CHAPTER XVI

MACHINERY AND TOOLS, FURNITURE AND FIXTURES, AND OTHER EQUIPMENT 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