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ments would have to be cut, and if they can be shown in fact to
increase the value of the pipe system, and the property as a whole,


this increase in value may be considered. In the most recent decision
of the U. S. Supreme Court, however, the Court has held that they
did not in fact increase value in the case under review.

The more recent and important Court and commission decisions
exclude from "fair value" those pavements and other items laid or con-
structed without expense to the company.

In 1907, the decision of District Judge Hough, of the Federal
Court, in the Consolidated Gas Co. case (Consolidated Gas Co. v. City
of New York, 157 Fed., S49, December 20th, 1907), included in
"fair value" the increased construction expense of pipe systems over
which pavements had been placed at the expense of the city. On appeal,
the United States Supreme Court (Willcox v. Consolidated Gas Co.,
212 U. S., 19, January 4th, 1909) did not take up the question of the
inclusion of pavements, but concurred with the Court below to this
extent :

"And we concur with the court below in holding that the value
of the property is to be determined as of the time when the inquiry is
made regarding the rates. If the property, which legally enters into
the consideration of the question of rates, has increased in value since
it was acquired, the company is entitled to the beneiit of such increase.
This is, at any rate, the general rule."

In 1912, District Judge McPherson, of the Federal Court, in the
case of the Des Moines Gas Co. v. City of Des Moines (199 Fed., 204,
August 21st, 1912), supported the exclusion by the Master of the
reproduction cost of pavements laid at the expense of the city, thus
taking a position diametrically opposite that taken by Judge Hough.

Upon appeal, this case went to the United States Supreme Court
(238 U. S., 171, June 14th, 1915), which supported the attitude of the
Master and of Judge McPherson regarding the exclusion of pavements
laid at the expense of the city. Mr. Justice Day says:

"As to the item of $140 000, which, it is contended, should be added
to the valuation, because of the fact that the Master valued the prop-
erty on the basis of the cost of reproduction new, less depreciation, and
it would be necessary in such reproduction to take up and replace
pavements on streets which were unpaved when the gas mains were
laid, in order to replace the mains, we are of opinion that the court
below correctly disposed of this question. These pavements were
already in place. It may be conceded that they would require removal
at the time when it became necessary to reproduce the plants in this
respect. The Master reached the conclusion that the life of the mains
would not be enhanced by the necessity of removing the pavements,
and that the Company had no right of property in the pavements thus
dealt with, and that there was neither justice nor equity in requiring
the people who had been at the expense of paving the streets to pay an
additional sum for gas because the plant, when put in, would have to
be at the expense of taking up and replacing the pavements in building


the same. He held that such added value was wholly theoretical, when
no benefit was derived therefrom. We find no error in this disposition
of the question."

One of the modern decisions along these lines is that of the Court
of Appeals of the State of New York (Kings County Lighting Co.,
People ex rel. v. Willcox, 210 N. Y., 479, March 24th, 1914). The New
York Public Service Commission for the First District declined to
include in a valuation of the property of the Kings County Lighting
Company the pavement over its mains in cases where such pavements
were not laid at the expense of the company.

The Appellate Division of the Supreme Court of New York
reversed the determination of the Commission. The case was taken
to the Court of Appeals, which reversed the action of the Appellate
Division and sustained the ruling of the Commission. Judge Miller
says (at pages 494-495) :

"In determining the cost of reproduction, the Commission allowed
$12 717 as the cost of restoring the pavement as it existed when the
mains and service pipes were laid in the streets. The relator claimed
an allowance of at least $200 000 for the cost of restoring pavements
subsequently laid, on the theory that the cost would have to be incurred
if the mains were to be laid to-day. But the new pavements in fact
added nothing to the property of the relator. Its mains were as ser-
viceable and intrinsically as valuable before as after the new pavements
were laid. The controlling considerations tmder the preceding point
also determine this. The rights of the public are not to be ignored.
The question has a double aspect. What will be fair to the public as
well as to the relator? (Smyth i'. Ames, supra.) Should the public
pay more for gas simply because improved pavements have been laid at
public expense? It is no answer to say that the new expensive pave-
ments suggest improved conditions which, though adding to the value
of the plant, will not, by reason of the greater consumption, add to
the expense per thousand feet of the gas consumed. The public are
entitled to the benefit of the improved conditions, if thereby the relator
is enabled to supply gas at a less rate. The relator is entitled to a fair
return on its investment, not on improvements made at public expense.
It is said that the mains will have to be relaid. So will the new
pavements, and much oftener. Both might possibly be relaid at the
same time. The case is not at all parallel to the so-called unearned
increment of land. That the company owns. It does not own the
pavements, and the laying of them does not add to its investment or
increase the cost to it of producing gas. The cost of reproduction less
accrued depreciation rule seems to be the one generally employed in
rate cases. But it is merely a rule of convenience and must be applied
with reason. On the one hand, it should not be so applied as to deprive
the corporation of a fair return at all times on the reasonable, proper
and necessary investment made by it to serve the public, and on the
other hand it should not be so applied as to give the corporation a
return on improvements made at public expense which in no way
increase the cost to it of performing that service.


"The Appellate Division felt bound by the decision of the United
States Circuit Court in the Consolidated Gas Case (157 Fed. Rep.,
849), and it is true that such an allowance was made in that case.
But the United States Supreme Court held in that case (212 U. S., 19)
that the rate established was not confiscatory, and did not pass on the
propriety of that allowance. What was said in the opinion on the
subject of present value was merely a general statement having no
necessary relation to the question now under consideration."

The more recent decisions of the California, Illinois, Indiana,
Maryland, New Jersey, New York, Washington, and Wisconsin Com-
missions have excluded from "fair value" the cost of pavements laid
without expense to the company.

This subject is discussed further under the caption "Shall Present
or Original Physical Conditions Govern?" on pages 13G3 to 1370.

Under special laws providing for the creation of some public
utilities, of which elevated railroads and large storage reservoirs are
examples, it is required that the owner of the utility shall pay inci-
dental damages on account of property injured, but of which no part
is taken. Such damages are an important factor in the original cost
of a property, and a corresponding item should appear in the repro-
duction cost, irrespective of the fact that the owner of the public
utility has no title to the property in question.

Working Capital.

It is customary to include under the term "working capital" the
amount of cash, materials and supplies provided for use in the plant
but not yet forming a part of it, and other current assets which are
essential for the proper maintenance, operation, and administration of
a property.

There should be included in a valuation an amount of working
capital siifficiently large, not only to meet the usual requirements,
but to provide for emergencies.

Securities Owned.

Ordinarily, the valuation of property devoted to public use should
not include securities owned or surplus cash not forming a part of
working capital, except in instances where such securities and sur-
plus cash are an offset, in whole or in part, for depreciation deducted
from the cost of the property. The treatment of such cases is covered
in Chapter YI, "Depreciation and Appreciation."




The term "original cost to date" is used in the Federal Valuation
Act, and appears to have substantially the same meaning as the terms
"original cost", "original cost plus improvements", and "actual cost".

In the absence of any generally accepted or well-defined legal
meaning of this term, the Committee has defined it as "the cost of
the original construction, plus all charges against capital proper,
under approved accounting principles, for expenditures incurred there-
after, and minus all proper credits to capital for the cost of property
which has been disposed of or otherwise retired".

Under this definition, the original cost to date of a property is
the first cost* of the identical property units now in use, including
overhead charges. This definition accords with modern methods of
accounting, by which the cost of property retired is credited to the
fixed capital accountf to which it stands charged, or to some corre-
sponding account, and the cost of property, added as a replacement,
or otherwise, is debited to the fixed capital account or other corre-
sponding account; it seems, also, to conform more nearly than any
other definition with the decisions of the Courts that property which
has been retired shall be excluded (excepting its salvage value) when
making a valuation.

In the case of properties built by present owners, original cost
to date should agree with the book or accounting cost in most respects,
if modern methods of accounting have been followed from the begin-
ning, but, even with such properties, correct accounting in accord-
ance with modern practice is rare, and book cost, even when the books
have been well kept, may differ greatly from original cost to date,
as above defined.

* The definition of cost given by the Committee includes "'not only money outlay,
but also the money value of services rendered and of other considerations involved".

t In "Uniform System of Accounts for Telephone Companies", as prescribed by
the Interstate Commerce Commission, First Issue, Effective January 1, 1913, fixed
capital is defined as "property, both tangible and intangible, which is devoted to
the accomplishment of the principal purposes of its business", and it "consists of
original capital, additions, betterments, and replacements".

Referring to replacements, which It defines as "the substitution of one building,
structure, piece of equipment, or machinery for another which it has become neces-
sary to retire, the substitute having substantially no greater capacity than the
properly replaced", it provides the following method of accounting :

"The cost of the fixed capital retired should be credited to the fixed capital
accounts in which it is carried and the cost of the fixed capital Installed In place of
fixed capital so retired should be charged to the appropriate subaccounts under
account No. 101, 'Fixed Capital Installed Since December 31, 1912'."

Under the head "Fixed capital withdrawn or retired", it provides:

"VV^hen any tangible fixed capital acquired subsequent to December 31, 1912,
is withdrawn or retired from service for any cause the amount at which It stands
charged should be credited to the fixed capital account in which it is charged, and
such amount, plus the expenses Incident to the retirement, less the value of salvage,
should be charged to account No. 102, 'Reserve for Accrued Depreciation — Cr.' "


One important difference between book or accounting cost and
original cost to date has arisen from a former method of bookkeeping
which is still in use for some classes of property, by which,
when a plant unit is replaced by an identical unit, no entry is made
on the books, and consequently the cost of the original unit is retained
and not the cost of the succeeding unit.

For instance, if a pipe costing $20 per ton for material is replaced
by one of the same size and weight costing $25 per ton for material,
the cost at $20 per ton remains on the books. Similarly, if a plant
unit is replaced by one of larger size or heavier weight, the cost of
the additional size or weight is entered on the books at the prices
existing at the time of the replacement, and added to the cost of the
original unit, so that the new unit appears in part at one price and
in part at another.

Difficulty in Obtaining Original Cost to Date.

The statement has frequently been made, by those dealing with
the valuation of public service properties, that it is not feasible to
obtain the original cost to date of most old properties, and this is
undoubtedly true in most cases in regard to the older portions of
such properties and to the overhead charges. The difficulty, however,
has been magnified in some cases by the conception that original
cost to date deals with the money paid for original property units
which have been replaced, and not with that paid for existing units.
In some cases much of the difficulty may be removed under the
definition given by the Committee, especially in the case of short-lived

As original cost to date, with comparatively few exceptions, is not
the book cost of the property but the cost of the existing items, it
will be necessary as a rule to make a schedule of the various existing
property items, in the same way that one would be made for deter-
mining the cost of reproduction; then reference would have to be
made to the accounts, to ascertain the vmit costs of the items.

It would seem that almost any system of accounts which was cor-
rectly kept, even if not based on modern accounting principles, should
show the cost of those items which have been purchased in the last
10 to 20 years. The cost of longer-lived items may not appear on
the books, or the books for the earlier years may not be available,
especially if the properties have changed hands. In such cases, the
only way in which the determination of original cost to date could
be completed would be by estimating, from the best information which
could be obtained, the unit prices existing at the time the property
items were constructed or acquired.


In the case of an old property consisting mainly of long-lived
items, it is seldom practicable to obtain the original cost to date, ex-
cept for the additions made in recent years, and if such cost could be
obtained it would have little value.

In every case where records of original costs of presently existing
items are not to be had, an attempt to determine original cost to date
becomes an estimate, the correctness of which will depend on the com-
pleteness and accuracy of existing historic data. The result is likely
to be less inaccurate in the case of a recently built property than in
the case of an old property, but in no case in which estimate must be
resorted to can the result properly be called original cost to date.


To ascertain original cost to date, it is necessary, as a rule,
that a schedule be made of the various existing property items in
the same way that one woidd be made for determining the cost of
reproduction. (See further discussion of "Schedule" on pages 1377
to 1380.)

Exceptional cases, in which a detailed schedule may not be neces-
sary for all parts of a property, include those in which the whole or
a part of a property has been built at so late a date that the original
units are still in existence, and those other properties of comparatively
recent date where the accounting has been such that additions and
betterments are charged to the fixed capital account and the cost
of property retired has been credited to this or a similar account.
However, even in these cases, an inventory may be desirable for the
purpose of checking the results obtained from the books. Under the
most favorable conditions as to records, it may be necessary to make
many adjustments in order to obtain correct results.

Costs — Unit Costs.

In cases where a schedule is necessary, the corresponding costs or
unit costs are also necessary in order to complete the inventory.
Whether these are the actual costs of units or groups of units, or the
imit costs, will depend on the method of bookkeeping which has been

There may be many cases in which work which covers many items
has been done by a contractor for a Itmap sum, in which case it may
be necessary, in making the schedule, to group the items included in
the contract and to place opposite them the total sum paid the con-
tractor, together with all the incidental charges properly attributable
to the work.

When practicable, however, it is preferable to keep the items on
the schedule separate, or in groups of identical items of the same age.


and to apply unit costs, either given directly in the books or which
may be determined from them, including in such costs the direct
incidental expenses, such as inspection, freight, carting, storing, lay-
ing or placing, etc.

In the case of property units acquired or created long ago, it will
be impracticable, as a rule, to obtain the costs or unit costs from the
books, and in such cases the ascertainment of the original cost is
impossible, and it would have little significance if it could be

Overhead Charges.

The expenses to be included in overhead charges are discussed more
fully under this head in the succeeding chapter relating to cost of

In brief, however, they may be said to consist of the preliminary
expenses of promoting, investigating, organizing, and financing, and
the incidental expenses during construction, which may be classified
under the heads of engineering, general expenses (including the ad-
ministrative, legal and financial expenses, taxes and insurance), and
interest. -i

When the detailed accounts giving the cost of a property are
available, these items should appear in them, but in many cases no
account may have been taken of the value of the services of those en-
gaged in promoting and constructing the work, or proper allowance
for interest on the capital, or the records may be in such shape as to
defy analysis.

Bonds may have been sold at discounts. Under the ruling of the
Interstate Commerce Commission, that proportion of discounts and
commissions on bonds is to be included in capital which is represented
by the proportion of the construction period to the life of the bonds.
The remainders of the discounts and commissions are not to be con-
sidered as capital, but are to be amortized over the remaining life of
the bonds.

The Committee believes that reasonable commissions for selling
securities of any kind should be included as a capital charge, but that
discounts on bonds over and above such reasonable commissions should
be treated as a capital charge only in such proportion as the con-
struction period bears to the life of the bonds, the remainder being
amortized over the remaining life of the bonds.

After the construction period has ended and the regular operation
of a property has begun, the method of accounting is frequently such
that the salaries and expenses of the permanent engineering, adminis-
trative, and legal staff are charged wholly to operating expenses, al-
though a part of the time of this staff is devoted to the construction of
additions to the property, and should properly be included as a part of


their cost. Similarly, there is frequently a failure to charge to the
proper account the interest during the construction of such additions.
Adjustments should be made so as to include in the cost of such ad-
ditions the overhead charges properly attributable to them. On the
other hand, there may be occasion, when determining the overhead
charges from the book accounts of an old property, to make deductions
of such charges as are properly attributable to plant units which have
gone out of use.

The statements in the last paragraph may invite the criticism that,
if the method of bookkeeping is such that a part of the overhead
charges for additions to the property has been placed in operating
expenses, it has been paid for by the public and not by the company,
and hence should not appear in a valuation of the property. In this
matter the Committee makes a distinction between valuation and
regulation, and takes the ground that in valuation the total cost of the
property should be included, regardless of past methods of bookkeeping.
It recognizes, however, that in continuous regulation, including the
control of rates by a public service commission, there should be no
duplications by charging items to both the capital and the expense

Development Expense.

The development expense actually incurred in connection with the
tuning up and creation of the business of a property should be in-
cluded as a part of the original cost to date. The subject is fully
discussed in Chapter VTI.




The Theory of Reproduction.

Different Applications of Reproduction in Past Practice. — Cost of
Reproduction is defined by the Committee as:

"The estimated cost of reproducing the property without deduction
for the loss of value due to age or other causes."

The practice of those engaged in valuation work, from the beginning
of such work up to the present time, has varied widely in the matter
of determining the cost of reproduction. Some base such cost on exist-
ing physical conditions, others on historic conditions, and still others
combine the two. Some engineers have included only those physical
property units which were actually created in the construction of
the property, that is, they have used historic conditions, as to items
of cost, with present-day prices for labor and material. Others have
used substitute units, or historic prices, or original instead of present
methods of work, and still others have used original conditions, original
prices, and original methods, in making an estimate of reproduction

This failure of engineers engaged in valuation practice to agree
on a uniform conception of reproduction has cast some doubt on the
real worth of Cost of Reproduction as one of the measures of value.

The United States Supreme Court, in the Nebraska rate case,
states the various matters to be considered in determining value, as
follows: (Smyth v. Ames, 169 TJ. S., 466, March 7th, 1898).

"And in order to ascertain that value, the original cost of construc-
tion, the amount expended in permanent improvements, the amount
and value of its stocks and bonds, the present as compared with the
original cost of construction, the probable earning capacity * * *
are all matters for consideration and are to be given such weight as
may be just and right in each case."

This case has been cited in most valuation cases, and the use of
the word "Reproduction" has been very general in subsequent decisions,
although it is to be noted it is not used in the decision in Smyth vs.
Ames. It is clear that the Courts in many cases have recognized the
reproduction estimate as one of the most important bases for deter-
mining value (Louisville & Nashville R. R. Co. v. Railroad Com-
mission of Alabama, 196 Fed., 800 (1912), Hon. Thomas G. Jones,
District Judge, N. & M. D., Alabama).

"In reference to the question of value with the view of rate regula-
tion, the most reliable test ordinarily is the cost of reproduction of


the road as it exists. I say 'ordinarily' because there may be instances,
which is not the case here, where by reason of paralleling the road by
a new road, and diverting its business or from other causes, its value
may be far less than what it will cost to reproduce it as it is at the
time of the inquiry. The original cost of the road may in some cases

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