Building the Union Pacific Railroad: a study of mid-nineteenth-century railroad construction accounting and reporting practices

Abstract

America's greatest technological achievement of the nineteenth century was the completion of the transcontinental railroad. The ensuing political scandal over the disposition of millions of dollars in government bonds led to congressional hearings that revealed accounting and reporting practices for construction contracts that obscured the relationship between the two companies involved – the Union Pacific Railroad Company and the Credit Mobilier of America. Some of the accounting practices, such as the reporting of assets, liabilities, and capital matched contemporary practices of the mid-nineteenth century. Other practices, such as accounting for stock dividends and bond discounts, may have been first employed by the two organizations, but some eventually made their way into common practice among railroads of that era.

Keywords:

• Credit Mobilier of America
• early railroad accounting
• financial fraud
• Union Pacific Railroad

Notes

For example, a UPRC contract ledger included a monthly construction trial balance that also reconciled with the CMA results.

Leonard was the historian at the UPRC who preserved the documents and correspondence related to the Union Pacific Railroad's construction period.

The reimbursement rate set by the law was to be $16,000 per mile in bonds for flat prairie lands such as Nebraska, $32,000 per mile for the foothill terrain and the high-plains between the Rockies and the Sierras, and $48,000 per mile the mountains.

The federal government developed this financing scheme because it did not have the cash necessary to build the railroad and, concurrently, fight the Civil War.

Doc Durant's penchant for greed and corruption were already apparent at this early stage of the venture, when he changed the route of the railroad to gain 50 additional miles in government subsidy bonds.

For example, the Wilson Committee found evidence that Durant used UPRC money to facilitate the passage of the 1864 Act.

The 1862 Act mandated track grades of no more than 116 feet causing more grading, no curves over 10 degrees eliminating switchbacks and forcing costly tunneling. It also required use of more expensive American-made iron tracks because Republican Thaddeus Stevens owned a track foundry in Pennsylvania (Ambrose 2000, 78).

Durant adopted the name Crédit Mobilier from a French joint stock company that originally was a symbol of progress and change in mid-nineteenth-century France. However, a scandal brought down the French company and the stock became nearly worthless.

Reconciliation confirmed the profit margin of 40% noted in the Leonard Collection (Box 20) dated from 1 December 1866, with $12,645,000 in construction charges to the UPRC, together with $401,000 in interest earned and $7,984,000 construction expenses incurred by CMA, leaving $5,063,000 in profits.

It was at this junction that the feeder lines would come north from Kansas City and south from Sioux City, South Dakota.

Crane created the exhibits by updating April 1870 balance sheets from the CMA's contract ledger (Leonard Collection).

The author is sensitive to the fact that one cannot expect accounting practices in days gone by to conform to current US GAAP. Nevertheless, current-day practices do provide a useful yardstick for better understanding the Ames contract balance sheet and other late-nineteenth-century financial statements presented in this paper.

The Chesapeake and Ohio Canal Company (1881) presented a similar balance sheet in 1881 to show the closing balances of major accounts as part of its presentation to stockholders.

Calculated as: $19.9 million dividends + $1.3 million allotment (future dividends) ÷ $29.9 million estimated profits.

Crane's reconciliation of the sales of UPRC shares to provide a dividend for CMA shareholders shows that the UPRC shares only garnered 40% of par value as follows: 28,125 shares x $100 par per share = $2,812,500 par value.

This would be similar to issuing $10 million in common shares in an arms-length transaction for a company worth $5 million with a resulting problem of accounting for goodwill to balance the transaction. In this case of the CMA and the UPRC, there was anything but an arms-length transaction involved.

For a nineteenth-century perspective of this issue, see Greene (1891).

The Davis contract balance was $24,552,000 in 1873, but the corresponding 1870 document indicated a balance of $20,063,000. The difference was $3 million in UPRC stock charges and $1.5 million in additional cash charges to Kennedy.

See Consolidated Edison, Inc. 2005 annual report p. 59 for an example of this reporting practice.

Though investors would not receive current income from the bonds, they could sell then on the New York market. According to the newly started Wall Street Journal (1891, 4) they sold at a premium in excess of 20% of par.

Based on the railroad act's hold 5% back clause, the government felt that the railroad had sufficient income to pay the bond's semi-annual interest and begin repaying the principal. It sued on behalf of the bondholders to force current payment of interest, which was not due for 25 years. In US v. Union Pacific (91 US 72), the Supreme Court agreed with the UPRC and ruled that there was no Congressional intent for the railroad to pay the interest (or the principle) before maturity. The Congress tried to circumvent the ruling and passed legislation in 1878 that required the UPRC to create a sinking fund for the future payment of the bonds. In Sinking Fund Cases (95 US 700), the court ruled in favour of the government and ordered the UPRC to set up a sinking fund. In the late 1890s the UPRC agreed to pay back more than $63 million in principal and another $104 million in interest to the federal treasury (Henry 1945, 182), which prompted one writer of the era to quip: ‘for the government, the whole outcome has financially been not less than brilliant’ (Meyer 1899, 443–4).

This practice would be contrary to modern corporate reporting, which would have shown a direct offset to the equity account on the UPRC balance sheet.

This may have been a mistake on Ham's part, because the CMA (and not the UPRC) appears to have absorbed the majority of securities discounts, unless, of course, he understood, like the Committee, that the two companies were actually one at this point.

(Bonds) $11,310,900.00 + ($24,000,000 UPRC stock at 30) $7,200,000.00 + (cash) $2,346,195.00 + (Hoxie $1,125,000 first mortgage bonds at 85) $956,250.00 + ($5,147,232.71 stock at 30) $1,544,169.81 = CMA cash profits $23,357,514.81.

(First Mortgage bonds $27,213,000.00 – discount $3,494,991.23 = $23,718,008.77) + (Government Bonds $27,236,512.00 – discount 91,348.72 = $27,145,163.28) = $50,863,172.05 – Cost of Road $50,720,958.94 = Excess of Receipts from Bonds over cost of Road $142,213.11.

Page 240 of the UPRC ledger from January to July 1868 listed most of the dividend distributions.

Other sources may have been the completed Hoxie contract or the yet unfinished Davis contract.

The CMA based the amount of dividends on a percentage of the approximately $3,750,000 of CMA capital. For example, a 60% dividend would mean a payout of $2,500,000.

According to the Committee, this last estimated dividend was made up of 2750 first mortgage bonds for $2,750,000 + 2750 land grant bonds for $2,750,000 + $7,800,000 in income bonds issued at 80 for a total of $13,300,000 or an amount substantially equal to the Davis contract's profit and loss account.

For an explanation of the complex legal negotiations preceding dissolution of the CMA in 1890, see White (1894, 80) and editorial in the New York Times (1890).

These are similar to sanctions included in the Sarbanes–Oxley act of 2002 to control misdeeds among corporate officers.