CHAPTER VI.

DEPRECIATION (h).

It is intended to deal with this subject only so far as it relates to those classes of property usually connected with manufacturing concerns (e.g., Mills, Warehouses, Leases, Plant, Machinery, Utensils, Furniture and Fixtures).

It may be regarded as a broad principle that existing Works, Plant, Machinery, &c., should be efficiently maintained by all necessary repairs and renewals, out of revenue, and, in addition, the Trading Account should bear an adequate charge for depreciation.

Amongst the causes of depreciation may be mentioned the following, viz:

(i.) Supersession by improvements.

(ii.) Reduction in cost of labour and material.

(iii.) Decline in profits.

(iv.) Wear and tear.

The effect of causes i., ii. and iii. cannot be estimated in anticipation, and the measure of provision in respect thereof must be wholly determined by prudential considerations.

The effect of Wear and Tear, although subject to no precise rules, can be fairly approximated.

The assessment of the charge for depreciation differs according to the nature of the property. The following observations point out the peculiarities of each class.

Buildings. The quality and durability of the structure of Buildings of all kinds must be considered. Local fluctuations in value of property may cause either appreciation or depreciation. It is recommended that changes in value from this cause should be adjusted by actual valuation. An unearned increment arising therefrom is a suitable element for a reserve fund; on the other hand, it is usually advisable to write off a decrease of value, either straightway or by instalments over a number of years.

MILL BUILDINGS cannot well be dissevered from their fixed motive powers, fixed power machinery (i), and steam, gas, and water pipes, inasmuch as without these the building itself is incomplete, and cannot properly be designated a Mill. Moreover, both the building and motive plant are affected for the most part by like causes of depreciation. It is true engines and boilers may be replaced while the building remains, but owing to the radical alterations in structure, necessitated by improvements in machinery, the design of the building

(h) It is entirely beyond the scope of this treatise to discuss the many polemical issues of the subject of depreciation. The present intention is simply to afford information of a strictly practical character, and to point out methods, admittedly empirical rather than scientific, which experience has shown to be reliable.

(i) The Bills of Sale Act, 1878, furnishes the following definitions:-Fixed motive powers comprise water wheels, steam engines, steam boilers and donkey engines. Fixed power machinery comprises shafts, wheels, drums, and their fixed appurtenances which transmit the action of the motive powers to the other machinery.

is often obsolete as soon as the motive plant is worn out. If
preferred, however, the depreciation of the building may be treated
separately from that of the motive plant. When a new engine or
boiler is laid down, the cost thereof, less the value (realised by sale)
of that which it replaces, should be added to the Capital value, but all
repairs should be charged against Revenue.

Leases. The depreciation in value of a lessee's interest in property
held for a term of years may be calculated :-

(i.) By dividing the purchase money, or original value, by the number of years of the term; the product representing one year's depreciation. By this method the earlier years bear the heavier burden, inasmuch as the interest on the capital invested in the lease is not taken into account, and such interest decreases year by year as the value of the lease diminishes.

(ii.) By finding the amount which, if charged annually, will exhaust
the value at the expiration of the lease, after taking credit for interest
on the annual balances at a fixed rate (j).

This method is more exact than the preceding one, as the
charge for depreciation is equally divided over the whole
term, and the amount taken to credit for interest on the capital
invested in the lease is diminished year by year as the value
of the lease decreases.

Although it is often perfectly justifiable to take credit for interest,
the former method is recommended in ordinary cases, on the ground
that it is always wise to be on the safe side and to charge the revenue
with a little extra in the present in order to provide for a lighter
burden in the future. Moreover, by way of compensation, repairs
are often heavier at the end than at the commencement of the term.
Special provision should be made when the lease contains a
dilapidation clause.

(j) From Inwood's Tables, or other similar work, select the table shewing the value in years' purchase of an annuity (or lease) at the required rate of interest. Divide the value of the lease by the years' purchase shown by the table, and the product represents the amount to be written off annually as depreciation, Interest on the annual balances will, of course, be passed to the Dr. of the Lease Account and the Cr. of the Interest on Capital Account.

Thus:-The value at 5% interest of a lease (or annuity) of £1 for three years is 2-723 (years' purchase). Assume the present value of the lease at £1000

1000 2.723 = 367-21 = £367 4s. 2d.

The Ledger Account of the Lease would be as follows:-
:-

Plant and Machinery.-The depreciation of Plant and Machinery may be assessed by any of the following methods, viz:—

(i.) Re-valuation; the amount of depreciation being the difference between the old and new valuations, after allowing for additions meanwhile.

(ii.) The deduction of a fixed amount yearly from the cost of each individual machine; the aggregate deduction being written off from the value of the plant as a whole.

This method involves much labour, but it is often carried out in order to know the exact value of the machinery in each room in case of partial destruction by fire. The account may be kept in the following form, of course apart from the ordinary book-keeping :—

The book may be ruled with as many columns as may be desired.

Fractions of a pound should either be omitted altogether or stated in decimals.

For the purpose of identification, the machines should be labelled with a number corresponding with the number in. the account.

Any number of machines of exactly the same type and age may be calculated in the aggregate.

(iii.) Having ascertained the probable working life of the machinery as a whole (or in each department) and the residual value at the expiration of the life, deduct the residual value from the first cost and divide by the number of years of the expected life; the product may be written off annually as depreciation until the residual value is reached.

By this method all additional machinery must be depreciated separately, as the value thereof will be exhausted at different dates.

(iv.) Having ascertained the probable working life of the machinery and the value, if any, when it is worn out, charge a percentage upon the diminishing value sufficient to reduce the first cost to the residual value by the time when the working life expires.

The last method (iv.) is the simplest, and the percentages may be adjusted with sufficient accuracy (see Table, page 236).

The following Table is compiled from the author's experience of a
large number of cases :--

In fixing the above rates of depreciation, it is assumed that the machinery will be kept running during the hours prescribed by the Factory Acts: overtime or short time must be allowed for. It is also assumed that the machinery will be kept in efficient repair. An independent valuation every five years may be made, where convenient, as a check upon the system of depreciation.