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business expediency. The author well remembers hearing one of the leading accountants in America, and a partner in one of the great national firms, say that while it was the policy of the firm always to adhere in practice to the best recognized principles of accounting, oftentimes expediency required them to depart somewhat from those principles. That is very largely the condition here. Suppose, in the case of an asset having an estimated life of twenty years, that annually for twelve years 5 per cent. of its value has been written off on the books of the business and has been taken as an allowable deduction on the federal tax return. In the thirteenth year, unforeseen by anyone, a new invention makes the old asset worthless. It would have been entirely possible for the internal revenue bureau to have said that if the business. desired to deduct that loss, it must revise its returns for the twelve years past and write off for each of those years the additional portion of the loss that rightfully belonged to each year—but what a protest there would have been from taxpayers everywhere. Expediency and common-sense demanded that obsolescence loss be handled as provided in this article 143. It should be observed, however, that the article does not provide how the loss shall be recorded on the books except that "to be deductible under this exception” the amount "must be charged off on the books and fully explained in returns of income." Whether the loss shall be charged into the current operations of that year or charged against the accumulated profits of previous years (being treated as a surplus adjustment) does not seem to concern the department. Therefore, even in this case, the procedure on the company's books may follow entirely the commonly recognized principles of good accounting as set forth in this paper,

SHALL DEPRECIATION BE DEDUCTED IN DETERMINING THE JUST

AMOUNT ON WHICH A UTILITY MAY EARN? Volumes have been written on the third and last problem to be discussed, and only a brief discussion can be given of it here. Two questions have been raised, namely, (a) whether or not depreciation really exists in the assets of such properties, and (b) whether or not that depreciation which does exist shall be deducted from the gross value to determine the amount on which the investors shall be permitted to earn the fair return,

In the valuation of railroad properties made in Minnesota, Wisconsin’ and Michigan, it was found that the depreciated value of the properties under the conditions existing in those states was on the average about 80 per cent. of the cost of reproduction new. After eliminating such items as land, grading and similar units on which no depreciation was computed, the depreciated value of the railroads in the tree states named was determined to be about 75 per cent of the estim: ted value new of the properties.

In a report of the St. Louis public service commission, Sept. u, 1912, relating to the United Railways Company of St. Louis and to the Southwestern Telephone & Telegraph Company, James E. Allison, chief engineer, determined the theoretical value curve of the United Railways Company to be 54.5 per cent. of the cost new of the property. In this case the scrap value of the property was taken, for the entire composite plant, at 9 per cent., making the theoretical depreciation 45.5 per cent. of the cost new of the . property. Mr. Allison would seem to deny, however, that actual depreciation exists if the plant is giving 100 per c nt. efficient service. From his study Mr. Allison formulated a general principle that in the case of a property of any complexity, after a sufficiently long period of operation, it will be about one-half worn out, or, more exactly, that it will reach a "normal theoretical value” approximately one-half way between 100 per cent. new and scrap value. Mr. Allison also says that if the "theoretical depreciation charges have been made from the installation of each item the accumulatio: in the depreciation fund will always equal the amount of depreci, ion * *

a great part of the fund will be a nee less accumulation as it can never be used for replacement or renewal.” It is interesting to note that in August, 1914, there appeared, in the Harvard Quarterly Journal of Economics, an article by Professor Allyn A. Young, of Cornell university, and the same article somewhat amended appeared as appendix E in a report by Mr. Allison on the Houston Lighting & Power Co. 1905, under date of July 22, 1914, in which Professor Young states emphatically that Mr. Allison "was the first to elucidate these general principles, though when once brought to light, they

1 Twenty-fourth annual report of the Minnesota railroad and warehouse commission (1908), p. 52.

Fifth biennial report of the Wisconsin tax commission (1910) appendix D. See also table in the fourth biennial report of the Wisconsin tax commission (1909), p. 128.

3 Bulletin 21 of the bureau of the census (1906), p. 78.

seem, as is the way with important new generalizations, both simple and obvious." Yet in a letter dated April 30, 1908, to the interstate commerce commission, regarding the treatment of maintenance and depreciation accounts in the new classification of accounts prescribed for railroads, Price, Waterhouse & Co. set forth the same general ideas, and state: "If a fund is established on a proper basis for an entirely new property or group of properties, it should steadily grow until it reaches a sum representing the difference between this percentage (the "average efficiency') and one hundred per cent. of the original cost." This letter states further, what Mr. Allison emphasized at considerable length, that "this sum will represent continuously what may be called the permanent depreciation of the property, which in practice will never be made good."

That depreciation does actually exist in the case of a public utility, it is assumed, no accountant will deny. Most accountants, undoubtedly, have not analyzed the problem as carefully or as thoroughly as either the engineer or firm of accountants above mentioned, but as one studies the problem one must be impressed with the fact that the present situation and present attitude towards depreciation as exemplified in private industry, by commissions and by courts is largely the accounting and the accountant's view of the problem.

And what is more, the problem must continue to be largely an accounting one. Double entry is always assumed by laymen to be a purely mechanical device, the only purpose of which is to see that the books are in arithmetical balance. Every accountant knows, however, that the double entry represents a double aspect of the facts of the case, and he will use the double-entry processes as a mental aid in keeping track of those facts. Many valuation experts will not admit those relationships between the assets and liabilities sides of the balance-sheet and between the balance-sheet and income sheet, which the accountant knows to be fundamental. The latter knows that a reverse for depreciation on the liabilities side of a balance sheet is inseparably connected with the wasting assets contra; he knows that no charge has any legitimate place in the income sheet, unless in some real way the asset accounts of the balance-sheet are depleted by a corresponding amount.* The

* For an economic discussion of the principles involved see Professor Taussig's Principles of Economics, Vol. I,, especially pages 77, 78, and 79.

Observe also the note at the bottom of page 78.

valuation expert admits none of these things and regards them as purely artificial arguments, arising from the fact, as Professor Young states, that the accountant is “misled by the arbitrary categories of accounting.'

In speaking recently with one of the foremost valuation engineers in the United States, the author was informed that in the opinion of this engineer a public service utility must collect from those served by it sufficient to cover (a) ordinary operating expenses, (b) taxes, (c) depreciation, (d) interest on funded and floating indebtedness and (e) a fair return on the investors' money. This engineer obviously recognizes that depreciation exists for the purposes of the income statement, and it may be assumed that Mr. Allison would be of the same opinion.

Professor Geo. F. Swain, of Harvard university, and ex-president of the American Society of Civil Engineers, in a report in 1911 to the Massachusetts joint commission on the New York, New Haven & Hartford Railroad Company, while maintaining that allowance for depreciation should not be made (page 59 of the report) in fixing rates for service, does recognize that depreciation exists, and he computed the depreciated value of the property. The present valuation new is shown (exhibit 5, page 134 of the report) as $304,601,824.00, while the present depreciated value is shown as $263,601,136.00. Here, then, is recognized existing depreciation of $41,000,688.00.

In 1909, the Supreme Court of the United States, in Knoxville v. Knoxville Water Company (212 U. S. 1) decided definitely (a) that depreciation does exist in the case of a public service property, (b) that such a company is entitled to earn its depreciation annually as the depreciation accrues and (c) that the ratepayers (customers) must pay for the depreciation on the property. This is entirely in accord with the best accounting practice, as known today. In 1912, in the Minnesota rate cases (230 U. S. 352), the court not only asserted that depreciation existed, but it disapproved the master's action in offsetting the depreciation, which had in fact happened, by appreciation.

It being generally recognized, then, that depreciation does exist in such a property, the real question is whether this depreciation, recorded usually in the income sheet and actually collected from the rate-payers, shall be considered a deduction in determining

the fair value or just amount on which the public service property may earn a return. The law on this question may be considered well settled. In the Knoxville v. Knoxville Water Company decision (1909), 212 U. S. 1, the city of Knoxville appealed from a decree of the United States circuit court permanently enjoining the enforcement of a city ordinance fixing maximum rates to be charged by the water company upon the ground of constitutional invalidity. No deduction was found to have been made for depreciation. The United States supreme court here definitely enunciated the rule that depreciation should be deducted from the cost to reproduce new. The court said:

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The first fact essential to the conclusion of the court below is the valuation of the property devoted to the public uses, upon which the company is entitled to earn a return.

The valuation was determined by the master by ascertaining what it would cost, at the date of the ordinance, to reproduce the existing plant as a new plant. The cost of reproduction is one way of ascertaining the present value of a plant like that of a water company, but the test would lead to obviously incorrect results, if the cost of reproduction is not diminished by the depreciation which has come from age and use.

The cost of reproduction is not always a fair measure of the present value of a plant which has been in use for many years. The items composing the plant depreciate in value from year to year in a varying degree.

It is not easy to fix at any given time the amount of depreciation of a plant whose component parts are of different ages with different expectations of life. But it is clear that some substantial allowance for depreciation ought to have been made in this case.

The court discussed the various phases of the case at length, but it seems fair to assume, from subsequent ruling,* that complete and incomplete depreciation should not be added to the present value of the surviving parts; that the court included in the term depreciation what is usually described as "accrued depreciation" or "theoretical depreciation," or the liability even now accrued toward the ultimate cost of replacement of still efficient apparatus.

As regards the Knoxville decision there is, of course, the opposition which naturally arises from contending counsel, but the author has not, in his reading, found a court or commission of standing, except possibly the supreme court of Idaho, that does not support the Knoxville decision. Following the authority of that decision, the courts, in later cases, have given full recognition

* People ex rel. Kings Co. Ltg. Co. v. Public Service Commission (1913), 156 N. Y. App. Div. 603, 611,

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