04-20-2014, 08:08 PM
I'm having trouble understanding why depreciation is counted against earnings. For example, let's say UPS buys a new truck. For the sake of simplicity let's say they pay for the whole thing up front. The cost of the truck gets subtracted from the company's earnings that quarter, because it was money out of pocket. The book value of the company does not change, except by the difference between the cash spent on the truck and its immediately depreciated value.
In subsequent quarters, the value of the truck declines, and the book value of the company along with it, but that doesn't cost UPS any money because it's already been paid for. All maintenance counts as OpEx. When the truck outlives its economic life and they sell it, they will exchange its depreciated value for cash, and the depreciation of the asset will have already been reflected in the book value of the company. In my mind, that should be the end of story. However in recording depreciation against EPS every quarter, it seems like companies are recording the cost of an asset twice.
The same should go for pipelines, drill rigs, railroad tracks, airplanes, office chairs, etc.
I was secure in this conclusion until I read the 2013 Berkshire Hathaway letter to shareholders. On page 14, Warren Buffet states:
Warren Buffet isn't one to defend GAAP accounting in order to maintain the status quo; in fact, in the previous pages of this letter he makes clear his disdain for GAAP rules he does not agree with. Therefore it seems that he genuinely believes that depreciation costs a company money. So I ask the forum: How can that be?
Dan
In subsequent quarters, the value of the truck declines, and the book value of the company along with it, but that doesn't cost UPS any money because it's already been paid for. All maintenance counts as OpEx. When the truck outlives its economic life and they sell it, they will exchange its depreciated value for cash, and the depreciation of the asset will have already been reflected in the book value of the company. In my mind, that should be the end of story. However in recording depreciation against EPS every quarter, it seems like companies are recording the cost of an asset twice.
The same should go for pipelines, drill rigs, railroad tracks, airplanes, office chairs, etc.
I was secure in this conclusion until I read the 2013 Berkshire Hathaway letter to shareholders. On page 14, Warren Buffet states:
Quote:Every dime of depreciation expense we report, however, is a real cost. And that’s true at almost all other companies as well. When Wall Streeters tout EBITDA as a valuation guide, button your wallet.
Warren Buffet isn't one to defend GAAP accounting in order to maintain the status quo; in fact, in the previous pages of this letter he makes clear his disdain for GAAP rules he does not agree with. Therefore it seems that he genuinely believes that depreciation costs a company money. So I ask the forum: How can that be?
Dan