While it is true that such charges are, strictly speak ing, a part of the investment, they are of such an evanescent character that they should be recovered as soon as possible. A machine does not change in value if moved to a new location, but the value of the outlay, incident to its erection on the original site, vanishes the instant that it is moved; while the founda tion, instead of being of value is, in many cases, such as to render removal or remodeling difficult and ex pensive. Depreciation has to do with a different kind of lessening value, and it is much better to carry erec tion and foundation expenses to a suspense-develop anent account and write them off as quickly as pos sible.
The "residual" or "scrap" value of an asset is its estimated market value at the end of the probable producing life.
The "present value" of an asset is the value found by subtracting the total depreciation, to date, from the original cost, due allowance being made for any re newals that have been carried to the plant-ledger ac count of the asset.
The foregoing discussion deals with assets that are "tangible" or "visible" but, in addition to such assets, there are often others that are "intangible" or "in visible." In this class would be included the cost of preliminary surveys, legal expenses of organization, cost of franchises and patents, and other short-lived assets. Many of these may constitute a true part of the cost of the plant or be indispensable to its opera tion, but while extremely valuable to the enterprise as a "going concern," their actual market value may be very small. Best practice, therefore, carries all such assets to "development accounts," making provision for depreciating such accounts out of existence by means of a reserve fund. Such methods will be de scribed in a later section.
9. Determination of depreciation.—All intelligent managers admit the necessity of making allowance for depreciation, but there is much diversity of opinion regarding the methods to be pursued in doing so. One of the reasons for this diversity of opinion is that enterprises vary widely, and, in addition, it is not always expedient to make as large a deduction for de preciation as may seem desirable. An old, and still common, method is to make an annual visual inven tory of every asset, the total value so obtained being the apparent inventory value of the plant. By com parison with the inventory of former years the de preciation is determined and deducted from gross profit before dividends are declared. While such a method seems practical and satisfactory for enter prises which close their books annually only, it has several disadvantages, and there are objections to its use. A visual examination may or may not be suf ficient for a correct valuation of the asset, and such methods of valuation require judgment backed by long practical experience. A periodical visual ex
, amination is, however, a good check on the methods to be described, for such a visual inventory often brings to light material and apparatus that have de preciated greatly tho appearing on the plant ledger or the stores or finished-product ledger at full cost.
More advanced practice, however, provides, as has already been explained in Section 2, Chapter VI, for a continuous inventory of all physical assets, and makes further provision for definite and systematic depreciation, as indicated on the plant-ledger card shown in Figure 18 (page 167). The depreciation so determined is distributed in the factory expense and becomes an integral part of the cost of production.
10. General method of depreciation.—In laying out a systematic plan for depreciating any asset it will be necessary, therefore, to know the original cost of the asset, the estimated productive life of the asset, and the probable "scrap value" of the building or ma chine at the end of this productive life. Some definite rate of depreciation is then decided upon that will re duce the original value to the "scrap value" at the end of the life period. It should be remembered that repairs, or renewals, or obsolescence, may make neces sary some modification of the plan laid down, and it may be necessary as circumstances change, to change the rate of depreciation.
The general method of depreciating an asset may be illustrated as follows: Suppose an asset has an original value of $5,000 and when installed its esti mated producing life is set at twenty years, at the end of which period it is estimated that its "scrap value" will be $500. The total depreciation which must be cared for, not considering modifying repairs or re newals, will be, therefore, $5,000 — $500 = $4,500. Suppose, now, that at the end of ten years the book value of the asset has been reduced by the method of depreciation in use to $2,000, and at that time the asset receives repairs and renewals amounting to $1,000. If such renewals bring the asset up to somewhere near the producing value of a new piece of apparatus of similar kind, it is clearly logical to increase the book value to, say, $2,500 and readjust the rate of depre ciation, if desirable. On the other hand, at the end of the fifth year, the asset may be found to be in first class repair, but almost valueless as a producing asset, because of new inventions, or changes in processes. Thus, it is clear that the "scrap value" and the pro ducing life depend on many factors and must, as a rule, be estimated.