Credit: Accumulated Depreciation account (Balance Sheet, under assets) for $10,000
- Explanation: The depreciation expense increases on the income statement, reducing net income, and the accumulated depreciation increases on the balance sheet, reducing the book value of the asset.
Amortization: Similar to depreciation, amortization spreads the cost of an intangible asset over its useful life.
- Scenario: A software company acquires a patent for $50,000 with a useful life of 5 years. It records a non-cash amortization expense of $10,000 each year to allocate the patent's cost over its expected useful life.
- Debit: Amortization Expense account (Income Statement) for $10,000
- Credit: Accumulated Amortization account (Balance Sheet, under intangible assets) for $10,000
- Explanation: Similar to depreciation, the amortization expense reduces net income, while the accumulated amortization decreases the book value of the intangible asset.
Stock-based Compensation: This is the expense associated with granting stock options or other forms of equity to employees as part of their compensation.
- Scenario: A startup grants its employees stock options worth $200,000 in total as part of their compensation package. The expense is recognized over the vesting period of the options, say 4 years, leading to a non-cash expense of $50,000 annually.
- Debit: Compensation Expense (Income Statement) for $50,000
- Credit: Additional Paid-in Capital – Stock Options (Balance Sheet, under equity) for $50,000
- Explanation: This records the expense associated with stock-based compensation on the income statement, reducing net income, and increases equity on the balance sheet to reflect the value of compensation provided via stock options.
Impairment Costs: When the carrying value of an asset exceeds its recoverable amount, an impairment loss is recognized as a non-cash expense.
- Scenario: A company owns a factory valued at $1 million on its books. Due to unexpected market changes, the factory's fair value decreases to $800,000. The company must recognize a non-cash impairment loss of $200,000 to adjust the asset's book value to its fair value.
- Debit: Impairment Loss account (Income Statement) for $200,000
- Credit: Asset account (Balance Sheet, under assets) for $200,000
- Explanation: The impairment loss increases on the income statement, reducing net income, while the carrying amount of the asset decreases on the balance sheet to reflect its lower fair value.
Provisions for Doubtful Debts: This is an expense recognized to account for future losses from customers who may not pay their debts.
- Scenario: A retailer estimates that 2% of its credit sales might be uncollectible based on past trends. If credit sales for the year are $500,000, it records a non-cash expense of $10,000 as a provision for doubtful debts.
- Debit: Bad Debt Expense (Income Statement) for $10,000
- Credit: Allowance for Doubtful Accounts (Balance Sheet, under current assets) for $10,000
- Explanation: This transaction increases the expense on the income statement, reducing net income, and creates or increases a contra-asset account (Allowance for Doubtful Accounts) on the balance sheet, which reduces the net realizable value of accounts receivable.
These non-cash expenses are crucial for understanding a company's financial health, as they affect net income and assets but do not impact the company's cash flow directly.
You may also be interested in this financial statement generator template.
More examples of non-cash expenses:
- Depletion
- Inventory COGS if the inventory is paid for months ahead of time.
- Fair Value Adjustments
- Deferred Taxes:
- Unrealized Loss on Foreign Exchange:
- Non-cash Rent
Article found in Accounting and Finance.
