11. Who should pay for the cost of progress?— The evils attending overcapitalization are much greater than those attending undercapitalization. When a railway company builds a new station and capitalizes the cost, we have an example of the cost of progress. Many public service corporations are com pelled to pay annually large sums for the improve ment of facilities which may not cause a direct in crease in revenue or at least may only realize the in crease after a series of years. If good material and efficient working equipment are scrapped and better operating equipment or more improved inventions substituted, should not these be considered as a part of the cost of progress? Should not this tendency be encouraged? Is it fair to compel the stockholders to pay for the entire cost of indugtrial progress thru the practice of charging all such expenditures to earn ings? Possibly a solution to the problem will be found in keeping two sets of records; one on the basis of original cost, under which all increased costs of re placements will be charged to revenue or surplus ; the other on the basis of "last costs" which basis will be used in determining a fair rate of return.
12. Extraordinary reconstruction costs where re serve for depreciation is inadequate.—The situation referred to in the preceding paragraph must be dis tinguished from that in which failure to provide ade quate provision for depreciation in prior years re sults in extraordinary expenditures for reconstruc tion. In this case, the failure to provide properly for the declining value in fixed assets, due to realization of their service-units, has resulted in stockholders re ceiving profits that were not earned. When condi tions require large expenditures for the purpose of restoring capital facilities, these costs should be assessed against the surplus ; and if no surplus exists, and the amount of the expenditures is so great as to make it unfair to charge the cost against the profits of one year, the amount must be clearly shown in the balance sheet in a properly ear-marked suspense ac count.
Moreover, in practice, the new equipment substi tuted is frequently more valuable and capable of ren dering more efficient service than the old. The re placement charge is then made up of three elements; first, a part which represents the increased value of the equipment or its greater service-rendering capacity; second, a part which represents deferred main tenance charges, and third, a part which represents the current depreciation applicable to the period in which the replacement is made. The first is a proper charge to capital account; the second is chargeable to the surplus account or if there is no surplus account, to a suspense account properly ear-marked; the last should be charged to the current income account.
The suspense account, in the last event, represents an impairment of capital and this condition should be remedied before any dividends are paid.
13. Danger involved in giving revenue the benefit of doubtful expenditures.—It must be admitted that there is great danger in capitalizing charges for bet terments which do not increase earnings nor decrease operating expenses. Some accountants favor giving revenue the benefit of all doubtful expenditures and increasing capital by the amount of those expendi tures and adding a corresponding increase to the amount of profits for the period. This practice in vites two dangers; first, that a dividend might be de clared out of a fictitious surplus which might render the board of directors personally liable, and second that the organization itself may be seriously handi capped by a lack of capital thru improper dividend disbursements, and might eventually have to retire from business. The board of directors might pro tect itself from these dangers by setting aside a por tion of the surplus to prevent the payment of un earned dividends where it is deemed best to capitalize such doubtful charges.
It should not, of course, be lost sight of, that where items are charged to capital that should have been charged to revenue, the matter is equalized over a period of years because the increased amount in the capital account makes necessary a larger provision for depreciation. This is charged against income with the result that when items are erroneously capi talized or carried in a suspense account for a series of years as abandoned property, the ultimate effect is to load the income account in the succeeding years with these amounts. The procedure results in charg ing future earnings with amounts which should have been charged against surplus created out of past earn ings. The outcome of this practice is that the stock holders of the future are robbed for the benefit of those of the present. The Federal Income Tax Law which permits a deduction from income for depreciation has broUght the advisability of providing for depreciation more keenly to the attention of operating managers. The result is that many who formerly opposed de preciation allowances or provisions for renewal and contingency reserves now favor the more conservative practice.
14. Gauging repair and renewal expenditures by profits made.—Many business executives claim that the depreciation factor is negligible in their respective businesses because thru liberal allowances for repairs and renewals they endeavor constantly to keep the organization up to one hundred per cent efficiency. On this basis they claim that the equipment is always as good as new.