Accounting theory and practice, Volume 2 (of 3)

by Roy B. Kester

The physical depreciation of tangible properties arises from two main causes, viz., the wear and tear from operation and the use of the asset and the wear and tear of age, known as decrepitude. Immediately upon the installation of an asset the forces of time and the elements begin their ravages even before operations begin. As H. R. Hatfield[20] trenchantly puts it, “all machinery is on an irresistible march to the junk heap,” and the statement is equally applicable to all other forms of wasting assets. The ties placed on the roadbed of a railway, conduits put in place for carrying water, gas, steam, electric current, or oil, rolling stock, poles for telephone and telegraph lines, buildings, even interior installations of various types—all are subject to the normal ravages of time and the elements, and nothing which man has been able to devise can do more than retard the inevitable. Thus, all assets decrease in value through the inevitable lapse of time. Attention should be here directed to the fact that decrepitude depends on the normal action of time and the elements, whereas accidents due to action of the elements (listed in the chart on page 121, under III, 1, b) are of an abnormal character and cannot usually be taken into full account at the time of the installation of any particular piece of property.

Causes of Depreciation[21]

A. Tangible Property	I.	Physical	1.	Wear and Tear from Operation
				(a) Maintenance Policy
			2.	Decrepitude
				(a) Action of Time and the Elements
	II.	Functional	1.	Inadequacy or Supersession
			2.	Obsolescence
	III.	Contingent	1.	Accidents	(a) Negligence
						Fire
						Lightning
					(b) Elements	Wind
						Water
						Temperature
					(c) Structural Defects
			2.	Diseases	(a) Parasites
					(b) Pollution of Water
							Mineral
					(c) Growths in Water-Mains		Vegetable
							Animal
					(d) Electrolysis
					(e) Crystallization
			3.	Diminution in Supply		(a) Natural Gas
						(b) Water
B. Intangible Property—Rights					1. Limited in Time
					2. Abandoned

Wear and Tear of Use

The wear and tear due to use or operation usually has a much more potent effect on the service life of an asset than that due to decrepitude. The established policy as to repairs and maintenance has an important effect on this kind of depreciation. Sooner or later every machine becomes unfit for service, due to the friction of its parts, the strains to which it is subject under normal load, those of much greater effect under abnormal load, the method of applying its power, etc. It must then either be withdrawn from service and completely depreciated, or it must be repaired in an effort to lengthen its life. It should be kept in mind that the determining factor here is efficiency. The serviceability of the machine must be kept up to a recognized standard through adequate expenditures for repairs and up-keep until the cost of up-keep is disproportionate to the service rendered, or until the machine becomes so decrepid as to make its operation hazardous.

The application of theoretical depreciation to operating wear and tear must proceed with great care. This is so because of the varying factor of maintenance. If the cost of maintenance Could be standardized, experience under such standard would give a reliable basis for the calculation of the depreciation charge. Since adherence to such a standard is difficult or impossible under the conditions that are constantly arising in a given establishment, the depreciation policy must of necessity be based on actual observation and inspection by experts. The expenditure necessary to restore an asset to a state of operating efficiency is called “deferred” or “accrued” maintenance, and it is the amount of this at a given time, estimated by expert inspection, which compared with normal maintenance forms the basis for an estimate of the depreciation charge.

Functional Depreciation

Tangible property is subject also to “functional” depreciation. This means a lessening in worth or service value due to causes, other than those already treated, which interfere with and operate against the proper functioning of the asset, making it impossible to render effectively and economically the full requirements of service expected of it. This inability to fulfil its proper function may result either from inadequacy or obsolescence. “Thus the structure may suffer total depreciation and be thrown out of service, not only because through wear and tear it has reached a condition where further expenditures for repairs or attempts to make it suitable for the required service would not be economical or expedient, but also because recent improvements, or new inventions, new developments and radical changes in service, or the demands of one kind or another involving sweeping changes in the existing plant, make abandonment necessary.”[22]

Inadequacy as a Factor

Inadequacy is a condition in which the asset is found unable to meet the demands made upon it, due usually to growth of business or to some rearrangement made necessary by changed policy before the asset has reached the end of This condition is also called “supersession.” For economical operation the asset must be discarded and superseded by a larger unit. As an example, dynamos and motors of a capacity sufficient to meet all demands on them at the date of their installation may, through growth of business, prove entirely inadequate after a few years to meet the service expected of them. Inadequacy as a factor of depreciation will have no appreciable effect in cases where the demand is fairly constant and the market does not permit of much expansion. Where there is a growing community and (or) a growing appreciation of the commodity manufactured, demand may increase to a point where original judgment and expectation will be shown to have been in error and the equipment will have to be superseded if advantage is to be taken of the expanding market.