Calculating Depreciation Velocity (Stick With Me, It's Not Really Accounting I Swear)

Friday, February 05, 2010 , , , 4 Comments




The idea of depreciation velocity isn't really a new one (though the term might be). It also may not normally be applied in standard accounting (at least the bizarre CPA Exam World accounting I am familiar with - which bears little resemblance to accounting "found in the wild") but it's something worth looking at moving forward. If we're going to bring integrity back to our balance sheets instead of this bullshit we've called financial reporting for the last... how many years? Want to say 30? Some do. 10? OK. 5? 2? Whatever. The point is not how long we've been fudging our balance sheets but what we're going to do from here on out to make them legitimate again.

So here's the crazy idea: how exactly are we coming up with depreciation? Does it assume economic bubbles in its models? What arbitrary, unrealistic assumption are we coming to?

WTF am I talking about?

Up until about a year ago, I had a 4 year old laptop. Since then, apparently, technology has "maxed out" to some extent and I found a replacement (burned that one out Shopping $$ coming out of Bernanke's ass, ooops) for half the price with four times the memory and 10 times the storage capacity. An important feature. =/ Anyway, are we still depreciating technology with the assumption of a "useful life" that existed in the capital-rich tech past? Not only has RAM maxed out but technological innovation is a money-hungry beast; with capital still evaporating around the globe (as it should, most of it is fake anyway), how can it thrive? I've turned into a deflationista these days and actually get a sadistic thrill out of watching it go up in smoke. Dollar after dollar, Zimbabwe Ben can't print fast enough to keep up with the made-up capital that is disappearing in his very hands.

In a technical sense, deflationista isn't the right word in my case either. This isn't deflation in the traditional sense; I don't believe we have a term for the sterilization of trillions of completely manufactured dollars. I'm not sure if the Fed meant to let accounting participate in its grand inflation scheme but that's exactly what happened, each thug complicit in his own way. Yeah I just called out my industry. It's not the first time; now let's see who comes out arguing and who slinks off into the darkness to restate their financials.

Uh anyway, let's use a different example. Sam Antar pointed to a great one that paints outrageous depreciation perfectly (even for those of us unfamiliar with the particulars of straight-line): the act of driving a car off the lot. Stick with me, kids, it's still not accounting I swear.

The moment you drive a new car off the lot, the car is depreciated. If you get into an accident the second after pulling out of the lot before the ink is even dry on your loan, the "asset" (that's your car) is already valued at less in the dealer's books than it was before your ass got behind the wheel and crashed it.

K, that's all well and good but shouldn't that assume a market for new cars? Bloated inventories? Low demand? Financing problems? $10,000 in depreciation in one month?! That arbitary measure relies on a false market that no longer exists (fine, perhaps temporarily).

So either accounting starts to teach that or, well, we stay fucked here with our bullshit financial statements and worthless cars. Not a win, BTW, if you really need it written out.

You wonder why we're here? Start with the blueprints, damnit.

Financial reform? LOL! When you guys get serious about "reform", tweet my ass, til then I have some shit to do. In the meantime, are the threats working? Didn't think so.

Jr Deputy Accountant

Some say he’s half man half fish, others say he’s more of a seventy/thirty split. Either way he’s a fishy bastard.

4 comments:

Anonymous said...

I like to think of money in the "real money" and the "future money" context where the real money is money earned and saved and the future money is credit or money borrowed. BOTH are real so long as people save AND borrow. People have been willing and able to borrow at a far faster pace than they have been able and willing to save for these past several years. I believe the powers that be like it that way and that they've encouraged that behavior for a variety of reasons. As people (both lenders and borrowers) slowly "detach" and start changing their behavior where the "future money" or credit activity is concerned, it creates demand destruction and then deflation. It is a proven fact that people will spend more and consume more (of any product or service) when credit is an available method of payment as opposed to taking those greenbacks out of their wallets and paying for something with saved money. The pain of paying is real. Borrowing is the far less painful alternative until all those statements start coming in the mail. Jeff and yes, you know I'm also "calling out" my own industry.

in the big picture of things, you know where we are at right now? There is an old phrase in my line of work of lending money to regular people and collecting it back with interest - "they all pay until they quit".

The whole thing comes unraveled and reprices when that statement kicks in - the big deals, the mbs's, the country to country sized credit arrangements, etc.

Depreciation can be calculated several ways. I think we can agree on that. In the tax world, you may have fully expensed your new laptop in the year you purchased it under Sec 179. If not, you used whatever MACRS table the IRS told you to (currently 5 year MACRS property).

On the books of your organization, you may have adopted a different policy for depreciation, maybe 3-5 years for computer equipment. I agree that it's totally arbitrary, but in most cases an organization would expect to replace computer equipment about every 3-5 years. So, on the books we're aren't considering the pace of change of the technology, just how fast we're expecting to use the asset up.

Ok, now I'm rambling. How is this not accounting related again? I think the point I'm trying to make is that in a normal world, an entity depreciates something in a rational manner over the expected life of the asset. Matching the expense to the use so to speak.

While the insurance company immediately depreciates the automobile a ton when you drive it off the lot, you didn't, so you've experienced a loss when you got hit by a bus. You have a difference in the FMV versus your book value. Doesn't matter what the automobile market is like, FMV is whatever the insurance company will give you.

Maybe I've totally missed your point. I hope not.

Michael,

No, I think you nailed it. It IS accounting related but sometimes I have to trick my readers to get them to read the accounting stuff :)

You may have missed it slightly in that I was not speaking in such official terms (insurance company FMV example totally makes sense, I was speaking more broadly) but I like the point you were trying to make and appreciate the input.

I will elaborate on this wacky idea later, just wanted to throw it out there and see what sort of reaction it caused. :) I was speaking mainly about "the useful life" of a given asset and trying to pin down whether accounting as a whole is being realistic about what a useful life is and how we come to that number.

AG

Awesome, can't wait to read more about this topic. Yes, I'm sick and enjoy this stuff immensely.

You're right in that useful life is an arbitrary concept. In the world of local governments (cities, schools, counties, etc.) the governing board actually determines what lives will be used. So, for instance, the City of San Francisco may have decided to depreciate fire trucks over 5 years because they normally replace them that fast. Whereas the small, rural municipalities I work with might set a life of 10 years and they end up keeping it for 30.

At a governmental auditing seminar I attended recently the speaker got off on a tangent on this very topic. He was telling us to look at each asset and evaluate it's remaining useful life, then adjust depreciation accordingly. So, if it's a 7 year asset in it's 5th year, but we think it'll last 4 more years, then stretch out the depreciation.

Yeah right. Even a small school or community can have far too many assets on the books to make this practical. Sounds nice, but you can't bill for the time.

In the end, useful life is (1)an estimate and (2)set up for maximum expediency. Are there better ways to estimate useful life? Most likely. Will I get paid for the time I spend looking at it and evaluating management's estimate? That's the rub.

Love the blog. Keep up the great work. It's required daily reading for me. On those rare days you take a break, it almost kills me :D