PANAMA CANAL FINANCES WEDNESDAY, APRIL 7, 1976 HOUSE OF REPRESENTATIVES, COMMITTEE ON MERCHANT MARINE AND FISHERIES, Washington, D.C. The subcommittee met, pursuant to recess, at 10:05 a.m., in room 1334, Longworth House Office Building, Hon. Ralph H. Metcalfe (chairman of the subcommittee) presiding. Mr. METCALFE. The recessed hearings of the Subcommittee on the Panama Canal will please come to order. Madam Chairman and members, ladies and gentlemen, this is the second day of what we hope are very productive hearings on the finances of the Panama Canal. Yesterday the subcommittee heard from the Governor of the Canal Zone and the Assistant Secretary of the Army, as well as the National Maritime Union, whose president could not be here today. The Treasury Department and the General Accounting Office will file statements for the record of these hearings, and so we will have all the additional Executive agency comments from them. Today we have another group of distinguished witnesses. Arthur Andersen & Co., very well known financial experts, will lead off our testimony. We have the American Institute of Merchant Shipping, a key organization representing canal users, who will follow. The third witness today will be Sea-Land Service, one of the carriers which are major users of the canal. We will also hear from various labor organizations, represented by their leaders in the Canal Zone locals, as well as by the national representatives. Since we have so many groups representing organized labor interests today, we have decided to ask that each labor group limit their testimony to ten minutes, and with unanimous consent we will proceed to hear each of the groups and their representatives, and we shall not attempt to unduly interrupt their presentations. Following all their presentations the representatives of all the labor groups, whom we will ask to sit at the witness table as a panel, will discuss the canal's financial problems, and how this matter relates to them and their organizations. We also will hear from the Civic Councils of the Canal Zone. I want to emphasize that the subcommittee is intent in its desire to help solve these financial and employee problems. We want to listen closely to all the groups who come before us. Now that we have set the stage for today's deliberations, let us welcome Mr. Leonard J. Kujawa and Mr. Donald Kane, unless the ranking minority member from Kentucky, or Madam Chairman, have anything that they would like to offer at this point. Mrs. SULLIVAN. I have nothing. Mr. SNYDER. I have no statement. Mr. METCALFE. Then may we hear from you, Mr. Kujawa and Mr. Donald Kane? Please identify yourselves for the record. STATEMENT OF LEONARD J. KUJAWA, PARTNER IN ARTHUR ANDERSEN & CO., CERTIFIED PUBLIC ACCOUNTANTS, ACCOMPANIED BY DONALD V. KANE, PARTNER IN THE WASHINGTON, D.C. OFFICE Mr. KUJAWA. My name is Leonard J. Kujawa. I am a partner in Arthur Andersen & Co. I am a certified public accountant, and am a member of the American Institute of Certified Public Accountants and several other professional societies and organizations. My entire 20 years of professional experience have been concerned with rate regulated public utilities and major governmental organizations. My clients include some of the largest public utilities in the United States. I am accompanied by my partner Mr. Donald V. Kane, who is a member of our Washington office, dedicated to rendering professional services to departments and agencies of the U.S. Government. As a matter of further background I have been a consultant to the Panama Canal Company on various financial and accounting matters since 1962. As an expert witness I previously testified before this committee on two occasions, and it is a pleasure that I appear before you again at your invitation. My firm, Authur Andersen & Co., is an international firm of independent public accountants with 49 offices in the United States, and 57 offices in 34 other countries. Our personnel number in excess of 14,000. We serve approximately 50,000 clients, and are among the largest of public accounting firms in the world. Our relationship with the Panama Canal Company started in 1951 when we assisted in the determination of the initial accountability for the property which was to be assumed by the newly formed federally chartered Panama Canal Company. Our work for the Panama Canal Company has included tolls, tonnage systems, computerization programs, and the subject of my testimony this morning, which is accounting and financial matters. My testimony and the summarization I will give this morning are in the interest of time, and therefore I request that my prepared testimony become a part of the record at this point in these hearings. Mr. METCALFE. Without objection, it is so ordered. [The following was received for the record:] PREPARED STATEMENT OF LEONARD J. KUJAWA OF ARTHUR ANDERSON & Co. My name is Leonard J. Kujawa. I am a partner in Arthur Andersen & Co. I am a certified public accountant and am a member of the American Institute of Certified Public Accountants and several other professional societies and organizations. My entire 20 years of professional accounting experience has been concentrated on work for rate-regulated utilities and governmental organizations. Among private companies I have responsibility for my firm's work for the railroad industry and my clients include United Air Lines, Chicago and North Western Transportation Company and several other major rate-regulated utilities. In the governmental sector I had responsibility for my firm's substantial engagement as financial and accounting advisors during the organization phase of Amtrak and I am responsible for my firm's work for the Chicago Board of Education and several other government clients. Regarding the Panama Canal Company, I have been a consultant on various financial and accounting matters since 1962. As an expert witness I have previously testified before this Subcommittee on two occasions regarding toll matters. In addition, I have testified before various Federal and state regulatory bodies, Federal .courts and the National Arbitration Board. I am accompanied by Mr. Donald V. Kane, a partner in our Washington, D.C., office. Mr. Kane joined the firm in 1945. He is a certified public accountant in Maryland and numerous other states, a member of the American Institute of Certified Public Accountants, the American Accounting Association and numerous other professional organizations. He is a member of the Greater Baltimore Committee, the Chamber of Commerce of Baltimore and other civic organizations. Mr. Kane is a member of our Washington, D.C., organization dedicated to rendering professional services to departments and agencies of the United States Government. He has had extensive practice in the areas of operating and capital cost studies, capital financing programs, subsidy evaluations, shortand long-range rate-making studies, cost accounting principles, financial reporting and information systems and electronic data processing, and has provided expert testimony to many different levels and types of government agencies and courts on these matters. Arthur Andersen & Co. is an international firm of independent public accountants with 49 offices in the United States and 57 offices in 34 other countries. Our personnel number in excess of 14,000. We serve approximately 50,000 clients and are among the largest of public accounting firms in the world. Our relationship with the Panama Canal Company started in 1951 when we assisted in the determination of the initial accountability for the property which was to be assumed by the newly formed Federally chartered Panama Canal Company. Of more immediate significance is the work we have done through continuous engagements for the Company from 1962 to the present time. Following is a brief description of some of our work: 1. We have consulted with the Company and prepared extensive studies to determine the most appropriate method to assess tolls on individual ships for the use of the Panama Canal. 2. We have performed an evaluation of the universal measurement system developed by the Inter-Governmental Maritime Consultive Organization, an -agency of the United Nations. The universal measurement system is now in the final adoption process by the various governments of the world as a replacement for existing national tonnage systems. It should be considered as a possible substitute for the Panama Canal and Suez tonnage systems which have been separately developed as a basis for assessing ships for the use of these respective canals. Our studies involving an evaluation of the possible problems for canals and ports in adopting the universal measurement system are the most extensive of any studies available in the world. 3. We recently assisted in the change in the level of tolls to reflect increased costs of operation. This was the first toll increase in the history of the Panama Canal. 4. We assisted the Company in the initial feasibility studies regarding computerization of many data processing activities. This included the selection of a computer, the training of personnel and the application of computer-based systems to the many diverse activities of the Panama Canal. 5. We assisted in developing its management reporting system for the purpose of controlling and reporting costs to all levels of management. 6. We have reviewed certain of the Company's accounting policies with respect to cost recognition. Such reviews principally focused upon the adherence of such policies to generally accepted accounting principles, considering that the Company is similar to a rate-regulated public utility from a legal viewpoint. 7. Reports we have issued over the last few years to the Panama Canal Company include: Report On Development Of Tolls Analytical Data (May, 1969), Report On Impact Of Universal Measurement System (March, 1970), Report on Development and Evaluation of Tolls Policies And Alternative Systems (November, 1970), Accounting For The Cost of Excavations (April, 1972), Evaluation of Accounting Policy Changes During Fiscal Year 1973 (August, 1973), Reevaluation Of Universal Measurement System (October, 1974). SUMMARY OF TESTIMONY It should be noted that we are not the Company's auditors and, accordingly, we have not expressed an opinion on its financial statements as of any date or for any period. The thrust of my testimony today is that there are no fundamental flaws in the financial structure of the Panama Canal Company. A review of the Company's financial history will show that it has been a financial success in sharp. contrast with other governmental bodies such as the U.S. Postal Service, ConRail and Amtrak, which were initiated with great optimism but soon came back to Congress for large sums of Federal subsidies. Contributing to the financial success of the Company has been its sound accounting policies which properly recognize all costs so that tolls can be set at levels to recover costs and maintain the Company's financial health. We do not find toll increases of the magnitude made by the Company to be shocking, but rather necessary and not uncommon in the inflation-impacted era being experienced by economic entities around the world. Throughout our years of association with the Company, we have observed and, to a certain degree, admired the ability of the Company to finance its operations and generate sufficient capital internally to replace and expand Canal facilities as ever-increasing demands were placed upon its capacity to render service. The high quality of Panama Canal service has continued unimpaired from the date our relationship with the Company began. Since its organization in the early 1950's, the Company has never had to seek further financial assistance from the Congress and has increased toll rates only once. In an era when government has had to subsidize an ever-increasing segment of our economy and when prices for most goods and services have risen almost constantly, this is quite an achievement. The fundamental economic factor contributing to this success has been traffic growth. Credit for this accomplishment should also be given to the Congress in the wisdom and foresight of its legislation governing the financial affairs of the Company, as well as management of the Company, which has adapted to continuous changes in the economic environment in which it operates. The fact that the Company has been able to sustain itself and, through recycling of its own capital, maintain and improve the facilities of the Canal, has benefited: 1. The shipping industry through relatively stable rates. 2. The employees of the Company whose substantial wage increases over a period of time have been financed through revenues, and particularly the Panamanian employees who are now paid based on U.S. wage standards. 3. The economy of the Republic of Panama through the funds that pass through its citizen employees and businesses that are generated initially by Panama Canal revenues. 4. Consumers worldwide who must ultimately bear the burden of Canal tolls through the prices they pay for goods shipped through the Canal. 5. The U.S. Government and its taxpayers who have not been required to subsidize the world trade that enjoys the benefits of Panama Canal world service. SIGNIFICANCE OF RATE REGULATION The difference between regulated and nonregulated businesses arises as a result of the capital intensity of regulated types of business. In commercial businesses, substantially less relative capital is required and duplicate facilities are prudent considering the pressures that free competition brings to the competitors in the business. To have such free competition in regulated public utilities or in a capital-intensitive canal would require more than one utility or canal to serve each locality of customer and the capital requirement would be completely prohibitive. No group of customers could afford two Panama Canals competing with one another in order to get lower prices. Such an economic structure was proven to be completely imprudent in the early days of construction of public utilities in the United States. As a substitute for this competition, the states organized regulatory commissions to grant rights to serve customers in certain geographic areas and to establish fair prices to be charged for the services since competition could not be relied upon to serve that function. The early legislation at the beginning of this century for regulated businesses recognized that it was necessary to allow costs for rate-making purposes to include both the recovery of capital (depreciation) and return on capital. Only after recovery of the cost dedicated to the capital service facilities and the cost of serving that capital could the companies be kept whole, maintained on a solvent basis and kept viable so as to be able to serve the customers' needs and the purpose of the legislative bodies in creating the regulatory commissions and the utility enterprises. THE TOLLS AND FORMULA AND COST RECOGNITION The U.S. Congress has legislatively required the Panama Canal Company to be a self-sustaining entity whose operations are financed through user charges. This requirement is set forth in Section 412 of Title 2 of the Canal Zone Code which provides the formula for tolls. Under this statutory formula, tolls are required to be set at rates calculated to cover, as nearly as practicable, all costs of maintaining and operating the Panama Canal and the facilities and appurtenances related thereto, including interest, depreciation and an appropriate share of the net costs of operation of the Canal Zone Government. The legislation, in our opinion, causes the Company to be similar to a rateregulated public utility, such as an electric or gas company, a railroad or airline. The type of costs incurred by the public utility is no different than the costs incurred by any nonregulated entity. They consist of (1) cash costs, such as labor and materials; (2) capital costs recognized through depreciation (which, simply put, is an allocation of labor and material costs over an estimated period during which the benefits of those costs will be realized); and (3) return on capital recognized as interest and/or dividends which constitute compensation to the investor who provided the funds which were transformed into revenue-producing assets. Since all costs of maintaining and operating the Panama Canal must be recognized to comply with the provisions of the statutory tolls formula, it is important that the term "cost" be thoroughly understood. The American Institute of Certified Public Accountants has defined "cost" in its Accounting Terminology Bulletin No. 4 as follows: "Cost is the amount, measured in money, of cash expended or other property transferred, capital stock issued, services performed, or a liability incurred, in consideration of goods or services received or to be received. Costs can be classified as unexpired or expired. Unexpired costs (assets) are those which are applicable to the production of future revenues. Examples of such unexpired costs are inventories, prepaid expenses, plant, investments, and deferred charges. Expired costs are those which are not applicable to the production of future revenues, and for that reason are treated as deductions from current revenues or are charges against retained earnings. Examples of such expired costs are costs of products or other assets sold or disposed of, and current expenses. Unexpired costs may be transferred from one classification to another before becoming expired costs as above defined, e.g., depreciation or insurance on plant may be included in unexpired costs ascribed to inventories." CASH FLOW IS CRITICAL TO CONTINUING FINANCIAL HEALTH In a manner similar to any business entity, the cash flow provides the means to maintain the financial health of the Panama Canal Company. From an accounting standpoint, the tolls formula requires that all costs of maintaining and operating the Panama Canal be recognized (reflected in the accounting records), for costs which are not recognized cannot reasonably be reckoned with in the tolls setting process. It should be appreciated that the accounting process for a rate-regulated public utility such as the Panama Canal Company has special significance in that the level of costs recognized through the accounting process establishes the level of the price to be charged for the service. Thus, the accounting process has a direct relationship on the actual cash received. This is in contrast to a profit-oriented company wherein |