Friday, October 31, 2003

Consider unit-based depreciation
with Tom Pryor
Q. My accountant uses I.R.S. guidelines to depreciate capital equipment over a set number of years. I know we must do that for external compliance, but is that a good method for pricing and profitability analysis?

A. No. Time-based depreciation methods were created decades ago when the expected life of a capital asset was long and not expected to be replaced with a new technology.

Typewriters, for example, had an expected useful and depreciable life of seven years. Typewriters were replaced with personal computers, word processing software and laser printers that improve annually. A problem developed with accountants kept using the old time-based depreciation for new technologies.

With the rapid development of new technologies in the healthcare industry, you would be wise to consider switching from time-based to unit-based depreciation. On capital assets that you expect to use for less than two or more than five years, divide acquisition cost by the total quantity of output expected over its useful life instead of the number of years.

For example, assume that you purchase a $1,000 oxygen concentrator. If depreciated over five years, $200 would be expensed on the P&L, no matter how many times it was rented. If you anticipate renting the concentrator 25 months during its lifespan, $40 would be depreciated each month the unit is in use. Unit-based depreciation would better align equipment cost with equipment revenue.

Tom Pryor is president of ICMS. Contact him at 817-483-6511 or