Earl A. Saliers[15] says: “This loss of value, whether tangible or intangible in form, resulting from physical decay, or from obsolescence or inadequacy, which indicate functional decay, is known as depreciation. It necessitates repairs, renewals, and replacements. Did it not occur, every outlay on plant would add to the investment. It does not result from one cause but from many causes, and this sometimes leads to the belief that it cannot be scientifically handled. But some adequate method of handling it is not merely desirable, but necessary, to a solution of the problems arising in the valuation of public utility properties, and in the management of industrial enterprises generally.”
Henry Floy[16] says: “It (depreciation) is used broadly to mean a reduction in utility value, expressed as a percentage but more usually in dollars, due to any deterioration in physical plant by reason of: (a) normal wear and tear, (b) age or physical decay, (c) inadequacy, (d) obsolescence, (e) deferred maintenance. The term depreciation, always used in connection with a reduction in value, has, however, four distinct and separate shades of meaning, so that the term must be qualified when used in order to distinguish which one of the following meanings is intended:
“First. The annual amount, expressed as a percentage or in dollars, that should be laid aside to renew or replace the article in question at the time of its abandonment.
“Second. The annual amount, expressed as a percentage or in dollars, that should be laid aside to renew or replace the article in question at the time of its abandonment, plus the annual expense of maintenance and repair expended in removing such part of depreciation as is practicable and good economy.
“Third. The total amount—usually that estimated as necessary to be expended to put the physical property in perfect operating condition—determined by the inspection and observation of an experienced engineer, expressed in a percentage or in dollars, which must be deducted from the ‘original cost’ or the ‘cost to reproduce new,’ in order to determine the absolute, actual, present value.
“Fourth. The total amount—it may be the sum of several years of depreciation—computed from ‘expectancy of life’ tables, more or less authoritative, expressed in a percentage or in dollars, that must be deducted from the ‘original cost’ or the ‘cost to reproduce new,’ in order to obtain the theoretical, present, depreciated value. This value may be increased or reduced by the condition of the property, as determined from inspection.”
The foregoing quotations from authoritative sources not only show the efforts made to define the term accurately, but also indicate the various elements included by different writers under the term, and suggest the need of further effort toward the standardization of its meaning.
Why the Depreciation Factor Arises
The distinction made in Chapter V between capital and revenue charges draws attention to the fact that the depreciation factor arises only because the fiscal or other period when information concerning values and costs, i.e., financial condition, is desired, does not coincide with the expiration of service life of the properties used in production. If the information just referred to were not desired at intermediate periods between the date of acquisition of the asset and the date of its discard or obsolescence, its cost should be treated solely as an expense of operation to be charged to the whole period in the same way that the fuel consumed, the raw materials used, etc., are regarded as revenue charges, or costs of manufacture. Practically, therefore, depreciation must be considered because a statement of financial condition is needed at regular stages of the life of the enterprise; and furthermore because the life of the various assets used in an undertaking is not uniform in length and their life histories in consequence overlap. Some assets wear out and have to be replaced, while others have still many years of useful service in them.
Actual or Absolute Depreciation