the recent case of the Kansas City Southern Railway,92 as follows: Depreciation is of two kinds,-(1) that which is not replaced in kind, and (2) that which is replaced by improved material. In the first case the property has served its purpose, and only past operations have benefited from it. So far as the profits of past operations have not been distributed to the stockholders, they are represented in the Profit and Loss Account, and therefore such an abandonment or depreciation is properly chargeable to that account unless a special depreciation account has been established in anticipation of such abandonments. The other kind of depreciation is the result of changes attributable to the inadequacy of the existing property to meet the demands of the future. Abandonments occasioned by changes of this character are therefore chargeable to future earnings, for the reason that the improved condition of the road is not only designed to meet the demands of the future, but presumably will result in economies of operation. The railroad company may, if it sees fit, anticipate general depreciations, and make provision for them by establishing a reserve for the purpose; but if no such provision has been made, the abandonment should be taken care of by charging them to present or future operating expense. After a careful study of this whole situation the Supreme Court committed itself to the extent of holding that although something was to be said for other methods which might have been established, still the question being whether the Commission had exceeded its powers, a statement of its theory was sufficient to show that the regulation was not arbitrary, in the sense of being without reasonable basis, and there was evidence to show that the Commission was warranted in adopting it, as sustained by expert opinion and approved by experience.93 92 Kansas City So. Ry. v. United States, 231 U. S. 423, 34 Sup. Ct. 125. 93 See the vague doctrines formerly current in the courts in Brymer v. Butler Water Co., 179 Pa. St. 231, 36 Atl. 249. § 957. Supervision of fixed charges. Since it seems to be established that a railroad is only entitled to earn annually a sum sufficient to pay its operating expenses and a fair return on the present value of the property used for the public, the depreciation regulations of this sort will not tend to decrease the sum on which the company may earn a fair return but will affect the payment of current dividends. It is true that on the question of exactly how that value is to be determined, the law is in a stage of development, but clearly the value as shown by the books, of the property being used for the public, must play an important part in the determination, both when the company itself fixes the rates and when the Commission adjusts them.94 Valuations for rate purposes which omit the element of depreciation would therefore seem to be erroneous; depreciation is lessened value due to deterioration physically or lack of adaptation to its function. Abandoned property is obviously no longer adaptable to function, and therefore such regulations as are being discussed seem both justifiable and necessary. The railroads argue that the cost of abandoned property is part of the cost of progress, and should therefore be retained in the property accounts, runs counter to the whole "present value" theory enounced by the Supreme Court. It would make the actual cost of the plant regardless of depreciation, and not its present value, the test for valuation purposes. If property is discarded, it is no longer used for the public, and therefore no return can be earned on it, even though the disallowance of such return results in a decrease or loss of dividends. It may be said that when improvement is made of an existing line, the company has withdrawn no property from public use, since the former construction still serves as a base for the new line, and hence as a matter of accounting the value of the old line need not be subtracted from the property accounts. 94 See the elaborate discussion from the earlier point of view in Smyth v. Ames, 169 U. S. 466, 42 The reply to that contention would be that, in ascertaining present value for rate purposes, a deduction for depreciation would have to be made to cover the decreased value of the old line when used simply as a base or foundation for the new line with its changed grades. That is, it would not be correct to say that the present value of the line equals the cost of the old line plus the cost of the improvements.95 § 958. Permanent improvements out of capital. Of course, it should be clear that outright new construction should not be charged to annual expenditures in any accounting, but that such investments belong in the capital account along with the original outlays in construction. Thus no advance in rates should result from construction of branch lines.96 And no permanent improvements of any sort should be charged to operating expenses for a year.97 And as cost of betterments should not be charged to operating expenses, they constitute no justification in themselves for increase in rates.98 The Commission has held consistently to the doctrine that permanent improvements are no part of operating expense.99 Finally when the railroads began to get restive as this ruling based upon this policy began to limit their course of finance, suit was brought to enforce the order of the Commission that the carriers desist from this practice. The court fully sustained the Commission,1 distinguishing a former 2 case from the one at bar, as that case was not dealing with rates of transportation or the rule which should determine them against shippers. But such is not the relation or concern of a shipper of 95 See Minnesota Rate Cases, 230 U. S. 352, 33 Sup. Ct. 729. 96 City of Spokane v. N. P. Ry., 19 I. C. C. 162. 97 Louisville & Nashville Railroad Coal and Coke Rates, 26 I. C. C. 20. 98 New York Butter and Cheese Rates, 28 I. C. C. 330. 99 In re Advances in Rates, Eastern Case, 20 I. C. C. 243. 1 Illinois C. Ry. v. I. C. C., 206 U. S. 441, 51 L. ed. 1128. 2 Union P. Ry. v. U. S., 99 U. S. 402, 25 L. ed. 274. lumber. His right is immediate, said the court. He may demand a service. He must pay a toll, but a toll measured by the reasonable value of the service. The elements of that value may be many and complex, not always determinable, as we have seen, with mathematical accuracy, but, we think, it is clear that instrumentalities which are to be used for years should not be paid for by the revenues of a day or year; and this is the principle of returns upon capital which exists in durable shape. § 959. Absorbing earnings in improvements. The Commission has from the first been consistently working toward the goal it has now reached. In Central Yellow Pine Ass'n v. Illinois Central Railroad,3 the Commission had before it an advance in the rate on yellow pine lumber from points of production in the South to the Ohio River. This advance was justified by the carriers upon the plea that owing to increased cost of operation their net returns were insufficient. In examining this matter the Commission found that the carriers had charged as a part of their. operating expenses large sums, which had, in fact, been devoted to the purchase of new equipment and to the making of permanent improvements to their roadway and structures, and held that these items were not properly chargeable as operating expenses, for the reason that the shipper of to-day could not be properly required to pay the entire cost of an improvement or addition which was to be of permanent use. The opinion was expressed that sufficient net returns would appear if these items of permanent use had not been included in the cost of operation. In Tift v. Southern Railway at about the same time the same contention of inadequacy of earnings was made, and it was found upon examination of the items going to make up the operating expense account, many expenditures which result in the permanent improvement or betterment of the property of the roads, such as expenditures 310 I. C. C. Rep. 505. 410 I. C. C. Rep. 543. 4 for right of way and station grounds, real estate, grading, tunnels, bridges, trestles and culverts, rails, ties, crossings and cattle guards, telegraph lines, station buildings and fixtures, shops, round houses, turntables, water stations, fuel stations, grain elevators, storage warehouses, docks and wharves, electric light plants and electric motive power plants, gas making plants, and miscellaneous structures. There were also included expenditures for equipment in the way of locomotives and cars of all kinds. And the Commission thereupon said that they should not, therefore, be taxed as part of the current or operating expenses of a single year, but should be so far as practicable and so far as rates exacted from the public are concerned, "projected proportionately over the future." Topic B. Separation of Interstate Accounts § 960. Apportionment of interstate business. 5 Where a road runs through several States the Constitution as interpreted by the Supreme Court of the United States requires that the value of the plant utilized in the intrastate business and the net earnings from such business must both be ascertained in order to determine whether the rates fixed by the State or its Commission are reasonable or confiscatory. In the leading case in the United States Supreme Court on this point Smyth v. Ames, Mr. Justice Harlan said: "In our judgment, it must be held that the reasonableness or unreasonableness of rates prescribed by a State for the transportation of persons and property wholly within its limits must be determined without reference to the interstate business done by the carrier, or to the profits derived from it. The State cannot justify unreasonably low rates for domestic transportation, considered alone, upon the ground that the carrier is earning large profits on its interstate business, over which, so far as rates are concerned, the State has no con§ 169 U. S. 466, 42 L. ed. 89, 18 Sup. Ct. 418. |