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Railroad Industry Overview Series - Accounting Principles - October 2007

LMSB Control Number: LMSB-04-1007-072
Affected IRM: X.XX.X

This document is not an official pronouncement of the law or the position of the Service and cannot be used, or cited or relied upon as such.

V. Accounting Principles

A.  Regulatory Accounting

The Surface Transportation Board (STB) defines a Class I railroad as one whose gross operating revenue exceeds $319 million per year.  Class I railroads are required to file annual reports with the STB described as Forms R-1.  These reports summarize the accounting transactions for the year and are useful in planning and conducting a Class I tax examination.  Class II and Class III railroads are not required to file R-1 reports.  For definitions of Class I, II, and III railroads, see Section IV.A above.

Generally all railroads’ books of account are maintained in accordance with STB guidelines.  STB provides a chart of accounts for use in regulatory reporting.  The STB's accounting system is contained in the Code of Federal Regulations at Part 1201, Uniform System of Accounts (USOA).  Railroads are required to use the USOA system for regulatory reporting purposes.  For financial and accounting purposes, a railroad may also maintain its own unique system of accounting, separate from the STB system.  Nevertheless, reports to the STB must be in conformity with the USOA.

The USOA system details accounting requirements for selected types of transactions.  Following are some of the important rules followed for STB reporting purposes that may differ from proper tax treatment.  Section 2 of the USOA provides instructions for "Property Accounts" (assets).

  1. [1] The threshold is at $5,000 and prohibits the parceling of purchases in order to fall under the minimum.Assets that cost less than $5,000 are expensed for regulatory purposes.
  2. Section 2-6- provides rules for capitalization of direct and indirect costs used in construction, including:
    1. fringe benefits, payroll taxes,
    2. materials and supplies,
    3. work trains,
    4. transportation,
    5. personal injury and damages, and
    6. interest during construction (see Section 2-1(c).
  3. Section 2-8- additions of complete units of property, either road or equipment, are capital assets subject to the minimum rule.
  4. Section 2-9- additions of less than complete units of property when not in the form of replacements, are assets.In contrast, the replacement of less than a complete unit of property is maintenance.Rehabilitation costs of second hand assets acquired are capital.[This is consistent with proper tax accounting.]
  5. Section 2-11- costs of removal are maintenance expense, [2]  as are costs incurred during construction projects for traffic management, including temporary tracks and false work.
  6. Section 2-12- requires the capitalization of rebuild costs.Rebuild costs are defined as those costs incurred which substantially extend the service life or substantially increase the utility of depreciable property.
  7. Section 2-19- provides a three-page list of the "units of property" as referred to above.
  8. Section 2-21- provides instructions for accounting for freight car repairs including heavy program repairs.These are treated as maintenance expense; however, see 2-12 for exceptions in the case of rebuilds.

  9. Section 4-2- requires depreciation rates on a composite basis for each Property Account.The rates are established in accordance with depreciation studies conducted every three years for equipment and every six years for road property.These studies are generally performed by contractors and are only required of Class I roads.

  10. Special rules for "Property Accounts:

    1. Account 2 Land - The STB treatment of removal and relocation of buildings is maintenance expense.

    2. Account 9 Rails and other track materials (OTM) a list is provided of all OTM.Also a list of items considered maintenance is provided.Any work "…not involving the placement of track material…" is maintenance.

    3. Account 11 Ballast - surfacing (surface correction of existing ballast) is maintenance.

  11. Operating Expense Accounting Codes 
    A six-digit code is used for expense accounts, defined as follows.

    • First two digits - natural expense e.g. material, purchased services, loss and damage.
    • Second two digits - activity e.g. running, switching, loco, freight car, administrative.
    • Third two digits - function e.g. loco repairs, dismantling retired property, tunnel repair.
  12. Income Accounts - these are three-digit numbers beginning with digit 5.  Exception is "531" which is reserved for the aggregate railway operating expense total.
  13. Balance Sheet Accounts - these accounts are three-digit numbers beginning with 7.
    • Asset Accounts are 701-744.Liability Accounts are 751-786.
    • Account 731 contains all road and equipment property. Each railroad uses various sub accounts to segregate these assets.
    • Liability Accounts - Accounts 774-784 are accounts of importance to income tax balance sheet audits:
      1. Account 774 Accrued Liability, Casualty and Other Claims - this account shall be credited with the amounts charged to operating expense to provide for the estimated liabilities for claims for deaths or injuries…damage to property…losses of property…revenue overcharges.  Separate sub accounts must be maintained for each type of liability…If settlements for claims are charged to this account, the balances for each year shall be maintained separately.
      2. There is a disconnect in these estimated liability amounts and the amounts allowable as deductions under IRC Section 461.  See Section B. Tax Accounting, below.
      3. Accounts 783 and 784 provide for Deferred Revenue and Deferred Credits.

B. Tax Accounting

There are significant differences in proper tax accounting and the above regulatory accounting practices.  A properly prepared Schedule M-1 should reflect the amounts of these differences, but does not always do so.

A partial list of M-1s commonly found in railroad tax return filings is set forth below.  IRS and railroad taxpayers often are of different opinions as to the propriety of these M-1s and/or amounts of same.

1.  Expense claimed for book not tax

  • State Taxes
  • Fines and Penalties
  • Lobbying Expenses
  • Club Dues
  • Separation Accrual
  • Stock Options
  • Travel Limitations
  • Uniform Capitalization
  • Merger Costs
  • Environmental Reserve
  • Reserve Casualty Loss
  • Reserve Overcharge Claims
  • Assets < $5000 Cost

2.  Expense claimed for tax, not book

  • Roadway Repairs - primarily track, bridge, and structures
  • Equipment Repairs - primarily locomotive and freight car work
  • Bad Debts
  • Vacation Pay Accrual
  • Sick Leave Accrual
  • Amortization- Software
  • Amortization - Start Up Costs
  • Pension Accrual
  • Road Property Retired

3.  Income for book not tax

  • Tax Exempt Interest
  • Capital Loss Carryover

4.  Income for tax not book

[1] Note however, that track removal or “dismantling” costs are required to be debited to the depreciation reserve.

[2] 1 Road Property is distinguished in the railroad industry from Equipment Property.  It consists of all the property associated with the track right of way.  STB accounts 3, 5, 7, 13, 17, 18, 19, 20, 22, 23, 24, 25, 26, 27, 35, and part of 16, are all Road Property.  See U.S.O.A. for a listing of all accounts.

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Page Last Reviewed or Updated: 05-Mar-2015