Two main factors or compelling forces may bring about inadequacy, viz., those of internal origin and those of external origin. Those of internal origin may become effective because of: (1) abandonment of original financial policy, (2) considerations of engineering economy, and (3) unforeseen development.
Inadequacy through Change of Policy
Perhaps the best illustration of the first type is that of a plant built to supply a certain commodity to the local community. A change in ownership brings about an abandonment of the original policy and a determination to provide neighboring communities with the commodity also. This change in policy frequently comes about when several smaller plants are merged under one control and the original units are found to be entirely inadequate to meet the demand. Again, when through a change in financial policy it is decided to lower the rates of a public service commodity, the original equipment may prove inadequate to meet the increased demand. It is not contended here that this type of inadequacy is to be taken into account in estimating the depreciation charge. Usually it cannot be foreseen and should therefore be provided against under the head of a general contingent reserve or appropriation of profit. If it can be foreseen intelligently, it should be taken into account in the estimate of depreciation.
Inadequacy through Motives of Economy
The second type of inadequacy may be a foreseen and calculated inadequacy. In a new community or in the case of a new commodity whose virtues are little known, it may be the part of economy and business sagacity to install originally only such equipment as will be adequate to meet the requirements during the development stage and then when the commodity is introduced and established to discard the old and install larger and more adequate structures. Although it may be foreseen with reasonable certitude that a power plant generating a thousand horse-power will be entirely inadequate in ten years, yet it may be the better business economy to scrap it at the end of ten years rather than incur the up-keep and depreciation charges on a larger plant which would give longer service. Whichever policy, according to best engineering economy, results in the lowest unit cost of product is usually the determining factor. If with all the facts and reasonable expectations under view the smaller plant is decided upon, then assuredly the depreciation due to inadequacy must be taken into consideration.
Inadequacy Due to Unforeseen Development
The third type of inadequacy, unforeseen development, has been shown to be due to an unexpected expansion of the market. This may be brought about by growth in population of the present market, growth in appreciation of the commodity manufactured, or sometimes by a lowering of transportation rates whereby new markets are opened. The very fact that this kind of inadequacy is unexpected and unforeseen makes impossible its inclusion in the current depreciation charge. This kind of inadequacy is revealed by a post-mortem determination of causes of which there were no symptoms leading to a correct diagnosis during life. The loss to be incurred through the scrapping of the property before its expected termination of service is a loss which must be borne by the future and not by the past. It is in the nature of a development cost which must be incurred if the opportunities of the new market are to be seized, and which must enter into a consideration of the advisability of making a bid for the new business.
Business policy might or might not dictate that these costs be charged against reserves of profits from the past. Theoretically they should be spread somewhat evenly over the future but in neither case can they have any place in present depreciation charges. It should be thoroughly understood that depreciation is a charge which relates always to the past, never to the future. There is no contradiction here in that a consideration of the future must help to determine the amount of waste which has taken place in the past. P. D. Leake[23] says: “It is a misconception to describe the annual provision for depreciation as a provision for future renewals, as though it has reference to the future. The annual provision for depreciation has nothing to do with the future but relates solely to the past. It is a replacement of capital in respect to past capital outlay expired in the process of carrying on the business.”
Inadequacy Imposed from Without
Inadequacy may be imposed by external forces or authority. In public service utilities this has often proved a source of expense. In the interests of a supposedly enlightened opinion—oftentimes a badly mistaken opinion—present equipment is found inadequate to meet the new demands. This type of inadequacy merges imperceptibly into obsolescence. Again, a municipality at the time of repaving the streets may require that the utility company discard present equipment and install a larger and heavier type; it may require that overhead wires be carried in underground conduits; and prudence on the part of the company may lead to the installation of larger carriers than the old. These losses—and there is almost invariably a loss to the utility company—must be charged against the future. So also, the passage of laws and ordinances in the interests of sanitation and fire protection frequently compels the private owner to discard equipment and devices before their service life has passed and install more adequate equipment.