Equipment accounting and internal rates

For earthwork, road and heavy civil contractors, equipment can be the largest asset on the balance sheet and one of the largest costs on every job. Even a building contractor like Kestrel owns loaders, skid steers, forklifts, trucks, concrete equipment and forming systems worth several million dollars. Owning equipment raises accounting questions that a firm which rents everything never faces: how to measure what a machine really costs per hour, how to charge that cost to jobs, what to do when the fleet sits idle, how to depreciate it for the financial statements and for tax, and when to replace it. CON-300 priced equipment into an estimate; this lesson looks at how owned equipment is costed and accounted for.

Ownership costs and operating costs

The cost of owning and running a machine falls into two groups. Ownership costs are incurred whether or not the machine works; operating costs are incurred only when it runs. Operator wages are usually charged separately as labour.

Rate guides published by governments and industry associations give typical ownership and operating rates by machine class, and some public owners use them to price force-account work and changes. A contractor should use its own records where it can, because its utilization, maintenance practices and financing differ from the averages behind the guides.

# Hourly cost of a 20-tonne excavator owned by Kestrel (illustrative)
price, resale, life_years, hours_per_year = 285_000, 95_000, 6, 1_400
life_hours = life_years * hours_per_year
depreciation = (price - resale) / life_hours
avg_investment = (price + resale) / 2
interest = avg_investment * 0.07 / hours_per_year          # 7 % cost of capital
insurance_tax = price * 0.025 / hours_per_year            # 2.5 % per year
ownership = depreciation + interest + insurance_tax
fuel = 16 * 1.65                                          # 16 L/h at 1.65 per litre
lube = 0.15 * fuel
repairs = price * 0.80 / life_hours                       # lifetime repairs 80 % of price
wear = 6.50
operating = fuel + lube + repairs + wear
print(f"Ownership per hour: {ownership:6.2f}  (depreciation {depreciation:.2f}, "
      f"interest {interest:.2f}, insurance and tax {insurance_tax:.2f})")
print(f"Operating per hour: {operating:6.2f}  (fuel {fuel:.2f}, lube {lube:.2f}, "
      f"repairs {repairs:.2f}, wear {wear:.2f})")
print(f"Total internal rate, without operator: {ownership + operating:.2f} per hour")

Ownership per hour:  37.21  (depreciation 22.62, interest 9.50, insurance and tax 5.09)
Operating per hour:  64.00  (fuel 26.40, lube 3.96, repairs 27.14, wear 6.50)
Total internal rate, without operator: 101.21 per hour

In this example, owning and running the excavator costs about $101 per working hour before the operator. About $37 of that is ownership cost, which continues whether or not the machine works, and repairs are the largest single operating cost. The fuel price and consumption are illustrative; a contractor should use its own fuel records.

Utilization: the key to equipment cost

Ownership cost per hour depends on how many hours the machine works. The excavator above was costed at 1,400 hours a year. If it only works 900 hours, its ownership cost per hour rises by more than half, because the same annual depreciation, interest, insurance and taxes are spread over fewer hours. Utilization, the hours worked divided by the hours available, is therefore the most important number in equipment management.

annual_ownership = (285_000 - 95_000) / 6 + (285_000 + 95_000) / 2 * 0.07 + 285_000 * 0.025
operating_per_hour = 64.00
for hours in (600, 900, 1_200, 1_400, 1_600):
    own = annual_ownership / hours
    print(f"{hours:>5} h/year: ownership {own:6.2f}/h, total {own + operating_per_hour:6.2f}/h")

  600 h/year: ownership  86.82/h, total 150.82/h
  900 h/year: ownership  57.88/h, total 121.88/h
 1200 h/year: ownership  43.41/h, total 107.41/h
 1400 h/year: ownership  37.21/h, total 101.21/h
 1600 h/year: ownership  32.56/h, total  96.56/h

At 600 hours a year the machine costs about $151 an hour; at 1,600 hours about $97. A machine that sits in the yard is not free: its ownership cost has to be recovered from the hours it does work, or it becomes overhead. That is the basic economic case for renting equipment that will be used only occasionally.

Own, rent or lease

Contractors acquire equipment in three ways. Owning, whether paid in cash or financed with a loan, gives control, availability and lower cost at high utilization, but ties up capital and carries the risk of idle time and obsolescence. Short-term rental gives flexibility for occasional needs and passes maintenance to the rental company, but costs more per hour. Long-term leasing sits in between and is covered from the financing side in Lesson 9.

Charging equipment to jobs: the equipment clearing account

Owned equipment is charged to jobs at internal rates, either per hour of use, per day on site or per month. As with labour burden in Lesson 6, the charges flow out of an equipment clearing account (or a separate equipment cost centre), and the actual ownership and operating costs flow in. If rates are right and utilization is as planned, the account balances. If utilization falls short, or costs rise, the account is under-recovered.

What to do with an under-recovery is a policy question. Some firms leave it in the equipment cost centre and report it as part of overhead, so that job margins reflect the internal rates the estimators used. Others allocate it back to jobs at year-end. A large, persistent under-recovery means either that the fleet is bigger than the work requires or that the internal rates are too low; both need action. Estimators also need to know, because bids priced at internal rates will not recover the real cost of an underused fleet.

Some contractors go further and set up their equipment as a separate company or division that rents equipment to the construction company at market rates. This makes the true cost of ownership visible, lets management judge the fleet as an investment and can have liability, financing and tax advantages, though it adds administration and related-party transactions that sureties will look through. Whatever the structure, the principle is the same: the fleet should earn back its cost from the work.

Depreciation in the financial statements

For the financial statements, equipment is recorded at cost and depreciated over its useful life to its estimated residual value. Contractors commonly use straight-line depreciation, or a usage-based method for machines whose wear follows hours. Useful lives and residual values are estimates and should be reviewed; a firm that depreciates its trucks over ten years when it replaces them after six will show inflated profits and then losses on disposal.

Under ASPE, depreciation is called amortization; under IFRS it is depreciation, and IFRS requires significant components with different lives, such as a crane's boom and carrier, to be depreciated separately. The economic idea is the same.

Depreciation for tax

For income tax, Canadian businesses do not deduct book amortization. They claim capital cost allowance (CCA) on pools of assets grouped by class, at prescribed declining-balance rates. Most power-operated movable equipment used to excavate, move, place or compact earth, rock, concrete or asphalt falls in Class 38 at 30 %. Automotive equipment and general-purpose trucks are generally Class 10 or 10.1 at 30 %, and many tools and other machinery fall in Class 8 at 20 %. Normally only half the usual rate can be claimed in the year of acquisition (the half-year rule). Under the Accelerated Investment Incentive, reinstated for property that becomes available for use from 2025 and scheduled to phase down in later years, an enhanced first-year allowance applies instead; for a 30 % class it is roughly 45 % in the first year. These rules change; confirm the current rates and conditions with the Canada Revenue Agency's guidance or a tax adviser.

# CCA on a 285,000 excavator in Class 38 (30 %), with and without the
# enhanced first-year allowance (illustrative; check current rules)
cost, rate = 285_000, 0.30
def schedule(first_year_factor):
    ucc, out = cost, []
    for year in range(1, 6):
        claim = ucc * rate * (first_year_factor if year == 1 else 1)
        out.append(claim); ucc -= claim
    return out, ucc
for label, f in (("Half-year rule", 0.5), ("Enhanced first year", 1.5)):
    claims, ucc = schedule(f)
    print(f"{label:20}", " ".join(f"{c:>8,.0f}" for c in claims), f" UCC left {ucc:,.0f}")

Half-year rule         42,750   72,675   50,872   35,611   24,928  UCC left 58,164
Enhanced first year   128,250   47,025   32,918   23,042   16,130  UCC left 37,636

Tax depreciation is usually faster than book depreciation, so a contractor that buys equipment pays less tax now and more later. The difference between book and tax values creates a deferred tax liability in the financial statements. Fast tax write-offs improve cash flow in the year of purchase, which is one reason contractors often buy equipment late in a profitable year. That timing should not drive decisions on its own: a machine bought to save tax still has to earn its cost on jobs, and the cash spent reduces working capital, which sureties watch closely.

Equipment and the balance sheet

Equipment affects a contractor's financial position in several ways. Buying with cash reduces working capital directly. Financing with a term loan keeps cash but adds a current portion of debt to current liabilities. Both increase total assets and, if financed, total liabilities. Sureties focus on working capital and equity, so a large equipment purchase can reduce bonding capacity unless it is financed sensibly or the firm has strong working capital. Lenders often secure equipment loans on the machines themselves and may set covenants limiting further equipment purchases.

When to replace equipment

As a machine ages, its depreciation per hour falls but its repair costs and downtime rise. The economic life is the age at which the average total cost per hour over the machine's life is lowest; keeping it beyond that point costs more each year than replacing it. Contractors track cumulative cost per hour for each machine to see when that point is reached. Downtime matters too: a machine that breaks down on a critical activity can delay a whole job, a cost that never appears in the equipment records.

# Average cost per hour over life for a machine kept 1 to 9 years (illustrative)
price, hours = 285_000, 1_400
resale = [220_000, 180_000, 150_000, 125_000, 105_000, 90_000, 78_000, 68_000, 60_000]
repairs = [6_000, 12_000, 20_000, 30_000, 42_000, 55_000, 68_000, 82_000, 96_000]
cum_repairs, best = 0, None
for year in range(1, 10):
    cum_repairs += repairs[year - 1]
    avg = (price - resale[year - 1] + cum_repairs) / (year * hours)
    best = (year, avg) if best is None or avg < best[1] else best
    print(f"Keep {year} years: average {avg:6.2f} per hour")
print(f"Lowest average cost at {best[0]} years")

Keep 1 years: average  50.71 per hour
Keep 2 years: average  43.93 per hour
Keep 3 years: average  41.19 per hour
Keep 4 years: average  40.71 per hour
Keep 5 years: average  41.43 per hour
Keep 6 years: average  42.86 per hour
Keep 7 years: average  44.90 per hour
Keep 8 years: average  47.50 per hour
Keep 9 years: average  50.48 per hour
Lowest average cost at 4 years