244
DEPRECIATION 245
The same is true with all material assets. Though
a building may serve its original purpose for many
years, sooner or later it becomes so ill-adapted to
changed conditions that extensive structural changes
become necessary. Perhaps it may then prove better
economy to pull the building down and build anew, in
which case the value of the building will have been en-
tirely consumed in production. A machine may prove
serviceable for half a century, but if so it is just as neces-
sary to charge one-fiftieth of its original cost to produc-
tion year by year, as it is to charge against the monthly
costs one-half the value of a furnace which is burned out
in sixty days. At first sight the long life of a building
or a heavy machine might seem to indicate that the wast-
ing of the assets is not a factor which need be taken into
consideration when calculating current costs. Yet, al-
though the consumption or depreciation is so slow as to
be almost imperceptible and for this reason is difficult
to appraise, it is none the less as legitimate a charge to
costs as is the consumption by furnace of the coal with
which the furnace is heated. There is no difference,
from a cost accounting point of view, between an item
of plant used in manufacture and an item of stores con-
sumed in manufacture. Both must be charged to costs
concurrently with their consumption.
2. Obsolescence
Another form of wastage or shortening of life to
which machines of a certain type are liable is that of
obsolescence. A new and improved type of machine
may be placed on the market of so marked a superiority
over the old type that the latter at once becomes uneco-
246
nomical to operate in competition with the new type,
and has no longer any value except as scrap. Develop-
ments in the engineering field have in the past afforded
many examples of the rapid obsolescence of gas-driven
and oil-driven engines, and similar tendencies are today
seen in the gradual replacement of many forms of hand-
manipulated machines by machinery of the automatic
type. Unless a machine is of a standard utility type,
which is little subject to change, such as mechanisms for
turning, boring, and the like, the possibility of its be-
coming obsolete before it is worn out should always be
considered and the depreciation rate be fixed so as to
cover this possibility. An example of equipment carry-
ing a high depreciation rate due to obsolescence is
matrices used for stamping out phonographic records.
3. Depreciation of Auxiliary Equipment
The liability to depreciation and obsolescence is very
great in such mechanisms and equipment as molds, pat-
terns, jigs, and the like. Auxiliary equipment of this
kind often represents a large item of cost in the produc-
tion of a machine-made article and the difference be-
tween profit and loss may depend upon correctly charg-
ing production with this cost. Not infrequently a num-
ber of expensive patterns or jigs may be manufactured
or purchased for a special order. The investment is per-
haps made in the expectation of similar work in the
future, and so only a small part of its cost is charged to
the original order. The repeat orders which have been
expected fail to materialize. The auxiliary equipment
then becomes, like unsalable stock, a dead loss, and may
make a heavy inroad on profits.
DEPRECIATION 247
4. Depreciation Rates
Since the wastage of a plant asset is in most cases so
gradual as to be practically imperceptible as it occurs,
the proportion chargeable to current production cannot
be determined with the same accuracy as can the value
of stores or services consumed. When an item of stores
is issued it can be weighed or measured, and, as the rec-
ord of its purchase price is available, production can be
charged with its actual cost. When a machine is pur-
chased or a building is constructed, its cost is equally
well known. But it cannot be said that such and such a
job has used up one dollar's worth of the machine or is
directly connected with the gradual depreciation and
the slowly advancing obsolescence of the building. It is
necessary to estimate the diminished values of ma-
chines and buildings and to charge production with
amounts based on these estimates. This is frequently
done by dividing the present estimated value of the as-
set, less its future scrap value, if any, by the number of
years of expected service. Thus, if a building costs
$20,000 and its estimated life is 40 years, with no "scrap
value," the depreciation rate is 2%%, the annual depre-
ciation charge $500, and the monthly charge $41.66.
Other and more complex methods of figuring deprecia-
tion are discussed in Volume IV.
Such depreciation rates are calculated for every item
of plant carried on the books as a capital asset. Thus
separate rates are often used for the building, power
plant, machinery, fixtures, etc. At the end of each
period a summary is made of the amounts chargeable to
departments for the service or use of the various plant
assets.
248 INDIRECT EXPENSE
5. Fixing Depreciation Rates
It is clear that the life of a plant asset will vary with
its nature, the use to which it is put, and the care with
which it is handled. A building which is estimated to be
serviceable for 60 years, and a motor truck which it is
estimated will have to be sold for its scrap value in 6
years, must obviously be charged to production at very
different rates. If the building cost $60,000 and the
motor truck $6,000, the annual "write-off" for deprecia-
tion in both cases disregarding scrap values would
be $1,000, but the depreciation rate in the first case
would be 1.66%, and in the second case 16.66%.
It will thus be seen that a depreciation charge is not
a definite and known quantity, but a matter of experi-
ence and expert estimate. Technical experience is
needed in the business for which depreciation rates are
to be estimated before the charges can be determined
with even approximate accuracy. Moreover, these
charges, however carefully determined, frequently re-
quire adjustment from time to time as the asset depre-
ciates more rapidly or more slowly than was at first
estimated.
The causes which may make these adjustments nec-
essary will be readily seen if a case in point is cited. As-
sume that the life of a machine costing $2,000 is, under
normal working conditions, expected to be 10 years, and
that its scrap value will merely cover the cost of its re-
moval. An annual charge of $200 for depreciation is
thereupon made to the overhead expense account of the
department in which it is installed. Under pressure of
business the necessity arises of working double shifts
and overtime. The machine in consequence is operated
DEPRECIATION 249
almost continuously, and the minimum amount of atten-
tion is given to its cleaning and adjustment. Over-
strained in this way, its life is bound to be shortened.
Under such abnormal conditions, it may either have to
be scrapped in 5 years or require such extensive repairs
as to cost almost as much as a new machine. Under
these circumstances the original depreciation charge of
$200 should be readjusted to cover the unexpected wear
and tear; i.e., the charge to production should be in-
creased sufficiently to absorb the entire cost of the ma-
chine in the diminished number of years of service.
The difficulty of determining fair depreciation rates
on auxiliary equipment can often be simplified by
adopting some average rate and applying this uniform-
ly to similar classes of articles, assuming that any under-
depreciation in one case will be offset by over-deprecia-
tion in another. Since the problems here involved are
also of a more or less technical nature, the rates should
not ordinarily be determined by the cost accountant,
whose interest in them is usually confined to the proce-
dure for charging them to production, but by those tech-
nically trained and experienced in the demands of the
particular trade.
6. Depreciation Schedule
For depreciation purposes the life and scrap value
of each plant asset must be first estimated. The depre-
ciation rates are then determined, and from these esti-
mates a schedule (Form 36) is drawn up for the pur-
pose of working out the monthly charges and the indi-
vidual charges to departments. The schedule consists
primarily of a list of the plant assets. In a plant of any
250
INDIRECT EXPENSE
DEPRECIATION AND
DATE
VENDOR
DESCRIPTION
COST
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DEPRECIATION
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size, the asset items are usually classified under the heads
of buildings, machinery, power plant, electrical machin-
ery, furniture, fittings, and the like, so that the total
depreciation on any one class of assets is summarized on
its own separate sheet, or part of a sheet.
The operation of the depreciation schedule is simple.
The book value of each item of plant is recorded and the
depreciation rate is shown, as well as the annual amount
of depreciation, and the charge applicable to each cost
period.
If the asset belongs to one particular department,
the total depreciation for the cost period is entered in
the column devoted to that department, as shown.
The totals of the depreciation charges for the period
are entered on the expense analysis sheet on which the
final departmental distribution is made. (See Chapter
XXI.)
REVIEW QUESTIONS
1 . Define depreciation.
2. What is the difference between obsolescence and wear and tear?
3. What is a wasting asset? Give two examples.
4 . How would depreciation rates be affected by a rising market for
machinery and equipment?
5 . What plan would you suggest for fixing upon a depreciation rate
for the copper matrices used to stamp out phonograph records,
in view of the fact that the master matrix may cost a thousand
dollars, on the one hand, and the so-called musical hit may be
short-lived, on the other?
CHAPTER XXI
EXPENSE DISTRIBUTION
1. Sources of Expense Charges
As stated in Chapter XVII, the sources whence the
departmental expense charges are obtained are as
follows :
1. The schedule of depreciation (Form 36, pages
250, 251).
2. The schedule of fixed charges (Form 35, page
235).
3 . Time tickets covering indirect labor (Form 34a,
page 228), and the pay-roll of salaried em-
ployees.
4. Stores requisitions for expense supplies (Form
17, page 134).
These factory documents together with the record of
current purchases chargeable directly to expense show
what proportion of the expenditures recorded on the
books is chargeable each period to overhead. From
these documents and the purchase journal an itemized
statement for overhead expense is made out by depart-
ments. The sum of these amounts will represent the
total expense burden for the period, which is to be dis-
tributed ultimately over the product. With the charg-
ing of the overhead against the operating departments,
the accounts kept with the non-productive departments
253
254
INDIRECT EXPENSE
OVERHEAD DISTRIE
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WATER
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Depreciation
Schedule
DEPRECIATION
On Buildings
On Machinery
-
On Furniture
and Fixtures
Fixed Charge
Schedule
INSURANCE
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On Machinery
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On Equipment
TAXES
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GENERAL SUPPLIES
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OFFICE SUPPLIES
As charged on%
SPOILAGE
TELEGRAMS AND
TELEPHONES
Pay-roll
SALARIES
TOTALS
Allocation on \
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Form 37. Overhead
EXPENSE DISTRIBUTION
$55
UTION SHEET
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PRODUCTIVE DEPARTMENTS
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TOTAL
EXPENSE
Distribution Sheet
256 INDIRECT EXPENSE
are closed so far as they are applicable to the period.
The productive department expense accounts, which are
now open, show the operating expense and the spread-
ing of this expense, by means of predetermined rates,
over the product.
2. Expense Distribution Sheet
An expense distribution sheet, examples of which are
shown in Forms 37, 38, and 39, is the mechanism usually
employed to departmentalize the expense for the period.
From the data entered on this sheet the journal entries
may be prepared, crediting the items of expense and
debiting the department overhead accounts. As will be
readily seen, when schedules and other documents from
which the data are taken are once prepared, the work
of making up the expense distribution sheet reduces
itself to a simple clerical task.
So far as concerns depreciation and the fixed
charges, the preparation of the expense distribution
sheet is merely a matter of transferring a set of figures
from one sheet to another. The posting from the
standing orders and stores requisitions is facilitated by
entering the standing order or requisition number on the
expense distribution sheet in the space to which a sum-
mary of the documents bearing that number is to be
posted. In a large organization with a hundred or more
departments, several thousand standing order items
may require distribution at the end of each cost period.
The overhead distribution sheet of Form 37 is given
to illustrate the general principle of overhead distribu-
tion to departments. The expense analysis sheet of
Form 38 shows the same principle adapted to the re-
EXPENSE DISTRIBUTION 257
quirements of a machine shop which rents the building
and buys light and power. At the top of the form
are assembled the data required for the distribution of
rent and light, depreciation, power, and general ex-
pense. It should be noted that insurance, taxes, and
building maintenance expense are absorbed into the
general expense, which is then distributed over all the
productive departments on the basis of, or in proportion
to, the direct labor plus expense in each case. This
matter of determining department overhead rates is
more fully discussed in Chapters XXII and XXIII
of this volume.
The expense analysis sheet shown in Form 39 illus-
trates the analysis of the overhead in a plant where the
distribution is made over the manufacturing and selling
departments. The data given in the column at the left
shows on what basis general expense is apportioned. In
the lower part of the form the department percentages
of manufacturing expense to productive labor are given.
These percentages determine the rates used in figuring
the overhead expense on job costs. Selling expense is
charged to Profit and Loss.
3. Allocation of Non-Productive Department Expense
After the overhead has been apportioned over all
departments, it is necessary to prorate the total expense
charged against each non-productive department over
productive departments in proportion to the demand
made in each case by these productive departments upon
the services of the non-productive departments. The
basis of the allocation must necessarily vary with the
different classes of expenses and can be decided only
258
INDIRECT EXPENSE
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