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Depreciation

Crouser Report OnLine May 1, 1996
Trasmitted from Sioux City, Iowa We ll be headed to DETROIT on May 11th where we will be spending Saturday morning chatting with you about printing and prices. Coming up: ATLANTA, May 18th; CHICAGO, June 1st; MIAMI, June 15th (note change from the 22nd); and COLORADO SPRINGS, August 24th. Fax (304) 342-5187 or call (304) 342-5100 if you want to attend any of the sessions. The session is FREE, but you must PRE-REGISTER.

Dear Friends. . .
I guess this is as good of time as any to comment about depreciation. Depreciation gets a very bad name, especially from folks who somehow misconstrue the concept as getting away with something, or in the United States, as cheating the government out of tax revenue. So, let s try to set the record straight. More importantly, the misinformation tends to keep some printers from realizing how poorly they are really doing.

Depreciation, and its first cousin amortization, comes from the fact that capital equipment has a positive impact on several years of your work and not just one year. A piece of capital equipment, by the way, is equipment used to produce goods and services. A machine to make automobiles or a printing press or a manufacturing facility are capital goods, or in this case, capital equipment.

Depreciation, by the way, deals with a real asset such as equipment. Amortization, on the other hand, deals with intangible items such as a Franchise Fee. There is generally no other conceptual differences between depreciation and amortization.

Example: Let us use a simple depreciation example. While this first example does not take into consideration current with tax law, it does supply you with a basis to understand the concepts of depreciation. We will consider taxes later.

We buy a press for $20,000. A basic accounting principle is to match income and expenses. The press is an expense, but is it an expense for the year inwhich it is bought? Yes, but its useful life extends over a number of years. For simplicity, let s say we know the press will last exactly five years and we purchase it on the first day of year one.

Further, let us estimate that the $20,000 press will have a salvage value at the end of 5 years of $5,000. Therefore, we would use up $15,000 worth of value over a period of five years. Taking it one step further, $15,000 divided by five years would yield an estimated depreciation expense of $3,000 per year.

The way your accountant will technically handle this transaction is that they would first debit an Equipment account for $20,000 and credit (deduct) $20,000 from the Cash account if you were paying cash. In order to keep ourselves focused on what happens to the depreciation, we will assume you pay cash for the equipment although that is rarely done.

Every month your income would be charged with part of the depreciation. For instance, a debit to Depreciation Expense for 1/12th of $3,000 or $250 would occur and a credit to Accumulated Depreciation for the same $250. This Accumulated Depreciation account is a contra account to the equipment asset account.

This allows the accountant to keep the amount of the original equipment purchase whole while still account for the estimated usage of the equipment (depreciation). At the end of year one, the Equipment account would show $20,000 and would be offset by Accumulated Depreciation of $3,000 (12 months x $250 per month). The net value of the equipment would be $17,000 or $20,000 - $3,000. This net value is called book value since that is the value placed on this piece of equipment on your books.

At the end of year two, the Accumulated Depreciation would be $6,000 ($20,000 - (24 months x $250)) and the net book value would be $14,000. At the end of year three, the net book value would be $11,000 ($20,000 - (36 months x $250)). Same thing at the end of year four. The net book value at the end of year four would be $8,000 ($20,000 - (48 months x $250)). And, at the end of year five, the net book value would be $5,000 ($20,000 - (60 months x $250)).

Now, assuming you do not change the basic assumptions that the equipment will be worth $5,000 at the end of the useful life, no further depreciation would occur until you sold the equipment.

Paying For The Equipment: Most of us don t have $20,000 in cash to give to the equipment vendor on day one. Instead, we finance with some sort of down payment and a payment plan over a period of time. For example, assume we put down $2,000 in cash and/or equipment and finance the balance for three years. And, to keep it even simplier, let s disregard interest charges and just stick to the $20,000, of which we have financed $18,000 over three years.

Let s say we get our local branch of the interstate bank to go along with the loan of $18,000 which we will pay back in 36 equal installments of $500 (again disregarding interest).

Assume then that we make 12 payments of $500 or a total of $6,000 in year one. What shows up on our income statement as an expense? The payments of $6,000. No. What shows up is our year one depreciation expense of $3,000. Hey. We pay out $6,000 of cash and get to deduct only $3,000! Yes, and this is why we have to be so careful in our equipment purchases. However, the $6,000 payout stops at the end of year three and the depreciation expense goes on for two more years at a rate of $3,000 per year, eventually catching up.

How does it catch up? You pay $2,000 up front and $6,000 per year for three years for a total of $20,000. Your depreciation is $3,000 per year for five years, for a total of $15,000 and you have a piece of equipment worth $5,000 or also a total of $20,000.

Tax Law: I have been describing what is known as straight line depreciation with salvage value. In the United States, this is not now used for our businesses. That s because there was other types of depreciation which attempted to estimate (some say estimate better) the using up of the value of the equipment.

Double Declining Balance placed more depreciation in the front years and less depreciation in the later years and was attractive for it more closely resembled the lot of most of us who had to borrow money to buy equipment. Sum of The Years Digits was another method like Double Declining, which attempted to do a similar feat of front end loading depreciation. And there were more. However, that s not really important now, for the US Internal Revenue Service stepped in.

I ve got to say I did feel a little sorry for the IRS in trying to keep up with the many different methods. I say that for it was hard for me to keep up with various clients on various methods. Anyway, I guess that was the reason they modified the tax code to developed the Accelerated Cost Recovery system. After a few years, that was modified and since has become something we all know and love as the Modified Accelerated Cost Recovery System.

This system places all equipment purchases, for instance, into a standardized time recovery of costs, or depreciation, can occur. It also allows some front end loading of depreciation while requiring the folks who bought a press and said it would be completely used up in two years to be more realistic in their estimates. In addition, it allows a certain amount of equipment purchases to be deducted and expensed in the year of purchase. Your accountant can explain the details as I am sure they may even change by the time you read this. However, the bottom line is, there is, more or less, a fixed chart of depreciation you can take for capital expenditures such as equipment.

The practical effect of this change, in my observation, has been for the printer to be able to have MORE depreciation than PAYMENTS in many cases.

Bottom Line: However, the bottom line is that the Modified Accelerated Cost Recovery System (MACRS) is also an estimate. You may choose to use some other form of depreciation for your internal books, but must report using MACRS. Net effect is folks don t go through the added hassle and expenditures of doing it. So, we are stuck with it and we all use it on our federal income taxes.

The Point: My point is that regardless of using MACRS and regardless of your depreciation expense being more than your payments, the net effect is the same. Depreciation is a real cost of using up the value of a capital asset over more than one year. Go buy a car. Drive it around the block and try to sell it back to the dealer. You will get less than what you paid. That s a real cost and it happens with cars as well as printing presses and computer systems.

So, to the many printers who tell me, I made money, but of course it didn t show because of depreciation. I say, hog wash. Where many feel they are making money is when the equipment is sold. Let s go back to the basic example.

Selling The Equipment: When we actually sold or traded in the piece of equipment at the end of year five, we may or may not get $5,000 for it. We may only get $2,000. In that case, we would recognize a Loss on the Sale of Equipment in the amount of $3,000 which would, in essence, be similar to taking an additional depreciation of $3,000 at the end.

Others will get $8,000 for the equipment. Well, that also is just an estimating variance and we would take a $3,000 gain at the sale which would have the effect of recapturing the over depreciation of the press.

Summary: I have seen printers with 20% plus in net owner s compensation but who have poor earnings. Why? Their operating income (Revenue minus Operating Costs of Direct Materials, Wages And Overhead) was 2%, but their Extraordinary Income was 20% based on the Gain on Sale of Equipment leaving them with 22% Net Owner s Compensation. I also hear printers very frequently refer to Depreciation as not being a real expense. It is. Regardless of whether you win or lose at buying and selling equipment, depreciation is a real expense. Believe it and don t lull yourself with a fantasy. Clarification

In April, I wrote the following paragraph about analyzing income.

Best Strategy: Which strategy is best? Any combination which produces 20%+ owners compensation. Can you have too much of a good thing? Yes. One owner asked me how to get more than his 35% owner s compensation. I suggested he start shorting the customer. When they order 1,000, deliver 950. That should eke out a percent or so more. In the meantime, he should spend more on sales activities. . . .

My best reader of all things important, my Aunt Annette Massey, drew my attention to this paragraph and suggested. . . naw, chastised me. . .for inferring that a person should do something like short a customer. I guess my tongue in cheek suggestion that someone short a customer was a lot much. I did not mean that a person should short a customer. I meant that the only way that person could get more compensation out of this business as a percentage of sales would have to involve something like shorting a customer, but I in no way endorse it. And, by the way, I have seen about 38% tops for a print shop over a full year. Anyway, that s what I meant even if it didn t come out that way.

Free Saturday Morning Seminars

By the time you read this, you may have missed our first overflowing FREE seminar in San Francisco (April 27th), but hopefully you will be able to spend some time on Saturday morning to visit with me about pricing and other topics in the following cities: Detroit, May 11th; Atlanta, May 18th; Chicago, June 1st; Miami, June 22nd; and Colorado Springs, August 24th. Officially, it s the 1996 Power Pricing Seminar. Unofficially, it s a great chance for us to meet and compare notes. Sessions will begin at 8:30 with coffee at 8 am and end at noon.



Happy Trails, Tom Crouser 1996 Power Pricing Seminar Featuring Tom Crouser s Pricing Systems With Special Comments On the 1996 NAQP Price Survey sponsored by Crouser & Associates.

Especially For Shops With Less Than 14 People Coming to:
Atlanta, May 18th
Chicago, June 1st
Detroit, May 11th
Miami, June 22nd
Colorado Springs, August 24th


Spend Saturday morning (8:30 -12 noon) with Tom Crouser and learn:

The 5 Strategies Of Printing Price Competition! These are the only ones available to you! Learn what they are and begin using them to increase your profit!

The Real Secret To Making Money In Print Shops- how to make lots of money with either a high or low price.

How the Printing Price Calculation Keeps You Poor - Using production standards for estimating, as most computer estimating programs do, keeps you from earning a decent living.

Calculating Your Costs the Easy Way - Learn two rules of thumb which allow you to quickly estimate a cost rate for anything you do!

Why Pricing Is Screwed Up In Printing - Why the price paid depends more on your negotiating skills than on your job cost. See how you do.

Cost, Pricing and Estimating - See how the differences in each may be costing you lots of money.

Plus! How the Crouser Method gets better prices! Throughout the session, Tom will use tools he has especially developed for the printing industry. See the new Crouser s Quick Estimator in action!

Using Customer Service To Get A Higher Price - An example of non-price competition you can hear.

Learn Where Printing Prices Come From - Tom relates a brief history of pricing in the printing industry. You will find it fascinating.

Also Hear Tom s Own Analysis of the results of the 1996 NAQP Price Survey sponsored by Crouser & Associates.

TO REGISTER: Email TomCrouser@aol.com with your name, address and telephone. You will be contacted regarding the meeting site. Or fax your reservation request to (304) 342-5187. Or call (304) 342-5100. The session is FREE but a ONE WEEK ADVANCE registration is required. Act now. BACK ISSUES May Be Found at the National Association of Quick Printer s America On Line Site (keyword: NAQP, publications, Crouser Report) or on the internet at the PrintUSA web site (http://printusa.com/articles/crouser.htm) or on PrinterNet. Hey, do we get around or what?

Crouser & Associates - Helping Printers Prosper Since 1985

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Sunday, May 05, 1996 7:33:47 PM

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