Whose_Depreciation_

Depreciation: Random Thoughts Depreciation: Which definition do we use' What is depreciation' On a general note, without going into too many technicalities, it is the charge for wear and tear. It is an annual reserve set aside by the firms to replace the capital at the end of its life. These two seemingly innocuous, similar definitions are different from each other. The first definition depends on the wear and tear of the machine without bothering anything about the cost of replacement. And cost of replacement depends on technological progress, competition and obsolescence. So, which is the one we use' It’s important because the one we use would determine the depreciation rate. Seems right. But, there is a catch in this too. How do we exactly know when would the next innovative machine come and replace the existing one' Answer is: We don’t know. That’s why we should use a rate that is more than the rate of wear and tear and that tries to factor in the next technological invention. Analysts’ guesswork begins much before the revenue, FCF forecast!! Some people also define it as the rate at which the machinery value gets converted into a product’s value. E.g. - Purchase price of machine=10,00,000 INR. If we assume a flat rate of depreciation to be 20%, then at the end of 1st year, the machinery value would be 8,00,000 INR and the 2,00,000 INR(or 20% of the machine cost) must have been converted to the product’s value, making it a zero-sum game. Loss in the value of machine is equal to the gain in the value of product. Again right, but how do we know how much value would be transferred a priori' We don’t know again. Philosophical Enquiry: Why and How' What is the purpose of depreciation' In calculating free cash flows and even valuation multiples like EV/EBITDA, we exclude the effects of depreciation. Does it serve any purpose, besides earning firms a tax-shield' Marx and Mill both pointed out that the purpose of machine is not to lessen the burden of labour, but to create a surplus value. But, we also know that the source of surplus value is only labour and not machine. This argument is disputable though. But, taking it correct, how do machines generate surplus value' They do so by reducing the number of wage or salary earners required to perform a particular job (that reduces the source of surplus value though) and then increasing the working-hours in the day (that more than compensates for the decrease in the source of surplus value). This looks a wonderful situation. Firms now have less number of wage-earners and increased working hours producing a surplus value. This was the situation during the times of Industrial revolution when there were no laws to limit the working hours in a day. And there crept in this peculiar word-Depreciation. The longer working hours also mean more wear and tear for the machines. Besides, there are rapid technological advancements too that render a machine useless even before its life ends. So, there is more pressure on the capitalists to speedily convert a machine’s value into a product’s value and that again means more working hours and more wear and tear. The 3 or 4 different shifts observed in factories also result from this intention- to speedily convert a machine’s value into a product’s value. The motive behind it is clearly the increased surplus value. And look at how the real motive (generating surplus value) and its implications (increased working hours) are disguised in the name of accounting, annual charge, cost of replacement, etc. Probably, wear and tear was not the original thought behind depreciation; it was simply a byproduct of increased profits. Till now, I thought that increased depreciation leads to lesser tax-burdens and thereby increased cash flows, but above argument shows that it is quite the contrary. Now, let us consider another situation that firms keep using the machines even after the life. Let us assume that there are not many technological advances or competitive pressures to force replacement. We have seen this situation in quite a few movies of 70’s & 80’s where a factory worker would lose his hand or leg or sometimes life too because of the use of old, faulty machines. We are talking of that situation. Does this argument hold good then too' Clearly yes. We can interpret depreciation as “Wage” to a machine and how is wage determined for any commodity' Any commodity is priced according to the amount of labour into it (Ricardo and Marx both agree on it). That is another important overlooked thing that even “labour” is priced according to this rule for “commodity”. The wages for working people are, in fact, also a result of the amount of labour-time contained in them. Simplistically, a Harvard grad gets paid more than any other B-school grad because the labour people took to build Harvard campus (physically), hiring world-class professors, establishing industry networks and reputation through advertisement, etc is much more than the labour employed for any other B-school. There are other theories on salaries too like opportunity cost, risk levels, etc. But, we mainly concentrate on this aspect at the moment- that the salary is determined by the amount of labour-time contained in it. By this logic, the machine is priced according to the labour contained in it. And we give an annual, rather than daily or monthly wage to the machine. The machine has come to the end of its life. The total wage or salary due has been paid and it is still being used. We are able to extract a surplus value out of the machine too. Like labour, it also becomes a source of surplus where the wages paid are according to the amount of labour contained, but the amount of work extracted is according to the amount of product value intended-clearly a source of profit. Philosophical Conclusion: Whose Depreciation' The fault, though, is not with anyone. The capitalist system is built on inherent contradictions. The increased working hours, the cut-throat competition, the desire for profits all forced the capitalists to extract more and more surplus value out of labour. Nobody paid attention to the fact that though labour is priced according to the rule of pricing of commodities, it is not a commodity. Though it can be bought and sold, it has got a human element to it. The jobless claims are still high in US and Europe. Though we find it safe here in India, there are millions in export-oriented industries like textile, leather, spices that have lost their jobs here too. The situation looks grim still. Unless the wages grow, there can be no increase in the consumer spending. That’s pure economics, no emotion. The recovery has been led till now only by governments’ expenditure (particulary Chinese government’s forceful lending and frenzied asset buying programs) and the countries like India where the threat of unemployment has not been that severe. It’s been proved that the unemployment and complete recovery can’t go hand in hand. We are gaga about the 2nd Quarter results of the companies across the world. But, there are announcements of lay-off too. Marx was not wrong when he referred to a part of depreciation as “Moral Depreciation”. It’s actually depreciation of men getting reflected in the depreciation of machines.