Distinction between Depreciation and Depletion
Inasmuch as depreciation is not here used to apply to current assets (with one exception noted below), and fluctuations in the market value of any asset subject to depreciation need not be considered, it may be well to state the class of assets to which it does apply. In general the value of all fixed or capital assets is affected by depreciation. The term frequently used in this connection is “wasting” assets. Under this nomenclature is included any asset which wastes away or is used up. For the sake of clarity the author desires to limit the term depreciation to those assets which are clearly affected by any of the causes of depreciation as discussed in the following chapter. For those assets which are used up without any possibility of their being replaced, and the life of which cannot be prolonged by repairs and renewals, the term depletion will be used. Accordingly the term “depreciation” will be applied to mine buildings and machinery; “depletion,” to the mine. Both are wasting assets, but their waste is due to somewhat different, although vitally related, causes. No better definition of wasting assets has been formulated than that by P. D. Leake[19] who says that they “consist of all forms of exchangeable value which inevitably diminish while applied to the purpose of seeking profits, increase, or advantage otherwise than by purchase and sale.”
Effect on Different Kinds of Business
Some types of undertakings are more subject to the effects of wasting assets than others. Concerns dealing in investments, insurance of all kinds, brokerage and commission, manufacturers’ agents, banking and financial houses, professional firms, and the like, only a small portion of whose capital is tied up in fixed assets, are comparatively unaffected by the charge for depreciation. Practically all other concerns are subject to it in marked degree—manufacturers, mines, transportation companies, light, heat, and power concerns, the telephone, telegraph, and cable, construction companies, agricultural, etc. Those engaged in extracting raw materials from the ground are, with few exceptions, subject to a charge for depletion. Those with an investment in any kind of terminating rights, such as leases, patents, copyrights, non-renewable franchises for a fixed term of years, and so on, are also subject to it. Opinions differ as to whether good-will and trade-marks may properly be considered as subject to depreciation. They will not be so considered here for reasons which will be stated when the principles of their valuation are discussed.
It will be noted that thus far all examples given have been those of fixed assets. The exception already referred to is made in the case of the current asset, merchandise or stock-in-trade. The term depreciation can perhaps correctly be used in connection with merchandise, which, however, is not to be classed as a wasting asset. Due to some of the causes discussed in the next chapter, the stock-in-trade of an undertaking does truly depreciate in value. The method of accounting for such depreciation differs entirely from that used for wasting assets. Hence, the treatment of depreciation of merchandise will be considered at the same time that its valuation is discussed ([see Chapter XIII].)
Having cleared the ground with this definition of terms and the general statement of what the depreciation problem is, attention will now be directed to a consideration of the causes of depreciation, to be followed by the method of accounting for depreciation and a treatment of some points growing out of the general discussion.
CHAPTER VII
DEPRECIATION—ITS CAUSES
Analysis of Causes
Most definitions of the term depreciation set the boundaries or limits of its meaning by naming the causes. These are normally: (1) wear and tear, or physical factors; (2) inadequacy and obsolescence, or functional factors; and (3) accidents or contingent causes. This statement of causes applies specifically only to physical or tangible properties. In the case of intangible property, consisting for the most part of rights of various sorts, the controlling cause is usually merely lapse of time. The chart on the following page analyzes the various causes and shows their detailed ramifications.
Age as a Cause of Depreciation