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Transactions of the American Society of Civil Engineers (Volume 81) online

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fund reserve, which should in this case equal the fund, is the account-
ing depreciation.

Unless reserves are set up for all property, as has been recommended
by the Interstate Commerce Commission, or a full depreciation fund is
maintained, accounting depreciation can never agree with the depre-
ciation present at any given time, but it should agree substantially
with it for those units or items which are maintained from the begin-
ning under depreciation allowance methods, if the estimates of service
life on which the allowances have been based have been correct, and
the propertj' has worn at the rate assumed by the particular allowance
method adopted.

The straight-line method will show at any time a larger accounting
depreciation than either of the compound-interest methods.

Summary. — None of the allowance methods works out in practice
exactly as indicated in the tables. Accidents, and errors of judgment
in prophetic estimates of service life, may cause sums received for
depreciation to be excessive or deficient, but, in the accounting of
a continuing property, these differences can be adjusted from time to

In the opinion of the Committee, the several methods described
are respectively more particularly applicable as follows:

The replacement method is applicable to those short-lived prop-
erties or parts of properties made up of a large number of items, the
replacement or retirement of which proceeds after a time with fair
regularity and causes no troublesome variations in return or service
rates. Railroad ties are an example. Rails, when a part of a very large
property, and machines where very many are owned and used, may also
be handled by the replacement method. Although applicable to all
such properties or parts of properties, the replacement method is at
present undesirable because it may result in loss to the company
owner in the case of a valuation, determined under an interpretation
of the Knoxville decision, which holds that all loss of service life of
physical items, except such as is made good by current repairs, is loss of
value of investment, and that obligation of the public to pay can
never be accepted as an asset to offset accrued depreciation.

The straight-line method of accounting applies to any property
units having more than a year of service life, which are assumed to
depreciate according to the straight-line theory. ' The compound-
interest theory applies similarly to property units assumed to depreciate
according to the compound-interest theory. Under either method it
may be necessary to maintain a fund not invested in the property itself,
as when the property is stationary or consists of only a very few large



units of long life. For such properties the sinking-fund method of
accounting could be adopted, if the compound-interest theory is held to
app^Jj provided it is fully understood and correctly applied, but it
is not recommended.

The great discrepancy in the growth of depreciation of long-lived
units under the straight-line and compound-interest theories should be
carefully noted when determining which theory to use. For short-lived
items there is not much difference, and in some cases the straight-line
theory may result in more uniform annual payments than the com-
pound-interest theory ; but, as already pointed out, there is a very great
difference in the results of the two theories when applied to long-lived
units. For such units, the Committee believes that the compound-
interest theory is more nearly in accord with the truth as expressed by
the unit-cost theory, which is thought to give results most closely
corresponding to actual depreciation, and here the compound-interest
theory would seem best to apply.

The extent of the difference in the amount of depreciation under
the straight-line and compound-interest theories, for property units
having various lengths of service life, is shown in Table 4. It is to be
noted that the first column shows the percentage of the total service
life which has expired, and consequently the percentage of existing
depreciation computed under the straight-line theory. The remaining
columns show the corresponding percentage of depreciation under the
compound-interest theory based on a 5% interest rate compounded
annually. For example, when 20% of the life of a property unit has
expired, the depreciation by the straight-line theory would be 20%,
regardless of the length of life of the unit, but by the compound-
interest theory the depreciation would range from 16.3% for a unit
having a life of 10 years to 1.3% for a unit having a life of 100 years.


Percentage of

Percentage op Depreciation Under Compound-Interest Theory.

total life which

Corresponding to Percentage of Loss of Service

has expired =

Life Given in First Column.

percentage of


by straight-


25-year 50-year

75- year


line theory.


unit. unit.
















25.1 '























This report is particularly concerned with depreciation account-
ing as it relates to valuation, and the determination of the deprecia-
tion of valuation. It would seem to be fair in any given case to give


tlie method of accounting used by tlie utility in setting up depreciation
allowances its proper effect in determining deductible depreciation or
the depreciation of valuation. The foregoing discussion of the several
more common methods is given in order that the proper effect of each
may be better understood by the valuing engineer.

The Depreciation of Valuation, or Fair Depreciation.

Cost of Decretion. — Finding the cost of decretion is a step
in the determination of depreciation, but the result is not necessarily
depreciation of valuation. By cost of decretion is meant the loss of
service life of an item converted into loss of value. This produces
what is sometimes called depreciation and what is depreciation for the
particular item. As it may or may not be a quantity to deduct from
cost or other base for value when finding value or "fair value", it is not
called depreciation here, but cost of decretion, simply to avoid confu-
sion likely to result from the use of the word depreciation in more
than one sense.

The first step in estimating the cost of decretion is to make the
necessary examination of the property unit by unit. This examination
should include an investigation of every element that has any bearing
on the future and past service of each item and the character of its
maintenance. From the investigation an estimate will be made of
the remaining service life of each unit under the method of main-
tenance being followed; its past service life will be known; from these
its total estimated service life, which may or may not agree with
assumptions made for past accounting purposes, is found. Examina-
tion should show also the efficiency of operation of each unit.

To estimate the fraction of service life consumed requires a knowl-
edge of past service and an estimate of future service life. There are
two questions of importance to be discussed in this connection.

1. — Treatment of Inadequacy and Obsolescence. — Experience
furnishes a guide in the making of reasonable estimates of service
life for those property units devoted to well-known operations, unlikely
to be superseded by newly invented units to perform the same service,
or to be rendered obsolete or inadeqiiate by the changing requirements
of a shifting population, or of commercial methods, or the changing
habits and demands of the community. It is very difficult, in some
cases, however, to make such estimates for property units which are
likely to go out of service for one reason or another before they are
worn out.

jSTevertheless, it is recognized to be good business policy to make
the best estimate possible in the light of such experience as may be
available, and to fix a periodic allowance for depreciation reserve
accordingly. In(^eed, it is prescribed by the Interstate Commerce
Commissions and many State Commissions, that the estimated effect


of inadequacy and obsolescence shall be included in the depreciation
periodically credited to reserve by common carriers. Many State
commissions make the requirement that these causes shall be included,
not only in fixing the depreciation credited to reserve, but in fixing
the amount of depreciation to be deducted in determining the "fair
value" of a property.

Although the matter has not been definitely passed upon by the
United States Supreme Court, some Federal and higher State Courts
have recognized the propriety of including inadequacy and obsolescence
as factors in the determination of depreciation.

The estimation of inadequacy and obsolescence is of necessity
somewhat more speculative in character than the estimation of the
results of wear, tear, and decay, but there is greater or less speculation
in all estimates of future service life of physical property, and it
would seem to be inconsistent to consider functional depreciation in
estimating depreciation allowances to be charged to operating expense,
and then to ignore it in a valuation.

The Illinois Public Service Commission, in the case of City of
Springfield v. Springfield Gas and Electric Company (March 9th,
1916), in the course of a long discussion and review of the opinions
of the Courts on this subject, says :

"Depreciation, accordingly, may be divided into two classes:
physical, due to wear and tear; and functional, due to inadequacy
and obsolescence which require replacement of equipment before it
actually is worn out.

"It is the opinion of this Commission that the M^eight of authority
compels a reasonable deduction from cost new for accrued depreciation
— both physical and fimctional — * * *."

"In view of all facts in this case, the Commission finds that it is
but reasonable, proper, and equitable to make deductions from cost
new to cover accrued depreciation, both physical and functional, and
that it is proper to treat depreciation consistently in all its features.
Nothing in the record, and no theoretical consideration presented in
this matter, are of sufficient weight to cause the Commission to
depart from this reasonable and thoroughly consistent treatment of
depreciation, which not only possesses judicial sanction but also is
sound in both economic theory and business policy."

The California Eailroad Commission, in the case of the Central
Pacific Kailway Company, decided December 8th, 1915, gives the fol-
lowing definitions which refer to functional depreciation:

"Physical depreciation is caused by the action of the elements
and the wear to which a facility is subjected; functional depreciation
IS caused by the inadequacy or obsolescence of the facility, due to
developments which have made it incompetent to perform its function
properly or economically.

"Keproduction cost of a railroad less depreciation, in a valuation
for general purposes, is the reproduction cost less the diminution in


the value of the physical elements of the property, due to use, age,
ohsolescence, inadequacy, or other causes, plus the increase in value
of physical elements due to age or other causes." (Italics ours.)

In the case of the Chesapeake and Potomac Telephone Company
of Baltimore City, decided March 8th, 1916, the Maryland Public
Service Commission made the following statement :

"Any theory for ascertaining existing depreciation in the plant
of a public utility which confines such depreciation solely to the actual,
visible, physical, demonstrable deterioration which can be seen by
the human eye and measured by the human hand, must of necessity
ignore that other species of deterioration which the experience of
the past has demonstrated beyond peradventure exists in tlie property
of every telephone company, although it can not always be seen by the
human eye or measured by the human hand.

"We refer to that tendency upon the part of all such property to
become inadequate or obsolete with the lapse of time. We find it in
the case of practically every building which this company owns. Ample,
adequate to-day, they may become entirely inadequate to-morrow."

The Colorado Public Utilities Commission, in the case of the
Colorado Springs Light, Heat and Power Company, decided March 1st,
1916, made the following statement:

"This Commission is familiar with the decision of the Idaho
Supreme Court in Murray v. Public Utilities Commission, 150 Pac,
47, and with the theory there announced that there should be no theo-
retical accrued depreciation deducted from the reproduction cost of
the physical property, but the court there states that actual deprecia-
tion should be deducted. Just what method an electrical engineer may
use in arriving at the actual depreciated value of an electric property
without considering theoretical depreciation is somewhat beyond our
scope of vision."

A limited search of the practice of public service commissions indi-
cated that inadequacy and obsolescence were included either in ascer-
taining the amount of depreciation to be included in earnings, or to be
deducted from cost to obtain "fair value", by the commissions of the
following states : Arizona, California, Colorado, Illinois, Maryland,
Massachusetts, New York, Oregon, South Dakota, Wisconsin.

The Board of Public Utility Commissioners of New Jersey, in a
decision concerning the rates of the Public Service Gas Company
(1 N. J. Bd. P. U. C. 433, December 26th, 1912), distinguished between
what is called, in its decision, theoretical depreciation, which must be
sufficient to take care of obsolescence and that depreciation which can
be determined by observation and inspection, and took the view that,
in the future, allowance should be made for depreciation on the theo-
retical basis, but that as applied to an existing property, where it ap-
pears that the depreciation, credited to depreciation reserve in the past.


has not included the effects of inadequacy and obsolescence and thus
been collected from the people, nothing should be held against the prop-
erty for accrued depreciation due to these causes. The decision in-
cludes this statement:

"We believe that from this time forth allowance for depreciation
should be made where possible, on the theoretical basis, but where depre-
ciation has been charged off, the amount charged off appears to have
been not theoretical depreciation, but merely amounts which would
measure depreciation ascertained by inspection. We, therefore, con-
clude that we are on certain ground when the allowance for depreciation
which is deducted from the cost to reproduce the property new is the
amount representing the wear and tear and aging, and when we do not
attempt to estimate the greater amount which would allow for obso-
lescence and inadequacy."

Although the matter of the inclusion of obsolescence and inadequacy
has not been passed upon definitely by the United States Supreme
Court, it is possible to infer from the language used in the Knoxville
case and in the Minnesota rate case that the Court had in mind as
a part of depreciation that due to inadequacy and obsolescence. In
the Minnesota rate case the following language is used:

"As the Master said, everything on and above the roadbed depre-
ciates from wear and weather stress. The life of a tie is from 8 to 10
years only. Structures become antiquated, inadequate and more or
less dilapidated, * * * cars, locomotives and equipment, as time
goes on, are worn out or discarded for newer types."

The use of the terms 'T^ecome antiquated", "inadequate", "are dis-
carded for newer types" clearly indicates that the master had in view
depreciation from obsolescence and inadequacy, and although the Court
quotes his statement it makes no unfavorable comment upon these

The decision in the Knoxville case contains the following language :

"But the reservoirs, the mains, the service pipes, structures upon
real estate, standpipes, pumps, boilers, meters, tools, and appliances
of every kind begin to depreciate with more or less rapidity from the
moment of their first use."

Since about the only way that reservoirs can depreciate is through
obsolescence, their inclusion in the foregoing statement, if not
accidental, must have been based on a consideration of obsolescence.

A case in the Federal Court, recognizing the inclusion of func-
tional depreciation in determining the sum to be deducted from repro-
duction cost, is that of the Des Moines Water Co. v. City of Des Moines
(192 Fed., 193, 197, Sept. 16, 1911), in which it is stated:

" * * * the question is. What would it cost to-day to reproduce
the plant? and from which, to get at the value of the present plant,


there would be deducted the value of depreciation, either by functional
or physical depreciation."

In the Kings County Lighting Company case, the New York Public
Service Commission for the First District included the effect of inade-
quacy and obsolescence in the determination of the amount to be de-
ducted from cost for depreciation. When this case was appealed to
the Appellate Division of the Supreme Court, that Court decided
(People ex rel. Kings County Lighting Co. v. Willcox, 156 N. Y., App.
Div., 603, May 9, 1913) to coniSrm the action of the Commission, but
did not discuss obsolescence or inadequacy.

While most of the opinions of public service commissions and Courts
in recent years have favored the inclusion of inadequacy and obso-
lescence, it is by no means uncommon to find in the opinions of masters
and minor Courts, and sometimes of higher Courts, the expression of
the view that all depreciation based on the life of a property unit
should be excluded, and this would cover the exclusion of inadequacy
and obsolescence. The basis in such opinions appears to be largely
that, where the service is maintained at 100% efficiency, there is no
depreciation. A recent opinion of this kind was that of the Supreme
Court of Idaho (Murray v. Public Utilities Commission of Idaho, 150
Pac. R, 47, July 1, 1915) :

"This Court is of the opinion that the rule of cost of reproduction
less depreciation, adopted by the commission, is the correct general
rule or principle to be applied in this class of cases. However, we
believe that in ascertaining values in this way the worth of a new
plant of equal capacity, efficiency, and durability, with proper discount
for defects in the old, and the actual depreciation for use, should be
the measure of value, rather than the cost of exact duplication.

"So far as the question of depreciation is concerned, we think
deduction should be made only for actual, tangible depreciation, and
not for theoretical depreciation, sometimes called 'accrued depreciation'.
In other words, if it be demonstrated that the plant is in good operat-
ing condition, and giving as good service as a neiu plant, then the
question of depreciation may be entirely disregarded." (Italics ours.)

Wliitten, Yol. II., page 1150, gives a part of the decision of the
Railway and Canal Commission of Great Britain concerning the value
of the property of the National Telephone Company and its transfer
to the Postmaster-General at the expiration of the Company's license
on December 31st, 1911. (16 A. T. & T. Co. Com. L., 491, Jan. 13,
1913.) Whitten makes the following statement:

"Under the purchase agreement between the parties dated August
5, 1905, the purchase price was to be based substantially upon the repro-
duction cost of the physical property less depreciation.

"In this case the Postmaster-General contended that in computing
the life of the plant for the purpose of estimating accrued depreciation.


the life period should be reduced on account of a probable shorter
'effective life' due to inadequacy, obsolescence, or other factors requir-
ing supersession of a particular unit before it has been worn out. The
greater stress was laid upon probable supersession through inadequacy
due to the probable growth of the telephone business. The court held,
however, that to give weight to these considerations involved a con-
fusion of thought and that the possible and even probable growth of
the Postmaster-General's telephone business had no bearing upon the
present value of the Company's plant. The court, however, attempted
to make due allowance for all functional depreciation actually existing
in the plant at the time of the valuation."

The trend of opinion at the present time seems to be in favor of
including inadequacy and obsolescence as factors in determining depre-
ciation, both as to the sum to be deducted from cost to obtain cost less
depreciation and as to the sum to be included in earnings. Until there
shall have been authoritative court decisions in this country covering
this matter, the estimator should proceed with caution, giving the
property the benefit of any doubt, lest by mental speculation he destroy
actual, existing value. Where the financial history of the property
shows that the charges for depreciation have not included obsolescence
and inadequacy, equity seems to require that they should not be in-
cluded when determining the reproduction cost less depreciation of the

Under existing circumstances it is well to segregate the depreciation
due to inadequacy and obsolescence from that due to other causes,
that the propriety and effect of its inclusion may be weighed by
the Court.

2. — Mortality Tables to be Used with Care. — It has been suggested
already that remaining service life is determined as the result of
examination and investigation; that depreciation is due to several
causes, one or more of which may be chiefly responsible for loss of
value in any particular case. The purpose of this paragraph is to
emphasize this point and to suggest that ordinary mortality tables for
physical properties are not to be carelessly used in this connection.
The determination must be based on an investigation which includes
not only age but character of past, present, and probable future service,
character of past, present, and probable future maintenance, possible
apparent or probable approaching inadequacy or obsolescence; and
often the accounts must be examined to find the amount of money
spent in repairs and general iipkeep, and the regularity of the ex-
penditure. Not only these but experience with other like properties
under similar conditions should be considered, and sometimes properly
prepared mortality tables giving estimated service life may be useful.

As has been suggested, many properties under proper maintenance
will last forever, so far as human intellect can comprehend the meaning
of that term.


That this is practically true, present existence of the following
named structures seems to prove:

Main stone sewer, Rome Built 600 B. C.

Arch bridge, San Angelo, Rome " 200 A. D.

Several stone bridges at Nuremburg " 1486-1728

Wooden bridge (Kapollsbriicke) " 1333

Iron suspension bridge, Nuremburg " 1824

Westminster Abbey, London, old portion stone — Built 13th Century
Hatfield House, England (Marquis of Salisbury). . " 1611— Stone.

Saint Lawrence Church (Nuremburg) " 1477 — "

South Church, Boston " 1750— Brick.

Church, Alexandria, Va " 1784— "

Howland House, Plymouth, Mass " 1660 — Frame.

Windmill, Nantucket, wood and shingles " 1746 — ''

Washington's home, Mt. Vernon, Ya " 1784 — "

Hobson's House, Montgomery, Ala " 1815 — "

On the other hand, apparently permanent structures have but a
short life; what were new high buildings only a few years ago are
already destroyed to make way for yet higher buildings. This means
inadequacy and obsolescence. It shows that mortality tables based
on the older structures are not applicable to the modern structures,
and, based on averages, they would be likely to be far from the truth
in any particular case.

At a recent meeting of railroad equipment officers from all sections
of the United States it was determined from railroad records that:

"Obsolescence and inadequacy have been the cause of retiring prac-

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