questioned. So far at least as concerns the depreciable physical plant (and this element alone is under discussion), there would seem to be distinct disadvantages in arriving at four different figures for its value in a going concern, according to whether the valuation has reference to transfer between private parties, purchase by government, regulation of security issues, or regulation of rates. The "fair value " of the plant of a going concern should mean in each case, I believe, the nearest possible approximation, fixed by honest, intelligent, careful appraisal, to what its rating would be in a voluntary, unforced sale of the entire concern in a period of normal business. Any other policy certainly makes against consistent action, and in the long run, I believe, for injustice. If justice requires, it is not difficult to make due allowance in other ways for losses, abnormally low real profits, or what not.3

I am

The problem of justice is an intricate one. ready to admit that cases may be found where, tho the plant investment is actually less than its net book value, well-managed companies have secured no more than a normal return because of reliance upon an assumption which, however erroneous, was fostered by court decisions and prevailing business standards; and that real injustice may be done by disregarding these facts entirely when rates are regulated. Yet I cannot think it safe now to presume that uncontrolled public service

1 The "break-up value" or value with "reference to a possible insolvency" would of course be different; but when we are dealing with a going concern such a value is potential, hypothetical, not actual, present, and need not be considered.

Here is implied, obviously, a criticism of certain court and commission decisions. Since, however, cost-of-reproduction-less-depreciation is a not unusual "basis" for valuing a physical plant, and since this would at least approximate the "fair value " as I regard it, my view is by no means revolutionary.

For example, the amount of the loss for which justice is held to require reimbursement may be made a deferred charge to profit and loss, and for the time being rates may be fixed which yield beyond the normal return on the present investment enough gradually to reduce this debit. Less satisfactorily, the sum may be made an independent item in the total valuation.

companies have treated the public better than if a requirement to keep depreciation accounts had been in force. If business men would recognize that the " sale value " of an old plant is less than for a new one similarly constituted, is it certain that they would think that the two represent the same amount of investment ? Or that they would not calculate upon large returns in early years which could be used in part for extensions without increasing the capital stock? Or that they would expect a normal rate of profit measured on the gross outlay for plant? One has been accustomed to believe, moreover, that before public regulation came into vogue the principle of monopoly value held large sway in public utility properties; and if monopolistic proprietors really fixed lower rates because they had not learned to allow for depreciation, their action is not in accord with what the usual expositions of economic theory lead us to expect. Certainly common report of stockwatering episodes and of fortunes made in this field does not predispose one to look upon the investors as having been but barely remunerated for their investment.

On the other hand, it is equally difficult to argue convincingly that the lack of the depreciation requirement has made no difference to investors. Abstract reasoning, it seems to me, cannot establish either this presumption or the other. The facts are not clear. Evidence should be presented to show that, in the main, properly managed public service companies have secured (but not necessarily divided) less than a normal rate of profit on their investment, properly valued. Professor Young offers only one bit of evidence. And I think he adopts too hastily the interpretation placed by the editor (the late Carroll D. Wright ?) upon the data published in the report of the Commissioner of Labor

one.

(1899). No figures for capital stock, surplus, or dividends were shown in that report. The depreciation allowance for the year which was included in cost was a highly arbitrary figure, as a rule merely an estimate by the official who made out the returns; the companies themselves did not use the figure, and a cursory study of the data strongly indicates that the allowance, which figured very heavily in the sum of costs, was a liberal But even supposing it to be substantially accurate, its inclusion in the year's costs showed merely that the net profits for that year were less than a normal return on the total outlay (undepreciated cost) for construction and improvements. If calculated on cost less accrued depreciation the showing could have been far different. It is significant, it seems to me, that so many companies admitted the fact of depreciation in that year, despite proper repairs and renewals, even tho they did not make a practice of dealing with depreciation in their accounts. Furthermore, another very plausible interpretation may be put upon the fact that, in so many companies, the current revenue did not exceed costs including current depreciation by an amount sufficient to yield, on the undepreciated investment, a rate of return even equal to that paid on its latest bond issue by the cities in which the plants were located. That interpretation is, that the companies did not consider the gross outlay on plant to represent the principal of the investment on which they figured their rate of profit. Has it not been true that most companies which have not "booked" depreciation have paid for extensions and inprovements out of earnings, and either have not included the cost of these in their figures for plant value, or while so including them have built up a correspondingly large (nominal) surplus? In either case, dividends would be measured on the

original capital, or on capital stock more or less arbitrarily issued, and no obvious figure would show the rate of yield upon what they considered the investment entitled to return. I suspect that many public service companies would be greatly surprised and delighted if rates were revised to yield a "normal return" on the undepreciated outlays on their plant and improvements.

In short, on the question of justice which I now understand him to regard as central, I regard Professor Young's reasoning as still inconclusive, and his recommendation based on that reasoning as still unacceptable.

JOSEPH S. DAVIS.

CONCLUDING COMMENTS

I am sorry to prolong this controversy, but Mr. Davis's rejoinder brings the difference in our views so nearly to a point that I must attempt to complete that task. He still maintains (1) that the existence of a reserve for accrued depreciation has no bearing upon ability of a company to make replacements, and (2) that the market value of a plant is what should be sought in valuation for purposes of rate control.

1. To Mr. Davis the depreciation reserve is merely a record of fact and has no other function, while I am pragmatist enough to insist that the definition of fact must itself hinge upon some specific function or purpose of the reserve. But there is a particular fact of which Mr. Davis would make the depreciation reserve a record, and that is the diminution of the market value of capital assets which results from the shrinkage of their aggregate expectation of life. Mr. Davis would not, I suppose, question the fact that charges for the depreciation of fixed capital were first introduced into

operating costs quite as much to assure provision for future needs as to record the diminution of capital values. Nor do I suppose that he would question the statement that for a long time there was a mistaken notion that in practice these two principles of depreciation came to about the same thing. At any rate, I do not find in standard accounting literature any clear recognition of the fact that the amount of depreciation to be charged on large and varied properties is more or less according as one principle or the other is adopted. And the mistake in question was made by the accounting authorities of the Interstate Commerce Commission in 1907.

The theory of the meaning of the depreciation reserve which Mr. Davis holds is not without support, but it cannot be said to command the unanimous approval of accountants. I do not, however, wish now to question its general appropriateness, and have already said that I see no conclusive reason why public authorities should not compel public service companies to accumulate a reserve against depreciation in market value. But I do object to the assumption that the companies should in every case have accumulated that particular kind of a reserve before the days of regulation.

This does not mean, however, that outside of the group of enterprises where annual replacements can easily be made from annual earnings the existence of such a reserve does not affect ability to make replacements. Mr. Davis holds that the reserve has no such bearing, but it is difficult to believe that he is seriously urging considerations which he thinks of practical consequence. Surely his statement that "the keeping of such a reserve does not hold in the business assets which might otherwise be distributed to stockholders" is quite out of line with the generally candid nature of his