"See-Saw" Depreciation Will Not Do!
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S. T. R. Explains to a Haulier the Fallacy of Fully Depreciating in Three Years Vehicles Covering Only 10,000 'Miles a Year
As I write this article I have just dispatched to the Editor the final figures for the next issue of "The Corn; mercial Motor" 'Tables of Operating Costs, part of which will be published in this journal on July 30. In preparing the new Tables, I followed my usual practice of going through notes on the subject which have accumulated in my notebook-since compiling the previous issue, which was published at the beginning of last year
I remember one conversation in particular with an operator whose business is situated somewhere in Yorkshire. His operations are mainly the local distribution of coal. When I met him he told me that he could not quite understand some of the figures for operating costs, and produced what was for him a typical costs sheet covering a quarter of a year. We had a fairly prolonged discussion of his accounts and several of the items have a bearing on the way in which I compile "The Commercial Motor" Tables of Operating Costs.
Comparison with "The Tables" He said that the average petrol consumptionof his fleet of half a dozen 2-tonners was less. favourable than that in the Tables. Eventually, however, we discovered on going through the figures that one vehicle gave a better result than was suggested by the Tables, two were about the same,but three indicated I If or 12 m.p.g., against the quoted figure of 13 m.p.g. It transpired that the vehicle giving most favourable results was in the hands of an exceptionally good driver. Two of the three which were not so good were old vehicles,, one dating back to 1939 and two having been built in 1941. I pointed these facts out to him and he accepted them as being justification for the difference between his figures and mine.
Going into his figures in 'greater detail I discovered that there was no entry against either depreciation or interest in respect of four of the six vehicles. Incidentally, 1 should explain that he treated depreciation as a standing charge.
"What has happened to the depreciation item for vehicles one to four ?" I asked.
"They have been written off," he replied.
"Oh, why ?" I asked. "Vehicle No. 4 was purchased as
recentfy as 1945." ' '
" YeS;" 'he replied. "These were low-priced vehicles and I was recommended' by a friend to write lhem off in three years." "What kihd of work does your friend do, and what sort of vehicles has he got ?" I asked.
"His are 5-tonnors of the same make as mine," he said, "and they, are tippers. He is engaged mainly in sand and gravel haulage."
"Is he, indeed," I said, "and what is his annual mileage, as a rule.?"
I suppose he would do about 400 or 500 miles per week.' "Oh," I said, "that is 20,000 to 25,000 per year. What mileage do you do ?"
"About 10,000 a year."
• "Well, don't you see there is a' vast difference between the ,34. types of work that you and your friend are doing, and that he is doing up to two and a half times your annual mileage ? It stands to sense that tippers engaged on sand and ballast haulage will wear out much more quickly than yours, and apart from that he is writing off his vehicles in 60,000 to 75,000 miles, whereas you, with your 10,000 miles per annum and easy work at that, are writing yours off in 30,000 miles, which is ridiculous."
"What has mileage got to do with it ?" he asked. "I thought it. was always the rule to write machinery off over an agreed period."
"That does apply to most machines," I said, "but you must discriminate between one kind of machine and another, and fix your depreciation period according to the life you may really expect from-it. .If you were operating a lathe or a drilling machine, year in and year out on fairly steady and not-too-arduous work, you would probably be inclined to depreciate it over 10 years. As a matter of fact," I said, "taking the work your vehicles are engaged upon as an example, and With a mileage of only 1000 per annum, I should be inclined to write off your vehicles over a period of 10 years.
Little Maintenance Cost After Nine Years
"The proof lies in these figures we have before us. You are Still operating quite happily and without any undue expenditure on maintenance, a vehicle which you purchased in 1939. How much longer are you going to run that one ?"
" Oh," he said, "it's good for another year or two, I think. It's running quite well and giving no trouble."
"There you are," I said.
" But wait a minute," he asked, "isn't it a good thing to write a vehicle down over a short period, because after that, with depreciation out of the figures, the cost of operation is reduced and I can modify my rates accordingly ?"
"Do you mean to say," I exclaimed, "that you are using these figures, which make ITO provision for either depreciation or interest, as a basis for assessing your rates ? What will happen when you buy a new vehicle? You will probably have to pay £630 for one like this. Out of that sum we will take £70 for tyres, which leaves £540, and £50 for its value on resale, leaving £510 net. That means that if you depreciate over three years, the amount for depreciation will be £170 per annum. In addition, you have ignored interest, which is another 120 per annum. That is £190 per annum altogether.
"On the other hand, I see you have the equivalent of these amounts set down in the current quarter's accounts for vehicles 5 and 6. The actual amounts are £37 10s. for depreciation and £5 for interest during that quarter. That is approximately £3 5s. a week. How are you going to make provision for that when you put a new vehicle on to the work/which the old machines are doing, bearing in mind that your present rates are calculated on costs which will inevitably increase by £.3 5s. per week ?"
"It will average out," he said, "amongst the other vehicles and at the end of three years that amount will be wiped out."
Running New Vehicles at a Loss "Excuse me," I said, "but you cannot wipe out an increase of £3 5s. per week on rates which are calculated on the assumption that the £3 5s. is absent. At the present moment you are running these two newer vehicles at a loss and you cannot possibly hope to make that up from the profits earned by the other four, because there is an insufficient margin at the present rates for that to be possible'
"But wait a minute," he said. "During the first three years I have only depreciation and little maintenance expense; after three years, maintenance begins to increase and, as there is no depreciation, the total of my costs is about the same."
That explanation may satisfy you," I said, " but if it does, you have not considered the figures to the extent which they undoubtedly merit."
"What do you mean?" he asked.
"Look at it this way," I replied: "You are suggesting to me that you start to spend as much as £3 5s. per week in maintenance on a vehicle covering barely 200 miles per week. I can assure you that you do not and you have made no allowance for such expenditure either. Let me
revise your figures and show how you ought to deal with that item, and that of interest as well,
"First of all we had better get our ideas on depreciation right, for until we do so 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 art item of your yearly balance sheet: that is not at all the sort of depreciation with which 1 am concerned, and which ought to concern you when you are trying to assess rates.
"My item of depreciation is not a book figure. 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, and I say will be' deliberately, because we have to look forward in these matters, and not backwards.
" Indeed, that is the real difference between you and me in the way in which we lciok at this item. In my figures for costs I am budgeting, whilst you and your accountant are, as I have just said,, gettingout a figure for inclusion in your balance sheet."
"What do you mean by ' budgeting' ? The only Budget I know anything about is the one we hear so much of in .April each year—and lately we have not liked much of what we have heard," he added.
"Quite so," I said. The word, as I use it has precisely the same meaning for me and you as it has for Sir Stafford Cripps. He, last April, presented the Houses of Parliament with what he Considered he would have to spend on the upkeep of this country. He set out that estimate not for -last year, but for this year, that is to say, up to April, 1949. He also made a corresponding estimate of the revenue which he expected from the Nation. Sir Stafford did as you ought to do. He tried to arrange his Budget so that revenue would exceed expenditure.
Budget Must Cover Life of Vehicle
" Now, in just the same way, I insist that for each new vehicle an estimate must be drawn up of the expense incurred in using it. For that estimate to be of any value it must relate to the whole period of use of the vehicle, its life from the date of purchase to the time when you conclude that it is going to give you more trouble than it is worth, and you purchase another. In that way you, in effect, budget for the cost of operation of the vehicle for all the time you have it.
" You should 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, which I am accustomed to call establishment charges, and make a profit.
"For the moment let us consider only depreciation, provided that you appreciate that it is only one of many items which you must take into account in drawing up your complete budget.
"You have a new vehicle. 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 that it will cover during its life. Now," I said, " have you any idea what mileage you would get out of this vehicle?"
"None at all."
"Well," I replied, "neither have I, so we start level. The question is: What are we going to do about it? Can you tell me how many miles
vehicle No. 1 has done? That is, the one you bought in 1939? I should think it is due for replacement, notwithstanding what you have said."According to the speedometer. 100,000 miles. . It has probably covered 120,000 miles altogether.'
" Let's take that as the basis for our calculation. Let us suppose that by the time it has covered 125,000 miles you will have to net rid of it. What did you pay for it ?"
" Three hundred and sixty pounds."
" Ah, that raises another point. How much are you going to have to pay for a new one ?"
" Six hunelred and thirty pounds."
" Then." I said, " as we are budgeting for the future, we had better assume that £630 was the cost of this machine. The vehicle is not in any event likely to last longer than th2 other one, and, after all, we are concerned with present prices.
We have already done part of the calculation. for we know that £510 is the net value after deducting the cost of a set of tyres (£70), and that its residual value is £50. Now £510 spread over 125,000 miles is approximately Id. per How do you get that ?he asked. Whereupon I showed him that I multiplied the £510 by 240 to bring it to pence and divided by 125.000.
" Oh, yes, I see,he said.
Wear-and-tear Allowance
Now," I said, " that Id. per mile is the figure for depreciation, which you should include in your accounts. It is a measure of the rate at which your vehicle is likely to wear out. Indeed. I would rather call it a wear-and-tear allowance than use the word depreciation.'
At the same time I must warn you that Id. per mile is not a future which I should suggest to many people whose vehicles cover only 10,000 miles per annum. In most cases that figure for wear and tear would not be adequate."
Why is that ?" he asked.
" Because you are in a sense a peculiar case. In your job it doesn't matter how old your vehicles may be; you can still use them without loss of prestige.
" Most operators find they cannot use the same vehicle for 10 years or more. As a rule the vehicle becomes out of date and.if the user he in any business in which competitions is keen, it does not pay him to use out-of-date machines. He must have something modern, spruce and smart."
" What difference does that make to the life of the vehicle ?"
" None whatever, but it does make a big difference tJ what the vehicle is going to cost to operate; to what it is going to set him back, as it were, between the time of putting it into use and the time when it must be replaced. In your case, as you can run a lorry for more than 10 years, which is equivalent to more than 125,000 miles, you can reckon on Id. per mile, but if an operator has to replace a vehicle in four years, it will have done a far smaller mileage and the depreciation costs will be greater. .1rt making provision for that sort of thing, we say we are budgeting for obsolescence, which, in your case, a5 I have just said, does not matter."
The rest of this conversation will he reported in a . subsequent article. S.T.R.