case of a toll-bridge company but very distant where a large and varied plant existed, whose different units had different ages and dates of installation. The utility of such a fund consists merely in the preparation which it provides for making expenditures on plant and equipment when needed.

In a word, the depreciation fund is an asset; the "reserve for accrued depreciation " is not, but is frankly an "offset" to a frankly inflated asset figure. The reserve proper has no necessary counterpart in any particular assets; a "depreciation fund" of an equal amount or much less may be maintained at the same time, but very commonly no such fund is found needful, much less is it commonly required by law or public service commissions. The depreciation reserve proper has nothing whatever to do with ability to make expenditures for replacements or renewals, regular or irregular, except in so far as it may insure more comprehensive knowledge of the plant and thereby facilitate intelligent prevision of future needs for such purposes. Thus Professor Young is right in saying that " the deduction for depreciation cannot be justified by appealing to the necessity of providing for replacements" (p. 662); but this is not the whole truth. If the requirement of deducting for depreciation necessitated the accumulation of a " depreciation fund" equal to the accrued depreciation, such a fund would in large measure be unnecessary to ensure proper repairs and replacements, and, tho it would probably be invested in income-bearing securities and not be " idle money," it would be a superfluous provision and in this sense" useless." Professor Young seems to imply throughout that this result tends to follow. On page 648 he asserts a modified form of this implication. "Altho no investment of a separate depreciation fund is required, yet the writing down of the capital assets

by the amount of the accrued' depreciation means in the long run either that other assets have to be larger in amount than they otherwise would have been or that liabilities have to be smaller. Usually the growth of the reserve for accrued depreciation means in practice that additional permanent investments are being made out of earnings. The reserve represents an additional, permanent, and compulsory investment in the business to take the place of the amount of the investment written off for depreciation."

It will be noted that this consequence, if it be such, is no different in the case of companies starting out under strict regulation than in the case of companies existing prior to such regulation and summarily brought under its provisions. The "depreciation fund" or its equivalent is equally "useless" in the two types of cases. But consider the alternatives actually presented to a company when required from the outset to provide reserve for accrued depreciation" on its plant. There are at least three. During the period of settling down to the state of normal average depreciation the expenditures for replacements and repairs will be small. (1) It may not divide the earnings representing this temporary saving as profits, for they are not so. It may use them, however, to purchase additional items of plant or equipment, thus increasing its current productive capacity without increasing its net investment. (2) Or, it may invest them in income-bearing securities, securing thereby a supplementary income. (3) Or, it may divide them to the stockholders, as a return of part of the investment, and reduce the capital stock accordingly. The first of these alternatives is commonly chosen, chiefly because businesses seldom spring fullfledged from the heads of their promoters and if successful usually expand. Where, however, conditions are

static and increase of output would be unprofitable, uneconomical, this policy would be avoided, and one of the others adopted. The second policy has the advantage of making possible the making of replacements at most advantageous times and of maintaining a stable rate of dividends; but there is no assurance that a fund precisely the amount of the accrued depreciation would be required to serve these purposes, and the policy has the disadvantage of involving the company largely in affairs outside the realm in which its managers are presumably most efficient. In practice, however, a combination of these first two policies is usually found desirable. But the third policy is not ordinarily precluded by law or public service commission ruling. Where no contingencies need be provided against, where instability of dividends is not deemed probable or undesirable, where increase of operating facilities is not called for, a frank division of such part of the original investment as proved to be no longer necessary would be the appropriate policy. The requirement of the depreciation reserve merely ensures that such reduction shall take place openly and in due form rather than surreptitiously or in ignorance. Control to this extent of the financial policies of the companies affected is today, in the view of many observers, far from inexpedient. And the slight adoption of this alternative is to be regarded as indicating not the compulsory adoption of one of the others, but their greater profitableness.

Three alternatives are similarly present in the case of a company which has not heretofore taken account of depreciation. Additions beyond mere replacements may at once or gradually be made to plant and equipment until the net investment equals the amount originally carried. Or, funds may be segregated, at once or gradually out of earnings, to constitute an income-yielding

depreciation fund. Or, the par value of capital stock or the stated surplus may be reduced, or the deficit figure increased, by the amount of the depreciation reserve, so that the "net proprietorship" figure will correspond to the actual amount of the investment. Business conditions, in the main, will determine which is the best procedure in each concrete case. Public service commissions may well be wary of laying down precise regulations as to the method to be adopted, provided the result be secured; but the mere requirement of recognizing the fact of past depreciation and taking it into account involves no burdensome or inexpedient control of financial policies of the companies concerned.

To conclude:

1. The requirement of an allowance for depreciation is necessary in order to state with an approach to accuracy the "present value" of or the present "amount of the investment " in a physical plant.

2. Such requirement, tho affecting companies which had deemed no such allowance necessary, involves no injustice to particular companies, while the absence of such requirement when making valuations for purposes of rate regulation would lead to unequal treatment of companies which had pursued different policies.

3. The presumption in favor of the expediency of such a requirement, raised by the foregoing facts and by the further circumstance that such "cost-keeping " tends to promote more intelligent conduct of the enterprise, is not overthrown by the appearance of any consequent inexpedient restrictions on financial policies.

Or, restated in a form comparable with that of Professor Young, these conclusions would be:

1. If depreciation charges have not been required by public authority, it cannot be assumed that the proprietors of a large public service undertaking should have

accumulated a reserve for accrued depreciation or a depreciation fund of the same amount.

2. The absence of such a reserve means, however, that the value of the physical plant is by so much overstated, and indicates that, unless an equivalent amount of earnings has been applied to extensions of plant without "charging to capital" or has been invested in other property or has been expended in building up immaterial assets which do not appear on the balance sheet, part of the principal of the investment has, whether intentionally or otherwise, been returned to the proprietors.

3. It is proper, just, and expedient that in valuation for purposes of rate control account should be taken of depreciation of the physical plant, regardless of the need or lack of need for a depreciation fund, and regardless of the actual or hypothetical expectations of the proprietors as to the necessity of reckoning with depreciation by means of the depreciation reserve or otherwise. JOSEPH S. DAVIS.

HARVARD UNIVERSITY.

A REPLY

I had not expected that my conclusions on the relation of depreciation and rate control, challenging generally received opinion as they do, would meet with easy acceptance. I am grateful to Mr. Davis for having cogently formulated some of the objections - the more weighty ones, I imagine that may seem to count against my thesis. The right solution of the problem is a matter of great practical consequence, and discussion which, like Mr. Davis's, helps to define and narrow the issues, contributes toward that end.