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Depreciation - where it belongs

Depreciation expense for a manufacturing company is allocated between COGS and operating expense based on the source of this expense. For a manufacturing company, depreciation on the manufacturing equipment and facilities is a manufacturing overhead and thus included in COGS. Whereas depreciation on non-manufacturing equipment is included in operating expenses.

It is interesting to note how various companies in the Internet Publishing and Broadcasting and Web Search Portals (NAICS 519130) are treating depreciation expenses and what is the reason behind this.

Facebook, Linkedin and Google are all under the same NAICS as mentioned above. Facebook and Google include depreciation associated with operation of data centers and amortization of intangible assets in cost of revenues whereas Linkedin reports D&A separately on the income statement. Since maintaining data center equipment and technology infrastructure is directly related to delivery and distribution of products and services of these companies this treatment is reasonable. These costs are similar to the depreciation on manufacturing equipment being included in COGS by a manufacturer.

For Linkedin D&A expenses include depreciation on computer equipment, software, leasehold improvements, capitalized software development costs and amortization of purchased intangibles. The cost of revenues does include data center equipment maintenance expenses. This could imply that depreciation related to data center equipment is included in cost of revenue and all other D&A is reported separately on the income statement.

For Target and Radioshack which are retailers D&A are a part of the operating expenses.

While modeling financial statements for Facebook and Google D&A need to be identified and separated from the COGS or it might lead to D&A expenses being double counted and resulting in an understatement in operating income. The alternative to this adjustment is to not have D&A as a separate line item in the income statement just as it is presented in the financial statements.