of prime importance in the consideration of this question in connection with a public utility is that the real permanent investment must be something less than the costnew. After a start with all new structures and equipment there will never be a return to this condition except in the case of extraordinary total supersession. Total plant supersession should be treated as a hazard rather than a cost (see § 452). As the permanent investment must be less than the original investment it is possible to reduce the permanent annual charge for interest and profits by amortizing a part of the original investment. It is possible to do this with justice to the consumers of the earlier period because in that period the expenditures for repairs, renewals and replacements are less than will be the later permanent average expenditures for this purpose. Moreover in view of the fact that such expenditures are ultimately permanently greater than during the first period there must be some permanent reduction in the annual charge for interest and profits as otherwise the total annual investment cost will not be uniform but will increase. Other conditions remaining the same, this will require an increase in the rates of charge. This would be unfair to the consumers of this period as they are equitably entitled to the same investment cost and the same relative rate of charge as the consumers of the earlier period. It is recognized that a railroad system cannot be kept in absolutely new condition. Although maintained at 100% efficiency, it will after construction show a greater and greater percentage of wear until it at length settles down to a practically constant percentage of wear and of depreciation in value and a practically constant expenditure for repairs and renewals. During the period when the system is thus settling down, the annual allowance for depreciation must be adequate to take care of all repairs and renewals and also to pay back to the owners the investment that permanently disappears through depreciation and will not again be needed in the business. If when this initial period is over the railroad will permanently show 15% depreciation over cost-new, this 15% should through the annual depreciation allowance already have been returned to the owners. As for the future, while the actual expenditures for repairs, renewals and replacements will be larger than during the initial period, there will be no further necessity for the amortization of a portion of the permanent investment and moreover the annual charge for interest and profits will be less. If the adjustment has been properly made the total annual investment cost will be the same as during the earlier period. It is claimed for certain large railway systems that the annual expenditures for repairs, renewals and replacements have become equalized so that the percentage of wear is constant and unchanging. Current repairs, renewals and replacements take care of all current depreciation and there is no need for an accumulated reserve to take care of either physical depreciation or the ordinary amount of functional depreciation. If this is true the actual annual average expenditure of the railroad for maintenance, renewals and replacements becomes the exact measure of the amount needed each year for maintenance and depreciation. No fund or reserve is required. Except perhaps for the very large utility systems the above condition though approximated is never actually reached. They have a few large structures having long lives, so that the percentage of wear and age for the system as a whole is not constant but fluctuates somewhat with the age of these large units. Nevertheless the total expenditures for repairs, renewals and replacements fluctuate only between certain well defined limits. There is a certain normal expenditure and there are also certain infrequent extraordinary expenditures in excess of the normal. It is only for these infrequent expenditures in excess of the normal, that it is necessary to provide by means of a reserve. The amount necessary to meet these large expenditures should be accumulated by the most economical method that will evenly distribute the burden. The sinking fund method seems well adapted for this purpose. Under the uniform annual investment cost method the existing depreciation is the amount of the original investment that has been amortized as a necessary result of the actual or theoretical application of this method from the initiation of the enterprise. § 402. New York Public Service Commission, First District, rejects sinking fund method. Re Metropolitan Street Railway Reorganization, 3 P. S. C. 1st D. (N. Y.) 113, 153, decided February 27, 1912, relates to capitalization after reorganization. In estimating the fair present value of the property the commission rejected the claim that depreciation if allowed for at all should be allowed for on a 5% sinking fund basis. The basis used by the Commission was the straight line method. The Commission says (at page 153): Notwithstanding the decisions of the Commission in other cases and the questions addressed to the witnesses called by the applicants, no testimony was presented by them to indicate what allowance should be made for depreciation or what was the actual value of the physical property at present. They did submit a statement by one witness to the effect that, even if depreciation were to be deducted from the estimated costto-reproduce-new, the amount thus subtracted should not exceed $7,329,130. This figure was reached by fixing an amount to represent part of the cost of the property as new, a salvage value, a life table and an age table for the different classes of property. From these assumed facts and the further assumption that a sinking fund could be made to accumulate at 5 per cent. compound interest per annum, the witness found that if the company had $7,329,130 now in a fund, and if other annual payments were paid into this fund and compounded at 5 per cent. annually, the company would have at the end of the assumed life of the property a sufficient sum of money together with what might be realized from the sale of the scrap to provide for the replacement of part of the property as it now exists. (6) The problem before us is not how to meet and provide for decrease in values, but what is the fair value of the plant at present. It may be that sinking funds will provide for the replacement of the various parts if they live out their allotted terms, but in the meantime, capital is impaired unless the value disappears at the same rate that the sinking fund accumulates. As a matter of fact this is true of few classes of property, and the curves which represent values from year to year are so varied that rarely does one coincide with the mathematical formula adopted by the witness who estimated $7,329,130 as the maximum deduction for depreciation. It seems to have been forgotten that the difference between cost and present value determines depreciation; depreciation does not fix present value. How the impairment may be met is a separate question. Mr. Connette, the Transportation Engineer of the Commission, prepared an estimate of present value, which was introduced in evidence. The most important difference between Mr. Connette's estimate and the calculation presented by Mr. Uebelacker, which he declared "absolutely useless," is that the former follows the straight-line method, while the latter adopts the 5 per cent. sinking fund method. Without going into the technical details of these two plans, suffice it to say that the fundamental difference is that the former assumes the property to decrease uniformly in value from year to year, the latter that it follows parabolic curve. The former assumes that the decrease will be met year by year as it occurs, that the payment from earn ings will be immediately expended and that it will not accumulate at compound interest. The latter assumes that nothing will be spent before the end of the period, that it will all accumulate and that impairment of capital need not necessarily be met as it occurs. § 403. Straight line method in New York City Street Railway Fare Case. Bion J. Arnold, consulting engineer, made a valuation of the property of the Coney Island and Brooklyn Railroad for the New York Public Service Commission for the First District for use in a case involving the fares charged by that company. In testifying as to his valuation in this case Mr. Arnold explained his method of treating depreciation as follows: 2 A. Depreciated Value of Physical Equipment: This value was obtained under the following instructions: Deduct from the Cost to Reproduce the Depreciation which may have been caused by Obsolescence, Inadequacy, Wear, Deferred Maintenance and Casualties. The equipment can deteriorate only down to its Scrap Value. In obtaining the Present Value of this part of the property, therefore, consideration should be given the following items: A. Cost to Reproduce including: Contractor's Profit, Incidentals, Administration during Construction, and B. Scrap Value C. Original Service Value. D. Depreciation due to Obsolescence, Inadequacy and Age. 2 Monheimer v. Coney Island and Brooklyn Railroad Company, 1 P. S. C. 1st D. (N. Y.) 705, July 2, 1909. |