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10. As a first step toward implementing the policy, I recommend the inclusion of a provision for depreciation of these assets, commencing July 1, 1973, in the annual budget program for fiscal year 1974. If the program is approved by the Office of Management and Budget and sent to the Congress by the President, the Appropriations Committees and the Congress will review the program and will either approve it or modify it. In our judgment, the inclusion of this item in the budget will be favorably received by the Appropriations Committees and Congress.

11. The recording of depreciation will in itself have no effect on the Company's cash position.

12. In view of the considerations outlined above, it is recommended that the Board of Directors approve inclusion of provision for the depreciation of the assets in question in the annual budget program for fiscal year 1974.

PHILIP L. STEERS, JR.,

Enclosure.

Comptroller.

EXCERPT FROM GENERAL ACCOUNTING OFFICE REPORT TO THE CONGRESS

(PAGE 2)

RECOMMENDATIONS OR SUGGESTIONS

This report contains no recommendations or suggestions.

AGENCY ACTIONS AND UNRESOLVED ISSUES

The Company continues to believe that it legally cannot amortize or depreciate the cost of certain assets without legislation authorizing it to do so and that the accounting treatment necessarily is founded on this construction of law. The Company, however, has agreed to reevaluate its position on this matter. (See pp. 10 and 11.)

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. (See p. 11.) The Company and the Canal Zone Government believe that, since the Republic of Panama historically has liquidated all delinquent accounts prior to the ratification of new treaties between the Republic and the United States that relate to the Canal, these receivables are collectible. (See p. 12.)

MATTERS FOR CONSIDERATION BY THE CONGRESS

This report is submitted to the Congress, as required by law, to disclose the results of GAO's audit and such other information as necessary to keep the Congress informed of the operations and financial condition of the Company. Excerpt from General Accounting Office Report to the Congress (Pages 10-11)

COMMENTS ON FINANCIAL STATEMENTS

DEPRECIATION NOT RECORDED ON CERTAIN FIXED ASSETS

As stated in note 2 (see p. 25) to the Company's financial statements, the Company interprets the Canal Zone Code as not requiring the depreciation or amortization of certain canal construction costs relating to titles; treaty rights; excavations of channels, harbors, and basins; and other works totaling $331 million at June 30, 1971 and 1970. The note further states that, if these assets were depreciated at 1 percent a year, there would be an annual charge of about $3.3 million against operations. The Company believes that it legally cannot amortize or depreciate the cost of these assets without legislation authorizing it to do so and that the accounting treatment necessarily is founded on this construction of the law.

At the continued suggestion of the Senate Appropriations Committee, the Company proposed legislation for the consideration of the Eighty-third, Eightyfourth, and Eighty-eighth through the Ninety-second Congresses, which would have amended the Canal Zone Code to authorize the depreciation of these assets. The legislation had not been acted upon by the Eighty-third, Eightyfourth, and Eighty-eighth Congresses and was not introduced to the recent Congresses. We were advised by Company official that the Office of Management and Budget had not recommended the introduction of the legislation to the recent Congresses because of the Department of State's views that the introduction of such legislation should be deferred pending the outcome of treaty negotiations with the Republic of Panama. Negotiations with the Republic of Panama regarding the replacement of the existing 1903 treaty, which gives the United States control of the Canal Zone in perpetuity, were resumed in June 1971.

It is our view (1) that the assets in question—excavations, 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 cost should be depreciated or amortized and (2) that a change in legislation is not necessary to permit the Company to determine the effective date of depreciation or amortization of these assets for the purpose of including costs relative thereto in its financial statements. These assets were constructed for the special purpose of enabling the passage of ships through the canal. When this purpose ceases the utility of the assets presumably will cease also. The assets involved therefore do not add permanent value to the land but, rather, have value of a terminable nature.

We discussed the propriety of the accounting treatment afforded these assets with the Company, and the Company has agreed to reevaluate its position relative to the basis for this accounting policy.

Mr. STEERS. With respect to titles and treaty rights-I refer the committee to the answer to question II H (2) which has previously been placed in the record.

Subsequent to 1951 up through fiscal year 1973, depreciation of these assets was not included in the Company's costs and therefore cannot be considered as having been recovered.

Mrs. SULLIVAN. Did the treaty negotiations that had been going on since 1964, or thereabouts, have much to do with the change of the accounting system?

Mr. STEERS. I would say not-that it was not a factor in their action.

We were faced with the need for a tolls increase based upon our economic forecasts, and in evaluating the cost that should be recovered under section 412, which provides for the recovery of depreciation, and it was a proper financial and accounting action to provide for the recovery of the U.S. Government's investment in these assets. At that time we had been carrying on the book, approximately $300 million in active fixed assets, which were not being depreciated. It was my recommendation to the Board that they should review this matter. Consideration of this was consistent with a continuing recommendation by the General Accounting Office that the company should depreciate these assets.

Mrs. SULLIVAN. Is that when that interest payment on that debt to be paid back into the Treasury originated, some $16 million a year? Mr. STEERS. No; the requirement to pay interest was part of the reorganization legislation in 1950.

Mrs. SULLIVAN. And has been paid since then?

Mr. STEERS. Yes, Ma'am, it has.

Governor PARFITT. I might add one point, Mrs. Sullivan.

From a standpoint aside from the issue of reasonableness, or acounting principles involved here, without an increase in deprecia

tion which we experienced in the last few years the alternative left to the Company would be to seek appropriations of the Congress for capital investment.

The amount of money we are generating for capital investment through the depreciating process is marginal at best right now, even with these additions.

Mrs. SULLIVAN. Section 412 of the Canal Zone Code provides that tolls should recover "an appropriate share of the net cost of operation of the agency known as the Canal Zone Government."

What were the net costs of operation of the Canal Zone Government for fiscal year 1975?

Governor PARFITT. Approximately $23.8 million exclusive of sponsorship costs, Mrs. Sullivan.

Mrs. SULLIVAN. What share of the net cost was assessed against the tolls?

Governor PARFITT. The entire amount of $23.8 million of net costs. The cost of the Canal Zone Government is recouped by services and billings to other recipients of the services, such as the military pay for hospitals and schools, and so forth, and the residual amount, what we call the net cost of the Canal Zone Government, has been constructed over years as the appropriate costs of the Canal Zone Government that should be borne by the tolls.

Mr. STEERS. May I elaborate on the Governor's response there?
Mrs. SULLIVAN. Yes; please do.

Mr. STEERS. The total amount of the net cost to the Canal Zone Government is not borne entirely by tolls.

Portions of that are recovered from other third parties to whom the Panama Canal Company renders service. For example, the rates that we charge for the various pier services include a recovery of the general corporate expenses, which include a portion of the net cost of the Canal Zone Government.

Mrs. SULLIVAN. Why did not the company assess only an appropriate share of these costs against the tolls?

Would you have a reason for that, Governor?

Governor PARFITT. I think the statement just made was that the Company is responsible to repay the total net cost of the Canal Zone Government, which they are doing, but that all of that cost is not transferred to the toll structure, only a portion of it.

Mrs. SULLIVAN. Section 412 further provides in the determination of the appropriate share substantial weight shall be given to the ratio of the total gross revenues of the Panama Canal Company exclusive of the costs of commodities resold and exclusive of revenues arising from transactions with the Company, or from transactions with the Canal Zone Government.

Now, has the Canal Zone Company ever determined an appropriate share of the net costs of the Canal Zone Government based on the statutory formula, and if not, what is the reason why not?

Mr. STEERS. The answer is the canal has determined the appropriate share of the costs to be recovered through tolls.

This question requires a rather detailed answer, and it is covered in our response to question number II (b) (8). Madam Chairman, you may recall the hearings held here some years ago, attended by the former chairman, Congressman Bonner, at which time we discussed in great detail the manner of allocating the net cost to the Canal

Zone Government and certain other costs. The Company's position was explained, in which we followed generally a contributory pricing policy system, that after charging for services other than the transiting of the canal, and the rates would include a recovery of general corporate costs. The rates were fair and equitable for the services received, the residue remaining or direct costs would be borne a contribution to the general corporate costs.

That philosophy in pricing and allocation was confirmed by the Bonner committee at that time, and is contained in their report, which we make reference to in response to the question I previously referred to.

Mrs. SULLIVAN. That brings me then to the retail and the food outlets.

Repeatedly these operations show a net loss. Why are not goods sold by these units priced sufficiently to cover the costs?

I know at one time your price base was that of New Orleans, and you probably still do price the goods according to what the prices are in New Orleans. But how about the cost of shipping food down to the Isthmus, is that not recovered in the pricing structure?

Governor PARFITT. No; there is some unrecovered cost in the Commissary operation. It is considered appropriate to maintain the cost of living in the Canal Zone at what it would be in the United States. Employees, by virtue of their being dislocated in the Panama Canal area, should not have to pay an unusually high cost of living.

The policy has been established for years that there would be comparability pricing, for example, the food that you mentioned. The food is pegged to the New Orleans prices, regardless of the cost to the canal entity.

The housing rental charges are based on comparable housing in Puerto Rico. This was done at the direction of the Office of Management and Budget. Many of our pricing policies are predicated upon assuring that the living costs of our employees are neither below nor above those of their counterparts.

Mrs. SULLIVAN. Is there any kind of a report that you have sent to us recently that would show the loss per year in the area of food costs, rental costs and other nontransit areas? Otherwise the employees are getting the benefits of these services, and yet they are being charged off against tolls.

Governor PARFITT. We have statistics. They may not be in the form you desire, but first let me say there is, at the moment, no unrecovered cost in U.S. housing. As a result of maintaining price equity there is an unrecovered cost in the commissary operation. If you would like to have some financial data in response to that question, we can provide it for the record.

[The information follows:]

Fiscal year 1975 operating results

[In thousands of dollars]

Housing (United States and Los Angeles communities).
Retail units (commissaries) .

Food units---

1 Costs include $2,797 for ocean freight and cargo losses.

Over (under) recovery of direct costs

170 13, 069

536

Mrs. SULLIVAN. I would, because I understand they are going to attempt now, and it has been testified to, and advocated, that we do away with the S.S. Cristobal, which is the only real lifeline that we have from the United States down to Panama that you can control.

I would like to have more information, and for purposes of our discussion, I want to know the loss today in operating the S.S. Cristobal, as your organization calculates.

I would like to know the losses on the shipment of food, and hardware, and everything else that is brought down there to the zone on the Cristobal. I want to know what it would cost if we had to ship these items by private line.

Governor PARFITT. Mrs. Sullivan, I have been directed to make a study to determine whether, in fact, it is most economical to proceed as we are doing right now, or whether alternative means of transport of our supplies would be more economical.

We have not yet come to that conclusion, nor have I received the results of that study, but I will be glad to provide you with the basic data contained therein very shortly.

Mrs. SULLIVAN. Good. When it is ready I wish you would let us have it so we can study it, not encumbered with a whole mass of other information, but boned down to something we can put our fingers on.

Mr. Chairman, I should at this point like to read into the record some specific questions, and if the Governor does not answer them, I hope he will when he gets his transcript.

Governor, you testified before the Transportation and Appropriations Subcommittee in February 1976, "we are again studying the economics of the S.S. Cristobal."

What is the status of this study?
When will the study be complete?

Will you furnish a copy to the committee?

What are the costs of operating the Cristobal for fiscal years 1974 and 1975?

What are the costs expected for fiscal year 1976, and where are the costs reflected in the Canal Company's financial data?

I believe the Cristobal carries cargo, that is, cargoes which have been transported overland from the west coast and the east coast of the United States to New Orleans.

Where do the costs of the overland transportation appear in the Company's figures?

Who pays these costs?

What were these costs for fiscal year 1974 and 1975?

Are the costs recovered in the Cristobal rates? If not, why not? Have any private carriers offered to carry cargo from the U.S. east coast or west coast to the Canal Zone, rather than the Company moving the cargo overland to New Orleans for movement aboard the Cristobal?

Did the Company accept or reject these offers from private carriers, and if so, why?

In comparing the cost of moving cargo by private carriers with movements by the Cristobal, does the Company include the inland cost of getting that cargo to New Orleans? Would not transportation

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