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 HE ACCOUNTING TREATMENT 
 
 (27^71 OVERHEAD CONSTRUCTION COSTS 
 
 ^ IN 
 
 PUBLIC UTILITIES 
 
 FIRST EDITION 
 
 ANDERSEN, DE LANY & COMPANY 
 
 Certifiecl Public Accountants 
 CHICAGO NEW YORK MILWAUKEE 
 
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 http://www.archive.org/details/accountingtreatmOOanderich 
 
THE ACCOUNTING TREATMENT 
 
 OF 
 
 OVERHEAD CONSTRUCTION COSTS 
 
 IN 
 
 PUBLIC UTILITIES 
 
 FIRST EDITION 
 
 Copyright, 1917. by Andersen, De Lany & Co. 
 (All riskts reserved) 
 
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 ANDERSEN, DE LANY & COMPANY 
 
 Certified Public Accountants 
 
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THE ACCOUNTING TREATMENT OF OVERHEAD 
 CONSTRUCTION COSTS IN PUBLIC UTILITIES. 
 
 Commission regulation of public utilities has brought 
 increasing emphasis to bear on the importance of overhead 
 costs of construction in valuations of physical property. 
 Heretofore a lack of adequate records of construction costs, 
 together with the common failure to recognize proper com- 
 ponents of such costs, has served to relegate to the field 
 of engineering estimate the determination of overhead 
 allowances. So diverse have been the practices of record- 
 ing many items of overhead cost that the present ten- 
 dencies as to such items are virtually impossible of ascer- 
 tainment. 
 
 It is the purpose of the present pamphlet to review the 
 general practices and actual overhead charges in a number 
 of utilities and to suggest a better and more uniform 
 accounting procedure. A study of the following pages will 
 lead, it is hoped, to further recognition and analysis of the 
 underlying accounting principles so that a better under- 
 standing and more careful application of these principles 
 may result. It is our intention to continue this study so 
 that the treatment of various overfiead icharges may be 
 more fully dealt with at a later time. 
 
 The lines along which we have proceeded in this investi- 
 gation of overhead charges have been: 
 
 (1) To ascertain the policies now followed by utility 
 
 companies in the apportionment of overhead 
 expenses between construction and operation. 
 
 (2) To ascertain the amount and nature of construc- 
 
 tion overheads actually charged by a number of 
 companies and the ratio of such overheads to 
 direct charges to construction. 
 
 (3) To determine whether construction items should 
 
 be considered as overhead or as direct charges 
 in those cases where the distinction is not clear. 
 
 In the course of our investigation of the policies now 
 followed by public utility companies we sent out a large 
 
 402634 
 
number of letters of inquiry to various companies in an 
 endeavor to secure reliable information as to their present 
 practices. Detailed replies have been received from a large 
 enough number of companies to justify the following con- 
 clusions : 
 
 (1) Many companies have paid little or no attention to 
 
 the subject. 
 
 (2) Many companies have not so kept their construc- 
 
 tion accounts as to be able to summarize the 
 overhead charges to construction without con- 
 siderable analysis of the accounts now kept. 
 
 (3) Some companies recognize fully the importance of 
 
 proper apportionment of overhead expenses and 
 are making their best efforts to secure such 
 apportionments or are attempting to ascertain 
 a generally recognized basis of apportionment. 
 
 In Exhibit 1 we have tabulated the information given 
 in thirty replies which gave most complete information 
 and which were from companies which appear to have 
 given most attention to the subject. 
 
 The practices now followed vary from charging the 
 bare prime cost only, in the case of a large number of 
 companies, to charging the greater part of the actual gross 
 overhead expenditures in other cases. Replies to our in- 
 quiries show very clearly, however, that companies which 
 have given the most thought to the charging of overhead 
 expenses to construction have adopted a conservative pol- 
 icy. Where there has been a question as to the propriety 
 of including a doubtful item in the construction account, 
 the charge has been made to operation. In this way the 
 danger of overcharging construction, which is constantly 
 present because of the pressure to keep down operating 
 expenses, has been avoided. 
 
 Before taking up the discussion of the suggested meth- 
 ods of dealing with overhead expenses, it will be desirable 
 to review the procedure now followed by those companies 
 whose replies indicate that they have made an attempt to 
 secure a correct distribution. Following is an enumeration 
 
of various classes of overhead expenses with a statement 
 of what seems to be the current practice. 
 
 (1) Engineering: 
 
 (a) If a flat fee is paid for a specific piece of con- 
 
 struction, the current practice, with very 
 few exceptions, is to charge the entire 
 amount to construction. 
 
 (b) Those companies which employ an engineer- 
 
 ing staff especially for construction work 
 usually charge to construction the salaries 
 of the staff, its direct expenses, rent of its 
 quarters and incidental expenses incurred 
 in its behalf. 
 
 (c) Of companies which employ an engineering 
 
 staff which devotes part of its time to con- 
 struction, the general practice is to absorb 
 all of the expense of the staff in operating 
 expenses, although some companies are mak- 
 ing a division between operation and con- 
 struction charges on the basis of the actual 
 time devoted to each class of work. 
 
 (2) Insurance — 
 
 Injuries and Damages: 
 The prevailing practice is to charge neither insur- 
 ance nor injuries and damages expense to con- 
 struction, although there are exceptions. In some 
 cases insurance is charged to construction up to 
 the time when operation of the new equipment 
 begins. Liability insurance is in some cases pro- 
 rated on a payroll basis. Frequently, of course, 
 no apportionment is needed as expenses on ac- 
 count of injuries and damages can be charged to 
 the work in connection with which they were 
 actually incurred. 
 
 (3) Taxes : 
 
 Although the general procedure is to charge all 
 taxes to operation, in some instances taxes actu- 
 ally assessed on the work in progress are charged 
 to construction up to the time that operation is 
 begun. Some companies follow the practice of 
 not charging any taxes to construction on work 
 which is completed within a short time, although 
 they would be charged on work which requires 
 a long time for completion. 
 
(4) Legal: 
 
 (a) For companies whose legal work in connec- 
 
 tion with construction is done on a special 
 fee basis the methods of handling differ. 
 Although some charge the actual cost of 
 such legal service to construction, others 
 charge none of it, and the practice of others 
 does not seem to be clearly defined. 
 
 (b) For legal services by members of the com- 
 
 panies* staffs the practice likewise varies. 
 Some companies charge all expenses to 
 operation; others prorate them on a time 
 basis, and in some instances a fixed per- 
 centage of the salaries of attorneys is regu- 
 larly charged to construction. 
 
 (5) Storeroom : 
 
 Three general methods of handling storeroom ex- 
 penses are followed. Many companies charge the 
 entire storeroom expense to operation; others 
 prorate the expense on the basis of material han- 
 dled, and still others add a fixed percentage to 
 the cost of materials. In some cases salaries and 
 expenses of the purchasing department are re- 
 garded in the same light as storeroom expenses, 
 although the more general practice seems to be to 
 treat these items as entirely chargeable to opera- 
 tion. 
 
 (6) Utility Equipment: 
 
 Expenses of operating utility equipment, such as 
 wagons, buggies, trucks, automobiles and supply 
 cars, with barn and garage expense incident 
 thereto, are in many cases divided on the basis of 
 time used for operation and for construction, 
 although here, too, there are a number of com- 
 panies which make no charge to construction. 
 In other cases no such charge is made unless 
 utility equipment is used on construction work 
 for a considerable time. 
 
 (7) General Officers: 
 
 With regard to salaries and expenses of general 
 officers, the prevailing practice as disclosed by 
 the replies to our inquiries, is to charge the total 
 to operating expenses. In the cases where excep- 
 tions have been noted, the practice of some com- 
 panies is to base the charges to construction 
 
upon the amount of officers' time spent on such 
 construction, while others charge a fixed per- 
 centage of salaries of officers to constntction, 
 apparently without reference to the volume of 
 construction work handled. 
 
 (8) General Office Salaries : 
 
 By far the larger number of replies received indi- 
 cate that no charge whatever is made to construc- 
 tion for salaries of general office clerks. In a few 
 instances a charge is made, based upon the time 
 spent in connection with construction matters 
 and in a few other cases, where the entire time 
 of a clerk is spent on such matters, his salary is 
 charged to construction. 
 
 (9) General Office Supplies and Expenses: 
 
 With the exception of a few companies which 
 charge to construction those expenses occasioned 
 by a specific piece of construction work and a 
 few which charge a fixed and apparently arbitrary 
 percentage of general office supplies and expenses 
 to construction, the general practice seems to be 
 to regard the entire cost of these supplies and 
 expenses as a proper charge to operation. 
 
 (10) Superintendents' or Local Managers' Salaries: 
 
 Practices differ also with regard to these expenses. 
 Those companies which charge any part to con- 
 struction usually attempt a division on an actual 
 or estimated time basis. The policy of some com- 
 panies is to consider all salaries of employes 
 above the grade of foremen as chargeable entirely 
 to operation. The general practice, it is safe to 
 say, is to make no charge to construction for 
 local managers' or superintendents' salaries. 
 
 (11) Interest: 
 
 The existing practices with reference to interest 
 vary as greatly as in the treatment of other over- 
 head charges, even though the propriety of includ- 
 ing an allowance for interest during construction 
 has been generally recognized in appraisal work. 
 The predominant practice seems to be to make no 
 charges to construction on account of interest. 
 Among the companies which have made such 
 charges to construction, the practice, as indicated 
 by the replies received, is to terminate them as 
 soon as the property is turned over for operation. 
 
8 
 
 In other cases interest is charged to construction 
 only when money has actually been borrowed for 
 construction purposes. Others charge half of the 
 legal annual rate on money used for all construc- 
 tion; in others actual interest upon bonds from 
 the date of withdrawal to the time of turning over 
 the property for operation is charged. 
 As to discount on bonds, the general practice is to 
 charge nothing to construction. 
 
 The foregoing summary, though interesting as illus- 
 trative of prevalent practices among utility companies and 
 of the lack of agreement among companies as to the meth- 
 ods which should be followed in dealing with overhead 
 expenses, gives us very little ground upon which to base 
 conclusions, either as to what overhead items are properly 
 chargeable to construction or as to what is the normal ratio 
 between overhead and direct charges. For the purpose of 
 throwing some light, if possible, upon the relations which 
 may be expected to exist between overhead and direct 
 charges, we have summarized below the charges actually 
 made by a number of utility companies, which have been 
 verified by us. In this summary construction expenditures 
 are shown in round numbers only. 
 
 Company No. 1 — Period of One Year. 
 
 Per Cent 
 of Direct 
 Charges. 
 Total Direct Charges— About $800,000.00. 
 Overhead Charges: 
 
 Engineering and Supervision 1.92 
 
 Salaries of Officers and Managers 1.96 
 
 Salaries of General Office Clerks 41 
 
 Injuries and Damages 17 
 
 Legal 35 
 
 Sundry Expenses 11 
 
 Interest During Construction 28 
 
 Total 5.20 
 
Company No. 2 — Period of One Year. 
 
 Per Cent 
 of Direct 
 Charges. 
 Total Direct Charges— About $500,000.00. 
 Overhead Charges: 
 
 Interest 94 
 
 Liability Insurance 94 
 
 Engineering and Supervision 5.54 
 
 Office Clerical Salaries, Expenses and Miscel- 
 laneous 47 
 
 Legal 19 
 
 Total 8.08 
 
 Company No. 3 — Period of Two Years and Ten Months. 
 
 Total Direct Charges— About $900,000.00. 
 
 Overhead Charges: 
 
 Engineering and Supervision 8.90 
 
 Law Expenses 47 
 
 Injuries and Damages and Liability Insurance 1.07 
 
 Interest 1.20 
 
 Salaries of Officers 1.52 
 
 Office Clerical Salaries, Office Expenses and 
 Miscellaneous 2.21 
 
 Total 15.37 
 
 Company No. 4 — Period of Three Months 
 
 Total Direct Charges— About $600,000.00. 
 
 Overhead Charges: 
 
 Engineering and Supervision 9.54 
 
 Injuries and Damages and Liability Insurance 1.31 
 
 Interest 2.31 
 
 Office Clerical Salaries, Office Expenses and 
 Miscellaneous 1.46 
 
 Total 14.62 
 
10 
 
 Company No. 5 — Period of One Year 
 
 Per Cent 
 of Direct 
 Charges. 
 Total Direct Charges— About $800,000.00. 
 Overhead Charges: 
 
 Engineering and Supervision 9.44 
 
 Salaries and Expenses of Office Employes. . . 1.09 
 
 Injuries and Damages 1.54 
 
 Interest 1.90 
 
 Taxes 08 
 
 Total 14.05 
 
 Company No. 6 — Period of One Year 
 
 Total Direct Charges— About $75,000.00. 
 
 Overhead Charges: 
 
 Engineering and Supervision 9.1 
 
 Salaries of Officers and Managers 4.8 
 
 Liability Insurance 2.1 
 
 Total 16.0 
 
 Company No. 7 — Period of Two Years 
 
 Total Direct Charges— About $30,000.00: 
 
 Overhead Charges: 
 
 Injuries and Damages 3.9 
 
 Engineering and Supervision 17.0 
 
 Total 20.9 
 
 Company No. 8 — Period of Eleven Years 
 
 Total Direct Charges— About $300,000.00 : 
 Overhead Charges: 
 
 Engineering and Supervision 10.19 
 
 Interest and Note Discount 1.25 
 
 Legal Expenses 1.23 
 
 Miscellaneous 19 
 
 Total 12.86 
 
11 
 
 It will be noted from the foregoing statements of over- 
 head that the practices of different companies differ widely 
 as to the total amount of overheads charged to construc- 
 tion and also as to the amounts charged for the various 
 classes. Engineering and Supervision charges range from 
 1.92 per cent for Company No. 1 to 17 per cent for Com- 
 pany No. 7. The latter company, however, made only one 
 other charge to overhead, that being for Injuries and Dam- 
 ages, amounting to 3.9 per cent, or a total of 20.9 per cent 
 on a total direct charge of approximately $30,000.00. 
 
 In the case of Company No. 1 the overhead charges 
 for the preceding year amounted to 7.46 per cent on a 
 total direct charge of $450,000.00 as against 5.20 per cent 
 on a total direct charge of about $800,000.00 as shown in 
 this report. In the case of this company the overhead 
 charges did not increase in proportion to the increase in 
 the direct charges. 
 
 Because of the differences in the practices of companies 
 whose charges we have verified, it has not been practicable 
 to classify the overhead items in the same way for all com- 
 panies, but as far as possible they have been grouped so 
 that they might be comparable. The foregoing summary, 
 of course, represents only the charges actually made. 
 Where the practice of a company has been to make no 
 charge to construction for certain items, as, for example, 
 interest or taxes during construction, the summary above 
 does not include such construction costs. Consequently 
 the summary is presented here, not as indicative of what 
 are normal ratios for overhead expenses but as showing 
 the nature and importance of indirect construction charges 
 actually made by companies following different policies. 
 
 We come next to a consideration of the principles which 
 should govern in the accounting treatment of overhead 
 expenses. As to the division between operating expenses 
 and construction, there are two extremes of policy. Under 
 one policy construction would be charged with all expenses 
 which would be incurred for such construction if the com- 
 pany were not operating. The other extreme would be to 
 
12 
 
 charge to construction no expense which would be con- 
 tinued during a period when there was no construction. 
 Under neither policy would operation and construction be 
 dealt with as co-ordinate functions of a public utility. 
 
 Either of these extreme policies is difficult of accurate 
 application. If the policy is to charge only the excess costs, 
 above what would be the cost if operation only should be 
 carried on, the difficulty is met of ascertaining what ex- 
 penses would really continue if construction were to cease 
 altogether. Temporary cessation of construction would 
 probably not reduce the salaries of officers and general man- 
 agement, but if the lack of construction means that the 
 business has become static, undoubtedly the supervisory 
 cost would tend to decrease below what it would be in a 
 company actively engaged in construction work. Hence 
 to charge all supervisory expenses to operation would tend 
 to charge more than the actual requirements for operating 
 purposes. If the opposite policy is followed it is difficult 
 to determine what the construction cost would be if no 
 operation were carried on. Estimating the overhead cost 
 of construction under conditions of non-operation cannot 
 be satisfactory. Although we may conclude that proper 
 methods of handling overhead charges lie somewhere be- 
 tween the extremes denoted, we cannot determine what 
 the proper method should be without considering the 
 question in the light of the effect which differences in 
 treatment would have. 
 
 The problem of handling construction overheads is a 
 two-fold one. If the practice of charging a large part of 
 overheads to construction is followed, the property and 
 plant account will be increased; operating expenses will 
 be kept at a minimum and the net revenue will appear to 
 be large. Desirable as such a condition may be, there is 
 another side to be considered: that public regulatory 
 bodies will probably be reluctant to increase expenses to 
 a point higher than that shown on the books; and the 
 apparently large net revenues, which result from charging 
 to construction certain overhead items which might have 
 
13 
 
 been charged to operation, may furnish the basis for a 
 reduction of rates by public authority. On the other hand, 
 if the practice has been followed of charging operation 
 with overhead expenses which really relate to construc- 
 tion work, there may be a tendency on the part of regu- 
 latory agencies to allow a very small overhead on the 
 property with the result that a return may be earned upon 
 less than its true cost. 
 
 The solution of the problem, in so far as any solution 
 can be offered at the present time, seems to lie in han- 
 dling overhead charges in such a way as to avoid either 
 of the extremes mentioned above. Viewing the question 
 from the standpoint of accounting principle, we conclude 
 that the aim should be to have the books show, as closely 
 as possible, actual costs, whether we are dealing with 
 property accounts or with operating expenses. The principle 
 is not different from that which should govern in the division 
 of operating expenses between different classes of busi- 
 ness conducted by a public utility. If a company operates 
 both gas and electric departments the cost of neither 
 department would be correctly shown by charging to it 
 only the direct costs or only the direct costs plus such 
 part of overhead costs as could be dispensed with by the 
 other department if that department were operated sep- 
 arately. Normally, the two departments would be treated 
 as co-ordinate and the books would show, as nearly as pos- 
 sible, the actual cost of each, with joint overhead operat- 
 ing expenses divided in such a way as not to unduly burden 
 either department. 
 
 Although there may be exceptions in the case of util- 
 ities in cities where the physical properties have reached 
 practically their limit of expansion, the normal present con- 
 dition in the public utility business is one of growth and 
 extension. With such protection from competition as is 
 afforded by their franchises, public utilities are generally 
 regarded as being no less obligated to extend their service 
 and facilities, within reasonable limits, than they are to 
 
14 
 
 supply service to customers already connected. This being 
 so, there seem to be two functions which a company should 
 perform, neither of which can be regarded as incidental, 
 although expenditures may be greater for one than for the 
 other. These functions are to supply service to present 
 customers and to extend service to others. Proper ac- 
 counting should aim to show the full cost of performing 
 each of these functions. It follows that in order that the 
 cost of each may be correctly shown, expenses which are, 
 in fact, overhead to both operation and construction, 
 should be, in practice, divided between operation and con- 
 struction. 
 
 Because of the importance of estimates of the cost of 
 reproduction in the valuation of utility properties and the 
 very general classification by appraisers of certain classes 
 of construction expense as overhead, the term "Construc- 
 tion Overheads" has come to have a more or less gener- 
 ally accepted meaning, not in all respects identical with 
 the accounting definition. In its general acceptance the 
 term includes some items of cost of construction which in 
 practice may be charged directly to specific pieces of con- 
 struction. The result of this and of the failure of many 
 utilities to charge to construction certain actual costs 
 has been a great deal of confusion and misunderstanding 
 in dealing with the allowance for overhead. Best results 
 will probably be obtained when the accounting practice 
 is brought into as close harmony as possible with the ac- 
 cepted engineering practice. 
 
 A first essential in connection with a discussion of the 
 procedure which should be followed with regard to over- 
 heads, is an understanding as to what are overhead ex- 
 penses. The bare cost of material and direct labor em- 
 ployed in construction work may clearly be regarded as 
 direct charges. In so classifying these items, however, 
 we are immediately confronted with the question of how 
 transportation and handling charges on material should be 
 treated and also how certain expenses of direct supervision 
 should be dealt with. 
 
15 
 
 We regard freight not as an overhead cost, but as a 
 direct cost, and the general practice of valuation engineers 
 seems to be to treat this as a direct addition to the bare 
 cost of materials. In addition to the bare cost of mate- 
 rials and freight, we are of the opinion that the cost of 
 handling material, including storeroom expenses and the 
 cost of hauling material to the point of use, is more 
 properly a direct charge than an overhead. The cost 
 of hauling is not materially different from the cost of 
 freight, merely because the hauling may be done by the 
 company itself. If the hauling is done by other parties, 
 its cost is clearly of the same nature as freight, and the 
 fact that the public utility does its own hauling does not 
 alter the circumstances. To be sure, the use of utility equip- 
 ment in connection with construction generally makes it 
 necessary to divide utility equipment expenses between 
 operation and construction. This does not mean, how- 
 ever, that these are overhead expenses. The apportion- 
 ment between operation and construction can probably 
 best be made on the basis of time used, and the construc- 
 tion portion of the cost charged directly to the construc- 
 tion job. This practice is followed by a number of 
 utilities whose records we have examined. 
 
 Storeroom expenses, also, are usually joint expenses 
 of operation and construction, but the portion which is a 
 construction charge is not really overhead to all construc- 
 tion work, but relates to the handling of material so 
 closely that it may be properly treated as a direct charge 
 upon the basis on which material is charged. The clerical 
 work of keeping storeroom records, although somewhat 
 less directly an addition to the cost of materials than the 
 cost of handling, nevertheless represents a cost in connec- 
 tion with the use of materials for construction work and 
 should, in our opinion, be added directly to the cost of 
 materials. 
 
 The cost of direct supervision of labor, such as wages 
 of construction foremen, is handled reasonably as a direct 
 labor cost and should not be included with overheads. 
 
16 
 
 With the elimination of the items mentioned above which 
 we would treat as direct charges, the term "overhead" 
 may be understood to include the following: 
 
 1. Engineering and Supervision. 
 
 2. Salaries and Expenses of Officers. 
 
 3. Office Salaries. 
 
 4. Office Supplies and Expenses. 
 
 5. Legal Expenses. 
 
 6. Injuries and Damages and Liability Insurance. 
 
 7. Taxes. 
 
 8. Interest and Bond Discount. 
 
 The cost of engineering and general supervision seems 
 to be clearly an overhead charge. A plausible argument 
 may be advanced for handling part of the cost of engineer- 
 ing as a direct labor charge to construction, but we con- 
 sider it better practice to follow a uniform policy for all 
 items of engineering and general supervision. The gen- 
 eral practice of appraisal engineers is to set out the cost of 
 engineering and supervision apart from the unit cost of 
 labor and materials charged directly. It seems desirable 
 that the accounting policy be consistent with the policy 
 followed in engineering valuations, if such consistency 
 can be obtained without doing violence to accounting 
 principles. Although it would undoubtedly be feasible to 
 charge a part of engineering and supervision cost as direct 
 labor, in our opinion such cost is actually overhead to the 
 prime costs of construction work. When engineering and 
 supervision work is done by a holding company and the 
 charge for such work is a percentage of the cost of labor 
 and material directly employed for construction purposes, 
 the necessities of the case practically require its treatment 
 as an overhead expense. The policy to be adopted for 
 handling such cost should be such that the treatment of 
 the cost of engineering and supervision will be consistent, 
 whether this work is done by a holding company, by the 
 regular staff of the utility, or by a staff specially engaged 
 for the work. 
 
17 
 
 Salaries and expenses of officers are often handled by 
 utility companies as being entirely expenses of operation. 
 Such companies take the attitude that such expenses must 
 continue even when no construction work is under way 
 and therefore the entire amount should be charged to opera- 
 tion. Although it is important that the method of divid-* 
 ing such salaries between operation and construction be 
 established with great care in order not to overburden 
 construction, the actual cost of construction work will not 
 be shown on the books unless a fair share of officers' sal- 
 aries is charged to such work. That portion of salaries 
 and expenses of officers which is charged to construction 
 is clearly overhead in its nature. 
 
 Although it is possible that some portion of office sal- 
 aries might be charged directly to specific pieces of con- 
 struction work, we are of the opinion that such salaries 
 are clearly overhead in that they do not relate directly to 
 the handling of construction material or to direct super- 
 vision of labor. The division between operation and con- 
 struction must, of course, be carefully made in order not 
 to overcharge construction. What has been said of office 
 salaries holds true of office supplies and expenses, and no 
 further discussion of these items is required. 
 
 Legal Expenses incurred in connection with construc- 
 tion are, in our opinion, proper overhead charges. Although 
 it would be possible in some instances to charge a part of 
 these expenses to particular items of construction, such as 
 legal expenses relating to the acquisition of land, such 
 expenses are not in the nature of prime costs and should 
 be treated as overhead. Legal expenses for construction 
 purposes may vary in their nature, and include such ex- 
 penses as: 
 
 (a) Legal expenses in connection with the purchase of 
 
 land. 
 
 (b) Legal expenses in connection with injury and dam- 
 
 age claims. 
 
 (c) Legal expenses in connection with contracts, etc. 
 
 (d) Indirect legal expenses considered as general office 
 
 expenses. 
 
18 
 
 All classes of legal expenses, however, are overhead in 
 nature. Whether they should all be charged to one ac- 
 count, "Legal Expenses During Construction," or whether 
 portions of them should be charged to other accounts, 
 such as "Injuries and Damages During Construction," is 
 a matter to be determined with reference to the classifica- 
 tion of accounts used by the company concerned, but this 
 does not affect their status as overhead expenses. 
 
 Accidental Injuries and Damages and Liability Insur- 
 ance are construction costs which it would often be 
 practicable to charge directly to the job to which they 
 relate. In the case of a charge for Liability Insurance, 
 where the premiums are based on the payroll, it would be 
 feasible to distribute the cost on the basis of construction 
 payroll distribution and charge it directly to the various 
 items of construction. Injury and Damage awards, too, 
 could in many cases be charged directly to that part of 
 construction work where the injury or damage occurred. 
 We are of the opinion that this is not the test. Direct 
 charges should include only those costs which may be 
 classified as prime costs, and the cost of insurance and of 
 accidental injury and damage claims is not a direct prime 
 cost which actually furthered the work of construction. 
 Moreover, the handling of these costs as overhead is con- 
 sistent with the policy of engineers in valuation work. 
 
 Taxes assessed during the period of construction should 
 be charged to construction as an overhead expense. The 
 correctness of this policy seems to be generally recognized, 
 although a great many companies are not applying it in 
 practice, especially as to miscellaneous construction not 
 covering a long period of time. 
 
 Interest during construction seems to be regarded ordi- 
 narily as an overhead construction cost, although many 
 companies have not charged to construction the full amount 
 of interest pertaining thereto. It is generally held that 
 when money is actually borrowed for construction purposes 
 the interest on such money, up to the time that construe- 
 
19 
 
 tion work is completed, should be charged to construction 
 as an overhead. 
 
 .Whether a charge for interest during construction 
 should be made for the use of funds provided by the sale 
 of stock is a disputed question. The classifications issued 
 by state commissions do not definitely authorize such a 
 charge. The practice generally provided by such classifi- 
 cations has authorized interest charges to the amount of 
 interest paid on borrowed capital, and, at least impliedly, 
 has limited such charges to the amount of such payments. 
 In accounting terminology dividends constitute a dispo- 
 sition of net income rather than a payment of interest. 
 The Interstate Commerce Commission, however, recognizes 
 as a proper charge for interest during construction a rea- 
 sonable amount for the use of the company's own funds. 
 As a general rule, part of the funds used for construction 
 must be funds of the company. The borrowing power is 
 ordinarily limited to about 75 per cent or 80 per cent of 
 the amount expended for construction. Some utility com- 
 panies finance a relatively large part of their construction 
 by the sale of stock. Others find it desirable at times to 
 finance extensions by stock sales, although at other times 
 bonds would be sold to provide the funds. In any case, 
 if the charge to construction is limited to a reasonable 
 amount for the use of the company's own funds, such a 
 charge is really for interest on capital furnished and as 
 such constitutes a part of the cost of construction work 
 which may properly be included in the charges to fixed 
 capital. 
 
 Inasmuch as this discussion deals only with the pro- 
 priety of charges to construction, we will not attempt at 
 this time to deal with the question of the proper distribu- 
 tion of the credit necessitated by a charge to construction 
 for interest on the company's own funds. This credit 
 might conceivably be shown as an addition to Surplus, 
 which might or might not result in its being distributed 
 in dividends, or to a Reserve or Special Surplus account, 
 which would not be available for dividends. 
 
20 
 
 That portion of bond discounts which relates to the 
 construction period should also be an overhead charge to 
 construction, being in reality merely interest paid in ad- 
 vance. 
 
 Although we consider it desirable to maintain a dis- 
 tinction between direct and overhead charges so that the 
 identity of overhead charges may not be lost, it may be 
 well to classify such overhead items as admit of such treat- 
 ment, according to the grouping of direct charges. The 
 possibility of so distributing overhead charges has led to 
 some confusion, and some companies have so kept their 
 accounts that only an exhaustive examination of construc- 
 tion charges will disclose their nature and extent. Con- 
 sequently, it would appear to be the better plan to first 
 charge all overhead items to distinctive accounts, which 
 may then be cleared, if desired, by spreading them over the 
 various construction accounts set up under the particular 
 classification in use. 
 
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THIS BOOK IS DUE ON THE LAST DATE 
 STAMPED BELOW 
 
 AN INITIAL FINE OF 25 CENTS 
 
 WILL BE ASSESSED FOR FAILURE TO RETURN 
 THIS BOOK ON THE DATE DUE. THE PENALTY 
 WILL INCREASE TO SO CENTS ON THE FOURTH 
 DAY AND TO $1.00 ON THE SEVENTH DAY 
 OVERDUE. 
 
 '''^"^•U31 
 
 
 
 
 MAR 6 1936 
 
 
 260d5ICr 
 
 
 v^-^ 
 
 
 l.t'^ 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 LD 21-100m-7.'33 
 
SC 92683 
 
 UNIVERSITY OF CALIFORNIA LIBRARY 
 

 
 
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