traffic falloff, but the full effect of the traffic falloff was to much to absorb. In our latest presentation to the House and Senate Appropriations Committees, we estimated a loss for fiscal year 1976 of $14.1 million. Since that last estimate, we found that although the exclusion of deck cargo from the measurement rule changes will reduce expected revenues, further cost economies are unfolding that may make it possible to lessen that $14.1 deficit figure. STATUTORY FINANCIAL ALTERNATIVES Although this loss appears large, it is far short of creating a financial crisis for the Panama Canal Company. Even if no statutory measures were available to us to dampen the impact of such a loss, operations would still not suffer in the short run. What would be affected would be our program for capital improvements and replacements. Of course, in the long run these are vital to the continued operation of the Canal, and Congress has, in its statutory plan for the Panama Canal Company, guarded against any deterioration in required capital investment. The Congress anticipated that, from time to time, the Company would sustain losses, and through the legislative process has provided the Panama Canal Company with a number of alternatives for use in such circumstances which assure the Company's financial viability without compromising its capital program. Let us look for a moment at these alternatives. Section 62 of title 2 of the Canal Zone Code requires the Panama Canal Company to pay into the Treasury: (a) Interest on the U.S. Government's net direct investment in the Company; (b) Annuity payments under article XIV of the 1903 Treaty with Panama as modified by article VII of the 1936 Treaty; and (c) Net costs of operation of the Canal Zone Government. In each case the requirement of the statute is that these payments "shall be made annually to the extent earned, and if not earned, shall be made from subsequent earnings." This provision for deferral does not replace the statutory requirement that the Company is to be self-sustaining, but provides flexibility by allowing the Company to achieve a balance between revenues and costs over a period longer than a fiscal year. In addition to the provisions for deferment of such payments, the statutory plan also authorizes, in section 72 of title 2 of the Canal Zone Code, appropriations to cover losses. This provision could come into play after the deferment provisions were exhausted. Also, the Panama Canal Company has statutory authority to borrow from the Treasury, for any of the purposes of the Company, not more than $40 million outstanding at any time. A portion of the $10 million borrowing authority is used to backstop obligations of the Company's capital program, and, although no portion of the $10 million has been withdrawn from the Treasury, the amount of that resource is reduced to the extent that it already is backstopping obligations. In addition to all of the above, one further source of funds is provided in the statutory plan, a provision authorizing appropriations for the purpose of meeting increased capital needs. These, then, are financial alternatives already contained in the statutory plan. What do they mean in terms of today's financial strain? To answer that, let me first state for you our perception of the problem. There are two factors; one, the Company, like many other entities, did not anticipate the depth reached by the economic slump, nor the heights reached by inflation. Over the years, the Panama Canal has had an excellent record of forecasting traffic revenues and costs, as you can appreciate from the detail in section II G, subparagraphs 1 through 7 of our written submission. But the past 2 years have broken all previous patterns and the traffic upturn we expected from day to day never materialized. The second factor contributing to our present problem is that once the extreme nature of the traffic slump became apparent, it was inappropriate to try to institute an immediate toll rate change. The slump appeared to be a temporary phenomenon, and we wanted to avoid asking for a sharp rate hike with uncertain consequences and subsequently have to revise it downward as soon as traffic picked up. So part of our loss this year could be attributed to our perceived obligation to keep toll rates stable in an uncertain economic situation. At this point, with the economy beginning to move again, the direction indicated by our statutory plan is so clear that we are brought to the conclusion that it was the specific intent of Congress to enable the Company to weather just such a storm as this, and still maintain tolls stability. Following that direction, in order to restore the balance between revenues and costs, we plan to seek a toll increase to be effective in fiscal year 1977. Included in the calculations for that toll rate increase will be a portion of all of the amount of interest unearned by the Company in fiscal year 1976, which is being withheld from the Treasury on a current basis. For fiscal year 1976 that interest expense is estimated at $16,578,000; annuity payments are estimated at $519,000, and the estimate for the net cost of Canal Zone Government is $23.899,000. Thus, in fiscal year 1976 it is estimated that costs totaling $40,996,000 will accrue for which payment need not be made in that year unless the amounts are earned. The unearned portion of such costs in fiscal year 1976 is presently estimated at $14,120,000, which is the amount of the estimated net operating loss for this year which I mentioned earlier. The present financial problems are the worst since the Panama Canal Company was organized in 1950, yet the statutory resources for dealing with financial crises are barely being touched. For this reason it is the view of the Panama Canal Company that the existing statutory provisions relating to the financial management of the Panama Canal Company assure the Company necessary financial viability under all forseeable operating adversities. The twin factors of recession and inflation have laid an enormous burden on the Panama Canal Company, but belt-tightening by both management and employees have put us into a position where, with the help of the tools provided by Congress, we can keep the Canal self-sustaining. This concludes my prepared statement. I would be pleased to respond to any questions you may have. Thank you. Mr. METCALFE. The Chair recognizes Mrs. Sullivan for any questions she may wish to ask at this point. Mrs. SULLIVAN. Thank you very much, Mr. Chairman. I do have a few questions. Governor, is it not true that if the various accounting changes instituted in 1972 and 1974 had not gone into effect the Company would not have experienced losses since fiscal year 1973 and would not be projecting a loss for 1977? Also, let me ask why the period of 40 years was chosen for depreciation? Governor PARFITT. Mrs. Sullivan, I do not believe that is quite correct. The accounting changes that you refer to were included in both the cost and the tolls increase, and therefore, their impact on the operating results was nil. The only factors contributing to the loss in fiscal year 1975 were economic events, that occurred subsequent to the toll increase. Had we not made those changes, the tolls increase and our costs in 1975 would have been less, and therefore the same results, that is a loss, would have been obtained. In other words, the accounting changes have been a wash. They were included, and resulted in an increase in the tolls rate, and therefore have been accounted for in the income, so there has been a complete wash of that transaction. Mrs. SULLIVAN. Well, after the last trip that a number of us made down there in January about a year ago, on our way back we discussed the changes in the accounting system, what kind of effect they were going to show, and why the need, or the necessity, for those changes. I do not think we were able to get all of those answers, Governor. I think all of this was just a few months prior to the change of Governors, and I am sorry to say that I did not really dig into that depreciation either because of a number of other problems, and I just did not get to it deeply, but we could not quite accept and understand the changes. It was very difficult to criticize the changes because we ourselves had not made a deep enough study, and maybe were not really able to make the kind of a study that you and those in charge of that department of the Company were able to come up with. It just seemed to me that things were being charged off and depreciated in a way they had never been before, and that it would reflect greatly on the figures that you ended up with. Governor PARFITT. There was a substantial increase in the cost to the Company, that cost was ground into the toll rate increase and has been accounted for in the 19.7 percent toll rate increase. Without those accounting changes the toll rate increase for 1975 would have been less, this is true. Mrs. SULLIVAN. That is the one conclusion we arrived at, that by changing that system you have a greater tolls increase. 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 . deprecia 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. |