Allocating Capacity Costs: Depreciation As seen in the previous section, a death spiral can result when a common resource with significant fixed costs and excess capacity is allocated to users who have discretion over utilization of the resource

Allocating Capacity Costs: Depreciation As seen in the previous section, a death spiral can result when a common resource with significant fixed costs and excess capacity is allocated to users who have discretion over utilization of the resource. In the telecommunications example, depreciation of the existing phone system is the principal fixed cost. One way to solve the death spiral is to not allocate some (or all) of the fixed cost. For example, allocate only the fixed cost of the capacity actually being used. If there is 40 percent excess capacity, allocate only 60 percent of the depreciation. However, this solution to the death spiral creates other concerns. Notice that the death spiral, or underutilization of the common resource, is really a problem of how to use an existing resource. How much of the existing common resource should each agent use? If there is excess capacity, any charge discourages its use. However, prior to deciding how to allocate the available capacity among existing agents, the firm had to decide how much capacity to acquire. In the previous example, the firm had to decide how large a phone system to buy (how much phone-mail capacity, how many lines, how fast a switch, and so forth). The current fixed costs of the phone system (including depreciation) were "variable" costs prior to acquiring the capacity. Accounting depreciation (such as straight line) represents the annual historical cost of acquired capacity. Depreciation is the allocation of the asset's historical cost over time. How much capacity should the firm a quire? The future users of that capacity usually have specialized, private knowledge of how intensively they will use the co c. If these users know they will not be charged for their future use because fixed costs are not allocated, they will overstate their future use. If they are not charged for the excess capacity, they will still overstate their use if the com a commitment device.2 Future users, knowing they will be charged for the historical cost of a durable asset, have less incentive to overstate their expected future utilization. Allocating accounting depreciation to users commits them to recovering at least the historical cost of the asset. (Allocating depreciation does not commit the opportunity cost of capital tied up in the asset.) In deciding whether to alloc and its efficient utilization after acquisition. Charging depreciation helps control the overinvestment problem, but at the expense of underutilizing the asset after acquisition. Most firms charge users for depreciation. Thus, control of the overinvestment problem tends to dominate decision-making errors involving asset utilization (the death spiral). This is another example of how accounting systems tend to favor control when confronted with a choice between control and decision making.