General Considerations

The valuation of assets grouped under the head of equipment presents nothing new in principle but requires consideration of many points in the application of principles and of some features in accounting. Here the principle of value as a going concern is particularly effective. As in the valuation of prepaid expenses on a going concern basis, so here forced sale or liquidation value has no place. The business is viewed as established and as expecting to operate continuously. Capital has become tied up in certain equipment essential to the undertaking, in the sense that to dispose of it in its entirety would mean a break-up of the business. It cannot therefore be freed or put to other uses without a reconstruction of the present enterprise. Accordingly, the possible market value, as second-hand property, should not in any way influence the valuation at which this group of assets is carried on the books. Only full cost at the time of installation and depreciation, using the term in its broad sense, need be considered in the problem of valuation.

Distinction between Personalty and Real Property

The present chapter deals with such fixed asset equipment as machinery and tools, furniture and fixtures, delivery equipments, patterns, lasts, dies, maps, drawings, electrotypes, ovens, furnaces, etc., as distinguished from the more fixed group of lands, buildings, leaseholds, and the like. In the main, the point of differentiation is the legal one of personalty and real property, although the intricacies of the law on this vexed subject are never, so far as is known, reflected in the books of account, nor is it the purpose here to attempt to lay down any working rules or standards by which such differentiation can be made. There seem to be none except certain broad generalizations, each case resting on its own peculiar surroundings. Circumstances, however, may arise under which a clear-cut distinction is desirable. A bond issue supported by a mortgage on real property or on personal property may depend, although not usually, on such a distinction for a large share of its security. The margin of safety may hinge on this point. It may be desirable to be able to trace on the face of a balance sheet the particular property covered by a mortgage. And should foreclosure of the mortgage become necessary, it is, of course, essential to know exactly the property subject to the lien. These are not points under contemplation in a going concern, although the possibility of their arising should not be lost to view. Here the problem of valuation and accounting for such valuation is viewed from the standpoint of a going concern and not one facing partial or total liquidation. Furthermore, as stated above, the point is, in its final analysis, one of law and not of accounting.

It is not intended by the foregoing statement to sanction any method of keeping the records in non-accord with fundamental rulings of the law, but only to state that, so long as substantial agreement is secured, accounting has served its intended purpose. Wherever any specific property is known to be subject to a lien, it is of value to the management for the accounts to reflect the fact. There may, however, be circumstances under which it is not desirable that the accounting records give this information. Conditions must govern each particular case without prejudice, and the principle holds that so long as substantial accuracy is reflected in the accounts as to this point nothing more is necessary.

Machinery and Tools

Under this head will be included not only the assets carried under that ledger caption, but also power machinery, power transmission, shafting, connections, electric transmission cables, and the like. The term is used in a very broad sense. While all these items are subject to one general rule of valuation, usually each must be separately considered to determine the practical application of the rule. The valuation involves, of course, the factor of depreciation, and it is readily apparent that not only do different pieces of machinery differ in this respect, but the same machines in different factories will vary as to this element and even in the same factory two similar machines will not usually be affected in the same way. This may be caused by defects or differences in quality, almost invariably latent, inhering in the machine and also by the different conditions under which they are operated. As pointed out in Chapter VI on depreciation, many of these are engineering problems which the accountant alone cannot solve but the existence of which he should know. Manifestly, all that can be attempted here is to point out their existence.

Accounting Records

The valuation of machinery and tools as here contemplated is dependent largely on the accounting records. Therefore, it is desirable to keep separate records for each of the two classes. This is so because of the greater degree of fixity of the one over the other. As to tools a distinction is also made between machine tools and general shop or hand tools. Machine tools are those with which the machine does its work. Thus, cutting tools for use with any particular machine, auxiliary equipment used for some operations, but not for others, and the like, constitute a very essential and component part of the machine and should be recorded and valued with the machine even though the tools need to be replaced much more frequently than the machine. On the other hand, shop tools comprise those of general utility which are largely used by hand. Hammers, wrenches, hand shears, pliers, chisels, bits, and the like, are examples of shop or hand tools.

Where the number of machines is large, proper accounting requires a subsidiary record known as a machinery ledger or register controlled by the machinery account on the general ledger. In this subsidiary record accounts should be kept with each class of machines, and with each machine separately if the record as to the performance of any specific machine furnishes essential information.

Operation of Machine Accounts

Every machine should be charged with its full cost. Full cost is understood to include invoice price, insurance during transit, freight, duty, and drayage charges, and installation costs. The last item usually includes the platform or stand on which the machine is erected, with all costs in connection therewith, when special supports or platforms in addition to the regular factory floor are needed. The cost of attaching the machine to the power and meters for measuring its power consumption are not usually included therein, these being classed as costs of power equipment—although practice is not entirely uniform in this regard. The machine record should also show the name of its manufacturer and its order number and any other useful information such as terms and period of guarantee, estimated life, rate of depreciation to be applied, numbers and kinds of tool equipment, etc. All deductions from the value of the machine must be on the same basis of full cost. Such deductions might arise because of fire, sale, or replacement. The proper handling of the account when deductions are necessary will be explained at the close of the chapter, as the method is applicable to all classes of asset equipment.

Valuations of Machinery and Tools

The statement of the principle of valuation for machinery is simple, but the application of the rule is complex. The valuation formula for machinery is cost less depreciation. As stated above, the condition of the market has no influence on the going concern valuation of fixed assets. If the market is now lower than at the date of purchase, this simply means that more capital was then required to start operations than is now required. If the forces of competition are free to act, the margin of profit or the margin of return on the investment in machinery will be somewhat less in the one case than in the other. If the market is now higher, then the situation is in favor of the earlier investment rather than the present one. In neither case should costs of production be falsified by valuing the machinery and other equipment at any other figure than cost.

Estimate of Depreciation

Estimating the depreciation on machines is the chief and vital problem in their valuation, because depreciation is reflected in the cost of the article manufactured, being a cost of production just as truly as the raw material used. As brought out fully in Chapter V, page 93, the so-called depreciating assets are really of the nature of deferred charges to operation and a depreciation estimate is the amount of the periodic charge against production. Because of the speculative nature of an investment in machinery (neither the quality of the machine being exactly determinable nor the conditions of its operation known), its depreciation is always an estimate. For this reason it should be based on the best possible knowledge available at the time of installation.

Any estimate so made must be the subject of periodic revision. How frequently this revision should be made will depend both on the length of estimated life and the way in which actual experience compares with the expected or estimated conditions. The experience on which the estimate is based should, of course, be with the same or similar machines, gained, if possible, amid the same surroundings and conditions under which the new machine will operate. In default of such experience or as a valuable check thereon, the results of others in the use of the machine and the expert advice of those who have studied the problem of depreciation in its practical applications should all contribute to the making of this estimate.

History of Machine

This need of experience data creates the necessity of a means for gathering and preserving the data, and the machinery record above referred to serves the purpose. Therein should be set forth the complete life history of the machine—not only the original cost and the additional data given above, but also the time and cost of all replacements and all information relevant thereto and, as a memorandum, the cost of maintenance, repairs, up-keep, etc. The record is not complete without the data as to repairs. A periodic statement should also be made as to any abnormal conditions under which the machine has been operated, such as overtime, overload capacity, etc. Where possible, the output of the machine in units of product should be included in the record. Where a group or battery of similar machines is operated, the average experience of all of them is the best possible data on which to base future estimates of depreciation.

The more life histories available, the more reliable will be the average obtained therefrom. After making due allowance for changed conditions of operation, this average should prove a reliable forecast of future experience. After all, an estimate of depreciation is in many respects very like an insurance charge, and the time may come when the life histories of a sufficiently large number of machines will provide a very reliable basis for estimate at any given time of the expected life of a machine when operating conditions are known.

Standards of Operation

One phase of the modern efficiency movement relates to the study of machine operation. This has helped in the study of depreciation, in that standardized methods of use have been established. These comprise a standard speed of operation, proper periods of rest, correct methods of throwing in the power, the proper adjustment of parts for each machine; and for each kind of machine tool, the proper degree of hardness to which the cutting edge must be tempered, the speed of cutting, and the number of operations before resharpening—all these standards have been established, resulting in an average performance of maximum efficiency which may be called the normal operating conditions of the machine. Where such studies have been made and where the set standards are uniformly observed, a very reliable basis is furnished for forecasting the future. To insure the observance of these standards a permanent card should be attached to every machine, giving all the information essential to standardized operation. A copy of this standard should be made a part of the record in the machine ledger.

Abnormal Operation

To make the periodic revision of the estimate of depreciation accord with the fact or rather with the best possible estimate of the fact, any abnormal operation of the machine should be considered. Thus, if the machine has been worked overtime, say on a three-shift day instead of one-shift, or if it has been crowded beyond its capacity, if repairs have not been made when they were needed, if the wage policy has been changed from a per diem or per hour basis to a piece-work basis—all these points must be considered.

Machines which are seldom used require careful consideration. It is oftentimes necessary to include in the equipment special machines for infrequent operations and processes. The normal operation of such must be estimated for each particular factory and depreciation based on such use.

All of the foregoing points must be taken into account in connection with the operation of both machines and power equipment. In the case of the power machinery, a consideration of kind and quantity of fuel, manner of feeding and cleaning, quality of the boiler water, etc., with the set standards, forms the basis for a revision of depreciation rates and estimates.

Map of Machine Location

In connection with the machinery record, a complete map showing location and number of every machine is especially desirable. In case of fire it makes identification easy.

Methods of Application of Depreciation

In the application of depreciation, three methods are used more generally than any others. The straight line method, as discussed in Chapter IX, is the one most widely employed. It is to be preferred to all others, giving satisfactory results and being easy of application. The fixed rate of diminishing value method also has many adherents, and depreciation based on the number of units of product turned out is a third method often used where applicable—though applicable in a very limited degree.

Under the straight line method, it may be ventured as an opinion that 10% is a fair average minimum rate and 15% to 20% an average maximum. The knowledge as to what constitutes an average rate serves little useful purpose, however, although it does give a rough estimate when spread over a large variety of machines. It has been said that from a mechanical point of view no machine can depreciate actually more than 30% and be operated efficiently. This does not, of course, mean that the depreciation reserve should never show more than a 30% offset to the value of the machine, as this would indicate too high a rate were the machine still in operation. It does mean that, according to a theoretical standard of operating efficiency, any machine which cannot fulfill at least a 70% efficiency test should no longer be used. It should be remembered that the depreciation reserve is a device for financing depreciation and nothing else.

Basis of Valuation

The basis, therefore, for the valuation of machinery is its full cost less estimated depreciation. Such an appraisal is subject to periodic revision by comparing the estimated with actual depreciation as more of the facts brought out by the period of life already expired become available. Perhaps the method of inventory, as will be explained in connection with hand tools, is best applicable to machine tools and even to certain small bench machines on the boundary line between tools and machines. However, special tools made for a particular purpose and perhaps not adapted to any other use should be charged against the job and not carried as an asset.

Scrap Material

A financial consideration in connection with machinery is the disposal of scrap material. This should be disposed of as advantageously as possible. It should be held until the market for old metals is high, if at the time of its discard prices are abnormally low.

Accounting for Tools

With regard to the method of accounting for hand and shop tools and the basis for valuing them, the additional factor of possibility of loss claims consideration. Unlike machines, which are for the most part securely attached to the premises, tools are loose, they may be carried off or lost, and so not only loss in value due to depreciation but loss from theft or carelessness must be taken account of. Unless an adequate control is established over the physical handling of loose tools, a very considerable leak may result at this point.

In accounting for tools, different practices are encountered. Thus, the Public Service Commission for the First District of the State of New York, in its Uniform System of Accounts for Gas Corporations, authorized that, “hand and other small portable tools liable to be lost or stolen shall, when first acquired and before issued for use, be carried in a suitable Materials and Supplies account; when issued, they shall be charged to the appropriate expense account. Portable tools and apparatus of special value may, however, be charged to the appropriate tangible capital account, and remain therein so long as record is kept of the persons to whom such tools and apparatus are issued and such persons are made responsible therefor.”

Sometimes the practice is found of charging all purchases of tools to an asset account for a short period of, say, two or three years, and thereafter to a suitable expense account, with a periodic revision based on an inventory about once in five or six years. Again, the Loose Tools account may be handled just as any other asset account, i.e., charged with all purchases, credited with losses, and depreciation provided for. The manner of handling the record is not vital, any method sufficing that fits particular needs. All methods must, however, take cognizance of the fundamental distinction between capital and revenue charges and provide some means by which the Loose Tools account, as an asset account, shall represent substantially correct asset values. A successful method of securing control over the physical handling of tools, where the plant is large enough to justify it, is to place all tools when purchased in the care of a stores-keeper and issue them only on authorized requisition, thus securing an accurate record of them.

Depreciation on Hand Tools

As to the valuation of hand tools, depreciation is often left out of account on the theory that, so long as a tool can be used to perform the service expected of it, it is worth approximately what it cost. Where as an adjunct to this method of valuation, a physical inventory of tools is taken periodically and all losses so shown are charged to expense, substantially correct asset values are secured. Of course, theoretically, tools are as much subject to depreciation as other similar assets, but the method of the inventory valued at cost, and therefore disregarding depreciation, is perhaps the best practical way of handling the valuation of tools, and it gives sufficiently satisfactory results for most purposes.

Valuation of Home-Made Machinery and Tools

Machinery and tools made in own factory offer a problem in valuation. It may be stated thus: Shall such be valued at the market price at the time when made, or shall valuation be the cost to manufacture? It is argued that had the machinery been purchased on the market, as is usually the case, the cost would have been market price; the machinery is worth that price and should be so valued. If the cost to make is less than the market, to bring the machine on the books at market would necessitate the taking of a profit of the difference between cost and market. No profit has been made, only a saving in capital investment. This confusion between profit and savings is referred to in Chapter XIII.

In the long run, i.e., in the period covered by the life of the machine, it makes no difference in profits for that period whether the machine is carried at cost to make or at market, because its value is written off to depreciation during its life and the higher value means an increased depreciation charge. This will exactly offset during the period of the life of the machine the profit taken by bringing it onto the books in the beginning at market instead of cost. As a matter of principle, however, the point involved is of sufficient importance not to justify the practice. By cost to make is meant full cost, which includes materials used, labor applied, and a fair share of the overhead expenses. Whatever the cost to make, whether lower or higher than the identical equipment could be purchased for on the market, that represents the capital outlay and is the true basis for valuation, taking cognizance of depreciation for the elapsed period.

Expenditure for Rearrangement of Machinery

In connection with expenditures made in the rearrangement of machinery within the plant for various purposes, the question of the effect of it on the value at which the machinery is being carried requires some consideration. In Chapter V where an attempt was made to mark out broad boundary lines for capital and revenue expenditures, it was stated that any expenditure which produces greater earning capacity or without which a lessened earning capacity would result (assuming that all normal expenditures for maintenance and repairs are being made concurrently), may be treated as a capital expenditure or at least as a deferred charge to be spread over several periods.

In the case of depreciating assets, the practical identity of the two methods is apparent. Thus, if the expenditures for rearrangement of the machinery have either of the effects mentioned above, there is no serious objection on theoretical grounds to capitalizing them. Instead, however, of injecting such intangible values into the machinery account, it is far better, because more exact and accurate, to show them separately. Practical considerations demand that such expenditures shall not usually influence the valuation of machinery and a conservatism born of the fear of inflation requires that when treated as deferred charges, they should be written off as quickly as may be done without undue burden on the periods’ profits.

Definition of Furniture and Fixtures

Furniture and fixtures, as an asset title, is not clearly defined. It may include the usual tables, desks, filing cabinets, bookcases, typewriters and other mechanical equipment, safes, chairs, counters, and in addition, light, heat, and plumbing fixtures, show windows, partitioning, shelving, and the like. The account should be charged originally with all such items at full cost. Great care must be exercised in handling repairs and betterments to avoid an inflation of values. The distinction between capital and revenue expenditures as regards all such assets already acquired is usually so slight and uncertain as to justify the establishment of a policy of charging all these to expense. Otherwise, the ease of inflation is apparent. All new purchases should be charged at full cost to the asset.

Valuation of Furniture and Fixtures

The basis for the valuation of furniture and fixtures is at cost less depreciation. In applying depreciation, account should always be taken of the usually very small residual values in this class of asset. Scrap value in some cases is only as kindling wood and therefore almost or entirely negligible. In some cases of easily movable equipment, the method of the inventory as used for loose tools will give better results in valuation than an appraisal method based on cost less depreciation. One often finds the conservative practice of bringing onto the books a rapid depreciation to scrap value during the first few years, at which nominal value the asset is carried thereafter. This is a common practice in financial institutions. While not theoretically justifiable, in comparison with the opposite tendency based on too great optimism as to the life of the asset, the practice is to be commended.

The average range for depreciation of this class of asset is from 10% to 20%, estimated by the straight line method. Where premises are leased and any equipment of this kind is, according to the terms of the lease, to remain with the building, it is necessary that a depreciation rate be taken high enough to accomplish complete writing off by the end of the lease. This rule also applies if the equipment may be removed but would be in a badly damaged condition, resulting in little remaining value.

Delivery Equipment—Definition and Valuation

Delivery equipment includes all property, direct or auxiliary, used in connection with the delivery of goods both inward and outward. Horses, wagons, and harnesses, motor trucks and cars, repair parts, and repair equipment, containers, holders, and the like, are common examples of this class of asset. In the main, these assets are handled very much as all the others of the general equipment group. Valuation is on the basis of cost less depreciation for the most part, but in many instances the method of the inventory should be applied.

If horses comprise a part of the equipment, not only must depreciation due to wear and tear be reckoned, but accidental causes such as death and disablement must be given consideration. Experience in each business based on the particular kind of work to be performed and the conditions under which it is being performed furnishes the only adequate basis for estimating the depreciation rate. Thus, heavy or light draughting, speed to be maintained, kind of road on which the haul is made—cobble stones, brick, asphalt, wood blocks, or dirt—and the standard of appearance to be maintained—all these affect not only the cost of up-keep but also the rate of deterioration. Sometimes it may be safe, as with loose tools, to charge all purchases to capital for the first few years until the equipment is complete, and thereafter all renewals to revenue, depreciating the asset account, say, 20%, and maintaining it at that figure. Any marked increase or decrease in numbers would require respectively an added capital charge or a reduction of the original charge. Whether this method or the method of the inventory be used for valuation purposes, there should be a periodic appraisal by an expert horse dealer and adjustment of values based on this appraisal.

Wagons, trucks, and motor vehicles should be numbered and all accounted for periodically by physical inventory. It may be desirable in some cases to maintain a register for these, wherein the performance of each can be recorded and so compared. This is particularly desirable when a change of delivery policy is under contemplation and comparative records are needed of the performance of various types of vehicles. This class of delivery equipment is best valued on the basis of cost less adequate depreciation, with the periodic inventory as a check on numbers and condition.

Carriers and Containers—Valuation

The most difficult of all the items of delivery equipment to handle and value is that class represented by carriers and containers. These may be barrels, kegs, casks, bottles, baskets, and boxes, and are met in the brewery, dairy, bakery, laundry, and oil businesses. In some lines it is feasible and is the practice to charge the customer with the fair cost of the carrier, giving a return privilege with refund, dependent upon the condition of the returned carrier. This is good where applicable, although it necessitates having an adequate redemption fund which may be operated somewhat as a bank’s reserve is, i.e., only large enough for normal needs but capable of ready enlargement when the need arises. In other lines of business such a method of handling the container cannot be used. Here, as in the bottled milk trade, only experience will give a proper basis for estimating the depreciation through loss, theft, and breakage. The rate is almost invariably high, and liberal depreciation should be provided for. Taken all in all, throughout the various kinds of delivery equipment rates ranging from 16⅔% to 25% constitute fair average rates.

Patterns, Molds, etc.—Valuation

The last kind of equipment items requiring consideration is comprised of such items as patterns, lasts, molds, dies, drawings, electrotypes, wood cuts, forms, models, and the like. Wherever possible, these should be charged to the particular job for which they were made and not carried as assets. Unless there is a probability that the pattern, mold, etc., will serve for other uses than those for which it was made, the costs of making should be borne by the job on which it was used. This is very often not the case, however, and these items can be used for successive production. This is particularly true of a standardized product which is not apt to be much affected by change in style or the whims of a purchasing public. At the best, however, they constitute a treacherous and highly speculative asset and require careful handling to avoid inflation of value. Thus, it is easy in the publishing business to allow electrotypes, wood cuts, etc., to assume unwieldy proportions to the other assets. In manufactories of wearing apparel, the fickleness of fashions requires that patterns, lasts, and models be written down ruthlessly to the lowest possible figure. Here obsolescence is a big factor.

Under the limitations set, valuation should be based on cost with a very liberal periodic depreciation. The rate will average anywhere from 20% to 50%, though a lower rate may sometimes be proper.

Disposal of Assets

In connection with the handling of the asset and its valuation account, the disposal of all or some portion of the asset requires consideration. It is a fundamental principle that whatever is taken out of the asset account must be taken at the same cost as it was introduced into the record. Thus, an asset recorded at cost of $5,000 and sold for $4,500 would be shown as taken out of its account at $5,000, the apparent loss of $500 being recorded in a suitable expense account. If the asset has suffered depreciation between the date of purchase and sale, and the depreciation reserve shows this, that must be taken into account. Practically, it is best handled by transferring to the asset account from the depreciation reserve the part of the reserve applicable to the portion of the asset disposed of. Upon disposal there is an additional credit to the asset account of the difference between cost and the depreciation to date, i.e., the amount of this credit is the present appraised value of the asset sold, taking into account not only the recorded depreciation but the accrued as well. This brings out the true as distinguished from the apparent profit and leaves in the reserve only that portion which is applicable to the asset remaining.

An illustration will show the process of handling. Assume that the $5,000 asset is a portion of a $50,000 machinery account, for which the recorded depreciation reserve is $10,000 and the depreciation on the portion sold accrued to the date of sale is $200. The entries, necessary to effect the sale, are: