to the deduction of depreciation from cost of reproduction new in order to find a basis for testing the reasonableness of rates.* The principal cases, perhaps, are Pioneer Telephone & Telegraph Company v. Westenhaver (1911), 29 Oklahoma 429; The Minnesota Rate Cases (1912), 230 U. S. 352; and The People ex rel. Kings County Lighting Company v. Public Service Commission (1913), 156 N. Y. App. Div. 603, (1914) 210 N. Y. 479.

In the Pioneer Telephone & Telegraph Company case, the Oklahoma supreme court held that

every year there is a depreciation in the physical properties of the plant that is not, and cannot be, taken care of by current repair, and, although some of the physical units have been used only for a brief time, such use brings about a depreciation; and the reproductive value, new, of such physical units represents the present value only when there is deducted therefrom the amount of annual depreciation.

The court did not in this case, however, specify the measure of the depreciation to be deducted.

The appeals to the United States supreme court in the Minnesota rate cases involved the validity of the orders of the railroad and warehouse commission, together with legislative acts of the state of Minnesota, in prescribing passenger and freight rates. Although the special master had found that depreciation existed, the lower court practically rejected it as applicable to valuation, and the master himself made no allowance on that account in the valuation of the railroads' property, but accepted as a satisfactory offset against depreciation the companies' readiness to serve, knowledge derived from experience, adaptation to the needs of the public, together with physical appreciation of the road-bed, repairs and renewals, depreciation reserve and a reasonable amount of working capital. The supreme court said:

We cannot approve this disposition of the matter of depreciation. * * * It is also to be noted that the depreciation in question is not that which has been overcome by repairs and replacements, but is the actual existing depreciation in the plant as compared with the new one. It would seem to be

Lincoln Gas & Electric Lt. Co. v. City of Lincoln (1909), 182 Federal 926; Louisiana R. R. Comm. v. Cumberland Tel. & Tel. Co. (1909), 212 U. S. 414; Home Telephone Co. v. City of Carthage (1911), 187 Federal 637; Pioneer Tel. & Tel. Co. v. Westenhaver (1911), 29 Oklahoma 429; San Joaquin & Kings R. C. & I. Co. v. Stanislaus, 163 Federal 567; Spring Valley Waterworks v. City & Co. of San Francisco (1911), 192 Federal 137; Des Moines Water Co. v. City of Des Moines (1911), 192 Federal 193; Montana, Wyoming & So. R. R. Co. v. Bd. of R.R. Commrs. of Montana (1912), 198 Federal 991; The Minnesota Rate Cases (1912), 230 U. S. 352; Wyoming & So. R.R. Co. v. Bd. of Commrs. of Montana (1912), 198 Federal 191; Bonbright v. Corporation of Arizona (1913), 210 Federal 44; People ex rel. Kings County Ltg. Co. v. Public Service Comm. of New York (1913), 156 New York App. Div. 603, (1914), 210 N. Y. 479; Public Service Gas Co. v. Bd. of Public Utilities Commrs, of N. J. (1913), 87 Atlantic 651; Murray v. Pub. Utilities Comm. of Idaho (1915), 150 Pacific 47.

inevitable that in many parts of the plant there should be such depreciation, as, for example, in old structures and equipment remaining on hand. And when an estimate of value is made on the basis of reproduction, new, the extent of existing depreciation should be shown and deducted. * *

*

* * * And when particular physical items are estimated as worth so much new, if in fact they be depreciated, this amount should be found and allowed for. If this is not done, the physical valuation is manifestly incomplete. And it must be regarded as incomplete in this case.

There seems to be, in this case some question as to whether the court implied a limitation of the deduction to actual as distinguished from theoretical depreciation. It is perfectly clear, however, that depreciation must be determined as to amount, and allowance must be made for it. Otherwise the physical valuation is incomplete and incorrect.

The People ex rel. Kings County Ltg. Co. v. Public Service Commission resulted from the commission's ordering the company to reduce its gas rates. An appeal was taken to the New York supreme court and later to the court of appeals, which is the highest court in the state. As this was the first appeal from a rate decision made by the commission in which depreciation was an issue before the court, a vigorous attack, in behalf of all utilities, was made upon the commission's decision in an attempt to prevent an injurious precedent. The commission held that the cost of reproduction, new, is not necessarily an indication of present value. Depreciation and deferred maintenance are important factors.

In this case it meant a deduction of $415,198 from an estimated reproduction cost new of $1,902,777, excluding lands. The counsel for the utility argued that since it was conceded that the plant of the company operated at 100 per cent. efficiency, there should be no deduction for accrued depreciation. The decision upon the depreciation issue was made by the appellate division of the supreme court and not by the court of appeals. The appellate division wholly rejects the contention that accrued depreciation should not be deducted from the cost of reproduction new, but it does not commit itself as to whether both functional and physical depreciation shall be included. The commission itself apparently used depreciation in its largest measure.

The prevailing opinion at present, therefore, is to the effect that depreciation must be deducted in determining the just amount on which a public service property may earn. Referring again to the Knoxville case, page 13, it will be seen how well it coin

cides with good accounting practice when it comes to providing for the depreciation expense. The court says:

Before coming to the question of profit at all the company is entitled to earn a sufficient sum annually to provide not only for current repairs but for making good the depreciation and replacing the parts of the property when they come to the end of their life. The company is not bound to see its property gradually waste, without making provision out of earnings for its replacement. It is entitled to see that from earnings the value of the property invested is kept unimpaired, so that at the end of any given term of years the original investment remains as it was at the beginning. It is not only the right of the company to make such provision, but it is its duty to its bond and stockholders, and, in the case of a public service corporation at least, its plain duty to the public. If a different course were pursued the only method of providing for replacement of property which has ceased to be useful would be the investment of new capital and the issue of new bonds and stocks. This course would lead to a constantly increasing variance between present value and bond and stock capitalization—a tendency which would inevitably lead to disaster either to the stockholders or to the public, or both. If, however, a company fails to perform this plain duty and to exact sufficient returns to keep the investment unimpaired, whether this is the result of unwarranted dividends upon over-issues of securities, or of omission to exact proper prices for the output, the fault is its own. When, therefore, a public regulation of its prices comes under question the true value of the property then employed for the purpose of earning a return cannot be enhanced by a consideration of the errors in management which have been committed in the past.

Following the Knoxville decision, the principal cases since 1909 not only recognize that the depreciation allowance should include accrued as well as actual depreciation but also hold that it should provide for obsolescence, inadequacy and other functional depreciation. Some of these later cases are Cedar Rapids Gas Light Co. v. Cedar Rapids (1909), 144 Iowa 426, 444; Home Telephone Company v. City of Carthage (1911), 235 Missouri 644, 665-666; Puget Sound Electric Railway Company v. Railroad Commission of Washington (1911), 65 Wash. 75, 81-82; Cumberland Telephone & Telegraph Company v. City of Louisville (1911), 187 Federal 637, 654; Pioneer Telephone & Telegraph Company v. Westenhaver (1911), 29 Oklahoma 429; and Spring Valley Waterworks v. City of San Francisco (1911), 192 Federal 137, 184.

Aside from the fact that these decisions cover all classes of public service companies, namely, water companies, street and other railroads, telephone and telegraph companies, gas and electric light and power companies, it is interesting to classify all utilities from their past handling of depreciation and their dis

tribution of net receipts. Roughly, every such company will come under one of the four following classifications:

First, those utilities which may have been regulated from the beginning, and have been allowed to collect, through the rates charged, a sufficient amount to cover depreciation and to give the investors a fair return upon their investment. A leading valuation engineer, who strongly opposes the deduction for depreciation in fixing rates for service, recently stated to the author that in this case, if a revaluation were being made of such property for a readjustment of rates, it would be entirely equitable to deduct the accrued and collected depreciation from the original cost, or from the cost of reproduction new (the latter basis of valuation, of course, giving to the investors the benefit of the unearned increment in the property), to determine the new value on which a return must be allowed. In this case there would be no question concerning the correctness of the depreciation deduction, for the company would have received from earnings amounts sufficient to keep unimpaired the value of the property invested, which means that the customers of the utility have made good the depreciation and provided for "replacing the parts of the property when they come to the end of their life." Those who argue that such a plant has not depreciated because it is now giving as efficient service as an identical new plant must realize that a used machine, to have the same value as an identical new machine, must yield the same service, at the same cost and for the same remaining period of time as the new machine. It is entirely incorrect to assume that because one machine will yield the same service at present, at the same cost, as an identical new machine, the used machine has not depreciated-the same service must be given at the same cost for the same period of time. Too often, it is feared, the valuation expert desires only the balance-sheet aspect of the plant in determining the value of a public service property-that is, its condition at that particular moment as compared with an identical new plant; yet every one at all familiar with accounting knows that for production purposes the element of time, or the remaining economic life of the plant, has much to do with determining the per-unit cost of goods produced or of services rendered. Identical plant, if operated under even approximately similar conditions, cannot give the same service at the same cost for

the same remaining period of time when it is new and after it has been used for, say, ten years. The above assumes also that all necessary or possible current maintenance has been made, in the case of the used plant, from year to year. This means that the provision for deducting depreciation in determining the just amount on which the utility may earn, as provided by the Knoxville and later decisions, is in accord with sound accounting and cannot but work justice in this type of revaluation to both the investors and the public.

Secondly, there are those utilities which in the past have or have not provided for depreciation but have collected more than enough from their customers to have made proper provision for depreciation and also to have paid a fair return to the investors. In either case excessive dividends were paid to investors, and then when the plant was taken over to be regulated, the investors would raise a great cry against deducting depreciation in determining the "just amount." A case in illustration is the Houston Lighting & Power Company, 1905. This company in 1905 issued $500,000 of common stock and $500,000 of 6 per cent. preferred. For the years 1906 to 1913, inclusive, the company paid on the common stock a stock dividend of 100 per cent. and total cash dividends actually withdrawn of $718,125. For the eight years, therefore, the cash dividends averaged approximately 18 per cent. on the original $500,000 of common stock, exclusive of the stock dividend. In 1914 the mayor and commission of the city of Houston ordered an investigation made in expectation of regulation of rates. Jas. E. Allison & Co., St. Louis, prepared the report for the company, and Lyndon & Elrod, Houston, prepared the report for the mayor and commission of the city of Houston. Mr. Allison showed a gross capital entitled to a return of $2,753,584.63. Messrs. Lyndon and Elrod showed a gross value for the property of $2,024,074.66, but they deducted for depreciation some $499,232.87, leaving a capital entitled to a return of $1,524,841.79, or about 55 per cent. of that shown by the engineers for the company. Although the company had made some provision for depreciation on its books, and the plant had been in operation for several years, the engineers for the utility held the opinion that because the plant was in as good operating condition at that moment as an identical new plant no depreciation should be