Ideology and reality in accounting: a Marxist history of the
US accounting theory debate from the late 19th century to the
FASB’s conceptual framework ∗
R.A. Bryer,
Warwick Business School.
Abstract
The paper explores the US accounting theory debate that started in the late 19th century to the FASB’s
conceptual framework. It argues that this debate did not lead to ‘generally accepted accounting
principles’ because it was between irreconcilable theories of value; between the theorists of practical
accounting who deployed an inchoate labour theory of value (LTV) and economists committed to the
marginalist theory of value. Driving it was a growing contradiction between the demand from investors
that management report ‘economic reality’ and their need for a theory of accounting that denied (a) that
the origin of profit is exploited labour, and (b) that there is any contradiction between the social
production of wealth and its private appropriation by relatively few individuals. Part 1 examines the
debate from the late 19th century when large, widely held corporations first appeared in the USA, to the
stock market crash in 1929, when they were dominant. Throughout this period and beyond, US
corporate capitalism faced strong opposition from the commercial and middle classes, farmers, and
hostile workers and trade unions with socialist aspirations, and needed an ideology of profit. It was in
this context that the accounting theory debate began with Fisher’s (1906) critique of accounting and the
accountants’ repost by Sprague (1907); it flourished with major contributions by Hatfield (1909, 1927),
Paton (1918, 1922), Littleton (1928, 1929), and concluded with the elaboration of Fisher’s theory by
Canning (1929). Part 2 examines the debate from the Securities Acts 1933 and 1934 to the FASB’s
conceptual framework. After the 1929 crash and evidence of accounting manipulations, investors
demanded that accountants spell out their ‘generally accepted accounting principles’. Paton and
Littleton’s (1940) response, supported by May (1943) and others, was a victory for practical
accountants, but their failure to produce an articulated theory left intractable problems for regulators
that mounted in the 1960s, and left the accountants’ ‘principles’ defenceless against criticisms from
economists. The paper argues these criticisms were ideologically motivated because they (a) denied the
exploitative origin of profit by suppressing the idea that cost + profit = price, and (b) denied the
contradiction between the social production and individual appropriation of profit by arguing that
accounting should provide ‘decision-relevant’ information to help individual investors make ‘rational
economic decisions’. The result was the FASB’s conceptual framework that, despite a massive
‘educational’ effort is still not generally accepted. The paper concludes that because capitalism’s
contradictions create the need for ideology rather than reality in accounting theory, and for reality rather
than ideology in accounting practice, so long as capitalism survives, accountants will never have
‘generally accepted accounting principles’.
“As far as the individual capitalist is concerned, it is evident enough that the only thing that
interests him is the ratio of surplus-value…to the total capital advanced…, whereas not only do
the specific ratios of this excess value to the particular components of his capital, and its inner
connections with them, not interest him, but it is actually in his interest to disguise these
particular ratios and inner connections” (Marx, 1981, p.134).
Why is there no generally accepted theory of accounting? The answer, according to
most scholars of accounting, is that the complexity of modern society, the economy
and business, has so far defeated our simple models. Another possible answer,
pursued here, is that if Marx’s labour theory of value (LTV) is true, a generally
∗
Working draft. Please do not quote.
2
accepted theory of accounting is impossible within capitalism. This is because wouldbe accounting theorists would then face two irreconcilable demands from capitalists.
The theory must portray ‘reality’, that is, reveal the realisation of surplus value, but it
must deny that the origin of profit is the exploitation of labour and the contradiction
between the social production of surplus and its private appropriation by relatively few
individuals. The paper explores the hypothesis that these irreconcilable demands
drove the long debate in the USA on ‘generally accepted accounting principles’ from
around 1900 to the Financial Accounting Standard Board’s (FASB’s) conceptual
framework today, and that they explain its structure and ‘technical’ details, issues
which existing histories avoid wherever possible.
Marx argued that the origin of profit was exploited labour even under conditions of
‘equal exchange’, where the long-run market price of all commodities (including
labour power) equals the money value of the amount of ‘socially necessary labour
time’ (defined later) it contains. As the worker gets less in wages than the value he or
she produces, profit exploits the worker because the capitalist gets something for
nothing. Possibly because from the late 19th century acceptance of this theory
threatened a new capitalist order facing a hostile ‘populist’ movement and workers and
trade unions with socialist aspirations, to “disprove Marx, or destroy his arguments
about the origins of profits in exploitation, became almost an intellectual crusade over
all Europe and North America” (Desai, 2002, p.61). The ‘disproof’ was neoclassical
(or marginal) economics. Whereas Marx and the classical economists argued that
commodities had objective use-values whose exchange values depend on the social
value of the labour to produce them, the marginalists’ “key insight was that exchange
value was explained by…the utility (use-value) derived from an extra unit of a
commodity they consumed” (Desai, 2002, p.187). Marginalism ‘disproved’ Marx,
therefore, by dropping the ideas of socially necessary labour and objective use-value
and replacing them with subjective use-value, with ‘utility’, the individual’s sense of
satisfaction from consumption. As money ‘profit’ measures the excess of the utility of
consumption over the disutility of production, it does not reveal exploitation, but the
capitalist’s ability to satisfy consumer wants by efficiently organising production in
competitive markets. In addition to ‘disproving’ Marx’s exploitation theory of profit,
therefore, neo-classical economics justifies who gets it – the ‘rational’ capitalist who
serves the needs of consumers.
The need to justify the capitalist’s appropriation of profit arose because, long before
James Burnham claimed to have discovered the ‘managerial revolution’, Marx pointed
out that capitalists perform two economic functions, supplying capital and organising
production for profit, which separated as capitalism matured (Rosdolsky, 1977):
“Stock companies in general – developed with the credit system – have an
increasing tendency to separate this work of management as a function from
the ownership of capital, be it self-owned or borrowed” (Marx, 1959, p.380).
Marx called the provider of capital the ‘money capitalist’, and the provider of
management the ‘industrial capitalist’. The money capitalist and the industrial
capitalist were initially the same person, but the growing scale of industry led to their
separation. Therefore, the other great contradiction in capitalism for Marx is between
the social production of wealth and its private appropriation by money capitalists who
3
are superfluous because they do no work. This threatens to become transparent when
capital becomes ‘total social capital’, when managers run large corporations and
capitalist investors passively hold well-diversified portfolios of all companies, when
“all excuses [for profit] more or less still justified under capitalist production,
disappear” (Marx, 1998, p.437). Holding well-diversified portfolios turns the
‘industrial capitalist’ into a ‘money capitalist’ who now holds only a fragment of social
capital, and turns the manager into “a worker, compared to the money capitalist, but a
worker in the sense of capitalist, i.e., an exploiter of the labour of others” (1998,
p.385). 1 When this happened, particularly during the second half of the 19th century,
all vestiges of the argument that profit was the capitalist’s reward for organising
production, for the capitalist’s labour, the so-called ‘profit of enterprise’ or ‘wages of
superintendence’, disappeared:
“The control over social capital, not the individual capital of his own gives him
control over social labour. … What the … [manager] risks is social property,
not his own” (Marx, 1998, p.437).
With the growth of the capital market (part of Marx’s ‘credit system’), “money capital
itself assumes a social character…, and since…only the functionary remains…the
capitalist disappears as superfluous from the production process” (Marx, 1998, p.386,
see also pp.437-438). 2
Building on earlier work, the paper argues that the most serious problem facing the
would-be accounting theorist is that underlying commonly accepted accounting
‘principles’ – capital maintenance, cost-based measurement, lower of cost or market
(L-C-M), realisation, matching, full cost absorption, etc. – is an inchoate LTV (Bryer,
1994, 1998, 1999a, 1999b, 2006).
‘Inchoate’ means ‘just begun, incipient,
undeveloped, immature’ (Onions, 1973, Vol.1, p.1044), not articulated from explicit
premises. The paper argues that the contradiction between investors’ need for an
articulated theory of accounting based on the LTV and its ideological unacceptability
drove the debate between theorists of practical accounting whose strength was their
realism, and economists committed to the marginalist theory of value, whose attraction
was and remains its ideological suppression of the contradictions of capitalism. 3
1
The paper uses the terms ‘socialised’ and ‘social capital’ to describe a continuum from recognisably
social to what Marx called “total social capital” (e.g., Marx, 1988, p.23). Socialised capital involves
pooling across a limited number of investors for limited purposes. Capital becomes social by losing its
identity with its owner, but with socialised capital there are restrictions on who can invest in the capital
and its purposes – on the transferability and the uses of capital. For example, a partnership where the
entry of a new partner requires the agreement of the other partners. By contrast, at its upper limit fully
social capital involves pooling across all investors and all investments. All members of an investing
society can participate in a social capital; the capital is freely usable for any lawful business; and is
freely transferable – for example, marketable government debt and listed shares. Here the identity of
the owner with the functioning of capital disappears and the social restrictions are minimal.
2
Although economists often say that investors perform the useful economic function of ‘risk-taking’,
the evidence is that investors who hold well-diversified portfolios bear little long-term risk, and in the
short term never more than society as a whole. For example, Dimson, Marsh and Staunton (2002)
calculate an annualised real return on equities for the whole of the 20th century for 16 countries of 9%
per annum.
3
By ‘ideology’, I mean Marx’s claim that bourgeois economics distorts reality in the interests of
capitalists by covering up the origin of profit in surplus value (cf. Chiapello, 2003).
4
Part 1 examines the debate from the late 19th century to the stock market crash of 1929.
Its genesis was the appearance and rapid growth of ‘big business’, large, widely held
manufacturing companies, where social capital appeared on a grand scale. Whereas in
1900 some 500,000 individuals owned common shares listed on the New York Stock
Exchange, by 1930 there were 10 million (Hawkins, 1963, p.145). In the late 19th
century, US accountants copied the British ‘going-concern’ theory and its solution to
the dilemma between the need to disclose full information to investors and the ‘labour
danger’ (for UK evidence see Bryer, 1993). This was the problem, which arose as an
acute form in the US around the turn of the century, that disclosure of the profitability
of the new giant corporations could provoke already severe labour problems and
challenges to the capitalist system. Part 1 shows that in response to the complex
accountability and ideological problems posed by the appearance of big business and
social capital, several US theorists went beyond the British theory and formulated a
‘proprietary’ theory of accounting. To provide the intellectual context for this debate,
it explains how Marx’s LTV articulates the accountants’ ‘principles’. Fisher (1906,
1930a, 1930b) and Canning (1929) criticized accounting principles and argued for a
neo-classically inspired ‘economic income’ accounting. Sprague (1907), Hatfield
(1909, 1927), Paton (1918, 1922) and Littleton (1928, 1929) responded to the
historical context and to the criticism with reformulations of the ‘principles’ of
accounting practice that were to varying degrees consistent with an inchoate LTV and
with neo-classical economic theory. Sprague’s LTV realism posed a serious
ideological problem for capital. Fisher, Paton and Littleton were openly hostile to the
LTV. Fisher aimed his theory of accounting as an answer to Marx, and Littleton,
Paton, and later Paton and Littleton (1940), disavowed the LTV while implicitly
accepting some of its features. Part 1 concludes that because proponents of
‘matching’, ‘realization’, etc., did not articulate Marx’s idea of ‘socially necessary
labour time’ and his distinction between ‘productive’ and ‘unproductive’ labour, their
principles, while often practical and popular with accountants, were ultimately vague
and inconsistent. Ideologically driven loose accounting theory opened the door to the
manipulation of accounts and underwrote the loose accounting practices that
contributed to the stock market boom of the 1920s and therefore to the Great Crash of
1929.
The wrath of investors after the Great Crash of 1929 pushed US accountants beyond
the British going-concern theory system of auditing. Instead of relying on voluntary
independent audits to certify that management had not paid dividends from capital, the
Securities Acts of 1933 and 1934 required auditors to certify that accounts used
‘generally accepted accounting principles’ (GAAP). This meant the accounting
authorities had to spell out these principles. Part 2 shows that the accountants
responded with a more sophisticated but still inchoate LTV, and that this underlay the
‘matching’ and ‘realization’ principles developed by Paton and Littleton (1940).
However, as the number of problems multiplied, so did the economists’ criticisms.
Simultaneously, academic efforts increased to explain away the contradiction between
social labour and private wealth revealed by the separation of ownership from control.
US academics first claimed that as management now controlled corporations, the
problem had disappeared, as capitalism no longer existed. When soaring profits and
burgeoning capital markets made this argument implausible, and over-mighty
management made it undesirable, they argued that a well-informed, ‘rational’ capital
market disciplines management to behave as an individual owner-manager-
5
entrepreneur would. Feeding on these arguments, after a sustained attack on
accountants’ principles and a growing number of unresolved problems of practice, the
profession set up the ‘Trueblood Committee’ whose report on the Objectives of
Financial Statements justified the private appropriation of profit by arguing that the
economic function of accounting was its ‘decision-relevance’. This idea, along with
Fisher and Canning’s theories, gave the FASB the ideas it needed to suppress ‘revenue
and expense’ accounting along with almost the last remnants of the LTV.
However, the debate continues because the FASB’s conceptual framework is not
‘generally accepted’. While “the idea of a conceptual framework generally has been
favourably received, the standards that have resulted from its application often have
met with significant resistance” (Storey and Storey, 1998, Preface). The paper
concludes that accountants will never have ‘generally accepted principles’ because the
theory that best explains the social reality they face in practice, Marx’s LTV, is
ideologically unacceptable.
Part 1: From rise of ‘big business’ to the stock market crash of 1929
The historical context in which US accounting theorists debated from the end of the
19th century was the rise of ‘big business’ and with it intense conflict between capital
and labour. From the 1880s to the 1930s, the US completed the transition from an
economy dominated by commerce, small owner-controlled farms and manufacturing
enterprises based on artisan labour, into one dominated by giant corporations owned
by a large number of shareholders, run by professional managers (Navin and Sears,
1955; Chandler, 1959, 1962, 1977; Werner, 1981; Roy, 1997; Cheffins, 2004; Hannah,
2007). This transition provoked widespread resistance and social and labour unrest,
creating the need for an ideological justification of profit and practical and theoretical
problems for accountants.
Big business and social conflict
In the 1860s, the typical American business was small, family-owned or a partnership,
specialised, labour intensive, producing small batches of commodities or manufactures
using artisan labour for local and regional markets. From 1900, large, capital-intensive
and bureaucratically run corporations, mass-producing for national and international
markets using wage labour, rapidly dominated the economic, social and political
landscapes (Licht, 1995, p.133). In 1893, the US had some 1,250,000 shareholders out
of a population of 62 million, mainly investing in government debt and railway stocks
and bonds. Control of the capital market was in the “hands of but few men, with little
or no government regulation” (Previts and Merino, 1998, p.113). This changed
following the ‘great merger wave’ from 1897 to 1902 that created huge manufacturing
corporations. Over 1,800 firms disappeared with half of the consolidations absorbing
over 40% of their respective industries (Lamoreaux, 1985, pp.2-4). After a shake out
of the ill conceived and the inefficient, the structure of corporate America that
appeared during the next two decades remains its bedrock today. In 1875, it was hard
to find a US company with assets greater than $10 million, but it had more than 100
companies with assets over $150 million by the 1920s (Previts and Merino, 1998,
p.132) as US investors beat a “fast retreat from personal capitalism” (Hannah, 2007,
p.33) and diversified their portfolios.
6
The transition to big business and the divorce of ownership and control stimulated US
accounting theorists to deal with the new problems created for investors. However, the
context in which they theorised was the class-conscious militancy of labour and the
popularity of a multi-sided ‘progressive movement’ that sprang up to criticise
‘industrial capitalism’ and demand either socialism or other forms of government
intervention (Kolko, 1963; Previts and Merino, 1998, p.176). The US had an
exceptionally high rate of strikes from the 1880s to the 1920s and again from the
1930s to the 1950s (Edwards, 1981, p.3, Figure 2.1). “[T]he nineteenth century
adversarial tradition of labor-management relations…was actually strengthened in the
mass production era” (Galambos and Pratt, 1988, p.79) and strikes “retained a unique
degree of intensity” to the 1970s (Edwards, 1981, p.253). On the surface, the majority
of US strikes were about pay, but underlying them all in one form or another was ‘job
control’ (Edwards, 1981, pp.233-234), in Marx’s terms, control of the valorization
process, particularly the rate of exploitation, the division of value-added between
wages and profit.
From the late 1870s, the “ongoing and vexing conflict between capital and labor [that]
marked the American experience” accelerated the rise of big business (Livingston,
1987, p.82; Licht, 1995, pp.161, 168), which in turn fuelled escalating,
institutionalised conflict. From the 1880s, US workers and trade unions “operated in a
political and social climate of incredible hostility”, employers calling on troops to
break strikes more than 500 times between 1877 and 1910 (Licht, 1995, p.193).
Underlying the hostility of US employers was that the real wages of US workers had
increased by 70% between 1865 and 1890 and profits fell (Licht, 1995, p.183).
American economists of the day fretted over the shift in the distribution of income
from profit to wages and stagnating labour productivity (Livingston, 1987, pp.75-78).
The causes were skill shortages, skilled labour’s control of production, successful
agitation for increased wages and shorter hours, coupled with falling prices in the
recessions of 1873-78 and 1893-97, whereas labour productivity stagnated and
therefore profits fell (Montgomery, 1976, p.499; Livingston, 1987, pp.79-80; Licht,
1995, p.183).
The underlying causes of the fall in profitability, the rise of big business, and the social
upheaval that it provoked, was the completion of the rail network that created a
national market after the Civil War, a five-fold increase in output from 1860 to 1900,
which created huge overcapacity in US industry, and fiercely destructive competition.
In response, leading capitalists first used trusts and then, when the courts declared
these agreements illegal, joint stock companies to consolidate businesses into giant
corporations to tame if not control the market and to raise the large amount of finance
they needed for capital investment, particularly in machines to wrest control of
production from skilled labour. In several key industries, corporations undermined
worker control of production by replacing skilled workers with machinery in large,
mechanised plants and distribution systems run by cheaper semi-skilled and unskilled
immigrant workers (Klapper, 1910; Montgomery, 1976; Edwards, 1981, p.245; Licht,
1995, p.161).
In short, the high cost of skilled labour in fiercely competitive conditions led US
capitalists to create big businesses to take greater control of the valorization process, to
7
exert control over the market and to use machinery, strict supervision and accounting
to redress an internationally low rate of profit (Livingston, 1987). Evidence gathered
by the Industrial Commission established by the US Congress in 1898 to investigate
trusts and industrial combinations, suggests that this strategy worked. It calculated
that from 1890 to 1900 the wage earners’ share of the net product of manufacturing (its
value-added) fell from 44.9% to 41% (1902, pp.725-726), that the rate of exploitation
had sharply increased.
The battle for control of production and the division of surplus between profits and
wages underlay the widespread discussion (if not the practice) of ‘Taylorism’ which
glorified the manager’s right and duty to manage (Licht, 1995, pp.130-131). Given the
high financial stakes involved, and as a nation of independent artisan manufacturers
with the absence of any feudal traditions of worker loyalty, US capitalists fiercely
opposed any interference with their ‘right to manage’ and, by European standards,
were exceptionally hostile to workers and to trade unions. Exceptional employer
hostility in turn helps to explain the equally deep hostility by America’s workers to big
business, manifested in the exceptionally high strike rate (Edwards, 1981, pp.243-245),
and why Veblen could write without fear of contradiction (and losing his job) of
widespread “socialistic disaffection” (1904, p.336) with American capitalism. Against
this background, and contrary to the popular view that the failure of socialism in
America was ‘inevitable’ (e.g., Bell, 1952), “a major myth-making campaign was
required to make socialism alien despite the widespread existence of conditions
favorable to its survival” (McNaught, 1966, p.507).
US capitalists had to mount an ideological campaign because the one thing that most
workers and their political champions and representatives agreed about was that
capitalism exploited labour in the interests of a parasitical class of money capitalists.
There was “a powerful Socialist presence in several unions” (Edwards, 1981, p.132).
Eugene Debs, leader of the American Railway Union, ran for president of the USA
five times for the Socialist Party of America and turned in credible performances
(Licht, 1995, p.173). From the 1890s, the ideology of the Western Federation of
Miners (WFM) of Colorado, Idaho and Montana “was Marxist” (Dubofsky, 1966,
p.139). In 1904, the WFM became the militantly radical and briefly influential
‘Industrial Workers of the World’, much feared by capitalists. Even Samuel Gompers,
creator and head of the American Federation of Labor (AFL) and the leading
‘conservative’ trade unionist of the day, often wrongly portrayed as the founder and
defender of ‘business unionism’, was avowedly a lifetime Marxist (Dick, 1972, p.21).
In 1916, eight years before his death, Gompers wrote in the AFL’s Federationist,
“Those who do the real creative work have been dominated by exploiters…. The real
power that governs our national life and development is exercised by Wall Street”
(quoted in Dick, 1972, p.114). Gompers “found himself immersed in a community of
skilled English and German immigrant workers who ate, drank, and breathed Marxism
and socialism” (Licht, 1995, p.179) and he had therefore to speak the language of
Marx to the workers even if Marxism did not guide his actions (Cotkin, 1979).
In this context, where within trade unions “socialists enjoyed considerable rank and
file support”, even Gomper’s ‘pure and simple’ unionism that eschewed politics, but
focused on defending and improving wages and the conditions of employment, was
consistent with Marxism (Dick, 1972, pp.21, 47, 114), and posed a grave ideological
8
threat. It threatened capitalists because it focused attention on profits and their
antagonistic relation to wages and promised the ultimate “abolition of all profit and
interest” (Gompers, 1897, quoted in Dick, 1972, p.48). ‘Pure and simple’ trade
unionism focused the workers’ attention on the rate of exploitation, which could
explain why employers at the time saw it as a greater threat to ‘Americanism’ than
revolutionary Reds (Hurvitz, 1977, p.521). The Lassalleanism of American socialists,
that prioritised political action and governmental power, failed in the 1920s in the face
of prosperity, constant attack by the press, by government, and by business and the
established political parties, and received no support from the powerful ‘pure and
simple’ unions. By contrast, Marx’s view that the workers must collectively organise
and educate themselves in trade unions before they can successfully take political
power, lived on in the USA, if unconsciously, even in the attenuated form of business
unionism that developed from the 1950s.
The majority of unskilled American workers in the 1920s lived in poverty – and
inequality in incomes was “striking” as, although output per head increased around
40% between 1900 and 1920, real wages stagnated (Robertson, 1973, pp.384, 401),
while profits soared. By 1920, as the editor of the Journal of Accountancy put it, “If
you stop any man in the street and ask him what is the big problem of the hour, he will
undoubtedly say: ‘The relation between capital and labor’” (Richardson, 1920, p.212).
The cause of the problem was that “In the past he [the capitalist] has made tremendous
mistakes and the laboring man has not had a square deal” (Richardson, 1920, p.212).
There was, therefore, as Anglo-American accountant Sir Arthur Lowes-Dickinson
noted, the “the consequent difficulty of removing from the mind of labour…the idea it
is being exploited”; “that it is not receiving a fair share of the profits of industry”
(1924, p.393). A CPA, who was for “many years a member of a trade union, a
delegate to Central Labor Union, etc.,…[knew] just how widespread among working
men is the idea that profits would suffice to increase wages by a large proportion”
(Thornton, 1927, p.147).
Ideological demand and supply
It seems reasonable to hypothesise that in the face of “no other labor organization in
the entire world…so class conscious as the [American] trade unions” (Gompers,
quoted in Dick, 1972, p.115), capital would demand a theory to persuade workers that
it deserved a ‘fair’ share of the wealth many people across America thought the
workers produced. American capitalism also faced strong opposition from the
commercial and middle classes and from farmers, who often supported workers in
their struggles by “community uprisings” (Licht, 1995, p.174), whose voice appeared
in the voluminous ‘progressive’ protest literature that sprang up to attack big business
(Licht, 1995, p.190). By 1914, “every politically literature person in the country must
have acquired at least a rudimentary conception of socialism” (Sweezy, 1952, p.465),
and “enterprises of all sizes shared the hostility towards business generated by liberal
reform and radical critiques of capitalism” (Galambos and Pratt, 1988, p.92). To
counter the widespread hostility to US capitalism and redirect it against the
“radicalism and subversive tendencies of workers”, it needed an “ideology stressing
the role of business… [and] the importance of profit” (Edwards, 1981, p.244).
9
The American contribution to neo-classical theory, the ‘marginal productivity of
capital’ theory answered this need by explaining and justifying capital’s claim to
surplus (Livingston, 1987, p.72). The ideological motive was evident. The
“proponents of marginalist theory assumed their first task was to discredit the labor
theory of value” (Livingston, 1987, p.88), and they set about this by defining “capital
in a way that would qualify it to stand, in production and distribution, on a par with the
labor factor and the land factor” (Schumpeter, 1954, p.889). A prominent example
was the essay by Francis A. Walker on the ‘Source of Profits’, which openly
recognised capital’s ideological need for a marginalist theory of income distribution:
“The bearing of this view of the source of business profits upon the socialistic
assumption that profits are but unpaid wages is too manifest to require
exposition. That this view of business profits, if fully understood and accepted
by the wages class, would have a truly reconciling influence upon the always
strained and often hostile relations between employer and employed, cannot be
doubted” (1887, p.288).
J.B Clark, the leading exponent of the marginalist explanation of profit, made clear
that his quest was to challenge the “indictment that hangs over society…that of
‘exploiting labor’…”, because, he frankly accepted, “If this charge were proved, every
right-minded man should become a socialist” (1889, p.4).
The accountants’ response
In the last quarter of the 19th century in the midst of economic, political and
intellectual ferment, in response to demands to regulate the auditing and public
reporting of big business, the American accounting profession began organising itself
on a national basis. The American Association of Public Accountants (that eventually
became the AICPA) formed in 1887 and over the next 25 years, all States, starting
with New York in 1896, gave CPAs legal recognition (Storey, 1969; Miranti, 1986;
Previts and Merino, 1998).
The two questions that preoccupied the Industrial Commission from 1898 to 1902,
“whether or not the new companies are as safe for investment as the old, and whether
or not the public interest is in any way endangered by them” (1902, p.595), were
directly relevant to accountants. To make them safe for investment and protect the
public interest, all agreed that accounting had the major role. 4 The Commission
concluded that “The evils of combination, remedial by regulative legislation, come
chiefly from two sources: (1) the more or less complete exercise of the power of
monopoly; (2) deception of the public through secrecy or false information” (1902,
pp.645-646). The remedy for both evils was accounting. To hold giant corporations
accountable to the public the government could levy a “franchise tax upon
corporations” to “return all or part of the monopoly gains to the people by appropriate
4
Promoters admitted that in 1899 combinations had issued $3.395 million of common stock, of which
two-thirds was ‘water’, ‘goodwill’ of dubious value. Evidence of stockwatering “and other abuses
added credibility to those who argued that economic concentration had eroded the moral justification for
private property rights” (Previts and Merino, 1998, p.184). The alternative to regulated disclosure was
“the radical view – supervision of all corporations, large or small, doing an interstate business; fixing
wages and maximum prices of product; redistributing profits to produce equality” (Montgomery, 1912,
p.288).
10
taxation”, and this would “require detailed annual reports from the corporation” and
audit. To hold the corporations accountable to management also required accounts as
“The remedy for deception of the public is publicity and responsibility of officials”
(1902, pp.646-647).
Many witnesses to the Industrial Commission, including most business leaders, “felt
that corporate publicity was the best available alternative” to control the abuses of big
business (Previts and Merino, 1998, p.184). As “most state company law did not
require financial reporting” (Bush, 2005), the Commission proposed Federal
legislation requiring large businesses to publish independently audited accounts
subject to government regulation (Previts and Merino, 1998, p.185, fn.63). However,
it called only for “reasonable detail” to “encourage competition when profits become
excessive…and to guard the interests of employees by a knowledge of the financial
condition of the business in which they are employed” (1902, p.650, emphasis added).
It stressed that “it would be possible, as has been pointed out, to apply to corporations
any degree of publicity or restriction that might be authorized” (1902, p.652). The
safeguard in the absence of full disclosure was the government auditor, the American
version of the British system that relied on independent auditors with statutory duties.
If full disclosure “did not seem to be advisable, a corporation would still find it
difficult to deceive the public as long as Government officials themselves, even though
sworn to secrecy, would know continually the exact condition of the business” (1902,
p.648).
Business leaders agreed that accounts were essential to control large corporations
efficiently and to hold top management accountable to investors, but all doubted the
wisdom of full disclosure or government auditors. Mr Charles R. Flint, a ‘merchant’
from New York, who was involved in the organisation of several corporations and held
executive positions, for example, thought it
“desirable that there should be a system sustained for proper auditing and
accounting, and regulation as to the issuing of securities, the evils which have
developed in connection with the organization of industries are being corrected
by natural laws” (1902, p.93).
By ‘natural laws’, Mr Flint meant that investors and bankers had learned from the
early excesses and now exercised their power of control through accounting and
auditing, to reap the same benefits for themselves as the top managers did when they
imposed accountability through ‘comparative bookkeeping’ to control the giant
corporations they created. To get their “managers and superintendents … [to] take the
same personal interest in the work that is taken by an independent producer who owns
the establishment”, most companies paid by results and used
“comparative bookkeeping, by which the different establishments in the
combination are regularly compared with one another in all the details of their
working. This system of frequent detailed reports is followed in practically all
of the combinations” (1901, p.XXXIII).
11
All the businessmen witnesses knew, as Mr Flint put it, with the rapid
“decentralization of ownership”, 5 “it is a matter of serious concern to the investors that
these concerns should be managed in the interests of the stockholders” (1901, p.91),
just as it was in the interests of top managers to manage their subordinates in the
interests of the corporation. Mr Charles M Schwab, president of the United States
Steel Company, told the Commission that he “very carefully” compared the costs of
different plants every month and “had the manager…make such explanations as were
necessary” (1901, p.452). While such accountability was essential for internal control,
for non-listed companies such as the Carnegie Company from which he came, he “did
not think it was wise” to publish accounts at all (1901, p.474). However, for listed
companies, a fact “which makes a great deal of difference”, while “there are certain
statements that every stockholder is entitled to”, particularly a statement of earnings,
he “did not believe in publishing details” (1901, p.474).
Faced with hostility from business leaders and investors against the full disclosure of
accounts, the US government continued with voluntary disclosure and audits and
relied on self-regulation by private sector accountants, and regulation by bankers and
the NYSE with support from the Federal Reserve Board (Chatfield, 1977, p.126;
Previts and Merino, 1998, pp.131, 185-186; Sobel, 1965). 6 Given the continuing,
intense conflict between capital and labour, a plausible hypothesis that explains why
successive American governments chose to stick with voluntary auditing and
disclosure until the 1930s, is what F.B. Palmer, a leading late 19th century UK
promoter, called the ‘labour danger’ (Bryer, 1993, p.678). 7 This was the danger that
full disclosure of profits might fuel labour conflict and political unrest in the UK, a
danger that loomed even larger in the USA. 8 This concern governed British attitudes
to disclosure throughout the 1920s and 1930s:
“Political and economic factors…militated against wider disclosure because of
anxieties about union militancy. Modernisers suggested that better accounting
disclosure would promote ‘industrial peace’…[b]ut the counter to this was that
disclosure gave the unions too much insight and would facilitate pay claims.
The evidence submitted to the Greene Committee [in 1926] persuaded it that to
5
Flint thought “that there are a hundred times as many people interested in our industrials now as there
were 25 years ago, and there probably will be at the end of another 10 years a hundred times as many
more” (1910, p.91).
6
Under pressure from the Federal Reserve Board, the American Institute of Accountants prepared a
guide to ‘Uniform Accounting’ published in 1917 that the Board reissued in 1918 as ‘Approved
Methods for the Preparation of Balance Sheet Statements’ that was mainly concerned with auditing
rather than accounting principles (Zeff, 1971, pp.113-115). This statement may have lowered auditing
standards that in practice often had gone beyond the recommendations that applied only to large
businesses with good internal controls, which merely gave the “illusion that there was an established
and accepted accounting and auditing theory”, and was widely ignored by practitioners (Previts and
Merino, 1998, p.233).
7
Bills for a federal incorporation law as the platform for federal regulation of accounting, appeared
every year from 1903 to 1914 and sporadically from 1919 to 1930, but failed (Previts and Merino, 1998,
p.186). The US government introduced a Federal corporate income tax in 1913 that encouraged the
spread of depreciation accounting, but it did not couple it with government regulation of accounting as
the Industrial Commission had proposed and accountants became tax advocates for businesses (Previts
and Merino, 1998, pp.254-255).
8
Consistent with this explanation of relatively poor disclosure in the USA, where capital’s relations
with capital were relatively peaceful, “in the continental countries [of Europe,] there is more widespread
publications of the details of profit and loss” (Hatfield, 1911, p.175).
12
reveal profit information would be playing into the hands of the ‘labour
agitator’” (Maltby, 2007, p.15; see also, Arnold, 1997, p.164).
As the potential beneficiaries of reform, US accountants were keenly, if one-sidedly,
interested in the social conflict that surrounded them and the debate. For example, in
1908, an editorial in The Journal of Accountancy noted a “wearisome lot of talk about
predatory wealth and the exploitation of the common people by the very rich” (p.312).
“[M]any men…contend that our great captains of industry and finance, having got
control of millions of money, are able by sheer force of accumulated capital to
consummate deals which strangle competition, defraud the small investor and rob the
plain people” (p.313). There were widespread calls for ‘government control of
corporations’, the title of the editorial that saw in them “the fundamental dogma of
socialism”, but it could not deny the evidence of abuse that implicated accounting. For
example,
“our railway managers have the power, and sometimes they exercise it,…to
divert net income into the treasuries of barnacle companies at the expense of
the small stockholders, and to humbug the small investor by the concealment of
facts or by the juggling of accounts. Such being the case it will be impossible
to convince the American public that the railways should go unregulated”
(1908, p.316).
Comparing America with Europe, Hatfield concluded that “almost unregulated either
by statute or courts[,]…[n]o authority recognized, almost every abuse apparently
sanctioned by the practice of prominent if not always reputable concerns” (1911,
p.181). In 1912, R.H. Montgomery admitted, “Deficits have been concealed as well as
large surpluses” (p.285). Accountants knew, “Without a knowledge of profits there
can be no regulation, no control” (Montgomery, 1912, p.283), but during the 1920s
“many US listed companies (up to 30 per cent of companies listed on the New York
Stock Exchange) produced no accounts whatsoever for investors” (Bush, 2005, p.6).
The effectiveness of the British system – secrecy coupled with independent auditors to
certify that dividends did not come from capital (Bryer, 1993, 1998) – would depend
upon producing many more accountants and arming them with a theory robust enough
to ward off attempted manipulations against investors’ interests by powerful
management teams. In the late 19th century, the American accounting authorities
accepted the British ‘going-concern’ theory of asset valuation popularised by Dicksee
(1897) (Storey, 1959). This theory – that the value of assets depended on their
function within a ‘going-concern’ – is consistent with many aspects of Marx’s LTV
(Bryer, 1993, 1998), but is inchoate. It justified using cost as value in circulation,
systematic depreciation accounting, the lower of cost or market rule, and realisation,
etc., but the meaning of a ‘going-concern’ was unclear (Previts and Merino, 1998,
p.445, fn.101) as the British had not formulated a theory of corporate reporting by big
business to an anonymous social capital. 9 Therefore, when faced with powerful
9
Whereas an individual capitalist decides whether an enterprise is a ‘going-concern’, whether to allow
its capital to circulate, social capital must impose objective rules on management based on the principle
that a ‘going-concern’ is a capital for which no impediment exists to prevent it doing its duty to earn its
required return. According to the LTV, a going-concern, therefore, values its assets as ‘capital’ in
circulation, as we shall see. Social capital and big business also created technical problems, particularly
13
managers and the demands of investors, and in response to criticism from economists,
from the turn of the century leading US theorists went beyond the ‘going-concern’
theory to generalise a ‘proprietary’ theory of accounting to all forms of ownership.
Although this theory was an advance, even if it had been legally required, its inchoate
foundations left US accountants’ powerless in the face of a determined management
and vulnerable to theoretical attack from economists as the power and increasing
complexity of big business created problems for US accountants they could not solve.
These problems were widely believed to have contributed to the stock market bubble
in the late 1920s that ended with the crash of 1929 leading to criticisms of accountants
for “loose accounting practices”, to the Securities Exchange Acts 1933 and 1934, and
to the search for ‘generally accepted principles’ (Chatfield, 1977, p.132), which the
paper examines in part 2.
To sum up: from the 1880s, US accounting theorists faced two contradictory demands.
One was for accounts to hold the managers of big business accountable to investors,
“the movement for ‘scientific accounting theory’” (Previts and Merino, 1998, p.207),
the demand by investors for reality in accounts, and another demand for a theory that
showed that profit did not come from exploitation, for a marginalist theory of
accounting profit. To explore the hypothesis that the US accounting theory debate was
a clash between the reality of the LTV, inchoately understood and clung to by practical
accountants and their theorists, and the ideology of marginalist economics, the
following section first shows how we can use the LTV to articulate the major
‘principles’ of proprietorship accounting the participants attempted to theorise. In
subsequent sections, the paper uses the LTV to examine the US debate.
The principles of proprietorship accounting and the LTV
The important ‘principles’ of accounting that figure in the US debate are ‘capital
maintenance’, ‘costs attach’, ‘realisation’, ‘matching’, ‘lower-of-cost-or-market’, and
the distinctions between ‘debt’ and ‘equity’, and ‘ordinary’ and ‘extraordinary’ items.
Accountants agree with Marx that capitalists invest ‘capital’ to produce commodities
or services whose sale will recover that capital and provide a profit, but what they
mean by capital is inchoate. A key principle of accounting is ‘capital maintenance’.
This says that accountants can recognise profit only after recovery of capital, but there
is no agreement on how accountants should measure capital. 10 At its clearest,
accountants see the repeated cycle of cash-to-costs-to-revenues-to-cash that recovers
capital as cycles of use-values and acquisition prices that they call the ‘operating
cycle’ 11 . Marx went further and theorised the cycle as the ‘circuits of capital’, with the
‘commodity’ as its smallest element. A commodity is a ‘use-value’ (something useful)
having an ‘exchange value’ (long-run price) equal to the money value of the ‘socially
necessary labour time’ required to produce it (explained below). Capital follows the
circuit M-C...P...C′-M′. During the first phase, M-C, the enterprise gets money (M)
and spends it on commodities (C), both labour power (L) and means of production
those related to holding companies and complex capital structures, which the British had not
encountered.
10
For example, the IASB’s conceptual framework (IASC, 1989) allows a choice of five different
concepts.
11
We shall see that Littleton makes this clear.
14
(raw materials, buildings, plant, etc.) (mp). In the second phase, the enterprise
consumes these use-values in production (…P…) to produce commodities (or
services) with use-values having a greater exchange value, C′ = (C+c), than the cost of
the commodities (C) it consumed in producing them. In the third phase, the enterprise
sells C′ for M′ = (M+m), a greater amount of money than it originally invested, where
the increment (m) is surplus value, the money value of unpaid ‘socially necessary
labour time’.
As the capitalist’s aim is to have the enterprise maximize the return on capital
employed, m/M, a related principle of accounting is that its primary objective is
‘stewardship’ or ‘accountability’ – requiring the objective measurement and reporting
of managements’ performance against targets – but accountants leave inchoate its
social foundations and its meaning remains contentious (e.g., IASB, 2006). Marx’s
LTV articulates ‘stewardship’ as the capitalist’s demand for control of the
‘valorization process’, the labour process of producing the required return on capital
(Bryer, 2006). In Marx’s LTV, therefore, the primary social function of accounting is
reporting the circuits of capital to motivate managers and other workers to act in the
interests of investors by punishing and rewarding them according to the financial
results (Bryer, 1999a, 2006).
Marx’s LTV articulates the principle of objectively measuring capital because the key
to it is that only ‘socially necessary labour time’ adds money value to commodities
(Foley, 2000, p.21; Mohun, 1996, p.40), and therefore, value is ‘objective’ because it
is socially determined. The money value of socially necessary labour time is not
necessarily the actual amount spent by the capitalist on a particular commodity, nor
does it include expenditures on all the commodities the capitalist buys, only those on
‘productive labour’ (defined below) that allow the capitalist to earn the general rate of
profit. This articulates the accountant’s principle of using ‘standard cost’ or ‘target
cost’ as the cost of production, the maximum expenditure if the capitalist is to earn the
required rate of return, rather than the actual cost (Bryer, 2006, 2007). Kenneth Most
understated it when he said, Marx “introduced the concept of ‘social labour-time’
which can be seen to resemble the ‘standard time’ of the cost accountant” (1963,
p.175, emphasis added). Adding together the money values of the socially necessary
labour times of all the inputs (including labour power) to calculate a commodity’s
value is the LTV’s articulation of the principle that ‘cost equals value’, that ‘costs
attach’. This is the notion that we can measure the ‘cost of production’ by adding
particular costs together, the ‘full-absorption cost’. Wells noted that the ‘costs attach’
idea “bears a striking resemblance to that enunciated earlier by classical economists”,
particularly by Marx, in whose idea of socially necessary labour, he concluded, we
find its “ultimate expression (1978, p.106). Part 2 shows that neither accountants nor
their theorists explain the “power of cohesion” (Paton and Littleton, 1940, p.13) of
particular costs, why they add up to the cost of production. Marx’s socially necessary
labour time, by contrast, gives us something “cardinally measurable [that] can be
added or subtracted to one another, not merely ranked” (Elson, 1979, p.137). Costs
‘attach’, therefore, because we can reckon all the costs of production – those that
produce use-values for immediate or ultimate sale (e.g., self-produced fixed assets) –
as the money value of socially necessary labour time they contain.
15
Marx’s distinction between ‘productive’ and ‘unproductive’ labour articulates the
accountants’ distinction between production overheads, which they add to the cost of
production, and non-production (or ‘general’) overheads that they deduct from
revenue. In the LTV, only labour that creates use-values a capitalist can sell can add
value to the commodity and yield a profit. This labour is ‘productive’ because it
produces capital, what accountant’s call ‘assets’. Accountants often say a balance
sheet is a statement of the sources (equity and debt) and uses (assets) of ‘capital’, and
profit its net increase or decrease for the period (excluding additions and withdrawals
by the owners), but their definition of an ‘asset’ is inchoate. Marx’s definition of a
‘commodity’ as the ‘unity of exchange value and use-value’ articulates the principle
that an asset is a ‘recoverable cost’. At any point in time, “A part of the capital exists
as commodity capital that is being transformed into money…; another part exists as
money capital that is being transformed into productive capital; a third part as
productive capital being transformed into commodity capital” (Marx, 1978, p.184). In
other words, if we stop the circuit of capital and measure its components, some will be
in use as:
(i)
(ii)
(iii)
money or enforceable claims to money (e.g., cash, debtors), or as
the cost of the means of production (e.g., stocks of raw materials, workin-progress, fixed assets), that is, the cost of the ‘service-potentials’ or
‘use-values’ 12 necessary to produce commodities or services for sale,
and, for a manufacturing company,
finished commodities awaiting sale (finished stocks).
Investors can only hold management accountable for things they control – for money
(or claims to money) or for controlled use-values 13 – and for costs to be ‘capital’ these
must be ‘recoverable’, that is, valued at the monetary value of the socially necessary
labour they contain. Marx’s LTV therefore articulates the accountants’ notion of an
asset as management’s control of money (or claims to money), or use-values
containing socially necessary labour value.
Having recognised an asset, management must value it. The principles of accounting
are that management must value fixed assets at the ‘lower of cost or recoverable
amount’ and current assets at the ‘lower-of-cost-or-market’ (L-C-M). Marx’s LTV
articulates these principles because within it the value of a commodity depends on
which sphere of the circuit of capital it is in, whether in production or circulation, and
when in the latter, whether it exists in a monetary or non-monetary form. Capital
functions in circulation as ‘money capital’ either to buy commodities or pay to
capitalists or as ‘commodity capital’ for sale. Marx calls this ‘capital of circulation’. 14
Otherwise, capital functions in production as ‘productive capital’. When in
circulation, the value of capital is the ‘lower of cost or market’ as cost measures the
money cost of the socially necessary labour time recoverable, and writing down to
12
‘Use-value’, or ‘service-potential’, or ‘services’, is whatever it is about an object or service that
makes it useful to the enterprise. For example, the ‘use-value’ provided by an aeroplane is the number
of hours flying time it will provide.
13
Either actually controls or potentially controls in the sense that the ability to control currently exists.
14
Although the natural term is ‘circulating capital’, political economists used it for a quite different
form, which Marx preferred to call ‘fluid capital’ as opposed to ‘fixed capital’. Late 19th and early
twentieth century British accountants called Marx’s capital of circulation ‘floating’ capital (Bryer,
1998).
16
market holds management accountable for any loss of capital it controlled. According
to this logic, accountants should not write current assets up to market value when this
is greater than cost because management cannot take credit for capital it does not
control. When in production, the value of capital is the ‘lower of cost or recoverable
amount’ for the same reasons.
For monetary assets, accountants adopt the principle of valuing at historical cost (for
liabilities, historical proceeds) and for nonmonetary assets, although in periods when
input prices change significantly, they switch to valuing nonmonetary assets at current
replacement cost (RC). As in the LTV the value of all commodities is determined by
the money value of the socially necessary labour time currently required to produce
them, the accountant should value only non-monetary assets at RC. Whereas
accountants talk vaguely about ‘physical capital maintenance’, Marx’s articulation is
that an increase in RC increases the capital management must recover, “ties-up” more
money value of socially necessary labour time in productive assets, and a decrease
reduces it, “releases” capital (1981, chapter 6). However, if management cannot fully
recover RC at current prices, the accountant should value all assets at the capital
recoverable. Capital has been lost. By the same logic, the value of money assets that
management does not replace but simply return to the enterprise, is their historical
amounts, and that of productive monetary assets, claims to money (e.g., a loan) held
for a return, the value is historical cost or lower recoverable amount.
The accountants’ principles of asset valuation lead them to account for debt and equity
in qualitatively different ways. Whereas an enterprise’s assets are uses of capital
management controls, its liabilities are sources of capital that create enforceable
obligations to remunerate the capital from total assets, and therefore accountants
charge interest as an expense before striking net profit, whereas equity gets its
remuneration (dividends) only from net assets, from profits after interest. Marx
articulates the accountants’ principle by asking, “How does this purely quantitative
division of profit into net profit and interest turn into a qualitative one?” (1998, p.369).
His answer is that underlying the quantitative division is a qualitative distinction
between “capital outside the production process, yielding interest of itself, and capital
in the production process which yields a profit of enterprise through its function”
(Marx, 1998, p.373). In other words, there is a qualitative distinction between the
circuit of money capital, M-M’, and the circuit of industrial capital, M-C-M’. The
importance of this qualitative distinction for Marx was that “the functioning capitalist
derives his claim to profits of enterprise, and hence the profit of the enterprise itself,
not from his [passive] ownership of capital, but from the function of capital” (1998,
p.377). That is, profit comes from the active management of the enterprise. Hence,
because “profit is produced before its division is undertaken, and before there can be
any thought of it” (Marx, 1998, p.379), we get the accountants’ distinction between
debt and equity. Debt, as Marx pointed out to Tooke, and accountants agree, was a
source of capital remunerated from total assets regardless of profit – regardless of
whether the capital successfully completed a circuit through production and back. In
short, whereas management cannot pay dividends if the enterprise makes losses,
interest payments increase losses. From the qualitative distinction between equity and
debt, it follows that in contrast to liabilities, which are enforceable obligations, the
accountant’s notions of ‘provisions’ or ‘reserves’ articulate as discretionary sums set
aside from profit (equity) for future losses or expenses.
17
To continue to circulate, capital must return to the enterprise with a profit through
sales of the commodities or services it produces. To decide when this occurs,
accountants’ adopt the ‘realisation principle’. Marx’s LTV articulates the realisation
principle to mean either possession of money or an enforceable claim to money from
transferring control of use-values. Capital realised through production is ‘revenue’,
the money or claims arising from selling to customers. All other sources of revenue
are capital gains. Although Marx does not discuss revenues and capital gains, he does
distinguish between their logical counterparts, expenses and capital losses. Only
expenditures necessary to produce the commodities or services realised are expenses.
This is Marx’s articulation of the ‘matching’ principle: “It is only in so far as
consumption is productive consumption…that it falls within the actual circuit of
capital; the condition for consumption to occur is that surplus-value is made by means
of the commodities thus consumed” (1978, p.155). It follows that any consumption of
capital outside the “actual circuit of capital” is unproductive, is not an expense but a
capital loss. For example, writing off irrecoverable debts, or if finished goods “get
spoiled, and lose, together with their use-value, the property of being bearers of
exchange value,…[b]oth the capital contained in them and the surplus-value added to
it are lost” (Marx, Vol.2, p.206). This distinction also articulates the accountants’
distinction between ‘operating income’ and ‘extraordinary items’ that depends on
whether management is accountable for the required return on the circulation of the
capital concerned, whether it constitute a ‘business’. For example, if management do
not set a target profit rate for sales of unwanted fixed assets, the revenues and expenses
are ‘extraordinary’ whereas if it expects a return on capital comparable to the risks
involved they are ‘ordinary’.
The remainder of the paper uses the LTV’s articulation of accounting principles to
argue that contradictory demands on accounting theorists – to report on the production
of surplus value and to suppress the contradictions of capitalism – drove the US
accounting theory debate. It starts with Fisher’s (1906) neoclassical critique of
accounting principles that built on the work of J.B. Clark and other economists.
Sprague (1907) counter attacked with the ‘proprietorship’ theory, drawing in Hatfield
(1909), Paton and Stevenson (1918), Paton (1922), Littleton (1928, 1929), Canning
(1929), and Fisher (1930a, 1930b), and others.
Fisher (1906, 1930a, 1930b)
Fisher understood the political context of his theory: “it is income for which capital
exists; it is income for which labor is exerted; and it is the distribution of income
which constitutes the disparity between rich and poor” (Preface, 1906, p.viii).
Fisher strongly hints that he and (later) Canning formulated their economic theory of
accounting as a critique of Marx. 15 In his review of Canning’s book (Canning, 1929),
Fisher criticised unnamed “economists” who “might have saved much useless labour
and disputation” if they had recognised that “[a]ccounts represent primarily those
measures of business that are practical” (1930a, p.66). Then, he thought, “we might
have been spared the wearisome discussions of the supposed important distinction
between productive and unproductive labour” (Fisher, 1930a, p.67). Of the 19th
15
Canning (1929) worked closely with Fisher in making the final changes to his book (Zeff, 2000).
18
century economists, only Marx stressed the critical importance of this distinction.
Fisher claimed that “the illusory ‘unproductive labour’ concept…died a natural death,
slowly and unobtrusively” (1930a, p.67), and that
“Professor Canning’s book will hasten the inevitable and unobtrusive death of
many illusory concepts of capital and income such as the once popular formula,
‘capital is wealth used to produce more wealth’, which is as fully futile as the
notion of ‘productive labour’ (as distinct from ‘unproductive labour’) to which
it is analogous” (1930a, p.67).
This ‘once popular formula’ is Marx’s view that capital moved through the cycle M-CM′. As we shall see, although they accepted the importance of cost and use-value,
Fisher, Canning and later the FASB, claimed, “money making…is the supreme object
of the enterprise” (Fisher, 1930a, p.77). In other words, that the supreme focus of
capitalists and therefore accounting was only the circuit of money capital, M-M′. As
this conception obliterates the accountants’ distinction between debt and equity and by
the same stroke obliterates the accountants’ understanding of profit, it explains why, as
we shall see, Sprague and other accountants so vehemently opposed the argument that
accounting should measure changes in economic value.
Fisher recognised the conflict between the businessman’s understanding of profit and
the views of economists, but claimed that businessmen were simply ‘conservative’
neoclassical economists: 16
“If a businessman were called on to explain them, he would say that book
values and market values are entirely distinct, the latter dependent on estimated
‘earning power’. The stock is worth its ‘capitalised earning power’, and its
value fluctuates day to day in response to a thousand causes. This is true, but
does not constitute a distinction between book values and market values, for
book values also represent estimated earning power. …The meaning of the
discrepancy is, therefore, not that one valuation depends on earning power and
the other does not, but that there are two estimates, one of the bookkeeper,
which is seldom revised and usually conservative, and the other, that of the
market, which is revised daily” (Fisher, 1906, p.71).
Marx and accountants agree with the businessman that accounting and market values
are ‘entirely distinct’; that costs do not measure the ‘earning power’ of an asset, but
rather management’s control of capital, the recoverable cost of controlled use-values.
Fisher disagrees because, in contrast to Marx’s view that wealth (capital) is the money
value of socially necessary labour time, he defined wealth as material objects and
property rights in those objects, including human labour (i.e., slaves), what he called
‘capital goods’. “I define wealth as consisting of material objects owned by human
beings (including, if you please, human beings themselves)” (Fisher, 1930b, p.51).
Whereas for Marx, capitalists extract surplus value from labour and consider this their
‘income’, the material source of their consumption and their investments to further
increase it, for Fisher ‘income’ or ‘services’ are psychological experiences. “[T]he
16
This view underlies the current research of Watts, Ball, Basu, etc. By contrast, to practical
accountants conservatism means understating revenues or assets below their recoverable amount and
overstating expenses and liabilities.
19
psychic experiences of the individual mind…constitute ultimate income for that
individual” (Fisher, 1930b). As all agents of production compare the subjective
pleasure from their expected income with the pain of labour, and all get a fair return,
exploited labour is not the source of ‘income’, any more than
“[i]f the farmer sells his raw cotton, or the ginner, the ginned products, the
price paid is identical with the price received. …No social income arises
directly and immediately from any of these intermediate operations. Only final
uses appear in gross social incomes and only labor sacrifice costs appear in
social outgo” (Canning, 1929, pp.152-153).
The wage or “[t]he dividend cheque becomes income in the ultimate sense only when
we eat the food, wear the clothes, or ride in the automobile that we bought with the
cheque” (Fisher, 1930b, p.46). Fisher agreed with Marx that we could think of capital
value as the quantity of material objects or rights multiplied by their price, but whereas
for Marx the money value of socially necessary labour times govern prices, for Fisher
prices are simply exchange values, the ratios in which use-values exchange. To value
the stock of future use-values and their prices from the individual’s viewpoint, to
calculate ‘capital value’, Fisher concluded that we must discount the ‘income value’ of
these future services to present value to allow for the ‘time preference’ with which
Nature has endowed us. He summarised his arguments thus (Fisher, 1930b, p.52):
Capital goods
→
Flow of services (income)
↓
Capital value
←
Income value
This was his answer to Marx:
“[T]he basic problem of time valuation which Nature sets us is always that of
translating the future into the present, that is, the problem of ascertaining the
capital value of future income. The value of capital must be computed from
the value of its estimated future net income, not vice versa. …This statement
may at first seem puzzling, for we usually think of causes and effects as
running forward not backward in time. It would seem then that income must
be derived from capital; and, in a sense this is true. Income is derived from
capital goods. But the value of the income is not derived from the value of the
capital goods. On the contrary, the value of the capital is derived from the
value of the income. Valuation is a human process in which foresight enters.
Coming events cast their shadows before. Our valuations are always
anticipations” (1930b, p.52).
In Marx’s LTV, cause and effect run in the normal way, forward in time: ‘capital’,
meaning money and the means of production management use to exploit labour during
a period, produces surplus value for that period. Certainly, individual capitalists and
social capital in the capital markets put prices on a series of anticipated surplus values
(profits), what Marx calls ‘fictitious’ capital to contrast it with the real human and
material capital that will produce this present value. However, as the foundation of
wealth is control of the valorisation process and accountability depends on cause and
effect running normally through time, practical accounting focuses on the sources and
20
uses of capital, the source of surplus value and the circuits of capital. Central to this
are socially necessary costs and controlled use-values. Fisher dismisses this idea with
the comment that
“it is sometimes said that ‘liabilities represent money received by a company,
and assets, how it has been expended’. But this is not strictly true. Since its
market value depends on the suitability to the uses to which it is put, not the
money sunk on its construction” (Fisher, 1906, p.125).
In his view therefore, “Capital accounts, that is, accounts of assets and liabilities,
merely represent the discounted valuation at a particular date of the series of services
and disservices or ‘outlays’ which are expected to be rendered subsequent to that date”
(Fisher, 1930a, p.71). However, as Chambers said,
“Fisher cannot have reached this conclusion about ‘the accounting ordinarily
employed in business’ from any observation of accounting. Accounting did
not, at the beginning of the century, and does not now yield balance sheets in
which assets are shown at the discounted values of their expected yields”
(1971, p.145).
Most early 20th century US accountants ignored Fisher’s theory who became the
subject of interest for accounting academics and policy makers only from his
association with J.B. Canning. However, he did come to their attention in 1928. In an
editorial of that year headlined ‘Income Defined at Last’, A.P. Richardson, editor of
The Journal of Accountancy, poured scorn on Fisher’s claim in a pamphlet, that the
courts were coming to accept his views. Fisher quoted the case of Eisner v.
Macomber, to which Richardson retorted, “But the quotation does not include the
paragraph in which the court after referring to economic concepts, popular usages and
dictionaries, approved an earlier definition of the court… [that] ‘[i]ncome… [was] the
gain derived from capital, from labor, or from both combined’…” (1929, p.126).
Richardson concluded that the question of whether economics could provide “a
comprehensive and yet sufficiently exclusive definition of income…still remained
unanswered in the minds of practical men” (1928, p.125).
One accountant that took Fisher seriously enough to attack his economic notion of
value and his entity concept was Sprague, who made serious theoretical inroads
towards Marx’s LTV in elaborating the practical accountants’ proprietary theory, thus
raising serious ideological problems that stimulated theoretical debate.
Colonel Charles E. Sprague
With the appearance of social capital came the development of the American
accounting profession and the need for university educated entrants and books to
explain the ‘science of accounts’ (Miranti, 1990). Existing American textbooks did
not deal adequately with accounting for capital stock companies (Previts and Merino,
1998, p.154). In 1907, Colonel Sprague, President of the Union Dime Savings Bank,
and close friend of the leading US accountant, Charles Waldo Haskins, responded to
21
this need by self-publishing his Philosophy of Accounts. 17 This book became a best
seller that, by coming remarkably close to the LTV, set the context for the debate for
future generations of American accounting theorists, particularly Hatfield, Paton,
Littleton, and Canning (Previts and Sheldahl, 1988), by posing ideological problems
with which accounting theorists still struggle.
Sprague’s Philosophy of Accounts was a radical departure from existing textbooks
because it attempted to explain to the student “the scientific basis of all systems, the
wherefore as well as the how” (1907, p. ix). Accountancy was an “Art”, perfected
through practice, but with a “scientific basis” (Sprague, 1907, p. ix). Rejecting the
idea that accounting was a branch of economics, Sprague declared it “a branch of
mathematical and classificatory science”; that “the principles of accountancy may be
determined by a priori reasoning, and do not depend upon the customs and traditions
which surround the art” (1907, p. ix). This was a radical step because by taking his a
priori stance to free himself from customs and traditions, we will see that Sprague
came close to discovering that the ‘scientific basis’ of accountancy was the LTV. This
raised intractable ideological problems because he used his a priori theory to criticise
Fisher’s economic theory, particularly his definition of asset value as present value and
his obliteration of the accountants’ distinction between debt and equity, which, we
shall see, Paton correctly saw as the thin end of a socialist conceptual wedge that, he
thought, accounting theorists should suppress.
Previts and Merino say that Sprague’s writings “were evidence of the unique and
essentially complete theory from which modern American accounting developed”
(1998, p.156). They credit him with inventing the ‘proprietorship’ theory of
accounting, “The restatement of the accounting equation from Assets = Liabilities to
Assets = Liabilities + Proprietorship”, which, they are right, “initiated a significant
change in direction in accounting thought” (Previts and Merino, 1998, p.442, fn.81).
However, just like leading British accountants (Bryer, 1998), Sprague did not ‘restate’
but rejected the Assets = Liabilities view. Sprague did not invent but formulated an
exceptionally clear ‘proprietorship’ theory of accounting, which argued the aim of
accounting was accountability for capital, whether the ‘proprietor’ was a sole trader, a
partnership, or the collective of actual or potential investors in a public corporation. 18
Understanding the trend towards social capital, Sprague and those who followed
rejected the “weird practice of personifying accounts” (Paton, 1972, p.v), the “rather
forced system” (Hatfield, 1909, p.21) of the traditional method of teaching DEB,
appropriate for personal capitalism, in favour of the cold, ‘scientific’ logic of
impersonal capitalism where assets – liabilities = proprietorship. However, whilst
exceptionally clear, Sprague’s theory remained inchoate in several key areas and
therefore, as we shall see, was not ‘essentially complete’.
Sprague defined an “account of value” in its “broadest and loosest sense” to mean
accountability for value. An account was “a narration, or statement of facts” by the
17
Sprague had published the material in the book in a series of 10 monthly articles in the Journal of
Accountancy during 1907. Sprague also published a series of articles on the ‘Algebra of Accounts’ in
The Office in 1889 that he had previously published in the Bookkeeper in 1880.
18
Although US corporations generally became widely held only in the 1920s (Hudson, 2007), at the
time Sprague was writing their size was such that even those owned by robber barons or wealthy
individuals or families had effectively divorced ownership from control, a fact they recognised by
appointing professional managers and accountants (Licht, 1995, pp.139-151).
22
agent, “a systematic statement of the facts; but this is not all, it must tend or point to
some conclusion”, must “prove or disprove some proposition” (1907, p.3). The
proposition that every account must prove for every transaction was “How Much
Value? How? When? And With Whom?” (Sprague, 1907, p.8). Accounting is
“systematic” because it “is a history of values” that follow a “transaction cycle”
(Previts and Merino, 1998, p.156). Therefore, the conclusion towards which the
“accounts of value or financial accounts” (Sprague, 1907, p.3) point is the closing
balance sheet, a periodic collection of values in different accounts of value in various
forms around the cycle. The balance sheet was “a summing up at some particular time
of all the elements which constitute the wealth of some person or collection of
persons” (Sprague, 1907, p. 30). By ‘wealth’, Sprague meant capital broadly defined
according to the LTV, “defined by economists as that portion of wealth which is set
aside for the production of additional wealth” (1907, p.47), particularly Marx, as M-CM′, and he saw the balance sheet as a statement of its sources and uses:
“Considering all the assets as capital, the proprietorship is that portion (in
value) of the capital, which the proprietor furnishes as distinguished from the
portion which he induces others to place in his hands for utilization, or the
liabilities” (Sprague, 1907, p.53).
Like the LTV, therefore, Sprague’s balance sheet “must comprise:
1. The values of assets, consisting of property and claims, to which the person,
or collection of persons, has title.
2. The values of the claims existing against the assets and which must be
satisfied from them.
3. The value of the residue after subtracting (2) from (1) and the respective
proprietary interest in that value” (1907, p.30).
An essential element in Sprague’s theory was that the “property or claim” gave control
of use-values, which he says we can look at either as a currently controlled ‘thing’ (the
currently consumed use-value), or as a currently controlled ‘right’ to a ‘thing’ (a
current use-value giving control over a future use-value):
“[E]very asset may be looked upon either as a ‘thing’ or as a ‘right’.
…Possession of a thing is merely the right to use it and control it. …Therefore
all our ‘things’ may be looked upon as merely rights of dominion” (Sprague,
1907, p.44).
Assets are use-values giving control, “rights of dominion”, in various “phases” of
circulation: “Things convert themselves into rights, and the reverse is true: rights are
convertible into things. Rights are but the future tense of things” (Sprague, 1907,
p.45). It followed that “all assets are the embodiment of services previously given;
and in still another they are a storage of services to be received” (Sprague, 1907, p.46).
That is, all assets are stores or stocks of future use-values produced by past use-values.
This self-evidently held for money, “the easiest form of wealth to value” (Sprague,
1907, p.12), for cash in hand and at the bank and other monetary assets. The
immediate use-value or ‘thing-ness’ of cash in hand is the right it gives to control over
23
future goods and services. The use-value of cash in the bank is the current “right to
receive money on demand or to transfer it”, and the current use-value of a debtor is the
right to receive future payment for the transfer of things (Sprague, 1907, pp.44, 45).
Thus, he concludes, “all rights rest ultimately on things, either present or expected”,
including those arising from personal indebtedness (Sprague, 1907, p.45).
Personifying all things as debts by fictitious actors, the traditional way of thinking
about and teaching DEB was unrealistic because “Neither the shepherd nor his dog is
in debt for the sheep” (Sprague, 1907, p.45). This was Sprague’s answer to the
“extremists” and “controversialists”, the “two camps of the materialists and the
personalists”, that try to “reduce all assets into things” or “reduce all things to personal
debts”, that in reality some assets are things and some are rights against persons (1907,
p.46).
Sprague argued for valuing assets at a ‘going business’ value rather than at market
value, the British going-concern theory that accountants should value capital in
circulation:
“This question of two valuations, one for liquidation, the other for a going
business, frequently arises. I am of the opinion that in a going business the
latter is the balance to be carried, because only in that way can the true
economic outlay or income be ascertained” (1907, p.73).
The argument for using a going value rather than market was, for example, because
“the same rule applies to supplies having almost no saleable value, such as business
stationery designed especially for a certain particular concern” (Sprague, 1907, p.73).
A going business value provided the basis for measuring all advances of capital
because whatever the asset’s form or function, “[i]ts value as an asset consists of
relieving us from the necessity of expending anything further for the same purpose”
(Sprague, 1907, p.73). By going business value, consistent with the LTV, Sprague
meant either historical cost or ‘present worth’, i.e., current cost. Of the seven ways in
which “assets comprising the balance sheet may be considered”, Sprague’s two
valuation bases are:
“4. As the result of services previously given, or cost.
5. As the present worth of expected services to be received” (1907, p.47).
Sprague’s theory that expenditures that give control of future use-values and avoid
future expenditures are assets is consistent with the LTV, but he leaves inchoate why
this measured ‘value’, whereas in the LTV current cost does because it measures the
current money price of the socially necessary labour time that attaches to those usevalues. Sprague comes very close to this:
“[A]ll assets are the embodiment of services previously given; and in still
another aspect they are a storage of services to be received. Someone must
have given labor in order to produce any wealth; but it will not in future
command the services of labor, or save the expenditure of labor, or of its
embodied results, it is worthless and not wealth at all. ….Yet the values
resulting from these two aspects are only approximately equal. On the one
hand, the services which were given may have been sold for more or less than a
24
just price as settled by competition…. On the other hand, a disservice (to use
Professor Fisher’s word) may have occurred…so that the services once
anticipated appear impossible of entire realization” (Sprague, 1907, p.47).
Sprague’s ‘just price as settled by competition ’, is an inchoate expression of the
LTV’s money value of socially necessary labour time or target cost (Bryer, 2007).
However, consistent with the LTV he completely rejected “the aspect of assets as the
present worth of future services”, Fisher’s argument, because this undermined
accountability for capital, “is entirely based upon opinion, while the aspect which
regards them as the resultant of services given is based upon facts” (Sprague, 1907,
p.47). It was inviting subjectivity into accounting to think of assets, as Fisher did, as
the present value of future cash flows rather than as a store of use-values with value,
the “services given”, giving rights to future use-values and value.
Sprague knew that capitalists should not simply account for assets at their initial cost
as often happened in practice, but should charge this value to production according to
the consumption of its use-values. As he put it regarding the purchase and
consumption of a stock of coal, but the same is true of fixed assets, “[t]he only
absolutely correct rule is to base the outlay account [i.e., charge the expense], not on
receipt of the supplies, nor on the payment for them, but on their consumption”
(Sprague, 1907, p.73). Therefore, the “depreciation of plant…is a normal charge and
should be provided for out of income; it is the case of current supplies being made
‘second-hand’ by the process which adapts them to their purpose” (Sprague, 1907,
p.73). However, he makes no attempt to explain how to select a depreciation method.
Accounting historians accuse proprietary theorists such as Sprague of a myopic
preoccupation with the balance sheet (Previts and Merino, 1998, p. ). However,
against this, Sprague’s profit and loss account, his “economic accounts”, reported the
results of “[t]he whole economic struggle (reducing everything to terms of service)
[which is] is to sell one’s own services high and buy the services of others cheap”
(1907, p.46). This is consistent with the LTV that the function of accounting is to
report the circuit of capital, M-C-M′ because at the end of this cycle is the “[i]ncrease
of proprietorship by giving service [that] is called ‘earnings’ or ‘income’” (Sprague,
1907, p.24). Previts and Merino say, “Sprague’s writings precede the development of
classical historical cost and matching notions” (1998, p.154). However, he values at
historical cost and he gives us the realisation and matching principle – that “it is really
the consumption or accretion of a right which we need to record in economic
statements, not the settlement of the claim in cash” (Sprague, 1907, p.74) – that sits at
the heart of accountability for capital:
“The whole purpose of the business struggle is increase of wealth, that is
increase of proprietorship. …The all-important purpose of the proprietary
accounts is to measure the success or failure in increasing wealth and to
analyze that success or failure so as to ascertain its causes, as a guide for future
conduct” (Sprague, 1907, p.67).
This is the function of accounting within the LTV, to report objectively on financial
success or failure so that investors can judge the returns and management’s
performance and reward or punish to guide future conduct. To achieve accountability
25
for increases (or decreases) in wealth, Sprague articulated his definitions of revenue
and expense consistent with the LTV’s focus on the control and value of use-values:
“Sales. On the credit side of this account are entered the amounts of
merchandise sold…. …On the debit side of the account is entered the cost of
goods sold…. …The company has given to its customers the services in
bringing its stock of goods near their homes” (1907, p.81).
Sprague distinguished expenses from losses, apparently deploying the idea of
productive labour versus non-productive labour. He defined expenses as outlays that
“are not ‘losses’, but are a necessary investment which is expected to be more than
returned; they are values laid out with the expectation that they will later come in”
(Sprague, 1907, p.80). 19 This is consistent with Marx’s distinction between productive
and non-productive labour – Previts and Merino paraphrase Sprague to say, as Marx
would have put it, that productive expenses are “business outlays, deliberately made
for the purpose of producing income” (1998, p.158) – but Sprague does not use it to
provide further details of accounting for overheads, for example.
In the LTV and for Sprague, liabilities are qualitatively different from equity because
he defined a liability as capital provided by outsiders that management must
remunerate and repay regardless of profits, i.e., from total assets. He saw “liabilities
“[a]s capital, …represent[ing] that portion of the total capital, which has been
furnished by others, or loan capital” (Sprague, 1907, p.49). Whereas the basis of
management’s accountability to creditors is legal, management is accountable to
shareholders through the accounts for the maintenance of their capital. As Sprague
says, from the accountability perspective, liabilities “differ materially from the rights
of the proprietor, in the following respects:
1. The rights of the proprietor involve dominion over the assets and power to
use them as he pleases even to alienating them, while the creditor cannot
interfere with him or them except in extraordinary circumstances.
2. The right of the creditor is limited to a definite sum which does not shrink
when the assets shrink, while that of the proprietor is of an elastic value.
3. Losses, expenses, and shrinkage fall upon the proprietor alone, and profits,
revenue, and increase in value benefit him alone, not his creditors” (1907,
p.53).
Sprague was not fooled by the collective nature of corporate enterprise into thinking it
was not owned by a ‘proprietor’, the ‘thing’ that Marx called social capital, and he
criticised the confusions introduced by Fisher’s ‘entity concept’:
“A business entity…is a collective unity, but a real one. Professor Irving
Fisher in his ‘Nature of Capital and Income’ says that it is a ‘fictitious person
holding certain assets and owing them all out again to real persons’. In this I
think he has been misled by the lazy habit of bookkeepers in calling all the
credit balances liabilities, although they know that some of those balances are
not liabilities. Even admitting that there is a fictitious entity it owes nothing to
19
Hatfield’s criticism that Sprague did not distinguish expenses from losses (1908, p.68) seems
unwarranted.
26
the real owners. It merely is a composite ownership which again is owned in
various shares by real owners, and has nothing to do with debt” (Sprague,
1907, p.38).
Like Marx, Sprague thought that debt and equity, “instead of being the same nature (as
is suggested when…[proprietary interest] is reckoned among the ‘liabilities’)[,] are
sharply antagonistic” (1907, p.30). “The Business does not stand in the same relation
to its proprietors or its capitalists as to its ‘other’ liabilities” (Sprague, 1907, p.57).
Marx agreed because the capitalists took the residual gain from the circuit of capital,
M-C-M′, from controlling the valorisation process, whereas the ‘other liabilities’, the
providers of debt, took a contracted rate from the circuit M-M′.
The stark realism of Sprague’s proprietary theory, the vision of passive investors
controlling management by holding them accountable for the value of capital and
profit, created an ideological problem for capitalists because it conflicted with the
standard view in economics that profit was the capitalist’s reward for taking risks and
taking control of the valorisation process. As Paton later pointed out,
“…the property-holder, investor, is commonly thought of as furnishing two
principal conditions or functions in production: (1) risk and responsibility
taking, and (2) ‘waiting power’ – pure capital service.
The agents
corresponding to these elements are the entrepreneur and the ‘capitalist proper,
respectively. The line drawn in accounting between proprietorship and
liabilities roughly corresponds to this economic division of functions” (1922,
p.60).
The separation of ownership from management control clearly “raised serious doubts
about the entrepreneurial function” (Merino, 1993, p.170), but this was not a problem
for proprietary theorists, as Merino suggests, who claimed merely to stick to the facts,
but for economists, such as Paton who saw in their theory a grave ideological threat to
the American capitalist order.
While most accountants were undoubtedly pro-capitalist, they could not respond to the
ideological threat by suppressing the realism of the proprietary theory and fulfil their
social function, and, in the early 20th century, they decisively rejected a proposal
inspired by economic theory to charge interest as a cost of production, that they saw as
transparently ideological and doomed to failure. Engineers (Dickinson, 1911, p.588),
bankers and business leaders (Mahon, 1916, p.253), and those few US cost
accountants who adopted the entity view (Previts and Merino, 1998, p.228),
championed this cause, but leading accountants strongly resisted. Clinton Scovell,
who led for the cost accountants, accepted the economists’ theory that “profits accrued
only after all factors of production received payment for their factor shares, including
payment for the use of capital” (Previts and Merino, 1998, p.228). A committee of the
American Institute dismissed this suggestion as “unsound in theory and wrong, not to
say absurd, in practice” (quoted in Zeff, 1971, p.115), “purely academic” (quoted in
Richardson, 1918, p.293). Auditors of the large corporations were “horrified”
(Merino, 1993, p.176).
27
The accountants’ response is consistent with the LTV in which interest is, as Marx
stressed, a mere division of surplus value that cannot possibly add socially necessary
labour time to a commodity or service; cannot be a source of surplus value. Dickinson
agreed,
“rentals, interest, or dividends are a mere division of profits resulting from the
business…. The profit…consists of the difference between the sale price of the
product and the cost of producing and selling that product. It is clear,
therefore, that interest or any other item in the nature of a return upon capital
invested cannot possibly form part of the cost of products” (1911, p.589).
Accountants such as G.O. May thought the ideological motive underlying the
capitalisation proposal was naïve. Proponents “hope[d] that, by including part of its
claim to compensation as a cost and part of profit, capital may be able to secure more
than it otherwise would obtain” (May, 1916, p.406); hoped to fool labour into thinking
profits were smaller than they actually were. May and other accountants thought this
hope was “ill-founded” because, although “the economist may attempt to differentiate
between pure interest, compensation for risk, and the reward to the entrepreneur,
etc.,… in the public mind and for practical purposes these elements are combined in
capital” (1916, p.407, see also Dickinson, 1911, p.590). Therefore, if capital staked a
claim for interest (usually defined as the cost of debt) to pre-empt labour by
understating ‘profit’, this would not fool anyone because “the general disposition will
be to assert claims to a part or whole of the balance” (May, 1916, p.407). In fact,
“labor leaders, some years previously, had suggested that interest of say 6% be
charged on invested capital” (Merino, 1993, p.177), precisely to reveal “what are the
excess profits over a reasonable return on the investment” (Cole, 1913, p.235). In
1917, the Federal Reserve Board ended the debate in Uniform Accounting by
proscribing capitalisation of interest (Previts and Merino, 1998, p.228).
Sprague went deeply into theory, but he did not go deeply into practice as he initially
intended his book on “Accounts in General” as a philosophical introduction to another
volume on “Accounts in Particular”, a task whose “encyclopedic proportions” he
found too daunting (Sprague, 1907, p. ix). However, his theorising, the ideological
problems he raised, and the many questions of practice he left unanswered, encouraged
others, notably Hatfield, Paton, and Littleton, to join the debate “over issues such as
costs and values, income and outlay, inventory and depreciation” (Previts and Merino,
1998, p.156). However, because these theorists worked with an inchoate LTV, and in
varying degrees attempted to reconcile it with accepted economic theory, we shall see
that as they pushed deeper into practice the problems and unanswered questions
mounted. If practicing accountants had referred to them for authority and guidance,
they would have found little to limit creative accounting during the ‘roaring twenties’.
28
Henry Rand Hatfield
Hatfield’s Modern Accounting: Its Principles and Some of Its Problems was the first
American academic textbook on accounting (Zeff, 2000b). Hatfield aimed to “present
the principles of accounting” (Preface, p.v). Starting from the depersonalised theory of
DEB, by pushing into the problems of practice Hatfield’s contribution to the debate
was his discovery of the need for a theory of value, but he never attempted to
formulate or pursue one even though he thought, “The vital question in all accounting
is the value which is to be placed on existing assets. That being determined, almost
every other question is decided” (1911, p.175). Although Hatfield starts his theorising
in an inchoate LTV, and repeatedly called for accounts to show the ‘truth’, he often
adopted Fisher’s economic valuation theory and became famous for the opposite, the
idea of ‘relative truth’ in accounting, the ‘authority’ for a wide range of accounting
methods. In the context, equivocation over truth in accounting was of ideological
significance. Hatfield was a ‘conservative’ (Zeff, 2000b) and by not taking sides on
the theory of value, in the historical context in which capital and labour were at war,
he actually sided with capital. He rapidly became the authority for the view that, as
Hatfield put it, “accounting is a mess” (quoted in Zeff, 2000b, p.133), which at least
carries with it the implication that ‘profit’ is an elusive idea that does not self-evidently
measure exploitation. 20
Like Sprague, whose work Hatfield thought of as a “scientific treatise”, he saw assets
as ‘goods’: “Goods is here used in the technical economic sense of anything, material
or otherwise, to which value attaches” (1911, p.182; 1909, p.1). ‘Goods’, therefore,
includes money as the means to access all use-values, or tangible and intangible usevalues with value. This starting point is consistent with the LTV where assets are
commodities circulating as capital, are use-values with value, but we will see that
Hatfield’s failure to define ‘value’ leads to impenetrable “uncertainty as to the correct
principles to follow in many cases” (1909, Preface, p.vi). Hatfield’s theory of DEB is
an outline of Marx’s circuits of capital:
“[A]ll operations of any form whatever which come under the cognizance of
the accountant may be reduced to the following:
(a) Operations in which the kind of Goods owned is altered by exchange of
Goods from one form for other Goods of equal value;
(b) Operations in which the amount (value) of Goods is either increased or
decreased[;]…
(c) Operations in which the kind of Goods owned is altered at the same
time as the amount (value) owned is either increased or decreased”
(1909, p.2).
In category (a) are “Exchange or pure exchange transactions” that correspond to the
initial stage of Marx’s circuit, M-C, “transactions which involve the exchange of
20
Hatfield’s exposure to the LTV is unclear. He did his PhD in political economy, and was a student
of Thorstein Veblen at Chicago University, whose intellect he admired, but Hatfield had “an ideology
that was foreign to Veblen, who passionately believed that profit-seeking, organized religion, capitalism
and nationalism were detrimental to society” (Zeff, 2000b, p.39), whereas Hatfield was a conservative
Methodist.
29
goods of equal value, [where] it is evident that there can be no change in total value”
(Hatfield, 1909, p.2). For example, “If the proprietor buys 25 horses for $2,500 cash”
(Hatfield, 1909, p.3). In category (b) are “Profit and Loss transactions”, for example,
“the proprietor rents his horses receiving therefore $100 in cash” (Hatfield, 1909, p.4)
that correspond to the circuit M-M′. In category (c) there are “many transactions”
where “there is both an exchange of goods and an element of profit”, for example, “the
merchant exchanges merchandise costing him only $100 for cash amounting to $110”
(Hatfield, 1909, p.11), that corresponds to the full circuit M-C-M′. In outline,
Hatfield’s theory of DEB corresponds to Marx’s circuit of capital. However, his
examples studiously avoid labour costs (we learn how to account for rent, interest,
dying horses, selling horses, buying and selling merchandise, but not for production
with labour), and he immediately notes the economic theory that the source of profit in
a mixed transaction is buying to fulfil market demand, from an equal exchange of
values:
“Theoretically, it may be held, that the profit transaction preceded the
exchange, that just before the sale the merchandise appreciated to the extent of
ten dollars, and the increased value of the goods must be balanced by taking
recognition of the profits. After this there is a pure exchange; merchandise
worth $110 being exchanged for an equal value in cash” (1909, fn.1, p.11).
He knew this theory was rejected by businessmen and practical accountants: “such a
conception is at variance with ordinary commercial expression, and is thoroughly
opposed to what is a cherished precept of accounting practice” (Hatfield, 1909, p.11).
Nevertheless, he did not rule out the possibility that “recogniz[ing] appreciation of
goods in the owner’s hands” could be a “principle of accounting theory” (Hatfield,
1909, p.11). The key choice, as he later put it, was between “either the cost value or
the present market value, depending on whether one adheres to one or other school of
accounting theory” (Hatfield, 1943, p.37), but right from the start he “was reluctant to
take sides on the global question” (Zeff, 2000b, p.229), that is, on the theory of value.
He knew that “One may consider either the exertion of the laborer or the expense of
the employer as entering the manufacturing process”, but did not like to
“wander…from the strict field of accounting to discuss economic theory” (Hatfield,
1914, p.482). Staying within the strict field of accounting left him and his students,
“when in doubt”, with “no ultimate arbiter to whom appeal can confidently be made”
(1909, Preface, p.vi). For example,
“Whether a given payment is an expense (Loss or ‘Negative Proprietorship’
transaction) or whether it is the means of securing an equivalent asset
(Exchange transaction) is a fundamental problem, but one sometimes difficult
of determination” (Hatfield, 1909, p.72).
Here the “economic viewpoint [that] even an expense involves the exchange of
equivalents” was of no help and was contradicted by the viewpoint of the accountant
who “for convenience sake, disregarded” the ‘good’ acquired (Hatfield, 1909, p.26).
“For instance, the wages paid to a watchman is treated as an expense, for the services
given are not considered as a ‘Good’ to be taken into account” (Hatfield, 1909, p.27).
According to the LTV and practical accountants, such expenditures are for
unproductive labour that accountants call general overheads, which although they
30
provide necessary services, do not create controlled use-values with value. At this
critical junction, rather than wander into ‘economics’ Hatfield turns to the law on the
distinction between capital and revenue and finds “No less than three theories”
(Hatfield, 1909, p.73). All these theories are inchoate expressions of the LTV’s
distinction between productive and unproductive labour, the nearest being “The most
commonly accepted…that in so far as a transaction results in an addition of a
substantial and permanent character [controlled use-values] which increases the value”
(Hatfield, 1909, p.73), it is capital.
Instead of looking for a theory of value, Hatfield “looked to practitioners…as
authorities on accounting theory” (Zeff, 2000b, p.232) and claimed he was attempting
to formulate ‘principles’ to reduce the confusions and inconsistencies in practice and
in textbook and other authoritative descriptions of practice, which he assiduously
searched for and found. Hatfield both provided some of the “clear thinking…needed
to solve some of the accounting problems that perplex the business world” and “raised
many problems; and most of them are still problems when he leaves them” (Cole,
1909, p.647). Given his theoretical agnosticism this criticism never disturbed him
because what he found “interesting” about accounting was precisely “that there are so
many points still open to discussion” (1914, p.482). Hatfield’s theoretical problems,
and his effective role as ‘spoiler’ in his “emphasis on the mere balancing of contrary
opinions…[which] tends to obscure the truth” (Cole, 1909, p.647), rather than his
diffidence because he was not a CPA, may better explain why he was “extremely
timid” in making recommendations about accounting practice (Zeff, 2000b, p.240).
Providing an authority for both elements of “sanity” and a wide range of accounting
choices could explain why, notwithstanding its inherent weaknesses as a “mass of
confirmatory and contradictory opinion” (Cole, 1909, p.647), Modern Accounting
instantly became “a hand-book for businessmen and for practicing
accountants…rank[ing] among the first books of its class” (Sterrett, 1911, p.346; Zeff,
2000b, pp.70-72). The reason was that “The author evidently realizes the futility of
attempting a dogmatic treatment of a subject containing so few fixed principles”
(Sterrett, 1911, p.346). Perhaps not surprisingly as it comes close to the LTV, the
reviewer, a partner in Price, Waterhouse & Co, and president of the AIA, did not like
Hatfield’s theory of DEB, which “might have been omitted without serious loss”.
However, what he really liked in the remainder of the book was the “frank
recognition” that the “principle of truthfulness in accounting is only relative and
limited”, that he found “refreshing”! He fully agreed with Hatfield that, for all his talk
about the ‘truth’, “So far from being an exact science, accounting is, in its best estate,
only an honest expression of mixed facts and opinion” (Sterrett, 1911, p.345), and we
shall see there was room for understanding and forgiveness so long as motives were
good.
From the LTV perspective, one apparently strong element of “sanity” in Hatfield’s
work was his agreement with Sprague that the “accounting function did not change
with the separation of ownership from control” (Previts and Merino, 1998, p.214),
with proprietorial theory’s insistence that the primary aim was accountability for
capital. He accepted the rationale underlying the British layout of the balance sheet
starting on the right with the capital because
31
“the Balance Sheet is…an account submitted by the company or by the
directors to the stockholders, for which purpose it is, of course, actually
prepared. As such it is logical to charge the directors with the capital and other
funds furnished to the company and to take credit for the assets on hand, which
at the time of the report are constructively tendered to the stockholders in
satisfaction of the account” (Hatfield, 1909, p.42).
Here Hatfield accepted Sprague’s view that, as the object of accountability was
proprietorship or net assets, “from a theoretical point of view debts are negative assets,
and differ radically from capital” (1909, p. 185).
Hatfield’s view of the necessity of charging depreciation, a major practical issue of the
day, was broadly consistent with the LTV’s focus on the transfer of the value of an
asset’s use-values to the commodity or service it co-produces:
“If changes in the market value of an unchanging asset need not be reckoned,
the converse is true. Actual changes in the use-value of a fixed asset, a
machine for instance, must be reckoned, even though to the eye the machine
remains unchanged. In technical terms, while fluctuations in fixed assets may
be ignored, depreciation must always be considered” (Hatfield, 1909, p.83).
Hatfield accepted the long-standing consensus of accountants on the meaning of the
debit entry to the profit and loss account that, consistent with the LTV, it “indicates the
expense or loss due to using up of part of the value of the machine” (1936, p.22). He
also accepted the implication of the LTV that management should choose the method
of depreciation by balancing the initial cost with the total cost for repairs such that the
cost of each use-value was the same (Hatfield, 1909, pp.134-135; see Bryer, 1994, for
the LTV theory of depreciation accounting). However, he switched to the economic
valuation theory when he accepted that “In addition to the loss from wear and tear
even material goods are subject to further depreciation from economic changes”
(Hatfield, 1909, p.140). While for reasonable estimates of an asset’s physical life and
deterioration accountants could turn to the opinion of technical experts, ‘economic
depreciation’ was “confessedly vague and indefinite, and implies the ability to
calculate the future activities of inventive genius” (Hatfield, 1909, p.140). This made
the calculation of the depreciation charges “a matter of the greatest difficulty” and
meant, “Depreciation in all such instances is scarcely to be distinguished from a
reserve” (Hatfield, 1909, pp.140-141). By contrast, according to the LTV management
should account for tangible fixed assets at their current replacement cost (putting
‘fluctuations’ into a capital maintenance reserve) and depreciate them over their
estimated physical lives because the current replacement price measures the current
socially necessary value that takes into account the market’s expectations of
technological change (Bryer, 1999b). During the 1920s and 1930s, with rapid
technological improvement and falling replacement costs, replacement cost accounting
would have increase the reported profits of US corporations, but Hatfield would only
give “cautious approval to revaluing fixed assets so long as the increment were not
credited to profit” (Zeff, 2000b, p.230).
According to the LTV, the credit entry for depreciation to the asset or asset valuation
account indicates either the recovery of the value of the asset transferred as constant
32
capital to the finished commodity or service when the business makes a profit; or it
indicates the loss of value of the asset without recovery if it makes a loss. In Modern
Accounting Hatfield agreed: “The existence of a depreciation account implies, except
in a Balance Sheet showing a net loss, the presence of new assets…of equivalent
value” (1909, p.139). However, by 1936, he appears to forget this, and, although
many textbooks accepted this understanding of the credit entry, as they almost
invariably imposed an ideologically acceptable, therefore inevitably confusing and
contradictory, spin on it, Hatfield could not resist ridiculing these explanations without
feeling the need to offer his own. Hatfield expressed
“great surprise to find such disagreement as to the meaning of the credit side of
the entry. …[I]t is difficult to understand how anyone can logically say that the
credit account represents anything other than the reduction in value which has
been the occasion of the loss or expense” (1936, p.22).
Hatfield listed “more than twenty-five writers, by no means an exhaustive list” who
did as he did and ignored the question of the corresponding increase in value of the
commodity or service in the case of a productive asset. That is, they side stepped the
fact, as Castenholtz (1931) put it in language close to the LTV, that “depreciation of
assets is merely an expression of values…that have reproduced themselves” (quoted in
Hatfield, 1936, p.21), that fixed assets are constant capital. The majority, in effect if
not intention, like Hatfield in 1936, side stepped the corollary that labour cost was
variable capital and therefore the source of profits. Other textbook writers and
authorities endorsed the idea that the credit entry meant the recovery of capital when
they variously said it “implies cash on hand… [,] a fund, not necessarily cash… [,] the
possession of other equivalent assets, although not necessarily impounded in a fund”
(Hatfield, 1936, p.26). Others, perhaps eager to show that these assets were not
available to pay dividends or wages, explained the depreciation credit as a ‘provision’,
a ‘reserve’, a ‘liability’, or a deduction from profit, to replace the asset or to recover a
loss. Hatfield knew all these explanations were “irreconcilable with the thesis that
depreciation is the loss in value due chiefly to wear and tear” (1936, p.26). He knew
that, if accepted, these arguments would weaken the compulsion on management to
charge depreciation that he thought was essential to show investors the ‘truth’ and,
perhaps, to fend off claims by labour that, as the British Labour MP Ernest Bevin
asserted, “reserves…are really the unpaid wages of industry” (1927, p.141).
Previts and Merino say that “[i]mplicit in the early debate was the enduring belief that
accountants must view either the income statement or the balance sheet as
fundamental, and the other as residual…, the belief being that you could not have
relevant values in both” (1998, p.213). They think that Hatfield “ignored the earning
process” (Previts and Merino, 1998, p.211). Zeff also thinks he had a “principal focus
on the balance sheet, rather than on the income statement” (2000b, p.235). If true, this
would put Hatfield firmly in the economic value school, but, in this respect, he was
consistent with the LTV’s circuit of capital and, like other proprietorial theorists, he
saw the profit and loss account and balance sheet as equally important.
Hatfield defined the revenue account as an element of the capital account, a
“temporary, collective account, recording the changes in net wealth due to business
operations of a stated period” (1909, p.72), the change in capital. Hatfield certainly
33
thought that the profit and loss account “shows changes in net wealth and is therefore
subsidiary to the Capital or other main proprietorship accounts” (1909, p.195).
However, this did not mean he thought that the profit and loss account was less
important than the balance sheet:
“the prime purpose of the ordinary Balance Sheet is to exhibit profits available
for dividends. But in practice this is not true, and in any case the Profit and
Loss account by its greater explicitness and completeness is a valuable adjunct
to the Balance Sheet, so that the two statements are generally published
together, as being mutually complementary” (1909, p.196, emphasis added).
Given, as Sprague put it, that “[t]he whole purpose of the business struggle is increase
of wealth, that is increase of proprietorship” (1907, p.67), proprietary theorists
understood that to calculate the return on capital, investors and management need both
profit and capital, and they must measure the same thing. What this thing was,
however, they left unclear. Hatfield was clear that distinction “between the Capital
and Profit and Loss…is of fundamental importance as it indicates the degree to the
enterprise is successful… [and] the measure of success is expressed in the percentage
which the profits gained in a single year bear to the initial capital” (1909, p.8).
However, as Cole said, “Mr Hatfield’s own point of view is uncompromisingly
favorable to making accounts show the exact truth, but he is not eager to argue for his
own beliefs as to just what is the truth” (1909, p.647).
Hatfield did not openly pronounce on a theory of value, and said he “attributed scant
importance” to the difference between the proprietorial and entity concepts (Zeff,
2000b, p.239), but in reality he often adopted Fisher’s entity concept and consequently
economic value theory and, for example, found
“that it is by no means easy to lay down a rule by which to determine whether
certain charges are to be treated as an expense or whether they are to be held in
the Balance Sheet as representing the cost of assets. From a purely theoretical
point of view it seems that any expenses necessarily involved in organizing a
going concern are properly assets of that concern, much as are the real estate,
the machinery, or the stock in trade. To the stockholder or proprietor it is part
of the investment from which profit is to come and hence is capital
expenditure” (1909, p.78).
By contrast, Hatfield had little difficulty with revenue recognition because, consistent
with the LTV, he defined realisation as transferring control of use-values for control of
money or equivalent:
“the distinction between unrealized and realized profits is by no means the
same as that between profits which have been received in cash and those
otherwise represented. Profits are in fact realized when once the transaction is
completed. If it is a sale of merchandise the selling price includes both profit
and a portion of capital. It matters not whether this price is represented by
cash, or by the note of the purchaser, or by other assets received in payment,
34
provided, of course, that there is no valid doubt as to their real value. If the
claim against the purchaser is good, profit has been realized” (1909, p.227). 21
The LTV defines expenses in the same terms as revenue, as the socially necessary cost
of the use-values consumed in business operations in creating and transferring new
use-values to customers, but Hatfield’s reliance on the ‘necessity’ of the expenditure
effectively adopts the entity concept because from its perspective all expenditure to
further the interests of a business entity is ‘necessary’. Hatfield was therefore happy to
contemplate capitalising interest on construction, research and development, and
organisation expenses (1909, pp.76-78) and disregard the need to control use-values.
From the proprietor’s point of view, for example, as interest adds no controlled usevalues with value, management should immediately expense it. However, from the
entity’s view, “To secure…a plant there must be paid not merely the cost of material
and equipment, the salary of the engineers and the wages of the laborers, but equally
essential is the payment of interest to the bondholder” (Hatfield, 1909, p.76).
Similarly, the “expenses incurred in making experiments…may be treated as part of
general expense[,] but there is a colourable argument the other side…[because] the
salary and other expenses…[of hiring an inventor]…seem to be the cost of the secured
invention just as truly as the price paid for…[a] patent” (Hatfield, 1909, p.77).
Necessity also allowed a liberal view of what expenses to add to asset acquisitions.
For example, “The expenditures actually incurred in acquiring the land, including
those incident to bringing it into the desired form for sale may properly be considered
as entering into the value at any time in the process”, including lawyer’s fees (Hatfield,
1909, pp.86-87). Hatfield was even prepared to contemplate “includ[ing] among
assets items representing the cost of some good to one who has no property right
therein… [such as] money paid by a railway company to improve a street giving
access to its station” (1909, p.75).
Hatfield also adopted the entity view for marketable investments, where again
valuation depended on management’s intentions. As a principle, he thought, “cost
price…is confessedly faulty for it refers to an earlier and not to the present day
valuation” (1909, p.90), but he nevertheless concluded that cost valuation made sense
where management held investments with the intention of controlling another entity,
for example, another railroad, because
“[t]he market price of this stock may vary, but such changes in value cannot be
realized by the purchasing company while it still continues to exercise the
function for which it acquired the stock – that is, to control the other road”
(Hatfield, 1909, p.91).
However, where management intended the investment to be speculative, where the
capital did not serve a productive function, “May not the inventory here rely solely on
the market quotation? Strict consistency would seem to give an affirmative answer”
(Hatfield, 1909, pp.91-92). This “strict consistency” follows from Fisher’s economic
entity view that the duty of management was to maximise its present value to all its
property owners.
21
Compare the view of Previts and Merino that Hatfield “ignored the earnings process and concepts
such as revenues and expenses” (1998, p.211).
35
The entity view is also evident in Hatfield’s analysis of merchandise, particularly his
rejection of the lower of cost or market rule:
“General usage prescribes that merchandise on hand shall be inventoried at cost
rather than at selling price. Prudence further demands that merchandise which
evidently cannot be sold except at a loss, be marked down even below the cost
price. If one could count not only on good faith but as well on unbiased
judgment in making inventories, the taking of present market value, instead of
the cost price would not be objectionable, but rather to be commended. Indeed,
the first principle of valuation…, that of the ‘going concern’ in strict logic
demands that merchandise for sale to be valued at the present selling price,
with a deduction to cover selling expenses” (Hatfield, 1909, pp.101-102).
Hatfield had predictably similar problems with valuing produced inventories:
“When the merchandise to be inventoried has not been purchased but has been
manufactured the determination of cost price is much more difficult…. The
principle is clear enough. All the costs which are immediately necessary to
secure the goods may be included in the inventory price. But difficulties arise
in applying this simple rule, because of the uncertainty whether certain
payments such as partners’ salaries should be included in cost or treated as part
of the general expenses of the business” (1909, p.104).
Finally, Hatfield’s economic entity concept starkly appeared in his original advocacy
of imputing goodwill to the minority interest in a consolidation (Zeff, 2000b, p.146). 22
Hatfield was popular with practical accountants, perhaps because, given his evident
theoretical agnosticism his apparent condemnations of ‘bad’ accounting practice
carried with them a sympathetic understanding. For example, like other proprietary
theorists who accepted the focus of the British going-concern theory on measuring the
profits available for distribution, Hatfield argued that reported “distributable income
be maximized” (Merino, 1993, p.171), and issued “stern criticism” of “wilful
misrepresentation”, by which he meant conservative smoothing (Zeff, 2000b, p.142).
Hatfield’s apparent condemnations had no impact on practical accountants who “were
not averse to adopting concepts, such as conservatism, and techniques, such as reserve
accounting, that would result in the understatement of distributable income” (Merino,
1993, p.171), perhaps because they were heavily qualified. For example, he only
objected to “excessive depreciation…far in excess of the actual decline in value”
because “while generally condoned, is still a divergence from an ideal accounting, and
its effect is to establish a Secret Reserve” (Hatfield, 1909, p.137, emphases added).
Hatfield recognised and gave several examples of “corporations desiring to be
considered conservative, or wishing to escape taxation, or to conceal large profits,
[where] it is not uncommon to purposely conceal the existence of such a Reserve”
22
Merino argues that proprietary theorists like Hatfield supported amortising goodwill was because
they “could not attribute goodwill to permanent monopoly control or to managerial expertise” and
sustain the myths of free competition and proprietorial control (1993, p.172). She provides no evidence
that their motivation was that “Amortization enabled successful organizations to ‘make good’ watered
stock by providing funds for reinvestment, thereby establishing the integrity of capital”, or that it was
for conservatism (1993, pp.172-173). An alternative explanation why practical accountants like
Hatfield advocated amortisation is that this method is consistent with the LTV (Bryer, 1995).
36
(1909, p.252). However, he did not totally condemn secret reserves but called for
moderation in their use:
“Again it appears a case of justifying a practice abhorrent to accounting
principles, yet not without certain practical merits. In the anxiety to escape the
prevalent temptation to exaggerate the value of assets, which in many cases
have led to such disgraceful results, conservative financiers applaud the equally
erroneous, but perhaps less dangerous tendency to understatement” (1909,
p.254).
Although Hatfield found “It is hard to believe that so good a cause as financial
conservatism needs such unholy allies as misrepresentation and deception” (1909,
p.255), he did not find it impossible, and quoted the judgement of Buckley, J in the
Birmingham Small Arms Company case, apparently with approval:
“If the Balance Sheet be so worded as to show that there is an undisclosed
asset, the existence of which makes the financial position better than shown
such a Balance Sheet will not, in my judgment, be necessarily inconsistent with
the Act of Parliament. Assets are often by reason of prudence estimated, and
stated to be estimated, at less than their real value. The purpose of the Balance
Sheet is primarily to show that the financial position of the company is at least
as good as there state, not to show that it is not, or may not be better” (Hatfield,
1909, p.255). 23
Underlying Hatfield’s stern but fatherly understanding of conservatism was, of course,
his theoretical agnosticism on the question of value. He warned readers of accounts
that
“Unclearness and consequent misunderstanding of Balance Sheets may be due
to…[t]he uncertainty of all accounting that can never be altogether avoided. It
appears principally in connection with the valuation of assets. In many cases
there is no outside criterion of value” (1909, p.55).
This uncertainty even made “Purposeful misrepresentation” understandable because,
while he condemned utterly “palpable untruth” against which “the outsider is of course
defenseless”, it arose in part from “insidiously taking advantage of the inherent
difficulties” of asset valuation and the “vagueness of terminology” (Hatfield, 1909,
p.56). The real problem was with accounting itself that “as practiced does not even
attempt to show the actual condition of the business, in that [for example] to a large
extent it ignores contingent liabilities” (Hatfield, 1909, p.32), essential if by the ‘actual
condition’ or ‘truth’ we mean the economic value.
Hatfield further weakened his apparent strictures against ‘conservatism’ by embracing
‘prudence’. ‘Prudence’ demanded a depreciation charge for physical wear and tear,
23
Hatfield was, for example, prepared to suspend judgement on “the C. & N. W. R. Co. which in the
fiscal year1898-9 deducted an even $5,000,000 from the cost of the road charging the same to the
income account” (1909, fn.1, p.32). He understood that “the directors, from time to time, make
correcting entries of enormous sums” and therefore allowed that this write off was either “a direct
violation of bookkeeping principles, or that, even in one of the best managed roads, the accounting
system broke down and had to be patched” (1909, f.1, p.32).
37
and in the case of inventory “further demands that merchandise which evidently
cannot be sold except at a loss be marked down even below the cost price” (Hatfield,
1909, p.101). He accepted ‘prudence’ as a necessary counter to over-optimistic
management, and this justified carrying inventory at a maximum of cost even though
the going-concern theory required the current market price. “If one could count not
only on good faith but as well on unbiased judgment in making inventories, the taking
of present market value, instead of the cost price, would not be objectionable, but
rather to be commended” (Hatfield, 1909, p.101). If ‘prudence’ justified not
recognising appreciation in values, for the same reason, although not ‘ideal’, it also
justified recognising depreciation in value.
Whether, as many claimed, conservatism was intended to “protect stockholders from
their own rapacity” (Merino, 1993, p.171), or was to fool working class investors and
protect wealthy stockholders from the envious eyes of labour, is debatable. At the
least, if wage demands related to reported profits, if management smoothed them it
would prevent ratcheting up pay when profits increased.
By 1927, having produced only ‘difficulties’ rather than consistent principles, Hatfield
still doubted whether
“progress [can] be made without formulating some theory as to what value is
proper for accounting purposes? There is, indeed, rather general agreement
that in the first instance a newly acquired asset is valued at cost. But as to any
theory, underlying and supporting this rule, there is general silence.… In the
more difficult problem as to the basis for revaluing assets at the close of the
fiscal period, the lack of sound theory is as great, the divergence in practice
appalling” (1927, p.273).
Hatfield never overcame his theoretical difficulties. 24 In the revised edition of his
book, Accounting: Its Principles and Problems (1927) he remained frustrated that
“while the ascertainment of profits enters into the sum an substance of
accounting and the nature of profits enters largely into discussions of every
economist, the term is still vaguely and loosely used and without satisfactory
definition by either economist, man of affairs, jurist or accountant” (quoted in
Zeff, 2000b, p.145).
However, in highlighting the need for a theory of value he raised and left unresolved
fundamental problems for Paton and Littleton (and others) to tackle, which they did,
but with limited success, as we shall see. Whereas Hatfield the Methodist and
Humanist, never openly took sides, someone who did was William Paton who was
keenly aware of the ideological problems posed to capital by proprietorial theory and
the need to suppress the LTV he saw looming within it.
William A. Paton
24
Hatfield still had a major problem with the L-C-M rule that he called “a brilliant…instance of flabby
thinking”; claimed he did not understand the nature of a balance sheet; said he could not theoretically
rationalise the selection of a method of depreciation accounting; and found the consolidated balance
sheet an “anomalous document” (1927, pp.274-278)
38
Starting from the work of Sprague and Hatfield, Paton’s arguments are initially
consistent with their inchoate LTV, but his attempt to integrate Fisher’s economic
entity theory with practice leads to confusion and, like Hatfield, to many unresolved
problems. Like Hatfield, he recognised the need for a theory of value, but although he
knew the theory to avoid, he could not formulate an economic theory of value to solve
his problems. Paton appears to have had no influence on practice except, like Hatfield,
as an authority to legitimate a wide range of accounting choices.
First, Paton takes from Sprague and Hatfield the LTV idea that the aim is to report the
circulation of ‘values’ and, periodically, the profit and the capital:
“It is the function of accounting to register all values coming into the particular
business, to follow their course within the enterprise, and to note their final
disappearance from the business, and at the same time to record the effect of all
these processes upon the various elements of ownership. Or,…the essence of
the accountant’s task consists in the periodic determination of the net revenue
and the financial status of the business enterprise” (1922, p.6).
Second, the balance sheet is a statement of the sources and uses of ‘capital’: “The
balance sheet…represents…properties and equities…. In one instance attention is
being focused upon the objects for which funds have been expended; in the other, upon
the sources of those funds” (Paton, 1922, p.44). Third, the aim of financial reporting is
the accountability of management for capital: “A record of properties is obviously
essential to sound management, to fix responsibilities, show the residence of the
capital of the enterprise, and control policies of replacement and extension” (1922,
p.20).
Nevertheless, Paton openly argues against proprietorship theory and for Fisher’s
‘entity theory’. He knew the choice of entity concept, effectively the choice between
the LTV and economic value, was of the highest importance.
“[S]hall the proprietary or managerial point of view be adopted in stating the
theory of accounts? …This is not a matter of tweedledum and tweedledee”
(Paton, 1922, p.52).
He thought the question easily resolved because, echoing Fisher, “from the point of
view of economics, the argument that proprietorship and liabilities are simply more or
less distinct subdivisions of a larger class, equities or ownership, is easily made”
(Paton, 1922, p.60). The ‘more or less distinct subdivisions’ were the attributes of
property ownership of the providers of capital that economists described as a four
dimensional space, a multi-dimensional continuum of ‘equities’ as different forms of
‘property ownership’:
“property ownership connotes such attributes as control, title, risk-taking, and
capital furnishing. Similarly, the status of each interest in the business must be
shown periodically to ensure that each owner receive equitable treatment.
Especially in the case of the corporation, with its constantly changing
39
membership, it is important that the integrity of the net income figure in each
period be preserved” (Paton, 1922, p.61).
As ‘property owners’ came and went, managers could not simply maximize the
common stockholders’ wealth – located at one end of the control, risk-taking, capitalfurnishing continuum – but had to provide ‘equitable’ returns to all. As far as
management was concerned, “The return to all equities constitutes the increase in
wealth which, from the accounting standpoint, motivates business enterprise” (Paton,
1922, p.89). Although his conceptual solution was easy, Paton admitted it would
create practical problems:
“If all existing corporate stocks and bonds were to be arranged in a series
according to degree of risk attaching to each…it would be impossible to draw
any hard and fast line of division which followed security types. …And if
control or any other aspect of ownership were followed in making the
arrangement there would again be no clear-cut line of cleavage” (Paton, 1922,
p.73).
To practical accountants, the sharp line of cleavage between debt and equity comes
from the sharp qualitative distinction between capital remunerated from profit (from
net assets) and capital remunerated regardless of profit (from total assets). The
providers of debt capital often have a strong influence if not outright control of a
corporation, but this does not permit them to appropriate any residual surplus, which
remains exclusively the property of the common shareholders. In the LTV, the
essence of capitalism is pursuit of excess profits or residual income. Accountants
reflect this by focusing on the ‘bottom line’, i.e., net profit attributable to common
shareholders after interest.
Paton disagreed with Sprague’s proprietorial view and its distinction between debt and
equity because, as he frankly said later in his career, it conflicted with the ideology
that investors were ‘entrepreneurs’ who deserved a fair share of social surplus. He saw
in it grist for the “socialist mill”:
“Divorcing consideration of ‘profits’ from the study of ‘interest’…pushes the
door open to acceptance of the position that while interest may be regarded as a
‘cost’ business ‘profit’ is a leftover, of dubious economic validity,…which will
tend to dwindle and disappear altogether…[, and to] condemning ‘profits’ as an
unwarranted exaction at the expense of workers and consumers” (Paton, 1976,
p.76).
As management and not shareholders actively managed the circuit of capital M-C-M′,
in insisting on a qualitative distinction between debt and equity, Paton realised that
Sprague and other proprietary theorists and practical accountants effectively accepted
Marx’s view that profits were an “unwarranted exaction at the expense of workers”,
the residual, unproductive interest.
From the proprietorship perspective, and from the LTV, we get distinctions between
‘operating income’, ‘extraordinary items’ – capital gains and losses – and ‘net
income’. From Paton’s managerialist or entity perspective, we get the FASB’s ‘clean
40
surplus’. With ‘clean surplus’ capital maintenance is not relevant because the
distinction between operating earnings and extraordinary items – capital gains or
losses – depends on the distinction between productive and unproductive labour,
between those costs that ‘attach’, and those that do not. By blurring this distinction,
Paton quickly ran into difficulties:
“the determination of the cost of the product is a problem which presents
peculiar difficulties. Not only is it hard to follow the transformation of
particular asset values with the business but it is especially difficult to discover
the amount of asset values which finally disappears from the business,
embodied in finished goods, when a sale is made” (Paton, 1922, p.144).
Paton distinguished “a kind of net gain, a gain arising, however, entirely outside of
regular operations” (1922, pp.175-176). However, within his entity view, like the
FASB today,
“nothing new whatever is involved in these additional divisions [of equity].
Were it not for certain complexities in the business process, and some matters
of expediency, these classes [of expense and revenue] might indeed be
dispensed with” (Paton, 1922, p.142).
Thinking of revenues as just ‘gains’ from any source, Paton’s economic approach
undermined his apparent acceptance of the LTV realisation rule, which he states as
“the sale from one point of view consists in the exchange of finished goods…for cash
or receivables of equal value” (1922, p.146). Contradicting this, from the entity
perspective he and many other theorists in the 1920s accepted Fisher’ ‘accretion’ or
‘appreciation’ idea, that we should recognise revenue as market value changes that
“was gaining widespread acceptance, a view rejected by practical accountants who
argued for realisation and valuation at cost (Previts and Merino, 1998, pp.221, 445,
fn.102). Paton had no difficulty in arguing that “Economically, the accruing of
business income (capital and enterprise cost) as the commodity passes from the raw
stage to completion is as sound as accruing of any element of material or labor
expense” (1922, p.146-147, fn.4). As an economist, Paton was happy accruing
revenue before realisation, but this economic value approach created predictable
problems with calculating the cost of production:
“The cost accountant assumes that the costs of material, labor, etc., consumed
inhere first in goods in process (throughout various stages), later in finished
stock, and disappear finally from the business as ‘cost of sales’ and the product
of the enterprise is disposed of. …But…the ‘indirect’ costs (the ‘burden’ or
‘overhead’) can only be allocated to operations and products on a more or less
arbitrary bases” (1922, p.157).
According to the LTV, production overheads are socially necessary costs of
production that management allocates to commodities and services to measure the cost
of the use-values they consume – using the old idea of activity-based costing (Bryer,
2006a, 2006b). Paton grasped the principle in outline – “value which is absorbed as a
necessary incident to production” – but without the idea of productive labour and
socially necessary labour time (target cost of production), he could not apply it to
41
“difficult” cases as, from the entity’s viewpoint, all expenditures were ‘necessary’.
For some items, Paton found the distinction between value absorbed and value lost,
quite clear:
“In principle the distinction between loss and expense is very clear. The value
of a ton of coal burned in the manufacturer’s furnace constitute, presumably, a
legitimate cost of product; the value of the ton of coal stolen, on the other hand,
is a loss. Any value which is absorbed as a necessary incident of production,
any cost which must be incurred if product is to result, becomes a cost of
revenue, an expense. Any item which disappears as a result of inefficiency,
accident, fraud, natural catastrophe, etc., without in any way facilitating the
purposes of the enterprise, is a pure loss.
However, Paton admitted he did not “always [find it] easy to draw the line between the
two classes…. Many costs incurred by the average enterprise may be unnecessary
from an ideal standpoint. …Is obsolescence an expense or a loss? What is the nature
of a fire loss?” (Paton, 1922, p.177). Paton could find no answers to these questions.
The productive-unproductive labour distinction could have provided answers, but
Paton later explained that he deliberately avoided it for ideological reasons:
“the accountant should take care not to furnish a basis for encouragement of
distorted or malicious opinions regarding the nature and results of business
operations. He should avoid giving the impression that only certain costs are
inventoriable…. The use of the words ‘productive cost’ should be avoided if
there is any resulting implication that some other kind is ‘nonproductive’…[because] [s]uch careless and misleading impressions help to
prepare the soil for deliberate propaganda unfavourable to private enterprise”
(1948, p.51).
The idea against which Paton brushes here is the implication of the LTV that if
management or labour is inefficient or unproductive, the excess over the socially
necessary (technical best practice, standard or target) cost is a loss. Unexpected
obsolescence and fire damage are losses because in the LTV, as Paton himself says, “it
is doubtful if they always have a specific effect upon the selling prices of the
enterprise” in a competitive market (1922, p.177). In other words, management could
not use these events to justify a price increase to its customers. The reason, according
to the LTV, is that they are not socially necessary costs of producing use-values.
Similarly, in depreciation accounting, expected obsolescence determines the useful
economic life of a fixed asset to the buyer and is not a cost of production. 25 Expected
fire damage is a cost of production if the firm insures productive assets to preserve the
capital value embodied in their use-values, but as charges for self-insurance do not
provide protection for use-values, management should not charge these to production.
Paton, however, eschews the idea of productive labour, and will entertain only the
economic idea of value, and therefore for him these costs and others such as
“Experimental costs and reconstruction outlays furnish difficult cases. Has a
particular outlay resulted in something of value from which the benefit will not
25
The shorter the economic life, the bigger the depreciation charge, but the lower the current cost of
purchase.
42
be exhausted for some time or has the money been thrown away? A company
spends $100,000 on an advertising campaign, for example. The accountant is
called upon to decide whether this value is a loss, a cost of producing current
revenue, or an asset balance” (1922, p.178).
Within the entity perspective, where every ‘necessary’ expenditure for the business to
earn its revenues are assets, Paton could not decide. By contrast, the proprietorial
perspective and the LTV support the instinct of practical accountants that experimental
and advertising expenditures are not productive because they do not give control of
use-values whose cost they can recover from customers and they are, therefore, capital
losses, not assets or costs of production (Bryer, 1995; 2006).
Paton wrote many books and articles on many issues over his long life, but he rarely
changed his mind. One writer who did effect a temporary change was Littleton, who
persuaded him to give up the idea of ‘value’ in accounting, as it was the self-evident
source of his problems.
A.C. Littleton
Littleton’s main contribution to the debate was his argument that accounting could
achieve its primary aim of accountability and avoid the Scylla of the LTV and the
Charybdis of economic value, if accounting theorists abandoned the search for a theory
of value, and focused on controlled use-values, but, without one, he failed to resolve
any fundamental questions of practice.
Littleton dismisses any role for Fisherian economic value in accounting. Failure to
sharply distinguish between economic value and price, he says, “makes for confusion”
(1929, p.148). 26 To remove it, Littleton points out that ‘value’ is subjective and
‘price’ is objective. “Value is a subjective estimate of an article’s relative importance;
price, however, is a compromise between such subjective estimates and is measured by
the quantity of money for which an article is exchanged…; a value, however, can exist
in one mind alone” (Littleton, 1929, p.149). However, if price is objective value, this
raises the question, an objective value of what? Littleton goes out of his way to stifle
the idea that this value is a commodity’s labour value, to distance himself from any
association with the LTV. It is, as he said, “easy to see how…some writers feel that
profit represented a certain portion of income created by labor but retained by
enterprisers or the result of a superior bargaining power on the part of proprietors”
(Littleton, 1928, p.281). He naturally dismissed “the old idea that [value] was stored
up labor of the past” (1929, p.149), “that cost is the basis of value”, and Marx’s idea
that capitalists set prices to return them at least the required return on capital, the idea
that price = cost + profit:
“Much of the loose usage of ‘value’ in accountancy may perhaps be due to the
generally held view that value in business has a cost base, that Price = Cost +
Profit. As a matter of fact: Price – Cost = Profit. …[I]f cost is a proper basis
for the inventory of a stock of unsold goods it must be for other reasons than
26
Littleton says this ‘confusion’ existed in 1929 “as it did in the lifetime of Adam Smith and David
Ricardo” (1929, p.148), studiously ignoring Marx who claimed to have removed precisely these
confusions.
43
that it express the value of the goods. As an expression of the investment in
goods, cost is quite acceptable, but not as an expression of their value…[,] a
record of recoverable outlay, and not a record of values. …What they are
worth will depend upon future circumstances” (1929, pp.150-152).
Littleton’s only counter to the ‘generally held view’, Marx’s view, that prices on
average tended to cost + profit, where the profit was the general rate of profit adjusted
for risk, is that only “long usage may have given unshakeable sanction to the word
‘value’ in accounting” (1929, p.150). According to the LTV, while individual
companies make profits or losses, social capital, personified by the well-diversified
investor, get the general rate of profit. As Paton later made clear, Littleton’s comment
that “As a matter of fact: Price – Cost = Profit”, applied only to individual companies –
was only a ‘fact’ if we ignore social capital. Paton only ever talks of individual
companies. For example, “Under competitive conditions the particular business
concern in no sense represents a cost-plus contract with a group of customers” (1948,
p.49). Only from the viewpoint of the individual business is “private enterprise…a
‘profit and loss system’ and not simply a ‘profit system’” (1948, p.53). For Marx,
capitalism was precisely ‘just a profit system’ at the aggregate level of social capital,
presumably in Paton’s view the inspiration for the “humbug dished up on this subject”
by the supporters of “collectivist, interventionist ideology…overrunning almost the
whole world…unwilling to see anything good in capitalism” (Paton, 1948, pp.50, 45).
Whereas in the LTV social capital holds senior management accountable for the value
of capital, given Littleton’s rejection of ‘value’, management can only be accountable
for incurred costs and realised revenues:
“[Accounting’s] particular service lies…in…recording capitalistic investments
and advances, and of weighing these against the returns flowing from them
under the influence of management” (Littleton, 1929, p.153).
Therefore, “The businessman’s real interest in cost…is not in connection with setting
prices or measuring value, but rather in the calculation of profits” (Littleton, 1929,
p.153). Not profits in the sense of value realised, but “profits…as a measure of
accomplishment…[;] as an indicator of operating results” (Littleton, 1928, p.278).
Littleton concludes, “[a]ccounting is a record function, not a valuation function”
(1929, p.153), and seeks to correct Paton’s depiction of the circuits of ‘value’ and turn
it into the circulation of use-values and past prices. Littleton quotes Paton and
suggests the relevant change: “the function of accounting would seem to be ‘to register
all values (prices?) coming into the particular business, to follow their course within
the enterprise, and to note their final disappearance from the business’ (PatonAccounting Theory, p.6)” (Littleton, 1929, p.154).
US accountants in the late 1920s faced a multiplying list of issues they could not
resolve with the value formula. Littleton saw “accounting wrestling with a dilemma: a
purely cost balance sheet is unacceptable and a purely appraisal balance sheet is
unacceptable” (1929, p.148). He rejected the “balance sheet view of profit…[because]
it is impossible to define profit as the difference between present and prior value since
value itself (as the value of a factory plant [for example]) depends in the end
upon…the profits flowing from the goods produced” (1928, p.287). If “[v]alue is
44
essentially the capitalization of earning power” (1928, p.287), and we measure earning
power by expected future net cash flows, Littleton is right that the reasoning is
circular. If, however, value is essentially the ‘capitalisation’ (i.e., accumulation, not
the expected present value) of socially necessary labour, profit is the change in this
value for a period. As Littleton will not go down this road, we shall see that he later
accepts the importance of economic value and argues for additional disclosures, but for
leaving the accounts based strictly on cost and realised revenue (1936). That is, for the
primacy of the profit and loss account and for seeing the balance sheet as a list of
residuals from the cost and revenue allocation process. However, realised profits are
not the same thing as ‘earning power’, are not a measure of the expected long-run net
cash flow except assuming a stationary state, and therefore Littleton’s ‘profit’ has no
primacy in the valuation process. Hence, as we shall see, economic income theorists
could and did argue that the dependence of value on future cash flows rather than
profit gave primacy to the balance sheet.
Having abandoned the idea of ‘value’, Littleton finds it easy to draw the ideologically
convenient conclusion that “profit is a highly intangible, inconclusive event”; Fisher’s
idea that “Profit is not a thing in itself, …it is an intellectual concept only and varies
from person to person and from time to time” (1936, p.10). In recognising this, the
ambitions of accounting must shrink. The best accounting can do is to measure “the
excess of the prices received in bargaining exchanges over the prices previously
given” (Littleton, 1936, p.12). In this measurement process, use-values play a key role
in underpinning the objectivity of accounting:
“Those who used accrual accounting recognized the fact that bargained
purchase-price, and not cash disbursed, was the element used to represent the
thing received; that bargained sale-price, and not cash collected, was the
element used to represent the thing given…. [T]hat it was utilization of goods
or services, and not the act of acquisition, which marked the appearance of the
expense; and that the alienation of goods or the act of rendering a bargained
service, rather than the receipt of an object in exchange, marked the appearance
of income” (Littleton, 1936, p.12).
Given his focus on the objectivity of historical cost and use-value, Littleton was
naturally critical of the common view among accountants, consistent with the LTV
(Bryer, 1999b), that when material accountants should use a “replacement cost theory
of profit” (1936, p.14).
Although Littleton tried hard to bury the valuation problem, it would not die. The
failures to deal with it satisfactorily left accountants open to attack from economic
income theorists. Fisher had fired his salvo against accountants in 1906 and in papers
preceding his book, but he did not probe the detail of accounting valuation rules. The
first full-scale attack by an economist came from J.B. Canning. Fisher and Canning’s
work forms the intellectual foundation of the FASB’s conceptual framework. In 1929,
“…‘valuation’ loom[ed]…large as an accounting topic” (Littleton, 1929, p.148). At
that time and for some years Littleton was right that US “accounting [wa]s not ready,
apparently, to go all the way with value-balance sheets” (1929, p.148), as it would be
impossible to avoid the implication that (for example) fixed asset revaluations were
distributable. US accounting would not be ‘ready’ until the late 1990s, when the
45
FASB forged ahead with ‘fair value’ accounting. However, as Littleton wrote,
Canning (with Fisher’s help) was preparing the groundwork for this shift by theorising
accounting using neoclassical economic theory.
John B. Canning
Canning says his method is ‘critical induction’ from observing accounting practices
(1929, p.13, fn.1). He thought it was pointless asking accountants for their theory
because they “have no complete philosophical system of thought about income; nor is
there evidence that they have ever greatly felt the need for one” (Canning, 1929,
p.160).
“Whether or not accountants as a class subscribe, or would subscribe, to any
theory of value is not known. They do practice valuation; and much of their
procedure they adopt in common” (Canning, 1929, p.198).
He thought “Their generalization…too inchoate…to permit one to suppose that they
have ever seriously put their minds to the philosophical task” (Canning, 1929, p.160).
Canning’s contribution to the debate was to use Fisher’s theory to explain some of the
details of accounting practice. Canning was a first rate ideological obscurantist.
Canning’s starting point was Fisher’s view that “The whole subject of accountancy, if
not the whole essence of economics, lies in the study of a series of services” (Fisher,
1930a, p.71). That is, the view that the essence of accounting lay in the study of
‘income’; that whereas for accountants like Sprague, and in Marx’s LTV, ‘income’ is
the increment to capital from completing the circuit of capital, Canning adopted
Fisher’s view and rigidly separated ‘capital’ and ‘income’. Canning thought this was
necessary because “Mental comparisons between two successive existing stocks have
a different meaning from comparisons of successive flows and from a comparison
between an existing stock and a subsequent flow from it” (1929, p.147).
Psychologically, comparing two stocks of use-values is not the same as comparing two
flows of use-values consumed, the ‘income’ from consuming them. If we see them as
use-values, ‘capital wealth’ and ‘income’ are obviously incommensurable. However,
“[i]f the successive desirable events proceeding from a wealth source can be expressed
in money valuations”; if we can translate the desirable and undesirable economic
events associated with a stock of use-values, look at it as a series of future cash flows,
we can discount it to present value. This, Canning claims, makes capital and income
commensurable: “net receipts plus appreciation or minus depreciation, is the measure
of earnings from a given source during a period” (1929, pp.154-155). 27 However, as
Chambers says, subjective NPV calculations made at the beginning and end of a period
are not “made under common circumstances” (1979, p.770) and are, therefore,
incommensurable.
27
Chambers shows that Canning double counts the increment to capital value in his definition as he
also defines ‘realized’ income to be equal to the difference between the capital values at the beginning
and end of a period (1979, p.769). Canning gets confused because he uses ‘capital value’ to mean both
capitalized income and the product of selling price and the quantity of use-values.
46
Like Fisher, Canning’s aim was to interpret the accountant’s deployment of use-values
and costs in asset valuation within neo-classical economic theory. His definition of an
asset therefore stressed the control of ‘services’:
“Neither the corporeal existence of a material object nor anything necessarily
associated with that existence suffices to make the object an asset. …What is
essential is that there must be some anticipated, identifiable, separate (or
separable) services (or income) to be had by a proprietor as a matter of legal or
equitable right” (Canning, 1929, p.14).
However, Canning notes that, following Fisher, “The term ‘income’ is
used…interchangeably with ‘services’….” (1929, p.14, fn.2). In other words,
‘services’ are the cash inflows that the controller expects from the use values, directly
or indirectly, “the right to the chance of obtaining some or all of the future services”
(Fisher, 1906, p.22). For Canning therefore “An asset is any future service in money
or any future service convertible into money” (1929, p.22). Canning’s advance on
Fisher is that he accepts it is impossible to implement this idea for assets engaged in
joint production, i.e., the vast majority:
“not only is the future not wholly foreseen, but even if it were, the allocation of
total sales income among the material objects and persons whose services, as a
totality, will have brought this revenue cannot be made except upon a basis
largely arbitrary. With the exception of money actually in the possession of a
concern at a specified time, no valuation the accountant makes of a particular
item can be more than an index of the present worth of its future earning
power” (1929, p.41).
As Marx said of Smith, to attempt to allocate revenues to the factors of production is a
logical ‘blunder’ of the first magnitude. We can know the use-values of assets,
“[b]ut…valuing of the service unit in terms of money can be fulfilled when, and only
when, those services are separately to be exchanged for money” (Canning, 1929,
p.232):
“In a plant in which tractors are manufactured for sale, how much of the
service of bringing in the dollar-receipts from a given sale is attributable to
coal burned under the boilers, how much to the service of the boiler, how much
to the various devices in foundry, machine shop, assembly floor, how much to
the firemen, moulders, machinists, and night watchmen?” (Canning, 1929,
p.233).
Canning thought that “[w]e can, perhaps, approximate the contribution of the purchase
or the hire of each of these agents to the total cost of the tractors sold in a given lot”
(1929, p.233), but
“Capital instruments used jointly with others in turning out goods for sale do
not, properly speaking, have separate capital values at all…derivable from, and
determinable by, any money-valued service series…. Their values represent a
kind of opportunity differentials rather than independent summations”
(Canning, 1929, p.233).
47
A “going-concern, or indirect, or opportunity valuation” confirms or denies that “the
existing stocks of service available for future use can be so combined with stocks
acquired in the future as to yield a rate of return on future outlays greater than that
necessary to induce the future outlays” (Canning, 1929, p.238). In other words, an
indirect valuation confirms or denies whether the firm is a ‘going-concern’, i.e.,
investors expect it to earn the required return.
In the LTV, management should value stocks of use-values at their current
replacement cost, their currently socially necessary cost. Canning appears to agree.
He says that if we have a used tool with a remaining estimated useful economic life
half that of a new one, if we need the tool and its costs are equal to or less than those
of the new tool, and if management expects the enterprise to earn at least the required
return,
“the used tool is worth at least half as much as a new one. This is true not
because it is possible to capitalize the money equivalent of the services of the
two tools and find that one is twice as great as the other; for that cannot be
done. …With respect to the whole situation it would be foolish conduct to pay
more for a like used tool or to accept less for this used tool than half the price
of a new one. …The argument made with respect to the used tool can be made
for every capital instrument held. …Each item represents the difference
between having a particular stock of services of a particular kind without future
outlay for it and being wholly without such services in the buying-holdingoperating-selling position of the enterprise at the time of valuation” (Canning,
1929, pp.240-241).
According to the LTV, the used tool has half the value of the new tool because its usevalues will recover only half the money value of the currently socially necessary
labour time of a new one. To avoid this conclusion, Canning warns his readers that he
does not mean that “accountants have a ‘cost of replacement less depreciation’ theory
of valuation or that their practice in any way implies such a theory” (1929, p.243).
First, he dismisses the vulgar view that the theory refers to the replacement cost of the
existing assets as such. Marx would agree that “[t]his is a fundamentally different
thing from the cost of replacing stocks of services” (Canning, 1929, p.243), if we
define ‘services’ to mean the necessary use-values. However, here Canning exploits
the ambiguity of his definition of ‘services’ to be both the use-values and the money
equivalent, and this has caused difficulties for readers. Whittington, for example,
interprets this move in Canning’s argument to mean that accountants should calculate
the minimum cost of replacing the expected cash inflows. He is right that “The author
emphasises that it is the service, not the physical object, whose replacement cost
should be calculated: this arises logically from regarding the value of the asset as the
present value of its future returns” (1980, p.238). Logically, therefore, Canning
emphasises the ‘value to the business’, or ‘value to the owner’, rather than value to
capital, the replacement cost of use-values. However, it does not follow logically that
“If the…present value of future net operating cash inflows exceed scrap value of the
whole concern…, and the service provided by the asset is essential, then he values at
replacement cost of the service” (Whittington, 1980, p.239). Canning only values at
48
replacement cost if replacement of the individual asset is worthwhile, i.e., has a
positive net present value:
“The consequential difficulties and losses from substituting one instrument for
another…are in general so great that the actual cost of the unused portion of a
stock of services is nearly always a more appropriate value than any other.
Even in the case in which the capital item in use can be replaced by another at a
price less than was paid for the one in use, it does not follow that this price
reduction should necessarily affect the proper valuation of the present
instrument. It may not actually pay to replace it now. …Present costs of
replacement have nothing to do with present valuations unless present
replacements are contemplated” (Canning, 1929, pp.244, 253).
If current replacement will not increase expected net present value, replacement cost is
not a better index of present value than historical cost. This, for Canning, explains
“the reluctance of accountants to allow so-called replacement costs of fixed tangibles
to affect book values…[; t]heir reluctance to recognize changes in the market price of
things not actually to be bought” (1929, p.245). Nevertheless, with “a good deal of
positive evidence” Canning would allow future replacement costs (1929, pp.254-255).
With this notion of an asset, Canning thinks he has solved the riddle of how to explain
the accountant’s preoccupation with use-values and exchange values in their
valuations of joint assets without recourse to the idea of cost as value. Canning
effectively transforms the socially necessary cost of use-values into their ‘opportunity
costs’, Fisher’s claim that accountants’ asset valuations are a ‘conservative’ index of
the asset’s present value. As Sorter and Horngren put it, following Canning,
“the cost of a machine can be viewed as the present value of the revenue
attributable to the machine…. However, translating this economic notion into
meaningful, objective measurement is too difficult, so accountants have used
historical cost as a maximum limit of these present values. Working within the
historical cost framework, the question becomes one of deciding when costs
represent future economic benefit and when they do not” (1962, p.394, fn.9).
Clearly, “the use of ‘valuation’ qualified by ‘direct’ and ‘indirect’ implies that the
valuations are the same in kind” (Chambers, 1979, p.772) – that both are present
values. This is the claim that “Past costs are utilized by accountants chiefly, if not
solely, as a means of valuing future or anticipated services” (Fisher, 1930a, p.72).
Thus, for example, although accountants, consistent with Marx’s LTV, would write off
all ‘organisation expenses’ as they do not give control of necessary use-values for
production, Canning’s accounting would allow them because
“The real meaning of the item, ‘organization expenses’, is, therefore, ‘this
amount was paid to procure the adopted form of organization in the expectation
that the services or assets to be utilized under it would be worth more to the
proprietary interest (by at least the amount of the outlay) than they would
otherwise be worth’” (Canning, 1929, p.32).
49
Although he recognises capital’s social nature, Canning never tears himself away from
Fisher’s idea that ‘income’ means the psychological satisfaction of the individual
consumer of services, here represented by the corporation as a ‘person’ (see below).
Canning shows us this in an example of a sole proprietor that buys a calculating
machine to cheapen his costs; then finds a slackening of his business at the same time
as the cost of a new calculating machine increases, and the proprietor employs his now
idle clerks to perform the calculations. Canning argues the proprietor should not write
up the calculator to current cost – or write it off – because the free labour of the clerks
generates the services that have the same value as the machine would have had if the
proprietor had used it (1929, p.243). It is hard to disagree with Chambers assessment
of Canning, that
“Obviously a capitalized value of the net proceeds of an asset is not the same as
a proportionate part of its cost. …Does the amount assigned to any such asset
represent ‘funds procurements’ that are expected to occur? Certainly not; the
cost of the unused portion of a stock of services is not an index of the funds
expected to be generated by its use or the sale of its products” (1979, p.772).
As there is evidently no general relation between cost and present value, it “cannot be
properly held that Canning’s definition of asset is implied by accountants’ practice”
(Chambers, 1979, p.767). Nor can we say this of his notion of ‘income’ and
accounting ‘earnings’.
Canning knew that Fisher was wrong in saying that “A businessman’s ‘moneyincome’ means to him the money receipts from his business, less the money expenses
of obtaining them” (Fisher, 1906, p.103). Canning corrected this with his “ideal
statistical treatment of income” – receipts minus disbursements plus appreciations and
minus depreciations in ‘true capital value’, plus increases and minus decreases in the
book values of assets that did not have a true capital value (1929, p.135).
Nevertheless, Canning followed Fisher in calling the series of future cash flows
underlying true capital value ‘realized income’. Canning notes this is different from
the accountant’s ‘realized’ income (1929, fn.9). In his view,
“accountants wish to ascertain enterprise earnings rather than enterprise
realized income. …There is no reasonable ground for doubt…that earnings
(earned income), to the extent that they can be economically measured,
constitute a superior and more immediately convenient measure of income”
(1929, p.169).
However, accountants do not do more to “approximate true earnings”, Canning says,
because no one will pay for the valuations and because of “the very great difficulty of
obtaining reliable data” (1929, p.169).
“The proprietor and those beneficially interested in proprietorship wish chiefly
to know what net changes in power to command future final income have
occurred within a year by reason of enterprise activities. Not only is this
information requisite to a proper determination of shareholders’ investment
policy, but to considered decisions about their scale of living income to be
planned for the near future. Those responsible for the administration of the
50
internal affairs are better able to plan and control their policies on the basis of
earned income than on that of realized income. The interests of creditors are
best served by the pursuit of policies that most greatly enhance earnings”
(Canning, 1929, p.170).
Canning does not define these ‘net changes in power to command future final income’
occurring within a period in relation to his definitions of assets, liabilities and
proprietorship:
“Net income is not defined qualitatively…. Had net income (or, alternatively,
earnings) been defined as the increment in a period in net proprietorship, the
whole set of basic terms would have…represented a coherent set of ideas.
Such an interlocking may have led to some discussion of the maintenance of
capital (or of net proprietorship). That notion was not novel…[b]ut Canning
did not discuss it” (Chambers, 1979, p.773)
Fisher did discuss ‘capital maintenance’, but Canning is more logical. In Fisher’s
theory, ‘income’ the personal pleasure derived from consumption whereas ‘capital’ is
the physical denomination of wealth and income, and there is no necessary relation
between them. As Fisher himself said, “a corporation as such can have no net income”
(1930b, p.58). Profit, therefore, as something an entity reports to its owners, does not
exist in Fisher’s theory. This is why, for Canning, the ‘chief’ purpose of accounts was,
as Hicks later said and the FASB subsequently endorsed, to guide investors’
investment and consumption decisions. While “[i]ts stockholders may get income
from it, the corporation itself…receives none” (Fisher, 1930b, p.58).
To sustain this conclusion, Fisher and Canning denied the social reality underlying
capital and income. Neither discussed the accountability of the corporation
“considered as a separate person” (Fisher, 1930b, p.58). Fisher recognised a problem,
but he solved it by abstracting from the social reality an imaginary ‘artificial person’:
“In the old days, when accounting began, the proprietor was a very definite
individual with specific liabilities; but today, with a multitude of investment
forms and with contracts in which creditors share in profits and take explicit
risks…, the whole concept of a proprietor becomes more and more difficult, if
indeed it does not vanish into thin air, while the concept of a corporation as a
fictitious or artificial person which, for bookkeeping purposes, receives and
dispenses all elements of the accounts becomes increasingly useful” (Fisher,
1930a, pp.75-76).
Fisher submerged social capital under the abstraction the corporation as a ‘person’
and, in so doing, as we have seen, obliterated the accountants’ distinction between debt
and equity: “This ‘person’ is the sole proprietor and its liabilities include stocks as well
as bonds” (Fisher, 1930a, p.77). Only by ignoring social capital is it “Obvious…[that]
the capital value of an enterprise, if it can be estimated with sufficient reliability, is a
much more significant figure than the summation of the assets” (Canning, 1929,
p.246).
51
Fisher and Canning’s ideas would ultimately have wide circulation amongst US
accounting academics (Zeff, 2000), and would have their day in the FASB’s
conceptual framework, by when, as we shall see, all concerns with use-values and cost
were suppressed. In the meantime, shortly after the date of Canning’s preface
(September 10, 1929), the Great Crash began (October 1929 according to Galbraith,
1954) and his book had no impact on the codification of accounting principles in the
1930s or on practice (Chambers, 1979; Zeff, 2000).
In the aftermath of the Great Crash, practical accountants distanced themselves from
economics and the era of proprietary accounting based on an inchoate LTV began,
whose future it was for the next 40 or so years, but against increasing and ultimately
overwhelming practical problems and ideological force. As the regulatory problems
mounted in the 1960s, economists renewed their attack with unequalled ferocity and,
in the 1970s and 1980s, the FASB’s conceptual framework all but deposed practical
accounting, and it has recently promised to finish the job with ‘fair value’ accounting
(IASB, 2006).
Part 2: From the Great Crash to the FASB’s conceptual framework: the search
for ‘generally accepted accounting principles’
Key elements of the political context for accounting theorists in the 1930s and 1940s
were the “sneers of cynicism” that greeted the Great Depression and business reaction
to the New Deal that many leaders saw as “clear evidence that FDR was driving the
nation steadily down the path to socialism” (Galambos and Pratt, 1988, pp.100, 105).
Although this was untrue, the continuing conflict between capital and labour gave
accounting theorists a sustained incentive to avoid giving the aim any credibility from
accounting. The problem was, as an accountant pointed out in 1947, that
“The newspapers daily carry reports of corporate earnings. The workman
reads them, notes that the figures are large and then and there concludes that
they are exorbitant” (Stans, 1947, p.24).
The Journal of Accountancy reported “an exhaustive survey” by the Controllership
Foundation in 1946, which found that profit was
“Often…regarded as the amount of money wrung from the pockets of
underpaid workers. Half of the people of America can think of one or more
companies that they think are making too much money. One third think
business in general is ‘making too much profit’” (p.487). 28
Given their class affiliation and absorption of economic ideology, accountants
naturally thought the solution was a “full understanding…that, in our economic
structure, the interests of labor, management and capital are not opposed but are
parallel”. In other words, that “labour should have a fair share of the productive
output, which means due respect also to a fair share to capital and management”
(Stans, 1947, pp.20, 28).
28
The survey found that around 25% of Americans read financial reports in newspapers (Journal of
Accountancy, 1946, p.487), but Stans thought that “Labor unions examine corporate reports more
thoroughly than do stockholders” (1947, p.24).
52
After the 1929 crash, “Public reaction was bitter, and a critical review of the processes
of the financial market, including financial-reporting practices, became an obvious
political necessity” (Carey, 1969a, p.165). Although the US Congress responded by
modelling the Securities Exchange Act of 1933 on the British Companies Act of 1929,
it omitted the provisions on shareholder rights to financial statements and the
requirement for a true and fair view (Bush, 2005, p.9). This is consistent with
“deference to the states” (Bush, 2005, p.9), but it is also consistent with the continuing
perception of an exceptional labour danger in the US. In this context, given its failure
to give “any sensible guiding accounting and reporting principles” (Bush, 2005, p.20),
its decisions not to legally require truth in accounting and not to give shareholders a
legal right to know, the US Congress gave accountants no choice but to search for
‘generally accepted accounting principles’.
The day of the accountant
We saw in part 1 that before the 1930s, American accountants faced virtually no
regulations governing practice (Walker, 1978, pp.128-133) and “[t]houghtful members
of the accounting profession were aware that financial-reporting practices were not all
they should be” (Carey, 1969a, p.157). After the Crash, the US authorities forced
accountants to tackle these issues, ushering in a new era of increased disclosure and
independent auditing based on ‘GAAP’ thus abandoning the voluntary British system.
As the Institute’s Committee on Cooperation with Stock Exchanges put it, under the
new system auditors would have to “display courage and independence when their
approval is sought for accounts which are either clearly inadequate or misleading, even
if technically accurate” (quoted in Carey, 1969a, p.169), implying they had not always
been adequate or transparent. Accountants knew that a pre-requisite for courage in the
face of powerful management was a robust theory. As George O. May, then senior
partner of Price Waterhouse put it in 1926, there was a clear “need for some rational
conceptual foundation on which the responsibility of independent auditors could be
based” (Carey, 1969b, p.5). For the next two decades, May led US accountants in
their adaptation to life after the Crash, particularly their search for ‘generally accepted
principles’ that crystallised in Paton and Littleton (1940) and ushered in the day of the
practical accountant.
G.O. May (1943)
William Z. Ripley caused a stir with his book Main Street and Wall Street (1927) in
which he criticised the manipulation of accounts and ‘the hoodwinking of
shareholders’ as others did throughout the 1920s. He (and others) advocated full
publicity and centralised regulation by the Federal Trade Commission. May
responded for the Institute and accepted appointment as advisor to the NYSE Stock
List Committee where he “constantly urged improved financial reporting, clearly
perceiving that the speculative boom, if not checked, would collapse. It did” (Carey,
1969a, p.164). Hoxsey (1930), an official at the NYSE, recited many important areas
of financial reporting where there were wide variations in practice (Miranti, 1990,
p.142). Central to management’s power was its ability to engage in “accounting
manipulation”:
53
“The integrity of the accountant and the soundness of his method are the
greatest single safeguard to the public investor. …But the rules of accounting
are not as yet fully recognized rules of law. …In fact, the failure of the law to
recognize accounting standards is probably due to lack of agreement amongst
accountants” (Hoxsey, quoted in Carey, 1969a, pp.170-171).
May thought, “inadequate or misleading reports of established business played but a
relatively unimportant part in causing the catastrophic losses that were sustained”
(1943, p.57). He laid any blame for the manipulations and misunderstandings that
occurred at the door of academics and their “concept” of economic income.
“The combination of the concept of income as including capital gains and that
of capital value as a multiple of income-producing capacity obviously may and,
indeed, did in the financial boom of 1928 and 1929 produce fantastic results”
(May, 1943, p.29).
Where did this idea come from? With no regulations, accountants turned to the
leading textbooks and technical journals. In these, where we find the dominant
practical view that accountants should use cost-based methods of valuation and match
costs with revenues, there were also “diverse opinions”, including Fisher’s argument
that accountants should value assets at “the present value of the services or benefits to
be derived from using those resources in the business” (Walker, 1992, pp.5). Whereas
during the 1920s and early 1930s some authorities, consistent with the LTV, accepted
replacement costs for fixed assets, others accepted general write-ups to ‘appraised’
present values or market prices or other values (Walker, 1992, pp.4-5). As May put it,
practitioners naturally regarded current value accounting as “permissible” but not
“compulsory” (1943, p.98). From 1925 to 1934, US corporations commonly wrote-up
their fixed assets (Fabricant, 1936; Dillon, 1979; Saito, 1983; Walker, 1992). Some
used the credit to capital from revaluation to offset write-downs, or to offset
accumulated losses (Walker, 1992, p.5).
Storey thought the realization “concept of profit was gradually taking form…after the
First World War and had become dominant in…accounting…by the late 1930’s”
(1959, p.232). It became ‘dominant’ in the late 1930s in response to the Crash and the
swing back to realism and the LTV. In May’s view,
“the [cost-realization] rule of today is the result of a revulsion of feeling….
The old rule, which permitted and in some cases encouraged the recording of
unrealized appreciation on the books of corporations, fell into disrepute
because of the abuses that were committed in its name, and because of a
change in the general concept of the major objective of accounting from the
determination of net worth to the measurement of income and earning
capacity” (1943, p.39).
To a practical accountant it was clear that “as a report of stewardship…[i]t is natural
that the management should account for the assets coming into its charge on the basis
of cost to the corporation” (May, 1943, p.24). Only “on rare occasions, if any, should
any reflection of changes in value that have not been realized be considered” (May,
1943, p.24). Echoing Littleton, May thought this shift from accretion to strict cost and
54
realization was the “shift of emphasis from the balance sheet to the income account,
that is, perhaps, the most significant change of recent years” (May, 1943, p.24). In the
boom, “[a]n outstanding characteristic…was the new emphasis laid on earning
capacity as the measure of value of such securities…[;] earning capacity was usually
the main criterion on value” (May, 1932, p.337). He thought, however, that many
investors were “hopelessly wrong” when they assumed that the “earnings capacity was
fairly measured by the past or prospective earnings for a comparatively short period,
without any adequate knowledge of the way in which the figures of earnings employed
in their calculations were derived” (May, 1932, p.337). Investors, often “not primarily
trained in accounting”, found “discussions of value and valuations…confusing”
(Sanders, 1936, p.72). If they had Fisher’s notion of value in their heads, they did not
understand that, given its grounding in cost and realisation, at best, “the value of the
income account depends on its being a fair indication of the earning capacity of the
business under the conditions existing during the year to which it relates” (May, 1932,
p.345).
“The prospective investor is not interested in past earnings as such – they are
significant to him only in so far as they are a guide to the future… – [i]t seems
desirable that the annual financial statements of American corporations
should…be regarded as historical and in no sense prophetic, notwithstanding
that the stock of the company may be listed and freely traded in” (May, 1943,
pp.21-22).
It was up to investors, with “full and more enlightening information in regard to the
operation of the larger companies whose securities are widely distributed” to value
companies and to “deal intelligently” with their investments by making “reasonably
informed opinions on the attractiveness of the stocks” (May, 1932, p.343). By this, as
an Institute committee chaired by May made clear in a letter to the NYSE in 1932, he
meant the aim of LTV accounting, using the accounts to hold management
accountable:
“The purpose of furnishing accounts to shareholders must be not only to afford
them information in regard to the results being achieved by those to whom they
have entrusted the management of the business, but to aid them in taking
appropriate action to give effect to the conclusions which they reach regarding
such accomplishments. …The only practical way in which an investor can
today give expression to his conclusions in regard to the management of a
corporation in which he is interested is by retaining, increasing or disposing of
his investment, and accounts are mainly valuable to him in so far as they afford
guidance in determining which of these courses he shall pursue” (May, 1943,
p.78).
In other words, investors could not use accounts to value businesses, but they could
use them to make judgements about management’s performance and use their
collective market power to reward or punish it by buying or selling shares. Buying
shares increases management’s ability to raise capital on favourable terms and
increases their chances of survival and commanding larger rewards. Selling shares or
55
not subscribing to new issues disciplines management by withholding capital,
threatening survival of the organisation and the management team. 29
Given the confusing theories of economists, during the 1920s many American
investors did not understand that accountability was the primary function of accounts.
May thought it “undeniable, though not fully recognized outside the profession, that
books of large enterprises are kept predominantly on a cost basis and do not, therefore,
constitute evidence of the value of either the enterprise as a whole or the separate
assets thereof” (1943, p.8). From the accountant’s viewpoint, “No one has a right to
interpret a report of stewardship as though it were an invitation to invest” (May, 1943,
p.19). Hence, May’s call for ‘educating’ investors into the ‘limitations’ of accounting
(1932, p.343).
Accountants, however, could tighten the rules to deny management the discretion it
had exercised before the Crash:
“In my experience,…losses from unsound accounting have most commonly
resulted from the hopes rather than the achievements of management being
allowed to influence accounting dispositions. To me, conservatism is still the
first virtue of accounting….” (May, 1943, p.44).
In short, there was a problem with accounting during the 1920s. Where did the
problem come from? Why were management “allowed” to inject their hopes into
accounts? May thought the blame must go to academics:
“In reading the American accounting literature, it is surprising to find how
generally accounting was described at one time as a process of valuation, up to
how recent a date this view was maintained, and how pronounced and rapid the
change has been” (1943, p.8).
In other words, the confusion generated by Fisher. Consistent with this, against the
academics call for a “unified and coordinated body of accounting theory” (AAA,
1941), May insisted that accounting was based on ‘conventions’, “the result of
common agreement between accountants” (1943, p.3), the ‘distillation of experience’.
In 1934, the Institute distilled some of this experience in a pamphlet, ‘Audit of
Corporate Accounts’, which spelled out practical rules “so generally accepted that they
should be followed by all listed companies” (Carey, 1969a, p.177) to deal with the
main boom-time abuses encouraged by the notion of economic income:
1. Unrealized profit should not be credited to income account…. Profit is
deemed to be realized when a sale in the ordinary course of business is
effected….
29
May says, “in an earlier day, stockholders who were dissatisfied with the results secured by
management could perhaps move effectively to bring about a change in policy or, failing that, a change
of management” (1943, p.78). May did not foresee the effectiveness of the market for management
control that emerged in the 1960s or the growth of shareholder/institutional activism. These, however,
merely multiply the discipline imposed by accounts. If management do not earn the required return,
agents of social capital may intervene to punish management by organising shareholder resistance to
pay increases or renewal of contracts. As this could threaten other members of the management team,
they often anticipate intervention and act against incompetent or under-performing managers.
56
2. Capital surplus…should not be used to relieve the income account….
3. Earned surplus of a subsidiary company created prior to acquisition does not
form a part of the consolidated earned surplus of the parent company; nor can
any dividend declared out of such a surplus properly be credited to the income
account of the parent company,
4. …[D]ividends on…[treasury stock] should not be treated as a credit to the
income account of the company” (May, 1943, pp.81-82).
Despite this and the Institute’s strong preference for self-regulation, the Securities
Exchange Act of 1933 required audits of private corporations issuing securities in
more than one state, and delegated “administrative authority to prescribe accounting
principles and methods. The British Companies Acts had never gone that far” (Carey,
1969a, p.182). After long deliberation and tentative moves in the direction of writing
accounting principles, the Commission eventually decided to leave this to the
profession (Walker, 1992). Disillusioned with academic theories, with the agreement
of the NYSE it declared, “[p]rinciples of accounting cannot be arrived at by pure
reasoning, but must find their justification in practical utility” (Carey, 1969b, p.6). On
this basis, the agreed standard form of the auditor’s report included the affirmation that
the financial statements fairly presented the position and the results ‘in accordance
with accepted accounting principles’. Therefore, it also agreed, a “relatively small
number of broad principles of accounting should be adopted as a framework within
which the validity of specific applications could be tested” (Carey, 1969b, p.6).
Not surprisingly if we suppose an inchoate LTV underlying practice, “the phrase
‘accepted principles of accounting’ became shrouded in ambiguity. What were they?
Where could they be found? In these questions”, as we shall see, “lay the seeds of
future discontent” (Carey, 1969b, p.7). This ambiguity left the door open for
American academics to continue to attack the profession and ultimately, from their
uniquely powerful vantage point in the AAA (Carey, 1969b, p.8), to succeed.
However, in the meantime, the SEC had “by the language of its regulations, lent
support to the view…that it is not the business of accountants to reflect the ‘value’ of
properties and plant” (Sanders, 1936, p.72). In June 1936, the AAA published ‘A
Tentative Statement of Accounting Principles Affecting Corporate Reports’. The aim
was accountability for ‘economic resources’, but the AAA did not expand on this, and
echoing Littleton’s view, ruled out the idea that accounting had anything to do with
‘valuation’:
“the purpose of the statements is the expression, in financial terms, of the
utilization of the economic resources of the enterprise and the resultant changes
in and position of creditors and investors. Accounting is thus not essentially a
process of valuation, but the allocation of historical costs and revenues to the
current and succeeding fiscal periods” (AAA, 1936, p.188).
In 1937, Carmen G. Blough, chief accountant of the SEC told the profession that,
unless it developed accounting principles to reduce the variety of accounting methods
approved by auditors, the Commission would do it. By 1940, the SEC used its ‘stop
orders’ to effectively ban present value estimates and estimates of selling or
replacement prices (Walker, 1992, p.25). Following this display of force, the AAA
and the SEC had no problem persuading the Institute to enlarge its Committee on
57
Accounting Procedure in 1939 to include three academics, Kester, Paton and Littleton.
This committee began producing Accounting Research Bulletins addressing particular
issues, but given the many problems needing immediate attention, it decided not to
attempt a comprehensive statement of accounting principles (Storey and Storey, 1998,
pp.15-16). To fill this gap Paton and Littleton wrote ‘An Introduction to Corporate
Accounting Standards’, published by the AAA in 1940. Their aim was to deal with the
“rather considerable literature which grew up…marked by a wide variety of
proposals as to what might be considered ‘sound accounting’; to bring “order
out of…chaos of conflicting ideas and practices”, to dispel “serious
misconceptions, not only in the minds of the public, but also in the attitudes of
business and financial leaders themselves” (Greer, Foreword to Paton and
Littleton, 1940, p.vi).
Given the economic accounting of the 1920s, it was unsurprising that, as Carey says,
“[t]his monograph gained wide acceptance for the proposition that the matching of
costs and revenues was the appropriate basis for income measurement, rather than the
process of asset and liability valuation” (Carey, 1969b, p.16). 30 Not least because “it
generally rationalized existing practice, providing it with what many saw as a
theoretical basis that previously had been lacking” (Storey and Storey, 1998, p.28).
However, we shall see that, conceived and written in a context in which “[d]uring the
nineteen-thirties interest in Marxism was widespread in the US” (Sweezy, 1952,
p.469), its inchoate presentation of the LTV left the door open for attack and the
eventual neo-classical suppression of practical accounting principles in the FASB’s
framework.
Paton and Littleton (1940)
Paton and Littleton attempted, in effect though not intentionally, to reconcile some
elements of the LTV with the core propositions of Fisher that income was personal and
that value was capitalised expected earning power. Therefore, on the one hand,
“Earning power – not cost price, not replacement price, not sale or liquidation price –
is the significant basis of enterprise value. The income statement, therefore, is the
most important accounting report” (1940, p.10). On the other hand, “The basic subject
matter of accounting is…the measured consideration involved in exchange activities,
especially those which are related to services acquired (cost, expense) and services
rendered (revenue, income)” (Paton and Littleton, 1940, pp.11-12).
Paton never understood social capital, but in Paton and Littleton (1940), it becomes the
key to corporate reporting. The introductory heading of their work is the “Separation
of Investment and Management”; they identify the accountability objective; and they
see a major role for accounting in reuniting ownership with control.
“With a condition of detached and scattered investor-interests the service of
accounting has necessarily been expanded; the function of reporting
information to absentee owners has been added to that of recording and
presenting data for owner-operator use.… [T]here is a need for developing
30
The book was the product of much deliberation, discussion and committee work within the AAA and
outside (Greer, 1940, pp.vi-vii), amplifying the ‘Tentative Statement’ of 1936.
58
standards to secure proper protection for the equities of corporate investors”
(1940, p.1).
Paton and Littleton here adopted Paton’s entity concept and sought equity between
different classes of investors. Second, they sought management’s accountability for
capital and the valorization process for the good of investors and, happily, as they saw
it, of society:
“accounting is important from the social point of view…[because] [c]apital
should flow…[to] the management…capable of using capital effectively. If
capital in an enterprise is…not earning a return over a period of time, this
probably indicates that capital is lodged in incapable hands or in an industry
whose service is not in continuing demand” (1940, p.3).
“accounting still does not go much beyond the supplying of information to
make possible various controls” (1940, p.11).
“Accounting exist primarily as a means of computing a residuum, a balance,
the difference between costs (as efforts) and revenues (as accomplishments) for
individual companies. This difference reflects managerial effectiveness and is
of particular significance to those who furnish the capital and take the ultimate
responsibility” (1940, p.16).
“The function of accounting is not confined to bare recording; analysis for the
purpose of understanding and control is involved throughout” (1940, p.118).
On the other hand, Paton and Littleton evoke Fisher’s entity theory in which control is
control of only use-values. While following “the accountant’s natural instinct to
conceive of business property as belonging to the entity, and income as assetincrement” (1940, p,9) allows them to focus on the circuit of capital through
production, the self-denying ordinance on valuation and hence on any distinction
between productive and non-productive labour, leads to vagueness.
As Marx said, if we look at the qualitative difference between interest and net profit
we may forget that both are mere divisions of the surplus value earned by the business
as a whole, as a process of production controlled by managers. However, whereas
according to the LTV managers control the valorization process, like Fisher and
others, Paton and Littleton see the ‘business entity’ as only the material process – the
‘business property’ belonging to the entity. Therefore, whereas the LTV takes the
proprietorial view, for Paton and Littleton,
“Since the concepts of business entity and continuity predicate an enterprise or
institutional point of view, accounting theory likewise is oriented first to the
enterprise as a productive unit and only secondly to the investor as a legal
claimant to assets” (1940, p.11).
Accounting professionals and academics did not accept Paton and Littleton’s entity
theory (Previts and Merino, 1998) and its one-sided focus on use-values was later
buried by the FASB’s asset-liability framework, but founding it on control of use-
59
values gave them their broad distinction between revenue and expense and capital
gains and losses, those occurring outside the circuit of capital:
“The concept of long-term matching…leads accounting to include in the
calculating process (1) windfall gains, those asset-appearances which are
obtained without observable effort and hence are not elements of operating
revenue, and (2) non-operating losses, those asset-disappearances which cannot
be readily associated with immediate efforts to produce results” (1940, p.17). 31
On this vital issue, Paton and Littleton go out of their way to distinguish their notion
that ‘costs attach’ from an anonymous “cost theory of value”. 32 First, they explain the
function of accounting in monitoring the circuit of capital in a way that Marx himself
could have written:
“When production activity effects a change in the form of raw materials by the
consumption of human labour and machine-power, accounting keeps step by
classifying and summarizing appropriate portions of materials cost, labor cost,
and machine cost so that together they become product-costs. In other words,
it is a basic concept of accounting that costs can be marshalled into new groups
that possess real significance. It is as if costs had a power of cohesion when
properly brought into contact” (Paton and Littleton, 1940, p.13).
However, this is not the circuit of capital, but Littleton’s circuit of use-values to which
the accountant attaches ‘acquisition’ or ‘disposition’ prices. “Accounting does not
match disbursements and receipts, but efforts and accomplishments, services acquired
and service rendered, acquisition price-aggregates and disposition price-aggregates”
(1940, p.16). Therefore, Paton and Littleton argue, “[i]t is not necessary to assume a
cost theory of value in order to explain the concept that costs cohere”, but that it could
be assumed, Paton was later to rue, as we shall see. Paton and Littleton rubbish the
idea by deploying the vulgar (i.e., erroneous) ‘Marxist’ view (they do not call it that)
that it implies recognising profit during and at the completion of production (for an
example, see: Macve, 1999, and the reply in Bryer, 1999a). They say that “[i]f cost of
production were to represent ‘value’, it should include an amount for the added utility
given to the product by the process of business operation itself. But this is not
attempted” (1940, p.14). Accountability demands passing the test of realization: “The
producer may think that utility has been added and that the product is worth more than
31
To capture all the dimensions of capitalist accounting for gains and losses requires the distinction
between productive and non-productive labour (Bryer, 1999b). Later, Paton and Littleton appear to
recognise this problem: “The difficulty lies in developing an acceptable conception of ‘operation’ in the
particular situation. One of the most common mistakes is to assume that the operation in the typical
enterprise is synonymous with production in the technical, physical sense” (1940, p.60). They do not
resolve this problem, concluding that “[t]o justify segregation as non-operating items, therefore, gains
(or losses) should be clearly extraordinary and connected with the avowed purpose of the business in
only an incidental way” (Paton and Littleton, 1940, p.60).
32
Previts and Merino say that early theorists drew on ‘classical economics’, but they do not mention
Marx! A possible source for the ‘cost theory of value’ is Sweezy who claimed, “Marx’s value theory
has…the great merit, unlike some other value theories, of close correspondence to the actual accounting
categories of capitalistic business enterprise” (1942, p.63). The dangers of this view were illustrated by
strikes in the automobile industry in 1946 that management saw “as an attempt by the unions to gain
control over certain key issues, of which details of company profits assumed the greatest significance”
(Edwards, 1981, p.237).
60
the sum of the several costs; but he does not know…[;] the test comes when a sale is
made” (1940, p.14). Although Paton and Littleton believed their definition of
realization disassociated them from the ‘cost theory of value’, it gives us the Marxist
definition of an asset as the recoverable cost (socially necessary value) of controlled
use-values, albeit with a marginalist spin on the origin of profit:
“The realization of revenue from sales…marks the time and measures the
amount of (1) recapture of costs previously advanced in productive efforts, and
(2) capture of additional assets (income) representing [the] amount of
compensation for capital services rendered, responsibility taken, and risk
assumed in the process of production” (1940, p.14).
Adopting the entity view, however, allowed them to forget that to be assets
management must have evidence it will ‘recapture’ the costs from sale or otherwise –
according to the LTV, that they must be those socially necessary. According to the
entity view, income is merely cash flow to stockholders as dividends or as interest to
creditors. Therefore, instead of assets being the socially necessary costs of production,
they become any necessary expenditure to generate the future cash flows. For
example, organisation and capital raising expenditures, both unproductive
expenditures, become assets:
“With the entity concept as a basis, there is no difficulty in accepting the
proposition that all costs legitimately incurred by the enterprise are properly
included, in the first instance, in the total of assets. Thus organization
expenditures, costs of raising capital, and related charges are elements of
enterprise assets and capital” (Paton and Littleton, 1940, p.9).
According to the LTV, accountants should deploy the distinction between productive
and unproductive labour and capitalise production overheads and expense nonproductive overheads such as expenditures on general management. In Paton and
Littleton we get the same result, but the distinction is fuzzy: “Some costs, like
manufacturing overhead, in which an affinity with a product can be detected, are
allocated directly to a product; but other costs, like administrative overhead, in which
it is difficult to detect an affinity with a product, are commonly allocated only to time
periods” (1940, p.14). This implies that it may be possible to detect an ‘affinity’
between general management expenditures and the creation of a product. The idea of
a minimum socially necessary cost is lost: 33
“Many units of labor service, considered critically, may not be productive. Are
the corresponding items of wages to be segregated as losses? Maintenance
charges are heavy because ‘green’ men are handling the machines. Is the
excess over normal a revenue charge or a loss? The appropriate answer to such
questions is that all expired costs are chargeable to revenue so long as
conditions are not too far out of line with ordinary standards of management”
(Paton and Littleton, 1940, p.94).
According to the LTV, necessary waste is a cost of production and socially
unnecessary waste is a loss, but for Paton and Littleton whether an expenditure is a
33
The average selling price minus the required return on capital (see Bryer, 2007).
61
loss depends on management’s ‘ordinary standards’, whatever that means! 34
Similarly, we lose the sharpness of the definition of depreciation as the element of
original cost absorbed by the product. Despite seeing, like Marx, that “[d]epreciation
as an expense is analogous to a rental charge”, for Paton and Littleton,
“It does not matter that the simple and convenient straight-line depreciation
may not accord with observed physical deterioration nor reflect fluctuating
prices for similar equipment. Under accrual accounting, depreciation is not a
valuation process nor a means of capturing replacement prices from customers;
it is simply a step in the process of associating past cost, which measures the
planned effort to produce goods and services, with the revenue actually derived
from the goods or services produced” (1940, p.17). 35
According to the LTV, depreciation is an allocation of the socially necessary costs of
production, a valuation of the costs of the use-values consumed and those remaining to
be consumed and does recover ‘replacement prices’, socially necessary costs. Because
Paton and Littleton ignore this idea, although for them “…‘[c]osts’ are the
fundamental data of accounting” (1940, p.25), recognising, measuring and classifying
them is fraught with “complexities”. Where no market price is immediately available,
they resolve the complexities by searching for and finding one. In these cases, Paton
and Littleton effectively find the socially necessary cost. Thus, in a transaction with a
related party, we must view the prices “with some skepticism” (1940, p.26) – we must
seek evidence of the socially necessary costs, the “effective market costs”. For barter
transactions, likewise, the cost of goods or services acquired is “the amount of money
implicit in the cash selling value of the goods or services furnished in exchange”
(1940, p.27). The same applies to the cost of shares issued, gifts and discoveries, the
treatment of discounts (1940, pp.28-30).
The market prices of commodities or services, however, are rarely their cost – usually,
the business must transport, install and test them – and, according to the LTV,
management should capitalise all socially necessary expenditures to control the usevalues. Management must capitalise all productive expenditures, all the socially
necessary costs of creating the use-values concerned.
34
Under this rubric, “the drilling of one or more dry holes in the development of a tract of oil land may
be unavoidable and may…be treated as a cost of property” (Paton and Littleton, 1940, pp.94-95). In
LTV accounting, management only capitalises successful efforts as only these are productive
expenditures.
35
Ironically, Canning’s solution to the problem of selecting the correct method, by contrast, adopts the
practical view that “[t]his question can never be answered rationally without considering cost of
operating, other than first costs, and without considering the amount of service that will be required and
that can be made available” (Canning, 1929, p.266). He generalises a method that “takes account not
merely of the ‘wearing value’, but also of all outlay costs and all services expected. It produces for any
type of asset a uniform total direct cost per unit of service. …[T]he used asset is valued to yield its
residual services at a cost per unit equal to the unit cost of like services implicit in the economically
purchased and used new (or substitute) asset” (Canning, 1929, p.339). The rationale within the labour
theory of value for constant charge per unit of use-value is that this, at minimum cost, is the socially
necessary value of each use value, regardless of whether it includes 20% other costs and 80% capital
cost or 80% other costs and 20% capital cost. Canning, however, merely appeals to their unbiased, nonerratic effect on the financial statements.
62
To this, Paton and Littleton add all expenditures ‘necessary’ to own or otherwise have
legal access to the use-values, the costs of buying. Because to them “[a]ll costs
incurred to secure services necessary to business organization and operation are
essentially homogeneous in their significance to the enterprise,…it follows that all
service costs incurred, prior to their absorption as charges to revenues, contribute to
the total amount of assets of the enterprise” (Paton and Littleton, 1940, p.32). Thus
their test for capitalisation: “when a tangible asset is purchased all cost necessary for
acquiring the property and for placing it in a position to serve the particular function
for which it is intended should be included in the cost of the property” (Paton and
Littleton, 1940, p.31). While this captures the costs of transportation, installation,
tuning, breaking in, engineering services and other production overheads, storage,
insurance, modification, LTV accountants would not include legal costs, taxes,
organization costs, and interest charges (Paton and Littleton, 1940, pp.31-32). Nor
would they include the costs of deciding what asset to acquire, negotiating with the
seller, specifying legal obligations, raising the necessary money or credit, etc.
Whereas transporting an insured machine to a factory, installing, testing it etc.,
delivers productive use-values to the buyer, the costs of ‘prowling around the market’,
as Marx put it, of hiring lawyers, paying taxes, organizing the business, paying
interest, etc., do not create or give the buyer control of use-values. None of the latter
are socially necessary costs of production, necessary expenditures for control of the
use-values concerned. For Paton and Littleton, by contrast, “[a]ny type of cost may be
‘deferred’ if it…represents a factor from which a future benefit or contribution can
reasonably be expected” (1940, p.65). 36 Similarly, “[t]he revenues of a particular
period should be charged with costs which are reasonably associated with the product
represented by such revenues” (1940, p.69).
Instead of Marx’s ‘narrow’ definition of matching as setting the cost of production
against the revenue arising from the commodities or services transferred, we therefore
have a ‘broad’ definition of matching that assumes that all costs ‘generate’ revenue.
This is the “blunder” that Marx thought Smith had made in attempting to define price
as the sum of profit, rent and wages – “the cost of any factor utilized in operating
activity is chargeable to revenue only as the resulting product is recognized as having
produced revenue” (Paton and Littleton, 1940, p.70). 37 If we can allocate revenue to
the factors supposedly responsible for generating it,
“Costs of general administration and of selling represent efforts to produce
revenue just as truly as do costs of direct labor and materials, and one class of
charges is just as legitimate and significant as the other, but the accounting
treatments accorded cannot be expected to be strictly comparable unless and
until the means of effecting association with particular quantities of revenue are
equally well developed” (1940, p.70).
36
As we shall see, the FASB agree with this definition of an asset and used it to abolish any interest in
use-values or cost and realisation.
37
Therefore, management can account for “general development costs, not readily assignable to
tangible factors” as “deferred charges” (Paton and Littleton, 1940, p.74). Similarly, capitalising “the
costs of preliminary advertising campaigns and other expenditures directed toward the building up of
future revenues…as a form of goodwill…is not intrinsically unsound” (1940, p.92).
63
Assuming it is for bona fide business purposes, the key question for them is Adam
Smith’s: “does the charge represent a factor from which a future benefit or
contribution can reasonably be anticipated” (Paton and Littleton, 1940, p.75). And
this, even though Paton and Littleton admit that “there is no means of discovering
causal relations between the segments of periodic net income and particular economic
factors embodied in the intrinsic services of the enterprise” (1940, p.122). Paton and
Littleton stress matching, but because they “avoid the problem of which costs are to
associated with revenues” (Chatfield, 1974, p.240), their broad definition left open the
door for asset-liability accounting. That is, in short, “Acceptance of matching as the
basis of income determination did not result in a single theory for its application”
(Storey, 1964, quoted in Carey, 1969b, p.17).
Paton and Littleton (1940) received wide acclaim and apparently influenced practice
(Storey and Storey, 1998, p.28), but the debate was not over. As May said just three
years after its publication,
“The use of accounts as a guide to the value of investments already made…has
created the most crucial problems of financial accounting, and the present
ferment in accounting thought is very largely due to conflicting objectives of
those who would continue to regard financial statements as reports of progress
or stewardship, and those who would treat them as being in the nature of
prospectuses” (May, 1943, p.21).
With this fissure running down the spine of accounting theory, it was clear to May in
1943 that “Today, an interesting question is presented whether accounting is likely to
move in the direction of more complete adherence to the realization concept of income
or towards wider application of the doctrine of gradual accrual” (1943, p.6). During
the next 30 or so years, as the principles of accounting failed to provide effective
regulation, academics renewed and redoubled their assault on it. 38 As we shall see,
they eventually muddied the origin of profit by replacing the pre-eminence of
realization with asset-liability accounting, and formulated a theory of economic
accountability that provided an ideologically consistent explanation of the apparent
separation of the ownership and control of widely held companies.
Neither Paton and Littleton’s theory nor other attempts to specify the principles and
postulates of accounting, nor the Accounting Research Bulletins of the Committee on
Accounting Procedure (1939-1959), nor the Opinions of the Accounting Principles
Board (1959-1973), provided the foundations for satisfactory regulation of accounting.
38
Some were openly ideological For example, Paton saw in the 1948 Revision of the Association’s
Statement of Principles forbidding corrections for asset write-off errors the creation of ‘public equity’ in
companies, the creation of a growing ownerless claim on the real assets of businesses, which he saw as
the product of the socialism inherent in the proprietorial view that profit was the increase in the residual
ownership claims:
“The proposal of the committees, masquerading under the label ‘concepts and standards,’ is
precisely in line with the idea that the private owner is entitled to nothing more once he has –
as a matter of bookkeeping – written off his costs. It is precisely in line with the accounting
ideas of those who have been campaigning for the impairment and minimizing of property
rights in every possible way and the concurrent glorifying and maximizing of the so-called
public interest in property, looking toward the goal of complete suppression of private rights
and complete state ownership, or socialism” (1949, p.53).
64
Methods proliferated as the profession dealt with issues on a case-by-case basis
(Storey and Storey, 1998, p.31). Mounting problems led to the failure of the CAP and
then the APB and the establishment of the FASB in 1973, whose members decided an
early priority “would have to be providing definitions of assets and liabilities and other
elements of financial statements to fill a yawning gap in the authoritative
pronouncements” (Storey and Storey. 1998, p.49).
In the debate running up to the FASB’s conceptual framework, the only serious
attempt to articulate and defend accountants was by Herman W. Bevis (1965). The
FASB saw Bevis’ book as “One of the most complete expositions of the revenue and
expense view” (1976, p.47). We shall see that it focused much of its fire on Bevis’
central argument that management should allocate expenses and revenues to periods so
as to “minimize distortions of net income which could be attributable to accounting
method as opposed to actual transactions and events” (1965, p.32). This ‘nondistortion
guideline’ posed a serious intellectual threat to the FASB’s asset-liability approach
because, we shall see, it was an inchoate expression of Marx’s idea that the origin of
profit was the production and realisation of surplus value through the continual,
repetitive circulation of capital. The FASB had to kill this idea to secure victory for
the economists’ ‘asset-liability’ or ‘decision-relevance’ theory. It noted that the
“literature of the revenue and expense view and letters of comment show that
something akin to the nondistortion guideline is widely used to judge whether or not
costs and revenues are appropriately matched in specific situations” (1976, p.47) and it
focused its attack on its clearest exposition by Bevis (1965).
Bevis (1965)
Social accountability for the “operating cycle”, the circuit of capital, was the prime
function of the accounts.
“Society has…assigned to corporate directors and management the
responsibility of employing resources gainfully; after delegating commensurate
discretionary authority over the utilization of capital, society expects, and
receives, the accounting to which it is entitled” (Bevis, 1965, p.7).
“Corporate financial accounting…is practical…[y]et there runs through most
of it a logic distilled from sound business practices and healthy corporationstockholder-society relationships” (1965, p.1).
Bevis understood how the accountability process worked:
“when a man is obliged to make financial accountings of his activities, the
discipline becomes more or less a part of his character and imposes on him
much higher ethical standards measured in terms of social responsibility than if
there were no reckoning” (1965, p.8).
Bevis stressed that accountability – “rendering accountings to present stockholders
from the stewards of their resources” – was different from and more important than
economic decision-making:
65
“the fact that prospective investors may use the information contained in the
report to assist them in making projections in connection with investment
decisions does not belie the report’s essential nature and purpose as an
historical accounting of what has taken place” (1965, p.9).
However, Bevis distances himself from any hint of a socialist disposition:
“[Society]…desires that the corporation create more wealth than the resources
of labor and materials it consumes in the process. …[S]ociety, like the
stockholder, must hope that the corporation makes a profit” (1965, p.12).
Here, he pays obeisance to Fisher’s definition of ‘wealth’ as the stock of use-values
that have higher utility to the stockholder than the disutility of their production.
Nevertheless, consistent with the LTV, Bevis spells out the “operating cycle of a
corporation” that begins with money capital that management transform into assets or
otherwise spends, that continues with the production of a commodity or service that it
sells, usually for a profit (1965, pp.13-14), or M-C-M′. Within the LTV, the task for
accountants is to allocate revenues and expenses to the various stages of the cycle of
capital. Consistent with this, Bevis says that because accrual accounting follows
production and realisation, “periodic income determined under the accrual
basis…more faithfully reflects this relative steadiness in a corporation’s progress, as
compared with what would be obtained if annual income were the net result of each
year’s cash receipts and disbursements alone” (1965, p.104). Consistent, also, is
Bevis’ acceptance of realisation, his rejection of the ‘all-inclusive’ or ‘clean surplus’
idea of income and hence the entity concept, and his distinction between ‘usual’ and
‘unusual’ gains and losses, but tempered with ‘judgement’.
Bevis does not advocate valuing inventories at the socially necessary cost of
production. However, he does offer guidelines for accounting for ‘repetitive
operations’, for the operating cycles or circuits of capital, that are inchoate expressions
of Marx’s theory that the production and realisation of surplus value is the origin of
profit and that each use value produced has the same necessary cost. These guidelines
are the ‘transaction guideline’ that management should recognise the effects of
transactions and events when they occur unless the ‘matching guideline’, the
‘systematic and rational guideline’ or the ‘nondistortion guideline’ justify recording
them in some other period or periods. While close to Marx’s LTV, these guidelines
are inchoate and Bevis therefore supplements them with ‘judgement’. This, we shall
see, gave the FASB the weak spot it was looking for to kill off revenue and expense
accounting.
Central to Bevis’ explanation of matching is Marx’s idea that during production there
is a “reasonably expectation that society will value the product at least at the
equivalent of the resources of labour and materials directly consumed”. That is,
according to the LTV, the reasonable expectation that the ‘cost price’, the socially
necessary value of the constant and variable capital consumed, become embodied in
the commodity. Consistent with this, “The corporation considers that the production
process adds value to the raw material processed and…substitutes the asset of
inventories for the cash disbursed for labor and materials and for the fixed assets
consumed” (Bevis, 1965, p.13). Consistent with the LTV’s distinction between
66
productive and unproductive labour, regarding expenditures on promotion, advertising,
general administration, all unproductive expenditures, Bevis thinks “Society sees no
direct relationship between these activities and the resources that are being or will be
turned over to it by the corporation” (1965, p.13). In financial terms, this means the
“corporation, too, does not consider that expenditures for these functions can be
directly related to products or services being produced, or that the value added can be
demonstrated” (Bevis, 1965, p.13). However, although Bevis is clear that the cost of
production is not a measure of economic value, because he does not have the idea that
strict matching requires management to set against revenue the socially necessary cost
of production, he cannot clearly distinguish production and non-production overheads:
“the costs of materials directly entering into the finished product, and of labor
expended in fabricating and assembling it – which touches it, so to speak –
should clearly be included in inventory. At the other end of the scale, the costs
of those activities remote from the plant in which the product is produced, such
as advertising, should not. …[T]he applicable guidelines tend to exclude far
more ‘gray area’ costs from inventory than are included. The result is that the
amounts added to inventory do not purport to be a fair market value or other
such economic value…and, in fact, are usually below any such amounts”
(Bevis, 1965, pp.112-113).
As Bevis has no clear notion that consumers buy commodities at their socially
necessary value (including unpaid labour), even advertising is a possible ‘gray area’:
“Corporations include in the computation of net income for the year some
amounts that benefit future periods. Advertising and other promotional
expenditures are examples. How can the three guidelines be reconciled here?
The answer is that, for repetitive operations of a going concern operating at a
fair consistent level, the transaction guideline is also systematic and rational,
and produces a nondistorted effect. It is only when the level of transactions
changes sharply upward or downward that the effects of the guidelines would
differ; then judgement must be applied in selecting an appropriate guideline”
(1965, p.106).
In other words, management should write off repetitive advertising, but could
capitalise unusually high levels if ‘judgement’ sanctioned it.
Under the ‘transactions principle’ Bevis generally sticks to the realisation principle,
consistent with the LTV, that “From the socioeconomic standpoint, it is only after both
development of a useful product and its acquisition by a consumer that anyone
external to the corporation (society) receives anything of value from the process”
(Bevis, 1965, p.14). Thus, “The matching principle can become potentially dangerous
when it attempts to match today’s real costs with hopes of tomorrow’s revenues, as in
deferring research and development costs to be matched against hoped-for, but
speculative, future revenues” (Bevis, 1965, p.101). Here Bevis recognises that
between society and the firm “There would be disharmony, for example, if the
corporation reported its consumption of resources in research and development as a
mere conversion into another asset form…, but did not develop a product” (1965,
p.15). The transaction date is for Bevis only a guideline, and he allows cash
67
accounting in the face of collection uncertainty or percentage of completion for ‘firm
orders’. The “nondistortion guideline may dictate that…the so-called percentage of
completion method be used” (Bevis, 1965, p.108), introducing the vulgar Marxist view
that capitalists should account for the increase in value during production!
Under the ‘nondistortion guideline’, Bevis advocated self-insurance provisions, for
example, but from the LTV viewpoint insurance is only a cost of production if the firm
buys it. He also suggests provisions for dry-docking or blast furnace relines, and from
Marx’s viewpoint these are costs of production and management should make them.
Where these are additional costs – e.g., scraping off barnacles – it would not be right to
designate a portion of the original asset and ‘depreciate’ it, as asset-liability
proponents advocate (e.g., Storey and Storey, 1998, p.57). These provisions are not
liabilities, any more than depreciation provisions are liabilities. In the LTV and in
practical accounting they are necessary for the ‘non-distortion’ of income – i.e., to
charge the full cost of production.
Under the ‘systematic and rational guideline’ Bevis give the “classic rationale” for
accelerated depreciation “that maintenance and repair costs are higher in later years,
offsetting the lower depreciation costs and giving a more even annual total property
cost over a property’s life” (1965, p.103), and Marx would have agreed (Bryer, 1994).
However, he also suggests that the rationale for straight-line that “the passage of time
is as good a measure as any of the expiration of the cost” (1965, p.103) and an
alternative rationale for accelerated methods, “that newer equipment has greater utility
than older equipment” (1965, p.103), that Ricardo would have agreed with. Bevis also
advocates the ‘use’ method, so that depreciation charges vary with production, which
is the straight-line method unitised. Bevis generally favoured ‘use’ or ‘activity’
methods, because, consistent with the LTV where value is first produced and then
realised, “It is a fair generalization that the increase or decrease in most corporation’s
revenues and in the use of their facilities are directly related” (1965, p.106).
According to the LTV, unusual or extraordinary items are those gains and losses not
related to production. This principle underlies Bevis’ view that their roots are that
“Plans and programs are changed; supposedly permanent investments are
disposed of; plants, products, or product lines are discontinued before their
costs are fully recovered. …[T]he gains an losses from liquidating the efforts
must be considered unusual. They are ‘distortions’ in the financial results of
the corporation’s operations” (1965, p.37).
Although all the examples that Bevis gives are gains and losses that are not related to
production (1965, pp.132-133), he again introduces judgement: “For many
corporations, it is infrequency and size in relation to a single year’s operations which
render the items unusual in relation to repetitive activities” (1965, p.38).
Other accountants were less rigorous than Bevis, advocating a broad notion of
matching and the idea that ‘assets are costs’ (Storey and Storey, 1998, p.59) that the
FASB found easy to dismiss.
68
Clearing the conceptual road to asset-liability accounting: the FASB’s demolition of
‘revenue-expense’ accounting
A critical element in the formation of the FASB that made an indelible mark on
itsapproach to theorising accounting was the report of AICPA’s ‘Trueblood’
committee, the Study Group on the Objectives of Financial Statements, comprised of
leading practitioners, academics and users of accounts. Its report, that built on the
‘decision usefulness’ approach of APB Statement 4 and the AAA’s ‘Statement of
Basic Accounting Theory’ (1966), “agree[d] with the conclusion drawn by many
others that [t]he basic objective of financial statements is to provide information useful
for economic decision making” (AICPA, 1973, p.61). With this aim as its “blueprint”
(Zeff, 1999, p.101), the FASB concentrated its fire on the failure of Paton and Littleton
and others to define an asset consistently. As they had abandoned ‘value’ as the core
idea in accounting, the FASB had little difficulty in ridiculing what it called ‘revenue
and expense’ accounting.
Respondents to its Discussion Paper used the ‘proper matching’ idea to argue that
managers should capitalise and amortise research and development expenditures,
provide for self-insurance, etc., which to the FASB “sounded a lot like excuses to
justify smoothing reported income, thereby decreasing its volatility” (Storey and
Storey, 1998, p.53). As former FASB board member Robert T. Sprouse put it,
“Members of the FASB concluded early that references to vague notions such as
‘avoiding distortion’ and ‘better matching’ were neither an adequate basis for
analyzing and resolving controversial financial accounting issues nor an effective way
to communicate” (1988, p.127). Its solution was to reintroduce ‘value’ into accounting
but to define it, as Canning had done, solely in terms of the ideal of present value.
Instead of Marx’s circuits of capital, or Bevis’ operating cycle, the Trueblood
Committee report gave the FASB Fisher’s circuit of money capital, M-M′: “While
users may differ, their economic decisions are similar. Each user measures sacrifices
and benefits in terms of the actual or prospective disbursement or receipt of cash”
(AICPA, 1973, p.20). This, we shall see later, is the FASB’s solution to the problem
of income distribution raised by the separation of ownership and control – to make
management ‘accountable’ to individual investors for economic value.
Paton highlighted the task facing the FASB – the same problem that had haunted his
monograph with Littleton – when he disowned ‘cost equals value’ and with it the
inchoate LTV that had supported its emphasis on ‘attaching’:
“For a long time I’ve wished that the Paton and Littleton monograph had never
been written, or had gone out of print twenty-five years or so ago. …The basic
difficulty with the idea that cost dollars, as incurred, attach like barnacles to the
physical flow of materials and stream of operating activity is that it is at odds
with the actual process of valuation in a free competitive market. The customer
does not buy a handful of classified and traced cost dollars; he buys a product,
at prevailing market price. And the market price may be above or below any
calculated cost” (1971, quoted in Storey and Storey, 1998, p.61).
Here Paton puts his finger on the basic conflict between ‘cost is value’ and ‘price is
value’, and he opts, as he had before, for the latter as the appropriate measure of
69
‘economic resources’. Bonbright had also highlighted the target when he criticised the
definition of “depreciation as ‘expired capital outlay’ – in other words, ‘expired cost’ –
thereby transferring the word from a value to a cost category” (1961, p.195). From the
economic value perspective, “cost does not ‘expire’. What may be said gradually to
expire is the economic significance of the asset as it grows older, in short, its utility or
its value” (Bonbright, 1961, p.195).
Finding no coherent definition of an asset in the works of accountants and their
theorists, the FASB discovered the “missing boundaries that were needed to bring the
accrual accounting system under control” (Storey and Storey, 1998, p.72) in economic
value. In making this choice, the FASB harked back to Fisher, Canning and the louder
echoes of the economist’s view of accounting espoused in the output of the AAA and
other academics. When the FASB searched for economic definitions it easily found
what it wanted, viz., “Definitions…[that] identified assets with economic resources
and wealth, emphasizing the service potential, or benefits, and economic values that an
asset confers on the holding or owning entity” (Storey and Storey, 1998, p.72).
‘Service potential’ means, as it did for Fisher and Canning, the future economic
benefits from the consumption of use-values. Like Canning, for the FASB historical
costs or current values are surrogates for present value to the owner.
The FASB’s definition of an asset effectively covered up the origin of profit in the
expropriation of a proportion of the money value of surplus socially necessary labour
time. Its other pressing ideological problem was to justify handing over profit to the
owners of capital who contributed nothing to its production. This is the so-called
problem of the ‘separation’ of ownership and control intensively debated in the USA
since the 1920s, which amounts to the question: who controls companies and in whose
interests? US scholars worked on this issue following the failure of accountants to
articulate ‘generally accepted accounting principles’, to suppress the accountants’ view
that the prime function of accounting was to allow investors to hold management
accountable for capital. Obscuring and suppressing this principle was also therefore
high on the FASB’s implicit agenda when it came to write its conceptual framework.
In this, it linked together its economic definition of an asset with the objective of
economic decision-making to declare that accounting gave the individual citizeninvestor control of corporations by giving him or her accountability for economic
value. Individual investors, by effectively controlling management in their own and
society’s interests, thereby had the rightful claim to the surplus.
The debate on the separation of ownership from control
Berle recognised that the separation of ownership and control “posed a significant
threat to the legitimacy of private property rights” (Previts and Merino, 1998, p.183).
Accountants were well aware of the significance of the separation of ownership from
control for accounting. They invariably thought that accounting either did or could
solve the conflicts of interest between management and investors and other
‘stakeholders’. For example, George O. May:
“The separation of beneficial ownership from control and the recognition of a
social interest in the corporations in which such a separation has occurred have
created a management class which does not and should not consider itself as
70
responsible solely to the security holders, to whom in theory its members owe
their positions, but recognizes a duty to the whole economy” (May, 1943,
p.16).
Accountants like May thought that academics had exaggerated the problem regarding
accountability to investors:
“The dweller in the academic world, fearful, perhaps, of being deemed naive, is
apt to exaggerate the danger…of managerial misrepresentation. …The
experienced practitioner…rates it as less extensive” (May, 1943, p.13).
The solution to management discretion was accounting principles and independent
auditing:
“There is always the danger that the administrative views about a corporation’s
accounting may be affected by the self-interest of executives. Some look for a
safeguard against this danger in an enforced uniformity. …The more effective
protection lies in the establishment of broad principles and in the acceptance of
responsibility for their proper application by…the independent auditors whose
primary duty is owed to actual and potential stockholders” (May, 1943, pp.1617).
Bevis also had little doubt that the aim of financial reporting was accountability to
social capital for capital:
“Society has, in general, assigned to corporate directors and management the
responsibility of employing resources gainfully; after delegating commensurate
discretionary authority over the utilization of capital, society expects, and
receives, the accounting to which it is entitled. …As human organizations and
institutions grow larger and more complex, they can become prey for selfseeking men. The less their accountability, the easier it is for them to misuse
their power and to violate the fiduciary relationship assigned to them by the
‘owners’…” (1965, p.7).
Bevis puts ‘owners’ in quotation marks, indicating that he knew a share is a special
form of ownership that is simultaneously individual and collective. As individuals,
Bevis knew that the 18 million or so US investors were diverse – “domestic and
foreign; insiders and outsiders; wealthy and no-so-wealthy; those investing for
themselves and those investing for others” (1965, p.44) – and that they had differing
time horizons, knowledge, preferences, risk aversion. Hence, many millions of shares
continually changed hands. Though any individual shareholder’s interest in a
company may be temporary, “Stockholders as a group, whether institutions or
individuals, are suppliers of capital to an enterprise assumed to have in indefinitely
long existence” (Bevis, 1965, p.50). It follows, therefore, “Taking stockholders
impersonally as a group, the longevity of which equals that of the corporation, cash
return on the capital invested must emerge as the long-range focus of interest” (Bevis,
1965, p.50). In Marx’s terms, that is, social capital’s long-term focus was “ultimate
cash dividends”, or M-C-M′. In the short term, therefore, the focus of the individual
investor is profit or ‘earnings’ because this is a “composite…of two factors: coverage
71
of current dividends, and extent to which resources have been increased” (Bevis, 1965,
p.50) or, in Marx’s terms, the realised money capital returned to investors and the
increase in realised capital reinvested.
Accountants like Bevis were sure that accounting played a major role in giving
‘owners’, in the form of social capital, control over directors and managers. However,
economists and others set about suppressing the idea of social accountability for
capital, first, simply by ignoring the views of accountants in the ownership-control
debate. Second, when accounting became too important to ignore, the accounting
establishment set about suppressing the idea of social accountability for capital by
redefining accountability to mean accountability to individual investors for economic
value.
The fundamental flaw in the ownership-control debate that took off following the
Great Crash and the publication of Berle and Mean’s book, The Modern Corporation
and Private Property (1932), is the failure to understand how capitalism uses
accounting to ‘control’ corporations. Modern scholars typically accept that “the need
to raise capital and the need to monitor an autonomous management class…created the
demand for audits during this period” (Previts and Merino, 1998, p.440, fn.58).
However, nowhere in this long debate is there any recognition that for accountants the
vital contribution of accounting is the ‘control’ it gives over the valorisation process,
the process of producing and realising a profit. Berle and Means (1932) effectively
argued that management controlled the use-values of large corporations in their own
interests because of dispersed ownership. Burnham similarly defined what he called
the ‘managerial revolution’ (1962 [1941]) as “control over access to the instruments of
production”, control over “hiring and firing…as well as organization of the technical
process of production” (1962, p.87, 102). Modern mainstream managerialists like
Chandler (1977, 1990) say that management rose to prominence because it developed
techniques and expertise in controlling the flow of materials through the process of
production and distribution to reap the economies of scale and ‘scope’. Chandler’s
explanation of the appearance and growth of large-scale manufacturing companies is
that they possessed or acquired the “organizational capabilities” to reap economies by
lowering unit costs, “the collective physical facilities and human skills as they were
organized within the enterprise. They included the physical facilities in each of the
operating units – the factories, offices, laboratories – and the skills of the employees
working in such units” (1990, p.594). In short, the ‘potential economies’ are the
technical and material use-values; the ‘actual economies’ are the transformation of
these use-values into other use-values for sale by employing the use-values of labour.
For Chandler, as for mainstream management accounting control theorists and most
social scientists, profit is not the sole object of production, infusing its every
component, but only a constraint on the technical process of production, a necessary
condition for survival. “If income is less than costs over an extended period of time,
the enterprise cannot remain commercially viable” (Chandler, 1990, p.594). This only
explains why enterprises cannot make indefinite losses. In explaining why “[p]rofits
are, of course, essential to the survival and growth of all capitalist enterprises”,
Chandler attributes profit to the ‘wages of superintendence’:
72
“most critical to the long-term health and growth of the industrial enterprise
were the abilities of the senior executives…who recruited and motivated the
middle managers, defined and allocated their responsibilities, and motivated
and co-ordinated their activities, and who, in addition, planned and allocated
the resources for the enterprise as a whole.
…Such organizational
capabilities…had provided the source – the dynamic – for the continuing
growth of the enterprise. They have made possible the earnings that supplied
much of the funding for such growth” (1990, p.594).
Chandler knows that investors demanded long-term growth in the value of their
investments, i.e., higher dividends in future, but why management should agree on this
is unclear (1990, p.595).
“Once the new consolidated enterprises in the United States and the managerial
enterprises in Germany were firmly established, the financiers had less and less
influence on decisions concerning current operations and the allocation of
resources for future growth. Bankers preferred to remain bankers and to let
industrialists run the enterprises. Moreover, retained earning provided
industrial managers with most of the funding needed to finance continuing
growth” (1990, p.597).
According to Chandler, then, net profits are the profit of enterprise, the wages of
superintendence, that the socially responsible managers share with investors who
“were wealthy individuals almost by definition” (1990, p.595). Although he has a
practical view of the role of accounting in management control, he sees no similar role
for financial accounting in enforcing the promise of “a long-term appreciation of their
assets” (Chandler, 1990, p.595). Regarding the ‘finance function’, a large department,
“Its tasks were to co-ordinate the flow of funds through the enterprise’s many
units and to provide a steady flow of information to enable top management to
monitor performance and allocate resources. …To provide information
concerning performance and resource allocation, the finance department set up
uniform accounting and auditing procedures” (Chandler, 1990, p.33).
We hear nothing of accountability for the valorisation process or of any role for
financial accounting in monitoring management’s performance in realising the
required return on capital. Chandler thinks that while large enterprises initiated
innovations in cost accounting around 1900, the innovators
“paid relatively little attention to financial or capital accounting. …[T]hey did
not develop as careful internal auditing as that initiated by the railroads fifty
years before. Nor did they concern themselves with the problem of
depreciation in determining their capital account” (1977, p.279).
It may be, as we have seen, that managers needed to give only a little attention to
capital accounting, as they well understood the principles enshrined in the English
‘going-concern’ theory. American accountants based this theory, as we saw, on an
inchoate labour theory of value. Management of nearly all large industrial firms
73
continued to use the replacement method, perhaps to systematically understate profits
in published accounts to avoid the ‘labour danger’.
Williamson, a noted anti-managerialist, attempted to answer the key question left by
Chandler: why managers – if they do – strive to maximize profits. This is problematic
for Williamson (1970), as it is for Chandler, because he sees the organisational control
problem as one of controlling the use-values of the labour process. Thus, in explaining
one of the main advantages of the M-form organisation, he says its “general
office…[can] intervene early in a selective, preventative way – a capability that is
lacking in external control systems” (Williamson, 1970, p.140). That is, top
management control the organization by ‘intervening’ where necessary to take control
of the use-values of production and distribution. Down below, barring interventions
from above, the division managers ‘control’ their divisions, i.e., control the use-values
of its production process. Not surprisingly, Williamson has little truck with the idea
that accounting could provide the capital markets with effective control over top
management, just as it gives top management effective control of the valorisation
process within the organisation. In Williamson’s view,
“Among the administrative or regulatory alternatives to product and capital
market competition that have been considered…as means of controlling the
exercise of managerial discretion are more extensive accounting disclosure….
No attempt will be made to evaluate…[this] other than to express general
scepticism” (Williamson, 1970, p.9).
Williamson gives us an explanation of Chandler’s ‘discovery’ of the historical
tendency identified by Marx, the separation of the prime function of capitalist
ownership – control of the valorisation of capital – from control of the technical or
material labour process. During the 1920s the opportunities for profit from large
corporations quickly led to the adoption of the M-form and control of the whole
organisation by a team of management experts. As this top management team focuses
solely on strategic planning and control it could impose a profit maximization
objective onto divisional managers, and in the long term Williamson thinks the capital
markets can better impose this objective on senior management. However,
Williamson enters some weighty qualifications to this conclusion.
“That profit should emerge as the principal criterion is broadly consistent with
the fiduciary duty responsibilities of the management. It is, moreover,
reinforced by the experience of the firm in the product and capital markets.
Inasmuch, however, as the latter pressures are long run, recurrent opportunities
for short run discretionary pursuit of non-profit goals can be anticipated”
(1970, p.164).
Agency theory was a response to Williamson’s failure to guarantee anything other than
‘long-term’ disciplining of management by the capital markets. It attempts to explain
why the separation of ownership and control is ‘efficient’ when viewed from the
perspective of the capital markets and the constraints it imposes on corporate managers
(Jensen and Meckling, 1976, p.228). Like Williamson, Jensen and Meckling also
rediscover the tendency for management or ‘decision-making’ to separate from
ownership or ‘risk-taking’. This is economically efficient specialisation, they say, as it
74
allows risk pooling and the attraction of capital and the manager to concentrate on
controlling the use-values of the labour process. Watts and Zimmerman, for example,
consider the key contribution of agency theory its emphasis on the “importance of
monitoring the performance of parties to the firm”, and its hypothesis that “an audit is
one type of monitoring activity that increases the value of the firm” (1983, p.613). By
‘performance’ they do not mean using accounting to objectively measure the realised
return on capital as the basis for punishment or reward. They envisage using
accounting to enforce action controls, i.e., to enforce ‘contracts’. “Enforcement of the
contract requires monitoring of management’s activities and it is hypothesized…that
this is a role of auditing” (1983, p.615). That the role of auditing is to
“report…discovered breaches of contract” to raise the expectation that “actions would
be monitored” (1983, p.615). This takes a naive view of the power of action controls
such as ‘contracts’ that attempt to specify agent’s behaviour in detail. Marx and
modern management control theorists, by contrast, recognise that when capital hires a
worker, particularly any skilled worker, it buys ‘labour power’, the ability to perform
value-creating labour, and not the use-values itself and that capitalists must use results
control or accountability for capital (Bryer, 2006).
Those Marxists who entered the debate stressed the distinction from Marx between the
functional separation of ownership from control, which they accept, and the economic
separation, which they reject. However, their grounds neglect Marx’s insistence that
social capital dominates the valorisation process and the importance of accounts. De
Vroey, for example, accepts Marx’s view (expressed by Coletti) that the functional
separation of ownership from control “express[es] the ever-increasing socialization of
capital or, in other words, its depersonalization” (1980, p.227). However, he
nevertheless follows Hilferding’s contention that the dispersal of stock ownership
“allows an increase of the power sphere of big capitalist who now control larger
economic units with a reduced proportion of legal ownership” (1980, pp.222-223). In
other words, the dispersal of ownership allows ‘big capitalists’ to control – if only at
critical junctures – the material process, use-values, of production. Although he
restricts it to strategy, Zeitlin defines control in the same way: “it refers to the ‘power
of determining the broad policies guiding a corporation and not to…actual influence of
the day to day affairs of an enterprise’….” (1974, pp.1088-1089). That is, the power
to determine the future material process of production. Thus, even though Zeitlin
recognises the existence of socialised capital, he follows Weber and defines control as
the “probab[ility] that an identifiable group of proprietary interests will be able to
realize their corporate objectives over time, despite resistance” (1974, p.1091).
Zeitlin, naturally, finds “no usable definition” of the nature of corporate objectives,
and calls for a “theory of the objective necessities of corporate conduct and the
imperatives of political economy” (1974, p.1091), precisely what Marx’s LTV theory
of accounting give us. Without it, he is stuck with “an analysis of concrete situations
and the specific control structure of the corporation involved” (1974, p.1092), and
merely asserts that “[w]hether or not manager are actuated by the ‘profit motive’, as a
subjective value commitment, ‘profit maximization’ is an objective requirement, since
profits constitute both the only unambiguous criterion of successful management
performance and an irreducible necessity for corporate survival” (1974, p.1097).
Zeitlin’s explanation for the necessity of profit for survival (a constraint) is that “the
social and economic interweaving of once opposed financial and industrial interests,
increased economic concentration, the fusion of formerly separate large capitals, and
75
the establishment of an effective organizational apparatus of interlocking directorships,
heightens the cohesiveness of the capitalist class and its capacity for common action
and unified polices” (1974, p.1112). In other words, ‘finance capitalists’ can
accumulate the power to control the material processes of production. Zeitlin does not
get to the bottom of Marx’s view that “social undertakings as distinct from private
undertakings” mean “the abolition of capital as private property within the framework
of capitalist production itself”, for him merely “confusing Hegelian comments” (1974,
p.1113). While Zeitlin is right that this merely means ‘abolishing whilst preserving’
private property, he does not explain how this happens. How it is that rich investors
retain property rights in shares after abolishing their rights to control. According to
the LTV, we can only understand how collective capital controls the modern
organisation by understanding how accounting allows it to control the valorisation
process. This understanding the accountants were now at pains to suppress.
Ownership, control and the FASB’s asset-liability framework: ‘accountability’ for
economic value
The Trueblood report went out of its way to suppress the idea of social accountability
for capital, to all “those who are, or would be, investors” (Bevis, 1965, p.9), as a
collective. First, it distorted the accountants’ idea of ‘stewardship’ for capital:
“Stewardship refers to the efficient administration of resources and the
execution of plans for conserving and consuming them. Reporting on
management’s stewardship has long been recognized as a principal purpose of
financial statements.
Nowhere in the literature of accounting does anyone define ‘stewardship’ to mean
simply administrative efficiency and safekeeping of assets! Second, having artificially
limited the idea of stewardship, Trueblood then redefined its central idea of
accountability for capital to mean accountability for economic value:
“Accountability extends beyond the element of stewardship involved in the
safekeeping of assets entrusted to custody. It encompasses the use and
conversion of those assets as well as decisions not to use them. Management is
accountable for the value of assets as well as for their costs. …Since the
principal goal of a commercial enterprise is to maximize cash return to owners,
its management is accountable for progress towards this goal” (AICPA, 1971,
p.25).
The Trueblood Committee recognised that management’s duty of accountability
extended to “all investors – past, present and potential” (AICPA, 1971, p.25), but it
ruled out thinking about these collectively as social capital by focusing only on
individual investors:
“In the United States, where the economic system emphasizes private
enterprise, individuals and enterprises generally attempt to maximize their own
wealth. Financial information helps them make sound economic decisions.
This process is assumed to lead to the efficient allocation of resources
throughout the economy” (AICPA, 1973, p.14).
76
To legitimate focusing on the individual investor, the Trueblood committee resorted to
Fisher’s idea that only individuals could have ‘income’ through their assessment of the
relative disutility of work and the utility of consumption. Thus,
“in deciding whether to sell a bushel of wheat for cash, the seller can estimate
with some precision the expected benefits from sale, that is, the proceeds.
Whether the amount of the proceeds is such that the seller is better off, and by
how much, is a matter that only he can judge” (AICPA, 1071, p.17).
The committee concluded therefore that all accounting can do is give investors
information on a company’s cash generating ability, its ‘earning power’, and leave it to
individuals to judge how much ‘better off’ they are, or are not. Thus, whereas
accountants emphasised the distinct nature of the information required by shareholders
compared to creditors, although there was an overlap (Bevis, 1965, p.2), the Trueblood
committee emphasised that, as individuals,
“the information needs of creditors and investors are essentially the same.
Both groups are concerned with the enterprise’s ability to generate cash flows
to them and in their own ability to predict, compare and evaluate the amount,
timing and related uncertainty of these future cash flows” (AICPA, 1971, p.20).
Whereas accountants stressed that corporate directors and managements “render
accounts for the results of their actions” (Bevis, 1965, p.7), i.e., results control, the
Trueblood committee also buried the idea of social capital when it recommended
holding management accountable for forecasts of the future and unfairly ridiculed
accountants for “a focus solely on history” (AICPA, 1973, p.26). In reality,
accountants agreed, “accountability requires that information be provided about
potential as well as actual results”, i.e., investors need a target against which to judge
actual results. However, whereas accountants thought this was outside accounting’s
remit – implicitly accepting that the only objective target was social capital’s required
return, Marx’s general rate of profit – Trueblood argued that the only acceptable target
was “to maximize cash return to owners”, and that “management is accountable for
progress towards this goal” (AICPA, 1973, pp, 26, 25). Bevis, by contrast, was clear
that evaluation of results was not the job of accounting:
“even the entire set of conventional financial statements with their footnotes
does not exhaust the historical financial information in the annual report which
is pertinent to their buy/sell/hold decisions. …[I]t is utterly impossible to wrap
up adequately and accurately the yearly progress of a complex corporate
enterprise in the single statistic of net income per share. There must be a
qualitative evaluation of this quantitative statistic” (1965, p.5).
In other words, whereas accountants left target setting and judgement of the results to
the capital markets, Trueblood argued that accountants should build the goal of
potential maximum cash into the accounts – that accounts should report ‘earning
power’, the firm’s expected cash-generating ability. Thus, it argued that “Since the
goals of an enterprise and its earning process involve the use of cash to generate the
maximum amount of cash, earnings cycles should relate cash receipts and
77
disbursements”, whether these cycles were “complete, incomplete, or prospective”
(AICPA, 1971, pp.27-28). The Committee followed Canning in arguing that though
the ideal of present value “is unattainable by any present direct measurement process”,
“Different approaches to value determination of particular assets and liabilities seem
desirable, since no single valuation basis approaches the ideal in every circumstance”
(AICPA, 1973, pp.32, 33). To move towards the ideal it suggested, “Various current
value measurements could be used as indicators of the prospective benefits of assets
and sacrifices for liabilities, and of the current sacrifice or benefit aspects of holding
them” (AICPA, 1973, p.35).
Having ditched revenue and expense accounting and the idea of social capital, the
FASB could theorise accounting from the economic value perspective using “selfevident propositions about the environment within which accounting functions”:
“For example, the observation that most of the goods and services produced in
the United States are not directly consumed by their producers but are sold for
cash or claims to cash…[which] suggests both why financial accounting is
concerned with production and distribution of goods and services and with
exchange prices and why investors, creditors, and other users of financial
statements are concerned with cash prices and cash flows” (Storey and Storey,
1998, p.71).
The proposition is self-evident as the US is a capitalist economy, but the ‘suggestions’
for accounting are not. We have seen that FASB accounting is not at all ‘concerned
with production’ and that investors are not necessarily concerned only or mainly with
cash flows. From these ‘self-evident’ truths, we get the entity view, the idea that the
aim of accounting is “general purpose financial statements” because there are “several
groups, such as investors, creditors, and other resource providers, have common
interests and common information needs” (Storey and Storey, 1998, p.1). In the LTV,
‘general purpose’ means accounting to social capital – all equity investors, current and
potential as an impersonal class – for the realisation of profit, whereas for the FASB it
means accounting to individuals for direct and indirect measures of expected cash
flows. Accountants knew they were accounting for an ‘impersonal group’ or class, but
could only assert that profit was ‘good for society’ by ignoring the implication that,
with the rise of professional management and financial analysis, rich individual
investors had no real economic function. However, from Trueblood and its academic
predecessors the FASB could claim that the aim of accounting was to help individual
investors make rational economic decisions that would sustain a “well-functioning,
healthy economy”, secure a “social good” (Storey and Storey, 1998, p.92), thereby
effectively legitimating the rewards that investors take for ‘controlling’ corporations in
society’s interests.
Concluding comments: the triumph of ideology in accounting?
The FASB’s conceptual framework suppresses almost all remnants of the LTV from
the American theory of accounting. In doing this, the FASB suppresses the origin of
profit in the exploitation of labour and rationalises away giving dividends to investors.
Some key participants in the debate leading to the FASB’s framework were conscious
of the LTV – Fisher criticised nameless ‘political economists’ – and Littleton and
78
Paton were conscious of an alternative theory of value that says that cost + profit =
price, that they must avoid. While only a few of the participants to the debate
consciously engaged in the ideological suppression of the contradictions of capitalism,
by uprooting the practical accountant’s principles, this was the result.
The FASB spent an unprecedented amount of money and time on its framework, and
economic theory is apparently triumphant. However, practical accountants were
overwhelmingly sceptical about the asset-liability approach from the start. In 1977,
Marshall S. Armstrong, chairman of the FASB reported a “problem” with the proposal
that the aim of financial accounting should be decision-usefulness. The problem was
that an opinion survey showed “only 37 percent of our respondents were able to
recommend the adoption of this objective” (1977, p.77). Accountants thought, “the
basic function of financial statements was to report on management’s stewardship”
(Armstrong, 1977, p.77). Although academics urged the FASB to mandate current
value accounting, it declined, allowing a range of valuation bases, probably because,
as Zeff says, it feared the “built-in resistance to change…from preparers, practitioners,
and the SEC” (2000, pp.123-124). Zeff attributes accountants’ reluctance to accept
decision-relevance to prior education stressing stewardship, but it is also consistent
with accountants having ‘built-in resistance’ to eradicating the LTV in practice. After
a huge ‘educational’ effort in America and now worldwide through the activities of the
IASB, accountants still resist the decision-relevance framework; the debate goes on. 39
The evidence of this paper supports the view that, as a contest between ideology and
reality, the accounting theory debate will run for as long as capitalism survives.
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