Depreciation-Repair-Reserve Plan
Page 20
Page 23
If you've noticed an error in this article please click here to report it so we can fix it.
An Interesting Scheme by Which a Link is Formed Between First Cost, Interim Expenditure and Surrender Value so That a Reserve Fund for Repair and Renewal Can Be Built Up
By Lewis Jones, A.I.A.C.
(Cost Accountant to Manorcroft Dairies, Ltd., Dewsbury, Yorks)
THE rather-unusual title, "Depreciation-Repair , Reserve," is used to describe a theory which may well become a practice in the calculation of motorvehicle Operating costs. It is based on the obvious truth that the first cost of a wasting asset, plus all the expenses necessary and in connection with the working . of that asset (in other words the total gross expenditure over a period of time), will equal the residual value and net Cost of
operation. '
So that, in theory, all we have to do when we wish to find out how much a certain vehicle has cost to operate, is to deduct the amount of money we recover on sale from the total sum spent on the purchase and working of the vehicle, In practice the calculation of cost is not quite so simple as that, as, for one thing, the cost sheet is usually, to be prepared when only a fraction of the useful life of the vehicle is expired, and the question of realization has not arisen.
Thus, in calculating costs on any period less than total life, we have to estimate the amount which could be realized and credited to a state ment of total expenditure. It is rather like taking stock or making a reserve for prepaid expenses in bookkeeping.
Buying Ability to Undertake Work When a new lorry is purchased, the buyer does not pay his money for font' wheels" and an engine, but for its ability todo work. A new lorry costs more than a used one, because, in the latter case, part of that ability is gone. It is the balance of power to earn money that governs the value of a used lorry, and on that basiA only can estimates of present worth be made.
It is usual to provide for the fall in value of a vehicle by writing off an annual sum which is called "depreciation" This amount is calculated by accountants in various ways, and most often is expressed as a percentage on the original cost or on the book value at the end of the last accounting period. In fact, for income tax purposes, the Revenue authorities allow A-licence operators to charge 30 per cent. per annum in this way.
Estimates of " expired value," assessed on these lines, can have no bearing on the actual position. How often does a vehicle sell for its book ' value? Is there not always a socalled " profit" or " loss '! on sale? This can be due only to the fact that depreciation has not been accurately assessed, and in all cases where the amount written off has been calculated by reference to age, cost, or previous book-value, the matter must be re-examined when preparing costings If costs are to achieve nearaccuracy (as they should) it is obvious that the value placed upon assets must represent the undisputed cash value of them in a free market.
Depreciation Figures Often Haphazard
I have seen many cost sheets of motor vehicles, and one thing that has always impressed me is the fact that whilst great care is taken to work out the actual cost per mile of petrol, oil, and other elements, even to the second and sometimes the 'third decimal place of a penny, haphazard figures are used for depreciation, and such figures may be as much as 2d.--or 3d. per mile away from the truth.
So far as I know, it was S.T.R. (who writes the costing series for "The Commercial Motor ") who first pointed out that depreciation on motor vehicles was a charge more
relative to use than to age. Two identical lorries, purchased on the same day, may have widely different values in 12 months' time. One wagon may have done a considerable mileage, whilst the other may have been but little used. The former cannot, therefore, be ejpected to have the " life " of the latter. Much depends, too, on the care given in use, and the maintenance work carried out in the meantime.
When we compare vehicles the first cost of -which is low, with those of higher quality and workmanship, it is again apparent that a flat rate of depreciation is out of place. Experience shows that with the cheaper type of vehicle, total replacement is required at frequent intervals, whilst the more-costly types give good and reliable service for twice and three times as long.
• Then, again, there is -the fact that the best-grade lorries keep going when the cheaper types and used vehicles have to be off the road al • frequent intervals for repairs. This loss of revenue while under reper is an important point, and vehicles which are likely to need such regular
' attention cannot have the value of those possessing greater reliability. _ If it be accepted that capital expenditure is that cost which can be spread over a period of time, then it is certain that, in the case of motor vehicles," this .refers not only to first cost, but to replacement engines, overhauled steering and transmission, renewed tyres, repainting, and other costly jobs. Expenditure like this prolongs life, and adds to value, as the ability to do work for a longer period has been assured.
On the contrary, in the case of a vehicle which has not covered a very big .inileage, there may be quite a few expensive jobs ahead. It is a fallacy to conclude that a new vehicle is costing nothing in repairs. Certainly the -cash outgoings are lowest in the first lease of life, but wear and tear are taking place every time the vehicle is used, and in the days that are to come it will be necessary to make good this wear and tear, .so that for every mile worked provision must be made for this "making
good." When calculating current and expired value, consideration must always be given to the amount expended and the amount.still to be spent.
The Reason for the New Plan
It is because of this definite connection between depreciation and renewals that the "DepreciationRepair-Reserve Plan" for costing, is introduced. It provides the necessary link between first cost, interim expenditure andsurrender value, and is, in theory, a method of.building up a reserve fund for the repair and eventual replacement of the asset.
The two essentials of cost accounts are (1) Records of the money expenditure.
. (2) Records of the work done.
In the case of road transport, the unit of work is the mile run, as this is the only common denominator for all circumstances. The mile run is the measure of work, the indicator of expired ability for work, and " unconsnraed " miles the basis for assessing current vehicle value. The speedometer is, therefore, an essential instrument, and one which repays its small cost many times over in the data it provides for record purposes. The mileometer reading should be taken once each day, and carefully recorded .
Expenditure should be thoroughly logged in the same way, complete to the smallest detail, and here again it is advisable that the record be brought up to date daily, so that nothing is likely to be overlooked.' Payments for fuel, lubricants and routine servicing have no part in the Depreciation-Repair-Reserve Plan, although they are, of course, part of the total cost.
Standing Charges
that are Omitted
Similarly, the standing charges, such as Road Fund and other licences, insurances, interest, garaging, and establishment expenses, are to be left out of the D-R-R Schedule.
The latter is confined to money expenditure on the asset itself, and begins with an entry of the first cost, or purchase price, of the vehicle. After this come, as they 'occur, the payments for repairs; renewals, tyres, bodywork and the like, It is necessary then, at the close of the period for which costs are required, to assess only the saleable value of the vehicle and credit this amount to the total obtained from the log or schedule.
It will be found.that to obtain suit able results from this method, the reckoning-up should take place only after a fair period, or substantial mileage, and I suggest one year, or 50,000 miles' service, whichever comes first, as the period for costing.
The system hinges on the valua tion placed on the vehicle at the close of the period, and the greater part of this article has been devoted to reasons why the usual accountancy method is unsuitable for this purpose. For. self-satisfaction, I would advocate that the mean of three independent offers from commercialvehicle dealers be used, so that the value placed upon the vehicle really is an indispntable one.
The owner will probably want to know how to assess, his costs, in the meantime. This is done by what is
known as a control account, which is best imagined as a banking account into which deposits are made at a predetermined rate based on the mileage run, and withdrawals made as necessary for the repair of, and other work done to, the vehicle. As a matter of fact, an actual banking account could be used, thus making sure of the increasing need to provide a new vehicle in some future period.
Rate-fixing for this scheme is a matter of estimating the probable life of the vehicle and the probable , amount which will be necessary to maintain it efficiently, in service for tbat lifetime._ In this connection, unless the operator has sufficient experience in the trade to give a reasonable forecast, expert advice sheuld be-sought.
Quoting from my own experience, I can give a rule-of-thumb method. which may meet the need in normal
cases, that is, to assume that the vehicle will cost as much in replacements as its original cost, and base the life on 120,000 miles. This provides a sum of £500 for every penny of the rate, and reference to the examples given will illustrate this method.
It is very important to bear in mind that rates calculated like this are not costing. They are only estimates, and must be corrected when the reckoning-up takes place. Costs are actual experience, and estimates for any item 'shouldnot be used when actual expenditure fi'gures become available.
In the specimen account shown the expenditure has been summarized, but in practice it should be recorded daily and carried. forward throughoutthe period,' inserting the prices and charges for spares and repair • work when the suppliers' invoice's are to hand. '