should always be applied to the valuation of plant even when associated with reserves. Thus, if a plant having a fair cost-new of $100,000, was being valued at the end of 5 years of a 10-year life, and the property of the undertaking was found to consist of the plant and outside securities to the amount of $46,312, drawing 3 per cent interest, it would be argued that the plant by the straight line method would be worth $50,000, and the securities $46,312, so that the present value of the property was $96,312, and upon that sum alone the undertaking was entitled to base its return. Such a line of reasoning is manifestly unfair to the undertaking. The company has done all that its duty to the public demands, in that it has made reserves sufficient to ensure to the public the continuation of the service; it has exacted from the public as small payments to the reserves as could be made and, at the same time, guarantee a continuation of the operation of the property. If the undertaking is to be thus penalized by a reduction of its assets below what it has actually invested, recourse would have to be made to larger reserves for depreciation at the early years of the operation of the plant, and gradually reduced annual payments, in order thus artificially to make the reserves conform to the loss in value produced by the straight line method applied to the plant. Rates cannot be changed each year. By the use of the sinking fund method as thus outlined the rates would remain unchanged throughout the life of the plant and even after it was renewed, as the capitalization, i.e., the value of the property, would remain unchanged. But in the case of depreciation as in all other matters relating to valuations, arbitrary rules cannot be applied. The choice of which method should be used to ascertain depreciation will depend upon the good judgment of those whose duty it is to make the decision. Thus cases can be conceived wherein a rigid adherence to the rule of using the straight line method for property consisting of plant alone, and the sinking fund method for plant associated with reserves, would prove inequitable to the undertaking. Thus if, in the case cited above, the reserves had been $100 instead of being $46,312, then, since there are reserves in hand, if this rule is followed the loss in value must be ascertained by the sinking fund method. $100 at compound interest for five years would be approximately $116. The accumulations of the annuity and interest at the end of five years on $100,000 at a three per cent rate is $46,312. Thus, by a strict adherence to the above rule, the loss in value would be $53,572; whereas it would have been fairer to the undertaking in such a case to have used the straight line method. 163. Returns based upon capital investment. — The theory of depreciation, which has been outlined in the preceding pages, is founded on the belief that justice to the public and to the undertaking can be obtained only when the fair value upon which rates can be based is ruled to be, as nearly as may be capable of determination, the proper investment of shareholders in the enterprise (neglecting for the present any question of the unearned increment), provided there is always maintained that value by adequate reserves to make good the loss in the value of the investment arising from the years of service. But, it has been contended, the courts have held that rates shall be based on "the present value of the property of the undertaking in use and useful to the public" and not the cost of the property. The answer to this contention is that it is a question of property, not plant alone, and of property maintained through adequate reserves at that value. But again it is argued, if that theory is correct the plant value may be a fraction of the cost, and the full cost be attained only by adding to the plant value the reserves for depreciation. On such a basis the public would have to pay a return not only on the plant value but upon the depreciation reserves which possibly may be drawing interest from some outside source. The plant is in use and useful to the public; the reserves are not. It cannot be right to make the public pay a return upon depreciation reserves which it has contributed to the undertaking. These arguments cannot be held to be sound. If all reserves are invested in plant, the method which has been described clearly determines a value upon which rates are to be based, which does not include the plant purchased with such reserves. If the property consists of plant and money properly invested, the value of the property is that sum which can be proved to be capable of use for the benefit of the public. The very fact that the plant is to be used only as long as it affords good service and will be renewed with funds held specially for that purpose maintains the full value of the investment in perishable property. Nor does the public pay a return upon the reserves; it pays a return upon the property as a whole which is held and used for the benefit of the public. The interest on the reserve funds does not go to swell the returns to the stockholders but is used to reduce the amount which the public has to pay toward the depreciation reserves. 164. Investment in property, not plant, ruled by courts as basis of fair return. - The Supreme Court has said, "It" (an undertaking) "is entitled, it is its duty, to see that from its earnings the value of the property invested is kept unimpaired, so that, at the end of any given term of years, the original investment remains as it was at the beginning." It must be noted that the court says that it is the value of the property, not value of the plant. This ruling of the Supreme Court states as clearly and definitely as words can express, that the sums set aside from earnings keep the property invested unimpaired. Another ruling of the Supreme Court is that it is "the fair value of the property being used by it for the convenience of the public," that must be the basis of all calculations as to the reasonableness of rates. In the light of these rulings, it must be property, the property invested and kept unimpaired by depreciation reserves, property invested by the stockholders in the undertaking and held by the undertaking for the perpetuation of the service to the public, that must be the basis for all calculations as to the reasonableness of rates. It is illogical and unreasonable to expect that the court will hold that, if the value of the plant diminishes year by year, the return to the stockholders must diminish correspondingly, and be increased when the reserves for depreciation properly set aside bring back to the plant its original cost. It is the investment in property that is the basis of fair rates and the depreciation reserves hold the value of the investment unchanged. In other words, the depreciation reserves are a part of the property of the undertaking, as much as is the plant itself. In another case the court has said: "It was obligatory upon the complainant to show that no part of the money raised to pay for depreciation was added to capital, upon which a return was to be made to stockholders in the way of dividends for the future. It cannot be left to conjecture, but the burden rests with the complainant to show it. It certainly was not proper for the complainant to take the money, or any portion of it, which it received as a result of the rates under which it was operating, and so to use it, or any part of it, as to permit the company to add it to its capital account, upon which it was paying dividends to shareholders. If that were allowable, it would be collecting money to pay for depreciation of the property, and, having collected it, to use it in another way, upon which the complainant would obtain a return and distribute it to its stockholders. That it was right to raise more money to pay for depreciation than was actually disbursed for the particular year there can be no doubt, for a reserve is necessary in any business of this kind, and so it might accumulate, but to raise more than money enough for the purpose and place the balance to the credit of capital upon which to pay dividends cannot be proper treatment." 1 This decision seems to establish the principle that it is the value of the property in which the stockholders of the undertaking have invested their money, which property has been kept unimpaired, that is the basis of fair rates. 165. Dangers resulting from making present value of plant alone the basis of fair rates. One more point only will be cited to show that the depreciation reserves not invested in plant must be included as a portion of the value of the property of an undertaking upon which rates should be based. If the depreciation reserves are to be excluded from the property of an undertaking, it would be necessary for all undertakings to invest all their reserves in extensions to their property whether there was a need of such extensions or not. In very many cases where the growth of a community is slow or the financial success of the undertaking is doubtful, it may be wiser to safeguard the reserves by holding them in good, readily convertible securities. 166. Valuation of new properties. In some cases it may be necessary to make a valuation of a property before it has been in operation long enough to have obtained a sufficient income to pay its operating expenses, to make proper and sufficient contributions to its depreciation reserves and to contribute a proper return to its stockholders. In such a case, in one state at least, the Public Service Commission has authority to permit a temporary abandonment of depreciation reserves, and the loss properly sustained may be considered as a part of the value of the property incident to making it a going con 1 Louisiana R. R. Com. v. Cumberland Tel. & Teleg. Co. 212 U. S. 424 (1909). |