The general plant overhead concept is meant to include the costs of operating
shops, labs, etc., as they are allocated to the operation of the plant. Research and
analytical expenses are often allocated also as part of plant overhead unless
accounted for separately.
Sales and Administration
In order to avoid further complexity, it is best to assume that these expenses are
included as part of the general plant overhead. At times, however, this is not
practical, principally if the plant is part of a more extensive organization.
A corporate overhead entry may be included in these cases. If not part of the
general plant, overhead, sales, and administration can then be assumed to be part
of corporate overhead. At other times, a cost of sales, say 5 %, is allocated as a
percentage of product revenue.
The actual accounting for this item is largely immaterial except for those few
cases when one wishes to distinguish a cost of production from a cost of
manufacturing, thus making a distinction between plant-related costs and other
extraneous costs.
Capital Items
Capital items are those directly related to the plant investment and include:
• Depreciation
• Amortization
• Interest on capital
• Interest on working capital
Depreciation and amortization expenses are significant in that they are substantial, but are not real. Thus, while both depreciation and amortization charges are
subtracted in order to calculate a net (pretax or posttax) income, they in no way
affect the cash flow out of the unit and, therefore, are added back for the purpose of
determining the cash flow.
Depreciation
Depreciation represents a capital recovery. As such, it is a certain amount of money
related to the capital investment spent up-front that is set aside on a regular basis,
without interest, over a certain period of time to represent the recovery of the
original capital.
Depreciation is accounted for separately, apart from any return on capital (ROI).
The reasoning behind this practice is that, as the plant ages, provision should be
made to accumulate capital for its eventual replacement. Obviously, in actual
practice, financing of an actual replacement, if any, will rarely depend on capital
accumulated in such a manner. If viewed as a capital build-up for plant replacement, depreciation would be equivalent to a zero-interest sinking fund.
Apart from philosophical interpretations, the real value of depreciation is that it
is almost universally tax deductible. On the basis that depreciation represents a
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shops, labs, etc., as they are allocated to the operation of the plant. Research and
analytical expenses are often allocated also as part of plant overhead unless
accounted for separately.
Sales and Administration
In order to avoid further complexity, it is best to assume that these expenses are
included as part of the general plant overhead. At times, however, this is not
practical, principally if the plant is part of a more extensive organization.
A corporate overhead entry may be included in these cases. If not part of the
general plant, overhead, sales, and administration can then be assumed to be part
of corporate overhead. At other times, a cost of sales, say 5 %, is allocated as a
percentage of product revenue.
The actual accounting for this item is largely immaterial except for those few
cases when one wishes to distinguish a cost of production from a cost of
manufacturing, thus making a distinction between plant-related costs and other
extraneous costs.
Capital Items
Capital items are those directly related to the plant investment and include:
• Depreciation
• Amortization
• Interest on capital
• Interest on working capital
Depreciation and amortization expenses are significant in that they are substantial, but are not real. Thus, while both depreciation and amortization charges are
subtracted in order to calculate a net (pretax or posttax) income, they in no way
affect the cash flow out of the unit and, therefore, are added back for the purpose of
determining the cash flow.
Depreciation
Depreciation represents a capital recovery. As such, it is a certain amount of money
related to the capital investment spent up-front that is set aside on a regular basis,
without interest, over a certain period of time to represent the recovery of the
original capital.
Depreciation is accounted for separately, apart from any return on capital (ROI).
The reasoning behind this practice is that, as the plant ages, provision should be
made to accumulate capital for its eventual replacement. Obviously, in actual
practice, financing of an actual replacement, if any, will rarely depend on capital
accumulated in such a manner. If viewed as a capital build-up for plant replacement, depreciation would be equivalent to a zero-interest sinking fund.
Apart from philosophical interpretations, the real value of depreciation is that it
is almost universally tax deductible. On the basis that depreciation represents a
754
D.S.J. Jones and P.R. Pujado ´