value of that item shall be its proportionate share of the value of the entire group in which the particular property is included.

Property retired means property which is sold, abandoned, demolished, or otherwise withdrawn from transportation service.

Salvage from retired property is the value of material recovered from property retired. When such material is retained and again used by the carrier, the value shall be computed upon the basis of fair prices for the material in its condition as recovered. When such material is sold, the net proceeds of the sale shall be considered as the value of the material.

7. PROPERTY Retired and REPLACED.-When a unit of property other than land or equipment-such as a section of road, side, or yard track, shop or power plant machine, building, or other structure is retired from service and replaced with property of like purpose, the ledger value of the retired property shall be credited to the appropriate accounts of this classification at the time that the property is retired from service. The amount of this credit shall be charged concurrently as follows:

An amount equal to the credit balance in the accrued depreciation balancesheet account with respect to the property thus retired shall be charged to that account and the remainder (less salvage and insurance recovered, if any), together with the cost of demolishing the property, if demolished by or for the carrier, shall be charged to the accounts in operating expenses appropriate for the cost of repairs of the property before retirement. The accounting for the salvage shall be in accordance with the disposition made of the material recovered.

If, however, the property retired and replaced with property of like purpose is of minor importance, such as a small roadway building or other small structure, and is replaced in kind without betterment, the cost of the replacement shall be charged to operating-expense accounts and no adjustment made in the road and equipment accounts.

If so authorized by the Interstate Commerce Commission, the carrier may charge to profit and loss any extraordinarily large item representing the cost of property retired and replaced, instead of charging such item to operating expenses. The carrier shall file with the commission a statement of the cost and a description of the property retired and the reasons which, in its judgment, indicate the propriety of charging the cost of such property to profit and loss.

The provisions of this section are applicable in accounting (at the time of retirement) for the cost of property abandoned, even though the new property has been actually installed previously to the date of the demolishment of the abandoned property.

When the renewals to be made to an important building or other structure will constitute the major portion of its value when renewed, the property, when taken out of service, shall be considered as retired and accounted for as provided above, and for the purposes of this classification the renewed property shall be considered as an addition, and the appraised cost thereof shall be included in the accounts of this classification, consideration being given to the secondhand portions remaining therein. In no case shall the charge for the renewed property exceed the cost (at current market prices of labor and material) of new property of equal capacity and equal expectation of life in service, less a suitable allowance on account of the secondhand parts remaining therein. 8. PROPERTY RETIRED AND NOT REPLACED.-When a unit of property other than land or equipment-such as a section of road, side or yard track, shop or power plant machine, building, or other structure-is retired from service and not replaced, the ledger value shall be credited to the appropriate property accounts at the time that the property is retired from service. The amount of this credit shall be concurrently charged as follows:

An amount equal to the credit balance in the accrued depreciation balancesheet account with respect to the property thus retired shall be charged to that account, and the remainder (less salvage and insurance recovered, if any), together with the cost of demolishing the property if demolished by or for the account of the carrier, shall be charged to the appropriate profit and loss account. The accounting for the salvage shall be in accordance with the disposition made of the material recovered.

9. EQUIPMENT RETIRED.-The instructions for accounting for equipment retired are contained in the text of the general account II, Equipment.

10. LAND RETIRED.--When any land, the cost of which is included in the accounts of this classification, is retired, the ledger value shall be credited to ac

count No. 2, "Land for transportation purposes." If the land is retained by the carrier, its estimated value shall be charged to balance-sheet account No. 705, "Miscellaneous physical property," the necessary adjustment of the difference between the ledger value and the estimated value on account of the loss in the property due to its retirement from transportation service shall be made through Profit and Loss. If sold, the difference between the ledger value credited to account No. 2 and the amount received for the land shall be adjusted in Profit and Loss.

11. ADJUSTMENTS FOR CONVERTED PROPERTY.-When property, such as a unit of equipment, a building, or other facility of one class, is converted into property of another class, so that the amount of investment in such property must be transferred from one account of this classification to another, the ledger value shall be credited to the appropriate road-and-equipment account. Proper account shall be taken of any salvage recovered in the process of conversion. The amount of the balance in the accrued depreciation balance-sheet account, with respect to the property thus converted, shall be charged to that account. The appraised cost of the property converted (consideration being given to the secondhand portions remaining therein) shall be included in the appropriate account of this classification. The charge for the converted property in no case shall exceed the cost (at current market prices of labor and material) of new property of equal capacity and equal expectation of life in service, less a suitable allowance on account of the secondhand portions remaining therein. The ledger value of the property before conversion, plus the cost of conversion, less the sum of the estimated value of the property as converted, the amounts charged to accrued depreciation accounts, and the salvage recovered, shall be charged to the operating-expense accounts, appropriate for the costs of repairs of the fixed improvements or for the retirement of equipment before conversion.

12. EXPENSES IN CONNECTION WITH ADDITIONS AND BETTERMENTS.--The cost of removing old material from equipment and from buildings, bridges, wharves, tracks, and other fixed improvements, shall be charged to the appropriate operating-expense accounts. Such charges shall include the cost of removing old foundations and filling old excavations, and restoring condition of grounds after addition and betterment work; rearranging or relocating existing tracks; relocating telegraph and telephone poles or lines, fences, track and other signals, buildings, bridges, trestles, culverts, and other structures, and farm and highway crossings, including crossing gates and alarms, when the provisions of section 8 of these instructions are not applicable; and maintaining or protecting traffic during the progress of addition and betterment work, including the cost of constructing, maintaining, and removing temporary tracks required for maintaining traffic during the progress of the work.

13. INTERPRETATION OF ITEM LISTS.-Lists of "items," "details," etc., have been given as a part of this classification for the purpose of clearly indicating the application of the accounting rules in specific cases. The lists in every case are to be considered as merely representative, and not as excluding from any account analogous items which happen to be omitted from the list appended. On the other hand, the appearance of an item in a list warrants the inclusion of the item in the account concerned only when the text of the account also indicates inclusion, inasmuch as the same item frequently appears in more than one list. The item of boilers, for example, will be found under accounts Nos. 18, 27, 37, 44, and 45, and the proper charge in any one instance must be determined by the text of the account.

14. SUBMISSION OF QUESTIONS.-To the end that uniformity of accounting may be maintained from year to year, carriers shall submit all questions of doubtful interpretation of the accounting rules to the commission for consideration and decision.

Mr. MCLAUGHLIN. If the Interstate Commerce Commission should change this definition or its interpretation from time to time, would that be controlling in this matter, whenever that change was made? Mr. MERRILL. I should say not so. I think the definition extant in here, as of this date, is controlling. This is something that has been in existence for some years. This classification of accounts is the classification that is adopted by the public utilities commissions in the various States as far as railroads are affected, and the same principles which apply in this definition have been adopted by the various

public utilities commissions in their definitions and treatments of cost. I think it is something that is as well established as you can hope to find anything established.

Mr. Escн. It is based upon the recommendations of Prof. Adams in 1908, I think, required by section 15 of the Hepburn Act.

Mr. MERRILL. I do not know the history of it.

The CHAIRMAN. Is the commission to determine what is a fair return and a fair value and also the excess above a fair return at the end of the period?

Mr. MERRILL. That would be determined by agreement. if possible, like other items in here. If there were a question of marked disagreement between the commission and the licensee in deciding what it should be, it would have to go to the courts as regular valuation proceedings go to the courts.

The CHAIRMAN. Suppose the commission should think that 10 per cent should be a fair return upon the property-I am using that figure as an illustration-and it made 15 per cent. Suppose that was made the first year, then 5 per cent would be regarded as written off the value of the property if the Government should take it over at the end of the 50 years. Would there be interest also calculated on that 5 per cent from the time it received it until the end of the period? Mr. MERRILL. I should say not, offhand.

The CHAIRMAN. Then it is not purely an amortization reserve. Mr. MERRILL. We have provided specifically the items that may be subtracted out of the original cost: First, the unappropriated surplus. That would be whatever amount has not been set aside for depreciation, amortization, or other reserve, and had not been paid out in dividends. Whatever balance might be remaining as undistributed surplus would go with the property, or what would be the same thing, be deducted from the cost. The second item is " aggregate credit balances of current depreciation account." Under the system of accounting prescribed by the States, and I assume under any system the commission might prescribe within its jurisdiction, the licensee would be required to set aside out of earnings from time to time such amounts as the commission might determine were necessary to maintain the property up to its full operating efficiency. Now, those amounts are set aside currently from year to year, or oftener, out of earnings. They may not at any particular time represent or be equal to the amounts that are actually paid out; first, because they would cover current depreciation running year after year, and second, because there might be moneys set aside to replace an item like a generator which would last for 10 or 15 years; but whatever amount had not gone back into the property at the end of the period and was still held in those depreciation accounts would go with the property or be deducted from the price.

The CHAIRMAN. Will it be the policy of the commission to hold down the price of products-when I say products I mean the electric current-to where it would represent only a fair return on the property investment?

Mr. MERRILL. Of course, I can not speak for what the commission may do. In my judgment, the commission ought to do just the same as any State public utility commission does, restrict earnings on

the property to that point, and to that point only, where enough money will come into the business to keep it going.

The CHAIRMAN. And pay a fair return?

Mr. MERRILL. And pay a fair return; and if you restrict it below what is a fair return the money does not come in and the business does not expand.

The CHAIRMAN. And if you put it above that, it helps to pay for the property, and when the Government takes it over it would owe that much less at the end of the term.

Mr. MERRILL. Yes; but it is only by an empirical rule that one may find out that rate of return under which enough capital will come into the enterprise to keep it going and to allow it to expand to meet the new market. If you cut below that, you do not get the money necessary

The CHAIRMAN (interposing). I am talking about going above it. Mr. MERRILL. If you go above it then you can do one of two things you can prescribe the method of disposition of the surplus earnings or you can require that it shall go into an amortization fund.

The CHAIRMAN. And you think the best policy would be to not have it go above or below a fair return?

Mr. MERRILL. Not in so far as it can be done.

The CHAIRMAN. I mean that is to be the object and purpose of the rules and regulations of the commission?

Mr. MERRILL. That I think is the general policy that ought to be adopted.

The CHAIRMAN. And you would treat it in that way, as though it were a railroad or cther public utility?

Mr. MERRILL. Yes.

Mr. ANDERSON. Is a fair return, as stated here, to be a fixed percentage or a percentage agreed upon between the Government and the licensee?

Mr. MERRILL. I do not believe it is a percentage that could be agreed upon for a full license term. You could not, for example, put in the license a provision that a fair return shall be 8 per cent. I mean it would be inadvisable to do so. Eight per cent might be sufficient earnings on the property under some circumstances, and under other circumstances it might be too much or too little.

Mr. ANDERSON. Then a determination of the whole question involved in this definition is one which would have to be made ultimately by a court?

Mr. MERRILL. In case of dispute, yes; that is, as far as the rate of return and the deductions are concerned, and it might be, of course, as far as the original items of cost are concerned; but there is less likelihood of there being a question or quarrel about the items of cost because the commission has authority under this act to prescribe a system of accounting and to keep a check on the costs as they are incurred just the same as the Public Utilities Commissions do.

Mr. ANDERSON. Let me ask you this question with reference to lines 12 and 13. I did not get your answer to Mr. Sims very definitely: "If and to the extent that such items have been accumulated." Now, what does that language mean?

Mr. MERRILL: It means this: We will assume, for the sake of argument, that 8 per cent is a fair return and that 8 per cent would

be allowed all the way through. If the company earns 10 per cent on its property and uses that extra 2 per cent either for retirement of capital, for amortization reserve or depreciation account, any one of those, then that amount would be deducted out of the cost of the property.

Mr. ANDERSON. The total depreciation account?

Mr. MERRILL. No; not the total depreciation account, but the balances that have not been put back into the property. The same way with the amortization reserve. If an amortization reserve is set up to cover a big piece of equipment, for example, and that equipment. has not been replaced at the time the license expires and the properties are taken over, the entire amount set up in an amortization reserve for that piece of property either goes with the property to the United States or is deducted from the cost. If the unit has actually been replaced, then the money will not be in the account, and there will not be anything to subtract.

Mr. ANDERSON. I understand that. I understand it so far as the amortization feature is concerned, but I do not get your point with reference to the depreciation reserve.

Mr. MERRILL. The depreciation reserve is the amount set aside from year to year or month to month, as you go along, for making repairs or minor replacements.

Mr. ANDERSON. The only credit to be given would be the net credit at the end of the period?

Mr. MERRILL. Yes; whatever money had not gone back into the property, and it must either be in that fund or have gone back into the property.

Mr. ANDERSON. I so understood it.

Mr. MERRILL. It must be either one thing or the other.

Mr. PARKER. Suppose they distribute the earnings in excess of a fair return.

Mr. MERRILL. That can be handled under the right to regulate rates. You can not handle it anywhere else.

Mr. PARKER. Suppose you take hold of my suggestion that there might be a sort of cooperative plan by which earnings in excess of a fair return might be distributed to the people who bought the power.

Mr. MERRILL. The only place that I can see where you could get a distribution of excess earnings, apart from the right to cut those earnings down by reducing the rate, is through the rental charge.

Mr. PARKER. But the suggestion I made is that they might charge a vary large rental and declare dividends on that just as dividends are declared by life insurance companies on policies and all that sort of thing. You load your rate and distribute dividends and in that way reduce it to a fair return. The trouble with the net investment proposition is that it puts a premium upon everybody to distribute all their profits instead of keeping the property up to the proper mark. Mr. MERRILL. No; it does not do that, because we require under this legislation that they shall keep the property up.

Mr. PARKER. Well, it is frequently against their interest to use what is in excess of a fair return for the benefit of the property, because if they do that they get less money.

Mr. MERRILL. Instead of deducting that from the price at the end of the period under this method here, we simply would have to require at the start that the property should be kept up.