Governor PARFITT. Nevertheless, it is my view, and after having reviewed the situation, that the accounting changes were appropriate. This has been verified by our consultant, Arthur Anderson. They made a very fine report that deals with these particular changes, and their rationale as to why they are justifiable. Likewise, the General Accounting Office has reviewed the accounting changes, and they likewise agree that they are appropriate. I think the basic reason for the change, the big change, which was to add depreciation for previous nondepreciables, was predicated on the determination that it was no longer valid to assume that the canal entity had an indefinite economic life, and therefore, it was appropriate, to amortize or to depreciate all of those assets, including the excavation and the fills over an appropriate period. Now, the appropriate period is a judgmental factor, and in this particular case it was determined that 40 years was about right. Mrs. SULLIVAN. These are some of the questions I wanted to follow up on, and possibly Mr. Steers had a great deal to do with it, did you not, Mr. Steers? Mr. STEERS. Yes; that is correct. Mrs. SULLIVAN. Maybe you can answer some of them. First, why was the period of 40 years chosen? Why was no adjustment made for the fact that, titles, treaties, and excavations have existed since the early 1900's, and what study was made to determine whether any portion of these charges had been recovered from previous profits from canal operations? Mr. STEERS. First, with respect to the 40 years. The Board of Directors in selecting the period over which to depreciate or to amortize these assets that had not heretofore been depreciated, considered a range of years from 30 to 100. It was their judgment that 40 years appeared to be a reasonable period, when one considered the implications of economics of shipping on the life of the canal. In addition events of the treaty discussion that continue to unfold indicated some yet undefined period of U.S. preserves. Forty years seemed to maintain an equity both to the Company, and to the shipping interests involved. The Board's action was based on paper that I submitted through the Budget and Finance Committee, dated May 30, 1972. A copy of this paper is submitted for the record and reads as follows: [The information submitted for the record follows:] PANAMA CANAL COMPANY, OFFICE OF THE COMPTROLLER, BALBOA HEIGHTS, C. Z., May 30, 1972. BUDGET AND FINANCE COMMITTEE MEETING No. 72–1 To: Members of the Budget and Finance Committee. 1. The purpose of this paper is to present for consideration a proposed approach toward initiating on July 1, 1973 (F.Y. 1974) the depreciation of certain assets heretofore not depreciated. The problem of depreciating these assets has been under varying degrees of consideration for some 20 years. Most recently it has been raised once again by the General Accounting Office (GAO) in its May 4, 1972 Report to the Congress on the "Examination of Financial Statements, Fiscal Years 1971 and 1970, Panama Canal Company and Canal Zone Government," (Enclosure A, pages 2, 10-11). 2. Section 412, title 2 of the Canal Zone Code provides that: "Tolls shall be prescribed at rates calculated to cover, as nearly as practicable, all costs of maintaining and operating the Panama Canal, together with the facilities and appurtenances related thereto, including . . . depreciation...." 3. Since the effective date of this provision (July 1, 1951), the Panama Canal Company has accrued depreciation on active assets of the Company valued at approximately $415 million at rates based on various service lives. Depreciation charges were $7.8 million in 1971 and total depreciation allowances through June 30, 1971 were $235.2 million, of which $124.2 had been charged since 1951. 4. As an operating expense, depreciation charges are, of course, deducted from revenues in arriving at annual net operating income or loss. 5. The assets on which depreciation has been charged since 1951 do not include certain assets valued at $331.2 million, such as excavation of channels, harbors, spillways and locks, and embankments for dams, the cost of depopulation of the Canal Zone and certain treaty payments. These assets were originally excluded from the assets on which depreciation was charged on the theory that they were nondepreciable. In our view, in which our consultant on accounting matters concurs, there is no sound objection from the standpoint of acceptable accounting practices to charging depreciation on these assets. In general, depreciation accounting is a system of accounting which aims to distribute the costs of capital assets over their estimated useful life in a systematic and rational manner. It is a process of allocation, not of valuation. 6. Section 412 of title 2 recognizes depreciation as a cost of operation of the Canal properly charged to tolls and, although the Office of Management and Budget has held otherwise, there is nothing in the statute or the legislative history that shows an intent of Congress to exclude the assets in question from depreciation charges. 7. The GAO has consistently taken the position that these assets should be depreciated. In their latest report on the audit for fiscal years 1971 and 1970, the GAO said: "GAO believes that the assets in question-excavation, embankments, fills, and related facilities-are limited-purpose land assets whose utility diminishes or terminates as the utility of the canal diminishes and that their costs should be depreciated or amortized. GAO believes that a change in legislation is not necessary to permit the Company to administratively determine the effective date of depreciation or amortization of these assets for the purpose of including the costs relative thereto in its finanical statements" 8. The selection of an appropriate period for depreciation of these assets lies in the discretion of the Panama Canal Company. The following tabulation shows the annual charges for depreciation of these assets that would accrue on the basis of several indicated depreciation periods ranging from 30 years to 100 years: 9. The Company also has the discretion as to the adoption of the date for beginning depreciation, i.e., (1) whether such date should be retroactive to the time the facilities were placed in service or possibly to July 1, 1951, or (2) whether such date should be prospective. In our view the prospective date should be adopted as the method involving the fewest complications and most consistent with the procedures recommended below for effectuating the implementation of the policy of charging depreciation on these assets. 10. As a first step toward implementing the policy, I recommend the inclusion of a provision for depreciation of these assets, commencing July 1, 1973, in the annual budget program for fiscal year 1974. If the program is approved by the Office of Management and Budget and sent to the Congress by the President, the Appropriations Committees and the Congress will review the program and will either approve it or modify it. In our judgment, the inclusion of this item in the budget will be favorably received by the Appropriations Committees and Congress. 11. The recording of depreciation will in itself have no effect on the Company's cash position. 12. In view of the considerations outlined above, it is recommended that the Board of Directors approve inclusion of provision for the depreciation of the assets in question in the annual budget program for fiscal year 1974. Enclosure. PHILIP L. STEERS, JR., Comptroller. EXCERPT FROM GENERAL ACCOUNTING OFFICE REPORT TO THE CONGRESS (PAGE 2) RECOMMENDATIONS OR SUGGESTIONS This report contains no recommendations or suggestions. AGENCY ACTIONS AND UNRESOLVED ISSUES The Company continues to believe that it legally cannot amortize or depreciate the cost of certain assets without legislation authorizing it to do so and that the accounting treatment necessarily is founded on this construction of law. The Company, however, has agreed to reevaluate its position on this matter. (See pp. 10 and 11.) GAO believes that the assets in question-excavation, embankments, fills, and related facilities are limited-purpose land assets whose utility diminishes or terminates as the utility of the canal diminishes and that their costs should be depreciated or amortized. GAO believes that a change in legislation is not necessary to permit the Company to administratively determine the effective date of depreciation or amortization of these assets for the purpose of including the costs relative thereto in its financial statements. (See p. 11.) The Company and the Canal Zone Government believe that, since the Republic of Panama historically has liquidated all delinquent accounts prior to the ratification of new treaties between the Republic and the United States that relate to the Canal, these receivables are collectible. (See p. 12.) MATTERS FOR CONSIDERATION BY THE CONGRESS This report is submitted to the Congress, as required by law, to disclose the results of GAO's audit and such other information as necessary to keep the Congress informed of the operations and financial condition of the Company. Excerpt from General Accounting Office Report to the Congress (Pages 10-11) COMMENTS ON FINANCIAL STATEMENTS DEPRECIATION NOT RECORDED ON CERTAIN FIXED ASSETS As stated in note 2 (see p. 25) to the Company's financial statements, the Company interprets the Canal Zone Code as not requiring the depreciation or amortization of certain canal construction costs relating to titles; treaty rights; excavations of channels, harbors, and basins; and other works totaling $331 million at June 30, 1971 and 1970. The note further states that, if these assets were depreciated at 1 percent a year, there would be an annual charge of about $3.3 million against operations. The Company believes that it legally cannot amortize or depreciate the cost of these assets without legislation authorizing it to do so and that the accounting treatment necessarily is founded on this construction of the law. At the continued suggestion of the Senate Appropriations Committee, the Company proposed legislation for the consideration of the Eighty-third, Eightyfourth, and Eighty-eighth through the Ninety-second Congresses, which would have amended the Canal Zone Code to authorize the depreciation of these assets. The legislation had not been acted upon by the Eighty-third, Eightyfourth, and Eighty-eighth Congresses and was not introduced to the recent Congresses. We were advised by Company official that the Office of Management and Budget had not recommended the introduction of the legislation to the recent Congresses because of the Department of State's views that the introduction of such legislation should be deferred pending the outcome of treaty negotiations with the Republic of Panama. Negotiations with the Republic of Panama regarding the replacement of the existing 1903 treaty, which gives the United States control of the Canal Zone in perpetuity, were resumed in June 1971. It is our view (1) that the assets in question-excavations, embankments, fills, and related facilities-are limited-purpose land assets whose utility diminishes or terminates as the utility of the canal diminishes and that their cost should be depreciated or amortized and (2) that a change in legislation is not necessary to permit the Company to determine the effective date of depreciation or amortization of these assets for the purpose of including costs relative thereto in its financial statements. These assets were constructed for the special purpose of enabling the passage of ships through the canal. When this purpose ceases the utility of the assets presumably will cease also. The assets involved therefore do not add permanent value to the land but, rather, have value of a terminable nature. We discussed the propriety of the accounting treatment afforded these assets with the Company, and the Company has agreed to reevaluate its position relative to the basis for this accounting policy. Mr. STEERS. With respect to titles and treaty rights-I refer the committee to the answer to question II H (2) which has previously been placed in the record. Subsequent to 1951 up through fiscal year 1973, depreciation of these assets was not included in the Company's costs and therefore cannot be considered as having been recovered. Mrs. SULLIVAN. Did the treaty negotiations that had been going on since 1964, or thereabouts, have much to do with the change of the accounting system? Mr. STEERS. I would say not-that it was not a factor in their action. We were faced with the need for a tolls increase based upon our economic forecasts, and in evaluating the cost that should be recovered under section 412, which provides for the recovery of depreciation, and it was a proper financial and accounting action to provide for the recovery of the U.S. Government's investment in these assets. At that time we had been carrying on the book, approximately $300 million in active fixed assets, which were not being depreciated. It was my recommendation to the Board that they should review this matter. Consideration of this was consistent with a continuing recommendation by the General Accounting Office that the company should depreciate these assets. Mrs. SULLIVAN. Is that when that interest payment on that debt to be paid back into the Treasury originated, some $16 million a year? Mr. STEERS. No; the requirement to pay interest was part of the reorganization legislation in 1950. Mrs. SULLIVAN. And has been paid since then? Mr. STEERS. Yes, Ma'am, it has. Governor PARFITT. I might add one point, Mrs. Sullivan. From a standpoint aside from the issue of reasonableness, or acounting principles involved here, without an increase in deprecia tion which we experienced in the last few years the alternative left to the Company would be to seek appropriations of the Congress for capital investment. The amount of money we are generating for capital investment through the depreciating process is marginal at best right now, even with these additions. Mrs. SULLIVAN. Section 412 of the Canal Zone Code provides that tolls should recover "an appropriate share of the net cost of operation of the agency known as the Canal Zone Government." What were the net costs of operation of the Canal Zone Government for fiscal year 1975? Governor PARFITT. Approximately $23.8 million exclusive of sponsorship costs, Mrs. Sullivan. Mrs. SULLIVAN. What share of the net cost was assessed against the tolls? Governor PARFITT. The entire amount of $23.8 million of net costs. The cost of the Canal Zone Government is recouped by services and billings to other recipients of the services, such as the military pay for hospitals and schools, and so forth, and the residual amount, what we call the net cost of the Canal Zone Government, has been constructed over years as the appropriate costs of the Canal Zone Government that should be borne by the tolls. Mr. STEERS. May I elaborate on the Governor's response there? Mrs. SULLIVAN. Yes; please do. Mr. STEERS. The total amount of the net cost to the Canal Zone Government is not borne entirely by tolls. Portions of that are recovered from other third parties to whom the Panama Canal Company renders service. For example, the rates that we charge for the various pier services include a recovery of the general corporate expenses, which include a portion of the net cost of the Canal Zone Government. Mrs. SULLIVAN. Why did not the company assess only an appropriate share of these costs against the tolls? Would you have a reason for that, Governor? Governor PARFITT. I think the statement just made was that the Company is responsible to repay the total net cost of the Canal Zone Government, which they are doing, but that all of that cost is not transferred to the toll structure, only a portion of it. Mrs. SULLIVAN. Section 412 further provides in the determination of the appropriate share substantial weight shall be given to the ratio of the total gross revenues of the Panama Canal Company exclusive of the costs of commodities resold and exclusive of revenues arising from transactions with the Company, or from transactions with the Canal Zone Government. Now, has the Canal Zone Company ever determined an appropriate share of the net costs of the Canal Zone Government based on the statutory formula, and if not, what is the reason why not? Mr. STEERS. The answer is the canal has determined the appropriate share of the costs to be recovered through tolls. This question requires a rather detailed answer, and it is covered in our response to question number II (b) (8). Madam Chairman, you may recall the hearings held here some years ago, attended by the former chairman, Congressman Bonner, at which time we discussed in great detail the manner of allocating the net cost to the Canal |