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 labor.

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 liter
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 figures are illustrative (16 liters per hour, about 4.2 gallons); 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 labor burden in Lesson 6, the charges flow out of an equipment clearing account (or a separate equipment cost center), 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 center 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 US GAAP, depreciation is recorded over the useful life using a systematic method; the tax rules below are separate, and most contractors keep two sets of depreciation records, one for the financial statements and one for tax.

Depreciation for tax

For federal income tax, US businesses use the Modified Accelerated Cost Recovery System (MACRS). Most construction equipment (asset class 15.0) is 5-year property, depreciated using the 200 % declining-balance method with a half-year convention, so the deductions are spread over six tax years. In addition, the One Big Beautiful Bill Act of 2025 made 100 % bonus depreciation permanent for qualifying property acquired after 19 January 2025, allowing the full cost to be deducted in the first year, and Section 179 expensing is available up to $2,560,000 for 2026, phasing out above $4,090,000 of purchases. Many states do not conform to federal bonus depreciation. These rules change; confirm them with IRS guidance or a tax adviser.

# MACRS 5-year (200 % DB, half-year) versus 100 % bonus on a 285,000 excavator
cost = 285_000
macrs5 = [0.20, 0.32, 0.192, 0.1152, 0.1152, 0.0576]   # IRS table percentages
print("MACRS 5-year: ", " ".join(f"{cost * p:>8,.0f}" for p in macrs5))
print("100 % bonus:  ", f"{cost:>8,.0f}", "       0" * 5)
print(f"Check: MACRS total {sum(cost * p for p in macrs5):,.0f}")

MACRS 5-year:    57,000   91,200   54,720   32,832   32,832   16,416
100 % bonus:    285,000        0       0       0       0       0
Check: MACRS total 285,000

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