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351, 536).

Outgo, Expenses Outside Operations. Certain operations
are located which separate in part, in a natural way, from the
body of the operations as a whole. It is found that their revenue
may increase or decrease without disturbing the revenue of the
road as a whole, and that their expenses, that produce this par-
ticular revenue, are separable from the expenses that produce
the revenue of the road as a whole. By this description they are
defined as entities. It is therefore but a natural recognition of
this real condition that classifies them as Outside Operations.*

* See page 205 et seq.


If they were merely temporary phases or incidents of the
operation (Cases 246, 262, 584} it would not be worth while to
set them up in special accounts, but their specific revenues would
have been deducted from the offsetting expense, and any surplus
would have been left to apply as a credit in that expense account
where it occurred, upon the theory that it was an irregular or
inconsequential condition that served so far to reduce the normal
expense at that point.

Deductions from Gross Corporate Income (Charges.) This
constitutes a form of outgo of a more general range than ex-
penses. It is mostly a fixed charge, therefore highly inflexible.
Under it classify rents and interest paid, losses on separately
operated properties, sinking fund payments when charged to
income, and like items.

Rents. As the term " rents " is here used, it describes the
payments made for the use of property or facilities, sometimes
to include the maintenance of such property and facilities, and
sometimes, still further, to include incidental service also (Case
372). Rents, if a disbursement instead of a revenue, are
handled, with interest, in the form of deductions from income
and not as expenses. Therefore they are not a part of the sub-
ject matter of which this book treats except so far as to distin-
guish them from expenses.

Rent is one of the regular forms of disbursement distin-
guished on the one hand from interest payments, because it is
a payment for use of a property and not for use of money, and
distinguished, on the other hand, from a license (Case 128),
which has not the formality of a tenancy. It may without preju-
dice include taxes (Case 285), and under certain circumstances
it is interchangeable with city license payments (Case 122). It
represents the cost of making good the deficiency in facilities
owned. When it occurs in regular and large amounts it becomes
worth while to preserve it in its typical character, and the charge
is therefore carried to rents paid, which is among the deductions


from Income account. But where it is a small or irregular inci-
dent, it is charged directly as an expense to the class of work
which it serves. " As a general principle, payments for the use
of property or facilities required by a carrier are considered
proper charges to Income. Exceptions have been made for
offices and station buildings rented" (Case 564, see also Cases
35, 345 and 638).

It is sometimes necessary to arrive at the rent charge by arbi-
trarily decomposing q, bill. In case of joint facilities where the
bills are regularly recurrent a.nd of significant amount and where
the other company is a common carrier, this breaking down of
lump bills is prescribed, but in case of the bill rendered the
express company by the railroad, because the amount of the rent
was not specifically stated in the contract, it was ruled that it
was unnecessary to attempt a separation of rent. To make the
" rent proportion " of a lump bill it has been ruled that the
estimated expenses and maintenance must first be deducted, and
the remainder is credited or charged to ' ' Rent ' ' ( Case 371 ;
see also Case 408).

Hire of Equipment. Equipment is in units of fairly stand-
ard type; furthermore, in the case of freight cars whose hire
forms the largest part of the charges and credits to this account,
the equipment moves freely from point to point to meet demand ;
a freight car on a foreign line tends to create the necessity for
borrowing a foreign freight car on the home line. For these
reasons the rent of equipment is set up under a special account,
" Hire of Equipment," and this is handled as a net account,
inasmuch as this credit tends to set up its offsetting debit.

The emergency use of hired equipment at a wreck is charged
to "Clearing Wrecks" instead of to "Hire of Equipment,"
because it is a temporary and local use ( Case 243 ) . In the same
way the hire of an instruction car is charged to " Transportation
Expense, Superintendence" (Case 254), and not "Hire of


Interest. The form of outgo called interest is easily under-
stood. While rent is the hire paid for the use of property not
owned, interest is the hire paid for the use of money or for the
use of so much of the plant as the funded and floating debt

Application of Principles in Income Account and Classi-
fication of Expenses. Incorporating the foregoing principles
the Income account is evolved. First, against the intake of
revenue is set the outgo of expenses to produce it, and the net
operating revenue (" profit ") is made. To this is added the
net result (profit or loss) of Outside Operations to make the net
revenue (operating "profit" less taxes). Then is deducted
" taxes," which, because of its inflexibility is different from
" expenses " and also different from first charges.

The figure thus produced is the operating " profit " before
the first charges have been deducted. It is specifically called
: ' Operating Income. " It is the income derived from operation
as distinguished from that derived from rents, profits and sepa-
rately operated properties in form of dividends and interest
on securities owned. These latter involved no current expenses
to produce them ; they are designated Other Income.

Operating Income is consolidated with Other Income and
from their sum is deducted the rent, the interest and like charges
to produce the " Net Corporate Income " which is the final true
profit of the property.

The foregoing conceptions of expenses, revenue and profit,
capital, income and net income, constitute the ground plan out
of which is worked the schedule of accounts that sets out intelli-
gently the story of the railroad's operations. When the expense
disbursements verge upon the character of capital expenditure
those individual items which are distinctly capital expenditure
are withdrawn from expenses through the Additions and Better-
ments accounts, where they are carried in a memorandufn clas-
sification for purposes of current study, and at the end of the


fiscal year (or shorter period) are gathered up into a total, and
permanently lodged in Capital account. The elaborate account-
ing and statistical tables constitute the mechanism by which each
of all the myriad and various transactions of the year is gathered
up as by a dragnet and carried forward in unbroken sequence
to the final stage of stated profit.

The Classification of Expenses defers to the essential scheme
of the physical property, its organized forces and its plan of
operation. It separates the rolling stock from the permanent
way and structures, and makes a distinction between the line
of road and the terminals; it groups the forces into main-
tenance, operation, and general supervision, distinguishing the
administrative gradations throughout the organization.

In its present form it neglects the distinction between pas-
senger and freight service (where separation is possible), and
the further obvious distinction between main line and branch
line. These, however, are refinements which the individual
carrier will make for its own information


Authority. " All accounting matters must be disposed of in
conformity with the principles embodied in the orders of the
Interstate Commerce Commission. Subject to this limitation,
where not covered by such orders, they may be disposed of
according to the judgment of the carrier " (Case 1). The clas-
sification of accounts is supplemented by Accounting Bulletins
interpreting the classification in the large number of cases sub-
mitted for ruling. These rulings embody the conclusions of the
Bureau of Statistics and Accounts, and should not be interpreted
as meaning that the Commission is not at liberty to modify its
own orders (Case 451). The regular Bulletin is supplemented
by Accounting Series Circulars which include cases " the
answers to which are regarded as subject to possible modifica-


tions." However, until superseded they constitute the exist-
ing rulings of the Commission. A few general principles are
laid down which serve as a guide in the application of the

Keeping of Accounts and Statistics. The accounts are
" prescribed for the use of carriers by rail (exclusive of electric
railways) subject to the provisions of the act to regulate com-
merce as amended June 29, 1906." Operations of roads not
common carriers are specifically excluded from these accounts
(Cases 383, 636). The railroad officers are held for the correct
application of the rules in the keeping and recording of the
operating expense accounts, and it is unlawful " to keep any
account or record or memorandum of any operating expense
item except in the manner and form " prescribed, save only that
they may subdivide the primary accounts here prescribed for
their own purpose provided the list of the sub-primary accounts
be duly filed with the Commission. They are also permitted to
keep temporary or experimental accounts provided such
accounts do not impair the integrity of any prescribed general
or primary account, and that they shall be open to the inspec-
tion of the Commission at all times. In the application of this
order it has been ruled in respect to the form of general balance
sheet, " It is not required that the accounts prescribed in this
classification shall be kept by name, and those only; but that
the accounts necessary to record the transactions therein pre-
scribed be kept, and it is permissible further to keep such
accounts as may be necessary to make whatever analysis a road
may require of the balance sheet entries " (Case 544).

Capital. Capital must not be impaired; the amount of it
may be increased or decreased according to contingencies of the
business, but the rate of productivity should be fairly constant
per dollar of the capital invested. Under perfectly free compe-
tition, in the groupings of economic forces, as they may be freely
made, the return on the capital devoted to railroad business is


controlled by competition of other capital for the same return.
It therefore will be exposed to wide variations, according as
the field is now overcrowded and now undeveloped. Under
sharp competition the tendency will be to neglect the return
upon capital previously invested and in this way to work large
injustice to investors whose money, once devoted to railroads,
cannot be recovered. These conditions that produce additions
and reductions of capital will be marked up on the books as they
individually occur at their estimated effect. This estimated
effect is crude, and besides, many effects must pass unnoticed.
Such effects of unrecorded tendencies, in course of time, work
large changes to impair or enhance the productivity of first
capital, and it becomes necessary to revalue the entire property
directly upon the basis of the conditions as they exist at a given
time. The accountant cannot question the equity of the con-
ditions which may have wrought special loss or gain. His dis-
cretion extends no further than to state exactly the present value
of the property which is a resultant of these conditions, good or
bad, just or unjust. But the court is competent to discuss con-
siderations of equity and public policy which are beyond the
discretion of the accountant.

It is become public policy to restrict the competition of rail-
roads by limiting the construction of new lines to those that are
deemed to be of reasonable public necessity, and furthermore,
in the regulation of rates, the commissions take cognizance of
capital as a factor of ultimate cost. In the determination of
the reasonable public necessity and of the fair return upon cap-
ital, and the fair estimate of what the capital actually is, there
is an effort to protect invested capital, as well as the public, by
injecting considerations of equity which unregulated compe-
tition and formal accounting would necessarily neglect. For.
instance, the formal accounting makes no provision for capital-
izing deficits during years of development. A pioneer road is
much more expensive to build than would be a later competitor.


An old road may have had to bear large losses in the rapid
changes of standards which the latest constructed road can avoid.
One property may have been built in a time of money stringency
and another when capital could be had upon easy terms. The
aggregate deficits over a series of lean years are a proper offset
to the liberal returns in any particular prosperous year. All
these are factors which enter into the equity of rate making, but
except for the provision for abandoned property and deferred
charge of discount and commission on securities sold devices
to spread such effects evenly over many years the accountant
is not permitted to make any allowances.

Depreciation. Depreciation is the charge made for deteri-
oration in values of specific parts of a physical plant. The Com-
mission permits wide latitude and discretion to individual rail-
roads in naming the amount which may be considered to be
depreciation, but it lays down the principle that charges on
some formula must be made. It confines its enforcement of this
rule to the rolling stock. This is probably upon the theory that
the rolling stock or equipment consists of entirely separate units,
whereas in the case of the way and structures a considerable
neglect of any one part would impair the operating efficiency
of the whole, so that renewals could not be slighted, as is pos-
sible in equipment. There is also the further reason that equip-
ment lends itself easily to the use of depreciation formulas
because it classifies under a limited number of very definite

The depreciation charge would seem to be limited to the
physical deterioration of specific physical units. But there is the
additional depreciation through the processes of obsolescence of
function for which a provision is made, though not so specifically,
as, for instance, by the Abandoned Property account and
the arrangement of dropping equipment to lower classes as it
passes down the scale of usefulness.

The entity which becomes obsolescent is itself composed of


subordinate units which may not only be in physical, but in
full functional efficiency in their relation to the other subordi-
nate units which together constitute a whole. Thus a locomotive
may be in good physical condition and its parts may be in good
physical condition, each performing its function in full effi-
ciency in relation to the other parts, while the locomotive itself
is of a type which has become obsolete. Or again, a tunnel has
been abandoned by construction of a new route about a moun-
tain barrier. The tunnel itself is in good working condition,
but it ceases to be of any use to the railroad as a whole. And to
carry the illustration a little further, the entire roadway and
rolling stock of a given branch line may remain at full efficiency
both physically and in function, but the mines which they served
having been exhausted, their earning or final economic efficiency
is wiped out. It would be difficult to anticipate by fixed formula
the depletions of value ranging, as illustrated, all the way from
physical depreciation to economic obsolescence that wipes out
the earning power of an entire section of the road. For this
reason the Commission apparently limits its theory of depreci-
ation to physical depreciation, leaving it to the discretion of the
carrier to anticipate functional obsolescence in a general way in
case of rolling stock, but reserving for its own authorization
through Abandoned Property account the more extensive and
irregular kinds of obsolescence.

The processes of obsolescence and the offsetting additions and
betterments, broadly viewed, are analogous to wear with its
offsetting maintenance. The loss of function of a given physical
type by obsolescence is offset by an addition of function to main-
tain the status quo by means of additions of new types or better-
ments of existing types. When the wear and renewal mutually
offset each other without disturbing the existing physical type
the maintenance is charged to expenses. But when extensive
cahnge of type is involved the theory is that the outgo of the
old thing and the incoming of the new thing should each be sep-


arately recorded. Though this may be a definition of the prin-
ciple in force, in its application there would be wide latitude of

Reserves. In strict adherence to the theory that an exhibit
should exhibit accurately and unequivocally the facts of the
property and its operation, the underlying principle of the
accounts is that items shall be specific and definite, susceptible
of measure by instruments of precision. It is laid down as a
fundamental principle that all reserves created must " be held
intact until the liabilities for which they were created are
liquidated " (Case 211). It is also laid down as a fundamental
principle that all entries in the accounts shall be upon the basis
of accruals, and not upon the basis of the actual payments
(Case 231).

Impairments of capital, so far as they can be ascertained
must be offset by reserves accumulated as the processes of
impairment proceed. But of these funds it has been ruled that
1 1 it is not required that a definite sum of money be set aside in
bank equal to the accumulations in the reserves for replacement
of equipment " (Case 171). In other words, a " book fund "
will suffice.

Secret Reserves. The intent of the Commission is not only
to set out in lucid form the operations of the railroad, but
frankly to make it impossible to create secret reserves, or, per
contra, to write up earnings that have not been earned. By
careful study it covers in advance all the usual forms of receipt
and disbursement of moneys. Extraordinary situations which
may be thought to justify spreading a charge beyond the fiscal
year through Profit and Loss, or Abandoned Property accounts,
or to open up a new account, or to make extraordinary adjust-
ments of Capital account, will be considered individually on
their merits by the Commission. As illustrating the intent of
the rulings in these particulars, we quote : ' What the Com-
mission requires is that when such reserves are set up, they


shall appear on the Balance Sheet Statement and that no secret
reserves shall be created. It is not permissible, however, to
create a reserve for Construction purposes by charges to Operat-
ing Expenses" (Case 557). Or again, referring to a previous
ruling, " It is not to be taken as meaning that appropriations
may not be made for extraordinary purposes, but does mean
that the property acquired by the expenditure of such appro-
priations should be included in the property accounts. Stated
differently, it is the purpose of this provision of the Classifica-
tion to prevent as far as practicable the creation of ' secret
reserves' in the future" (Case 555).

Maintaining Types of Operation. Because of the necessities
of comparison, railroad operations in their multifarious phases
are standardized after a certain type to which all must conform,
even though in special cases the rule would seem arbitrary,
thus a switching road must charge to " Freight Train Cars
Repairs," the bill rendered by the owning road for cars dam-
aged on their lines, regardless of the fact that the switching
company owns no cars itself to offset its car repair expense
(Case 456).* Again, an operating carrier that is debited for
the maintenance of joint facilities must charge the maintenance
part of the bill to Maintenance Account " Joint Facilities,"
although the road itself has no property to maintain (Case 161,
also case 163).

In the case of joint facilities used by two or more carriers
the carrier operating the train should take into its statistics all
the mileage of that train arid of the cars therein, regardless of
the fact that a portion of the distance travelled may be over the
tracks of another company (Case 502).

When a road is so small as not to have an individual officer
for each department, then it must apportion among the several
departments served the salary of the officer who performs the
several functions. When bills are received in lump sum from

* Eulings 456 and 161 are in apparent conflict with the ruling in Case 549.


other carriers they must be broken down to their constituent
parts to conform to the Classification, arbitrarily if necessary.

Expense Account Not to Be Used for Suspense Items.
As far as possible, expense accounts are not to be used to hold
items in suspense, or as a device for clearing the amount of bills
rendered against other companies and individuals. When the
item is not a joint facility item or is irregular or small, it some-
times remains necessary to clear such bills through the regular
detail expense items (Case 56) ; but in the case of considerable
items which would derange comparisons if passed through the
expenses a temporary account is necessary. An illustration
would be the insurance recovered on buildings destroyed. To
pass so large an amount through the month's account when the
insurance was collected and to charge it again when the build-
ing is reconstructed would impair comparative figures (Case 30).

Reasonable Accuracy. Reasonable accuracy in compilation
of statistical figures, rather than forced exactness, is the guid-
ing principle. Thus in the computation of depreciation it has
been specifically ruled that any period less than one month
should be ignored ( Case 49 ) . Another illustration is the ruling
(Case 174) that it is proper to estimate the scrap taken from
cars and locomotives torn down.

Sometimes it is not possible to exactly apportion an amount
which has reference to two or more items of the expense classi-
fication. When the preponderance is obvious, instead of making
an arbitrary apportionment, the best practice is to classify
roughly to one account only. Thus, cars alternating between
commercial and work train service would be classified as
commercial cars if for the majority of the time they were in
commercial service, and their expense of upkeep would be
charged accordingly (Cases 47, 468, 482, 418, 452, 594).

Apportionment. In the apportionment of expenses among
several accounts the usual arbitrary plan is to apportion equally
where no basis is assumed, but in case of Shop Expense (See


cases 177, 179, 183) and Stores Expense (Case 184), or adjust-
ment of inventory (Case 9), the overhead charges or adjust-
ments are apportioned on the basis of the direct expense. In
case of Water Supply Expense, the distribution to the road and
switching service is on the basis of tons of coal consumed on the
locomotives using the water (Case 253).

Clearing Accounts. Throughout the operations there occur
groupings of work or extended intermediate processes which do
not conform to the general fixed schedule on which the work of
the railroad is laid out and to which the Classification conforms.
The expense involved in these intermediate processes must be
finally lodged in the accounts of the regular Classification. To
trace the disbursements through these intermediate processes
and finally to apportion them, we must set up temporary pools
called accommodation or clearing accounts. In these are assem-
bled all the direct expenses of the particular process, and over
against it are set the units of product which, carried over into
the particular places in the railroad's operations where they are
used, serve as a basis of apportioning the expense necessary to
produce them.

For instance, such accounts are necessary in the case of
ballast pits to produce yards of ballast that are distributed over

Online LibraryJames Shirley EatonHandbook of railroad expenses → online text (page 3 of 52)