"The attractiveness comes about by reason of the fact that there is coupled with the suggestion for amortization one that the present net direct investment be reduced by the amount that would represent amortization in the years previous to 1951. This is on the basis that the Company made sufficient income during those years to amortize but failed to do it, and on the basis that that failure is not the fault of the current management or of the tolls payers. This retroactive application of amortization would thus take off some $126 milion if it were at $3 million per year for the 43 years since 1914 when the canal started operation. The $3 million per year is arrived at by reason of the fact that the original investment at that time was computed at about $300 million. This would put the amortization on a 100-year schedule.

"The reason, however, that the committe did not accept this suggestion is because it would impose upon the commerce passing through the canal the immediate burden of a regular annual additional corporate charge-i.e., an amount to be paid back to the Treasury for amortization. That in itself is not objectionable, but what the committee cannot consent to at this time is establishing this additional corporate cost based upon a net direct investment of the Government concerning which there is a long standing controversy. Further evidence of the fact that the amount of the net direct investment is subject to attack is the following language and particularly that which the committee has underscored, taken from page 40 of the 1952 GAO audit of the Panama Canal, House Document No. 207, 83d Congress (printed document erroneously bears fiscal year ending June 30, 1953—should be 1952):

"Primarily because of major deficiencies in the accounting polices and practices of the Panama Canal agency and the consequent lack of reliable financial and operating data, the information contained in this report is generally restricted to operations during the year ended June 30, 1952, and the financial position of the entities at that date. Furthermore, there is not sufficient information readily available to indicate the extent to which prior operations of the Panama Canal agency have recovered, through tolls and other revenues, the cost of its activities or to determine the full effect of property and other adjustments required to put the accounts on the sound, realistic basis contemplated by the recent reorganization.

"The tolls payers have repeatedly asked for some adjustment of that investment in recognition of the national defense value of the canal. They claim that the only recognition of that value is the $50 million reduction of the capital base (on which tolls must pay interest) brought about by the provision of Public Law 841 which eliminated interest during construction from the capital base. Government agencies just as consistently claim to the contrary. This committee feels that there should be no change in the present method of attempting to retire the debt; that there should no change in the present freedom of tolls from paying interest during construction and that there should be no change in any of the other items having the effect of increasing corporate charges until there is some authoritative statement and consequent action on the national defense value of the canal."

S.2167 never came to a vote. (See 102 Congressional Record 11541, 12901, 13901.) 5. 1960

PANAMA CANAL SUBCOMMITTEE, FEBRUARY-MARCH 1960

10

These hearings considered bills, which, among other things, applied the Administrative Procedure Act to hearings and decisions on tolls increases and changes in measurement rules, and one bill requiring supporting activities to pay a greater share of costs, and another requiring tolls to pay for supporting services.

Governor Potter, also President of the Panama Canal Company testified (Hearings, p. 9):

"Neither do the toll rates make any allowance for depreciation or amortization on about $280 million of fixed assets now classified by law as 'nondepreciable.'"

Governor Potter added (Hearings, p. 14): "The canal is being amortized except for the so-called nondepreciables, $280 million worth of them. They are

10 Panama Canal Toll Formula, Hearings before the Subcommittee on Panama Canal of the Commiteee on Merchant Marine and Fisheries, House of Representatives, 86th Cong., 2d Sess. on H.R. 8983 and H.R. 10968, February-March, 1960.

L

the excavation itself, the land on which the excavation sits, and I believe the locks. They, by act of this Congress, are considered as nondepreciables." 6. 1967—

PANAMA CANAL SUBCOMMITTEE, MAY 1967

11

These hearings heard testimony from members of the Atlantic-Pacific Interoceanic Canal Study Commission regarding a bill to authorize a study of a sea-level canal.

The following discussion between Congressman Downing and Mr. Sheffey, Executive Secretary of the Commission, is found at page 36 of the Hearings: Mr. DOWNING. "You are not depreciating your capital investment?"

Mr. STEFFEY. "It's not allowed to charge tolls high enough to amortize itself under the present law."

The hearings also included testimony from the Panama Canal Company, Arthur Andersen & Co. (including Mr. Kujawa), and Stanford Research Institute on the results of a tolls study commenced in 1965 and scheduled for completion in 1968. Acording to Governor Leber, President of the Panama Canal Company, "tentative" conclusions of the tolls study included:

(a) Revenue from tolls can be increased—(1) Up to 25 percent with little effect on level of traffic; but (2) Traffic will become progressively smaller as the magnitude of tolls increases in excess of 25 percent." (emphasis added). Ely Brandes of Stanford Research Institute, who since has performed a number of studies of cargo sensitivity to tolls for the Canal Company, testified (Hearings, pp. 129-30):

"Another alternative mode of transport, the railroads must be considered particularly with respect to the U.S. intercoastal trade. Intercoastal shipping has been reduced considerably in the last few decades and only in recent years have container ships given hope for revival of intercoastal shipping through the canal. However, with substantial increases in tolls intercoastal shipping would again be very vulnerable to further inroads by rail transport."

Also, page 131 of the Hearings: ". . . there are more alternatives over the long term than over the short term; furthermore, even for those alternatives which are available over the short term, the availability tends to be limited by various constraints. Thus it appears inevitable that the impact resulting from a given toll increase will be far greater in the long run than in the short run.” (Emphasis added).

Mr. Brandes added at page 136: "For intercoastal shipments between the east coast and west coast of the United States the primary alternative is rail transportation. Over the past decade coastal shipment has declined very sharply and only in recent years has there been a slight recovery due to the growth in container ships. However, the comparative edge that intercoastal shipping holds at present is slight, and any sizable shift in cost could have a serious effect on traffic volume."

7. 1973

12

A. MERCHANT MARINE AND FISHERIES COMMITTEE, APRIL 1973 Previous hearings recognized the need for legislation-legislation never passed by Congress-for amortizing or depreciating the nondepreciable items. In April 1973, the Merchant Marine and Fisheries Committee held hearings on Panama Canal treaty negotiations and contemporary activities of the Panama Canal operation. This was the first detailed presentation on Canal operations to the Committee since April 1970. The April 1970 hearings contain no reference to amortization or depreciation of nondepreciable items.

The following discussion appears at pages 28-29 of the 1973 hearings.

Mr. LEGGETT. "You do not include in that the cost of amortizing the cost of the canal?"

General PARKER. "We have been depreciating a little over half the investment in the canal as a depreciation that goes into the cost of operation every year, $10 million of our costs.

11 Canal Tolls and Route Studies, Hearings before the Subcommittee on Panama Canal of the Committee on Merchant Marine and Fisheries, House of Representatives, 90th Cong., 1st Sess. on H.R. 6791, May, 1967, Serial No. 90-6.

12 Panama Canal Briefings, Hearings before the Committee on Merchant Marine and Fisheries, House of Representatives, 93rd Cong., 1st Sess., April 13, 1973, Serial No.

"We are adding an additional element of amortization or depreciation starting in our budget for fiscal 1974 which we will be discussing with the transportation subcommittee of House Appropriation Committee next Monday. We thought that hearing would be behind us before we appeared before you.

"That will add an additional $8 million or $10 million of cost to our operating costs.

"Now, the law requires us to raise tolls if, and only if we are unable to meet expenses. Since we have been able to meet expenses each year, it has not been necessary to come in with a request for tolls.

"Out of the toll rate that was established back in 1914, with a change in measurement in 1938, we have been able to finance the daily operations of the canal as well as the capital improvements necessary to increase its capacity. "We have attempted to follow the desires of Congress in this regard. "Through this fiscal year, we are able to operate on a better than break-even basis, at least we are recovering our costs.

"As I indicated to you in the budget for fiscal year 1974, that we are discussing with the Appropriations Committee on Monday, our operating results for the year will show a deficit in operating margin of $3 million to $4 million as nearly as we can predict right now.

"As a result of that operating deficit, the Board of Directors has directed me to consider whether or not it is appropriate to proceed with a recommendation to raise tolls. We have that under study at the present time."

Mr. LEGGETT. "Would this be the first time tolls were adjusted in recent history?"

General PARKER. "If we should come in with such a recommendation, yes." Apparently, from the above discussion, Governor Parker had no intention of raising the issue of authority to amortize or depreciate nondepreciable items. His prepared statement (Hearings, pp. 54-62) does not even mention the matter. We believe this is the first public mention of taking this action. The comment elicited no questions from the Committee members present-Congressmen Leggett, Kyros, and Breaux.

The Canal Company did propose a rate increase in FY 1974, the first in the Canal's history. The above discussion shows this tolls rate increase was a direct result of the accounting changes, creating new expenses without which the Canal Company would have shown a profit.

B. MERCHANT MARINE AND FISHERIES COMMITTEE, JULY 17, 197313

These hearings concerned the importance of the Canal to carriers and commerce, toll structure, and forecasts of Canal capacity and future shipping requirements. The prepared statement and extemporaneous remarks of Governor Parker did not refer to tolls increases or to depreciation or amortization of nondepreciable items. Witnesses from AIMS testified to the adverse effects upon the maritime industry and on commerce of substantial tolls increases (Hearings, pp. 48-50), as did a witness for the American Maritime Administration (Hearings, pp. 59-60, 63-64). Although questions of Governor Parker concerning a tolls study commenced at page 72 and continued thereafter, no reference was made to depreciating nondepreciable items in the Governor's testimony or in the summary of information concerning tolls and alternative tolls policies submitted for the record (Hearings, p. 84). Governor Parker noted a future recommendation to the Canal Company Directors in October 1973 of whether an increase should be made. Governor Parker did testify (Hearings, p. 83):

"You yourself, and your committee are going to have to arrive at some basic conclusions in your own minds as to whether to reaffirm the intent of Congress in what we establish as a tolls rate; that is, whether we continue to just charge established tolls to recover the costs of operating the canal without making significant profit, or without generating other sums which could be used for other purposes, such as payments to Panama.

"Mr. Chairman, that type of question, I think, will be uppermost in the decision process in arriving at this first stage of establishing a new tolls system if one is to be established.

13 Shipping and Canal Operations, Hearing before the Subcommittee on Panama Canal, Committee on Merchant Marine and Fisheries, House of Representatives, 93rd Cong., 1st Sess., July 17, 1973, Serial No. 93-19.

"If we were then to try, without affirmation of that, in the basis for the cost, because it will be a question of what we charge as cost in any presentation we will make, there will be many questions whether this or that is an appropriate charge to cost, and until we wring that out, yes, we have done this properly, that yes, it appears that this is an appropriate amount that you need to generate the income, and until we wring that to then talk about how we recover this amount through the various toll systems, I think would be rather difficult for us."

Mr. LEGGETT. "Well, I do not think anybody wants to particularly use the canal as a taxing mechanism to raise income for the United States and likewise whether or not we pay off our investment down there in 5 years or 10 years, or any particular fixed period of time, does not particularly bother me." Neither hearing in 1973 contains in its record the Arthur Andersen report of April 30, 1972 upon which the depreciation and amortization of nondepreciable items over 40 years is based.

8. 1974

APPROPRIATIONS COMMITTEE

Changes in accounting policies to depreciate or amortize nondepreciable items were approved by the Directors of the Panama Canal Company on October 30, 1973, and noticed in the Federal Register on November 23, 1973. On December 15, 1973, the Canal Company proposed a 19.7% tolls rate increase. Sea-Land, AIMS and other affected parties filed comments against the increase and testified in opposition to it before a Panel of the Board of Directors. AIMS and Sea-Land also testified before the House Transportation Appropriations Subcommittee in March 1974. Bringing the appropriations bill to the floor, Chairman McFall stated (Cong. Rec. H5279, July 19, 1974): ·

"The bill provides the Panama Canal $62.7 million for operating expenses, $6 million for capital outlay, and a limitation on general and administrative expenses of $23,837,000. The Panama Canal Company has recommended a toll increase of approximately 20 percent. Most of the items on which this increase is based appear to be valid costs, but we are concerned with the company's change in depreciation policy. The depreciation of certain assets which previously were not depreciated adds an annual charge of about $8.3 million to operating expenses and is partially responsible for the toll increase. We feel the legislative committee should consider whether this change is related to possible treaty modifications. We also feel that the part of the toll increase related to depreciation costs should not be implemented until the legislative committee has approved this change in policy."

Despite Mr. McFall's comments, the Canal Company has assessed, tolls with the additional depreciation expense since 1974 without any approval from the Committee.

C. Canal Company Depreciation/Amortization of Nondepreciables The excerpts from the Congressional hearings reveal: (1) acknowledgment by the Canal Company and the Comptroller General that legislation to depreciate or amortize the nondepreciable items was needed; (2) efforts to pass legislation soon after organization of the Canal Company in 1951, and valuation of Canal Company assets in 1954 and 1955 by GAO; (3) refusal by Congress to pass legislation in 1956; (4) no known efforts to obtain legislation after that time, despite continued acknowledgment by the Canal Company that legislation was needed; (5) a value on the nondepreciable items of excavations, titles and treaty rights of about $290 million, a sum approximately $44 million less than the amount used by the Canal Company in 1973; (6) testimony by GAO in 1956 that any amortization or depreciation should be retroactive to 1914 because profits from tolls prior to 1951 were more than adequate to pay for these items; (7) agreement by GAO and the Canal Company that depreciation or amortization of nondepreciable items, which are a major part of net U.S. investment for interest purposes, should reduce that investment and thereby reduce interest charges.

After the House of Representatives and Senate refused to pass legislation in 1956 to amortize or depreciate the nondepreciable items, the Canal Company apparently discontinued efforts to pass authorizing legislation, although acknowledging the need for it. The following sequence of events leading to the depreciation or amortization of these items is based on known documents,

14

ARTHUR ANDERSEN & CO. LETTER, APRIL 30, 1972 *

This letter concluded "that the Company should begin to recognize the costs of the lands and excavations through depreciation charges over a period of 30 to 40 years and that the depreciation should be recovered from the users of the Canal through tolls." The letter based its recommendation on "generally accepted accounting principles for regulated businesses." The letter did not refer to the previous requests for legislation to authorize the practice, and did not cite specific authority for doing so.

The letter cited two recent events challenging an indefinite economic life for the Canal: (1) increasing consideration of construction of a new Canal; and (2) "the evolving policy of the United States Government in its continuing treaty negotiations with the Republic of Panama." Today no present plans for constructing a new Canal exist to our knowledge. Thus the only possible reason for considering a limited economic life for the Canal is the treaty negotiations. Without reference to past GAO testimony that any depreciation or amortization of the items should commence in 1914 and credit be given against the net direct investment, the letter suggested depreciation be solely prospective, and the period be 30 to 40 years because "the United States Government has indicated a willingness to accept a termination date of 'sometime in the next century' for the existing treaty."

MERCHANT MARINE AND FISHERIES COMMITTEE HEARINGS, APRIL 13, 1973 As noted in the excerpts of the testimony of Governor Parker quoted in the prior portion of this memorandum the Governor announced that the Canal Company intended to begin depreciating these nondepreciable items. The Governor neither requested legislation to do so, nor cited legislation for doing so.

HOUSE TRANSPORTATION APPROPRIATIONS SUBCOMMITTEE, APRIL 16, 1973

15

The prepared statement of Governor Parked stated: "The estimates for 1974 include a new provision for assuming $8.3 million of costs for annual depreciation accruals prospectively over 40 years on certain properties and plant of the Company, originally costing some $331.8 million, on which depreciation had not previously been accrued." (Hearings, p. 1127).

The justification of these changes was provided at pages 1132 and 1133 of the Hearings:

"ACCOUNTING POLICY"

"32. The Company's Board of Directors has approved some changes in accounting policies that are reflected for the first time in these estimates. As this committee is well aware, the cost of certain assets of the Canal have not heretofore been depreciated. The problem of depreciating these assets has been under varying degrees of consideration for some 20 years. Most recently it has been raised once again by the General Accounting Office (GAO) in its May 4, 1972 16 'Report to the Congress on the Examination of Financial Statements, Fiscal Years 1971 and 1970, Panama Canal Company and Canal Zone Government'.

"33. The GAO has consistently taken the position that these assets should be depreciated. In their latest report on the audit for fiscal years 1971 and 1970, the GAO said:

“GAO believes that the assets in question-excavation, embankments, fills and related facilities-are limited-purpose land assets whose utility diminishes or terminates as the utility of the canal diminishes and that their costs should be depreciated or amortized. GAO believes that a change in legislation is not necessary to permit the Company to administratively determine the effective date of depreciation or amortization of these assets for the purpose of including the costs relative thereto in its financial statements.'

14 Arthur Andersen & Co. also prepared a report for the Canal Company in 1970 entitled Report on Development and Evaluation of Tolls Policies and Alternative Systems. We do not know whether this report recommended depreciation or amortization of nondepreciable items because the report has not been made public.

15 Department of Transportation and related Agencies Appropriations for 1974, Hearings before a Subcommittee of Committee on Appropriations, House of Representatives, 93rd Cong., 1st Sess. Part 2, p. 1125 and following.

16 Note the GAO Report is after the Arthur Andersen & Co. letter of April 30, 1972.