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"If we were then to try, without affirmation of that, in the basis for the cost, because it will be a question of what we charge as cost in any presentation we will make, there will be many questions whether this or that is an appropriate charge to cost, and until we wring that out, yes, we have done this properly, that yes, it appears that this is an appropriate amount that you need to generate the income, and until we wring that to then talk about how we recover this amount through the various toll systems, I think would be rather difficult for us."

Mr. LEGGETT. "Well, I do not think anybody wants to particularly use the canal as a taxing mechanism to raise income for the United States and likewise whether or not we pay off our investment down there in 5 years or 10 years, or any particular fixed period of time, does not particularly bother me." Neither hearing in 1973 contains in its record the Arthur Andersen report of April 30, 1972 upon which the depreciation and amortization of nondepreciable items over 40 years is based.

8. 1974

APPROPRIATIONS COMMITTEE

Changes in accounting policies to depreciate or amortize nondepreciable items were approved by the Directors of the Panama Canal Company on October 30, 1973, and noticed in the Federal Register on November 23, 1973. On December 15, 1973, the Canal Company proposed a 19.7% tolls rate increase. Sea-Land, AIMS and other affected parties filed comments against the increase and testified in opposition to it before a Panel of the Board of Directors. AIMS and Sea-Land also testified before the House Transportation Appropriations Subcommittee in March 1974. Bringing the appropriations bill to the floor, Chairman McFall stated (Cong. Rec. H5279, July 19, 1974):

"The bill provides the Panama Canal $62.7 million for operating expenses, $6 million for capital outlay, and a limitation on general and administrative expenses of $23,837,000. The Panama Canal Company has recommended a toll increase of approximately 20 percent. Most of the items on which this increase is based appear to be valid costs, but we are concerned with the company's change in depreciation policy. The depreciation of certain assets which previously were not depreciated adds an annual charge of about $8.3 million to operating expenses and is partially responsible for the toll increase. We feel the legislative committee should consider whether this change is related to possible treaty modifications. We also feel that the part of the toll increase related to depreciation costs should not be implemented until the legislative committee has approved this change in policy."

Despite Mr. McFall's comments, the Canal Company has assessed tolls with the additional depreciation expense since 1974 without any approval from the Committee.

C. Canal Company Depreciation/Amortization of Nondepreciables The excerpts from the Congressional hearings reveal: (1) acknowledgment by the Canal Company and the Comptroller General that legislation to depreciate or amortize the nondepreciable items was needed; (2) efforts to pass legislation soon after organization of the Canal Company in 1951, and valuation of Canal Company assets in 1954 and 1955 by GAO; (3) refusal by Congress to pass legislation in 1956; (4) no known efforts to obtain legislation after that time, despite continued acknowledgment by the Canal Company that legislation was needed; (5) a value on the nondepreciable items of excavations, titles and treaty rights of about $290 million, a sum approximately $44 million less than the amount used by the Canal Company in 1973; (6) testimony by GAO in 1956 that any amortization or depreciation should be retroactive to 1914 because profits from tolls prior to 1951 were more than adequate to pay for these items; (7) agreement by GAO and the Canal Company that depreciation or amortization of nondepreciable items, which are a major part of net U.S. investment for interest purposes, should reduce that investment and thereby reduce interest charges.

After the House of Representatives and Senate refused to pass legislation in 1956 to amortize or depreciate the nondepreciable items, the Canal Company apparently discontinued efforts to pass authorizing legislation, although acknowledging the need for it. The following sequence of events leading to the depreciation or amortization of these items is based on known documents.

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This letter concluded "that the Company should begin to recognize the costs of the lands and excavations through depreciation charges over a period of 30 to 40 years and that the depreciation should be recovered from the users of the Canal through tolls." The letter based its recommendation on "generally accepted accounting principles for regulated businesses." The letter did not refer to the previous requests for legislation to authorize the practice, and did not cite specific authority for doing so.

The letter cited two recent events challenging an indefinite economic life for the Canal: (1) increasing consideration of construction of a new Canal; and (2) "the evolving policy of the United States Government in its continuing treaty negotiations with the Republic of Panama." Today no present plans for constructing a new Canal exist to our knowledge. Thus the only possible reason for considering a limited economic life for the Canal is the treaty negotiations. Without reference to past GAO testimony that any depreciation or amortization of the items should commence in 1914 and credit be given against the net direct investment, the letter suggested depreciation be solely prospective, and the period be 30 to 40 years because "the United States Government has indicated a willingness to accept a termination date of 'sometime in the next century' for the existing treaty."

MERCHANT MARINE AND FISHERIES COMMITTEE HEARINGS, APRIL 13, 1973 As noted in the excerpts of the testimony of Governor Parker quoted in the prior portion of this memorandum the Governor announced that the Canal Company intended to begin depreciating these nondepreciable items. The Governor neither requested legislation to do so, nor cited legislation for doing so.

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HOUSE TRANSPORTATION APPROPRIATIONS SUBCOMMITTEE, APRIL 16, 1973 The prepared statement of Governor Parked stated: "The estimates for 1974 include a new provision for assuming $8.3 million of costs for annual depreciation accruals prospectively over 40 years on certain properties and plant of the Company, originally costing some $331.8 million, on which depreciation had not previously been accrued." (Hearings, p. 1127).

The justification of these changes was provided at pages 1132 and 1133 of the Hearings:

"ACCOUNTING POLICY"

"32. The Company's Board of Directors has approved some changes in accounting policies that are reflected for the first time in these estimates. As this committee is well aware, the cost of certain assets of the Canal have not heretofore been 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 16 'Report to the Congress on the Examination of Financial Statements, Fiscal Years 1971 and 1970, Panama Canal Company and Canal Zone Government'.

"33. 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:

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'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.'

14 Arthur Andersen & Co. also prepared a report for the Canal Company in 1970 entitled Report on Development and Evaluation of Tolls Policies and Alternative Systems. We do not know whether this report recommended depreciation or amortization of nondepreciable items because the report has not been made public.

15 Department of Transportation and related Agencies Appropriations for 1974, Hearings before a Subcommittee of Committee on Appropriations, House of Representatives, 93rd Cong., 1st Sess. Part 2, p. 1125 and following.

16 Note the GAO Report is after the Arthur Andersen & Co. letter of April 30, 1972.

"34. Section 412 of title 2 of the Canal Zone Code recognizes depreciation as a cost of operation of the Canal properly charged to tolls and 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.

"35. It is our view that it is sound accounting to depreciate the cost of these assets. Accordingly, the 1974 estimates reflect depreciation of the assets commencing with July 1, 1973, at an annual rate of 2-2%. The recording of depreciation will in itself have no effect on the Company's cash position."

The excerpts from the hearings previously quoted show: (1) the statement that "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" is not accurate; and (2) GAO's opinion that "a change in legislation is not necessary" is contrary to GAO's testimony before Congress in 1956 and at other times cited previously.

Governor Parker and Mr. Steers also testified at pages 1148-49 about the new changes: "There is a question from time to time in the Congress. Our Board of Directors after reviewing this situation this last winter directed us to go ahead and start depreciation of these assets over a 40-year period beginning with fiscal year 1974."

Mr. Steers added: "The action which has been taken by the Board, which has the full concurrence of the GAO, will provide, and properly so, for the recovery of these costs in the toll rate structure of the Panama Canal."

No questions were asked by the Committee about the lawful authority to commence these new policies, and no reference to such authority was given by Canal Company witnesses.

SENATE APPROPRIATIONS COMMITTEE HEARINGS, APRIL 19, 1973

Chairman Robert Byrd noted (Hearings, p. 25): "On page 2, there are identified in the narrative certain assets having an original cost of $331.8 million, which had previously not been depreciated.

"Please give some insight into the nature of these assets and the basis for depreciation."

Governor Parker: "The assets are essentially features of the original canal construction; excavation of channels, fills and embankments, and land acquisition costs which were not put in our depreciation base in times past.

"Whether or not these items should be included in our depreciation base has been a subject of controversy or discussion through the years.

"The GAO has consistently recommended that they be included.

"This year our Board of Directors authorized us to add them to our depreciation base for fiscal year 1974, adding to the cost of operations somewhat over $8 million."

No further disucssion occurred.

PANAMA CANAL SUBCOMMITTEE HEARINGS, JULY 17, 1973

Excerpts from these hearings quoted previously show that Governor Parker discussed a possible tolls increase, but did not discuss any changes in accounting policy, the action of the Board of Directors the previous winter approving these policies, or the impact of the new policies on tolls. According to Subcommittee Chairman Leggett, "subjects to be covered [during the Hearings] include importance of the canal to shipping interests, current commodities, and products transported and future for these and others, adequacy of the canal and problems encountered in its use, future shipping requirements for the canal to the year 2000, and effects of current tolls structure with considerations as to revision of tolls." (Hearings, p. 1).

ARTHUR ANDERSEN & CO. LETTER, AUGUST 24, 1973

This letter was a review of proposed changes in accounting policies "scheduled to be finally approved by the Board of Directors on October 30, 1973".17 One topic addressed by the letter is that "accounting policies should comply with legal requirements". Quoting section 412 (b) of the Canal Zone Code, the

17 Although the new accounting changes were not approved until October 1973, and were not published in the Federal Register until November 23, 1973, they became effective July 1, 1973, the first day of FY 1974.

"tolls formula", Arthur Andersen contended that this "section . . requires the Company to set tolls to recover all costs." (Emphasis added). This statement is not correct as a matter of law. The statute does not provide for recovery of "all costs", but only for certain costs. If Arthur Andersen were correct, interest during construction could be assessed against tolls. Section 412(e) of the Canal Zone Code specifically prohibits this.

The letter adds: "It is our understanding that, under applicable provisions of law, both the adoption of accounting principles and the setting of tolls rates are subject to the discretionary authority of the Company whose management is vested in its Board of Directors."

Again this statement is not legally correct. The Company does not have unlimited discretion, but is limited by applicable law. If Arthur Andersen were correct, and if the Company could depreciate or amortize nondepreciable items in the exercise of discretion, then no reason for legislation to authorize this action existed. Yet both the Company and GAO repeatedly acknowledged the need for legislation, and supported bills which would permit this depreciation. Furthermore, the Supreme Court in the Grace Line case specifically rejected unlimited authority in the Canal Company, finding the Company a creature of Congress and of the Executive. As noted in the excerpts from hearings in 1956, the IRS refused (and to our knowledge has never agreed) to find that these actions would be legally permissible. The 1956 Senate Interstate and Foreign Commerce Committee Report found the actions inconsistent with existing IRS regulations.

This letter also refers to the report by Arthur Andersen & Co. of April 30, 1972, entitled "Accounting for the Cost of Excavations." This change in accounting, according to the letter, "should have been effective in 1973. However, the time required to clear the policy with the Congress of the United States precluded the implementation in that year". We are unaware of any instance to the present time when the Congress of the United States specifically "cleared" this policy. The only times the appropriate legislative committees clearly faced the policy, they rejected it (see excerpts from 1956 House and Senate hearings, quoted previously).

NOTICE OF ACCOUNTING CHANGES, NOVEMBER 23, 1973

The Canal Company Directors approved the changes in accounting policy in October 30, 1973. They appeared in the Federal Register on November 23, 1973 (38 Fed. Reg. 32293). The Notice stated: "The application of generally accepted accounting principles to the Panama Canal Company, a rate-regulated public utility established by Congress, determines the manner in which costs are recognized in the setting of toll rates."

After quoting the tolls formula in section 412 (b), the Company listed the accounting changes, including: "12. The costs of land, titles, treaty rights, canal excavation, fills, and embankments, and cost for widening, deepening, and straightening the channel through fiscal year 1973, are depreciated over a 40-year life beginning with fiscal year 1974."

The Notice gave no legal authority for this action.

PROPOSAL TO INCREASE TOLLS, DECEMBER 15, 1973

The Canal Company on December 15, 1973 issued its Proposal To Increase Tolls by 19.7%. The Proposal contains a section on "Construction and Application of the Tolls Formula", with references to the origin of the Canal Company in 1951 (citing the House Report), to the Grace Line case, and to the 1960 hearings before the Panama Canal Subcommittee on the Panama Canal Toll Formula (H.R. 8983 and H.R. 10968) excerpted in the previous portion of this memorandum. The Proposal made no reference to any prior hearings on legislation to amortize or depreciate nondepreciable items (1956 House and Senate hearings), to the repeated efforts and statements of the Canal Company to obtain this legislation, and to the absence of legislative bodies to pass it. The paragraph on new expenses resulting from this policy reads:

"The increase of $10.1 million in depreciation expense from 1973 to 1975 consists principally of depreciation on Canal excavations and certain other assets initiated in 1974, following the inclusion of such depreciation in the budget approved by the Congress for that year. This depreciation will amount to

some $8.3 million a year. The depreciation of these assets was recommended by the Comptroller General of the United States." (Proposal, pp. 11-12)

Appendix A to the Proposal contains a section entitled "Construction and Application of the Tolls Formula". (Proposal, pp. 45-47). It is divided into two sections "judicial construction" and "legislative construction". The "judicial construction" contains three paragraphs, one for the decision of each court in the Grace Lines case. The "legislative construction" (5 paragraphs) cites only the 1960 Hearings on H.R. 8983 and H.R. 10968. The excerpts quoted by the Canal Company do not include the testimony of Governor Potter at page 14 of those Hearings: "The canal is being amortized except for the so-called nondepreciables, $280 million worth of them. They are the excavation itself, the land on which the excavation sets, and I believe the locks. They, by act of this Congress, are considered as nondepreciables." (Emphasis added)

The Proposal does not refer to any of the other hearings, previously excerpted, in its "legislative construction" of the tolls formula. Indeed, this discussion in the Proposal contains no reference at all to depreciation or amortization of nondepreciable items.

CARRIER COMMENTS/TESTIMONY, FEBRUARY-MARCH 1974

Sea-Land's comments on the proposed tolls increase, filed February 1, 1974, questioned the depreciation of excavations, titles, treaties, etc.: "Section 412 of Title 2 of the Canal Zone Code [tolls formula] defines items to be properly included in costs of operation. Depreciation as defined therein applies to facilities and appurtenances related to maintenance and operation of the canal. The section contains no provision for recovery of original construction costs." (Comments, p. 20).

Sea-Land (and also AIMS) again raised the legal justification for the accounting changes in public testimony before a panel of Canal Company directors on March 5, 1974: "Research reveals the Company has sought without success to depreciate these items in the past. Congress repeatedly rejected the proposal."

No mmber of the panel commented. The report, if any, of the directors after comments and public hearings was not furnished to the carriers. The full tolls increase was approved. The depreciation of nondepreciable items continued.

HOUSE TRANSPORTATION APPROPRIATIONS SUBCOMMITTEE HEARINGS,
APRIL 23, AND MAY 9, 1974

The following discussions of the change in depreciation policy occurred between Chairman McFall and Governor Parker Hearings, pp. 827-28):

Mr. McFALL. "In last year's hearings we questioned the change in your depreciation policy. At that time you indicated that this cost would be included in any study evaluating toll rates. You also stated, however, that, ‘I am not suggesting that we will necessarily recommend a toll increase.'

"In view of the fact that you did recommend a substantial toll increase, approximately 20 percent, perhaps we should take another look at this matter. Prior to fiscal year 1974, your interpretation of the Canal Zone Code did not provide for depreciation on titles, treaty rights, excavation of channels, harbors, basins and other works which originally cost $331.2 million. Why did you decide to change your policy on this matter?"

General PARKER. "As you have noted from my testimony last year, the Company's Board of Directors had approved at that time some changes in accounting policies which were reflected for the first time in those estimates. As you have indicated again, these costs have not heretofore been depreciated.

"The question of depreciating these assets has been under varying degrees of consideration for some time. It was raised again periodically by the Comptroller General, for example in his May 4, 1972 report to Congress on the examination of the financial statement and more recently in his latest report of March 6, 1974. Copies of these reports from the Comptroller General are in your files and available to the committee."

Mr. McFALL. "Would you tell us briefly what the Comptroller General has said?"

General PARKER. "The Comptroller General has consistently taken the position that these assets should be depreciated. In his audit report for 1971 and 1970 he said:

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