Proceeding in the same manner with the other years it is evident that during this first year, the value of the whole instrument would rise to $3,854.97, an increase of $502.82, or 15 per cent of the original cost of $3,352.15. At the end of the year, because of the re ceipt of the service whose supposed value is them $1,000, the value of the instrument would abruptly fall by that amount to $2,854.97. The effect of the rise during the year and the fall at the end of the year is a net fall of $497.18.
In a similar manner during the second year the in strument's present worth would rise to $3,283.22, an increase of $428.25, or 15 per cent of its present worth at the beginning of that year, and then abruptly fall $1,000, to $2,383.22. This time the net shrinkage is $571.75, and so on.
The theory just illustrated may be called the value shrinkage theory of depreciation. The reader will observe that it treats this instrument in the same man ner in which the annuity certain was treated in Chap ter XVII. The advocates of this theory might reason that five years' time was involved in realizing some of the service rendered by this instrument during its fifth year; and, as in the case of the annuity, the profit or loss of the investment therein is not all assignable to the fifth year, but is distributable over the whole period. There is a vital difference, however, between the case of a productive instrument and of an annuity certain. The latter represents a definite amount of money income which has been promised by contract; the former, only the right to the chance of obtaining service, the amount and value of which is entirely con j ectural.
One method of measuring depreciation—the an nuity method which will be treated later—deals with the problem in just this way. It represents the cost value of the instrument as rising during the year to the extent of a certain chosen percentage of itself (taking account of a profit to the extent of this in crease), and then falling to the extent of a constant amount, the latter being called the depreciation.
7. Fallacy of the interest advocate of the value shrinkage theory may also argue that the cost of the later years' service consists, not only of the original outlay to obtain it, but also interest on this outlay from the time it is made until the service is realized. The consistent application of this argu ment to the above illustration would actually make the cost of each year's service $1,000. It has already been shown, however, that interest is one of the causes of business profits, and that profits are made only when there is a sale, i.e., when a turnover of capital is in
prospect by legal contract, and Ascertained only in the money income that is received.
To allow interest on an investment in the assets, therefore, and to count this as an additional cost is to do three things : First, record the same thing both as cost and income—for under the double entry principle, while interest as a cost will be represented by a debit, there will be a corresponding credit also to interest, which credit will be interpreted as a source of income. Secondly, record an income and a profit where there is none. There is no cash received or receivable, cor responding to the above credit, and when the manu factured article is sold, the actual cash income in pros pect will be represented by another credit to the sales account. Thirdly, record a cost where there is no cash outlay. The theory that profit is earned by a turnover of capital, contemplates actual outlays of cash and actual cash incomes, or their equivalent, not mere entries in books. Therefore, the theory of the allowance of interest as cost and the value shrinkage theory of depreciation are untenable.
8. Depreciation of intangible assets.—The cost of intangible assets is incurred because of some advan tage supposed to flow from them—the exclusive right to restrict the output and regulate the price of a patented article, the advantage in production that re sults in excluding competitors from the use of an im proved process, the right under a franchise to use the city's streets and so on. This advantage also ex tends thru time, and therefore the cost of such rights is apportionable. What has been said about the de preciation of tangible assets applies with suitable modification to intangible assets.
9. Causes of depreciation.—The immediate cause of depreciation is the rendering of a limited portion of the service which the article is capable of ren dering, or the waste of it thru idleness or other cause. The more remote causes consist of those agen cies or facts which make the service life of an asset a limited one, and these may be summed up under five heads : (1) wear; (2) decay thru operation of natural elements ; (3) inadequacy; (4) obsoles cence, or the progress of invention; (5) the expira tion of title in the asset as in the case of limited fran chises, patent rights, copyrights, and the like.