COSTS THAT COUNT (3)
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by David Lowe, MInstTA, AMBINI DEPRECIATION is a cost item which, as I wrote earlier in this series, I prefer to calculate on a time rather than a mileage basis and therefore should be included under the standing cost heading. In this way it becomes an item of cost which has to be taken account of whatever mileage the vehicle covers or even if it is idle owing to maintenance work or lack of business.
There are two ways of calculating depreciation on a time basis. One is what is called the "straight line" method by which the amount to be depreciated is divided by the number of years over which the depreciation is to take place, so providing an equal annual figure for this item over the life of the vehicle.
Reducing figure
The alternative method is one by which a reducing annual figure is achieved. This way a high rate of depreciation is shown in the early years of the vehicle life, offset by relatively low maintenance costs, reducing to a low rate of depreciation when the vehicle nears the end of its economical working life and at a time when maintenance costs are naturally expected to be considerably higher.
Whichever method is chosen—and this is entirely at the discretion of the operator —the method of arriving at the total amount to be depreciated is the same. The initial price of the vehicle is taken, including the body and any special equipment attached to it—unless the body or equipment is to be depreciated over a longer period than the chassis—and from this has to be deducted the value of the original set of tyres on the vehicle because these will be costed separately with the running costs, and secondly the expected resale or scrap value for the vehicle when the operator has finished with it. This calculation will leave the figure that has to be depreciated over whatever period of life the operator expects to get from the vehicle. Before showing examples of how this is done I will deal with the point just mentioned about bodies or equipment which are expected to outlive the original chassis. In such cases the chassis and the body and equipment have to be depreciated separately, taking the original cost of each less the resale or scrap value and in the case of the chassis less the value of the tyres and divided by the expected life in each case as outlined above. This situation particularly applies where, for example, expensive insulated or refrigerated bodies or specialist mechanical handling equipment such as taillifts, loading cranes or pneumatic discharge pumps on dry bulk tankers are fitted to relatively short-life mass-produced chassis,
Repainting
One further point which has to be considered concerns the case when vehicles, particularly those with van bodies, are subjected to regular repainting programmes to maintain the company image so that a vehicle may be repainted perhaps two or three times during its life. Such cases need special consideration in the costing exercise. The original painting cost should be deducted from the initial invoice; and this together with estimated figures for the future cost of repainting during the life of the vehicle should be added together and divided by the expected vehicle life to provide an annual painting cost which can be included in the depreciation or set down as an additional standing cost.
To take examples of the methods of calculating annual depreciation as outlined here, we can use as a basis the vehicle previously mentioned costing £3500 andfor ease of calculation suggest a life of three years for the chassis (£2000) and six years for the body which cost £1500 including £150 for painting and signwriting. Painting costs Original paint cost £150 plus repair and repaint when body changed to new chassis £180 = £350 6 years = £55 per annum.
Total depreciation cost £470 + 220 + 55 = £745 per annum.
The operator will have to remember to carry the balance of the body depreciation and the painting cost forward to subsequent years' costings.
Reducing depreciation method
If this method of calculating depreciation is used the operator has to decide on the percentage by which the vehicle is to be depreciated in each year.
Using our existing example figures we can calculate as follows: Depreciation of chassis Net amount to be depreciated = £1320 over six years on the following basis: year 1 30 per cent = 396 year 2 25 per cent = 330 year 3 20 per cent ---264 year 4 10 per cent = 132 year 5 10 per cent = 132 year 6 5 per cent = 666 CI 320 Total depreciation cost Over a period of three years covering the life of the original chassis and including painting costs the annual depreciation figures would be as follows: In conclusion a number of points should be made. First, if the latter method is used then the seemingly high depreciation costs on the first chassis will be offset by much lower costs on the second when the original body, which has already been depreciated by 75 per cent, is re-used. Secondly, where the body lasts only the life of the original chassis the calculation will be considerably simplified. The third point is that these calculations take no account of inflation, so the amount of the depreciation will not cover the cost of the replacement vehicle. This can be simply overcome by inflating the figures arrived at by say, 10 or 15 per cent which still may not be sufficient over five or seven years but will be some contribution towards the greater cost.
Next week: What to include in establishment costs.