Misusing capital surplus;

              74 HASKINS & SELLS October
T H E fallacy of making charges against
what frequently is termed capital sur­plus
lies in the fact that the charges usually
represent actual losses of capital, while the
so-called capital surplus too frequently is
a product of the imagination.
First, and foremost, it is a mistake to
regard an estimated increase in the value
of depreciable property as capital surplus.
Carefully examined, the credit for the
increase proves to be nothing more than
bookkeeping, inasmuch as, properly ap­plied,
the credit serves to adjust the amount
of depreciation chargeable to operations.
Such treatment explodes the fiction that
because of a theoretical increase in value
there has been an increase in the amount of
depreciation. It insures a continuation,
in the future, of the depreciation charge
in the same amount as would have been
the case had the depreciable property
not have been revalued.
In the face of the foregoing assertion,
perhaps one should examine the question
of what may give rise to capital surplus.
Broadly defined, capital surplus might be
said to be the excess of asset values over
liabilities and reserves and capital, whether
actual or stated, and earned surplus. But,
irrespective of certain statutes and judi­cial
decisions, the opinion may be ad­vanced
that the time has passed when any
such definition will suffice. The tendency,
now strongly marked, is to inquire into
the origin of so-called capital surplus and
to determine whether or not the recogni­tion
of such surplus is justified by the
reason advanced for its creation.
The doubt well may be expressed that
capital surplus properly springs from the
upward revaluation of any asset, the
amortization or writing down of which is
contemplated in the future. Strongly
intrenched as the idea has become that
capital surplus may be so created, pro­vided
the increase in value is realized out
of future earnings, careful thought tends
to convince one that such reasoning is
fallacious, and that the treatment of such
items should be the same as that appro­priate
in the case of depreciation of
appreciated value.
Excluding physical assets subject to de­preciation
and intangibles subject to amor­tization
from those assets, the revaluation
of which may give rise to capital surplus,
there remain land, certain classes of in­tangibles,
like contracts and good-will, and
securities, either readily marketable or held
for investment. It may be conceded that
land, in certain cases, appreciates in value
and that such appreciation may be recog­nized
and given effect on the books by
writing up the asset and crediting capital
surplus. It may be granted that con­tracts
and good-will may follow the same
course and be similarly treated. Like­wise,
an increase in the market value of
securities, and an increase in the value of
securities representing related companies
not wholly owned might serve as a reason
for their revaluation, with the increase
reflected in a capital surplus account.
While no particular good would be
accomplished in the foregoing cases by
writing the assets up to their estimated
value, further than to gratify a desire to
see them appear in their best light, no
harm would be done if the amount corre­sponding
to the increase were to be credited
to capital surplus. And, going a step
further, no particular harm would result
if the increase in value were apportioned
among stockholders in the form of a stock
dividend. But, inasmuch as such steps
would be based on estimated increases, it
seems that no conservative directorate
would be tempted, by so doing, to chance
criticism later in the event that the esti­mate
were not well founded.
Misusing Capital Surplus