In making up a statement of earnings of a business or corporation it is very easy to deceive oneself by not taking into proper consideration the falling off in value of the property on account of the wear and tear; machinery becoming antiquated; reduction of the life of the property, as in the case of a mine, etc. In examining the statement of earnings furnished by a company in which a person is considering investing money this matter of " depreciation" should be seriously considered. It differs, of course, in different industries, but it is safe to say that the depreciation in what is called an industrial property is considerable. Some manufacturing concerns make a point to set aside each year from their profits a sum equal to 10% of the cost value of all the machinery and 5% of the cost value of the buildings. The question of charging off real estate depends upon the location, etc. In street railways the depreciation is very large. This does not appear at first, and in new roads the net earnings are given as much larger than they will appear later on unless there is an increase in business. The wear and tear to electric plants is considerable. In many classes of business which have been running years, so that the depreciation is constantly apparent, calling for repairs to the machinery, etc., it may be a sufficient safeguard to charge all such repairs, replacements and the like to operating expenses and create no special fund to cover it, but it must be certain that such repairs and replacements are equal to the actual depreciation. If some method is not adopted to set aside from earnings each year a sum to offset the depreciation of the property, the share and bondholders of such a corporation will eventually find that they have had their investment gradually returned to them in the shape of dividends and interest, representing a piecemeal payment of their principal sum rather than actual profits of the corporation. Bear in mind that it is always easy for any corporation, by a method of bookkeeping, to show fictitious earnings, and it is to safeguard this very thing that a competent " expert accountant " should, in the majority of cases, verify the earnings of a corporation before the investor may safely purchase its securities.
A distinction is made between "depreciation" and loss resulting from "wear and tear," on the ground that no matter if a plant is continually kept in the most thorough repair, the time is bound to come when, on account of newer mechanical devices and inventions, it will have to sooner or later be entirely replaced. A piece of machinery, even in the best of repair, may be suddenly thrown out and replaced by a different one. The former is but little more than old junk; the cost of the new is what must be provided for by a " depreciation account," which includes obsolescence.
Greene1 in reference to the depreciation of street railway property declares that "In the cases of companies freshly established and operating in large cities, it may be assumed, for the purpose of a rough calculation, that the roadbed will require a complete renewal in ten or twelve years, the overhead construction (if the trolley is used) within fifteen years, the electric station and buildings in from twenty-five to fifty years, the car bodies in twelve or fifteen years, and the motor trucks ten or twelve years, with the steam machinery in fifteen years. These averages of life should, of course, be extended in cases where circumstances would make such a test too severe, as for instance, in interurban lines using the turnpikes."