ShmoopTube

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Accounting Allah shmoop depreciation the how to model Okay we're

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back to our little pillow that could company pillow talk

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The finest makers of Bluetooth enabled bedtime whispering pillows on

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the planet You may recall that the owners ex Apple

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employees Morton and Milton bought an already existing tiny pillow

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making company that well just made pillows They had no

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Bluetooth no batteries in the pillows and so on They

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were just nice pillows Not all that sexy So Eminem

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were ableto buy that company for a song one not

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even available on iTunes Their vision was toe Add Bluetooth

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two pillows and make something dull and boring in a

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well soft into a sexy business product that would change

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the way people all around the world went to sleep

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They would no longer have to rely on videos from

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Shmoop Okay so after Eminem purchased the pillow factory from

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our friendly farmer any well they wanted Toa automate the

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production process as much as possible Keyword robots Well they

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knew that labor to sew stuff and package the pillows

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was costing them more than it should They employed union

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workers in America and they believe that their costs was

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somewhere between eight and ten dollars per pillow to do

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all that human labor will The human labor decision was

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a good one when the company was tiny Spending ten

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million dollars on automated robot sewing stuffing and packing machinery

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made no sense for the farmer who was only making

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a five to ten thousand pillows a month like humans

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could handle that volume easily That small volume amount wasn't

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a large enough units scale against which toe amor ties

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the many million dollar cost of sowing and stuffing robots

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Yeah all right Well had the farmer spent millions on

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automating machinery with his low volumes he never would have

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gotten his money back But Eminem being the sophisticated people

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they are decided that they wanted to scale the business

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to be able to efficiently produce millions upon millions of

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pillows like way more than him Iwas human labor simply

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did not scale that is human labor costs the same

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dollar amount per hour whether it was deployed for forty

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hours a week or in scale of forty thousand hours

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a week like it was always fourteen bucks an hour

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or whatever they're paying And there were other issues as

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Well First of all Eminem probably couldn't even hire locally

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the thousands and thousands of sewers like Well there just

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weren't that many people in the area of available for

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hire And second there was no cost efficiency and producing

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pillows That way that is the two million pillow cost

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you about the same in labor as it cost to

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produce the first one So Eminem decided to make capital

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investment of ten million dollars to buy a robot sewer

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stuffer in Packer machine set which would essentially replace all

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of the human labor that had been deployed making pillows

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Well The companies selling the robot machines guaranteed that it

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would cover all maintenance on the robots for ten years

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and that company also confirmed that the robot would probably

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be worthless after ten years Its parts would wear out

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and it's cost of maintenance would be off warranty so

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the company would then have to pay a very high

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price to maintain that set of robots and relative to

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the new technology likely coming from Silicon Valley At that

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point well it would no longer makes sense to keep

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the old gray mayor around So now the hard part

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from an accounting perspective revolves around how to do the

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math for this capital investment Consider the basics aren't gonna

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capital investment here Ten million box could be worth nothing

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In ten years it'll replace ten bucks per pillow of

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human labour said that marginal cost of production units going

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to only be about a dollar And we're just kind

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of mumbling We're thinking through this Sline here Yeah okay

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moving on So now is Eminem Scale up production of

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pillows We think about a model case we're in for

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ten years They make four million pillows a year each

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year and then an asteroid strikes the Earth So nobody

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cares what happens after that Well think about what happens

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from a business perspective with four million pillows being made

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and with labor costs of only a dollar a pillow

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At this point don't worry about all the other inputs

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from costs of cotton and feathers to taxes to wholesale

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and other types of sales formats All we care about

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here is illustrating how depreciation works Because the ten million

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dollars Eminem spent on the robot has to be a

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earned back by the robots I'ii they have to pay

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for themselves and then some and be map such that

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from an accounting perspective we recognize that the value of

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the robot itself decreases in value each year by some

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logical rationally set number It is the sum set number

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here That's the hard part's the made up part Well

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we could argue that the robot declines in value massively

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a few weeks after its installed because well we couldn't

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just go sell it somewhere on eBay and get our

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ten million dollars back But most companies that sell large

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capital equipment build in some sort of money back guarantee

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for some period of time And since there are so

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many variables in the way we could annotate the decline

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in value of these robots over a year we'll just

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use the standard form of depreciation I'ii straight line depreciation

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were in the value of a piece of capital equipment

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declines the same amount year after year until it hits

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its final sale or period of valueless nous So let's

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do some math as we think through the value this

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robot labor system will have created for the company Yes

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at the expense of all those human beings who have

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now just been fired all right well the company was

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paying eight bucks per pillow in labor and it is

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now costing the company a dollar a pillow in labor

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that is the company is saving seven dollars per pillow

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in cost Who the company went from making a few

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thousand pillows a year and change to now making four

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million pillows a year each year in the cost savings

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with robots are spectacular at a savings of seven dollars

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per pill of times the four million pillows made her

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year while the company is saving twenty eight million dollars

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a year in production costs and they essentially make back

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all the ten million dollars they just spent on robots

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in only the first few months of operation Wow what

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a deal Well the capital cost of the robot will

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decline in straight line form the same amount each year

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for ten years appreciating the value from ten million bucks

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to zero Then after the first year the value of

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the robot then is held by the company on its

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balance sheet That asset as is being worth only nine

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million bucks after the second year It's then held that

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eight million and so on through this very profitable decades

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and you'll note that the company would apply as an

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expense on its income statement With loss of a million

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dollars in value from the Capital Asset in its robot

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each year the asset of the ten million dollars robot

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would be held on it's Balanchine initially is being worth

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ten million dollars and then each year the balance sheet

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would change and reflect that reduction of a million bucks

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a year So yeah all important stuff Keep in mind

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if you want your money to go toward the sewers 00:06:30.87 --> [endTime] and not down the sewer

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