Posted by Deepshikha Shukla
March 15, 2022 | 5-minute read (841 words)
Noncash expenses are a common type of expense incurred by businesses in the course of operations. The term refers to those expenses reported on the business’s income statement that do not involve an actual cash transaction.
Noncash expenses are recorded on the income statement in accordance with generally accepted accounting principles, even though they were not paid for with cash. The most common noncash expense is depreciation, but there are several other types, which we will delve into below.
Why do noncash expenses need to be recorded?
As previously stated, GAAP requires companies to deduct noncash expenses — for example, the value of stock options granted to employees — to determine profits.
Further, investors may want to know a business’s actual value rather than its net income. To perform a valuation, they analyze the business’s cash flow. As noncash expenses can reduce the actual income of a company if they’re not considered, they will add back noncash expenses to get actual cash inflow and outflow. Also, recording noncash expenses allows you to find out the net income of your business.
Common noncash expenses
Many companies own fixed assets such as machinery, vehicles and electronics used in their daily operations. The value of these assets depreciates gradually over time. When the amount of depreciation is deducted from the income statement, the net profit of a company is reduced. This recognizes a loss of value in the company even though no monetary transaction occurred.
Amortization is a type of noncash expense related to a business’s nontangible assets. It accounts for the cost of these assets over the length of their expected lifetime by allowing businesses to spread the costs of maintaining and upgrading the assets over many years. For example, a business that pays $500,000 to use another brand’s trademark for five years would amortize this asset of usage rights by $100,000 a year. Businesses record amortization costs as noncash expenses because they don’t require an immediate cash payment.
Unrealized gains and losses
Unrealized gain is an increase in the value of a company's assets or investments that haven't been sold yet. On the other hand, an unrealized loss occurs when the value of a company's asset or investment declines. Businesses can report these noncash profits or losses on the income statement as noncash expenses. It can also include a future loss in the value that a company expects in an asset.
Goodwill impairment occurs when a company purchases an asset for a price higher than its identifiable market value due to its goodwill, and then the value of the asset declines. The company can record the loss of value as a noncash expense on their income statement.
Many companies reward their employees or executives using stock options instead of monetary wages. The value of these stocks given to employees can be listed on the income statement as a noncash expense since it doesn’t involve actual cash payments. Businesses may also report any losses in the value of stock awarded to employees.
Provisions for future losses
Some companies that expect a future revenue loss estimate the total value of the loss, and then set aside funds to cover those losses, known as contingencies or provisions, for future losses. A company can list these provisions for expected losses such as bad debt as a noncash expense, since the expenditure is hypothetical.
Best practices for recording noncash expenses
1. Understand the different types of noncash expenses
Depreciation and amortization are the most common forms of noncash expenses businesses encounter. But business owners should be familiar with the types of noncash expenses described above, along with other less-common types such as deferred income taxes, asset write-downs and asset impairments or charges.
2. Recognize the difference between cash flow and net income
Cash flow is the amount of money that a company earns and spends. Net income measures the total profit of your business after deducting taxes, expenses and interest. Noncash expenses only affect the company's total income, not cash flow, since they don't require any financial outlay.
3. Report noncash expenses on your income statement
After evaluating the types of noncash expenses incurred, companies should record the value of the loss on their income statement. Recording noncash expenses reduces the total income value of a company, thus reducing its net taxable income.
Advantages of recording noncash expenses
Recording noncash expenses can help business owners gain a better understanding of the money available for company operations. An income statement that includes noncash expenses can also give investors a more accurate view of a company's financial viability and long-term prospects. Recording noncash expenses can also help businesses reduce their total taxable income.
Disadvantages of recording noncash expenses
Since companies don't actually spend money on noncash expenses, they often have to estimate the value of these costs. And if they portray an inaccurate picture of a company's financial situation or calculate their income incorrectly by over or undervaluing their noncash expenses, it could mislead investors.