Unravelling Financial Complexity: Estimating Depreciation, Amortization, and Provision Costs for Your Industrial Feasibility Study

This process refers to breaking down the business’s non-cash expenses over the useful lives of assets. They are accounting terms related to the allocation of costs and the recognition of future liabilities. Depreciation costs are typically the summation of the net cost of fixed tangible assets, like machinery and building, (after deducting residual values) divided over each asset life expectancy period (e.g., usually counted in years).

Amortization is the same as depreciation, but it is for non-physical assets like goodwill, patent, copyrights, trademarks, pre-production costs or capital financing fees. It represents the gradual write-off of the cost of intangible assets over their estimated useful lives. Like depreciation, amortization helps match expenses with the revenue generated from the use of intangible assets.

Provisions are expenses resulting from impairment (i.e., potential losses or liabilities before assets are materialised) of investment sub-accounts like account receivables, inventories, or fixed assets.

These costs depend on the purchasing costs or initial investment estimates and life expectancy period (e.g., (5) years for the pre-production costs, (15) years for machinery, and (25) years for the building).

The importance of estimating these non-cash expenses includes allocating associated expenses of sales for each financial reporting period (e.g., a year), maintaining the accurate values of fixed assets, revolving cash equivalent to investment costs for future replacement, and enabling assets growth. These expenses play crucial roles in financial reporting by accurately reflecting the consumption of assets, the value of intangible assets, and potential future obligations.  

Step-By-Step Process

• Clarify the investment cost and identify each sub-account, including the nature of the account, classification (e.g., depreciation, amortization, or provision), beginning balance, and useful life.
• Check industry benchmarks on asset useful lives.
• Choose the method of depreciation (e.g., fixed, accelerating, or decelerating method).
• Prepare a table showing the investment account, its beginning balance, and useful life, and conclude every asset’s depreciation, amortization or provision expenses over its useful life period.
• Spread the depreciation, amortization, and provision expenses over a period of years equivalent to asset useful lives.
• Share findings with your team and experts for finalization.

Example

Here is the table of the depreciation costs for a pharmaceutical manufacturing facility:

Accounts	Sub-accounts	Initial Investments	Dep. Period	Yr. 1 ($)	Yr. 2 ($)	Yr. 3 ($)
Current Assets	Receivables	8,026,714	1%	40,134	40,134	40,042
	Inventories	3,022,278	1%	15,111	15,111	23,602
	Cash	12,040,071	–	–	–	–
	Total	23,089,063	–	55,245	55,245	63,645
Current Liabilities	Payables	1,511,139	–	–	–	–
	Other Payables	445,887	–	–	–	–
	Total	1,957,026	–	–	–	–
Pre-investment costs	Pre-Investment Costs	500,000	5	100,000	100,000	100,000
Fixed Assets	Production Technology	58,933,000	15	3,928,867	3,928,867	3,928,867
	Warehouse Equipment	1,270,000	15	84,667	84,667	84,667
	lab. Instruments and Facilities	2,000,000	5	400,000	400,000	400,000
	Spare Parts and Consumables	1,624,975	5	324,995	324,995	324,995
	Other Tools and Equipment	1,700,000	5	340,000	340,000	340,000
	Freight, Testing, Installation, and Commissioning	10,214,000	15	680,933	680,933	680,933
	Stage 1- Manual Secondary Packaging Lines	500,000	15	33,333	33,333	33,333
	Stage 1- Pilot Plant	5,566,000	15	371,067	371,067	371,067
	Construction	39,697,000	25	1,587,880	1,587,880	1,587,880
	Civil and Electrical Works	1,984,850	15	132,323	132,323	132,323
	Registration & Licensing Fees	2,600,000	5	520,000	520,000	520,000
	Product Formula and Profiling	21,620,000	10	2,162,000	2,162,000	2,162,000
	IT Support + PCs	1,400,000	5	280,000	280,000	280,000
	Furniture	400,000	5	80,000	80,000	80,000
	Vehicles	1,400,000	5	280,000	280,000	280,000
	Other Fixed Assets	4,527,295	5	905,459	905,459	905,459
	Depreciation costs for the fixed assets	155,437,120	–	12,111,524	12,111,524	12,111,524
Capital Financing Costs	Capital Financing Costs	925,000	5	185,000	185,000	185,000
Total		177,994,157		12,451,769	12,451,769	12,460,169

Useful Tips

• Collect sufficient information on the assets’ useful lives from industry indicators.
• Share discussion with your team and consult experts.

Things To Avoid

• Avoid guessing works and assumptions without evidence.

Final Note

This article is sourced from my new book- Your Guide For Preparing An Industrial Feasibility Study. For more information about the book: https://growenterprise.co.uk/book-your-guide-for-preparing-an-industrial-feasibility-study/To register in our newsletter: http://eepurl.com/ggcC29Or email us at: maldawood@growenterprise.co.ukThe author: Munther Al Dawood- Industrial Enterprise Expertwww.growenterprise.co.uk