Depreciation, Market Valuations, and Investment Theory

In this paper the theory of optimal replacement investment decisions is employed to interpret the problem of depreciation accounting and market valuation. An asset should be replaced when its net contribution to present worth from an additional (marginal) year of service no longer exceeds its external market value. Three concepts of depreciation are contained or involved in this investment decision rule: market value, capital recovery, and net contribution to present worth. Market value and capital recovery are commonly suggested “methods” of depreciation. Net contribution to present worth declines with asset age, and represents a concept of depreciation that generally may not coincide with market valuation in exchange. The existence of a market for a used asset is interpreted in terms of multiple uses (and marginal internal values) for an asset. Through exchange the asset is downgraded from one use to another until it is junked.