Definition of Non-Operating Costs, Examples, Advantages, Disadvantages

By | January 6, 2022

On this occasion we are going to learn about the cost of non-operating expenses which are businesses.

Then what are non-operating costs and where are these costs positioned in the income statement ? Please study this article.

What are non-operating costs?

Companies incur expenses to run their day-to-day operations and generate revenue. Such costs are called operating costs .

But the company also incurs costs that fall outside its core line of operations. These costs are incidental or peripheral to the company.

Borrowing money is an outside activity for the merchandising business, so interest payments are included in non-operating costs.

Non-operating costs are costs incurred by companies that are not directly involved in operational activities or the company’s main business activities which are often reported in the income statement after the Operating Profit and Loss item under Other expenses. Such expenses are usually non-recurring and do not take into account the company’s daily expenses.

Non-operating expenses include financial liabilities that are not related to core operations.

Examples of these expenses are:

  1. Legal fees
  2. Interest fees and other financing costs
  3. Losses from selling assets
  4. Disadvantages of exchange rate fluctuations
  5. Reorganization costs
  6. Loss drop
  7. Disadvantages of derivative instruments
  8. Cost of obsolete inventory
  9. Claim settlement fee

Non-operating costs are not taken into account when calculating the company’s profit. These are shown as bottom-line items in the income statement.

Calculation of non-operational costs

The following is an example of calculating non-operating costs and their position in a company’s income statement.

Presentation of non-operating income in the company’s income statement:

PT ABCDEFGH

Income statement

For the year ended December 31, 2020

Sales revenue500000
Cost of goods sold200000
Gross profit300000
Operating costs
Salary and wages15000
Advertising costs10000
depreciation20000
rent3000075000
Revenue from operations225000
Other income and profits (Non-operating income)
Interest income5000
Gain from asset disposal2000025000
Other expenses and losses (Non-operating expenses)
Interest expense1000025000
Loss due to damage15000
Entry limit225000

In the income statement above, interest expense, legal fees, losses from the sale of assets are included in non-operating expenses. Non-operating expenses are usually deducted from EBITDA 1 on the income statement.

These are described as bottom-line items on the income statement and are recorded just below the results of continuing operations.

Non-recurring events give rise to non-operating losses hence, they are reported on the company’s income statement.

They are displayed separately from normal earnings so that analysts and investors can see how the business is performing over a given period of time.

Example:

Assuming that after subtracting the cost of goods sold and all operating expenses from sales revenue, a company reports operating income of Rp. 1,500,000 for one year.

Apart from running its core business, the company also made several investments, which resulted in dividends of Rp. 500,000 and interest income of Rp. 200,000.

During the year, the company paid Rp 600,000 interest for the previous financing year and sold a plot of land for a loss of Rp 100,000. Also, it was sued and charged Rp 150,000.

The company’s income from dividends, interest income, and interest expense are all non-operating gains or losses. Overall, the company experienced a net non-operating loss of Rp 150,000 which is shown below.

Dividend Income500,000
Interest income200,000
Interest expense-600,000
Loss of land sale-150,000
Litigation fees-100,000
Non-operating income (loss)(150,000)

In the technical sense in the table above, interest expense, loss on sale of land, and litigation costs are non-operating expenses. The classification of items as non-operating expenses/income depends on the nature of the business being run.

For financial companies, interest income/expenses are treated as operating income/expenses while other companies are treated as operating income/expenses.

The Importance of Non-Operational Costs

It is true that non-operating expenses are listed at the bottom of the income statement, but that does not diminish the importance of these expenses.

The income statement structure is built in such a way that users of financial statements can easily assess business performance based on the activities recorded at the top of the income statement.

But it is also important for analysts and investors to understand trends in operating costs because they have the potential to affect a company’s financial performance.

For example, a company’s cash balance may deteriorate if it continues to experience recurring non-operating losses over a long period of time.

So, analysts and investors should also pay attention to these expenses after analyzing the core business risks.

Advantages of Reporting Non-Operating Expenses

Some of the main advantages are as follows:

  • Disclosure of non-operating costs results in transparency that is appreciated by all stakeholders – investors and even employees.
  • Companies can reduce non-operating costs relatively easily compared to core business costs.
  • Recognizing non-operating expenses and operating expenses separately in the income statement helps analysts to assess core business performance much more easily.

Disadvantages of Reporting Non-Operational Expenses

Some of the main drawbacks are as follows:

  • There is often a risk of manipulation by accountants where they may classify operating expenses as non-operating expenses in order to increase revenue from the core business.
  • The lack of standard criteria for dividing operating and non-operating costs results in confusion.

Accounting Manipulation:

The non-recurring nature of non-operating expenses and income provides room for accounting manipulation . Non-operating income may be increased to compensate for losses on operations.

It can also explain incorrect operating income by including gains from unrelated activities.

Sudden increases in profit are more likely to be contributed by unrelated and non-operational activities.

Non-operating income and expenses are excluded from the calculation of Earning Per Share (EPS) because they are not part of the company’s normal operations.

Non-recurring events can inflate/deflate the company’s revenue so that it reflects the company’s financial position that is not true.

Write-off can be considered as a non-operational expense if it occurs due to a one-time sudden event such as a natural disaster, a downturn in economic conditions.

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Description:

1 EBITDA stands for Earning Before Interest, Tax, Depreciation which means Income Before Deducting Interest, Tax and Depreciation.