The Gisborne Herald IN WHICH IS INCORPORATED “THE TIMES." GISBORNE, WEDNESDAY, DECEMBER 15, 1948. BUSINESS HEADACHE: REPLACING ASSETS

Gisborne Herald, Volume LXXV, Issue 22820, 15 December 1948, Page 8

The Gisborne Herald IN WHICH IS INCORPORATED “THE TIMES." GISBORNE, WEDNESDAY, DECEMBER 15, 1948. BUSINESS HEADACHE: REPLACING ASSETS

ONE of the businessman’s greatest worries today is the replacement of capital assets out of existing depreciation reserves. Attention to this problem is focussed by an article in the latest issue of the Accountants’ Journal which, among other things, quotes comment by the chairman of the huge organisation of Lever Brothers and Unilever. Limited. Sir Geoffrey Hcyworth.

The replacement of capital assets centres mainly around wornout buildings and plant in the face of present-day high costs. Sir Geoffrey recently pointed out to his shareholders that the cost value of the company’s assets at the end of 1947 was £82,000,000 and that depreciation was being written off in the usual way and would lead to the accumulation in due course of that sum for replacements as and when required. It, was estimated, however, that, to replace those assets on today’s costs would require £148.000,000. but that the depreciation fund would fall short by £(10,000,000. This is big business, but in a smaller way dozens'of examples could be given here in Gisborne of a similar position brought about ! y •’ •• uwrease in the prices of plant over the past 10 years. No Chance of Survival

To illustrate the point more clearly let us take the case of a Westland sawmill quoted in the Accountants’ Journal article. The sawmill cost £IO,OOO about 20 years ago. Depreciation has been written off each year over the life of the areas which are almost cut out. Taxation policy permits depreciation be based on the £IO,OOO cost so that, theoretically, when the areas are finished the original capital of £IO,OOO will be available out of such depreciation towards the cost of erecting a new sawmill on a new area. But the cost today will be £25,000 because of increased prices, and yet the cutting capacity of the new mill will be no greater than the old one which cost. £40,000. The £IO,OOO now available will be quite inadequate to get started again, and with the price' structure assessed on an industry basis such a new undertaking would have no possible chance of survival.

If prices rise further the deficiency will be greater; if they fall it will be less. But it is most unlikely that prices will fall to such an extent that depreciation reserves on the basis of original cost will be adequate.

Lever Brothers’ chairman commented: “The only way then in which we can maintain that part of our capital which is invested in fixed assets is to recover in the price of our products an amount which truly represents the wastage in the value of our fixed assets at present-day prices. If we cannot do this, then we shall be fixing our selling prices on a basis below real costs, and if the business community as a whole does the same the country will be consuming part of its capital instead of paying its way.” Concern is also being felt in the United States, where the position is much the same. The National City Bank Review states that the increase in replacement costs over original values creates not only the problem of providing the actual funds to finance such replacements as they become necessary, but also accounting problems in the preparation of financial statements to reflect this advance. It adds that because of the inadequacy of depreciation at present charged against earnings there is in a sense an over-statement of net income. “What happens,” the review states, “is that business is selling out piecemeal its low-cost production assets and taking the ‘profit’ into operating income.” Simultaneously, the carrying of fixed assets at original cost, less the usual depreciation, results in an undervaluation of net worth—the hook value of total assets Jess total liabilities and reserves, represented by capital stock and surplus accounts. Capital Losses Made

In New Zealand the position has been eased by the allowance of special depreciation, in addition to normal depreciation, over a period of five' years on buildings and plant installed at the present high prices. This concession, however, is to cease in respect of purchases after March 31, 1949. Companies installing plant after that date will be allowed only normal depreciation. Because of the delay in new plant deliveries and increasing prices justice demands that the special depreciation allowance should be continued for some years.

Because of inadequate depreciation capital losses have already been made by countless companies and individuals. The Government may reply that there is nothing to prevent a company or individual from writing off as much depreciation as desired, but no allowance would be made for this in price fixation or in taxation policy. For years in most businesses depreciation written off has been determined by the amount allowed as a deduction for income tax purposes.

A solution, in the words of Sir Geoffrey Heyworth, is a recognition of what true profits are, an acceptance of the fact that the maintenance of a reasonable.level of true profit is necessary to the life of a nation, and the revision of taxation so that only true profits are taxed.

There is evidence in New Zealand today that business is already leaning heavily on the banks, advances having increased about £50,000,000 in the past five years. This is the position despite the fact that trading has been good. With reserves depreciating in value because of increasing costs, with building and plant replacement funds in most cases inadequate, with credit strictly controlled by the Government through the banks, and with constant pressure being exerted to reduce the profit margin, the future bristles with problems of national importance. They are problems that demand the urgent attention of the Government, for there is much that is false in our present period of prosperity. The ability of business today to meet reverses, its resiliency, is not as great as is commonly believed.