Non-cash expenses are such expenses that do not involve real cash outlay or against which no real cash outflow has taken place at least in the period in which such expense has been reported. And as they are recognized as an expense they will cause entity’s retained earnings to decrease but such expenses will not cause decrease in cash in hand, cash at bank, any other resource or increase in liability of the entity.
Therefore we need to understand two things:
- Although such expenses are recognized and reported in the income statement but for the same expenses entity do not make any payments in cash or in kind. For example depreciation expense. Such costs are also called notional costs. However, notional costs are not the only non cash costs.
- Cash outflow will possibly take place but not in the period in which such expenses has been reported therefore, for that particular period at least such expense is a non-cash expense. For example accrued expenses.
To clarify even more, non cash expenses are such expenses which are recognized as an expense but they are not backed up with outflow of resources either in liquid form i.e. in cash or cash equivalents like promissory note or other form i.e. exchange of fixed asset etc.
Examples of such expenses include:
- Depreciation expense of non-current assets
- Amortization expenses – For example intangible assets or any other form of amortization of costs or expenses
- Impairment expenses – e.g. impairment of physical assets as well as intangible like goodwill etc.
- Increase in provision expenses like:
- Provision for doubtful debt expenses
- Provision for discount expenses
- Warranty provision expenses
- Almost all kinds of expenses recognised towards provisions are unreal or non-cash in nature.
- Bad debt expenses
- Interest winding up expenses – these expenses are recognized when future payments of significant amounts were recognized on present value basis and with the passage of time require adjustment.
- Expensing out deferred costs – advertisement expenditures or pre-commencement expenditures
- Accrued expenses – i.e. all kinds of expenses that are still payable by the end of accounting period
I must emphasize that students must not confuse non-cash expenses with such expenses for which non cash has been paid out but a liability has been assumed. This is a usual example in business environment where a person ABC owes money to DEF and DEF owes to GHI. ABC instead of paying DEF takes up his liability towards GHI and DEF stands discharged and now ABC owes directly to GHI. This is a usual case when negotiable instruments are endorsed to another person. Such endorsements are NOT an example of non-cash expenses.
Similarly such payments that involve payments in kind are also NOT the example of non-cash transactions. Non-cash does not strictly mean the transactions that exclude liquid cash involvement. Here the word non-cash means cash outflows which can take place any form of resource outflow.
Company named Cash n’ Cash has bought a set of machinery costing 100,000. Entity expects to use the asset for ten years. No residual value estimates can be made so entity expects zero scrap value.
In this example yearly depreciation expense can be calculated by dividing cost over useful life of asset as follows:
Cost / useful life
100,000 / 10
So 10,000 is the yearly depreciation expense. But the point to understand is that asset was bought and payment was made for the whole amount of asset i.e. real cash outflow took place at the time of acquisition. However, the expense is not recognized at the time of acquisition. This cost of the asset is not expensed out in the income statement in the year of purchase because not all the benefits are rendered in just one year rather a small proportion of such cost is transferred to profit and loss every year that equates the rate at which benefits are extracted from asset. However, the next 10 years in which such expense will be recognized no cash outlay will take place in this regard but still expense will be recognized. Thus a perfect example of noncash expense.