Treatment of surplus from appreciation of depreciable property;

              50 HASKINS & SELLS July
The Treatment of Surplus from Appreciation of
Depreciable Property
BY H. L . WILSON, with Haskins & Sells
THE period of increased costs which
had its beginning during war time, and
which has since continued, has led many
concerns to have their properties appraised,
and to set up the appraised values on the
books. Almost invariably these appraisals
have resulted in a valuation in excess of the
book valuation previously carried. There
is doubtless entire agreement among ac­countants
that the excess of the appraised
valuation over the depreciated cost should
be credited, not to earned suplus, but to
some special surplus account. Many in­teresting
questions arise, however, in de­termining
the amount of and the ultimate
disposition to be made of this special sur­plus,
or, as it is frequently called, surplus
from appreciation.
The amount of the surplus from appre­ciation
is not necessarily the difference
between the appraised value and the net
book value. If, before the making of the
appraisal, repairs were capitalized or in­adequate
depreciation was provided, the
treatment of such a difference as surplus
from appreciation would result in an under­statement
of surplus from appreciation
offset by an overstatement of surplus from
operations. If, on the other hand, addi­tions
and improvements have been charged
to expense, or the property has been over-depreciated,
such treatment would result
in an overstatement of surplus from appre­ciation
offset by an understatement of
surplus from operations. In order to in­sure
the correct determination of surplus
from appreciation, not only must the
appraisal be correct, but the net book
value of the property must be properly
stated. Of course, the only method of
determining that the book value of the
property is correctly stated is to make an
examination of the property and related
accounts.
Before setting up the appraised values on
the books, consideration should be given to
the relative amount of depreciation which
has been reserved. The accrued deprecia­tion,
as determined by the appraisal, is
arrived at after a study of the physical
condition of the property, and hence is
assumed to be more accurate than book
reserves, which are based on estimates of
useful life. Suppose that the accrued
depreciation as figured by the appraiser is
50% of the replacement cost of the prop­erty.
If we find that the reserve for de­preciation,
as shown by the books, is only
25% of the gross book value of the prop­erty,
it is apparent that the property has
been under-depreciated. If, on the other
hand, we find that the reserve for depre­ciation
carried on the books is 75% of the
gross book value, we know that the prop­erty
has been over-depreciated. There
seems to be no question that the reserve
for depreciation of each class of property
as shown by the books should be adjusted
so that it bears the same ratio to the gross
book value of the property as the accrued
depreciation shown by the appraisal bears
to the depreciated replacement cost. This
adjustment of the reserve for depreciation,
together with any adjustments resulting
from the examination of the property and
related accounts, should be charged or
credited, as the case may be, to earned
surplus. The excess of the appraised
sound value over the net book value ad­justed
as above is the true surplus from
appreciation.
The question now to be considered is:
What ultimate disposition should be made
of this surplus from appreciation?
Since the surplus from appreciation arose
in connection with the revaluation of de­preciable
property, there seems to be no
question that it should be entirely ex­tinguished
upon the expiration of the useful
life of that property. Moreover, inasmuch