Depreciation

• DOI: 10.1177/000271621405300119
• Author: James E. Allison
• Published date: 01 May 1914
• Date: 01 May 1914
• Subject Matter: Articles

DEPRECIATION
BY JAMES E. ALLISON,
Former Commissioner and Chief Engineer, St. Louis Public Service
Commission; Member A. S. C. E., A. S. M. E.
I
In public valuation for rate-making purposes there is probably
more at stake in the problem of so-called depreciation than in any
other one element. Yet a clear conception of what depreciation
means and how and when it should be applied or omitted as an ele-
ment in so-called valuations is rare among the engineers, commissions
and courts upon whom rests the responsibility of determining the
status of hundreds of millions of public service property.
To have a clear conception of the problem it is necessary in the
first place to understand clearly in each case just what is meant by
the term &dquo;value&dquo; or &dquo;fair value.&dquo;
To say that a property is worth
so much money might mean that the sum arrived at is the one which
in the judgment of the speaker the property ought to bring or he
might mean that the amount stated was the sum which in his judg-
ment it would bring under conditions of sale. In handling the dis-
cussion it is probably necessary to limit the meaning of the word
&dquo;’value,&dquo; when unqualified, to the exchange value in money. In
fact when we measure any value in money we must mean an exchange
value and if the term value is unqualified it must mean that sum
which the property in all likelihood would bring at a fair sale.
It should be evident that, in the case of public service properties,
the value of the property as a whole means its value as an invest-
ment and the controlling factor in the value of an investment is the
return upon the investment and the stability of that return. If this
is true it must follow that the &dquo;present value&dquo; of a public service
property depends largely upon the present net returns and their
stability and that any change in rates or regulation of service which
will change the returns will change the present value of the property.
Therefore, if as is so often stated by commissions and courts, the
object of so-called valuation work is to obtain &dquo;present value&dquo; the
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very statement would prohibit any change in rates or operating
expenses affecting the returns.
That there are other elements going to make up the present
value of the property besides the net returns may be true but these
elements are in fact subsidiary elements to the factor of net returns.
If for instance a property is in a bad condition; in determining its
present value the important circumstance to the prospective buyer
or investor is that he will be deprived of returns upon his investment
in order to put the property in condition or he will be obliged to make
an added investment to bring it into condition and thus cut his rate
of return on the whole capital invested. If we concede as seems
necessary that in a rate or service regulation case the present value
cannot be obtained unless it is granted that there is to be no change
in the rates or expenses of service (which would make the whole
work of valuation useless) then the necessary conclusion must be
that the object of so-called valuation for rate making or regulation
purposes is not to obtain a &dquo;present value.&dquo;
It would seem that the only possible and the only dependable
object of valuation work is to obtain what may be called a &dquo;just
amount&dquo; upon which the investor should be allowed to earn reason-
able returns. While this amount may or may not closely approximate
a present exchange value this circumstance is merely accidental and
the two things are fundamentally different in principle.
The history of values as established by our courts shows that,
in the era preceding attempts at valuation for rate-making purposes,
the principal object in establishing any value was for the purpose
of sale under condemnation or for taxing purposes. In either of
these cases it is seen that justice is accomplished by comparison; that
is, if in the condemnation the owner receives a value comparing with
what would be received under free sale for similar property he is
justly treated and if the owner is taxed in proper comparison with
other owners possessing property of similar exchange value he also
will be justly treated, therefore the probable present exchange value
of the property was properly the object sought.
The courts, and following them some of the public service com-
missions, have never been able to clear their minds of this idea of
obtaining present exchange value in rate cases. They have of
necessity recognized, however, that, in rate cases, the present returns,
although the principal factor in determining present value, could not

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be taken into consideration. They have, therefore, been forced to
take the first step in a correct method of arriving at a &dquo;just amount&dquo;
to be earned on. This step is a so-called valuation of the property by
means of an inventory and assignment of unit costs, together with
estimates of costs of establishing a going business, etc. It is seen
that this step is not directly toward ascertaining present exchange
value of the property as a whole but merely arrives at a summation
of costs or at the present real investment in the service of the public.
Having ascertained as nearly as possible the full investment or
full costs of the present property and organization in the service of
the public, in other words having ascertained the money efficiently
sacrificed by the investor to serve the public, the courts and com-
missions have then suffered mental lapse by introducing the ques-
tion of present exchange value and have tried to arrive...