DEPRECIATION • 1. General theory.—In all industrial enterprises there are some assets which are fairly stable in char acter and which either do not change in value, or, if they change, do so only by slow degrees. Thus, the purchasing power of cash may increase or decrease but in either case it will do so slowly. The value of real estate may increase or depreciate but this change will also be comparatively slow in most cases. There are other forms of assets, however, that constantly tend to depreciate in value and this depreciation may be very rapid. For example, buildings waste away by reason of the action of the elements, as well as by the normal wear and tear that they undergo. Ma chinery, tools and furniture also wear out and must be replaced. Materials and supplies, worked and un worked, may depreciate to scrap value, either from the action of the elements or as a result of becoming obsolete thru changes in the art.
Such losses must be compensated for if the busi ness is to continue and make profits. The sub j ect of depreciation has, therefore, steadily assumed greater and greater importance. Formerly almost entirely a matter of private interest, it has become a decided factor in the regulation of public utility corpora tions, and in other legal procedure. Anything ap proaching a comprehensive discussion of this subject is far beyond our present scope; therefore, only enough will be included to indicate its place in cost finding practice.
2. Capital account and revenue account.—A care ful distinction should be made between losses on capi tal account and losses on revenue account. If an un insured building is burned, or if an uninsured vessel is lost at sea, the loss so sustained is a loss of capital which is in no way connected with depreciation. No allowance which the owner can make for wasting de preciation of other assets can properly be used to re place the building or the vessel. Such replacement should come out of new capital, whether it be taken from savings or borrowed elsewhere.
Suppose, however, that a company begins business with $500,000 and, at the end of a given period of time, finds that after having made allowance for wasting losses, and having suffered no losses on capital account, its assets are worth only $400,000. The
company is said, then, to have suffered a loss of $100, 000 on revenue or trading account. Depreciation is one of the factors that enter into, and greatly affect, loss or gain on revenue account. For, if the natural wasting losses on buildings and machinery are not pro vided for in the costs, and, as a consequence, the bal ance sheet shows a deficit when such losses are pro vided for, the enterprise has suffered a loss in revenue account because of this procedure. Wasting losses of this kind are a just charge against production and, as will be seen, should be included in manufacturing expenses.
3. Forms of depreciation, wear and tear.—The de tail in which cognizance is taken of depreciation will vary widely with the enterprise. Thus, in the ap praisal of public utilities where toll rates are to be fixed upon the basis of valuation the following forms of lessening value are often recognized: (1) Wear and tear, or maintenance (2) Physical decay, or decrepitude (3) Deferred maintenance, or neglect (4) Inadequacy (5) Obsolescence.
In simpler cases less detail is necessary and these items are then grouped under two or three heads.
Under wear and tear is included the ordinary wast ing away as a result of use and the action of the ele ments. All machines tend to wear out, the paint on buildings wears away, fences constantly break down, etc. All such wasting losses that can be com pensated for by ordinary running repairs and re newals are classed under wear and tear. Under this head also may be included the results of accidents or sudden damage from unpreventable causes. The rate at which such wasting progresses will manifestly vary quite widely with the asset and the service. In some classes of assets the fall in value may be very rapid in the beginning of service, slowing up as time goes on ; while in other cases the reverse may occur, the rate of depreciation becoming greater as the asset nears the end of its usefulness.