BALANCING THE BUDC
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7,T OF DEPRECIATION AT the conclusion of the article in the October 7 issue of The Commercial Motor, I had reached a point, in the discussion of the operating costs of a fleet of vehicles belonging to a coal haulier, where it became necessary to go into detail in connection with the method of providing for depreciation. All that I need now recapitulate of the argument is that this haulier had been depreciating, over three years, vehicles which covered only about 10,000 miles per annum, and I had told him that that was useless as a basis for calculating rates.
"Now," I said, "we had better get our ideas of depreciation right, for until we do I shall not be able to persuade you to alter your methods. The depreciation of which you are thinking is something you have agreed upon with your accountant as an item of your yearly balance sheet, but that is not at all the depreciation with which I am concerned.
" My item depreciation, however, is not a book figure at all. In this matter, I am a realist and my assessment of depreciation is estimated on what I believe will be the actual life of the vehicle. It is a measure of the rate at which that vehicle will be wearing out.
" The real difference between us is that, in my figures of cost, I am budgeting, whilst you and your accountant are, as I have just said, getting out a figure for inclusion in your balance sheet."
"What do you mean by ` budgeting ' ? The only budget I know is that which we hear so much about in April every year !"
"Quite so," I said. "The word, as I use it, has
exactly the same meaning. The Chancellor of the Exchequer, each April, presents the Houses of Parliament with an estimate of what he considers he will have to spend on the upkeep of this country and all the services during the subsequent year. He accompanies that by a corresponding estimate of the revenue which he will expect from the nation.
"In a similar way, I insist that for each new vehicle an estimate must be drawn up for the expense incurred in using it, and, for it to be of any value, that estimate must relate to the whole period of use of that vehicle. You are, in effect, budgeting for the cost of operation of the vehicle for all the time that you have it. That corresponds to the first half of the work of the Chancellor.
" You then proceed, correspondingly, to consider what revenue you must obtain from the operation of that vehicle in order, not only that you shall balance the expenditure, but also cover certain incidental expenses of your business and make a profit."
"Yes, I think so. Indeed, I think the idea is sound, but I would like to know how it works out in practice."
"For the moment we are considering only depreciation, and I'd rather like us to stick to that for the time being, provided you appreciate that that is only one of many items which you must take into account in drawing up your complete budget.
" You have a new vehicle which you are just putting into service. Its value to you depends upon the work which it is going to do, and that value cannot be more simply or adequately expressed than in terms of the mileage which it will cover during its life. Now, have you
any idea what mileage you will get out of this vehicle?" "None at all."
"Well, neither have I, so what are we going to do? Can you tell me how many miles Vehicle No. 1 has done ? That's the one you bought in 1929, isn't it? I should think it is very nearly due for a part exchange."
" Acccording to the speedometer, 110,000. It has probably covered 120,000 miles altogether."
"That is a basis for your calculation. I suppose that we can take it that by the time it has covered 125,000 miles you will have to get rid of it. What did you pay for it? "
"Four hundred and eighty pounds."
"And what is a set of tyres worth?"
"Forty pounds."
" Now, when you do get rid of it, I suppose it will be in part exchange for a new Vehicle. What is your experience as regards the amount you are likely to obtain for it? "
" Oh, I expect I shall get about £40."
"That means, then, that in reckoning your depreciation you will have to take £400 as the cost, since we start with the £480 total, then deduct the cost of the set of tyres and what you are likely to get for the vehicle in part exchange. The technical term for the latter amount, incidentally, is residual value.
" Now, £400 spread over 125,000' miles is 0.77d. per mile. That is the figure for depreciation which you must include in your accounts. It is actually a measure of the rate at which your vehicle is being worn out. Indeed, I would rather call it a wear and tear allowance than use the word depreciation. I can tell you,. moreover, that that is not a figure I would suggest to many people whose vehicles cover only 10,000 miles per annum. In the majority of cases that figure for wear and tear would not meet the case. It would be insufficient."
"Why is that?"
"Because there are not many operators of commercial vehicles who can continue to use their yehicles for 10 years or more. As a rule, a vehicle becomes out of date, and if the user be in any business in which competition is keen it does not pay him to use out-of-date machines. In your job that does not seem to matter."
"What difference does that make to the life of the vehicle? "
" None whatever, but it does make a considerable difference to what the vehicle is going to cost its operator. In your case, the cost is merely that of wear and tear. In the case of a man to whom an out-of-date vehicle is no use, he has to buy a new vehicle before it is worn out. He cannot get the full benefit of the
wear and tear and his costs go up correspondingly. " Actually, in making provision for that sort of thing, we state that we are providing for obsolescence. In your case obsolescence does not matter.
" The method, in respect of vehicles of the type you use, is to add 5 per cent. to the wear and tear allowance for every 1,000 miles per annum less than 24,000. Your figure of 10,000 miles per annum is 14,000 fewer, and, in providing for obsolescence, it is necessary to add 14 times 5 per cent., that is, 70 per cent., to the 0.77d. per mile which is the cost for wear and tear. That brings the figure to 1.31d. per mile."
"Do you mean to tell me that another operator, using the same type of vehicle as I am using, would have to allow 1.31d. for depreciation, whereas I need allow only 0.77d. per mile? I cannot see that."
"I can explain it briefly in this way., Your allowance —0.77d.—is sufficient to provide for your vehicle's runing 125,000 miles, which is actually 12i years—this No. 1 machine of yours seems to have been doing more than 10,000 miles per annum during its life.
"The other kind of operator, who cannot afford to run out-of-date vehicles, sets aside an additional 0.54d. per mile so that he will have enough money to replace his vehicle when it becomes out of date, although it will not have worn out. On the basis of 10,000 miles per annum he will have provided sufficient to buy a new vehicle in about seven years. That is the difference."
(To be continued.) S.T.R..