[1940] Ch. 34 THE RELATION OF DEPRECIATION AND SIMILAR CHARGES TO EARNING POWER
Edited: 1 year ago

Summary:

Chapter 34 investigates the link between depreciation and similar charges, and their effect on a company's earnings. Depreciation, the anticipated decrease in asset value due to wear and tear or obsolescence, can take various forms and is complex to account for. Accounting rules may allow different base values, some companies may not follow standard practices, and there can be inconsistencies between accounting and investment perspectives.

The chapter focuses on industrial, oil, and mining companies, and public utilities. It discusses the complexities of depreciation base, rate, and discrepancies between balance sheets and income accounts. The cases of American Can and National Biscuit Company illustrate how poor depreciation practices can distort earnings.

In the mining sector, accurate reporting of depletion charges is vital as reserves deplete. However, many companies fail in this, so investors should independently calculate these charges. In the oil industry, depletion charges reflect the ongoing costs of maintaining production levels. However, accounting policies vary, affecting reported earnings. Analysts should use a uniform, conservative amortization rate when evaluating oil companies.

The comparison of Continental Oil Company and Ohio Oil Company highlights the challenges of adjusting accounting practices in the oil industry. Despite similar oil production, they used different accounting methods for intangible drilling costs. It's recommended that losses on retired property and abandoned leases be charged against earnings, not surplus.

In conclusion, accurate accounting for depreciation and similar charges is crucial for assessing a company's profitability. Depreciation practices vary across industries, and discrepancies can distort financial statements. Therefore, investors should independently calculate these charges for a clearer understanding of a company's actual earnings.