On the other hand, extensive repairs and renewals may be made on an asset, which may be considered as increasing its earning value and hence increasing its inventory value. Thus a machine may have a depre ciated value of $5,000, when extensive repairs and re newals amounting to $1,000 may be expended upon it. If the producing power of the tool is thus in creased it would be allowable to increase the value of the machine to, say, $5,500 and make such an entry on the plant ledger. But it should be very clear that the earning capacity has been augmented before the inventory value is raised; otherwise, the cost of the repairs should be carried to the manufacturing ex pense account.
7. Relation between depreciation and capital.—It appears from the foregoing discussion that if the capital invested is to be maintained, the wasting losses due to depreciation must be carefully and systemati cally compensated for. Now there is only one source from which these losses can be compensated for, namely, revenue from output. It is a fundamental principle, therefore, that no profits should be consid ered until all losses to capital thru depreciation have been replaced from earnings.
This principle is very clear when applied to such enterprises as are limited in time, as, for instance, a mine. In such a case the investment is represented by the cost of the land acquired, the cost of sinking the shaft and running the tunnels, the cost of the ma chinery and equipment, with such cash, etc., as may be necessary to carry on the operations. When the ore is extracted the land may be valueless, and the ma chinery, even tho in good repair, may be equally valueless, because of its special character and the place where it is located. Obviously, the operator should sell his ore at a rate that will return to him his original investment, plus the cost of operation and plus such a profit as he can obtain on the venture. Clearly, he cannot say that he has made a profit until he has recovered his original investment and paid for all operating expenses.
One important feature of depreciation in its rela tion to capital is its elusive character. The general books of any concern usually give minute details re garding the changes in cash, notes receivable and ma terial in process, but the wasting changes that take place in buildings and equipment are seldom accu rately known. Furthermore, as will be shown, they are particularly difficult to evaluate, since, unlike changes in cash and other current assets, they do not force themselves upon the attention of the account ant.
The very elusiveness of depreciation often gives rise to wide differences of opinion in cases where the enterprise is owned by several parties, and especially when both bondholders and stockholders are inter ested. The bondholder who is assured of a return on his investment very naturally will insist that the plant be kept in good repair, since that is necessary to insure the permanency of his capital. The stock holder, free to sell his stock at any time, is more in terested in dividends, and may not object if profits are paid out of capital because of insufficient attention to depreciation. The problem, therefore, of dealing fairly with the bondholders who are the creditors and with the stockholders who should have a fair return on the stock, is intimately connected with depreciation.
8: Original, present and scrap values.—It may be noted in passing that the value of any asset will vary with the purpose for which the valuation is made. There is a great difference between the value of a plant viewed as a "going concern," and its value at forced sale. In appraising public utilities, for in stance, several kinds of value are recognized. Thus the "service value," or the value as measured by the effectiveness of the asset at that particular time, may be considered important, since this value may be high, tho the asset itself may be old or depreciated. Again, the value of "cost of reproduction," or the value as measured by the cost of replacing the asset with new apparatus of equal effectiveness, is often an impor tant consideration in the appraisal of public utilities. In the usual factory inventory, however, the "original cost," "residual" or "scrap" value and the "present value," are the most important values with which the factory manager and the cost keeper are concerned.
The original cost is the cost of the asset plus freight and cartage, excluding foundation and erection costs, since these are irrecoverable and should be included in preliminary expense and written off independently. Some accountants include erection costs in the origi nal value, on the ground that they are not expenses properly chargeable to the current period, and that depreciation charges will eventually dispose of them. This view, it would seem, loses sight of the fact that the assets are thereby unduly inflated.