Calculating Depreciation
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Several Methods of Assessing Depreciation, but Not All are Good : Why "The Commercial Motor" Treats it as a Running Cost : Providing for Obsolescence : Depreciation as the Tax Authorities See It TABLE I, which accompanies this article, embodies a recommendation to car dealers who accept a used car in part payment for a new one.. I include it because I want to stress a point which is of interest to hauliers, in that it shows what an important factor obsolescence can be when assessing depreciation. At the end of the first year of ownership the value of a car drops by from 33* per cent. to 45 per cent. of its value when new. If commercial vehicles were treated in the same way, there would have to be a big increase in rates to offset such a high depreciation rate.
Fortunately, depreciation is not reckoned in that way, at least so far as the hauliers' costs of operation are concerned. There are several methods of assessing depreciation as an item of operating costs. For the man who is running the vehicleas a means for earning profits, they are not, however, all good.
Depreciation as Running Cost In "'The Commercial Motor'. Tables of Operating Costs" the item is always treated as a running cost, being measured in miles of life. For example, if a vehicle is presumed to have a life of 240,000 miles, which is a good average fo: one of the heavier types of goods vehicle, the figure for depreciation is arrived at by dividing the net cost of the complete vehicle-less the cost of a set of tyres and what is called the residual value-by 2,40,000.
But, comes the obvious rejoinder, if depreciation be a running cost and it is debited against the vehicle at a definite amount per mile, it will never be the case that there will be no depreciation reckoned as a part of costs.
That is the crux of the matter. It is a point about which there has always been disagreement although, as far as the Tables arc concerned, the position has always been made plain. The Tables are a guide and are intended to indicate to those persons who have no authentic figures for costs what those costs are likely to be.
Depreciation cannot be reckoned on a time basis unless the precise conditions of operation and the make and type of vehicle are known. Given that knowledge depreciation can be calculated with reasonable accuracy.
This can be more easily explained if I take as an example a lorry which is owner-driven, well eared for and covering not more than 20,000 miles per annum. Such a vehicle could easily be made to last 15 years.. Now, take another vehicle forming part of a fleet run by a contractor who concerns himself more with the amount of work he can get out of his vehicles and his drivers than with the condition.of his vehicles or their prospect of life. a am not
criticizing the method of operation: the haulier may believe that it is more profitable to work that way. After all, the vehicles are the means for and not the object of his operations.) The mileage per annum is probably in the region of 48,000 and the expectation Of life about 24 to 3 years.
The figures in the Tables would meet both these cases, in this way. Assume the first cost of the first vehicle to be £2,800. It is equipped with 10.00-20, 14-ply tyres. The cost of these tyres is made up as follows: Cover, 1,43; tube, £3 Os.; flap, 18s. Total £47 4s. per tyre or £280 per set of six tyres, calculated to the nearest pound.
That must be deducted from the original cost-f2,800--leaving £2,520 as the net cost less tyres. Then comes what I have referred to as the residual value. This is the amount the owner may expect to get for the vehicle when he Sells it or trades it in after completing 240,000 miles. It is usual to take about 10 per cent, of the net value for that and in this case the figure I shall take is £250.
240,000 Miles' Life Deducting that amount from the £2,520 leaves me with £2.270 as the basis for the calculation of depreciation. The expectation of life has been assumed to be, in this ease,. 240,000 miles, and that must be divided into £2,270 to get the figure for depreciation. The answer is 2.27d. per mile. . The second vehicle cost. £1,200 shall we say, with an expectation of 160,000 miles of life. The tyres-9.00-20--cost £180, so that the net cost, less tyres, is £1,020. Take the residual value at £120 and the amount on which • depreciation must 12,e calculated is £900, Divide that by 160,000 and we get the depreciation as being 1.35d. Those are the figures which, if the circumstances turn out to be very similar, would appear in the Tables for the size of vehicle concerned.
It.is vital that the existence of these Tables should never be taken as an excuse for not keeping accurate and actual costs of operation. If accurate records be kept the need for calculating depreciation, or, indeed, for calculating any item of running costs does not arise.
But that is not all. The first example led us to the conclusion that the vehicle would last for 15 years. In many cases that would he too long. In that time many improvements would have bech made to the type of vehicle concerned, more particularly perhaps in imparting longer.
life to the engine. Obsolescence, then, will have to be reckoned with, and must be taken into consideration.
It must be made practicable for the user of the vehicle to provide means for allowing for that factor. Not all vehicles need that consideration. The second of the two vehicles mentioned in this article needs no provision for obsolescence; it lasts for only three years or thereabouts.
The question is, how shall that provision be made? There are two ways. One, an excellent method, is that used by the National Association of Furniture Warehousemen and Removers. In the method they recommend, depreciation is split into two parts, one, part taken as ,a standing charge and the other. is treated .a.S a runing cost.
Explaining this rceomMendatiOn. the Association says:— " lithe full **tit: Df depreciation be debited as a standing charge the reit& wduld be that .a short-distance custOmer would be overcharged and a long-distance customer would be undercharged.' Putting half the depreciation as a standing charge and. half as a running cost evens' matters up and does justice to both clasSes of customer: An exception, as pointed.„ out by the Association. is where Aides are being used for large mileages in any one year, iii which ease a larger Percentage than one-half could be charged to depreciation in the running costs and an appropriately smaller proportion to the depreciation in standing charges.
In arriving at the figures in the Tables, however, a different procedure is followed. It can beSt be explained by way of an example and for that I take the first of the Iwo vehicles I have already quoted, the `one which, without provision for obsolescence, wilt be depreciated over 15 Years.
Provision for Obsolescence The method is to take a figure for a minimum annual mileage below which provision for obsolescence must he made, This is done -by adding a certain percentage to the depreciation figure calculated by ordinary means.
The figure for depreciation per mile, reckoned without any allowance for obsolescence, was shown to be 2.27d. That applies so long as the vehicle runs not less than 40,000 miles per annum. Provision for obsolescence is made as follows:—For every 1,000 miles short of 40,000 per annum add 5 per cent: to the basic figure-2.27d.--for depreciation.
lf, for example, the vehicle covers. only 39,000 miles in a year then 5 per cent. 'of 2.27d.-0.11d.—must be added, making the depreciation 2.38d. If only 38,000 miles is the average annual mileage 10 per pent, must he added-'-0.23d. —making 2.50d. and so on.
Another way of assessing depreciation is that which appeals to the income tax collector, or assessor. The practice in that connection ha S varied considerably during the past few years and there is point in dealing with the matter at some length.
Prior to 1945, the allowance was at the rate of 25 per cent. per annum on the falling value as written off by the tax inspector. Thus, a £2,800 vehicle would qualify for an allowance of £700 in the first year of its life. The value of the vehicle is, for the second year, written down by £700 to £2,100. and the wear and tear allowance, as it is called. is 25 per cent, of that sum, namely, 025, whilst the writtendown value of the vehicle becdmes £1,575.
The figures for subsequent years. are given in Table II. It should be observed that the Value of the' vehicle at the end of the sixth year is still, according to the income tax authorities, £497, and it Will readily be appreciated that the vehicle never dies.
Additional Allowance
In .1945, a new prdvision was made whereby an additional „ allowance was. made, 'known as the initial allowance. The amount in the first place was' 20 per cent, of the capital sum paid for the vehicle. This was in addition to the 25 per cent. wear and tear allowance so that, in the first year, a £2,801:I vehicle qualified for two allowances, an initial allowance of 20 per cent-060—plus 25 per cent, wear and tear
. —£790--paking.£1,260 in all. .•
The whole of that amount was written off the value of the vehicle which, in the second year, was reduced to £1,540. That point should be noted, for it meant that the wear and tear allowance for the second year was only £385 (see Table III).
The idea behind this unnionted generosity on the part of the income tax man was to encourage the purchase of new and up-to-date equipment and thus accelerate the country's return to prosperity. "In faCt;the 20 pet cent. initial allowance was, for a time, increased to 40 per cent, and again dropped to 20 per cent. until the Budget of 1954, when the investment allowance was introduced.
This was similar to the former initial allowance, being 20 per cent. of the initial expenditure. but With this important difference: the investment allowance was not .deducted from the value of the vehicle, whereas the wear and tear allowance was.
There are strings attached to this allowance, however, In the first place, it applies to new vehicles only, and, furthermore, if the vehicle is sold during thefirst three years of its life it must not be sold to, other than those who propose to use it wholly or mainly for hire to merobers.of the public, or for scrap. •
If it be sold, the Inland'Revenue Must be advised and they ask the seller'for,Such. infdrmation as may be required in order that they may be satisfied that no attempt is being made to cash-in on the allowance. How this scheme works out in practice is shown in Table IV on the previous page.
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