The Critical Issue of Depreciation in Public Utility Valuation

Abstract

The problem of reconciling depreciation as an operating expense with the depreciation to be deducted in valuation constitutes one of the most important problems of public utility regulation under normal circumstances. Depreciation expense, on the average, takes up approximately ten per cent of the operating revenues of gas and electric utilities and a somewhat larger percentage of the revenues of telephone utilities. Assuming straight line depreciation accounting,' the depreciation reserves of stable, mature utilities should theoretically approximate fifty per cent of the value of the depreciable property. Under existing conditions in a young and dynamic industry where much of the property is comparatively new it would not be unreasonable to expect reserves of thirty per cent, assuming that the depreciation allowances made in rate cases were actually credited to the reserve account. The reserves would represent the normal excess accumulation of these credits over property retirements during the past life of the utility property.2 The funds represented by the credit balance of the reserve have almost always been invested in property extensions. To the extent that such excess accumulations have been made, the ratepayers have contributed to the capital of the utility. This is the equitable basis of deducting the reserve in determining the rate base. By virtue of the prevailing judicial doctrines and other circumstances, however, the complete amounts of such reserves are seldom if ever deducted in determining the rate base. Actual deductions are usually but a fraction of the reserves. If, for example, the plant and property is financed to the extent of 30 per cent by reserve accumulations, a deduction of only 10 per cent results in a rate base inflated by 28.6 per cent over the investment made by the utility