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the net carrying value of any particular asset or class of assets without first analyzing the account. It is also difficult, if not impossible, to verify its accuracy as time shows how much the actual depreciation on a special class of assets has been. It will be seen, therefore, that the same objections may be made to either of these plans.

(c) Specific Reserve for Depreciation. Without a doubt this is the best plan of all. The amount of depreciation is credited to a reserve for depreciation on each asset affected. This reserve is then deducted from the asset to which it applies in the Balance Sheet so that the asset is shown at its cost, less depreciation, and its present value shown as a current or fixed asset. This is the net carrying value to the business.

(d) Reserve Funds. In all the above methods the effect of the provision for depreciation is simply to provide for depreciation and deterioration by setting aside a part of the profits annually and preventing their distribution. However, creating the reserve does not set apart a specific sum and label it for the purpose of replacing certain assets. Creating a reserve fund is entirely different from creating a reserve for depreciation. The object of the reserve fund is to set aside annually a certain sum estimated to be sufficient to replace a certain asset when it has become worthless or obsolete. In the first three methods outlined above, the problem of interest does not arise. When a reserve fund is created and a certain sum set aside and invested in securities, these securities will earn interest which in itself may increase the fund or may be treated as an income on the books and not a part of the fund. While this plan has its advantages, at the same time it reduces the working capital of the company by tying up a certain part of its funds in such a manner that they cannot be used for any other purpose than that for which they were intended. By the reserve for depreciation methods, that part of the profits set aside, are retained in the business as working capital and may be reinvested in stock-in-trade or other, assets, the income from which will very likely be greater than could be realized from a reserve fund invested in conservative securities. In order to illustrate the four methods explained above, let us assume that the depreciation on a certain machine costing $1000.00 amounted to Io per cent the first year, or $100.00. Under the first plan a journal entry would be made as follows: Manufacturing Expense. . . . . . . . . . . . $IOO.oo Machinery. . . . . . . . . . . . . . . . . . . $Ioo. oo Note that the Machinery account is credited for the amount of the depreciation thus reducing its value on the books. Under the second plan the following entry would be made: Manufacturing Expense. . . . . . . . . . . . $1oo. oo Reserve for Depreciation... . . . . $1oo. oo A general Reserve for Depreciation account is here credited. The same account would also be credited for the amount of

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depreciation on buildings, furniture, delivery equipment and possibly even for a reserve for doubtful accounts. The asset account with Machinery is not affected by the entry.

Under the third plan the following entry would be made:

Manufacturing Expense. . . . . . . . . . . . $1oo. oo
Reserve for Depr. on Machinery. $1oo. oo

A special Reserve for Depreciation on Machinery account is credited. The asset account with machinery is not affected. In stating the value of machinery in the Balance Sheet, the reserve for depreciation on machinery is deducted and only the net amount listed as an asset.

Under the last plan two entries are necessary, the first setting }. the depreciation and the second establishing the reserve und.

(First Entry)

Manufacturing Expense...... . . . . . . $IOo.oo
Reserve for Depr. of Machinery. $IOO.oo

(Second Entry)

Cash. . . . . . . . . . . . . . . . . . . . . . . . . $1oo. oo

It will be seen that the first entry is the same as that under the third plan above. The second entry is entirely different and is really no part of the depreciation entry. After this last entry has been made the cash would be turned over to a trustee, much the same as in the case of a sinking fund, and he would be instructed as to the handling of the fund. It is usually invested in high-grade securities.

Appreciation. It is always unwise to write up the value of assets even when they have undoubtedly increased in value. If we are to stick to the rule that no profit can be made except through sales, then we can never, under any circumstances, show appreciation of assets by increasing their book value.

Sometimes it is held that the appreciation offsets the depreciation and that no provision for depreciation need be made. For instance, the increase in the market value of agricultural land, might be such that it would seem that no depreciation should be considered. The fact is that the present increase in market value is a mere fluctuation in prices and may suddenly decrease while the productive value would not in the least be affected by such fluctuation. Experience has shown clearly that agricultural land is depreciating in productive value through its use. At present the upkeep is not such as to maintain the original productive value of such land and therefore, it is advisable to provide for certain depreciation.

Under no circumstances should an estimated appreciation of one asset be considered to have offset the depreciation of the same or another asset.

INCOME TAX PROCEDURE

Depreciation is a Proper Deduction from Income. It has been shown that depreciation is an operating expense and that it should be charged off by writing down the value of the fixed assets or by setting up a reserve for depreciation, preferably the latter. The Income Tax Law has clearly recognized this theory.

Income Tax Law. Section 214 (a-8) [Individuals]; Section 234 (a-7) (Corporations]. “In computing net income there shall be allowed as deductions:

“A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business.”

Capital Expenditures not Deductible. Expenditures which actually increase the value of the assets cannot be deducted as an expense.

Income Tax Law. Section 215 for individuals and Section 235 for corporations. “That in computing net income no deduction shall in any case be allowed in respect of L

“Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate.”

Replacements and Renewals must not be Deducted Twice. As previously explained expenditures for repairs and replacements cannot be deducted as an expense and again be provided for through a depreciation reserve.

Income Tax Law. Section 214. (c) “That in computing o income no deduction shall in any case be allowed in respect O

“Any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made.”

(Reg. No. 33, 1918, 432.) “The cost of incidental repairs which neither add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition, may be deducted as expense, provided that the plant or property account is not increased by the amount of such expenditures. Such repairs, to the extent that they arrest deterioration, should have the effect to reduce the depreciation charge otherwise deductible.”

Income Tax Primer, 1918, question 99. Ruling. “If a tax payer wishes to claim the full amount of depreciation estimated to have occurred in the value of a building or other property used for business or trade purposes, he may do so, but this precludes his claiming a deduction to cover any amount expended during the same year in making repairs. If he wishes to claim a deduction on account of repairs, their cost must be deducted from the full amount of depreciation, and the balance

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may then be claimed as a deduction under the heading of ‘Depreciation'; that is, if the tax payer expends $100.00 in making repairs to a building which will depreciate in value $200.oo during the calendar year he may claim $100.00 as a business expense and $100.00 as depreciation, or he may claim $200.00 as depreciation and nothing for repairs, in short, the aggregate deductions claimed on account of repairs and depreciation must not exceed the full amount of depreciation estimated to have occurred. (Note—The repairs referred to in this paragraph are such as are general in character, represent replacements, etc. Small items, such as replacement of broken window panes, papering, minor repairs, etc., are allowable, even though full amount of depreciation has been claimed.)”

Depreciation must be Entered on the Books or it Will not be Deductible. The 1918 law does not specify that depreciation must be charged off on the books of an individual or a corporation, but the commissioner, is given ample power to enforce proper accounting methods and the following regulations show that he has done so.

(Reg. No. 33, 1918, 484.) “Within the purview of this item depreciation, to an amount measuring the decline in value due to exhaustion, wear and tear of property arising out of its use, is a loss. This loss, in order to constitute an allowable deduction from gross income, must be charged off. The particular manner in which the amount shall be charged off is not material, except that the amount measuring a reasonable allowance for depreciation must be either deducted directly from the book value of the assets or credited to a Depreciation Reserve account, and as such shall be reflected in the annual Balance Sheet.”

(Reg. No. 33, 1918, T 48o.) “The fact that no reserve was made for depreciation indicates that there is no loss on this account to be provided for.”

Basis of Depreciation. (T. D. 2754, Aug. 23, 1918.) . “A reasonable allowance for the wear and tear of property arising out of its use or employment in the business or trade is to be based on the cost of such property or on its fair market price or value as of March 1, 1913, if acquired prior thereto. In the absence of proof to the contrary, it will be assumed that such value as of March 1, 1913, is the cost of the property, less depreciation up to that date.”

Rates of Depreciation. (Reg. No. 33, 1918, "I 485.) “No definite rate has been fixed by which an allowable deduction on account of depreciation in the value of any class of property subject to wear and tear is to be computed, but it is contemplated that this allowance shall be computed upon the basis of the cost of the property and the probable number of years constituting its life. The deduction to be allowed relates solely to loss due to use, wear and tear, and the matter of obsolescence is not relevant, inasmuch as when the property becomes obsolete a deduction for the loss sustained thereby, representing the difference between the cost and the amount of depreciation previously charged off or which should have been charged off in prior years will be allowed.”

It will therefore, be noted that the law makes no reference to definite rates of depreciation. Neither does the Treasury Department specify rates which shall be considered satisfactory. The law merely specifies that the depreciation allowances shall be “reasonable.”

REVIEW OF THE LAW OF CONTRACTS

As to time of performance, contracts may be divided into two classes—EXECUTORY and EXECUTED.

A contract is said to be executory when some condition remains to be performed. It is an engagement to do or not to do a particular thing. All contracts are or have been executory.

A contract is said to be executed when all the conditions have been performed and nothing remains to be done. An unpaid note is an example of an executory contract, but when paid it becomes an executed contract.

The chart on page 62 of Chapter Five shows that a contract may be discharged “by performance.” When all the conditions to a contract have been performed the contract is discharged. These conditions may be classified according to the time at which they should be performed, and are known as (a) PRECEDENT CONDITIONS, (b) CONCURRENT CONDITIONS, and (c) SUBSEQUENT CONDITIONS.

A Condition Precedent exists when some condition must be performed by one party before the other party becomes obligated to perform his part of the contract, or when some condition must be performed before a contract exists.

A Condition Concurrent exists when a condition must be performed by one party at the same time that the other party is required to perform some other condition of the same contract. The one party must perform or offer to perform the conditions imposed by the contract, at the time the demand for performance is made upon the other party. Otherwise, the other party cannot be said to have committed a breach.

A Condition Subsequent exists when the occurrence of some fact will destroy the contract in the event it happens, provided the parties have expressly agreed thereto.

Sunday Contracts. Contracts made on Sunday are void or at least unenforceable under statute law in practically all the states. Statute law forbids work, labor or business on Sunday, unless it can be shown that they relate to works of mercy, charity or necessity. Examples of Sunday contracts which are usually

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