it is about "half worn out," it does not follow that half of the investment, or any part of it, even, has been returned to the stockholders - and that whether their profits have been high or low. Mr. Davis's adherence to the necessarily arbitrary categories of accounting seems to blind him to this simple fact.

When he says that to write down the values of present properties for past depreciation involves "no regulation of past actions or profits" he fails to weigh the real effect of this procedure upon a company which made its investment and adjusted its whole business policy in accordance with the admittedly reasonable supposition that operating expenses need not be charged with any burden for the upkeep of capital beyond the cost of proper repairs and renewals. To write down the properties of such a company for depreciation is to adjudge that past profits have contained or should have contained an element representing the return of part of the investment. And when he goes so far as to say, "the investors are not required to disgorge the sums they received in the false guise of profits; they are not required to return the profits actually secured for years when rates were allowed to remain at a level to yield normal income on a capital sum higher than the actual investment,” he openly begs the whole question at issue.

Mr. Davis raises the problem of the proper valuation of two similar plants, one of which has regularly charged depreciation to operating expenses, while the other has not. The answer is, of course, that there is a reasonable presumption that one plant has adjusted its investment, its service, and its rates to a higher scale of operating expenses than the other. That is, there is a presumption that one company has collected or planned to collect in rates enough to repay part of its investment. Depreciation might fairly be deducted from the valua

tion of one, but not from that of the other. The problem is, of course, largely hypothetical. It could not arise in the case of railroads, and but infrequently in that of public utilities.

Let me repeat again that the general question of the justification of the deduction for depreciation is one to which a categorical answer is impossible. The concrete facts in the history of a business do not fall easily into the rigid concepts of modern accounting. Viewed retrospectively, there is no sharp line between principal and interest, between investment and return. Money is expended in building a plant. More money is expended in operating it. All proper renewals are provided for in operating expenses. For the period in question, the present accounting scheme with its regular charges for depreciation is neither compulsory nor in customary use. An annual money income is received, in excess of operating expenditures. How much shall be called net profit? How much shall be counted as repayment of principal ? Is there any definite reason to hold that any part of the investment has been repocketed? The question itself is an artificial one, forced upon us as part of the practical problem of regulation. There is, of course, a doubt to be resolved. But I have tried to show that there is a reasonable presumption that under the conditions stated it would be unjust to refuse to allow the company to charge rates that would give a fair return on the undepreciated value of its properties.

Mr. Davis's criticism misses the mark because it fails to deal with the fundamental ground on which I based my conclusion that there is such a general presumption. I see no reason to modify that conclusion.

ALLYN A. YOUNG.

CORNELL UNIVERSITY.

A REJOINDER

I REGRET to have misconstrued Professor Young's language respecting the uselessness of the depreciation reserve. I think I am right, however, in crediting him with holding that to accumulate such a reserve needlessly keeps in the business assets which might be distributed to the stockholders, and that the reserve is used for replacements and is useless if it will at no time be entirely exhausted by replacements. Such a view, I am clear, involves an erroneous conception of this reserve. Assuming that depreciation of a physical plant is an inescapable economic fact, despite the utmost assiduity in keeping the plant in proper working condition and regardless of circumstances or methods of taking the fact into account, a reserve for accrued depreciation which approximates the actual depreciation is, I believe, corresponded to by no real assets and does not represent an additional, permanent, and compulsory investment in the business to take the place of the amount of the investment written off for depreciation" (p. 648). It is simply an accounting device to measure the amount by which the value figure for plant, on the balance sheet, exceeds the actual value, as nearly as the excess can be estimated. Tho a "liability account" in the sense of being a credit item, it is a mere

Tho a

offset," a "negative reserve," and is to be sharply distinguished from those reserves which are segregated parts of the surplus and are corresponded to by equivalent amounts of specified or unspecified assets, in reality as well as on the balance sheet; just as a deficit, often listed among the assets, is to be sharply distinguished from items which represent actual assets. Such a reserve is merely a record of fact, altho, since the fact the amount of depreciation - cannot be ascertained

with precision, the record is, like many records, only an approximation to the truth. And Professor Young seems to me to argue beside the point when he endeavors to show "the fallacy in the view that the 'reserve for accrued depreciation' is a necessary record of fact," by pointing out that replacement requirements do not necessitate an advance accumulation of a "fund" that will amount to much more than the annual cost of such replacements (pp. 650-651). As I pointed out in my criticism, the keeping of such a reserve does not hold in the business assets which might otherwise be distributed to stockholders, tho by preventing liquidated capital from masquerading as profits it may restrict ordinary dividends. The reserve is typically and properly reduced when property is retired (by the accrued depreciation on the item retired), the reduction going to offset the writing down of the plant account by the cost of the property retired. Far from releasing assets for distribution to stockholders, the making of replacements involves locking up, in more or less fixed capital, liquid assets already in the business or brought into the business for the purpose. The ability to make replacements depends on the amount of such liquid assets available or obtainable; it is less in times of financial depression than in other times, it is greater for companies which make a policy of keeping against such contingencies an amount of liquid assets largely in excess of ordinary needs. The proper keeping of this reserve account does indeed eliminate from the profit and loss account all variations due to the circumstance that replacements are not even normally made with entire regularity. But I see no reason to modify my conclusion that the ability to make replacements or renewals is not affected by the keeping of this account. Granted that the reserve for accrued depreciation will never be " used up as replacements are made, what of it?

This matter is, I believe, intimately related to the question of impairment of investment and the reality of stated profits. If a large and varied physical plant, like each of its several elements, actually depreciates and the reserve for accrued depreciation represents no real assets, figures showing the total outlays for the present plant cannot correctly represent the present amount of the investment in it; and, if a reserve for accrued depreciation is lacking or inadequate, any surplus shown is in part spurious corresponded to by no real assets in the business - while if no surplus is shown, something in addition to genuine profits has been distributed to stockholders, or else losses have directly impaired the investment. I had understood from his original article that Professor Young would deny the depreciation and maintain that, provided repairs and replacements were made as needed to keep the plant in good working order, the investment "in every real sense " remained intact (p. 651). He now admits, however, comparing an old plant with a new one of similar make-up, (1) that the older embodies a smaller store of productive power,1 (2) that outlays for needed repairs and replacements will be larger for the old than for the new (till the new one has reached the stage of normal average depreciation), (3) that accordingly, in an important sense, if not in the sense he prefers, the productive efficiency of the new one is greater,2 and (4) that whether sold at forced sale or changing hands as a going concern in good condition selling prices would be different. Perhaps I am safe in assuming, therefore, that we agree that, from most standpoints, the present

1 At two points in his reply (p. 382), Professor Young imputes to me the use of "productive efficiency" where my term was actually "productive power."

2 Cf. also the statement in his original article (p. 652): "In the absence of such a reserve net profits for the time being would of course have been higher than if a reserve had been accumulated."