Writing-off a Vehicle
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ACORRESPONDENT writes that he is having an argument with his accountant. The subject—depreciation. He reckons that item according to "' The Commercial Motor' Tables of Operating Costs," namely, on the mileage basis: his auditors tell him that he is wrong, that the amount to be set aside on account of depreciation must be calculated on a time basis, in this particular instance at 20 per cent. per annum.
It is obvious from the tone of his letter that he expects me, as being responsible for the Tables, to side with him so that he can show his auditors the letter and thus prove that his method—and mine—is correct. I am afraid he is going to be at least partially disappointed; for the answer is that both. are correct.
There are at least five methods of assessing depreciation, any or all of which can be stated to be correct. I propose to describe all of them, after first taking steps to arrive at the basic amount on which depreciation should be calculated.
Assume that the price paid for the vehicle is 11,250. The cost of a set of tyres, say £150, must be deducted, leaving £1,100 as the net -cost of the vehicle less tyres, that item being treated separately in the complete statement of operating costs. Next take away the residual value, which is
• what the operator expects to get for the vehicle in part exchange for the new one when it becomes advisable to get rid of the original vehicle. I take that to be £100. Deduct that from the £1,100 and we are left with £1.000 as the amount on which depreciation must be calculated.
. Spread Over Time
Of the five methods of calculating depreciation I take first what I call the straight-line method. Depreciation is, according to that method, spread over an agreed number of years, five being the most usual. The depreciation figure is thus £200 per annum, wiping out the first cost 'in five years. Note the simplicity and ease of calculation. This method is most common when weekly mileage is regular My second method is the one which most auditors use, and although it may seem to be too complicated when the figures are to be used in the assessment of operating cost there are arguments in its favour, one of which is that it is the method which must be used when making a return to the Inspector of Taxes.
According to this method the depreciation is calculated, each year, on the falling value of the vehicle. Thus, taking our £1,000 machine as an example, at the end of the first year. the depreciation allowance is 25 per cent. of £1,000, which is £250. For the second year the basic amount is £1,000 less £.250, and becomes £750. The allowance for depreciation is now 25 per cent. of £750., which.; to the nearest £1, is £188. The value of the vehicle is now £750 less £188. £562. and so on.
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The value of the vehicle falls year by year in this. way. End of first year, £750; second year, £562; third year, 1421; fourth year, £316; fifth year, £236, and so on.
Next comes the mileage method, according to which the operator knows that by the time the vehicle has covered a certain mileage it will begin to cost too much for maintenance and repairs and had better be replaced. Suppose that the expectation of mileage of our £1,000 vehicle is 120,000, the depreciation is £1,000 divided by 120,000, which gives us the final figure for depreciation of 2d, per mile.
That method is perfectly correct if the vehicle covers not less than 24,000 miles per annum. If the annual mileage is much less than that, some provision must be made for what is called obsolescence.
Obsolescence Factor
ln the Tables I make provision for that in this way: in the case of certain types of vehicle (those to which our example belongs and, as stated above, are likely to run 120,000 miles before becoming due for the scrap heap) I calculate the depreciation in this way. lithe vehicle runs 24,000 miles per annum, or 480 per week, the figure of 2d. per mile stands: if the annual mileage is less than that, •a small percentage must he added to that 2d. to provide for obsolescence For every 2,000 miles less than 24.000, add 5 per cent. to the depreciation figure. For example, supposing the annual mileage is 20,000, there must be an allowance of 10 per cent, to the depreciation figure, making it 2.20d. per mile instead of 2.0d.
Please note that I do not think this method of reckoning depreciation suitable for the ordinary haulier to calculate for himself I put it down here to show that there is provision for obsolescence in the Tables, Perhaps I should explain obsolescence in a practical way
I have taken a gross mileage of 120,000 as the expectation of life of a particular vehicle. If, as is quite likely, the vehicle covers only 10,000 miles per annum, the machine must last 12 years which, although possible, is not really practicable. Something must be done to allow for the fact that, long before that period is over, current models issuing. from the manufacturers' production lines will embody many improvements of value. in acknowledgment of that fact, the operator prepares to lose a little on the exchange deal whereby he is enabled to buy a new vehicle.
Another factor enters into this argument in that not all hauliers are concerned with obsolescence: a typical case is that of a haulier who tours the markets, collecting and delivering for farmer customers. He could not care less if his vehicle is 20 years behind the times. He probably bought it when it was already seven or eight years old and expects to get another eight years of service out of it. There is still one more method of calculating depreciation. It is used by furniture removers and is recommended to members by the National Association of Furniture Warehousemen and Removers.
" According to that method, half the depreciation is calculated on a time basis and half as a running cost. Referring to our £1,000 vehicle, £500 would be depreciated at, say, five years and would be regarded as a standing charge, and the other £500 as a running cost, in which case our figure for depreciation could be ld. per mile (£500 divided by 120,000, the agreed expectation of life).
The reason for this is that whilst some users regard the depreciation of a vehicle as a standing charge, others lodk upon it as a running cost. Actually it is affected by both factors. To meet the criticism that were the full amount of depreciation included under the heading of standing charges the short-distance customer would be overchargedand the long-distance customer undercharged, it is proposed to allocate one-half to standing charges.
Thus, half the capital cost will be written off in from five to seven years. If the annual mileage has been comparatively small, the present value will fairly be reflected as the time depreciation will have been charged. Alternatively, if running has been excessive, the adjustment will have been made automatically by a larger depreciation charge in the running costs.
Large Mileage
The desirability of treating depreciation in this way may be more fully realized when the items included under the heading of standing charges are shown in detail. When a vehicle is being used for a large mileage in any year, a larger proportion than one-half might be charged to depreciation in the running costs, and a lesser proportion in the standing charges. There must be quite a number of operators other than furniture removers who might benefit by using the same method.
Now for a few words on the aspect of costing as a whole, including depreciation, as i.t appears to the accountant who has not made a study of the requirements of the haulier. First, _bear in mind that he and I are not viewing costing from the same angle. He is concerned with the balance-sheet of his customer, showing what profit, if any, has accrued from the year's working. He may not reach the point of criticizing, but he will fail, perhaps, to understand the need for segregating the vehicles in respect of their operating costs. Ordinary accounts are not designed to give that information, being concerned with expenditure as a whole.
For orthodox accountancy purposes it is sufficient, for example, if the expenditure on oil fuel or petrol and lubricants is given in total, if actual expenditure on tyres during the period under examination is stated, and if the operator contents himself with noting what ' he has actually spent on maintenance and repairs. Moreover, it is not customary, in these orthodox accounts, to budget but merely 1,3 record. That is to say, it is unusual to make provision, as is absolutely necessary in a haulage business, for expenses which may not be incurred for a year or more.
Even depreciation, which hauliers appreciate is actually provision for the purchase of a new vehicle, is not so interpreted by the auditor. To the accountant, each year is complete in itself. He desires to know what has been spent and what has been earned. He makes adequate provision, as a rule, for depreciation (an item which he will necessarily include), but not for some future disbursement on account of overhauls and repairs.
Before me at this moment are some figures of cost in connection with a small haulage undertaking. I am asked to check the figures as part of the process of valuing the business itself. I am short of much information which I would like as guidance.
Actual Expenses
On going through the figures, I find that only actual expenditure is set down and, as it happens, nothing has been spent, during that quarter on tyres or maintenance. Perhaps I should say that there are no figures relating to such expenditure whether it has been incurred or not.
The profits which the business is presumed to show are thus, according to my methods of costing, artificial, and in excess of those which the business is actually yielding. Yet, to the accountant, the figures given to me are perfectly reasonable; they show the expenditure and revenue and, therefore, the net profit for the period under examination.
One feature, at least, is common to both systems. Both the orthodox method of accounting and my system of costing insist that every halfpenny that is spent must be recorded. In my system of recording costs, I have to keep in mind not only the necessity of such accounts as will enable the state of the business, at the moment, to be calculated, but to arrange matters so that its actual potentiality for profit shall appear. In addition, the individual cost of operation of each vehicle must be shown so that each can be checked against others.
One secret of success in any business is always to have a grip on matters of finance. There is no need to be unduly disturbed because occasionally the takings fall below the expenses, so long as the reasons of the deficiency are known and it is appreciated that they are only accidental or occasional.
In this matter I am, to a certain extent, following the same principle as that already laid down in respect of• vehicle operating costs. I insist that these be taken out daily and concern individual machines, so that any discrepancy, Or excessive expenditure is immediately noted and can be checked and corrected before serious results
accrue. S.T.R.