Construction Equipment and Depreciation

Construction Equipment

• Studying equipment operation costs is crucial for bidding and construction planning.
• The goal of equipment procurement is to provide the right equipment at the right time and place, allowing work to be done at the lowest cost.
• Efficient machine utilization impacts purchasing or renting/leasing decisions.

Economics - Depreciation

• Depreciation is the loss of value in construction equipment due to wear, tear, and obsolescence.
• Common depreciation methods include Straight-Line (SL), Sum-of-the-Years (SOY), and Declining Balance (DB).

Depreciation Accounting

• Depreciation accounting estimates current market value.
• It allocates depreciation over a period to determine billing rates.
• It's used to maximize tax benefits.
• Usually, there are two or three depreciation methods used for one piece of equipment by the owner simultaneously. These methods are used for internal purposes to calculate billing rates, determining company's net worth, and for IRS estimations.

Calculating Depreciation

• To determine depreciation, these factors must be known:
  • Purchase price (P)
  • Economic life (n or N)
  • Salvage value (F or S)

Depreciation Accounting Methods

• The common depreciation methods include Straight-Line, Sum-of-the-Years, and Declining Balance.
  • Straight-Line: Equipment depreciates equally each year.
  • Sum-of-the-Years: Depreciation is higher in the early years of life, gradually decreasing.
  • Declining Balance: Depreciation is maximum in the first year, then decreases, often not reaching salvage value. A double-declining balance (DDB) is the maximum permitted rate.

Straight-Line Method (SL)

• Equipment depreciates equally over its useful life.
• This is a simple method used to estimate repair and maintenance costs.
  • Annual depreciation rate (R) = 1 / N
  • Annual depreciation amount (D) = R * (P - F)
  • Book value (BV) = BVm-1 - Dm

Straight-Line Example

• A tractor's purchase price is 150,000,withanestimatedsalvagevalueof150,000, with an estimated salvage value of 150,000,withanestimatedsalvagevalueof70,000 after 8 years.
• The annual depreciation amount is $10,000 using the straight-line method, and the book value at the end of each year of use can be determined using the formula.

Sum-of-the-Years Method (SOY)

• This method has a non-uniform depreciation rate, higher in initial years, and gradually decreases.
  • Annual depreciation rate (Rm) = (N - m + 1) / SOY
  • SOY = N(N + 1) / 2

Declining-Balance Method (DB)

• Maximum depreciation occurs in the first year.
• The method doesn't automatically reach salvage value.
  • Annual depreciation rate (R): can range from 1.25 to 2 depending on the desired acceleration. R = X / N.
  • Annual depreciation amount (Dm): (BVm-1) * R

Double-Declining Balance Method

• X = 2 is the maximum depreciation rate in the DDB method.
• Depreciation cannot fall below estimated salvage value.

Comparisons and Uses

• DDB depreciates equipment faster than SOY or Straight-Line. DDB is preferred for tax purposes.
• SOY is often used to determine book value.
• Straight-Line is often used for maintenance and repair cost estimations.

Summary

• Construction equipment loses value with time.
• Book Value (BV) is the value at the end of each year after depreciation has been deducted. BVm = BVm-1 - Dm
• Depreciation calculation varies by method:
  • Straight-Line: Equal depreciation each year.
  • Sum-of-the-Years: Higher initial depreciation.
  • Declining Balance: Highest depreciation in the first year, percentage based on previous year's book value.

Economics - Ownership and Operating Costs

• Life Cycle Cost: Total cost of operating equipment over its lifetime.
• Ownership costs: Costs associated with owning the equipment whether used or not. includes depreciation , insurance, taxes, salvage value, and shop expenses. Purchase price - salvage value + Overhead = Ownership expense.
• Operating costs: Costs associated with using the equipment. Includes items such as fuel, oil, grease, filters, repair, maintenance, tires or tracks, and other wear and tear items like cutting edges.
• Ownership costs typically decline with age due to depreciation. Operating costs tend to increase with age due to higher repair costs.
• Use time value of money analysis to estimate useful life based on hours of use

Explore the crucial aspects of construction equipment operation costs, procurement strategies, and efficient machine utilization. Dive into the world of depreciation, learning about various methods and their impact on financial accounting for construction companies.