Is Depreciation and Amortization an Operating Expense?

Depreciation and amortization is an operating expense in most cases, and it appears within Selling, General, and Administrative costs on the income statement. The exception is depreciation tied to assets that directly produce goods, such as factory machinery or a production building, which is treated as a product cost and rolled into cost of goods sold. The classification changes which profitability line the charge reduces, so it matters when you’re reading an income statement or comparing companies.

When D&A Counts as an Operating Expense

The test is functional: does the asset support general business operations, or does it help make the product? If it supports operations, its depreciation or amortization is an operating expense. Office computers, executive furniture, the company car the sales team drives, the building the accounting department works in, and capitalized software the HR team uses all fall on this side of the line. Their annual depreciation or amortization sits in SG&A alongside salaries, rent, and insurance.

Because SG&A is part of operating expenses, D&A on these assets directly reduces operating income, sometimes called EBIT. That line is how investors judge whether a company’s core business is profitable before financing and tax choices enter the picture. Leaving office-side depreciation out of operating expenses would make operating income look better than the business actually performs.

Amortization of intangibles follows the same logic. A patent, a customer list, or capitalized software that supports back-office functions produces amortization expense that lands in operating expenses. A $200,000 patent with a 20-year legal life generates $10,000 of amortization each year, and if the patent supports general operations, that $10,000 hits SG&A.

When D&A Belongs in Cost of Goods Sold

Manufacturing is the exception that everyone should know. When an asset directly contributes to producing inventory, its depreciation is a product cost. Depreciation on a stamping machine, an assembly-line conveyor, or the factory building itself gets attached to each unit produced. That expense sits on the balance sheet as part of inventory value until the product is sold, at which point it flows through to cost of goods sold on the income statement.

The impact is meaningful. D&A embedded in COGS reduces gross profit, and gross profit margin is the metric that tells you how efficiently a company converts production capacity and raw materials into revenue. If production depreciation were buried in operating expenses, gross margins would look artificially high and management would have a harder time seeing production inefficiency.

Most manufacturers have D&A in both places at once. A company might record $2 million of depreciation on factory equipment inside COGS and another $400,000 of depreciation on office furniture and delivery trucks inside SG&A. Both are real costs. They just hit different lines because they serve different functions.

The Underutilized Capacity Wrinkle

Not all production depreciation stays in inventory when a factory runs below capacity. Under GAAP, fixed manufacturing overhead, including depreciation, is allocated to inventory based on normal capacity rather than actual output. If a plant designed to produce 10,000 units only makes 6,000, the depreciation attributable to the 4,000 unproduced units gets expensed in the current period instead of sitting in inventory. Companies running underutilized factories will see this drag on margins even when the equipment is idle.

Why the Classification Matters

Depreciation and amortization affect three profitability lines depending on where they’re recorded:

Production-related D&A flows through COGS and reduces gross profit.
Operations-related D&A sits in SG&A and reduces operating income (EBIT).
All D&A, regardless of placement, reduces net income.

When you’re reading a filing, this is why the same dollar of depreciation can tell you different things. A rise in production depreciation compresses gross margin and points at the factory floor. A rise in SG&A depreciation leaves gross margin alone but pushes on operating margin and points at back-office investment. Two companies with identical net income can look very different at the gross-profit line if one puts more of its equipment cost into COGS than the other.

Analysts often step around the placement question entirely by using EBITDA, which strips D&A out along with interest and taxes to approximate cash generation from operations. That’s a useful shorthand, but the SEC treats EBITDA as a non-GAAP measure and requires companies that report it to reconcile it back to net income.¹ EBITDA also ignores the real cost of maintaining a company’s asset base. A useful check is comparing D&A to maintenance capital expenditures, which over time should roughly match; a company that consistently spends less on maintenance capex than it records in depreciation is quietly shrinking its productive capacity, and EBITDA won’t show it.

The Non-Cash Side That Still Matters

D&A is an expense on the income statement, but no cash moves when it’s recorded. The cash left the business when the asset was purchased, and that outflow shows up as a capital expenditure in the investing section of the cash flow statement. The annual D&A charge is just an allocation of that historical purchase price across the years the asset produces value.

That non-cash nature is why D&A gets added back to net income at the top of the cash flow statement under the indirect method. If a business reports $500,000 of net income and $150,000 of D&A, operating cash flow starts at $650,000 before working capital adjustments. The D&A add-back is typically the largest single reconciling item between net income and operating cash flow.

There’s a tax benefit on top of that. Because D&A reduces taxable income, a company paying the 21% federal corporate rate saves $21,000 in cash taxes for every $100,000 of D&A recorded. The expense is non-cash, but the tax savings are real cash. This tax shield is one reason capital-intensive businesses with heavy depreciation can produce strong free cash flow even when net income looks modest.

Two Assets That Are Never Depreciated or Amortized

Some long-lived assets don’t produce D&A expense at all, so they never enter the operating-expense-versus-COGS question. Land has an unlimited useful life and doesn’t wear out through use, so it’s never depreciated under either U.S. GAAP or international standards. Goodwill, the premium paid to acquire another company above the fair value of its identifiable assets, is not amortized by public companies. Instead, public companies test goodwill for impairment at least once a year to check whether its recorded value still holds up.² Private companies can elect to amortize goodwill on a straight-line basis over ten years, and that amortization would then follow the same operating-expense classification as other intangible amortization.³

The Short Answer, Restated

If the asset helps run the company, its D&A is an operating expense inside SG&A and reduces operating income. If the asset helps make the product, its depreciation is a product cost inside COGS and reduces gross profit. Most companies have D&A in both places, and the split tells you something about what kind of business you’re looking at. When in doubt, ask whether the asset participates in production. That single question resolves nearly every case.