Question

Explain the concept of depreciation and how other fixed costs play a major role in determining profitability?

Answer 1

• Depreciation is a method of allocating the cost of a tangible asset over its useful life.
• Long term assets are depreciated by businesses for both tax and accounting purposes.
• For tax purpose , businesses can deduct the cost of tangible assets , they purchase as business expenses.
• Depreciation expense does not represent a cash transaction.
• It indicates how much of an Assets value has been used up.
• Example a company buys a piece of equipment for$30,000.
• It can either write the full cost in the first year.
• Or can write the value of Asset off over the life of the Asset which is 10 years.
• That is why most of the business owners prefer to expense only a portion of the cost which artificially boosts net income.

• Increase in any type of business expense lowers profit.
• Income statement has three levels of profit.
• Relationship between operating expenses and profit can be seen directly when looking at operating profit.
• It is also known as profit before income and taxes.
• Profit is calculated by deducting the cost of goods sold from total net sales is call gross profit.
• Both fixed and variable are production costs.
• Both costs reduce gross profits.
• Fixed production cost like buildings and Equipments are not affected by production levels.
• Wages paid to factory workers and the cost of Raw materials increases when production level rises.
• At the second level of profitability operation profit is calculated by subtraction expenses from gross profit.
• Which is also known as sales general and Administrative expenses.
• Profit is equal to revenues minus the cost of goods sold operating expenses and interest.
• Business expenses such as purchases of new information technology innovatIon
• Lower net income over the short term.
• Raises income potential over the long term.
• Capital expenses on equipments and other fixed assets can be depreciated over several years.
• By lowering the impact on profits.