Dr. Stephen A. Zeff;xNLx;Rice University
Prior to the early 1930s, there was only the New York Stock Exchange to encourage its listed companies to provide fuller financial disclosure, especially in the form of audited financial statements. By the end of the 1920s, the Exchange succeeded in persuading most of its listed companies to have their annual financial statements audited – yet there was great variation among companies in the content of the statements. The Stock Market Boom and Crash in the 1920s led many critics to argue that a precipitating factor was the lack of reliable financial information – many financial statements were skeletal, and often an income statement was omitted.
Following the Stock Market Crash of 1929, an American Institute of Accountants’ special committee, in correspondence with the New York Stock Exchange, recommends five ‘broad principles of accounting which have won fairly general acceptance’ and introduces the passage ‘[the financial statements] fairly present, in accordance with accepted principles of accounting consistently maintained’ in the auditor’s report. These five ‘broad principles,’ plus a sixth, are approved by the Institute’s membership. The purpose is to improve accounting practice.
Congress completes approval of two major Securities Acts to restore public and investor confidence in the fairness of the securities markets after the Stock Market Crash of 1929; and creates the Securities and Exchange Commission with authority to prescribe ‘the methods to be followed in the preparation of [financial] reports’. The SEC becomes a strict regulator and insists on comparability, full disclosure and transparency. In 1935, the SEC creates the Office of the Chief Accountant. The SEC insists upon historical cost accounting so that the financial statements do not contain ‘misleading disclosures.’ One of the important units created in the SEC is the Division of Corporation Finance, which is charged with reviewing periodic filings by companies to determine whether they satisfy the SEC’s requirements, especially for conformity with proper accounting, full disclosure and comparability.
SEC issues its first Accounting Series Release, which conveys the Commission’s views on accounting and auditing. They become known as Financial Reporting Releases in 1982.
SEC issues its first Accounting Series Release, which conveys the Commission’s views on accounting and auditing. They become known as Financial Reporting Releases in 1982. SEC, by a narrow vote, supports a reliance on the private sector to establish GAAP. Under pressure from the SEC’s chief accountant, the Institute’s Committee on Accounting Procedure begins issuing Accounting Research Bulletins to provide the SEC with ‘substantial authoritative support’ for proper accounting practice. The Committee is composed of practitioners and three accounting academics, all serving on a part-time basis, with a small research staff. Dissents are to be recorded. Congress permits companies to use a new inventory method, LIFO, for income tax purposes only if LIFO is also used in all corporate reports. There is immediate pressure to allow LIFO as an accepted practice for financial reporting purposes. An Institute committee recommends the wording, ‘present fairly…in conformity with generally accepted accounting principles’ in the standard form of the auditor’s report.
AAA publishes Professors W.A. Paton and A.C. Littleton’s monograph, An Introduction to Corporate Accounting Standards, which is an eloquent defense of historical cost accounting. The monograph provides a persuasive rationale for conventional accounting practice, and copies are widely distributed to all members of the Institute. The Paton and Littleton monograph, as it came to be known, popularizes the ‘matching principle,’ which places primary emphasis on the matching of costs with revenues, with assets and liabilities being dependent on the outcome of this matching. During the decade, the Committee on Accounting Procedure frequently allows the use of alternative accounting methods when there is diversity of accepted practice.
The committee issues ARB 29, which allows FIFO, LIFO and average; LIFO is accepted primarily because of its acceptability for income tax purposes. Committee issues ARB 32, which favors the ‘current operating performance’ concept of the income statement, thus displaying ‘unusual’ and ‘extraordinary’ items after net income; the SEC chief accountant, favoring the ‘all-inclusive’ income statement, threatens not to enforce the ARB.
Contrary to pressure from some major companies, the Committee opposes use of inflation-adjusted depreciation expense except in supplementary disclosures, a view that the SEC supports. Committee reaffirms this view in 1953. In 1947-49, major companies were trying to persuade Congress to allow replacement cost depreciation for income tax purposes, and they hoped that an ARB in support of that position would strengthen their argument. The companies were also trying to resist labor unions’ claims for wage increases based on overstated profits during a sharp inflation.
Leonard Spacek, managing partner of Arthur Andersen & Co., begins to criticize the Committee on Accounting Procedure for allowing alternative accounting methods. This reflects a philosophical split among big accounting firms: uniformity versus flexibility.
Congress amends the Internal Revenue Code to allow companies to use accelerated historical cost depreciation for income tax purposes. Many companies adopt faster depreciation for taxes but continue to use straight line depreciation in their financial statements, making ‘deferred tax accounting’ an important issue.
