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Bernard H. Arnold, Meyer D. Stern and Bernard Rose announce the formation of a partnership under the firm name of Arnold, Stern & Rose with offices in the Andrus building, Minneapolis, Minnesota.

R. S. Stone and Harvey J. Stevenson announce the formation of a partnership under the firm name of Stone & Stevenson with offices in the Security building, Los Angeles, California.

Curtis F. Scott and G. A. Ruhl announce the formation of a partnership under the firm name of Scott & Ruhl, with offices in the Whitney Central building, New Orleans, Louisiana.

Edwin F. Herold announces the opening of an office in La Salle building, Broadway and Olive street, St. Louis, Missouri.

Charles P. Rupp announces the opening of an office at 613 Claus Spreckels building, San Francisco, California.

Orrin A. Redman announces the removal of his office to 1310 Lake View building, Chicago, Illinois.

Guthrie Hunter & Co., New York, announce that Thomas Heads has become a member of the firm.

Frank L. Pollard announces the opening of an office in Granite block, Watertown, South Dakota.

P. Miles Taylor & Co. announce the removal of their office to 49 Wall street, New York.

Theodore Krohn announces the opening of an office at 763 Broad street, Newark, New Jersey.

Stanley W. Park announces the removal of his office to 56 Pine street, New York.

S. J. Levenson announces the opening of an office at 507 Fifth avenue, New York.

Charles Frost announces the opening of an office at 277 Broadway, New York.

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Every writer on the subject of valuations and of accounting in general has given more or less attention to the problem of depreciation; yet every careful student of depreciation fully realizes that much yet remains to be done. In this brief paper, only three points of interest and of importance will be discussedpoints which affect in a vital way our every day practice in accounting, and our understanding of the fundamental meaning of depreciation.

Before taking up these special problems, however, it is well to observe anew the fundamental purpose of the depreciation charge. This purpose is two-fold. In the first place, every expenditure for equipment, supplies or materials of any kind is a cost of producing commodities during the economic life of those assets. Inasmuch as supplies and materials are entirely consumed in one or, at most, a few processes of production, these items are obviously costs of the current accounting period. But in the case of long-life equipment lasting over several accounting periods, the total cost must be apportioned to the several periods in which this item of equipment will help to produce income. This is depreciation.

But a second purpose of the depreciation charge, in apportioning to the several accounting periods the value of the asset due to its use for productive purposes, and due to the passage of time, is to show the asset at its net value on the balance-sheet and in the books of the business. The question at once arises as to

* A paper read at the New England regional meeting of the American Institute of Accountants, Boston, December 8, 1920.

whether the depreciation charge can accomplish both these purposes, and, in case both cannot be accomplished, which shall take precedence. Accountants themselves may be assumed to understand the relative importance of these two purposes of the depreciation charge, but the belief is prevalent among laymen that the showing of true values on the balance-sheet is the sole thing intended. And so immediately there arises criticism of the whole accounting scheme. Engineers tell us that a machine with an economic life of ten years is not one-half worn out at the end of five years, but that if the machine is producing as efficiently, at that moment of time, an identical new machine it is worth its costnew value. Perhaps at the end of eight or nine years, such a physical valuation would show the machine worth 50 per cent. to 70 per cent. of its original cost-even though in another year or two the machine must be scrapped. We are thus told that our accounts are incorrect and largely worthless, and that they do not show the true going-concern value of the assets. An economist of national repute informs us that depreciation over and above adequate repairs, replacements and renewals is a mere abstraction -a bookkeeping fiction; while even Dicksee, in his Advanced Accounting (p. 5) says there is not necessarily any close connection between the intrinsic value of capital assets at any given moment and the (depreciated) value at which they appear in the books of account.

This leads us to conclude that the whole purpose, or even the main purpose of depreciation is not to show values on the balancesheet. What, then, is the main purpose of the depreciation charge? Briefly, the main purpose of the depreciation charge is to distribute proportionately over the economic life of the asset the net outlay of capital. This annual charge may leave an amount having little relation to the actual value of the asset at a particular moment, and so the man interested only in valuations may feel that it is a fiction; but it is the one safe and sound basis upon which business today can venture to operate. The total net outlay for wasting assets must be absorbed by all the output of that asset or group of assets, and not by that part of the output produced during the rapidly declining efficiency of the assets. This means that the expense must be distributed over the entire period during which the assets are productive, and this is why the de

preciation charge is made annually from the installation of the plant units-even though such procedure may mean that the written-down book value of the assets, as reflected by the balancesheet, is not their real value at a given moment to a going concern.

ON WHAT BASIS SHALL DEPRECIATION BE COMPUTED ?

Of the problems discussed, the first deals with the somewhat common question, resulting from this period of rising prices, as to whether depreciation should be computed on the basis of the cost of wasting assets or on the basis of what it will cost to replace these assets when worn out. To make the problem concrete, assume a manufacturing plant which originally cost $1,000,000 (or which had that value at March 1, 1913), and that it would require $2,000,000 to replace it. Shall the annual depreciation charge to operations be made on the basis of the $1,000,000 or on the basis of $2,000,000? Or, to express it another way, is the purpose of the depreciation charge to maintain the capital investment or is it to replace the physical plant?

It is well recognized among accountants that the cost of doing work or of producing commodities of any kind includes the loss due to the physical and functional depreciation of fixed assets. This wearing out and this obsolescence loss take place during the life of these particular assets. Hence, this expense is chargeable against the product turned out during the life of these assets and not against the product turned out after their lifetime. If a true cost is to be obtained, therefore, the original cost of the equipment, less any salvage value, is the depreciation expense chargeable to the total output of a unit of plant during its economic life. The fact that the equipment cannot be replaced at the same cost, but only at much more, has nothing to do with the cost of the present product but only with the cost of future product turned out by the subsequent plant. True cost, therefore, can be obtained only by including as the total depreciation charge the loss based on the original cost of the equipment.

However, the fact that true cost can be obtained only by computing the depreciation charge on the original cost of the equipment does not mean that prices must be fixed on the cost figures so obtained.

This would mean that the customer would get the use of low-cost equipment in the days of high-cost equipment.

Whether the manufacturer or the customer shall get this advantage is a question of policy or expediency and not of pure accounting. As most equipment now in use was purchased when prices were considerably lower than now, true costs are lower than they would be if the charge to operations for depreciation were made on the basis of replacing the present physical plant at the present price level. So, unless a somewhat greater percentage is added to cost to obtain the selling price, the customer gets the benefit arising from the purchase of equipment when prices were lower than now. This policy concerning selling price cannot alter actual cost, however, for the current price level cannot determine the depreciation expense chargeable to operations.

Whether the customer or the producer shall have the advantage of the low-priced equipment will determine the composition of the selling-price of the commodity. In case the customer reaps the advantage of the low-cost equipment the selling-price of the article will be made up of (a) a certain sum representing cost and (b) a sum representing normal profit. In the other case the selling-price must equal (a) a certain sum representing cost, (b) a certain sum representing additional provision for replacement (being an actual surplus and measuring the amount of capital contributed by the customers to compensate the manufacturer for the excess value of his equipment at whatever the market price may be at that time and without considering at all what the plant may have cost) and (c) a balance as normal profit. Upon the wearing out of the original equipment the books will show, if the estimated life of the asset was correct, the reserve (or allowance) for depreciation account credited for the original cost, less salvage, of the plant; while a reserve for replacements or similar account will be credited for as much of the increased cost of replacing the equipment as the business had succeeded in collecting from its customers. As pointed out in a previous article by the author, appearing in THE JOURNAL OF ACCOUNTANCY, the closing entries for both accounts would be very simple. By this method the proprietor would get the proper return for his more valuable equipment, and at the same time have the benefit of knowing his true costs.

This computing of the depreciation charge upon the original cost of the equipment is not only sound in theory but is largely

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