1. That discount on securities is not an item properly included in the cost of property.

2. That depreciation is an element of operating cost, and should be included in operating expenses.

3. That betterments and additions are not elements of operating cost, and should be charged to income or to capital.

4. That the total of assets and the total of liabilities should be shown upon the balance sheet, and that "profit and loss" should be so analyzed as to show the different kinds of liabilities covered by the accumulated surplus.

The first of the principles above named pertains to the future rather than to the present, for up to the present time carriers have been accustomed to charge discount on securities sold to cost of property, carrying such discount as a permanent asset. It is important, as bearing upon the influence likely to be exerted by this system of accounts, to know that the construction accounts promulgated by the Interstate Commerce Commission and adopted by most of the States, propose to open the balance sheet account with a cash statement of what it costs to create the property at one hundred cents on the dollar. A moment's consideration will show that this is a sound principle of accounting. The balance sheet statement of cost should be the book record of actual investment. The amount of securities issued to obtain the money spent in construction has nothing to do with the statement of such cost, for it is the money spent that measures cost and not bonds or stocks issued. A correct statement of investments is the beginning of correct accounting, if for no other reason than that it is the basis from which to measure depreciation charges on the one hand and charges for additions and betterments on the other.

Another fact, also, is worthy of mention in this connec

tion. The rules governing the construction accounts have been drawn with a view of the possibility that Congress may at some future time deem it wise to require an inventory valuation of railway property and to authorize some form of supervisory control over capitalization. The analysis which underlies these accounts, as indicated by the principle that discount should be excluded from costs, is an analysis which easily lends itself to this general purpose. The propriety of a law calling for some form of supervisory jurisdiction over the capitalization of property used in transportation is not under discussion, but, should Congress deem such a measure proper, the accounts thus far prescribed are believed to be adjusted to the requirements of such supervisory jurisdiction.

The second and the third of the above principles may be considered together, for the "depreciation accounts" and the "additions and betterments accounts" are each complementary to the other. The purpose of depreciation accounts is to guard against the overstatement of net revenue by failure to include all the costs of operation in operating expenses, while the purpose of additions and betterments accounts is to guard against the understatement of net revenue by including in operating expenses, as a cost of operation, what in fact is an improvement to the property. Heretofore no uniform rule has controlled these charges. The executive officer, perhaps to make a showing, perhaps to influence the market (the purpose is not important), has believed it to be a prerogative of management to vary these charges from time to time, according to some special purpose or fancied exigency. It is the purpose of the system of accounts promulgated by the Interstate Commerce Commission to deprive the executive officer of the liberty of deciding arbitrarily when a liability shall be taken into the accounts. There can be no doubt as to the soundness of the rule that a formal

provision for depreciation is required by a sound system of accounts. It has been well stated by an English writer that

no profit can exist until expired outlay on productive plant has been provided out of gross revenue. One of the most vital matters connected with productive industries and trading concerns is the regular assessment with substantial accuracy of the annual net profit or loss which has resulted from the operations of each year; and unless a near approximation to the outlay on productive plant which has expired within each year is made and fully provided for out of gross revenue, no correct statement of profit or loss can be obtained.1

The reverse of this comment is equally true from the point of view of betterments and additions, for a correct statement of cost of transportation requires not only that current revenue should bear a sufficient charge to cover all the wear sustained by the capital assets used in operation, but that such revenue should not be called upon to bear a charge the purpose of which is to increase such assets. A system of accounts is composed very largely of a series of definitions, and the rules for depreciation, as also for additions and betterments, take their proper place in such a system, when it is recognized that such rules are essential parts of the definition of operating expenses.

The fourth principle submitted above refers to the balance sheet, mention of which leads to a range of technical questions too large to be considered at this time. A properly constructed balance sheet should reflect the results of operation and of financial transactions from the birth of the corporation to which it pertains. The significant figure with which it closes is the surplus accumu

'P. D. Leake, F.C.A., F.I.D., in paper read before the Institute of Directors, "The Question of Depreciation and the Measurement of Expired Outlay on Productive Plant."

on

lated during the life of the corporation,-that is to say, the profit and loss; and it is essential that this surplus should be so analyzed as to represent in fact what it assumes to represent. Here, if anywhere, is an opportunity for the strict application of sound rules. The balance sheets published at the present time are of slight value, except for those who are acquainted with the details of the supporting accounts upon which they rest. If, however, the supporting accounts are kept in a uniform manner by the carriers, and if, as the result of adequate supervision, the accumulation of these accounts into the balance sheet may be relied upon as correct, the balance sheet will prove to be in fact what it is in theory,the key to the financial and operating management of a carrier.

Having described the work undertaken upon the authority of the twentieth section of the Act to regulate Commerce, the query naturally arises as to its industrial and political significance. To make this entirely clear would require a more detailed analysis of the accounts than has been possible in this cursory survey, and I shall therefore content myself with a few generalizations in response to what I know, from a somewhat extended experience, will be specially acceptable to university students. These generalizations may be regarded as superficial or they may be regarded as profound; but, in any case, they will, I trust, make yet clearer the farreaching results of this new form of activity upon which the Interstate Commerce Commission has entered. What follows covers four points.

First. The promulgation of a uniform system of accounts for all transportation agencies, and the organization of a board of expert examiners one of whose chief duties it will be to see that the carriers comply with the rules of accounting laid down, will tend to the creation and per

petuation of a stable market for railway securities. The investor at present has no assurance that his capital placed at the disposal of corporate management will be maintained. If he receives a dividend, he does not know whether the money thus returned is money earned or a return under the name of a dividend of a portion of his original investment, nor, on the other hand, is he sure that the accumulated surplus stated on the balance sheet represents all of the earnings of his capital. Unfortunately, the investor (and I speak of the investor in railway securities and not the speculator) relies almost exclusively for valuing securities which represent his investment upon the statement of net revenue from operation or upon the dividends which are anticipated or paid. The monthly and annual statements of net revenue become, therefore, a means in the hands of the management for affecting the price of securities, and so long as the executive feels himself at liberty to instruct the accounting officer to vary charges to operating expenses from month to month or from year to year, he is exposed to the temptation of making an improper use of such liberty,—a temptation to which a sufficient number of executive officers will succumb to spread suspicion over the entire situation. The first step, therefore, toward the creation of general confidence in railway securities is a strict and comprehensive definition of operating expenses and the promulgation by competent authority of the rule that all statements of net revenue from operation shall reflect the facts of operation, and not be influenced by the desire of the management to make a good or a bad showing. The form of depreciation charges required by the approved definition of operating expenses is, perhaps, the most significant illustration of the many provisions to be found in the scheme of accounts promulgated by the Interstate Commerce Commission which are designed to create