Bulletin HASKINS & SELLS 75
Before Depreciation
THE idea that net earnings before depreciation
and Federal income tax
indicate the ability of a corporation to
cover the interest requirements of its
capital obligations has come to be generally
accepted by those who have to consider
the handling of interest-bearing securities.
This idea is predicated on the theory that
the amount of income tax payable cannot
be determined until after interest has been
deducted, and that depreciation is a "bookkeeping
matter" which does not involve
the disbursement of cash.
The difficulty for the accountant in
assenting readily to this theory lies in the
fact that readers of financial statements
to which he attaches his name do not
always differentiate the bondholder from
the shareholder. The bondholder is concerned
with the remainder of earnings
available to satisfy his rights with respect
to interest. The stockholder inquires as
to the residue of earnings out of which he
may receive dividends.
Full consideration of the question of
depreciation must be based on a view
which comprehends bondholders as a class
and over the life of the bonds. Bondholder
" A " may figure that he will invest
for a relatively short term, during which
time the net earnings probably will take
care of his interest and before the expiration
of which the depreciated value
of the property securing his obligation will
