Depreciation발음듣기
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Depreciation
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And what I'm going to do is I'm going to actually write out its income statement over a given number of years.발음듣기
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What we did in the first video on this series is we just did one snapshot of the income statement.발음듣기
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I think it was 2008. But here we're looking at the income statement over a bunch of years, and in this case, I'm just assuming that they have a very stable revenue base, that they bring in a very stable amount of revenue every year.발음듣기
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Now, their cost of goods, I'm going to split up this time, because there's two components of cost of goods, so I'll just make a cost of goods category right here.발음듣기
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COGS, but that just stands for Cost of Goods Sold, but sometimes you'll hear someone say our COGS were this or our COGS were that.발음듣기
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Cost of Goods Sold. So they're the variable costs. And this video isn't a video on variable versus fixed costs, but you might learn a little bit about it.발음듣기
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So they're the variable costs, and that's literally the actual costs of making those widgets.발음듣기
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So if the widgets are made out stainless steel, it's the cost of buying the stainless steel and maybe the electricity bill of melting it and reforming it or however you have to work with stainless steel.발음듣기
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So let's say the variable costs each of these years - and I'm assuming stainless steel prices don't change - is $100,000.발음듣기
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They have people on hourly wages that are forming these stainless steel widgets, so that incorporates everything.발음듣기
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And let's say that they essentially have to build a new factory every two years, or let's say they have to do major repairs to the factory every two years.발음듣기
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Because that's part of the cost of building the widgets, because if you continue to make widgets at this kind of $1 million a year pace, your factory has to be retooled or revamped every two years.발음듣기
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So the factory retooling. And most times, and we'll see this when you look at an actual company's income statement, they're not going to break up the variable and fixed costs within their cost of goods sold like this, because really, they actually want to hide it from a lot of their competitors.발음듣기
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They don't want their competitors to have too much intelligence on what their cost structure is like.발음듣기
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It could be used against them potentially, or maybe they don't want their customers to know.발음듣기
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Anyway, factory tooling. So the way I just described it, one way to account for it is when you do the factory retooling, you essentially just mark it as an expense.발음듣기
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Minus $500,000. And so their operating profit, the amount of pre-tax income, but you know, we're not considering financing either, so this is their operating profit or their EBIT.발음듣기
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And then their pre-tax profit is going to be the same thing as the operating profit, so minus $100,000, minus $100,000, $400,000 - I'll make the good years in green - $400,000.발음듣기
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Because that's not the point of this, but you can apply some tax rate to this and figure out what their net income is.발음듣기
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But the point of this is, even though their business is ultra stable, they do the exact same thing every year, when we look at the pre-tax or the operating income, or if we tax it, or even at the net income, we see a super lumpy business, because in one year they lost $100,000.발음듣기
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That you have such a sleepy, stable business that's just making COGS year in year out, and they have the exact same amount of revenue?발음듣기
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And I think you know, because you have this every other year factory retooling, where they have to spend $500,000 to essentially rebuild their factory because of all of the wear and tear that happened over the last two years.발음듣기
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So the question is, is this a good way to account for it, where when you have to - I guess you could say - buy new equipment.발음듣기
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Let's say this $500,000 is to buy actual new stainless steel shaping tools, so is it a good idea to account for it only in the period that you spend it?발음듣기
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Because the whole purpose of accounting is to give the person reading the income statement in this case as accurate a picture of the actual state of the business as possible.발음듣기
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And this, in my opinion, isn't an accurate picture, where it creates this huge lumpiness and it creates the impression of a volatile business even though it's a super, super stable business.발음듣기
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So what you do, instead of just saying, oh, I had to buy $500,000 worth of equipment in 2005, so I literally put a $500,000 expense there, and I didn't have to do that in 2006, so I have no expense.발음듣기
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Instead of doing that, what you do is - I'll put the balance sheet down here - so whatever the balance sheet was in - so I'll draw both hand sides of the balance sheet.발음듣기
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And just so you don't get confused, there's always a liability side of the balance sheet as well.발음듣기
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So in 2007, maybe before I spent the $500,000, right when I do it, I probably had $500,000 of cash sitting here.발음듣기
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Cash, $500,000. And instead of just using this an expense, and we'll go in the future on kind of how you account for things in a little bit more detail and how you actually do the debits and credits,발음듣기
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but a simple way to think about it, instead of using this $500,000 as an expense, we just transferred this $500,000 to buy an asset.발음듣기
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So when you use cash to buy an asset, and that asset has a useful life that's more than just that period, you're essentially capitalizing the expense or you're essentially creating that asset on the balance sheet.발음듣기
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So instead of this $500,000 just disappearing expense, you say, no, now I have - let's call it F for factory tools.발음듣기
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So the way you'd think about this is instead of having factory retooling, you could say factory tool.발음듣기
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Likewise, in this year, no cash went out the door, but my equipment got a little bit older, so I used half more of it.발음듣기
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I'm only willing to pay $250,000, because you've already used it for a year and it only has one year of useful life left, so it's of $250,000 of value to me.발음듣기
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And then the other $250,000 essentially went to an expense called depreciation, which is right there.발음듣기
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So over here, let's say you did it right at the beginning of the year, the asset's worth $500,000.발음듣기
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Now, it's worth $250,000. Now, the asset's worth zero, but at the beginning of this year, you buy a new asset worth $500,000.발음듣기
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Then it's worth $250,000 again. And this is just an arguably long-winded way of saying that the way you account for this is you spread out the cost over time, over its useful life, and this spreading out is called the depreciation of an asset.발음듣기
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And I'm running out of time in this video, and I'll cover it in the next, but you might have also heard of the word "amortization." Amortization is to spread out a non-tangible cost over a period of time.발음듣기
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So for example, depreciation, this was factory equipment, and it gets old as I use it, so I spread out its cost.발음듣기
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That's what depreciation does. And it accurately reflects what's actually happening in the business.발음듣기
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Amortization is the exact same thing as depreciation, but it applies to things that aren't equipment.발음듣기
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It applies to - and I'll do it in the next video - but let's say I had one big expense in terms of I had to pay a bunch of fees to the bank, but the benefit of those fees are going to be over time.발음듣기
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