Are depreciation and amortization included in gross profit?

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Gross profit is the income earned by a business after deducting the direct costs of producing its products. The direct costs of labor and direct materials used in production are called cost of goods sold.

Generally, depreciation and amortization are not included in the cost of goods sold and are expensed on separate lines in the income statement.

Gross profit is the result of subtracting the cost of goods sold by a business from total sales. Therefore, depreciation and amortization are generally not included in the gross margin calculation.

However, it is important to note that there are situations where depreciation is recorded in cost of goods sold and may affect gross margin. Below, we explore how gross profit is calculated and how depreciation and amortization may or may not impact a company’s profitability.

Components of gross profit

Before exploring the impact of depreciation and amortization on profit, we must first look at the two main components of gross margin: revenue and cost of goods sold.

Revenue is the total amount of revenue generated from sales during a period. Income is also referred to as net sales because discounts and deductions on returned merchandise may have been deducted.

The cost of goods sold is the direct costs associated with producing the goods of a business. Cost of Goods Sold or COGS includes both direct labor costs and all costs of materials such as raw materials used in the production of a company’s products.

Gross profit measures the efficiency with which a company generates profits from its direct labor and direct materials. Gross margin does not include non-production costs. Only the costs and benefits associated with the production facility or factory are included in the gross margin. Some of these costs include the following:

  • Raw materials
  • Direct labor
  • Equipment costs involved in production
  • Utilities for the production site
  • Delivery fees

As stated earlier, gross profit is calculated by subtracting COGS from revenue. For example, if it costs $ 15,000 in production costs to make a car and the car sells for $ 20,000, the difference of $ 5,000 is the gross margin on that car.

Key points to remember

  • Gross profit is the income earned by a business after deducting the direct costs of producing its products.
  • The direct costs of labor and materials used in production are called cost of goods sold (COGS).
  • Generally, depreciation and amortization are not included in the cost of goods sold and are expensed on separate lines in the income statement.
  • However, part of the depreciation of a production facility can be included in the COGS because it is linked to production, which has an impact on the gross margin.

Depreciation and amortization

As previously stated, in most cases, depreciation and amortization are treated as separate items in the income statement.

Depreciation is typically used with fixed assets or tangible assets, such as property, plant and equipment (property, plant and equipment). Depreciation is a method of allocating the cost of an asset over its expected useful life. Instead of recording the purchase of an asset in the first year, which would reduce profits, companies can spread that cost over the years, allowing them to earn income from the asset.

Depreciation is similar to depreciation, but is used with intangible assets, such as a patent. Depreciation allocates the capital expenditure of intangible assets over a period of time, typically over the useful life of the asset.

Depreciation and amortization are accounting methods designed to help companies recognize expenses over multiple years. The expense reduces the amount of profit, allowing a business to have lower taxable income. Since depreciation and amortization are generally not part of cost of goods sold, which means they are not directly related to production, they are not included in gross profit.

Example of gross profit, depreciation and amortization

Below is a portion of the income statement of the former JC Penney Company Inc. as of May 4, 2019.

  • Total revenues are highlighted in green at an amount of $ 2.55 billion, while COGS is lower than revenues, reaching $ 1.63 billion.
  • The depreciation and amortization of $ 147 million is listed separately, highlighted in yellow.
  • For JC Penney, the gross margin for the period would include revenue and COGS. Depreciation and amortization would not be used in the calculation of gross profit, but would instead be included in the calculation of operating profit. JC Penney’s operating profit for the quarter was -93 million, a loss.

JC Penney Income Statement May 2019.
Investopedia

The source of the depreciation charge determines whether the expense is allocated between cost of goods sold or operating expenses. Certain depreciation charges are included in cost of goods sold and, therefore, are recorded in gross profit.

For example, depreciation of the head office building and its furnishings would not be included in COGS because it is not a direct cost associated with the production of goods. However, a portion of the depreciation of the factory or the manufacturer’s facility would be included in the overhead or fixed costs of the factory. Therefore, this part of the depreciation can also be included in the COGS because the depreciation is directly related to the plant.

It is much rarer to see depreciation included as a direct cost of production, although some businesses such as rental operations may include it. Otherwise, amortized expenses are generally not recorded in gross profit. The accounting treatment of income statements varies somewhat for each company and by industry.


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