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Expensing a truck leads to inconsistent performance

Expensing a truck leads to strange looking income statement. Created by Sal Khan.

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  • mr pants teal style avatar for user ericp
    That sounds helpful if trucks consistently last 3 years. Who sets the useful lifetime of things? Is there a resource investors can consult to make sure businesses are being accurate with their predictions? Are there laws about how businesses can make their predictions?
    (22 votes)
    • leaf yellow style avatar for user Erik Carlson
      For accounting purposes, a company decides how long the truck is expected to last over its useful life. There are various rates and methods allowed under generally accepted accounting principles (GAAP) for depreciating assets, including trucks. The company must decide which rate (expressed as a percentage, in years, or other rate) and method (straight line method, declining balance method, etc.) to use and use it consistently each year, and every time they buy a truck in the future.

      However, for tax purposes, when the company's tax return is prepared, local tax laws dictate how the same assets must be deprecated using rates and methods that may differ from the rates and methods chosen by the company for accounting purposes.
      (37 votes)
  • blobby green style avatar for user thanh30194
    what happens if at the end of 3 years, the truck has no value anymore on the book, but the company sells it and receives money. what would we do with that money? is that a profit?
    (5 votes)
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  • leaf blue style avatar for user Neil
    What happens, if at the end of three years, the truck is still in great condition and they determine they could probably get another year or two out of it? Are any adjustments made? Or is there just no truck depreciation expense recorded for those 1-2 years?
    (0 votes)
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  • ohnoes default style avatar for user a.m.ahkee
    In the video, how does labor count as revenue for each year? Can we describe what is the labor?
    (1 vote)
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  • blobby green style avatar for user Jessica Inman
    Please help:
    I need to figure out a $40,000 loan with annual payments for 5 years at 3% interest. I know how to calculate for the annual payment of $5,611.65, but I don't understand what the equation is for figuring out the interest amount or the reduced principle for the amortization. Once I figure out what the calculation breakdown is, I will be able to do it for all 5 years. I'm just stuck on this and it's driving me crazy

    Any help will be greatly appreciated.

    Thank you.
    (1 vote)
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  • blobby green style avatar for user Renee  Keeble
    how do you do cost pricing?
    (1 vote)
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  • leaf green style avatar for user jenni
    How do you agree with the statement “Extra focus on efficiency leads to a lower effectiveness”?
    (0 votes)
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Video transcript

You buy a truck for $60,000 to start a shipping business. The truck has a useful life of 3 years. You then have to buy another truck. What I've done here is, I've drawn our actual ... a series of income statements for our shipping business. This is year 1, year 2, year 3, year 4. This is the revenue that we make in each of those years. It's kind of a business that right from the get go we start making $100,000 a year. This is all in thousands. Let me it write that. This is all in thousands. This is 100,000. It kind of just stays steady there. We just keep making $100,000 a year in revenue, for the first 10 years. Then, we have to pay a driver. Let's say the cost of the labor is $50,000 a year. Once again, this is in thousands. What I want to address in this video … This would be a cost. When you just subtract out the labor cost, you have $50,000 left. Then, your other cost is going to be the truck itself. What I want to think about in this video is how should we account for the cost of the truck. You might just say, "Hey look, to start off" "I spent $60,000." In year 1 we'll actually go out to the truck store and buy the truck. Why don't I just call it an expense of $60,000? One reality is, you can just say, "Hey look, in year 1 my truck cost $60,000." Then, in year 2 I don't have to spend any money on a truck, because I have one. In year 3 I don't have to do it, but then in year 4 my first truck now has to be scrapped, because I used it so much. In year 4 I have to buy another truck for $60,000. Then, again in year 5, year 6 I don't have to do anything. Then, in year 7 I have to buy another truck for $60,000. 8, 9, I don't have to do anything. Then, in year 10 I have to buy another truck for $60,000. If you've counted for the purchase of your truck every 3 years this way, your profit would look like this. In year 1, 100 - … This is revenue and these 2 lines are expenses. 100 - 50 - 60, this is -10,000 in profit in that first year. The second year you make 50,000. The third year you make $50,000. Just 100 - 50. Then, fourth year, again, -10,000. Then, you make 50,000 and 50,000. Then, again -10,000. Then 50,000. Then 50,000. To someone who looked at this series of income statements, they'd say, "This is some type of bizarre business." "In the first year …" "Every 3 years you lose a tone of money." "I don't know why." "Maybe it's being mismanaged," "maybe something strange is happening," maybe it's because of bad weather." "Who knows?" "Then, you make a ton of money." "Then, you lose some money." "Then, you make a ton of money." It seems like some type of very bizarre business when you look at it from the operating ... when you look at it from the profit line. Just when you just expense the truck every 3 years. An operating profit is the profit from the operation. Before you think about how you're paying for the operations, how you're financing them or taxes, or any of that type of thing. This is strange, because this is a very stable business. It's very strange for it's operating profit to kind of jump around like this. The way that we kind of reconcile this is by doing something called capitalizing the expense of the truck and then depreciating it over the course of it's life. I'll cover that in the next video.