Consider that a business owns a 3D printer which forms the core of the business. They use the printer on a daily basis to fulfill customer orders. The purchasing price of the printer is $25,000 with a life expectancy of 10-years. In its lifespan, the printer can print upto 250,000 3D items. Rather than taking the whole $25,000 expense at once, accounting rules allow the business to spread the cost of the assets over its useful life (which is 10-years here). This concept is called depreciation. It allows business to take out a certain percentage of the invested amount on the asset each year while it’s making money for the business (Dammon & Senbet, 1988).
Explicit cost, on the other hand, takes out money from the company while affecting the cash flow of the business (Walia, 1977). Let’s look at an example to understand this well, you own a pizza house at Thamel. As part of the business, you’ve employed three full-time employees and an equal number of part-time employees as well. You made an investment in the space, equipment, and furniture to ensure that you’ve got the best place in town. Every month end, you are obliged to pay the bills including the rent, salary to the staff, loans and other utility costs. These expenses are measurable and required a fixed amount of payment at the end of a period (month). This type of cost is called an explicit cost.
The expenses of depreciation are recorded in the cash flow statement as a positive amount. The company would have already placed the full expense of the product as part of liabilities while adding the product as part of assets. The depreciation that is taken into account every period is to account for the depreciation expense in the income statement taken at the initial stage of the purchase of it and to adjust the net income. Deprecation can never be a source of fund. Assigning it a zero cost helps in improving the efficiency of the process, reduce future expense, and operations while ensuring no expenses are added as part of it. No additional interest need to be paid while an assets deprecation happens. All of which is the reason why funds generated from deprecation has no explicit cost and should be assigned zero cost while computing a firm’s capital schedule.
References
Dammon, R., & Senbet, L. (1988). The Effect of Taxes and Depreciation on Corporate Investment and Financial Leverage. The Journal Of Finance , 43 (2), 357-363.
Walia, T. (1977). Explicit and Implicit Cost of Changes in the Level of Accounts Receivable and the Credit Policy Decision of the Firm. Financial Management , 6 (4), 75-78.
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Consider that a business owns a 3D printer which forms the core of the business. They use the printer on a daily basis to fulfill customer orders. The purchasing price of the printer is $25,000 with a life expectancy of 10-years. In its lifespan, the printer can print upto 250,000 3D items. Rather than taking the whole $25,000 expense at once, accounting rules allow the business to spread the cost of the assets over its useful life (which is 10-years here). This concept is called depreciation. It allows business to take out a certain percentage of the invested amount on the asset each year while it’s making money for the business (Dammon & Senbet, 1988).
Explicit cost, on the other hand, takes out money from the company while affecting the cash flow of the business (Walia, 1977). Let’s look at an example to understand this well, you own a pizza house at Thamel. As part of the business, you’ve employed three full-time employees and an equal number of part-time employees as well. You made an investment in the space, equipment, and furniture to ensure that you’ve got the best place in town. Every month end, you are obliged to pay the bills including the rent, salary to the staff, loans and other utility costs. These expenses are measurable and required a fixed amount of payment at the end of a period (month). This type of cost is called an explicit cost.
The expenses of depreciation are recorded in the cash flow statement as a positive amount. The company would have already placed the full expense of the product as part of liabilities while adding the product as part of assets. The depreciation that is taken into account every period is to account for the depreciation expense in the income statement taken at the initial stage of the purchase of it and to adjust the net income. Deprecation can never be a source of fund. Assigning it a zero cost helps in improving the efficiency of the process, reduce future expense, and operations while ensuring no expenses are added as part of it. No additional interest need to be paid while an assets deprecation happens. All of which is the reason why funds generated from deprecation has no explicit cost and should be assigned zero cost while computing a firm’s capital schedule.
References
Dammon, R., & Senbet, L. (1988). The Effect of Taxes and Depreciation on Corporate Investment and Financial Leverage. The Journal Of Finance , 43 (2), 357-363.
Walia, T. (1977). Explicit and Implicit Cost of Changes in the Level of Accounts Receivable and the Credit Policy Decision of the Firm. Financial Management , 6 (4), 75-78.