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Misconceptions about Depreciation

21st April 1950, Page 54
21st April 1950
Page 54
Page 57
Page 54, 21st April 1950 — Misconceptions about Depreciation
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Which of the following most accurately describes the problem?

Many Hauliers Treat This Matter in an Arbitrary Manner Which Can Only Redound to Their Disadvantage

ONE difficulty which, frequently arises in calculating depreciation is when a vehicle has been completely depreeiged ittis.the books and ceases to be a charge, against its operating cost. As a rule, this comes about when an owner has under-estimated the life of a vehicle. He finds

when the estimated life is run that the lorry can still be used for some time. However, it has to be written off, and strictly speaking he need not include depreciation in his schedule of costs for operating the machine. One aspect of this problem was pat before me a short while ago when an operator suggested a scheme for meeting zompetitiort by rate-cutting. His plan was to buy good vehicles, depreciate them over five years, and then in the subsequent two or three years of vehicle life, with no depreciation amount to bother with, as he put it, he would beat his rate-cutting competitors. , His scheme was obviously wrong in principle, but the

fallacy was not immediately evident. The flaw was, of course, that for five years he would have a' heavy depreciation account If he were to be in a position after the live years to adopt the rate-cutting plan he had in -mind, he would hatre to make a high profit in those five years.

If he could do so and obtain the rates Which heavy depre:iation and reasonable profit-making involve, his rates would have lobe higher than average. If ,he could obtain those rates, despite any competition and rate-cutting that might he prevalent, then there would be no point in his.going on with-the scheme of cutting out his competitors.

There are other flaws. A haulage contractor is consideribly dependent upon good will. If for five years he serves :ustomers'at a high rate and then suddenly, without any reason which he can divulge, cuts those rates, his customers are not going to be as pleased with the cut as might be :xpected. They are going to wonder why they have been paying what would seem to be excessive rates for five years.

Furthermore, this period of five years for depreciation makes no allowance for variation in mileage. If the vehicles under consideration have been covering 30,000 to 40,000 miles per annum, then by the end of five years they will arobably be due for disposal, otherwise the bill for main:enance during the subsequent years will exceed any savings rom having no depreciation charge.

Estimating Costs This reminds me of another example of a fallacy in lepreciation which is typified in an inquiry which came :rom a haulier who appears to have acquired a business, imong the assets of which were three indifferent lorries. His own valuation of the three was £300. He asked me to 2stimate the operating costs of these vehicles and in his letter pointed out that as the figure was practically negligible, he would need to make no provision for depreciation. Indeed, he suggested he should take as a basis for his own estimate Pf costs the figures in "The Commercial Motor" Tables of Operating Costs, less the amount included in those Tables an account of depreciation.

I went into the figures of cost carefully, having in Mind :flown performance and age of vehicles of the type, and I vill cite the case of one of the three lorries in question. Ibis is a 5-tonner and, having in mind its probable state of iisrepair and other disabilities inseparable from out-of-date hassis, the running costs will be approximately as follows:— Fuel consumption, 8 m.p.g., which, with fuel at 2s. Id. per gallon, means approximately 3.13d. per mile. Oil consumption will be heavy and for that I have set down 0.3d. per mile. Tyres—rather more than the average figure as quoted in the Tables because of faulty alignment, backlash and worn kingpins—say I:1d.

Cost for maintenance is entirely an unknown quantity, but likely to be in excess of average if only for the fact that the Ministry of Transport inspector will be inclined to pay special attention to old vehicles. I think I may take I.63d. as against 1.23d. set doWn irt the Tables. That is maintdnance (e). For maintenance (d) I will take 0.38d.. as in A36 the Tables'. The total of these items is 6.54d. per mile. The total of the corresponding five items according to the Tables, including deprCciation, is, with correction for petrol prices, 6.07d. per Mite. • '

Therefore, these old vehicles, notwithstanding the elimination of any debit on accdunt of depreciation, swill cost more to run than new ones with full allowance for depreciation.

Questions about depreciation on used vehicles are often asked. A reader will ,write to me and inquire what he should allow for depreciation on a vehicle which he has just bought. He tells me how much he has paid for it, which is usually less than the price of a new vehicle, and quite obviously, from the general tone of his inquiry, he expects rue to tell him that the allowance for depreciation is correspondingly less. Actually it is, as a rule, more.

Expectation of Life Let us take an example in the type of vehicle with which I dealt in the previous article, costing £2,000 new and having an expectation of life of 240,000 miles. This would be debited with a basic figure for maintenance of 2d. per mile if the annual mileage be riot less than 40,000, and 21d. per mile on an annual mileage of 30,000.

In assessing depreciation as an item of operating cost. with the ultimate objective: of using costfigures for calculating rates, the amount debited against depreciation must be regarded as a contribution towards buying another vefficle when the one being operated has finished its useful life.

Assuming that a used vehicle of the type described above has been bought for £1,400, it is unlikely these days that a vehicle bought for that price will have covered a small mileage. On the contrary, the mileage it has run is likely to be about 200,000. Therefore, according to our theoretical figures for the life of that vehicle, 40,000 miles of life are all that are left. If we accept that figure for the residual mileage, an operator should put aside an amount for depreciation which in 40,000 miles will replace £1,400. Depreciation at that rate is 4.2d. per, mile. If he wants to be able to buy a new vehicle at £2,000, then depreciation will be Is. per mile.

I agree that if he has got a bargain, or if the used vehicle which he has bought has been reasonably well maintained, and he is in a position to effect economical maintenance and thus prolong the life of his vehicle, then the figures will be affected accordingly. He may even be able' to run it for another 100,000 miles, although I would regard that as an extreme figure. In that case his basic figure for depreciation would be 3.36d., increasing to 4d. per mile, if he be doing only 30.000 miles per annum. If he wants to buy a new vehicle when this one is depreciated, then his basic figure will be 4.8d. per mile, and on the assumption that the vehicle does 30,000 per annum, 6d. per mile.

Clearly, therefore, it is.not correct to anticipate that the allowance for depreciation can be less in the case of a used vehicle: rather it is, likely to be more. Maintenance costs will be above average and the operator is likely to suffer loss as the result of a used vehicle being off the road much more frequently than would a new one. In that connection it should be borne in mind that the loss of use of a vehicle can be regarded as anything from £5 per day.

can put the matter in another way. Assume that an operator is intent upon buying a new vehicle and that he manages to get £200 for the old one when he disposes of it.

That means he has to save £1,800. If the used vehicle runs for only 40,000 miles, I assume in the first case that his basic figure. for depreciation is 10.8d. per mile. If by good management he makes it last 100,000 miles, his basic figure for depreciation is .4.32d. per mile. The correct figure probably lies between those, two extremes, but it is certainly more than would be called for in the case of a new vehicle.

An operator may say that he need not assess the amount he puts aside for depreciation on the assumption that he is going to pay cash for his new machine. He may say that he will be satisfied if he puts aside enough to enable 'him to find the down payment necessary for the acquisition of a new vehicle under a hire-purchase scheme. This brings forward another aspect of depreciation. Can hire-purchase payments be substituted for depreciation?

Different Amounts

The answer is no, if we are to use the figures as a basis for charges, for the simple reason that the difference between the amounts to be set aside for hire purchase and those needed for normal depreciation are so different as entirely to upset proper calculations for rates.

Let me go into figures. I will take a vehicle costing initially £1,000. The hire-purchase agreement arranged to cover two years will involve the down payment of £250, leaving £750 to be covered by instalments. Actually, 11 per cent, must be added to that £750 to pay for the accommodation, that is £82 10s., making a total of £832 10s. That, spread over two years, means that the operator will nave. to pay monthly instalments of £34 14s.

If the vehicle be covering 30,000 miles per annum,-it will in the two years during which that £832 10s. is to be paid, run 60,000 miles and the cost will be 3.3d. a mile. When the two years is up, the operator, if he is to be consistent, will still want to get back by way pf depreciation the down payment of £250. There as still, according to our reckoning, 180,000 miles of use left in the vehicle, and if that be divided into £250 it means that the depreciation for that period will be' at the rate of 0.33d. per mile.

lf, thererore, he uses these figures as a basis for calculating rates, he will for the first 60,000 miles of use have to charge 3d. per mile more to his customers than he wall during the later period of the vehicle's life, thus involving himself in the same difficulties as those which resulted in the case of the man who depreciated his vehicles quickly and then eliminated depreo:ation from his accounts at one stroke.

Taxation Method

Finally, there is the method of depreciation which is at present in vogue by the Inland Revenue department, whereby in the first year of purchase the vehicle is to all intents and purposes depreciated by 65 per cent, and in subsequent years at the rate of 25 per cent. of the vehicle's depreciated value, which is diminished year by year by the amount already credited.

In the case of the £1,000 vehicle, the first year's depreciation will be £650, and if it ruhs 30,000miles in that time depreciation allowance is equivalent to .5.2d. per mile. In the second yeaf, allowance Ls 25 per cent. of £1,000 after deducting £650, that is £350. That Comes to £88, and again taking 30,000 miles per annum the depreciation allowance has fallen rapidly to 0.7d. In the third year; the allowance is £66, which is equivalent to 0.53d. per mile, in the fourth year £49, which gives us 0.39d. per mile. In the fifth year it is £37, which is equivalent to 0.3d per mile, and in the sixth, and usually final year £28, equivalent to 0.22d per mile. It is obviously impossible to use figures like that as a

basis for cost in rates assessment. S.T.R.


Organisations: Ministry of Transport

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