Depreciation

Depreciation over the life of a machine is the difference between initial cost and the final value (i.e., Q - Cy). The yearly depreciation d) is sometimes calculated by a straight line method  

A sinking fund method is also sometimes used  

The use of depreciation as an allowance against tax forms part of net present value and discounted cash flow measures of profitability to be considered later. 

The variable costs are those directly resulting from the operation of the plant and dependent upon how much product is made. They will include the costs of all raw materials and other materials consumed by the process, of all utility services (electricity, gas, water, compressed air, steam, etc.), plus the costs of packaging, and maybe a waste disposal cost, if that is related to production rate. These costs will vary if, for example, an underrun in the first year or two is being allowed. 

The fixed operating costs are those that do not change with production level. The most important is the cost of operating, maintenance and service labour, plus its management, but also included are such items as insurances of all kinds, local taxes, waste disposal (which may be a fixed cost rather than a running cost) and energy tax (carbon levy). Apart from labour, the cost of which is based upon the nature of the plant (its complexity, its level of automation), these other fixed costs are usually obtained by factoring from the plant s capital cost. 

If the project and the company are the same, then these are all the costs to be considered. However, it is usual for the project to be situated among other plants belonging to the company on a larger site, and then there are general costs for the whole site (such as a fire station, the security guard system, a canteen) to be shared among all the plants. This overhead charge (direct if it is for the same site, plus indirect for the company s other activities) is usually derived on a capital investment proportional basis. 

This leaves just one major production cost item to deal with, that of depreciation. 

Fixed assets (excluding land) used by a company usually decrease in value over time, even when properly maintained. This can be due to product obsolescence or simply wearing out (with an ultimate need to be replaced). If an asset life is less than a year, the expenditure on it is included in the profit/loss account as a cost. If, however, its life is greater than 1 year, then a way has to be found to adjust both profit/loss account and balance sheet to give recognition to the actual life of the asset. 

In Section 6.1.2.3.viii, installed capital cost was calculated to be 13,800. Writing the investment off over three years, the capital element of the cost per batch is  

---

It should be noted that a capital allowance Is not a cashflow item, but is only calculated to enable the taxable income to be determined. The treatment of capital allowance for this purpose is a petroleum economics approach, which may differ from the accountant s view of depreciation when calculating net book values and profit. 

Land purchases and many of the costs associated with faciUty development can be accompHshed with long-term loans of 15 to 30 years. Equipment such as pumps and tmcks are usually depreciated over a few years and are funded with shorter-term loans. Operating expenses for such items as feed, chemicals, fuel, utilities, salaries, taxes, and insurance may require periodic short-term loans to keep the business solvent. The projected income should be based on a reaUstic estimate of farmgate value of the product and an accurate assessment of anticipated production. Each business plan should project income and expenses projected over the term of all loans in order to demonstrate to the lending agency or venture capitaUst that there is a high probabiUty the investment will be repaid. 

Simply looking at the feedstock prices or price ratios is iasufficient to accurately identify the most attractive feedstock because the values of all of the co-products and by-products must also be taken iato account. This is usually accompHshed by calculating the cost to produce ethylene with all other coproduct and by-product yields credited against the cost of ethylene. An example of the cost of ethylene is presented ia Table 4. The cash costs of ethylene from various feedstocks are compared for the months of July and November of 1991. Cash costs reflect all plant manufactufing costs except depreciation and are a measure of the out-of-pocket cash costs generated by the operation. 

This includes labor costs, variable costs, overhead, taxes, and depreciation. 

The first stage of the Stuart oil shale project near Gladstone, AustraUa, 6000 t/d (6600 short tons /d), is scheduled to be constmcted by Southern Pacific Petroleum. Einancial assistance from the AustraUan government, consisting of special depreciation incentives and exemption of gasoline taxes equivalent to about U.S. 1.91/m of cmde shale oil ( 12.00/bbl) has been assured (68). 

The key elements of the cost of production of phenol are feedstock cost and capital cost. For phenol produced on the U.S. Gulf Coast in a 200,000 t/yr phenol plant built in 1994, the cumene feedstock cost represents 70% of the net cost of production, after allowance for acetone coproduct value. Depreciation of equipment represents 14% of the net cost and utilities approximately 7.6%. The remaining 8.4% covers all other expenses, including plant labor, maintenance, insurance, adininistration, sales, etc. 

Among the key variables in strategic alkylphenol planning are feedstock quaHty and availabiHty, equipment capabiHty, environmental needs, and product quahty. In the past decade, environmental needs have grown enormously in their effect on economic decisions. The manufacturing cost of alkylphenols includes raw-material cost, nonraw-material variable cost, fixed cost, and depreciation. 

Depreciation costs can drop from as high as 50% of the total manufacturing cost to less than 10% as the plant ages. The effect of the changing depreciation rates is tempered if after-tax analysis is used. 

Indirect charges are 16% of fixed investment per ton per year 10% depreciation 1.5%, insurance 3%, maintenance (labor, materials) 1.5%, general sales and marketing. 

Cash cost excludes 10% depreciation allowance and 20% pretax ROI. 

Increasing fuel costs and sizes of industrial and utiUty installations have forced the emphasis in economical considerations to shift to high thermal efficiency, rehabiUty, and avadabihty. The investment, operating, maintenance, transmission, insurance, and other costs as well as depreciation must also be considered, but these are often less important. 

Land cost, a part of the direct plant cost, is placed in a separate capital category because it is not depreciable. Land cost is site-specific and highly variable. 

The manufacturing cost consists of direct, indirect, distribution, and fixed costs. Direct costs are raw materials, operating labor, production supervision, utihties, suppHes, repair, and maintenance. Typical indirect costs include payroll overhead, quaHty control, storage, royalties, and plant overhead, eg, safety, protection, personnel, services, yard, waste, environmental control, and other plant categories. However, environmental control costs are frequendy set up as a separate account and calculated direcdy. The principal distribution costs are packaging and shipping. Fixed costs, which are insensitive to production level, include depreciation, property taxes, rents, insurance, and, in some cases, interest expense. 

Raw material costs should be estimated by direct computation from flow rates and material prices. The flow rates are deterrnined from flow sheet material balances. The unit prices are obtained from vendors, company purchasing departments, or the Chemical Marketing Reporter. For captive raw materials produced internally, a suitable transfer price must be estabHshed. Initial catalyst charges can be treated as a start-up expense, working capital component, or depreciable capital, depending on the expected catalyst life and cost. Makeup catalyst is frequendy treated as a raw material. 

The most common approach to fixed cost estimation iavolves the use of a capital recovery factor to give the annual depreciation and return on capital. This factor typically is between 15 and 20% of the total capital investment. Property taxes are taken as 1—5% of the fixed capital and iasurance is assumed to be 1—2% of the fixed capital. If annual depreciation is estimated separately, it is assumed to be about 10% of the fixed capital investment. The annual iaterest expense is sometimes neglected as an expense ia preliminary studies. Some economists even beHeve that iaterest should be treated as a return on capital and not as part of the manufactufing expense. 

Money Flows. Estimation of sales revenues and manufacturing expenses has been discussed. Depreciation, part of the manufacturing expense, is treated separately in the money flow, as is interest. 

Book-Bas s Depreciation. The book-basis depreciation is arbitrarily determined by management on a year-to-year basis, subject to acceptable accounting practice. This is not an out-of-pocket expense. It is simply a charge for the recovery of capital ia earnings calculations and is available as capital for reinvestment or distribution. Some consistent treatment for recovery of capital must be assumed ia profitabiUty analysis. 

DecoveTj of Capital. In Figure 1, the annual book depreciation is used to retire the fixed capital investment. Whereas this accounting model does not correspond to the typical money flow, it is one possible model for recovery of capital. This model assumes that the investment is reduced each year by the amount of the annual depreciation. Another model (22) assumes that a uniform yearly book depreciation payment is made to an interest-bear sinking fund that accumulates to the depreciable fixed capital amount at the end of the venture. Using this second model, the investment is outstanding throughout the lifetime of the project. This also does not correspond to the actual money flow in most cases. ProfitabiUty analysis utilizes a third model based on discounted cash flows. 

Possible numerators include the gross income net pretax income net after-tax income gross profit, ie, gross income minus book depreciation cash flow or net income. An average return value is selected by defining a typical or mature proof year as the basis of calculation. The denominator can be the original total investment, depreciated book-value investment, lifetime averaged investment, or fixed capital investment. 

Federal income tax rate 0.34 Depreciation straight line... 

Mfg cost (less depr and int) Capitalized fixed capital Capitalized total capital Operating income Interest on debt Depreciation (Tax basis) Net taxable income Federal income tax Investment tax credit Net income Cash flow... 

For this example, the tax-basis depreciation method in line-item 11 is a straight-line calculation based on the capitalized fixed capital, ie, fixed capital plus interest to the start of operation any salvage should be subtracted from the capitalized fixed capital and the result divided by the number of expected operating years to obtain the aimual tax-basis depreciation. 

Inflationary Effects. Inflation can have a significant effect on the profitabiUty of a venture. However, the U.S. federal tax laws do not allow for indexing the inflationary effects on depreciation schedules, salvage values, replacement costs, or taxable income. Inflation rates can vary unpredictably with time and can differ for certain revenues of expenditures. 

Annual income or expenditure particularized by tbe subscript Annual allowances against tax other than for depreciation of fixed assets Annual writing down (depreciation) of fixed assets, allowable against tax Asset-turnover ratio defined by Eq. (9-131)... 

A Allowance against tax other than for capital depreciation ... 

BD Depreciation allowance shown in company balance sheet ... 

The revenue from the annual sales of product As, minus the total annual cost or expense required to produce and sell the product Af , excluding any annual provision for plant depreciation, is the annual cash income Ac( ... 

The relationships among the various annual costs given by Eqs. (9-1) through (9-9) are illustrated diagrammaticaUy in Fig. 9-1. The top half of the diagram shows the tools of the accountant the bottom half, those of the engineer. The net annual cash flow Acp, which excludes any provision for balance-sheet depreciation Abd, is used in two of the more modern methods of profitability assessment the net-present-value (NPV) method and the discounted-cash-flow-rate-of-return (DCFRR) method. In both methods, depreciation is inherently taken care of by calculations which include capital recoveiy. 

FIG. 9-1 Relationship between annual costs, annual profits, and cash flows for a project. A d — annual depreciation allowance Acf — annual net cash flow after tax Ac/ = annual cash income Age = annual general expense Aqp = annual gross profit A/r = annual tax A e = annual manufacturing cost Avc/ = annual net cash income Avvp = annual net profit after taxes A/ p = annual net profit As = annual sales Apc = annual total cost (DCFRR) = discoiinted-cash-flow rate of return (NPV) = net present value. 

Depreciation The term depreciation is used in a number of different contexts. The most common are ... 

---