Another of the writer's objections was the absence of an allowance for "wear and tear of materials during the period of construction." As to this, Mr. Riggs says:
"This deterioration is a necessary incident to any construction work. It has not been customary or usual to take account of it. To add to the amount capitalized on account of this item would be manifestly improper. The only way in which this could be cared for would be in an adjustment of the depreciation reserve when raised to cover that which takes place during the construction period."
Of course, the depreciation account, when there is one, is a charge to operation. Therefore, Mr. Riggs' anxiety to disagree with the writer has led him into a frame of mind in which he is prepared to find that it is "manifestly improper" to charge to capital the real cost of construction, but is quite proper to charge to operation a part of the cost of construction, even though this results in carrying into the operating account items of expense incurred long before operation began or could have begun.
Mr. Riggs thinks that the writer was incorrect in objecting that "a uniform price for earthwork was used, thus ignoring the varying character of soil and length of haul," but he admits that there was "practically no classification in the Southern Peninsula of Michigan, or, in fact, on 90% of the mileage of the State," and his defense goes no further than to assert that "the price * * * was not much out of the way when considered as a fair average for the territory."
His criticism of the objection to the use of a uniform price list for materials, and ignoring the source of supply and the cost of delivery at the point of use, is equally forced, for it admits that "no effort was made to use different unit prices as between counties," and only contends that "in a number of cases" differences in prices were made.
The absence of an allowance for interference by labor troubles, weather conditions (which he admits are "a frequent source of annoyance, delay, and sometimes of expense"), Mr. Riggs defends on the ground that it is "an expense difficult to separate and set up," and therefore ought to be covered by an allowance for contingencies. On the same ground, he could easily carry every item of cost of replacement into the contingent account.
The two remaining objections specifically raised by the writer are squarely attacked by Mr. Riggs. As to one of them, the propriety of an allowance for carrying charges up to the time of attaining a revenue basis, has been admitted by the Railroad Commission of Wisconsin, but it is a broader question than ought here to be discussed. The writer will only suggest, at present, that in some form or other, these charges must be on the whole and in the long run met out of net operating income, and that the cheapest way, for the user of the services supplied, is to carry them into the capital account—otherwise there must be an early amortization of this item, which cannot do otherwise than to throw a heavy burden on the early schedules of charges. The language of the Wisconsin Railroad Commission on this subject merits quotation, and is as follows:[[40]]
"But new plants are seldom paying at the start. Several years are usually required before they obtain a sufficient amount of business or earnings to cover operating expenses, including depreciation and a reasonable rate of interest upon the investment. The amount by which the earnings fail to meet these requirements may thus be regarded as deficits from the operation. These deficits constitute the cost of building up the business of the plant. They are as much a part of the cost of building up the business as loss of interest during the construction of the plant is a part of the cost of its construction. They are taken into account by those who enter upon such undertakings, and if they cannot be recovered in some way, the plant fails by that much to yield reasonable returns upon the amount that has been expended upon it and its business. Such deficits may be covered either by being regarded as a part of the investment and included in the capital upon which interest is allowed, or they may be carried until they can be written off when the earnings have so grown as to leave a surplus above a reasonable return on the investment that is large enough to permit it. When capitalized, they become a permanent charge on the consumers. When charged off from the surplus, they are gradually extinguished. (These facts alone, however, do not always furnish the best or most equitable basis for the disposal of such deficits.) Whether they should go into the capital account, or whether they should be written off, as indicated, are questions that largely depend on the circumstances in each particular case."
The other objection that is squarely opposed by Mr. Riggs is the refusal to allow for unavoidable discounts on the securities sold. Here he quotes with complete approval an unnamed writer, who contends that the impropriety of such an allowance is proven because, as between an issue of $10,000,000 in bonds (par value) at 4% and at 4½%, the 4% bonds bringing 90 and the 4½% selling at par, there is an annual saving, in issuing the 4% of $50,000 in interest, and that, if the issue is to be for fifty years, this saving is $2,500,000, or $1,500,000 in excess of the discount. Of course, these figures are correct, but both Mr. Riggs and his unnamed authority seem strangely to have overlooked the fact that if a railway construction requires $10,000,000, it cannot be obtained by issuing $10,000,000 in par value at 90. The comparison, of course, ought to be based on the issue of enough bonds at each rate to obtain equal sums of money. As $10,000,000 in par value of bonds sold at 90 would produce $9,000,000, the following comparison is based on the issue of enough bonds at each rate payable in fifty years to secure that sum.
| Fifty-Year Bonds, | ||
|---|---|---|
| 4½% sold at par. | 4% sold at 90. | |
| Amount of capital required | $9,000,000 | $9,000,000 |
| Par value of bonds necessary | 9,000,000 | 10,000,000 |
| Annual interest charge | 405,000 | 400,000 |
| If 4% bonds are used: | ||
| Annual saving in interest | $5,000 | |
| Fifty years saving in interest | 250,000 | |
| Loss, original discount | 1,000,000 | |
| _________ | ||
| Net loss | $750,000 | |