[OPE-L:3752] Revaluing capital

From: P.J.Wells@open.ac.uk
Date: Tue Sep 05 2000 - 10:42:34 EDT

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This is an initial response to John E and Michael P's posts about
depreciation and the problems of estimating the physical and economic life
of constant capital (strictly, I suppose, we should talk of the fixed
component of constant capital if we confine ourselves to depreciation as
such - but it seems to me that the wider issues involved here also relate to
the problem of valuing inventories, i.e. circulating constant capital).

In #3711 John asked Fred M how he would calculate depreciation in the case
of a new machine costing $1000 and with a physical life of 20 years and an
economic life or 10 years, and speculated that Fred would charge $50
(assuming no technical change).

I don't think Fred has responded to this precise point and I look forward to
his answer, because it seems to me that there's nothing in his
interpretation that requires this.

Fred says that the value of constant capital is the sum of money advanced to
purchase it.

In the UK, the relevant accounting standard (SSAP12, which incidentally
defines depreciation as " a measure of wearing out, consumption or other
loss of value of a fixed asset whether arising from use, effluxion of time
*or obsolescence through technology and market changes* ") says that
provision for it should be made "by allocating *the cost or revalued amount*
... as fairly as possible to the periods expected to benefit from their use"
(emphases added).

The effect of the second emphasis is to put on all fours a continuing
enterprise and a new one which begins at the start of year two by *actually*
buying a second-hand machine. - i.e. at the start of the second year of the
machine's life a continuing enterprise can be viewed as advancing ($1000 -
depreciation) to purchase a second-hand machine from itself (or rather from
itself in its incarnation of the previous year).

Hence I claim that what is actually charged to depreciation (and for what
reason) is irrelevant to Fred's interpretation.

However, I agree with John that a sensible enterprise, given the estimates
of physical and economic life in his example, would expect (at the beginning
of year 1) to charge $100. What they actually charge in the event, of
course, will depend on events during the year.


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