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Packet Company v. Bain (Court of Session, Scotland, ist, 2nd and 16th June, 1897). The Commissioners had allowed depreciation at 572 per cent, being 5 per cent on cargo steamers and 6 per cent on passenger steamers (on diminished value), and the company appealed, claiming 7/2 per cent-viz., 7 and 8 per cent respectively. The court dismissed the appeal.

Questions to Commissioners on their basis of assessment:

(1) What period of years they assumed as the average duration of the profit-producing life of the ships, having regard to their annual depreciation in value solely by wear and tear;

(2) Whether an allowance of 5/2 per cent on the value of the steamer (year by year) would of itself be sufficient to produce a sum at the end of the steamer's average life equal to the steamet's cost; and

(3) Whether in fixing the sum allowed for depreciation they took into account the probable return obtainable by the due investment of the sum so allowed.

Reply of the Commissioners:
(1) That they had assumed 22 .years as the average;

(2) That 572 per cent on the diminished value will itself amount, in 22 years, to 71 3s. 1od. per cent; and if the money so allowed were used in trade to produce 5 per cent, the amount would be increased to £138 25. 8d., also, if invested in Consols, say' at 2%, per cent, it would amount to £98 11s. 2d. That this left out of view the breaking-up value of the ship; and

(3) That in fixing the deduction they had taken into account that the sum annually allowed might be so invested as to produce a return of 3 per cent per annum.

The statute, Lord Trayner said, did not limit the deduction to such a sum as if invested at 3 per cent would indemnify the person; it entitled him to the full amount of the depreciation, without condition as to how he disposed of it. The Commissioners were, therefore, wrong in taking the interest into account.

At the meeting of the Peninsula and Oriental Steamship Company in December, 1896, Sir Thomas Sutherland, speaking on the question of wear and tear, stated that between 1870 and 1894-a period of 25 years—the company had sold for £516,601 steamers of which the original cost was £4,436,362, and, further, that during the time in which these steamers had been in the company's service the amount of depreciation written off at 5 per cent on the original cost, added to the amount realized by the sales, aggregated only £4,267,621, as compared with the original cost as above.

The usual allowance for refrigerators or refrigerating machinery is understood to be 6%2 per cent on the prime cost; for oil tank steamers 5 per cent on prime cost.

Soap industry.-Depreciation in this industry is about the same as in chemical factories.5

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Textile industry.—In the textile industry the depreciation on buildings is somewhat heavy owing to the vibration of the machines. The rate assigned to the machinery is often made high because of the likelihood of obsolescence and the introduction of new appliances. The average depreciation provides for about 3 per cent on the building and 6 per cent on the machinery

There is a wide variance in practice as to the depreciation of textile machinery. In some districts where machines, perhaps fifty years old, are giving good service today, the disposition is toward low rates. In this industry the continual renewal of many different parts of a loom serves to reduce the depreciation rate. Experience proves, however, that some of these old machines are “pets” and more modern machines which have been worn out and replaced several times in the same period are forgotten. A writer in the Textile World Record suggested 334 per cent as a rate for cotton and woolen machinery, including spinning and weaving machinery. A prominent Boston firm of textile mill engineers uses these rates : Woolen and worsted machinery....

2-22% Cotton machinery..

3 Dyeing and similar machinery subjected to acid fumes, etc.

5

Timber industry.53—Specific provision is made in the regulations regarding depreciation on property used in a timber project when the probable life of the asset exceeds that of the

"See page 714.

"For regulations relating to depletion of timber lands, see Chapter XXXI.

project itself. The same rules as apply in the case of mining, oil and gas projects apply here, viz., that the life of the project shall be considered a limiting factor, due allowance being made for salvage value. (See page 726.)

Tools, jigs, dies, etc.-As a rule the practice of depreciating small tools by means of a percentage cannot be followed satisfactorily. So many such tools are used up, lost or stolen, that an inventory should be made periodically and all the tools on hand should be revalued. If this plan is followed for several years and a trustworthy rate of depreciation is secured, it may be feasible to omit the revaluation for a year or two, applying the rate previously ascertained. The tax commissioner of one of the states has adopted rates varying from 25 to 50 per cent or, as an alternative, the entire cost of replacements.

In many manufacturing concerns the item of tools, jigs, dies, etc., not standard equipment, is a large one and the tendency is to overvalue it. Heavy depreciation should be applied, because most of such equipment is made or adapted for special uses, and the inevitable changes in types and styles of production require corresponding changes in the tools. As stated heretofore under “Patterns, drawings, models, designs, etc.” page 730), the book value should be written down very rapidly. The minimum rate should not be less than 20 per cent.

Edward N. Hurley, former chairman of the Federal Trade Commission, urges that special tools be charged off practically at once, and states that the neglect to depreciate this account rapidly enough has been responsible for many failures.

Typewriters.-In the average office, and where properly cared for, the life of a good typewriter is from three to five years. In some offices the machines are turned in and new ones purchased every two to three years. Such typewriters are repaired and resold and are used several years more by those who buy them second-hand. Repairs are not profitable

after the machines have been used from six to eight years. An annual depreciation rate of 20 per cent is conservative.

Wagons, trucks, etc.—In the case of wagons it will be found that 8 to 10 per cent per annum is an ample allowance, provided that all repairs, renewals of parts and maintenance are charged to operating expenses.

Wood-working industry.-On buildings and equipment in the wood-working industry the depreciation is low-about 2 or 3 per cent on buildings and 6 per cent on equipment.

CHAPTER XXX

DEDUCTIONS FOR EXTRAORDINARY
OBSOLESCENCE AND AMORTIZATION

Federal income tax laws prior to 1918 contained no reference to obsolescence and amortization but conditions in 1918 required that explicit authority should be given to the Treasury to grant and to taxpayers to deduct adequate allowances for losses which might not otherwise be permitted.

Ordinary obsolescence is usually merged with depreciation and is discussed in the preceding chapter. In this chapter extraordinary obsolescence and amortization will be considered.

Obsolescence

LAW. Section 214. (a) That in computing net income there shall be allowed as deductions: .

(8) A reasonable allowance for . obsolescence;'

The Treasury prior to 1918 allowed as deductions realized obsolescence. As such deductions could have been made as losses whether or not obsolescence as such was specified in the law, the reason for the specific mention of obsolescence in the 1918 law was to permit the accrual of obsolescence "so as to allow for such future obsolescence as may be expected from experience to result from the normal progress of the art."

Under the most recent rulings so-called “ordinary obsolescence," vir , that obsolescence which is accruing but which cannot be definitely ascertained, is to be included in the annual depreciation allowances rather than in a specific reserve for obsolescence.

*This section deals with individuals. Section 234 (a-7) applies the same language to corporations.

'Reg. 45, Art. 166.

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