"the cost of establishing the business," "interest during construction," and the like, become unintelligible. I cannot ask for space to develop this contention at this time-it would necessitate a review of the whole general theory of valuation-but its soundness will be admitted by all conversant with the matter. What I called the investment entitled to a return may not be the only factor in valuation, but it is easily the dominant one. A possible rejoinder to all this is that the appeal to authority is inconclusive when it comes from one who is questioning the soundness of the findings of that same authority in one very important detail. But altho I believe that my thesis might derive convincing supports from general considerations of equity, the matter cannot now be pursued that far. It is sufficient to show that the treatment of the depreciation problem by courts and commissions has been inconsistent with the general principles of valuation which they themselves have adopted.

If investment is the ruling factor, Mr. Davis's emphasis upon the " store of productive efficiency" is misplaced. The question is not whether a plant in a state of normal depreciation is as " valuable " for productive purposes as a new one. It is merely whether there is a reasonable presumption that the lower operating costs in the first years of a plant which does not accumulate a depreciation reserve involve a virtual return of part of the investment to its proprietors. I see no way of getting at the matter except by weighing the probability that these lower operating expenses were taken into account in determining the amount of the investment and the level of rates.

Mr. Davis holds that "it is not safe to presume that if an allowance for depreciation had been required from the outset investments would not have been made or

would have been smaller." But is it safe to presume that such a requirement would have made no difference to investors ? There is, of course, no evidence which directly bears on this point. But there is food for thought in some statistics gathered in 1897 and 1898 by the Commissioner of Labor.1 For each of eighteen groups in which 375 privately-owned waterworks were classified (on the basis of size) it appeared that the average cost of production per unit of product (including an allowance for interest) was more than the average price charged for the water sold. A similar condition was found in seven of the eleven groups into which 344 privately-owned gas plants were classified." "The explanation of these results," says the editor of the tables, " may be found in the fact that depreciation, which is here included in the cost of production, is, as a rule, not considered by the plants themselves as an actual charge against cost, and that prices are consequently based on cost exclusive of this element."

That these figures are accurate in detail is not to be expected. But the general conclusion to which they point seems to me unmistakable. For many years most public service companies failed to charge to operating costs all of the items which, under present rulings, they are entitled to charge. But their policy was in line with what was current business practice and found support in court decisions. Part, at least, of the immediate saving went to the public in the form of larger facilities or lower rates. And yet we are asked lightly to assume that all of it went back into the pockets of the proprietors.

Because a property administered with a view to continuous operation has reached that normal state where

1 Water, Gas, and Electric-Light Plants under Private and Municipal Ownership Fourteenth Annual Report of the Commissioner of Labor (1899). See especially pp. 42, 43, 396, 397.

• Comparable figures were not given for electric-light plants.

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

The probIt could not

tion of one, but not from that of the other. lem is, of course, largely hypothetical. 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 "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