chargeable to capital include those which are incurred in the original construction of the works, and in the subsequent enlargement and improvement thereof." 1

§ 1161. Replacement considered as repair.

In the leading case of Reagan v. Farmers' Loan & Trust Company,' where it was contended that the cost of new rails should be charged to construction, and not to expenses of operation, Mr. Justice Brewer said: "Now, it goes without saying that, in the operation of every road, there is a constant wearing out of the rails, and a constant necessity for replacing old with new. The purchase of these rails may be called "permanent improvements," or by any other name; but they are what is necessary for keeping the road in serviceable condition. Indeed, in another part of the report, under the head of 'Renewals of rails and ties,' is stated the number of tons of 'New rails laid' on the main line. Other items therein are for fencing, grading, bridging, and culvert masonry, bridges and trestles, buildings, furniture, fixtures, etc. It being shown affirmatively that there were no extensions, it is obvious that these expenditures were those necessary for a proper carrying on of the business required of the company.”3 § 1162. Renewal of equipment to offset depreciation.

The equipment of the road must be renewed from time to time; and an expenditure of the proper proportionate amount in each year for new equipment is a proper annual charge. So in Milwaukee Electric Railway and Light Company v. Milwaukee, it was held proper to buy yearly and charge to annual expenses a sufficient number of cars, with motors and complete electrical equipment,

1 See also Metropolis Trust Co. v. Houston & T. C. R. R. Co., 90 Fed. 683 (1898).

2154 U. S. 362, 38 L. ed. 1014, 14 Sup. Ct. 1047 (1894).

4

See also Long Branch Commission v. Tintern Manor Water Co., 70 N. J. Eq. 71, 62 Atl. 474 (1905). 487 Fed. 577 (1898).

to keep up the necessary standard of equipment. It may aid one to appreciate the nature of the problem and the method of its solution to cite from the expert testimony adduced in that case and adopted by the court. "In reference to the element of depreciation, the witness Beggs thought that experience had demonstrated that the most life that could be expected from the best roadbed was twelve years, when it would have to be almost entirely renewed. The street railway company must now of necessity lay about twelve miles of track annually, being about one-twelfth of its total mileage; and would be required, whether they wish to or not, to lay that amount annually hereafter, to keep their tracks fairly up to the standard. The same applied to the equipment. The company should put on not less than twenty of the most modern equipments, thereby keeping its standard up to the minimum as it had, 240 equipments; because he thought it fair to assume that the average life of the equipment, taken as a whole, will not exceed twelve years, the life of the motor being somewhat less than that, and that of the car we hope may exceed it possibly several years." 1

§ 1163. Permanent improvements should not be annual charge.

However it may be in doubtful cases, where continual replacements going on from year to year may not unreasonably be considered as equivalent to annual charges to repair account, it is obvious that permanent improvements should not be charged as annual expenditures in the year in which they are constructed, but should be carried to capital account. The United States Supreme Court 2

1 See however Nashua & L. R. R. Co. v. Boston & L. R. R. Co., 136 U. S. 356, 34 L. ed. 363, 10 Sup. Ct. 1004 (1893).

2 Illinois C. R. R. Co. v. Interstate Com. Comm. 206 U. S. 441, 51 L. ed. 1128, 27 Sup. Ct. 700 (1907).

was perhaps speaking within limits when it held that the Interstate Commerce Commission was not acting unreasonably in disallowing as operating expenses of the Illinois Central Railroad expenditures for real estate, right of way, tunnels, bridges, and other strictly permanent improvements; and also for equipment such as locomotives and cars. The Commission expressed the opinion that such expenditures should not be charged to a single year, but should be so far as practicable projected proportionally over the future. And this view Mr. Justice McKenna, speaking for the court, adopted. "It would seem," he said, "as if expenditures for additions to construction and equipment, as expenditures for original construction and equipment, should be reimbursed by all of the traffic they accommodate during the period of their duration, and that improvements that will last many years should not be charged wholly against the revenue of a single year.'

§ 1164. New construction should be charged to capital

account.

The rule will be generally conceded that outright new construction should be charged to capital and should not therefore be admitted as an annual expense of operation. As Mr. Justice Carter of the Florida court recently put it in a case 2 where the railroad in complaining of the rates put in force by a commission alleged that its total receipts would not now be sufficient to recoup it for its "costs of operation" and its "cost of construction: "

2

1 In the latest case on this point it is held that the earnings of a railroad company applied to the purchase of additional equipment, extension of its lines, and other improvements, must be regarded as a part of the net earnings, and are

not properly chargeable to operating expenses. Coal & Coke Ry. Co. v. Conley (W. Va.) 67 S. E. 613 (1910).

2 State ex rel. v. Seaboard A. L. Ry. Co., 48 Fla. 129, 37 So. 314, (1904).

"The use of the words 'reasonable cost of constructing' renders the pleading very ambiguous. The reasonable cost of construction is to be considered in determining the fair value of the company's property, which is an element entering into the question of reasonableness of the rate; but the cost of construction is not to be deducted from the earnings under the proposed rates in ascertaining if those rates are reasonable; for under such a rule the public would be compelled to pay for constructing the road without being entitled to its ownership." So in estimating the net profits of a gas company it was held that operating expenses would not include "expenditures for new wells, mains, or other permanent improvements or betterments." 1

§ 1165. A liberal policy desirable.

This problem under discussion is peculiarly one where the desirable principle should be adhered to, that the State should as far as possible confine itself to regulation leaving the companies to work out their own problems of management. Public service companies should not be prevented from making substantial betterments out of current earnings as private companies advisedly do, if they can manage it. There are extremes here as to which all must agree; but there remains a middle ground where discretion may well be left to the railways themselves. No one would deny that current repairs should come out of current earnings; and every one would concede that new construction should be provided for by additional capital. There remains the debatable ground of improvements and betterments to which the American railways have been used to devote such part of their annual earnings as they could afford. When the results of this progressive American policy are compared with

1 Erie v. Erie Gas & C. Co., 78 Kans. 348, 97 Pac. 468 (1908).

the physical condition to which the English railways have been brought by the opposite policy of distributing all earnings and issuing new capital, it will be seen how necessary to the community it is that a railroad should increase its standard from year to year out of current earnings. At all events, if the American railways are to be restricted henceforth in this manner, they are likely to be much hampered in keeping their facilities up to the modern requirements of their business. It seems fair enough for each generation to pay its share of continual betterment.

Topic C. Amortization Requirements

§ 1166. Depreciation now generally allowed.

In general an annual charge for depreciation in value of the plant by use is proper.1 This is again a matter which cannot be decided by general rules as to a standard percentage, but is a matter of careful investigation into the

1 The general proposition is supported by the following cases, among others:

United States.-Union Pac. Ry. v. U. S., 99 U. S. 402, 25 L. ed. 274 (1878), reversing 13 Court Cl. 401; Reagan v. Farmers' L. & T. Co., 154 U. S. 362, 38 L. ed. 1014, 14 Sup. Ct. 1047 (1893); San Diego L. & T. Co. v. National City, 174 U. S. 739, 43 L. ed. 1154, 19 Sup. Ct. 804 (1899), affirming 74 Fed. 79; San Diego L. & T. Co. v. Jasper, 189 U. S. 439, 47 L. ed. 892, 23 Sup. Ct. 571 (1901); Knoxville v. Knoxville Water Co., 212 U. S. 1, 53 L. ed. 371, 29 Sup. Ct. 148 (1909); So. Pac. Ry. v. Railroad Comm., 78 Fed. 236 (1896); Milwaukee Electric Ry. & L. Co. v. Milwaukee, 87 Fed. 577 (1898); Perkins

v. Missouri Pac. Ry. Co., 155 Fed. 445 (1897); San Joaquin & Kings R. C. & I. Co. v. Stanislaus County, 163 Fed. 567 (1898).

Michigan.-Grand Haven v. Grand Haven W. W., 119 Mich. 652, 78 N. W. 890 (1899).

Minnesota.-Steenerson

V. Gt. N. Ry., 69 Minn. 353, 72 N. W. 713 (1897).

Ohio.-Hamilton V. Hamilton Gas Light & C. Co., 11 Ohio Dec. 513 (1901).

Pennsylvania.-Pennsylvania R. R. Co. v. Philadelphia County, 220 Pa. St. 100, 68 Atl. 676, 15 L. R. A. (N. S.) 108 (1908).

Washington.-Twitchell v. Spokane, 55 Wash. 86, 104 Pac. 150, 24 L. R. A. (N. S.) 290 (1909).