Accounting theory and practice, Volume 2 (of 3) : a textbook for colleges and…

(a) Straight Line Method The straight line method is, first of all, simple in application and can easily be adapted to any asset under almost any conditions. Partly because of the ease of calculation and application, it has been designated as an official method by many regulatory boards. Its basis is a time basis and it spreads the charge evenly over the periods of the service life of the asset. Accordingly, where the time elements of depreciation, viz., decrepitude, inadequacy, or obsolescence, control and where the output does not fluctuate much from period to period, the straight line method should give satisfactory results for its intended purpose, i.e., for allocating the real depreciation charge. Its effect, however, must be considered also in conjunction with the distribution of the other costs connected with the asset. Many engineers maintain that repairs are light during the early life of an asset and heavy during the later years. If this is true and these costs are charged to the period in which they are incurred, the combined depreciation and up-keep costs place an unjustly heavy burden on the output of the later years. Almost equally good authority maintains that the cost of repairs is in no sense uniformly graduated as implied above but can be counted upon in practice to be extremely irregular. If this is true and up-keep costs are charged as above, then many periods are apt to be underburdened and others loaded too heavily. While, however, these considerations must be given weight when a single asset is under view, in a large plant after operation has continued to the point where a normal and fairly regular cost of up-keep has become established, the inequalities of the individual up-keep charges may merge into fairly equal charges for the up-keep of the plant as a whole. This the law of averages accomplishes to a greater or less degree. But in a small plant with few assets subject to depreciation, the equality of the whole might not result from the individual inequalities. After all, this magic rule of averages which is invoked to cover up many troublesome and embarrassing situations is obnoxious to scientific accounting; it is a makeshift which carries with it a shiftless trust in the happy outcome of things—a trust which has been so often betrayed as to carry little weight. If depreciation costs can be predetermined with a satisfactory degree of accuracy—and an estimate of them is all that can ever be made—with equal accuracy and satisfaction can up-keep costs be predetermined. The one is no more difficult than the other and equal reason exists for predetermination in both cases, viz., the securing of an equitable distribution of costs. With both estimates made at the beginning of the service life of the asset, all costs in connection with the asset can thus be prorated over the years of its service life. If, as stated above, the output is fairly regular as between periods, fair and equitable results will be obtained. If the output fluctuates violently, unsatisfactory costs and an inequitable burdening of product will be the result. The proper treatment of overtime and “beyond-capacity” work, i.e., abnormal operations, requires care. It is expected that such work will have a higher unit cost than normal output, and it is proper that a sliding scale of depreciation be applied in such a case. (b) Working Hours Method Most of the considerations taken into account for the straight line method are equally applicable to the working hours method. Here, with the service life expressed in terms of working hours instead of fiscal periods, a far step has been made towards securing an equitable distribution of depreciation costs over product. The rate per working hour can in this way be applied directly to the product. The machine-hour and sold-hour methods of costing distribute the depreciation along with all other costs on this basis of “rate per working hour.” Where a machine or other asset is limited in its use to a few operations equally wearing in their effect, this method should give satisfactory results. Where, however, one asset can be used for many different processes, involving inequalities in wear and tear, if the service rendered is the controlling factor, an inequitable distribution will result. Similarly, beyond-capacity operation, i.e., operation beyond the normal speed at which depreciation cost has been predetermined, will not be taken care of automatically by this method. Adjustment is necessary and, though arbitrarily made, must be attempted. Thus, ten articles might be turned out in one working hour, whereas an estimated output of six formed the basis for determining the rate of depreciation per working hour. As with the straight line method, so here equal care must be exercised in securing an equitable distribution of up-keep costs. (c) Composite Life Method This is not a working method for estimating individual depreciation costs, but rather a method of proof or check, which proves very valuable in some cases. The method is discussed in detail on page 197 where the uses to which it may be turned are pointed out. (d) Service Output Method The service output method bases the depreciation cost not on years of life nor on life in terms of working hours of service. Here an attempt is made to predetermine the output of the asset in terms of units of product, and so burden every unit with its fair share of depreciation. To secure full equality of charges, up-keep costs must be reckoned on the same basis, rather than on a time basis of service hours or length of life. If conditions are uniform and normal, this method, where applicable, secures perhaps the most satisfactory of all allocations of depreciation costs. To an individual machine performing several different processes the method would scarcely be applicable. To a group or battery of machines, turning out a uniform product in finished form or in the same degree of partly finished condition, the method could be well applied. The estimated total output of the group would then be taken as the basis for calculating the service output of each machine in the group. When calculating service life in whatever units, that speed of operation which secures the highest efficiency is taken as the figure of normal operation. From the foregoing it follows that the service output method of calculating the depreciation charge per unit of output is well adapted to an inherently wasting asset, such as a mine, a quarry, and timber lands, and is almost invariably applied in such cases.