Depreciation as a
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Running Cost DEPRECIATION, considered as an operating cost, is a difficult subject at the present time, because it is . possible to sell an old vehicle for nearly as much as the list price of a new one. While this situation continues, depreciation might almost be considered of negligible importance.
Of course, the situation is not so simple and straight forward. Few free-enterprise hauliers can obtain new vehicles quickly and, therefore, cannot sell any of their vehicles until they are able to get delivery of new replacements. They need all the vehicles they have to continue with their businesses. It is no use selling an. old vehicle, even if a good price can be obtained for it, if it means a reduction in earning capacity.
However, no matter what may be prevailing at the time I write, if ever I mention depreciation I am sure to receive prompt criticism from a reader. In an article which I wrote recently, dealing with rates of haulage for local authorities, I included depreciation among . standing charges instead of •the running costs as is snore usual. I gave a reason for this, pointing out that where the weekly mileage likely to be run by a vehicle was comparatively low and fairly consistent, it was more convenient to deal with depreciation as a standing charge. My critic asked me to be consistent. Either depreciation was a standing charge or a running cost, and it was not fair to my readers for me to change about from one to the other.
It would be useful to see where treating depreciation as a running cost will lead. Assuming that an operator buys a vehicle with a life of 240,000 miles and that he runs it 800 miles per week, in those circumstances he bases his estimate of depreciation on a life of 300 weeks, that is, six years. the circumstances
Obsolescence Factor
That should be quite satisfactory, but suppose that instead of running 800 miles per week, the vehicle runs only 200. In that case it will have a life of 1,200 weeks, or 24 years, which is clearly absurd. In 24 years, however little they may have been used, present-day vehicles will be obsolete. It seems then that in considering depreciation, the factor of obsolescence must be taken into account.
There are several ways of doing this. One is to split depreciation into two parts, entering a certain amount in the running costs, and the other in the standing charges, apportioning the two so that the cost of the vehicle is writen off in a reasonable time although its annual mileage be low. Another way is to vary the amount debited to depreciation in the running costs, increasing it as the annual mileage covered by.the vehicle decreases. In that way, art amount for obsolescence is added to the basic allowance for depreciation.
This is the method in use in "The Commercial Motor" Tables of Operating Costs. I assess first the basic figure for depreciation, taking into account mileage only, making no provision for obsolescence. I then fix what I consider to be a reasonable minimum mileage which must apply if the vehicle is to be written off as worn out before it is obsolete, according to the time factor. If, in use, that minimum annual mileage is not reached, then I add a percentage to the basic figure for depreciation so as to provide for obsolescence. .
I can perhaps make my point more clear if I take an example. Assume that an operator buys a first-class make of vehicle and pays £2,000 for it and that its expectation of life is 240,000 miles. The basic figure for depreciation is calculated by dividing £2,000 by the 240,000 miles, which gives 2d. per mile. I apply that figure so long as the vehicle runs 40,000 miles a year.
Increase in Provision
If it does that mileage, or more, the figure stands at 2d. per mile. If it does not reach 40,000, or 800 per week, I increase the provision for depreciation by adding 5 per cent. to it for every 2,000 miles per annum by which the mileage run falls short of 40,000.
For example, if the annual mileage run is 30,000, or 600 per week, then I take into account the fact that it is running 10,000 miles short of my basic minimum, and I add 25 peccent. to my basic figure for depreciation. I i then assess t at 21d. per mile instead of 2d. It is that percentage which accounts for the way in which the depreciation figure in the tables differs with varying weekly mileages. That addition provides for obsolescence.
• Whenever I write an article to show, hauliers how they should calculate rates I always try to keep it simple and easy to understand. In the article which has been criticized, the weekly mileage run by the vehicles was
likely to be far below the minimum which 1 stipulated for the use of the basic depreciation figure. Had I attempted to use the methods described here, 1 should have had to include a complicated description, whereas in such a specific instance that was not necessary. It was known what the mileage would be; it was known that obsolescence in that class of work was not so important as usual. For those two reasons it was possible to fix a period Of years over which the vehicle could reasonably be depreciated irrespective of mileage. In Other words, it was more convenient to reckon depreciation on a time basis in dealing with that problem. .
There is no compulsion either way. The operator is free to use whichever • method he -pleases. I am not so free when compiling the tables because t have to. arrange them in such a way that they are of the greatest use to the greatest number of readers. The majority of operators. finds that the 'mileage run by their vehicles fluctuates from week to week. Itis in such circumstances that the importance of calculating .depreciation on a mileage basis becomes evident, as the following example will demonstrate.
• it'concern's an operator who is careful to keep proper i'ecords of his operating costs. He sets out first his standing Charges and establishment costs which, for his six vehicles of varying size, total approximately £1,500 per annum. The method he adopts is first of all to total the establishment charges; and he then divides them among. the vehicles pro rata to their load 'capacity, He-then totals the standing charges for each vehicle and adds them to the appropriate amount for establishment costs, obtaining a fixed charge per annum for each vehicle. This is broken down into a weekly charge and added into his accounts, which he checks Over weekly.
Working Overtime This operator keeps a separate account of his running :gists and wages. The latter cannot be included in the standing charges, as they vary from 'week to week, largely as the outcome of working overtime. Each week, by adding a proportion of fixed charges to the actual running costs, he obtains the cost per week for each vehicle. He sets by the side of that result the total earnings of that vehicle and is thus aware, week by week, how much each vehicle is earning.
When I came across this haulier and we started discussing his accounts, he had had the system in operation some five or six months. He was using estimated figures for his establishment costs to start with, but he was also keeping a careful record of the actual expenditure so that he would be able in time to use actual figures instead of estimated ones. When I had examined the accounts generally and expressed myself as being without criticism, he said: " But, look here, I am about 1300 out." He turned to the book in which he kept a note of actual establishment costs. The total to date here is £321 6s. 8d. According to the standard to which I am working, I have £638 2s. 9d. debited as fixed charges."
"But your totalof fixed charges set down against the vehicle is more than just establishment costs," I explained. " It includes, for example, the tax and, in your case, depreciation." If I had not corrected him he .would have concluded that it was merely his estimate of establishment costs that was exaggerated and that he really had £300 to spare. If a man who keeps careful records can make a slip like that, bow much more likely is it that a haulier who keeps no account is going to make mistakes of the same kind.
Provision the First Essential
have already remarked upon the fact that this operator included depreciation of his vehicles among the standing charges. I have pointed out this article that there is no hard and fast rule as to whether that depreciation should he regarded as a standing charge or a running cost. So long as a haulier makes a proper provision for it—and that is essential—it does not always matter how he classifies the item. Sometimes, however, it does make a difference, and in showing what that difference is, I shall give further proof of the advantage of regarding it as a running cost.
To regard it as a running cost is usually more convenient for the purpose of the haulier, which is to ascertain the actual cost of operation at any time and be able to arrive at a picture of the state of his business.
-the wisdom of this method was exemplified in this instance. At this period of the year there occurs for haulage contractors engaged in the class of business in which this man was interested, a slack time of a month or six weeks, and as this haulier checked the progress of his business week by week, matters did not appear too bright. The mileage covered by each vehicle was considerably below that current during the profitable months of the Year.
As, however, his item of depreciation is a fixed weekly sum, it comes about that his apparent profit
during these slack weeks is almost negligible. Now, if depreciation were treated as a running cokt, its amount would, of course, rise and fall in proportion to the mileage, so that in a week when the mileage Was low, depreciation also would he low, and affairs would not appear to be so . serious. The difference between Costs and revenue would not then fluctuate to such an extent as when depreciation is entered as a fixed charge.
Moreover, there is a criticism which applies in the Contrary direction. In busy times when tonnage and mileage are high, depreciation, considered as a standing charge, is still fixed and when compared with work done is comparatively low. Since, however, earnings are approximately in proportion to mileage, the profit seems high; aetually it is less than appears to be the case, according, to the books. There is a tendency to be too optimistic during busy periods, engendering a feeling that, perhaps, in case of need, a cut in rates could safely be made. On 'the other hand, when business is slack, there is a tendency for the haulier to become alarmed and cut rates so as to obtain more business and thus increase his mileage.
In the case of a haulier whose business fluctuates, it is much wiser for him to reckon depreciation as a 'running cost and not as a standing charge.
I have more to write about depreciation, hut before going on to other aspects, I would like to point out thaf the big difficulty with depreciation also applies to the recording of expenditure on tyres and maintenance. The principle involved is different, but the effect is similar.
If expenditure on tyres and maintenance is recorded as it actually Occurs and not, as I recommend, according to a regular estimated figure per mile, then considerable fluctuations can occur in respect of these items and the' operator may think one week that he has made a big profit and another that he is running at a loss, whereas, in pOint of fact, neither of these two things is happening. I referred
to this matter in an issue dated March 24, S.T.R.