Harvard business reports (1930)

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FORD THEATERS, INCORPORATED 511 Commentary: This case is particularly concerned with the proper method of setting up an equipment depreciation rate for a chain of theaters. Three proposals were made. The first was that an accountant be employed for the purpose of suggesting a treatment of the problem. This proposal was discarded on two grounds: first, that it called for a specialized knowledge which might be difficult to obtain; second, that it was too expensive. It is true, of course, that the employment of such an accountant was by no means essential. If the management of the corporation possessed sufficient accounting knowledge and business experience, there is no reason why it might not be able to solve its own problems. It is not clear that the decision in the present case was wise. It may be noted that the real problem was not setting up an accounting system for merely four theaters; the company expected to add other theaters to its chain. The expense, therefore, should properly be considered in the light of the ultimate needs of the company rather than of its immediate requirements. Having decided not to employ an accountant, the company was faced with the necessity of determining a depreciation rate for its equipment on the basis of its own experience and good judgment. Two alternatives were suggested to it. Under the one, no attempt would be made to segregate the equipment into various classifications. The probable life of each item would be determined, and an individual depreciation rate arrived at accordingly. A simple arithmetic average would then be computed from these individual rates. No conscious weighting of their relative importance would be undertaken. It would be obvious, however, that unconscious weighting would result, since the low-cost, short-life equipment would be given the same weight as would the high-cost, long-life items. It would appear that the executives had in mind the establishment of such a rate. This conclusion is based on the statement that the treasurer did not believe that the equipment of theaters could be divided accurately into several classifications, and also on the statement that composite averages tended to depreciate long-life items too rapidly. The experience of several companies had indicated that it was possible to classify equipment on the basis of its probable life. Waiving the question of the soundness of the treasurer's belief, however, it is apparent that composite averages would not tend to depreciate long-life items too rapidly for equipment as a whole, if weighted according to relative investment in such equipment. Whereas some equipment might depreciate more slowly than the average rate would indicate, other equipment would depreciate more rapidly. If the figure were accurately determined, therefore, the net result would be the setting up of a depreciation reserve, which would closely harmonize with the requirements of the