Depreciation in Cost of Sales: A Mining Financial Modelling Perspective

Accounting Systems vs Financial Modelling

Depreciation in cost of sales is often misunderstood in mining financial modelling, particularly when analyzing unit economics. Using an accounting package is like riding a train: it runs on rails, everything is controlled, and there is no room for error. This is how it must be. There is also no room for experimentation, because experimentation would undermine the consistency, comparability, and security of the system.

Using Excel for mining financial modelling, on the other hand, is like riding a bicycle. It can go wherever the user wants and can provide surprising or unexpected insights. It does not have the security of the train, but it offers freedom. Each mode is correct for its own purpose.

The Role of Financial Statements and Models

The purpose of financial statements is to present the financial results and financial position of a company accurately and in a standardised, comparable way. This is where flexibility in modelling—not in reporting—becomes valuable. In some cases, an unorthodox modelling approach will reveal information that is more useful for a specific decision-making purpose than strict adherence to accounting presentation.

Financial modelling is therefore a practical aid to decision-making, allowing alternative ways of thinking about cost and value.

Depreciation and Cost of Sales in Mining

Depreciation is an expense that accounts for the cost of using an asset. Whether on the train or the bicycle, the principle remains the same: Cost of Sales comprises all the costs required to bring a product to a saleable condition.

While there may be some grey areas, in mining it can be argued that most fixed assets are used directly to obtain the product. Assets are largely single-purpose and production is homogeneous. Under these conditions, depreciation can reasonably be treated as a production-linked cost and therefore included as depreciation in cost of sales when modelling unit economics.

Why Include Depreciation in Cost of Sales?

Why do this? Including depreciation in cost of sales will affect gross profit, but it will not affect operating profit or profit after tax, because depreciation appears below revenue in any case.

The point is not the profit lines themselves, but the signal they send. What we are often trying to determine is not accounting profit, but the economic cost of production for a single unit of output.

Unit Cost as a Key Variable

This is a critical number, particularly where selling prices are controlled or administered. In such environments, profitability is driven primarily by cost discipline rather than pricing power. Unit cost is therefore the key variable that must be understood and actively managed.

That number should not be expected to appear directly within the income statement, which is not designed to reveal economic unit costs. We should not look for it on the train.

Using Financial Models to Calculate Unit Costs

Instead, we must use the bicycle and calculate unit costs separately in Excel, using costs as they actually relate to production.

Hourly labour costs, electricity consumption, floor space, feedstock, and other inputs must all be included. Their proportions must be calculated and their costs itemised, including the hourly depreciation cost of the equipment used—understood as the cost of consuming productive capacity.

From a modelling perspective, the treatment of depreciation should reflect how productive capacity is consumed over time. While accounting standards prioritise consistency and comparability, financial models exist to support decision-making. Including depreciation in cost of sales can therefore provide a clearer view of production economics, particularly in capital-intensive industries such as mining.