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James Shirley Eaton.

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plant and the processes of operation. The distinction between
outgo and intake is everywhere present and forms the first basis
of classification. We shall see how intake itself subdivides into
revenue and income. The cleavage between revenue and income
is determined by the relation of intake to outgo: that intake
which is offset by current outgo is called " Revenue " that

* Certain charges which cannot be identified against the classification of
expenses it is permissible to carry to Profit and Loss directly, although they
may belong to the current year (Cases 398, 514, 519,



8 RAILROAD EXPENSES

intake which has no offset of current outgo to produce it (or
from which the offsetting current outgo has been previously
deducted) is called " Income."

We shall find that the ruling characteristic of the items of
either outgo or intake is that each with every other of its class
bears the same general relation to the other side as a whole and
not to any one part or item of the other side. When, as some-
times happens, any item develops a specific offset among one
or more items of the other side (less than the whole) it drops
out of the general class of intake (or of output, as the case may
be) and becomes a direct deduction from its apposite. This con-
dition, we shall see, accounts for " Deductions from Revenue/'
" Credits to Expenses/' and " Outside Operations."

Intake is known to have a usual relation to outgo as it is sup-
posed to be the price realized for service rendered. On this
assumption significant deductions are made from the figures of
intake alone (as gross earnings per mile of road), or the fig-
ures of outgo alone (as expenses per mile of road). These
deductions would plainly be invalid to the extent that the
assumption did not apply, although the net effect of intake, less
outgo, might be undisturbed. Therefore the I. C. C. accounts
make a primary broad distinction between intake (revenue) and
outgo (expenses), and do not permit transactions to be recorded
as intake or outgo unless public service is involved in the trans-
action. " The classifications of Operating Revenues and Oper-
ating Expenses are based throughout upon the idea that nothing
is to be included as an expense which does not represent a pay-
ment made or actually to be made, and nothing included as a
revenue which does not represent revenues actually earned.
Obviously, a carrier cannot collect from and pay to itself, and to
charge Operating Expenses and credit Operating Revenues with
rents of the houses in question would overstate both Operating
Expenses and Operating Revenues, to the extent of such
entries " (Case 488).



THE CAPITAL AND INCOME ACCOUNTS 9

From intake (revenue) and outgo (expenses) is evolved the
third term of net intake or net outgo. To the extent that the
intake exceeds the outgo it is net intake, or profit. The final
intake is cash, but leading up to the stage when the railroad may
actually collect cash, are the manifold antecedent processes, each
serving as a link to the next higher, in which the intake is
product measured in units that are useful in the next stage of
the process.

These subordinate net effects may be produced at any mis-
cellaneous point throughout operations, but only at one point
can there be a true net effect, and that point is the point of real
profit, or loss.

It is the problem of the accountant to hold in coordination,
through the advancing sequences, the figures of outgo and
intake, so that, for as much as they record, they yield the true
net effect and not merely a partial net difference. There is
much inaccuracy in the use of the word " Profit." It is used
loosely to describe the amount of any intake in excess of its
directly offsetting outgo. For instance, a bill rendered may
include an arbitrary allowance of fifteen per cent for overhead
charges above the actual labor costs. This excess is sometimes
improperly called " profit," whereas it is merely the offset to
overhead charges for supervision. But because it is not credited
to that account it appears as an excess over the actual cost of
the labor cleared through the regular expense classification, and
is therefore wrongly considered a profit on the labor. When the
bill rendered further includes allowances above direct expense,
which in reality represent use of plant, as rent charge, we are
again misled into calling such charge a profit, simply because
it is not carried to the credit of rents. The only real profit is
that which is the product of the entire cycle of railroad opera-
tions as a class, and of the railroad plant as an entity. Such
profit is the net result arrived at by deducting the grand total
of outgo from the grand total of intake.



10 RAILROAD EXPENSES

In order that a particular bill rendered shall contain in it
the factor of real profit it must include :

(1) Reimbursement for actual cash outlay.

(2) Its proportion of the burden for overhead charges of

administration.

(3) Its proportion of the burden of interest or rental for

borrowed capital used or plant hired.

(4) A surplus above all these charges which constitutes

profit.

The railroad operates primarily to realize a profit from
transportation. Any other service performed is incidental and
even at times merely a matter of accommodation. The ' ' profit ' '
of such irregular service is practically a reimbursement of
unlocated expense, and not a real operating profit. It is gener-
ally an arbitrary charge to cover such reimbursement. For con-
venience the direct cost of the service together with the arbi-
trary charge (or a " profit," miscalled) for the unlocated
expense of supervision and use of plant, is included as a single
figure and cleared through expenses. This practice is specific-
ally approved by the Commission in Cases 246, 262, 274, and
538. The general characteristic of the bills in the cases cited
is that the " profit " is an irregular incident of the service in
connection with which the profit arises, while the service itself is
more or less a fixed feature of the railroad's general service, and
not easily detachable. Whether the service result in profit or loss
is determined by conditions more nearly related to the conditions
that control expenses as a whole than by those that control rev-
enue as a whole, and therefore, whether profits or losses, the
charge classifies with expenses.

In case of regular large bills, as for joint facilities, the
charge is decomposed into operating, maintenance and admin-
istrative expense, and rents; and the credits are severally
applied to each until the " profit " lias been entirely absorbed



THE CAPITAL AND INCOME ACCOUNTS 11

(Cases 116, 117, 120, 121, 268). The decomposition of a bill is
an arbitrary process to separate the amounts belonging to
expenses, maintenance, rent and profit. While it is encouraged
in joint facilities bills it is not encouraged in the case of a bill
to the express company for facilities or service, unless in the
express contract is designated an amount for rent. Such desig-
nated amount would be immediately credited to the rent expense
of the railroad, and the balance would remain in the express
revenue account. In the absence of such stipulated rent charge
there would be no effort to decompose the credits arising from
the bill, but the total would be carried directly as a whole to
Express Revenue (Case 119).

Intake, Revenue, Defined. In so large an operation as a
railroad the revenue produced is the result of a great body of
preliminary and intermediate causes, many of them very indi-
rect. All of these causes together are necessary as a class to
the production of the revenue ; or all of them are so interrelated
and joined that no one could be logically detached from the rest
and set against its specific result or revenue. Revenue, then, is
that intake which is realized through the use of the whole body
of causes or outlay, not from any one. Revenue intake is dis-
tinguished from the intake by rents, or dividends and interest
on securities owned, by the fact that these latter require no
expenses to produce them. Revenue intake is the intake incident
to the performance of service for an intended profit and is not
the mere intake of cash by conversion of assets.

Deductions from Revenue. When less than the entire body
of causes as a class is involved, and the revenue realized is a
special revenue, the result is a special operation. Thus, refer-
ring to cold storage plants, it has been ruled (Case 142) : " If
the refrigeration operations can be treated satisfactorily as an
outside operation that is to say, if a fairly accurate determina-
tion of the cost of maintaining and operating such refrigeration
operations can be made (i.e., if a separation from the general



12 RAILROAD EXPENSES

body of costs can be made) the amounts charged for refrigera-
tion in warehouses should be credited to Outside Operations
' Cold Storage Plants.' "

If the expense to produce a revenue is absolutely separate as
a class from all other expenses, and affects no other revenue,
then it becomes a deduction from revenue because it cannot pos-
sibly be set against any other " result " at any other point.
When large " profits " are realized on materials and supplies,
these profits are of a special character, the expense to produce
them (i.e., the cost of the material) applies directly to the spe-
cific intake on these materials and to nothing else. It is there-
fore directly deducted from the price realized, and the net
amount only is taken up as revenue, or as a part of the general
intake of the property. When sale operations producing such
profits are regular and the profits large the operations should be
treated as Outside Operations* (Cases 584, 598).

Deductions from Revenue, as illustrated in the two cases
above are justified when a specific cause (item of cost) is so
separable from the general body of causes (or expenses) to pro-
duce revenue that it may be drawn out and set directly against
the particular revenue which it produces. When the revenue
also is separable from the general revenue as a class, it is but a
step further to draw off the revenue from the general revenue
into an Outside Operations account and set its specific revenue
against it. On this plan certain designated Outside Operations
have been set up by the Commission.

The I. C. C. is very cautious in permitting any deductions
from regular revenue because such deductions offer the chance
for concealment. But a switching charge " absorbed " in the
rate in order to get the business is plainly a deduction from
revenue. " The theory upon which the accounts of operating
revenues prescribed by the Commission have been established,
is that the aggregate revenue of all carriers should represent
* For fuller discussion of Outside Operations, see p. 205 et seq.



THE CAPITAL AND INCOME ACCOUNTS 13

total freight charges assessed against shippers on the basis of
tariffs." By this precaution an open tariff rate is automatic-
ally carried over from the tariff sheets into the accounts, and
no shipper can be treated differently from any other shipper
because the only concession possible is in the form of a service
whose expense must be set out in the body of expenses in the
other side of the Income account.

But there is a class of disbursements such as payments for
i( switching absorbed," which payments are not related to any
other revenue than the particular revenue to which they apply,
and therefore are deducted at once and are not included among
the body of causes to the general revenue which constitutes the
expenses. In effect the revenue in which switching is absorbed
is not created until after the rate has been reduced to the point
of absorbing the switching because the freight would otherwise
move by the competitive route. " Such charges [when the
switching company does or does not participate in the revenue]
should be charged to revenue account No. 1, Freight Revenue "
(Case 218). In fact such deductions from the revenue are prac-
tically divisions of a joint rate, the ' ' switching absorbed ' ' being
practically the proportion of the through rate accruing to the
switching carrier. The following ruling, with reference to the
transfer of passengers is a case in point : ' ' Passenger Kev-
enue " should be charged " with amounts paid to local transfer
agents or companies when the cost of the transfer is included
in the rate and has been credited to t Passenger Revenue. ' The
exception refers to instances when the cost of the transfer is
provided for in the division of the through rate and credited
directly to the transfer agency " (Case 320).

But all payments in connection with handling what may at
first seem to be a specific business are not deductions from rev-
enue, because they do not in reality serve a specific, separable
business. Thus, ' ' Switching charges on empty cars when not in
connection with loaded movements, should be charged to account



14 RAILROAD EXPENSES

Other Expenses under Transportation Expenses " (Case 218).
" Query: This company owns a wharf at which boats are docked
and freight transferred between the cars and ship's side. We
have a contract with a warehouse company for transferring the
freight at a stated amount per ton. To what account should
this expense be charged?

" Answer: Assuming that the rates or division of rates
received by a company apply to and from ship's side, the
expense of transferring freight should be charged to Account
No. 63 Station Employees" (Case 517).

In the two cases next above, we have illustrations of services
which may be more or less identified against specific revenue
but which belong to the general class of things done in the gen-
eral operation of the road, and they cannot be arbitrarily
detached and taken out of the classes to be set against a specific
revenue. The distinctions, however, are not always as clear as
in the above illustrations, " When the empty movement is in
connection with the loaded [i.e., revenue] movement and wholly
incidental thereto, the amount paid therefor should be charged
to revenue account No. 1, Freight Revenue " (Case 218). Or
again, when a carrier, instead of performing the service with its
own power, finds it more convenient to pay an industrial con-
cern a rate set forth in the railroad tariff to perform this service
for itself, the distinction is hard to draw between what is a
deduction from revenue and what is an item of expense. In the
latter alternative it has been ruled that payments made shall be
accounted for as deductions from revenue (See Case 220).

Payments for elevator charges of which note is made in the
tariff are practically refunds to the elevator companies of collec-
tions made for their account, and therefore should be deducted
from freight revenue where the gross collection was first car-
ried (See Case 219).

Intake, Income, Defined. The intake that is produced by
expense (outgo) and is called revenue has been discussed above.



THE CAPITAL AND INCOME ACCOUNTS 15

The intake that is not produced by expense (or from which the
expense has previously been deducted) constitutes a different
class. It is a proper offset to interest charges which are deducted
from it. It is called income. It falls under the two general
heads of

(1) Operating Income (the revenue after expenses

and taxes have been withdrawn).

(2) Other Income such as

Rent of property owned.

Profits on property owned but operated ' sepa-
rately.

Dividends on stocks.
Interest on bonds owned.

These items represent the return on property owned for
which the offsetting carrying expenses is interest charges. In
addition to the items above, which require no explanation, there
may be miscellaneous current intake such as a general unlocated
credit that is neither net revenue after deducting expenses, nor
rent, nor dividends, nor interest. For instance, after an indus-
trial track which has been charged to property has been com-
pleted, the industry pays the railroad $500 to cover the cost of
labor in laying the track, while the title to the entire spur is
retained by the railroad. " $500 received should be credited to
mi appropriate account under ' Income ' ' (Case 523).

Outgo, Expenses and Charges, Defined. If the whole
operation of the railroad is kept clearly in mind as merely the
play of cause and effect, of causes having various ranges of
effect and effects related to local or more general causes; and
if we hold to the conception of outgo (expenses and charges,
and capital outgo) as the cause to produce intake or revenue and
income, we very early find that the outgo falls into two distinct
classes with reference to the intake it avails to produce. The
outgo that extends to an indefinite range of intake does not have



16 RAILROAD EXPENSES

to be repeated, it is made once and for all time ; but the outgo
that is related to only one intake or to a limited range of intake
must be periodic, continual and repetitive; it is current,
whereas the other is final. In illustration of this, at the one
extreme is the wages and supplies expense to move a special
revenue train over the road. Such expense has no relation to
any other special train or to the body .of general train service,
but must be paid for out of the revenue of that special train, if
paid for at all. At the other end of the scale is the outgo to
build and equip the railroad, which we have discussed under
Capital. This outgo, as we have seen, cannot be set against the
revenue of any particular ton mile, or of a special train, or even
of a particular year, but renders possible the operations of the
whole road over a long series of years. Between these two
extremes of specific direct relation to a specific revenue at a
specific time and a general relation to all the revenue over an
indefinite series of years, is every possible stage of differen-
tiation.

The general notion of a continuing productivity of a fixed
property, as already noted, quickly divides the outgo into these
two classes, of expenditure (investment) and expenses, using
' ' expenses ' ' in the broad sense. Investment being a permanent
thing, its only relation to a current period is the expectation
of return on the capital invested at a usual rate. The invest-
ment charge itself is set up in Capital account, while the Profit
and Loss account, or its annual derivative, the Income account,
has to deal only with those outgoes which are not capitalized
because they are not offset by a permanent physical property or
continuing values.

Outgo must be made before the intake can be had. The outgo
is based upon certain assumptions, apriori reasoning ; it is based
on an expectation of return. Outgo is designed to produce
intake, but it does not always produce it in the way or in the
amount intended. In other words there is inseparably an arti-



THE CAPITAL AND INCOME ACCOUNTS 17

ficial factor in designating an outgo under a classification based
upon the assumed relation of this outgo to intake. This arti-
ficial factor must be frankly recognized in stating capital and
classifying expenses, for it reaches to wide social consequences.
Not all capital is permanently productive or continually pro-
ductive or even productive at all. Enforcing the artificial dis-
tinction between capital outgo and expense outgo is the most
delicate function of the Classification of Expenses. The distinc-
tions set up are at the last avowedly arbitrary. Thus it is ruled
that in the course of construction of a new railroad, the outgo
ceases to be capital outgo and becomes current or expense outgo
at some arbitrary instant when the property is " accepted for
operation " (Case 317). Or again, referring to a road in process
of construction it has been ruled that it becomes an operating
road with reference to any particular portion of its line " as
soon as that portion [section] has reached such a stage of com-
pletion that operations are the main portion of the business
carried over such portion [section] " (Case 115). But the Com-
mission is particular not to predetermine this exact time by any
ruling it has made (Case 438).

Having, in this way, set out to itself as 1 1 Capital ' ' the outgo
which is made once and for all time, we have left the outgo
which is periodic, continual, current, grading down from that
whose effect reaches over so many years that its distinction from
capital investment is not always clear, to that whose effect is
consumed from day to day ; as the price of the pint of oil used
on a particular engine run. Here again, in current outgo itself,
a broad division is made at the outset into that outgo which is
the charge for use of property or invested capital, and which is
paid for as rent or interest (charges), and that outgo which is
for upkeep and operation, and is called " expense." The former
class is designated as " deductions from income'*; the latter
class, as " expenses," is divided into the elaborate classification
of which this book treats.



18 RAILROAD EXPENSES

Outgo Expenses. This is the direct offset to current
intake. Part of it is directly applied to produce the intake, e.g.,
wages and supplies, which are expenses with no deferred fac-
tors. Part of it is applied indirectly, through the maintenance
of organization, plant and tools. Because of this different rela-
tion to current intake, the primary basis of grouping the expense
(outgo) into classes, is the period affected, and not the scope of
things done. In other words, the operations are, for the most
part, considered as an entity at any one instant, and we classify
the outgo as having different degrees of flexibility or control
with reference to any particular instant or period.

With the elaboration of the processes of an industry and the
growth of its plant, the maintenance part of its expenses (which
is that part whose effect is deferred) assumes greater and
greater predominance. (The function of expenses is to make
good the wear and tear of plant to produce the intake revenue.)

The plant to be maintained is, first, a physical thing of dif-
ferent parts which wear and deteriorate at different rates with
reference to use, to extraneous conditions, and to time. But
while the plant is a physical thing, it is in essence a functioning
thing in the process of producing intake. Ultimately it is not
a thing, but a continuing function or one designed to be con-
tinuing that has cost original capital outgo to set up, and which
expense outgo must maintain at its original efficiency. The
expense of repairing and renewing it is the physical maintenance
of it by tangible physical applications. To these is added a
third kind of maintenance called depreciation which maintains
the functioning thing in respect to those effects that. are intan-
gible, that cannot be located against specific parts but are gen-
eral to the whole, such as effects of age. The processes from
which these effects arise are so minute, insidious and impercept-
ible, that we know them in their final outcome rather than in
their instant phases. From " experience " we deduce the law
of their operation and allow for it empirically on basis of formula



THE CAPITAL AND INCOME ACCOUNTS 19

from month to month or year to year. " Depreciation," which
takes care of those elusive physical processes, naturally becomes
the account where is charged the maintenance against obso-
lescence which is deterioration of function. This is economic
deterioration.

Deductions from Expenses. When any intake is specific-
ally related to a particular outgo, and to that outgo alone, it
should not be embraced in the same group with the intake that
.is related to the general body of outgo. That is, applying this
principle in the terms of the accounts, if we have a revenue
which is the product of a particular expense and no other, and
does not spring out of any conditions that classify it with any
other revenue that is the product of other expense, then it is a
revenue local to that particular outgo, and accordingly should
be deducted from this expense because it is the direct cause
creating this expense. Such a transaction involves something
less than the whole plant and the entire cycle of operations as
a class, and the net effect only is incorporated in the general
accounts. For instance, if a particular locomotive realizes a
value above the book value, this appreciation, it has been ruled,
is not the product of the property and its operations as a whole
but represents the accumulation of excess charges previously
made to expenses and is therefore credited to expenses (Cases



Online LibraryJames Shirley EatonHandbook of railroad expenses → online text (page 2 of 52)