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

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tically all equipment in this country, and wear and age have not,
except in very few cases, been the cause of retirement. There is,
therefore, little data on which to base life tables, and as wear and age
have not been the cause of retirement, experience is lacking which
would permit the preparation of such life tables."

Although data may be lacking on which to base estimates of future
loss of service life due to age and use, it would seem that, with all the
data available with respect to inadequacy and obsolescence, there might
be sufficient to estimate in a general way what the service life of
railroad equipment is xmder varying conditions of service. Indeed,
some such estimate must be made for any given road, in order to fix
reasonable depreciation allowances for equipment as required by the
regulating body. An estimate prepared with care for any given unit
from a large number of data covering the service life of similar units
would certainly be more trustworthy than one based solely on an ex-
amination of the particular unit. Tables showing the lives of certain
units will be found in Appendix II.

Depreciation of Overhead General Expense. — Shall depreciation be
estimated on overhead and general expense? The Committee believes


that the answer depends on the character of those expenses, and divides
them into two classes: (1) Those which, like promotion expense, pre-
liminary and location surveys, legal and other expenses, connected with
the creation of the property, cannot be segregated into parts assignable
to particular units, but apply to the property as a whole; (2) Those
which would be incurred were the units to be reproduced, not as a part
of a general reproduction, but for the maintenance of the property.

Expenses of the second class may be included sometimes in unit
prices, but are not always entirely separable. Expenses of the first
class cannot be thus included. The test as to whether or not a par-
ticular item of overhead shall be depreciated is : Will it be incurred in
replacing units that are retired. If so, it is part of the cost of those
items the service life of which is being consumed, and hence will be
a part of the sum to be depreciated with the loss of service life of those
items. If not, it is a part of the ever continuing property, and can
suffer no depreciation except as the exchange value of the whole prop-
erty may be lowered, in which case everything that went to make it
loses value.

The Committee is of the opinion that all overhead charges which
may be included in the unit prices of particular units, or which are
specific charges against particular structures, should be depreciated,
if the particular units or structures are to be depreciated, and as a
part of the cost of those units or structures; that all overhead charges
which would be incurred in replacement of units but which may not
be easily separable in a reproduction cost estimate, should be depre-
ciated by the average depreciation assigned to the units to which they
belong; that overhead charges appertaining to the property as a whole
and not to be reincurred in the replacement of units should not be
depreciated at all, if the property is a continuing one.

Depreciation of Valuation Affected hy Accounting Methods. — De-
cretion or loss in service life being always present in any going prop-
erty, the cost of decretion is always present. Decretion is a fact, and
is independent of methods of accounting, or character of regulation,
but is much dependent on character of maintenance. In determining
it, one is not helped in any way by reference to the accoiinting methods.
He must examine the property units, estimate their remaining service
lives, know their elapsed service lives, the character of their past
service and maintenance, and the prophecy as to future service and
maintenance. To estimate the cost of decretion one must know,
also, the costs or estimated reproduction costs of the property units,
but the amount of the estimate and whether or not it shall be treated
as depreciation of valuation may be, and very probably will be, de-
pendent, at least in part, on methods of accounting for depreciation


that have prevailed. Whether or not it will thus depend may also
depend ag'ain on the character of public regulation.

(a) — Replacement Method. — If by order or sanction of a regulating
body, or by long continued proper custom under no regulation, a prop-
erty has been maintained in normal working condition, necessarily less
than new in some or all of its parts, by the replacement method, and
at any given date is being valued for any public purpose and at that
date shows normal condition, all its several parts being in as good con-
dition as could be expected, the accounts showing that always those
amounts have been expended in renewals that were necessary to keep
the property in normal working condition, and the fact appearing that
no expenditure reasonably to be expected could put the property in
better tlian the normal condition in which it is found, and that no un-
usually large expenditure is presently to be necessary for this pur-
pose, then, in spite of the fact that there is an existing decretion in its
several parts, there should be found no depreciation of valuation.
Under the method of accounting, the public has not paid, and could not
I)ay, for the accrued depreciation, and under this condition its accrued
obligation to pay should be considered an asset of the company owner.

If parts of the property are maintained under the replacement
method and part by some proper allowance method, then, except as
noted below, depreciation of valuation should be found with respect to
those parts maintained under the allowance method, but this deprecia-
tion of specific physical units will be made good in whole or in part
by existing funds or property purchased with allowances, either or
both of which will be included in the valuation as they are found.

Railroads are properties of the class just considered. Their owners
have long maintained the greater part of their perishable properties by
the replacement method, and, except for a comparatively recent require-
ment of allowances or reserves for equipment, this method has been
sanctioned by the Interstate Commerce Commission. Therefore,
for such properties as are found in normal condition, as suggested
above, there will be no depreciation of valuation for those items main-
tained by the replacement method. If these items are found below
normal working condition, there will be depreciation of valuation, some-
times called deferred maintenance, and it will be measured by the sum
necessary to bring the items to normal working condition — not new.
the initial decretion necessarily present in such items in normal work-
ing condition being ignored, but upon restoration to normal working
condition, the integrity of the investment should be considered to be

If in the judgment of the valuing engineer, the replacement method
may not be used with propriety for a given property, either because not
in accordance with law, or because the method is not adapted to the
property, then whether or not the property has been maintained in the


past under this method the valuing engineer should estimate deprecia-
tion in the amount of the cost of the decretion he finds. There can be
no certainty that the property will be properly maintained in the

When a comparatively new property, other than a railroad, is to
be valued, and it has not been under any regulation that has affected
its accounting methods, the law as laid down in the Knoxville decision
would seem to make it necessary to find depreciation of valuation in
amount equal to the cost of decretion found for all items, whether or
not maintained by the replacement method. The Committee, however,
believes that this may work hardship and injustice in some instances,
and suggests that in such cases the facts be reported with svich recom-
mendations as to equity, as may seem fair to the engineer.

The public utility is entitled to see that from earnings the value
of the property invested "is kept unimpaired" and that "before coming
to the question of profit at all, the company is entitled to earn a suffi-
cient 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". This is a reasonable right,
the existence of which permits of renewals of parts of a property, that
can be called current repairs, under the replacement method.

(&) — Allowance Methods. — If either the straight-line or sinking-
fund theory has been used in computing depreciation and the method
of accounting for it has been prescribed by a regulating body or
voluntarily followed by a company owner from the beginning, the
same theory, so far as it applies to the property in question, should be
used for estimating the cost of decretion, and the entire cost so found
lessened by any accumulated depreciation funds will appear as depre-
ciation of valuation, unless the sinking-fund method of accounting has
been used. In the latter case, if the valuation has to do with the
reasonableness of the return and the accounting is to go on as before,
apparently-existing depreciation would not be depreciation of valua-
tion, and therefore would not be deductable ; but if the valuation
has to do with condemnation or purchase, then, as in other cases, the
apparently existing depreciation is depreciation of valuation, and
the owner should receive the depreciated value of the physical property
and the existing fund.

As has been said, the unit-cost method of estimating depreciation
can hardly be used with convenience as an accounting method. When
there has been no regular depreciation accounting method followed,
the unit cost method for estimating depreciation at any given time may
be used with fairness.

The Committee has advised that the proper interest rate to be
used in computing depreciation annuities is the same as the fair
rate of return. This advice pertains to present and future accounting.


If, however, an old property, that has been properly maintained under
the sinking-fund theory, is to be valued, that rate of interest should
be used in computing the growth of theoretical depreciation that has
actually been realized and has produced the existing depreciation fund
or reserve. If there has been no depreciation accounting and it is
desired to estimate the accrued depreciation under the sinking-fund
theory, the engineer may choose the interest rate, but, inasmuch as new
accounting to be installed after the valuation or rates to be based on
the valuation should include, in accordance with the Committee's
advice, an interest rate for depreciation equivalent to the fair return
rate on capital, it is suggested that this same rate be used in computing
the accrued depreciation.

Ejfect of Investing Allowances in the Property. — Under the
straight-line or compound-interest method of accounting it is con-
templated that, so far as possible, the depreciation allowances shall
be invested in additions or betterments to the property. If such con-
tributions of the public toward depreciation of existing property are
invested in betterments and additions, then there must be depreciation
of valuation to whatever extent cost of decretion is found, because in
the inventory the betterments and additions made with the deprecia-
tion allowances will be listed as part of the property to be valued just
as are the original items, the depreciation allowances for which were
used to provide the betterments or additions. There will be no off-
setting funds, but there will be property contributed by the public
which cannot be capitalized and for which credit can be given to the
public only by deducting an equivalent depreciation.

If, at the time of any valuation, not all the contributions of the
public toward depreciation have been re-invested in the property, de-
preciation of valuation should still be found in the amount of the
estimated cost of decretion of the physical property, but this will be
offset to such extent as other assets, such as cash or outside securities,
are in hand representing the portion of allowances, not re-invested in
the property, but held for this purpose, and which, therefore, should
be inventoried and included in the valuation.

Ejfect of Regulation on Depreciation of Valuation. — Regulation
which determines the method of accounting will in part determine
the amount of depreciation of valuation when finding "fair value",
because it determines the method by which the public shall pay for
the loss of service life.

It has been said by the Courts that it is not possible to go into the
unregulated past to find losses or excessive profits, but if there has
been regulation determining the method of accounting for deprecia-
tion from the beginning, or for a long time, and this regulation has
fixed the sums to be included in the earnings for depreciation, it should
be permissible to inquire into the adequacy of these sums. It seems


clear that in this respect it is proper to go back into the past and
inquire to what extent the public has compensated for the loss of value
due to loss of service life. If the regulating body has prescribed the
replacement method for the whole period that units have been in
existence, then, although depreciation may exist, it is not depreciation
of valuation, because, under the method of accounting, the public
has not paid, and could not pay, for the accruing depreciation, and is
still under obligation to pay for it.

Methods of accounting in force at the present time which make
proper provision for the accruing depreciation should not have full
weight, if, in previous years during the life of the property units,
other methods were in use which did not make proper provision for
such depreciation. The amount of depreciation of valuation in
such cases should be equivalent to the accumulated contributions of
the public for depreciation allowances mider the various methods of
accounting which have affected the property unit from time to time.
The public is still under obligation to make good that part of the loss
of service life not yet paid for, and this obligation should be con-
sidered to be as much the property of the company usable to offset
accrued depreciation as renewal funds or property actually in existence.

Whether or not this reasoning will stand in any case is for the
Court to determine. Valuing engineers and accountants should report
what they find as to the actual cost of decretion, and the sums which
have been received to offset such cost, under the methods prescribed
by the regulating body from time to time. They may give their
opinions as to the amount of depreciation that should be deducted
from cost to find cost less depreciation as an element in the quantity
known as ''fair value".

If regulation has not fixed accounting methods, but has limited
the earnings, it should be permissible to inquire whether the limited
earnings have been sufficient to pay operating expense, depreciation,
and fair return. If so, depreciation found should be considered depre-
ciation of valuation to the extent warranted by the accounting methods
lawfully or properly followed; if not, a question arises. It is remem-
bered that the duty of the company o\\Tier is first to maintain the
property "before coming to the question of profit at all", and that
it is the duty of the regulating body to see that rates are such as to
permit the company owner to earn operating expense, depreciation,
and fair return. If the regulating body has made sufficient earnings
impossible, is it still the duty of the company owner to maintain the
property before paying fair return to its security holders? If it is,
depreciation of valuation should be found in the amount of the total
cost of decretion or so far as warranted by the accounting methods
followed. If not, depreciation found should not be considered depre-
ciation of valuation except to the extent covered by earnings after


deducting operating expense and fair return. This is a matter of
equity to be determined by a Court, and the Committee will not
venture an opinion. If under regulation the property is a losing
venture, it is not included in the class of properties now being con-
sidered. The depreciation existing will be found and reported,
together with all pertinent facts, and the Court will determine the
equities of the case.

Concluding Suggestions. — The valuing engineer should bear in
mind that when a company owner has invested a reasonable sum in
a property for public service, it is entitled to, but not guaranteed, a
fair return on its investment, so long as the money remains in the
property, either as property, or funds, or accrued public obligation
to paj^ Therefore, so long as the company owner keeps a sum equiv-
alent to the total investment at work for the public, either as property
serving the public, or funds held in reserve for such property, no policy
should be followed in estimating depreciation that will reduce the
property to a value less than the investment, or, when using cost of
reproduction less depreciation as a basis of "fair value", to a value less
than the cost of reproduction of that part of the property estimated to
have been created with company funds, acquired by gift or in any way
not the result of public contributions to cover depreciation.

Valuing agencies should also bear in mind the fact that for 30
years, until 1909, the Supreme Court of the United States not only
recognized the replacement method as a proper method for the
maintenance of public utility property, but disapproved the practice
of charging the public with depreciation allowances in advance of the
necessity for their use, holding that only money actually expended
could be charged in operating expense and so collected from the
public. In 1909 the Court apparently reversed itself in the Knoxville
case. For the purpose of the present discussion, there is no need to
speculate as to the strict applicability of this decision to all kinds of
properties or property units, but it is thought to be proper to advise
that valuing agencies should proceed in such a manner with respect to
depreciation of properties that grew up under the law as it was before
1909, so that such properties shall not be unfairly reduced in value by
strict application of a current interpretation of the Knoxville decision to
all their parts. If the law changes, equity would seem to demand
that the change shall not be retroactive; and it may be said fairly,
we think, that though law must in general govern in all matters on
which it speaks, yet, with respect to such matters as the details of
valuation of public utilities, of which depreciation is one of import-
ance, in the determination of which there never can be more than
approximate results, and concerning which the minds of men have
been and are changing, equity should not be ignored.

1498 valuation of public utilities


Definition and Application. — Appreciation, as used in connection
with the valuation of public service properties, according to the
definition given in the Glossary "is generally restricted to physical
items, and measures their gain in value due to age, use, and properly
directed labor. Its principal application in connection with railroads
is to roadbed, which, for instance, is increased in value by solidification
and grassing of slopes."

Appreciation, therefore, represents the improvement in quality and
usefulness of certain parts of the physical properties of a railroad or
other public utility property, and it results from the lapse of time
from work not specifically charged to capital account, from main-
tenance, from use, etc., and covers items not represented either by
the quantities, or unit prices, that are determined in connection with
a valuation.

Upon a railroad, appreciation is found in connection with roadbed,
both in cuts and fills and in the modification of embankments; the
general improvement of the slopes through various forms of protec-
tion of both embankments and cuts; and improvement of drainage
facilities along the roadbed, and right of way in general.

In the case of irrigation works, appreciation may be realized upon
dams, canals, and embankments, particularly when not originally built
with great care.

Its determination is difficult, and care must be exercised lest any
of the allowances be duplicated in development expense.

General Principles. — In the case of the San Joaquin, etc.. Canal Co.
vs. Stanislaus County, et al., 191 Fed., 875, in which was involved the
value of certain canals, the Company claimed that the earthwork had
appreciated in value, the claim being that, by the lapse of time and
by reason of the packing of the banks and the silting of the canals,
an additional value had come, in the way of avoiding breaks and in
preventing the loss of water by seepage. Judge Morrow, in reviewing
the findings of the master, quoted from various Supreme Court deci-
sions to the effect that a public utility property is entitled to earn a
fair return upon the reasonable value of its property, at the time it is
being used for the public, and added:

"We then have this rule for ascertaining the value of a plant of
the character of that owned by the complainant in this case : Find the
cost of reproduction as of the date of the use in question and then from
this cost deduct the depreciation that has occurred from age and

The master to whom the case was referred having determined that
depreciation should be deducted, said :

"Likewise it would seem to me that if by reason of a lessened
amount of depreciation, the canals of complainant in their present


condition are capable of delivering more water, thereby producing
greater revenues to the Company, it would be of more value than a
canal estimated on the basis of the reconstruction figures aforesaid."

The master, however, was not satisfied with the evidence submitted
as to the amount of depreciation or appreciation, and held :

"After a careful examination of all the testimony on this question
1 find that I am unable to make either a calculation as to appreciation
or depreciation of the earthworks of the canal and shall assume that
the one offsets the other."

Circuit Judge Morrow, when he reviewed the case (page 855),
stated :

"After carefully reading the testimony on this subject I have
reached the same conclusion the master did with respect to this claim."

In this case, therefore, appreciation was acknowledged; but the
one was considered to offset the other.

In the Minnesota Rate case, where the value of railroad property
was sought to be determined through the cost-of-reproduction method,
and where the Court below found that appreciation and depreciation
existed in practically equal amounts, so that the one offset the other,
Justice Hughes stated, in settlement of the matter:

"If there are items entering into the estimate of cost which should
be credited with appreciation this also should appear, so that instead
of a broad comparison there should be specific findings showing the
items which enter into the account of physical valuation on both sides."

It appears from this decision that there can be no general offsetting
of appreciation against depreciation, but that appreciation must be
determined separately from depreciation.

Determination and Estimation of Appreciation. — It is now con-
ceded that all items that are measurable by units, such as rip-rap, pro-
tection of slopes by sodding or other forms of vegetation, in whatever
manner it has been secured, should be measured and unit prices at-
tached, and the value of rip-rap, sodding, and other forms of slope
protection should be determined in that manner; and that this method
should be followed in valuing common carrier properties, and other
public service properties, such as dams, protected embankments of
reservoirs, etc.

There are two forms of appreciation that are particularly applicable
to railroad properties; one is described by the terms "Solidification and
Seasoning", and the other by the term "Adaptation".

Solidification and seasoning are found in railroad, canal, and other

Online LibraryAmerican Society of Civil EngineersTransactions of the American Society of Civil Engineers (Volume 81) → online text (page 134 of 167)