Depreciation vs. Loss on Disposal of Assets & EBITDA

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Depreciation and loss on disposal of fixed assets are both expense items found on the income statement, while EBITDA (earnings before interest, taxes, depreciation and amortization) is a measure of income that is often reported as a discrete item on the income statement, although it is not required to be under generally accepted accounting principles, or GAAP.

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Depreciation Expenses and Accounting

Accounting Tools reports that a depreciation expense is recorded to reflect the amount by which a physical asset, such as machinery and equipment, becomes obsolete during the fiscal period. This is done because different kinds of assets do not hold their full value over time. It is a non-cash expense that reflects the accrual method of accounting, under which expenses are recorded when they are identifiable and measurable.

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Depreciation does not result in any cash outflow for the firm, but it still represents genuine economic obsolescence. It must be properly recorded in order to have an accurate financial picture of the business. Therefore, depreciation expense for accounting purposes results in a decrease in GAAP earnings.

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Consider also:Why is Depreciation an Expense?

Loss on Disposal of Assets

When a company sells fixed assets, such as property and equipment, and collects proceeds amounting to less than the asset's book value, a loss on the disposal of assets is recorded as a nonoperating loss on the income statement. When it comes to loss on disposal of assets, income statement numbers are not impacted. This means that it does not affect the company's operating income or operating margin. Also, it is a non-cash expense; the actual cash inflows and outflows associated first with the asset's purchase, followed by the asset's disposal, are accounted for on the cash flow statement as investing cash flows.

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The asset's book value has little relationship with its fair market value, and proper accounting methods take this into consideration. It is a GAAP measure that's equal to the company's original cost minus accumulated depreciation. Accumulated depreciation is equal to the sum of all depreciation expenses recorded to date, with respect to that particular asset.

Small companies generally do not record asset disposals every year, and large gains or losses on the disposal of assets are typically treated as nonrecurring items, adjusted out of earnings for analysis purposes.

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Consider Also:Advantages & Disadvantages of Depreciation

Understanding EBITDA Basics

According to Investopedia, EBITDA is an acronym that stands for earnings before interest, taxes, depreciation, and amortization. EBITDA is the earnings or cash flow stream – it can be considered both – that investors assign the most importance to when analyzing financial performance. If not broken out separately on the income statement, EBITDA is calculated by adding interest expense, depreciation and amortization costs back to pretax income. The resulting cash flow stream is free of the effects of the decisions made by management with respect to the company's capital structure and asset depreciation methods.

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Investors value being able to analyze income solely from operations, because it provides an indication of the company's intrinsic value, therefore giving them a good idea about how to best invest their money. The company's fair market value is based on the premise that a hypothetical investor could purchase the company and incorporate an optimal capital structure. Depreciation schedules can also be changed with no real impact on the company's operations.

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