Group Title: study of institutional forces concerned with financial accounting in the United States, utilizing the annual reports of the United States Steel Corporation as reference points
Title: A Study of institutional forces concerned with financial accounting in the United States, utilizing the annual reports of the United States Steel Corporation as reference points
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 Material Information
Title: A Study of institutional forces concerned with financial accounting in the United States, utilizing the annual reports of the United States Steel Corporation as reference points
Alternate Title: Financial accounting in the United States
Physical Description: xii, 353 leaves. : ill. ; 28 cm.
Language: English
Creator: Vangermeersch, Richard G. J., 1940-
Publication Date: 1970
Copyright Date: 1970
 Subjects
Subject: Steel industry and trade -- Accounting   ( lcsh )
Corporation reports -- United States   ( lcsh )
Accounting thesis Ph. D   ( lcsh )
Dissertations, Academic -- Accounting -- UF   ( lcsh )
Genre: bibliography   ( marcgt )
non-fiction   ( marcgt )
 Notes
Thesis: Thesis--University of Florida, 1970.
Bibliography: Bibliography: leaves 334-351.
Additional Physical Form: Also available on World Wide Web
General Note: Manuscript copy.
General Note: Vita.
 Record Information
Bibliographic ID: UF00097744
Volume ID: VID00001
Source Institution: University of Florida
Holding Location: University of Florida
Rights Management: All rights reserved by the source institution and holding location.
Resource Identifier: alephbibnum - 000554673
oclc - 13420362
notis - ACX9519

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A Study of Institutional Forces Concerned with Financial

Accounting in the United States, Utilizing the Annual Reports

of the United States Steel Corporation as Reference Points













By
RICHARD G. J. VANGERMEERSCH














A DISSERTATION PRESENTED TO THE GRADUATE COUNCIL OF
THE UNIVERSITY OF FLORIDA
IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE
DEGREE OF DOCTOR OF PHILOSOPHY










UNIVERSITY OF FLORIDA
1970















ACKNOWLEDGMENTS


The writer would first like to acknowledge Dr. D.

D. Bay for the many hours he worked with and for the

writer on this project. Dr. Ray supplied the very much

needed encouragement to the writer in both the items of

taking his written and oral exams and of completing the

dissertation. Without such encouragement, the writer

would have not completed the requirements for the degree.

Dr. William M'. Fox also worked many hours with the writer

and deserves to be thanked for his advice and encourage-

ment. Drs. Joseph Perry, Ralph Blodgett, and Larry J.

Ben.nin. :r are thanked for their encouragement and help

during the course of the project. Dr. David R. Dilley

of United SLates Steel provided immeasurable assistance

to the writer in the earlier stoges of the work.

















TABLE OF CONTENTS


PAGE


ACKNOWLEDGMENTS . . . . . . . . . ii

LIST 0' TABLES . . . . . . . . ...... vi

LIST OF FIGU ES . . . . . . . . . v il

ABSTRACT . . . . . . ..





I. INTRODUCTION TO THLE 'iPO . . . . 1

Th;p Problem 1
The Scope 9
Methodology 13

II. THE FIRST FUL2L-YEAR ANNUAL REPORT OF

UNITED STATES STEEL CORPORATION, 1902 . .

Historical Risumnc and Synopsis of
Financial Accounti'_ng Ev;c:. l 19

Financl? l Accounting Events ?1

Suinmwnry Ascssir~ri et 56

III THE LA SSE;-FAIRE YEARS AND rTE I:MPOSITION

OF THE FEDERAL COR~-0:,- INCO!iE TAX,

1903-1915 . . . . . . . . .


~. ..










TABLE OF CONTENTS (continued)


CHAPTER PAGE


Historical Resu&m and Synopsis of
Financial Accounting Events 60

Financial Accounting Events 63

Summary Assessment 80

IV. WORLD WAR I AND THE RETURN TO NORMALCY,

1916-1929 . . . . . .. . . 82

Historical Resum6 and Synopsis of
Financial Accounting Events 82

Financial Accounting Events 85

Summary Assessment 103

V. THE DEPRESSION, 1930-1940 . . . . . 105

Historical Resume and Synopsis of
Financial Accounting Events 105

Financial Accounting Events 110

Summary Assessment 146

VI. WORLD WAR II AND ITS AFTERMATH, 1940-1949 154

Historical Resume and Synopsis of
Financial Accounting Events 154

Financial Accounting Events 156

Summary Assessment 200

VII. THE CURRENT YEARS, 1950-1969 . . ... .211










TABLE OF CONTENTS (continued)


CHAP,1 TETR


Historicl Hi tEs.i;. a nd Syn:orss of
F1Ci-nci l Account ing EvcE-nos

Financial Account.in, Evcrnts.

Su:" nry A' iscssnnt

VIII. S ; '.< :Y AN. CULTO 'l IONS . . . .

For'c-2 ]nfluiencin the '~n ncial
Sto tcrm nts of ti. Unite.- St tc. Stcc.l
Cc :^,or tion


I pli c i" O c for P"K. nt-
Acco ntin t


API E:"l X F1' C:;I'"

AT'P. DX C C}'i-


.~r I"


Il T


API i


i >L ~C '-` L.~i~Ir'


BJ LI : I ;Y
BiQ} .] Ii


PAGE


211

214

249

253


254


269


28?
-P '3


S. 1


303

310


333


3 352
















LIST OF TABLES


PAGE


CHAPTER II


TABLE 1.

TABLE 2.

TABLE 3.

TABLE 4.


Income Account for 1902 . . .

Profit and Loss Account for 1902.


Valuation Schedule for 1902 .

Summary of Financial Operations
for all Properties . . .


CHAPTER III


TABLE 1.


TABLE 2.


TABLE 3.



TABLE 4.


Undivided Surplus Account,
December 31, 1904 . . . .

Constructive Balance Sheet of
Steel Corporation, 1901-1910.

Comparative Income Account for
the Fiscal Years Ending
December 31, 1903 and 1902 . .

Condensed General Profit and Loss
Account for Year Ending
December 31, 1968 . . . .


CHAPTER


TABLE 1.


Surplus of United States Steel
Corporation and Subsidiary
Companies . . . . . .


279

281

283


285


288


290



292



293


296










LIST OF TABLES (continued)


PAGE


CHAPTER


TABLE 1. Comparative Consolidated Statement
of Income and Surplus for the
Year Ending December 31, 1936
and 1935 . . . . . . .


298


CHAPTER


TABLE 1.

TABLE 2.


Consolidated Statement of Income . .

Notes to Accounts . . . .


CHAPTER VIII


TABLE 1.


TABLE 2.


References for Conclusions in
Chapter VIII . . . . . .

Page References to the Annual
ReDorts of the United States
Steel Corporation . . . ..


vii


304

306


311



316
















LIST OF FIGURES


PAGE


CHATPER V

FIGURE 1. How the Corporation Earned
its Living in 1939 . . . . 300

FIGURE 2. Balance Sheet in Chart Fashion . 302


viii








Abstract of Dissertation Presented to the Graduate Council
in Partial Fulfillment of the Requirements for the
Degree of Doctor of Philosophy



A STUDY OF INSTITUTIONAL FORCES CONCERNED WITH
FINANCIAL ACCOUNTING IN THE UNITED STATES,
UTILIZING THE ANNUAL REPORTS OF THE
UNITED STATES STEEL CORPORATION
AS REFERENCE POINTS


By


Richard G. J. Vangermeersch

August, 1970




Chairman: Dr. D. D. Ray
Major Department: Accounting


The purpose of the study was to trace and assess

the institutional forces which have been concerned with

financial accounting in the United States from 1902 to

1969, utilizing the annual reports of the United States

Steel Corporation as reference points. Since the United

States Steel Corporation was founded in 1901 and has been

confronted with many of the financial accounting problems

of the United States during the years from 1902 to 1969,

the financial accounting of the United States Steel Corpora-

tion from 1902 to 1969 should closely parallel the develop-

ment of financial accounting in the United States from 1902

to 1969. A sample of such financial accounting problems

included valuation and stock watering, the doctrine of







conservatism, special problems of wartime financial ac-

counting during the two world wars and the Korean Conflict,

the interpretation of generally accepted accounting

principles, the financial accounting adaptations to

depression conditions, the use of the lifo inventory

method, the effect of inflation, especially during the

mid and late 1940's, the equating of pension expense with

pension funding, the treatment of the investment credit,

and deferred income taxes. The writer chose various ac-

counting groups, the New York Stock Exchange, financial

writers and financial services, labor unions, stockholders,

and the federal government as the major groups of institu-

tional forces concerned about financial accounting in the

United States.

In pursuing the tracing and assessing of the insti-

tutional forces which have been concerned with financial

accounting in the United States from 1902 to 1969, uti-

lizing the annual reports of the United States Steel

Corporation as reference points, the writer was concerned

with the influences on financial accounting by various

groups of institutional forces and with the utilization

of financial accounting by the management of the United

States Steel Corporation to further management's own goals.

He was also concerned with drawing implications from the

study for present-day financial accounting.

The study indicated that stockholders, labor unions,








and the New York Stock Exchange were not major factors

in the development of the United States Steel Corporation

statements. It was indicated that accounting groups and

writers, financial writers and financial services, and

the federal government were major factors in the develop-

ment of the United States Steel Corporation statements.

It was also stressed that no longer could the American

Institute of Certified Public Accountants and the Securi-

ties and Exchange Commission disclaim responsibility for

deficiencies in financial accounting. The management of

the United States Steel Corporation also has played a

very important role in the statements of the United States

Steel Corporation. The writer concluded that the manage-

ment of the United States Steel Corporation has tended to

be a positive force in disclosure to stockholders and in

choosing accounting methods that generally lowered net

income in the year of the choice.

The writer drew implications from the study for

present-day financial accounting in such matters as the

possible reorientation of financial accounting to financial

analysts, the effect of federal income taxation on finan-

cial accounting, the maintenance of'"ndependence'in the

public's eye in view of accounting groups and writers

lobbying in favor of industry, and the relationship be-

tween the American Institute of Certified Public Accoun-

tants and the Securities and Exchange Commission. Impli-








caticns were also drawn on the questions of compliance

of the United States Steel Corporation to past American

Institute of Accountants-American Institute of Certified

Public Accountants promulgations, of management's freedom

to improvise in financial accounting, and of the allowing

of engineering-oriented experts to determine the amount of

yearly depreciation.


xii
















CHAPTER I


INTRODUCTION TO THE PROTLE'I'


The Probletmi


Financial accounting emerged as s control dcvlcc

for stockholders during t.h trust movrc.nt frcpm 195 to

1902. Since the United Stater Steel Corpo-ratoI wn v.s

foundicr in 1901 rnd hrs been confronted with reny, of

the fi~j nc-l: accoorntinr problcqr, of the UnitcM ~State-

during the yeair from 19022 to 1969, the finrncil]

accountiln~ cf the United St'tert Steel Cor;cnati.on frvom

1902 to 1969 should clo:cly pn'rllel the develco:.eut of





FiSW i :l c cunct ng is here dcfi; c ar Lth
account in ] 'n I ~s!i l pr'ecti ce pr c t Ct i o FIl
terry ni iL: n- 2 cmyl o I In the fore st t :.V nt oC s;-ual
report;

2'lie y -r 3 :2 is utilized bcovur u it vr. Li fir t.
full y-"' of cu'l c.t A c for th UnitPd Sd't SA (.l
Corpo v': o I I : the y: r of th fir;t, full-y r r 1rl
rapo-t,








2

financial accounting in the United States from 1902 to

1969. For instance, George 0. May held that the 1902

Annual Report of the United States Steel Corporation was

a landmark for financial accounting in this country.3 A

sample of such financial accounting problems includes

valuation and stock watering, the doctrine of

conservatism, special problems of wartime financial

accounting during the two world wars and the Korean

Conflict, the interpretation of generally accepted

accounting principles, the financial accounting adaptations

to depression conditions, the use of the lifo inventory

method, the effect of inflation especially during the

mid and late 1940's, the equating of pension expense with

pension funding, the treatment of the investment credit,

and deferred income taxes.

The purpose of the study is to trace and assess

the institutional forces which have been concerned with

financial accounting in the United States from 1902 to

1969, utilizing the annual reports of the United States

Steel Corporation as reference points. The study




George 0. May, Financial Accounting: A
Distillation of Experience (New York: Macmillan Company,
1943), p. 54.







3

portrays how financial accounting in the United States

arrived at its present state as the resultant of various

institutional forces. Certain rather specific questions

were raised in the mind of the writer during the

preparation of the study. Some of these questions are

now stated.

Accounting professional bodies have issued formal

pronouncements from the 1930's to the present. Were there

accounting forces which provided guidance for financial

accounting before that time? Have the formalized

pronouncements by the accounting professional bodies been

effective in achieving compliance? The influence of the

New York Stock Exchange on financial statements is

sometimes considered in financial accounting circles as

originating during the late 1920's and the depression of

the 1930's. Did the New York Stock Exchange affect

financial accounting before this time? Since the topic of

this work is financial accounting, what has been the

influence of financial writers and financial services on

accounting statements?

Labor unions are the collective bargaining agents

for many United States firms. Since union wage demands

have been said, at times, to be limited by the profit

position of the company, have labor unions applied pressure








4

to have profits determined by financial accounting methods

which would yield a higher profit? If so, were these

pressures on financial accounting effective? Financial

accounting is considered as being oriented towards the

stockholders. It is to them that financial accounting

statements are often said to be issued. What influences on

accounting were brought to bear by stockholders? What

success have they had?

Financial accounting has sometimes been depicted as

being free of federal government intervention for the

first three decades of the 20th century and limited by

federal government intervention since then. Were there no

federal government influences on financial accounting

matters during the first thirty years of the 20th century?

Has financial accounting been severely limited by the

federal government since then?

Accounting writers, the American Institute of

Certified Public Accountants, the Securities and Exchange

Commission, and the New York Stock Exchange have held that








5
4
the statements of a firm are those of its menage.ent. A

recent article questioned this assumption. Herbert E.

Miller felt that the statements were not really

management's, but neither were they the certified public

accountants' nor the Securities and Exchange

Commission's.5 One might, therefore, ask "Whose

statements are they?" To what extent has the management

of the United States Steel Corporation been molded by

various accounting institutional influences in financial




4
Louis H. Rappaport, SEC Accounting Practice and
Procedure (New York: Ronald Press Company, 1956), p. 23;
Walter B. Meigs and F. John Larsen, Principles of Auditing
(4th ed.; Homewood, Illinois: Richard D. Irwin, Inc.,
1969), p. 14; The American Institute of Certified Public
Accountants, Responsibilities and Functions of the
Independent Auditor in the Examination of Financial
ts, Sments, Statement on Auditing Procedure No. 30 (New
York: The American Institute of Certified Public
Accountants, 1960), p. 40; The American Institute of
Certified Public Accountants, Accounting Research and
Terminology Bulletins: Final Edition (New York: The
American Institute of Certified Public Accountants, 1961),
p. 10; The United States Securities and Exchange
Commission, Accounting Series Releases: Compilation of
Releases 1 to 112 Inclusive (Washington, D. C.:
Government Printing Office, 1969), p. 108; G. Keith
Funston, "Financisl Reporting for the Investor (remarks
before the Executive Committee of the American Petroleum
Institute, February 2, 1967), p. 3.

Herbert E. Miller, "Audited Statements--Are They
Really Ianagements's?" The Journal of Accountancy, 118
(October, 1964), 46.








6

accounting matters? Has the United States Steel

Corporation's management taken financial accounting

positions on its own initiative? Has the initiative of

the United States Steel Corporation's management in

financial accounting matters decreased as more formal

promulgations have been issued by accounting professional

bodies and governmental agencies? Has the utilization of

financial accounting by the United States Steel

Corporation's management created overconfidence among

stockholders?

As late as 1929, John B. Canning regarded the

balance sheet as the focal point for accountants.7

However, by 1932, a committee of the American Institute of

Accountants held that the income statement had become the

crucial fact in the valuation of an enterprise and was,




6
The writer assumes that overconfidence is created
when management chooses a financial accounting procedure
which increases net income in the year of the choice.
Such an increase in net income may be the reason why
existing stockholders do not sell their stock.

7
John B. Canning, The Economics of Accountancy:
A Critical Analysis of Accounting Theory (New York:
Ronald Press Company, 1929), p. 179.









henceforth, far more important than the balance sheet.

This latter position has been reiterated in the years

following 1932. Was there a relatively sudden shift of

emphasis from the balance sheet to the income statement

in the early 1930's?

In pursuing the tracing and assessing of the

institutional forces which have been concerned with

financial accounting in the United States from 1902 to

1969, utilizing the annual reports of the United States

Steel Corporation as reference points, the writer is

concerned with the influences on financial accounting by

various groups of institutional forces and with the



8
The American Institute of Accountants, Audits of
Corporate Accounts: Corresoondence between the Special
Committee on Co-operation with Stock Exchanges of the
American Institute of Accountants and the Committee on
Stock List of the New York Stock Exchange, 1932-1934
(New York: American Institute of Accountants, 1934),
p. 8.

George 0. May, "The Nature of the Financial
Accounting Process," The Accounting Review, 18 (July,
1943), 191; William J. Vatter, The Fund Theory of
Accounting and its Inmlications for Financial Reports
(Chicago: University of Chicago Press, 1947), p. 74;
'Charles T. Horngren, "Security Analysts and the Price
Level," The Accounting Review, 30 (October, 1955), 576;
Accounting Research and Terminology Bulletins, p. 7;
Eldon S. Hendriksen, Accounting Theory (Homewood, Illinois:
Richard D. Irwin, Inc., 19637, p. 51.








utilization of financial accounting by the management of

the United States Steel Corporation to further

management's own goals. He is also concerned with drawing

implications from the study for present-day financial

accounting and with the validity of certain rather

prevalent generalities, such as the financial statements

are those of management and the alleged primacy of the

balance sheet prior to the 1930's, which are all too

often asserted in the literature of financial accounting.











The Scope


The topic "financial accounting" means that "public

utility accounting" is not discussed in the work. This

work is not a study of the internal accounting policies,

practices, and procedures of the United States Steel

Corporation. The project is mainly limited to financial

accounting in the United States, although there is some

discussion of the English accounting profession in the

1890's and early 1900's, as English financial accounting

was a standard for early United States financial

accounting. The writer utilizes the term "management" as

representative of corporate officers who have to bear the

ultimate responsibility for financial accounting.

The writer chose the following as representative of

the major groups of institutional forces10 which were most

concerned about financial accounting in the United States

and were, therefore, possible influences upon financial

accounting.





The term "institutional force" is here employed as
meaning an organized societal unit with the power to
effectuate action. This is, of course, an assumption.











1. Various Accounting Groups--Public

Accounting firms, textbook authors,

writers in accounting journals, the

American Institute of Accountants,

the American Institute of Certified

Public Accountants, the American

Accounting Association, the Financial

Executives Institute, and the

National Association of Accountants.

2. The New York Stock Exchange.

3. The Financial Writers and Financial

Services.

4. The Labor Unions.

5. The Stockholders.

6. The United States Government. The

federal agencies stressed in this

project were the Treasury Department,

the Internal Revenue Service, the

United States Bureau of Corporations,

the Federal Trade Commission, the

Securities Exchange Commission,

wartime governmental bodies, and

different congressional committees.











Mention was also :' e of the atiolnal Assocition: of

I:-anufactu r'r;' interest in simpli.fyin- nnual reports an(

economists' irter st in ad'litional dp.reci;tiont to :mtch

hiher rel" ce:-ent cos of fixed assets.

The rit er vc:s thi e afor e: t i oe rou is

beinr external tc othe United States Sroel Coriosration.


idered

This

nci a

, utili




n aM -1



1 Cori o




etri or

.yv of

' fi.


The

cons




fi n

1969

Stco




acco

Sto
Stern

St

in_, *l




Styt

durl

of t



the


ent of the United States Steel Corporation is

to cb an i ntUrna. force.

stily of the rinstitit ic na forces affectC: in,

ccuntInE in the United S tt from 190 to

viF te a.nna:: r exports of thie Unitd St at

raticn as reference points, is nt i ntOcn d t

n:luri.c hiatery of United States fin ncial

'"c to Since t'C Unli d S::ta:

r :!;atio: ,: -on a very Qroif:icnt Unit:`

cr cn In t.ce rain-rtricna of eccnoaic ana

6cvve3 t ard protibly V' a' n c s ecM to

t -, t .- ]tic fc}'ces aff ctL Unit .

. ... ...-. a s Y.er C 8c;


.on cf the,

vMan. if;


1 Cc


n f cOc


C:il Cea t


I its
1 '; -


1
i

ii


SC,0


or I 1V t1 byt the
W",. 1 it P f







12

many of the significant sentiments about and important

reactions to United States financial accounting are

revealed in these sources, nevertheless, an exhaustive

and inclusive coverage is not attempted. For those more

interested in the historical detail of the financial

accounting of the United States Steel Corporation, the

writer has placed various tables in an appendix for

Chapters II, III, IV, V, VI, and VIII, which are included

in individual appendixes which are included in the Appendix.

The writer does examine in some detail, however, the finan-

cial accounting occurrences of the United States Steel

Corporation in Chapters II, III, and IV so that the

readers can better determine the behavior of management

of these periods.











Methodology


A review was made of each of the annual reports of

the United States Steel Corporation from 1902 to 1969.

This review was the basis for noting the financial

accounting of the United States Steel Corporation in 1902

and subsequent changes in its financial accounting.

Access to the stockholders' minutes of the United States

Steel Corporation's annual meetings enabled the writer to

gauge the financial accounting influences brought to bear

on management by stockholders. A court action brought by

a group of stockholders in 1902 was examined. Various

publications dealing with the general influence of

stockholders were examined in order to obtain information

on the general interest of stockholders in their

corporations. Access to public statements by the

management of the United States Steel Corporation aided

the writer in the determination of the extent to which

the United States Steel Corporation's financial

accounting was affected by the aforementioned

institution] forces. Personal conferences with the

United States Steel Corporation officials were helpful in

obtaining the location of various source material.










Financial accounting and related literature was

searched for indications of accounting institutional

influences. The two principal libraries utilized were the

American Institute of Certified Public Accountants' library

in New York City and the library at the University of

Florida. The Accounting Research Bulletins, the

Accounting Principles Board decisions, and the American

Accounting Association statements were utilized in

determining the effect of the American Institute of

Certified Public Accountants and the American Accounting

Association on financial accounting.

The files and reports of the United States Bureau

of Corporations concerning its 1910 investigation of the

United States Steel Corporation were reviewed at the

National Archives in Washington, D. C., in order to

obtain original source data on the formation and early

years of the United States Steel Corporation and its

financial reporting. The annual reports of the

Commissioner of Corporations, issued as a part of the

Annual Report of the Secretary of Commerce, were examined.

These documents yielded data as to the extent of federal

government interest in financial accounting from the turn

of the century to 1913. An examination of the annual

reports of the Federal Trade Commission was utilized to










ascertain gove r.nLental interest in financial accountinZ


from t1i y-ers 1911


to 1 <3.


The annual reports of the Securities and E1


Cor mission it

publications o

1935 to the pr

Securities and-i

provided addt'.

doc- onts 7 re'

in financial a

States WasrUr

ServicU wrcric U

Ien"Vca l1a'vs I


:ouantin- Series releases, and its oth


as

:fe




e


"" C ] ", %it


to zovoi er.

ren:e with

ssien in

I ct- Co



librari es


d of the In

;'tlno the e


.tal into

n offici

2 shin>ton

ta 'v ccn'

rc'ssion.l





St. Ut" s


t il


I-1_


d withV

1 1' 1a ,


of:'


'CL j I S 01-

Jial acS un i ... _L ]


tis P ari1 A cop,


s froc, leY5/ tt I


AS 1




. 1 1
S" a C i S a *


r


est

of

D.



v* V


York

mo C u

mer:;its


11]


Ac*-
i? r *


t e!


official


in z tc


* I I *










this official concerning the financial accounting aspects

of the years after 1938.

Correspondence was conducted with the research

director of the United Steelworkers Union to determine its

influences upon the financial accounting of the United

States Steel Corporation. An interview with one of the

research assistants13 of the United Steelworkers Union and

a review of certain internal and external documents

yielded data which could only have been obtained at the

source.

Interviews to determine a brief history of each of

the organizations and the extent of past interests in

financial accounting were conducted with officials of the

Federation of Financial Analysts, the Financial Executive

Institute, the Robert Morris Associates, and the United

Shareorwners of America. Relevant economic history works

were searched in order that a brief historical background

for the institutional influences could be presented.

The work is basically organized around six major

time periods. The first time period dealt with the

founding of the United States Steel Corporation and its



13
Mr. Marco Vestich, Assistant to the Research
Director of the United States Steelworkers, was
interviewed in June of 1969.








17

first full-year annual report. As this 1902 report marked

the inception of financial accounting of the United States

Steel Corporation, it was thought necessary to study the

financial accounting occurrences found in the report in

some detail. The second span covered the years from 1903

to 1915 and discussed the laissez-faire years and the

imposition of corporate income taxation. This period was

chosen because of the desire to segregate financial

accounting occurrences of peacetime from wartime. The

third period ran from 1916 to 1929. It included the

topics of World War I and the return to normalcy. This

period allowed a segregation of financial accounting

events of the World War I period and of the relatively

prosperous period before the depression. The period of

the depression from 1930 to 1940 was treated in the fourth

time period. The depression caused a political and social

upheaval in the United States and its effects on the

financial accounting of the United States Steel

Corporation were extremely important. The fifth section

dealt with the period from 1941 to 1949 and was

primarily concerned with World War II and its aftermath.

World War II dominated the United States for this decade

and financial accounting reflected this domination. The

last section dealt with the current years from 1950 to

1969.







A very brief historical sketch is presented in each

chapter; then a synopsis is made of the financial account-

ing events discussed in the chapter. These two sections

compose the introductory part of each chapter. The body

of each chapter is concerned with a discussion of the

financial accounting events of United States Steel for

the given period. A summary assessment section is included

at the end of each chapter. In this section the writer

makes certain judgments about the development of financial

accounting in the United States for the period of time

covered by the chapter, utilizing the annual reports of

the United States Steel Corporation as reference points.

The writer makes some overall assessments, based on the

study, about United States financial accounting from 1902

to 1969 in the concluding chapter.

The annual reports of the United States Steel Corpora-

tion are not footnoted in the text. The reference to a year

indicates the year for which the annual report was issued.

Table II in the Appendix for Chapter VIII details the

references to the annual reports by year and page.


















CHAPTER II



ThE FIRST FULL-YEAR ANNUAL R. OR. T

OF TiE U:-ITED STATES STEEL

COm1ORATIOY, 1902


Historic: ..As aP-d S_!_w.yno2i s of Fjnal~ ciol

Account in' events


The Unitci S'tate Steel Cortora ion ws founded


duri',ln the trust .ov


_r of 1898 to 1901, and was


l"!e]Lcd the first "Eillio Dollar Trust."2 A trust w:s

a in le corI or-ation whichh held the securities cf oth) l

cor-rt c l as its only asset. The otiicr co nies kept


E':-;:rd SC.er:.;o'!" .*a:e Trust Fi rncc: A S&t
of the GI c 0 Fi ni-r ri 1 t I. of .c
Co1:. i > r c!. (.:,' : : D. A. ,o : 1
p. 2.


2

Cor~ -:
To o tc: 1


1 CotLe I- t

.d Q, : jot


SC-ty 1 ): Yo : and
-a y, 1 ), 22-


''








20

their corporate entities but their affairs were placed

under the control of the permanent directors of the trust.

Competition among these companies was thereby prevented.3

The promoter and the investment banker were the

key men in the trust formation. The promoter first

conceived the possibility of the enterprise; he then

planned the details of the operation. He and the

investment banker prepared the financial plan and then an

underwriting syndicate was formed by the investment

banker. The final step was the sale of the securities to
4
the public. Eight steel companies were acquired on

April 1, 1901, by the United States Steel Corporation and

four other companies were acquired during 1901. These

companies produced at least 58 per cent of the steel

making pig iron in the United States.




Meade, Trust Finance, p. 37.

4
Arthur Stone Dewing, The Financial Policy of
CorDorations (3rd ed.; New York: Ronald Press Company,
1926), p. 236.
5
U. S., Bureau of Corporations, Report of the
Commissioner of Cornorations on the Steel Industry: Part
I Organization Investment, Profits and Position of
the United States Steel Corporation, Herbert Knox Smith,
Commissioner (Washington, D. C.: Government Printing
Office, 1911), p. 12.







Topics discussed in this chapter include the

inclusion of an Income Account in the annual report, the

confusion between "funds" and "reserves," and the yearly

recognition of depreciation. Other topics mentioned are

the valuation issue, the overall reporting policy of the

United States Steel Corporation, and the accounting treat-

ment for inventories and working capital contributions.


Financial Accounting Events


The Income Account


The first two pages of the 1902 Annual Report were

devoted to the yearly Income Account, which included the

total net earnings from the General Profit and Loss Account,

various appropriations, and the payments of interest and

dividends. (The Income Account appears as Table I in the

Appendix for this chapter, and the General Profit and Loss

Account in Table 2.) The placing of the Income Account at

the beginning of the annual report was not surprising in



Refer to page 18 of the text for the statement that
the annual reports of the United States Steel Corporation
are not footnoted in the text but are referenced in Table
II in the Appendix for Chapter VIII.








22

view of the importance of earnings for financial writers.

Two editorials from the Wall Street Journal highlighted

this importance.

The highest classification of a trust was the

ranking of an investment security. An August 15, 1900,

editorial in the Wall Street Journal listed thirteen

questions that should be asked in the process of

determining the investment status of a trust stock. The

first six of these questions related to the earning power

of the trust.7 Without an income account and a detailed

profit and loss account, such questions as how much were

expenses reduced because of the consolidation, how much

were gross earnings increased because of the consolidation,

and what were the excess earnings over 7 per cent because

of the consolidation could not be answered.

The renowned first editor of the Wall Street Journal,

Charles H. Dow wrote that values followed earnings and that

while manipulation made temporary movements, the main

course of prices was simply a response to changes in

values. Prices could not be kept down if supporting




7Meade, Trur-t Finance, pp. 123--4, quoting an
editorial of August 15, 1900, from the Wall Street
Journal.









8
values were present. With no income account, earnings--

the base of stock value--would have been hidden. It

appeared that the income figure was a vital one for the

editor of the Wall Street Journal.

Three other examples of interest in the Income

Account were the interest shown by a financial service,

the New York Stock Exchange, and the United States

Industrial Committee. Of the first thirty industrial

stocks analyzed in Poor's Manual 1903, twenty of them

included a current net income figure.9 This financial

service undoubtedly served as an example of information

that other companies reported and, as such, probably gave

readers a standard to judge the amount of information

disclosed by the various firms. In 1900, a committee of

the New York Stock Exchange was formed to obtain compliance

of the listed companies in the matter of the requirement of

a detailed income statement published at least once a year.

If a corporation desired to join the list after 1900, a




8
George W. Bishop, Jr., Charles H. Dow and the Dow
Theory (New York: Appleton-Century-Crofts, Inc., 1960),
p. 123, quoting an editorial of March 6, 1902, from the
Wall Street Journal.

9
Poor's Railroad Manual Co., Poor's Manual 1903
(New York: American Bank Note Company, 1903), pp. 1138-59.










published income statement was a prerequisite.10 The

United States Industrial Commission, a body comprised of

five senators, five members of the House, and nine

industrial representatives and founded by Congress on June

18, 1898, urged on March 1, 1900, that a profit and loss

statement be published annually.1 Thus, Congressional

interest in financial accounting was present at the turn of

the 20th century.

Financial accountants were also quite concerned

about the income figure. Arthur Lowes Dickinson, the first

senior partner of Price, Waterhouse & Company in the United

States, stressed the fact that dividends could only be




10
Committee on Stock List of the New York Stock
Exchange, "Historical Account of Relationship of New York
Stock Exchange with Listed Companies as it affects
Accountants," (review prepared for internal uses, April 8,
1938), p. 1.

Mr. William R. Satterfield, Assistant Director of
the Department of Stock List of the New York Stock Exchange,
was unable to locate the 1901 agreement of the New York
Stock Exchange with United States Steel, but he felt that
no listing contract after 1900 would have been drawn
without reference to an annual publication of the income
statement.

U. S., Congress, House, U. S. Industrial
Commission, Preliminary Report on Trusts and Industrial
Combinations, H. R. Rept, No. 476, Part I, 56th Cong.,
1st sess., 1900, pp. 1-7.










]2?
3.33
lo (ly paid fru:: profits. 2Even n

boncc, the vital factor was hold tlo be

incom. Th amount of nt evrro ^n.'r


bas. is for rap


lb



I t L;

a very ij n

turn of the}

the cli: tr

of Lthy 11


a nn, i n cn,. o
ti anni ia] l

iA York 1 to


inin the w;'orth of the

e to (de. I .th con


ia

n t

20qh


cpn


oCA deCt,




W'r:iy. Po

tG 1 a it

vir'n' ] f; I


thait




or'

t in

r f;.


the o.urchn;'o of a

the ability of

1 Opre;c the idc'r

Cc '::1:0ny It ':': of

ppt of n&t


the



t n. *


1 ; I i: the
33~~c: .'i'~

I;: ~~i .71


ICI 3:


i b~t


.l] Co;:- i :






Sjoin n.


f i


t:.


nI o T

Son r

,c::,-i.1


Courn jI pr c iti .cnr


C ,


, O 3n


afLtr 3


I. i i


12
i, rth .
"' L, "
Y : C


1 e


C,


Co N', 0
] el"r (







26

stressed the importance of the net income figure. The

importance placed on the income figure and on its

computation tend to give less credence to the oft-

expressed view that financial accounting was more balance-

sheet oriented than income-statement oriented until the

1930's. (Refer to pages 6-7.)


The Use of Funds

Four funds were established from the Income Account.

They were entitled: (1) the Sinking Funds on Bonds of

Subsidiary Companies; (2) Depreciation and Extinguishment

Funds (regular provision for the year); (3) Extraordinary

Replacement Funds (regular provisions for the year); and

(4) Special Fund for Depreciation and Improvements. Two

other funds were established by charges to the General

Profit and Loss Account. These were: (1) the Contingent

and Miscellaneous Operating Funds; and (2) the Insurance

Fund. These six funds were portrayed in the Balance Sheet

under the caption Sinking Reserve Funds in the liability

section.










Sinking and Reserve Funds:

Sinking Fund on U. S. Steel
Corporation Bonds
Sinking Funds on Bonds of
Subsidiary Companies
Depreciation and
Extinguishment Funds
Improvement and Replacement Funds
Contingent and Miscellaneous
Operating Funds
Insurance Fund


$ 1,773,333.33

217,344.36

1,707,610.59
16,566,190.90

3,413,783.50
1,539,485.25

$25,217,747.93


An accounting writer felt that care should have

been exercised to avoid confusing the reserve accounts with

an actual sum of money and/or working capital set aside for

a particular purpose--that is, a fund. The term "reserve"

was to be used for "an amount set aside out of profits

either for some specific purpose or for the general

purpose of strengthening the business by way of

accumulating working capital."l5 If there were no specific

allocation of cash and/or other working capital accounts
16
set aside, the use of the term "fund" was not advisable.




1Leo Greendlinger, Accounting Practice, Modern
Business Series, Vol. V (New York: Alexander Hamilton
Institute, 1910), p. 239.

16
Ibid.








28

The United States Steel Corporation had no

specific category in the asset side of its Balance Sheet

for a fund of cash and/or other working capital accounts

for these fund balances. However, the 1902 Annual Report

did contain a caption in the schedule of funds that

mentioned a relationship between "funds" and "reserves."


The balance to the credit of several
funds on December 31, 1902, per the
preceding table, are included in the current
assets of the organization,

In General Cash $ 1,773,333.33
In Current Assets:
Cash, Marketable
Securities, Inventories 18,491,145.85

$20,264,479.18


Whether this entire amount was actually set aside for the

specific funds was problematic.

The United States Steel Corporation's handling of

these terms probably left the reader unclear as to

whether there was an actual allocation of cash for the

"funds." This was important because it was apparent

from the dollar amount of these "funds" that they were a

significant part of the United States Steel Corporation's

financial accounting presentation. Two of these "funds"

are now discussed in more detail.










Bond Sinking Fund


The importance of the public accounting firm of

Price, Waterhouse & Company, which has been the public

accounting firm auditing the financial statements of the

United States Steel Corporation from 1902 to 1969, in the

matter of the United States Steel Corporation financial

accounting policy is illustrated by this particular topic

--Bond Sinking Fund. Controversy surrounded the inclusion

of the bond sinking fund amount as a deduction from net

earnings. Should conservatism17 rule or should actuality

prevail? The view that conservatism was more important in

this matter than legal actuality was held by Arthur Lowes

Dickinson and Leo Greendlinger. Dickinson agreed that the

charge to earnings for the bond sinking fund amount was

not an expense but the reduction of the liability.

However, since the only source of the redemption of bonds

was income and since it was usual to provide in the bond

contract that the sinking fund came from yearly profits,

Dickinson felt that the charge for the reserve fund should



3.7
7Conservatism, as here employed, referred to the
reporting of a lower net income figure because of the
decision to employ a financial accounting procedure which
was not related to an actual financial accounting event.
Other uses of this term are found in Chapter III and in
other parts of the study.








30

be to the income account.18 Greendlinger felt that since

this charge to the income account prevented directors from

declaring excess dividends, this practice was desirable.

He stated:


Then too, since accountants are not
living in a scientific world of their own
construction, wherein everything is arranged
to their own ideas, but in a commercial
world which as yet knows very little about
accounting principles, the shrewd accountant
will make concessions, and base his practice
upon business and legal principles as they
now are, not as, in theory they should be.19


Seymour Walton attacked this view which he held

failed to distinguish between a fund and a reserve account.

Should one charge the part payment of a six-month note to

revenue? Why then should one do it with a bond which runs

forty times longer than the six-months note? The

stockholders were misled as to the amount of surplus

available for dividends. Since the amount of the retired

bonds was charged to the liability account, the amount of

the bond sinking fund reserve was constantly increasing.




18
Greendlinger, Accounting Practice, p. 366,
quoting Arthur Lowes Dickinson.

19bid., 67.
Ibid.. p. 367.








31

This account in reality represented a locking up of the

surplus amount and should have been classified as such.20

The strength of the influence of the American

branch of Price, Waterhouse & Company in its relations with

the United States Steel Corporation management was

undoubtedly apparent here, as the United States Steel

Corporation reflected its public accounting firm's view on

the deduction of the bond sinking fund from net earnings.

This policy probably dampened stockholder confidence,

since a lower earnings figure was reported.


Depreciation Funds


In 1902, the first of the three fund accounts

applicable to capital assets was the Depreciation and

Extinguishment Fund. It was charged for the amount needed

to liquidate the original capital investment in the

properties at the end of their useful life. The second

was the Extraordinary Replacement Fund, which was charged

for the amount estimated to have been needed to improve

and modernize the fixed assets. The third was entitled




20
2Seymour Walton, "Sinking Funds and Reserve
Accounts," The Journal of Accountancy, 6 (October, 1908),
394-9.








32

the Special Fund for Depreciation and Improvements. The

topic of depreciation centered around (1) whether it

should be recognized, (2) what basis should be employed to

calculate depreciation, (3) to what extent it should be

used to stabilize earnings, and (4) where on the balance

sheet should the accumulated credits be shown. The

following discussion of the views of leading accounting

authorities on the matter of depreciation showed that this

financial accounting topic was well studied at this time.

These views should prove to be useful for the other

occasions when the topic of depreciation will be discussed

in this work.

Ewing Matheson in his classic work, The Deureciation

of Factories, stressed that the determination of the

proper amount of depreciation should be a function of

those who were technically acquainted with fixed assets.21

Because of the problems associated with a yearly

revaluation of fixed assets, it was most desirable to

establish an average rate to be written off each year.

This amount would be reviewed by a complete or partial




21Ewing Matheson, The Deoreciation of Factories
(2nd ed.; London: E. & F. N. Spon; New York: Spon &
Chamberlain, 1893), preface.









22
valuation at given intervals. The three factors to be

considered in the depreciation process were held to be the

original value or cost, the probable working life, and the

salvage value. Specific reference was made to the

practice of varying depreciation amounts with good years.


In the large industries such as iron,
steel, and chemical works, the improved
methods that are continually arising render
necessary an outlay of a speculative nature
for new experiments and plant which if
successful will render much of the old
plant obsolete of diminished value. A
large annual return may alone justify the
outlay, and such return cannot safely be
treated as profit without a considerable
reduction in capital value. Therefore,
while in average or normal years of
working a moderate rate of depreciation
may suffice for mere physical
deterioration, advantage should be taken
of prosperous years to write down
liberally the book value of the plant.23


Matheson stated that when the write-down was to a

fund entitled Depreciation and Reserves and charged to the

income statement, shareholders might be led to the belief

that there was an actual sum of money set aside to replace

the capital assets. This association between the accounts




2?
2Ibid., p. 15.

23Ibid., p. 44.








34
24
and funds was not advisable. Matheson urged the

recognition of an amount of depreciation established by

technically oriented experts, the cost basis for

depreciation, the use of a larger depreciation amount

in years of prosperity, and the careful distinction

between cash and depreciation.

Garcke and Fells stressed the factor of

obsolescence. This factor necessitated a depreciation

amount even though the fixed assets were renewed

continually by repairs and maintenance. Depreciation

was a judgmental matter which should be taken into

account each year. They held that the ideal method of

computing depreciation was to apportion the original

cost plus interest and renovations less the residual
25
value over the estimated useful life of the fixed asset.25

Garcke and Fells also urged the yearly recognition of

depreciation and the cost basis as the starting point of

depreciation.

Francis W. Pixley held for a strict adherence to

the cost basis for recording fixed assets and depreciation.




24Ibid. p. 21.


25Emile Garcke and J. M. Fells, Factory Accounts
(5th ed.; London: Crosby, Lockwood and Son, 1902),
pp. 105-17.








35

The reserve account was to be subtracted from the cost of

the fixed assets to give a fair value of fixed assets for

the going concern. He advocated that the accountant

should determine the cost of the fixed asset and that

engineers in the operating depa.rtments should determine the

amount of dprecicaion., Pixley held views similar to

that of I:.ath.so on: he cost basis for depreciation, the

nature of tho r:es rve account, and the use of en ine er to

estimate a;O:. nt of depreciation.

"Prudential depreciation" was to be esta-bli shei as

a charge a.i. nst revenue before any dividend could be

declared. The purpose vs to provide a-ainwt unrcalise

but probable lo css in capital a ssets. The o- rd of

directors boe 'a co;i der ble I responsibility in inclu'in:

such a ch r f 5n r nition to the "w'rki' n depIrec action"

char.e 'whi ch reiatn to the replacement of the realized

losss in fixed as:ts, This policy w'as to be fo] ]owe

even tit ': ji -ht result in sharehold i di .er sure

The bord of dire .. were to eer th t.hey h a

very strong tru te. reltions ip vwith p:re's -, a.n! fut.,,.,~I




26 :ri s .. li c: A cr n ill (Ci l n: Pj; n
an: Son K O., 39 ), pp. 2 .








36

shareholders and it was the duty of the board of directors

to replace the fixed assets.27 This writer stressed the

importance of the board of directors' allowing an amount

for possible losses in the value of fixed assets.

Seymour Walton felt that depreciation was the

lessening of value of fixed assets due to use and

contrasted it to fluctuations in value by outside

influences and not use. Since fixed assets were not

ordinarily held for resale, accountants should ignore the

change in value due to fluctuations. It was the auditor's

duty to be sure that an expression of depreciation

appeared in the accounts and the writing-off of an

arbitrary amount to equalize earnings should be
28
unreservedly condemned by the auditor. Walton was in

favor of the yearly recognition of depreciation and was

opposed to its use for the equalization of income.

It appeared that the United States Steel

Corporation's decision to recognize depreciation on a

yearly basis was in line with the insistence of accounting




27
27John H. Armstrong "Depreciation Reserves," The
Accountant, 29 [New Series] (August 8, 1903), 1014-18.

28
Seymour 'Walton, Auditing, Modern Business Series,
Vol. XI (New York: Alexander Hamilton Institute, 1911),
pp. 63-7.








37
writers. The basis for the calculation of depreciation by

the United States Steel Corporation and the extent to

which it was used to stabilize earnings could not be

determined from the 1902 Annual Report. The United States

Steel Corporation classified the depreciation reserves as

a part of the liability section of the Balance Sheet and

not, as recommended by accounting writers, as a deduction

from the fixed asset account.

It was apparent that the topic of depreciation was

a financial accounting item that was covered extensively

in the literature of the time. The cost basis for

depreciation appeared to have been accepted. The stress

placed on the utilization of engineers to estimate the

yearly amount of depreciation was interesting in the light

of today's employment of depreciation as a result of a

mathematical formula not necessarily coinciding with

engineering estimations.


Valuation of The United States Steel Corporation


It was stated in the 1902 Annual Report that:


The Balance Sheet included in this
report, page 24, exhibits the combined
assets and liabilities of the United
States Steel Corporation and of the
Subsidiary Companies, based on the
valuation at which the stocks and bonds











of the Subsidiary Companies were taken
over by the Steel Corporation,
liabilities from one company to another
company being omitted.


This paragraph in the report was only one sentence

but it contained the most controversial accounting and

financial issue of all--that is, the matter of the

valuation of the corporation. The United States Steel

Corporation employed the par value of its securities,

which were comprised of bonds, preferred stock and common

stock, exchanged for the securities of its subsidiary

companies as the basis for the valuation of its assets.

The use of the par value of these securities as the

capitalization basis was held by a financial writer to be
29
generally agreed upon.29 The impotence of the auditor in

this valuation process was accepted by such accounting

authorities as Henry Rand Hatfield, Arthur Lowes Dickinson,

and Walter A. Staub.

Hatfield felt that it was customary to record as

the cost of property the par value of the stock exchanged




29Meade, Tru finance, 290.
Meade, Trust'Finance, p. 290.








39

for it.30 The reason for this accounting practice was

that there was no satisfactory criterion for the valuation

if manufacturing establishments combined into a trust.

Even the cost to the combining companies could not be

relied upon because the assets may have been acquired at

an exorbitant price or they may have been purchased at a

bargain sale. For this reason, the courts have relied

upon the valuation of the company's directors.


An illustration of the extent to which
this deference to the directors' discretion
may go is found in a decision of one of the
Federal courts to the effect that the
purchase by a corporation for $2,000,000
bonds and 3,600,000 stock of a railroad bed,
the construction of which cost $2,000 and for
which the vendor had paid $15,000 was not on
the face, a fraudulent transaction [Stewart
v. St. Louis, etc., R.F. 41 Fed. Rep. 736
(1887)]31


Hatfield felt that the solution was to value the assets at

the par value of the stock but that this method of

valuation should be clearly explained by a statement in




30
Henry Rand Hatfield, Modern Accounting: Its
Principles and Some of its Problems (New York and London:
D. Appleton and Company, 1910), p. 79.

31
Ibid., pp. 161-2.








40

the balance sheet.32 Dickinson stated that "If stocks or

bonds are issued for the purchase of any definite property,

it may be presumed that the property is worth the par

value thereof."3 Staub felt that there was a consensus

that the auditor could not expect to be an appraiser and,
34
therefore, determine the actual value of the concern.

In 1900 the United States Industrial Commission

concluded that overcapitalization as a result of promoters'

and underwriters' urge for huge profits was often against

the public interest and should be checked, Even a fairly

conservative combination resulted in capitalization that

was two to three times the value of the plants and

patents.35




32
Ibid., pp. 170-1.

33
3Dickinson, "The Profits of a Corporation," 185.

34
Walter A. Staub, "Mode of Conducting an Audit,"
Official Record: Congress of Accountants, 1904 (New York:
George Wilkinson, 1904), p. 210.

35
35U. S., Industrial Commission, Preliminary Report
on Trusts and Industrial Combinations, pp. 12-6.








41

There was very little that accounting practitioners

and writers could do about the valuation of the United

States Steel Corporation. The Industrial Commission could

study cases of overcapitalization and recommend a checking

of the power of promoters and underwriters in this area

but it did no more. A financial writer, Meade, was

willing to accept the fact that the securities were selling

at their face value as the criteria for over-
36
capitalization. This judgment was, of course, after the

fact of the financial accounting valuation. This very

important matter of valuation was left to the board of

directors and the management of the United States Steel

Corporation. Was the stock of the United States Steel

Corporation watered? If so, how much water was estimated

to be present? Was the valuation amount of the board of

directors and management questioned in the courts?

Stock watering was defined as the issuance of

nominally fully-paid stock in an amount exceeding the

value of the assets against which the stock has been

issued. Three advantages accrued to the corporation from

this practice. First, the public tended to overvalue the




36
Meade, Trust Finance, p. 303.










securities on the market; second, the creditors or future

creditors of the company were given an exaggerated equity

position on which to base their credit decision; third, the

excess profit position of the combination was concealed

from the public and from competitors by the high
37
capitalization.

The relativeness of the valuation process was

illustrated by the varying values of the United States

Steel Corporation obtained by different experts. Charles

M. Schwab, the United States Steel Corporation's first

president, estimated the value of the corporation at

$1,466,278,000 in the year 1902 in an affidavit in regards

to a court controversy about the conversion of preferred

stock into bonds. The valuation principles and breakdown

were illustrated by the following summary of the affidavit

in Table 3 of the Appendix for this chapter. The decision

of the court was to uphold the value of the United States

Steel Corporation as reported on the certificate value.

This certificate was held to be filed in honesty and good

faith and anyone questioning such valuation must bear the



37David L. Dodd Stock Watering (New York: Columbia
University Press, 1930), pp. 3-12.








43

burden of proof. The dissident stockholders could not even

meet the minimum requirements for proving their point as to
38
the overvaluation of the United States Steel Corporation.

William H. Lough estimated that a minimum of

$542,000,000 of the capitalization of the United States

Steel Corporation represented water. The basis for this

amount was the $1,252,000,000 of securities--$868,000,000

of stock issued to the owners of the combining companies,

$240,000,000 of stock issued to the promoters, and

$144,000,000 of additional bonds issued to the owners of

the combining companies--added by the combination and the

$710,000,000 of aggregate capitalization of the old

companies. However, the $710,000,000 figure was already

watered before the combination occurred.


But what are the facts as to the
capitalization of the original companies?
Daniel G. Reid, president of the American
Tin Plate Company, testified before the
Industrial Commission that of the
$46,000,000 capitalization of the company,
$18,000,000 (preferred stock) was supposed
to represent the value of the property and
$28,000,000 (common stock) represented
hopes for the future and pay of the




38
Edward Sherwood Meade, "The United States Steel
Corporation's Bond Conversion," Quarterly Journal of
Economics, 18 (November, 1903), 47-8.











promoter. It is well known that in the
capitalization of the National Steel,
American Can Steel, and American Sheet
Steel Companies, all of which were
promoted by the same interests as the
American Tin Plate Company, the same
principle was followed.39


Three different estimates of the value of the United

States Steel Corporation at April 1, 1901, were made in the

Bureau of Corporation's study of the founding of the

United States Steel Corporation. The first method was the

cost of the tangible property to the combining companies

and yielded an estimate of $676,000,000 as the valuation.

The second method was the addition of the market values of

the securities of the combining companies and yielded an

estimate of $793,500,000 as the valuation. The third

method was the detailed estimate of the physical properties

of the departments of the firm. This method was held to be

the most detailed and conclusive of the three. The

valuation and breakdown under this method appeared thusly:






39
39William H. Lough, Corporation Finance, Modern
Business Series, Vol. VI (New York: Alexander Hamilton
Institute, 1913), p. 81.











Manufacturing properties,
including blast furnaces $250,000,000.
Transportation properties 91,500.000.
Coal and Coke properties 80,000,000.
Natural gas and limestone
properties 24,000,000.
Current assets 136,500,000.
Ore properties 100,000,000.

$682,000,000.40


The estimated amount of water and intangibles as of April
41
1, 1901, under the third method was $721,328,839.4

While there was water present in the United States

Steel Corporation at its inception, the writer was very

hesitant about issuing a blanket condemnation'of the

United States Steel Corporation's board of directors and

management. One reason was that if one accepted the

United States Bureau of Corporation's amount of

$721,300,000 as water and intangibles (there was no attempt

to factor out these intangibles), the overcapitalization

was only a little more than 100 per cent over the value of

the assets. The United States Industrial Commission held




40
United States Bureau of Corporations, Report of
the Commissioner of Corrorations on the Steel Industry:
Part I, letter of submittal, xx-xxi.

41 d., p 328.
ibid., p. 328.








46

that a fairly conservative capitalization was one that was

capitalized at two to three times the actual value of its

plants and patents. (Refer to page 40.) The United States

Steel Corporation's overvaluation was far less than this.

If one held, like Meade, that the capitalization of a new

company should be based on a conservative estimate of its
42
earning power,42 there might have been no water. The

writer is of the opinion that the board of directors and

the management of the United States Steel Corporation did

not misuse their prerogatives as to valuation. Even if

one were to judge the board of directors and management

harshly in this matter, one would have to temper his

statement with the fact that the United States Steel

Corporation underwent a de-watering policy for the next

three decades.


Reporting Policy


The strong influence of Price, Waterhouse & Company

in the reporting of the United States Steel Corporation is

noted in the subsequent discussion. The British public

accounting firm of Price, Waterhouse & Company, through its




42
Meade, Trust Finance, p. 292.









47

American branch, Jonesr and Ceasar, had dealt with J. P.

Nor- n enterprises before the formation of the United

States Steel Corporation. In Dece~ober, 1897, Jones and

Cea'sar re pard- an examination of the records of the

co:,.panie;s V 7lic:h co .cin e into the Am ericn 'telo and ''ire


Company

corbin id

vwa on t

in the

indi v id i

ex c f', 0

the a cc

forn t

st ockhi

Bri 1i h

a u o.

fi;;t r a

Bri


to forn; th






2l cc: any's




u.ntin: a 5r

n Un



;r rent of Jo

Thus the Uni

ior U 'ni1, e
I ")


w, whic

Unitcal


S,",ia



fixed











n'-, an-l






rhe tce


:h was later one of the corp;:

State:; Stel Coor-oration.

Sthe firm acquired exprc:: en

pro : of reconcilin- t-h

asset account to th.e ]ar2er

SJone and Cea- rrfo;

for the co:' nrati o n v,' h c h

teel Cor orati on, bt:i t-"

; v-y 17, 19 2, to I.ve h".

SCea:;"rr erfor- th; y' :



5ndurslrii coc any to a i y :
c ':ho ]d r Col '. ,


L:i


_. : -1 - ---
''" ) ,
"
I:.3 1


It

30


- t


, n *


N'C' Je


r ,


of







48

While it was the stockholders who voted for Price,

Waterhouse & Company as auditors, the fact was that not

more than twenty people, many of them reporters, were
45
present at the annual meeting in 1902. It appeared that

management really picked Price, Waterhouse & Company

through the proxy method.

Two major accounting decisions appeared to have been

made by the public accounting firm. One was the afore-

mentioned issue of the appropriation of an amount equal

to the bond sinking fund from net earnings. Arthur

Lowes Dickinson was a staunch proponent of this practice.

(Refer to pages 29-31" The other was the matter of the

issuance of consolidated statements. The United States

Steel Corporation's lawyers and bankers desired stock-

holder statements covering just the activities of the

parent. Thus the only subsidiary operations that would

have appeared were the dividends and interest they paid

to the parent company. Dickinson held out for consolidated

statements of operations so that shareholders could ac-

quire a more accurate presentation of their company.



't"The Steel Trust Meeting," The ,c', .-~ Tij,,
February 18, 1902, p. 14.


.6DeMond, P r V- -
p. 60,











The management of the United States Steel

Corporation was very committed to an annual reporting

policy. An illustration of this policy toward reporting

was the exchange between Judge Gary, the first chairman

of the Executive Committee of The United States Steel

Corporation, and another member of the board of directors

after the public issuance of the 1901 Annual Report.


"Judge Gary," he (Henry Rogers of the
Standard Oil Company) said, "do you mean that
you are going to give out that report to the
newspapers?"

"I do," he replied.

"Now, Judge, I am an older man than you,
I have been longer in business. Some day you
will have a poor report, what will you do
then?"

"Give it out, Mr. Rogers, give it
out."47


Judge Gary and William J. Filbert, the first controller of

the United States Steel Corporation, were ranked as true

pioneers in the field of corporate reporting. Gary

utilized the publicly issued statements as an important




I7da M. Tarbell, The Life of Elbert G. Gary: A
Story of Steel (New York and London: D. Appleton and
Company, 1925), p. 142.








50

factor in the United States Steel Corporation's public
48
relations program.

As early as January 23, 1895, the New York Stock

Exchange had recommended to listed companies that they

publish and distribute to stockholders, at least fifteen

days before the annual meeting, a balance sheet and an

income account. By 1900, as already mentioned, an effort

to obtain compliance took the place of the
49
recommendation. The United States Industrial Commission

recommended that corporations be required to report to its

stockholders its financial condition, verified by a

competent auditor, at least once a year. Trusts should be

required to publish an audited annual report, including

both a reasonably detailed balance sheet and profit and

loss report. Such reports would be open to governmental

inspection.5



48
4DeMPond, Price, Waterhouse & Company in America,
p. 59.

49
4Committee on Stock Lists of the New York Stock
Exchange, "Historical Account of Relationship of New York
Stock Exchange with Listed Companies as it affects
Accountants," p. 1.

50
United States, Industrial Commission, Preliminary
Report on Trusts and Industrial Combinations, p. 6.








51

The influence of Price, Waterhouse & Company was

felt heavily in the overall reporting policy of the United

States Steel Corporation. The issuance of consolidated

statements led to a far better informed reader of the

annual report than the very sketchy unconsolidated ap-

proach desired by the United States Steel Corporation's

lawyers. Both the New York Stock Exchange and the United

States Industrial Commission stressed annual reports. As

was already mentioned, financial services, such as Poor's

Manual, published yearly summaries of companies. (Refer

to page 23) There certainly was no vacuum of institutional

interest in the financial accounting reporting. The manage-

ment of the United States Steel Corporation not only ex-

pressed a very open reporting policy but also put such

expression into practice.


Other Accounting Matters


Accounting writers stressed the importance of the

realization of profit on the date of sale and, therefore,

accepted the doctrine of not carrying inventory amounts at

more than cost. This rule of revenue realization




5laalton, Auditinp, p. 56.








52

apparently was followed by the United States Steel

Corporation, because the statement was made in the 1902

Annual Report that "Inventories are taken on basis of

actual cost of the materials and products at the several

departments of the companies holding the same."

The Undivided Surplus Account had the two separate

classifications of Capital Surplus Provided in Organization

of the United States Steel Corporation of $25,000,000.00

and of Surplus Accumulated by all Companies since

Organization of the United States Steel Corporation of

$52,874,597.05. Controversy surrounded the inclusion of

the $25,000,000 of working capital received from the

promoters as part of the Undivided Surplus of the company.

Dickinson stated that the Undivided Surplus Account had the

connotation of profits and surely that was not the case for

working capital contributed by the promoters.52 There was

a detailed schedule of the Undivided Surplus Account.

There was a decrease of $1,583,514.70 in the Undivided

Surplus Account for amounts Written off in 1902 to Cost of

Property and for Adjustments of Sundry Contracts and




52
Arthur Lowes Dickinson, "Notes on Some Problems
Relating to the Accounts of Holding Companies," The
Journal of Accountancy, 1 (April, 1906), 487.








53
Accounts. The warning about the use of the Undivided

Surplus Account to absorb and hide items that might be

pertinent in the judgment of the earnings capacity of the

business was made by Dickinson.3 The sum charged off to

surplus in 1902 vas minor. However, the succeeding years

will illustrate very poignantly the problem of

extraordinary charges and credits to the Undivided Surplus

Account, in the light of Dickinson's warning.

Accounting writers' inventory valuation method was

followed by the United States Steel Corporation. The

opinion of Price, Waterhouse & Company's senior partner in

America vas not followed on the issue of the working capital

contribution.


Other Features of the Annual Reuort


A schedule entitled Maintenance, Renewals and

Extraordinary Replacements classified these expenditures

by type of property. The amount of quarterly dividends

since the first quarter of operations and the quarterly

dividends' relation to net profit for the quarter and to




53
5Dicinson, "The Profits of a Corporation,"
189.








54

the surplus amount at the end of each quarter was

illustrated in another section. A schedule of the activity

of the trustees of the bond sinking fund was portrayed.

Schedules of raw material production and of rolled and

other finished products for sale gave the reader an

inkling as to the happenings of the firm in terms of tons.

A very detailed schedule was made of the changes in

Bonded, Debenture, and Mortgage Debt. A list of the

principal additions to the Property Account covered four

pages. Detailed information was given about the Union-

Sharon Purchase and of the Purchase of Troy Steel Products

Company.

The average number of employees and their total

salaries and wages were shown in a schedule entitled

Employees and Pay Rolls. A description of the employees'

stock purchase plan was given in a section entitled

Employees' Subscriptions to Preferred Stock. A schedule

was prepared of the number of stockholders. Orders on

hand were stated. A discussion of top management policy

regarding the handling of the subsidiary companies and a

list of their presidents were included in the Organization

section.

It appeared that a funds statement was included in

the 1902 Annual Report. The Summary of Financial








55
Operations followed the General Profit and Loss Account.

The make-up of the funds statement is worth noting and is

Table 4 in the Appendix for this chapter. A description of

the different bond issues, the amount of each issue, the

amount held by the trustee of the sinking funds, the

balance in the hands of the public, the maturity date of

each issue, and the interest rate and interest payment

dates of each issue were included in a schedule entitled

Bonded and Debenture Outstanding, December 31, 1902.

Monthly earnings from April 1, 1901, to December 31, 1902,

were shown. Thirteen pages were devoted to a very lengthy

listing of the various types of property held by the

subsidiaries.

Management can only be commended for the very

informative data it presented to the stockholders. The

writer had envisaged that the 1902 Annual Report would

have been comprised of a one-page balance sheet. When he

reviewed the 1902 Annual Report, he found much detailed

information not normally presented in annual reports.











Summary Assessment


The writer was surprised at the depth at which

various financial accounting topics were examined at the

turn of the 20th century. The writer concludes that the

general opinion that financial accounting was more

balance-sheet oriented than income-statement oriented until

the 1930's should be re-examined in the light of the stress

placed on the income figure in the early 1900's. This

heritage of financial accounting should be mined for ideas

which may be quite useful for present-day financial

accounting.

For example, it is possible that a depreciation

amount selected by means of an engineering study would

yield a more meaningful depreciation amount, and hence a

more meaningful income amount than some of today's

depreciation methods. The use of the double-declining-

balance method of depreciation in a year in which

considerable fixed asset procurement occurred and

relatively little production happened would undoubtedly

yield an expense amount much greater than the engineering

estimate of depreciation. Might not those interested in

the net income figure be better served by a net income

figure arrived at by utilizing the engineering estimate of








57

depreciation? Another example is the probable abuse by

management of the corporate valuation procedure. Any

financial accounting model based on valuation by

management through an appraisal method should be viewed

today in the light of past experience.

Various accounting forces played a very important

role in financial accounting at the turn of the 20th

century. Leading writers and practitioners stressed the

importance of the income amount and provided guidance in

the area of "funds" and "reserves." Controversy existed in

the question of the deduction from net earnings of the

bond sinking fund amount and the United States Steel

Corporation's approach was in line with the approach

suggested by the senior partner of Price, Waterhouse &

Company in America. The topic of depreciation was well

covered in the literature. Accounting practitioners and

writers admitted their impotence in the very important

area of corporate valuation. Price, Waterhouse & Company

insisted upon a consolidated basis of reporting but was not

successful in getting the United States Steel Corporation

to reclassify its working capital surplus account.

Accounting writers stressed the cost basis of inventory

valuation.

There were other influences on financial accounting

besides the accounting forces. The editor of the W'all








58

Street Journal stressed the importance of an income

statement and Poor's Manual provided an example of what

corporations were reporting. The New York Stock Exchange

played a very important role in the requiring of the

publication of an annual balance sheet and income statement

for corporations joining the list after 1900. Congress

through the United States Industrial Commission,

recommended the annual reporting of audited statements.

The United States Industrial Commission findings on

overcapitalization might have had an effect on the

valuation of the United States Steel Corporation, as the

United States Steel Corporation was overcapitalized by a

much smaller per cent than even fairly conservatively

valued companies.

A few dissident stockholders failed in a court

action to question the valuation of the United States Steel

Corporation. While stockholders did vote for Price,

Waterhouse & Company to be the auditors of the United States

Steel Corporation, management really picked the auditors

through the proxy method.

The management of the United States Steel

Corporation adopted a very broad reporting policy.

Management exercised its discretion in financial accounting

on such issues as valuation, the method and placement of








59

funds and reserves for depreciation, the classification of

the working capital contribution, and the use of the

Surplus Account. Management may have created a feeling of

overconfidence to stockholders because of the "very

moderate" overcapitalization. The non-disclosure of the

method of depreciation may have caused some uncertainty,

but overall management's financial accounting activities

were very well disclosed to stockholders.
















CHAPTER III


THE LAISSEZ-FAIRE YEARS AND THE IMPOSITION

OF THE FEDERAL CORPORATE INCOME TAX

1903-1915


Historical Resume and Synopsis of Financial

Accounting Events


These years could not be labeled as unbridled

"laissez-faire" years. President Theodore Roosevelt

shocked big business by his smashing of the Northern

Securities consolidation. The Hepburn Act of 1906 gave

the Inter-State Commerce Commission the power to determine

and promulgate just and reasonable rates and to prescribe

a uniform accounting system for railroads. Conservation

policies projected the federal government into a new

sphere of activity. The United States Bureau of

Corporations was established In February, 1903, as a

division in the Department of Commerce and Labor in order

to investigate trusts and combinations and to advise the

60








61

Justice Department on antitrust matters. The muckrakers

severely attacked the big business power structure.1 The

Bureau of Corporations urged that annual reports be
2
issued. Yet one could classify this era in financial

accounting as an era of relative freedom. The editor of

The Journal of Accountancy stressed that management had

much leeway in the decision to report the results of

stewardship and that the investors had not made significant

demands for adequate reports.3

The Corporate Income Tax of 1909 was included as a

section in the Revenue Act of 1909. While no specific

system of bookkeeping or accounting was required by the

Bureau of Internal Revenue, the accounting system of the

firm was to be established in such a manner that the return




1
Harold V. Faulkner, The Decline of Laissez-Faire,
The Economic History of the United States, Vol. VII (New
York and Toronto: Rinehart & Co., Inc., 1951), p. 35,
p. 205, pp. 377-78, pp. 177-9.

2
U. S., Department of Commerce and Labor, Renorts
of the Deoartment of Commerce and Labor, 1906 (Washington,
D. C.: Government Printing Office, 1906), p. 16.

3
"The Reports of American Corporations," The
Journal of Accountancy, 2 (October, 1906), 458.










could be readily verified upon examination. The

importance of an accounting system was further magnified

by Article 183 of the Bureau of Internal Revenue regula-

tions for the 1913 Act.

The books of a corporation are assumed
to reflect the facts as to its earnings,
income, etc. Hence they will be taken as
the best guide in determining the net income
upon which the tax imposed by this act is
calculated. Except as the same may be
modified by the provisions of the law wherein
certain deductions are limited, the net income
disclosed by the books and verified by the
annual balance sheet, or the annual report to
the stockholders should be the same as that
returned for taxation.


The financial accounting events discussed in this

chapter include the leeway the management of the United

States Steel Corporation had in utilizing the Undivided



4U. S., Department of the Treasury, Office of the
Commissioner of Internal Revenue, T. D. 1571, Regulations
Relating to the Assessment and Collection of the Special
Excise Tax Imnosed by Section 38. Act of August 5. 1909,
on CorDorations. Joint Stock Companies. Associations. and
Insurance Comoanies (Washington, D. C.: Treasury
Department, December 3, 1909), P. 11.

5u. S., Department of the Treasury, Office of the
Commissioner of Internal Revenue, Regulations No. 3.,
United States Internal Revenue Law and Regulations Relative
to the Tax on Income of Individuals. Corporations, Joint
Stock Comuanies. Associations, and Insurance Comnanies
(Washington, D. C.: Government Printing Office, 1914),
p. 84.










Surplus Account for miscellaneous expenses and reserves

and in the applications of the many-faceted concept of

conservatism. Other topics discussed are the issuance of

a Comparative Income Account, the statement of the basis

for depreciation by the United States Steel Corporation,

the modification of its Condensed General Profit and Loss

Account, and the regulations of the Bureau of Internal

Revenue.


Financial Accounting Events


Utilization of the Undivided Surplus Account


Starting with the 1903 Annual Report, the United

States Steel Corporation adopted the financial accounting

policy of utilizing the Undivided Surplus Account for

miscellaneous charges. The expense associated with the

conversion of 7 per cent preferred stock for 5 per cent

bonds amounted to $6,800,000 and was charged to the

Undivided Surplus Account. In the 1903 and 1904 Annual

Reports, charges were made to the Undivided Surplus Account

for expenditures for construction and for payments of

capital liabilities; $17,234,128.58 was charged off in

1903, and S8,493,235.58 in 1904. The amount of $2,500,000

was debited to the Undivided Surplus Account in 1906 to

create a Reserve to Cover Possible Losses in Advanced

Mining Royalties. There was an entry made from the








64

Undivided Surplus Account for $663,018.37 for a permanent

pension fund reserve in 1911. The sum of $500,000.00 was

charged to the Surplus Account each year from 1912 to

1916. In the Undivided Surplus Account of 1912, the charge

of $913,950.00 was made for the discount on bonds issued by

subsidiary companies. In 1914, this policy was reversed

and $878,026.84 was added back to Undivided Surplus and

debited to a deferred asset account on the Balance Sheet.

The United States Steel Corporation used the

Undivided Surplus Account as a device to record charges

such as the bond conversion expense, possible losses in

advanced mining royalties, and the pension reserves which

could have been made either to the General Profit and Loss

Account or to the Income Account. Stockholders may have

been led to overconfidence because of the resultant higher

income figure, but the amounts of the charges for the

possible losses in advanced mining royalties and for the

pension reserve were not very large in comparison with the

income figure. The charge to the Undivided Surplus Account

for expenditures for property and for the payment of

capital liabilities was probably another instance of

conservatism, which is discussed in the next section. The

reversal of the bond discount entry may have been in

response to the fact that the general practice in










accounting was to amortize the discount over the life of

the bonds.


Conservatism


Conservatism was a word employed in the financial

accounting parlance of the times for the purpose of (1)

balance-sheet valuation, (2) recognition of revenue, (3)

normalizing income, and (4) de-watering the original

overcapitalization of a company. As the writer could not

differentiate whether the United States Steel Corporation

was more interested in normalizing income or in de-watering

(or possibly a combination of both), he combined the third

and fourth uses in this discussion.

The term "conservative" was employed in the annual

reports of the United States Steel Corporation for the

first time in the description of inventory valuation

in the 1903 Annual Report. "Inventory valuations are

conservative. They were taken on the basis of actual

purchase or production cost of materials to the respective

companies holding the same, unless (as happened in some




Robert H. Montgomery, ed., The American Business
Manual: A Comnlete Guide to Modern Systems and Practise.
Vol. III: Administration (New York: P. F. Collier & Son,
1911), p. 860.








66

circumstances) such cost was above the market value on

December 31, 1903, in which case the market price was

used." This policy led to a charge to the Income Account

of $5,378,837.63 for Charged for Depreciation in Inventory

Valuations and for the Adjustments of Sundry Accounts.

The inventory principle of cost or market, whichever is

lower, was extended to the marketable securities held in

the Sinking and Reserve Fund on December 31, 1907.

An example of accountants' interest in this policy

of conservatism was Walton's feeling that the "conservative

man" would not realize profits until the selling process

was completed and would keep the inventory value at cost

unless there was a downturn in the market prices for

different types of raw materials. The careful auditor

would insist upon this policy, for it was better to be

pleasantly surprised than to be disappointed. If there

were an error, it would be on the safe side.7 The use of

the "cost or market, whichever is lower" rule by

management was in tune with the accounting principle

stated by Walton.





7Walton, Auditing, p. 56.








67

A very significant departure from past practice

occurred in 1904. The intercompany profit in inventory

was removed from the calculation of net earnings for the

year, and the amount of intercompany profits in inventory

as of December 31, 1903, was taken from the balance of

Undivided Surplus as of that date and reclassified as a

separate part of that statement. (Refer to Table 1 in the

Appendix for this chapter.) This change in accounting

policy had been heralded in the 1903 Annual Report. The

policy change was stated in the 1903 Annual Report to be

conservative and safe. It was reported to be a radical

change from current practice, but one that would put

earnings more closely in tune with the cash basis. This

policy represented a middlepoint between the non-

recognition of intercompany profits in inventory until

sale to outsiders and the previous policy of recognizing

income when inventory items were sold to other divisions

of the United States Steel Corporation. The net earnings

for the year were not affected by this item but the total

of the Undivided Surplus Account remained the same. An

accounting writer held that while the inclusion of

intercompany profits in inventory was accepted by

accountants on the basis of convenience, care was to have

been exercised so that dividends were not paid from these









8
profits. It appeared that management of the United States

Steel Corporation was willing to have been more

conservative than the accounting writer on this matter.

Another sign of conservatism vas the recognition of

only one-half the estimated profits on uncompleted bridge

and structural contracts in 1903. It appeared that 100

per cent of the estimated profits for work in process, as

far as the work had progressed, was included in the 1902

Annual Report. A major revision of accounting policy

occurred in 1911. The Undivided Surplus Account was

reduced by the amount of intercompany profits in inventory

and the inventory amount on the balance sheet was decreased

by the amount of intercompany profits in inventory.

An example of normalizing income and/or de-watering

was the shifting of the charge for the Appropriation for

Property Expenditures Made or Authorized from the Undivided

Surplus Account to the Income Account in 1905. The yearly

addition to the Undivided Surplus Account was thus

substantially lower than if these charges had been made

against the Undivided Surplus Account. There were two

Sinking and Reserve Funds accounts credited for these




8
Montgomery, ed., Administration, pp. .1003-4.








69

charges until 1909, when the balance of the one account

still open was transferred to an account entitled

Appropriated Surplus to Cover Capital Expenditures. The

charges made to the Income Account from 1905 through 1910

amounted to $105,300,000 for Additional Property and

Construction and Discharge of Capital Obligations and

$65,000,000 for Contemplated Appropriations and

Expenditures.

A financial writer stated that it was impossible to

pay out the entire amount of profits each year to

stockholders, because of the fact that no stock could

attain the investment ("blue-chip") status without a

regular distribution of profits. A surplus reserve must be

established before dividends were distributed to

stockholders. The amount so reserved (the financial

writer confused a surplus reserve with a fund) might be

invested in plant and equipment.9 He stressed:


In no other way can a corporation, the
permanence of whose earning power is in any
way doubtful, so certainly reach an investment
position as by a resolute adherence to the
policy of reserve accumulation, and a refusal
to pay dividends until its ability to
continue paying dividends is unquestioned.




9Meade, Trust Finance, p. 159.










This process of salvation may be tedious, but
it is certain. No matter how inflated the
capitalization of a new company, no matter
how threatening the danger of competition, no
matter how irregular the demand for the
product, the steady investment of profits in
surplus earning power will in time build a
solid foundation of productive assets, upon
which, slowly though it may be, conservative
management will rear a structure of
investment value.10


Accounting writers also stressed the importance of

reserves established from earnings so to normalize earnings

and/or de-water the original overcapitalization.

Conservative management would not issue all the profits as

dividends but would apply a large sum of such earnings to

new construction so as to "squeeze out" the water.11

Profits were not to be considered distributable unless (1)

the profits could reasonably be expected to recur under

normal conditions, (2) the dividend rate could be continued

and large renewal demands, for which no provision had been

set aside, would not absorb the profits of future years,




10
Ibid., p. 159.

11
William M. Lybrand, "The Accounting of Industrial
Enterprise, Part III," The Journal of Accountancy, 7
(January, 1909), 231.








71

and (3) future years were to be charged on a fair basis for

all renewals necessary for the opera-ion of the business.12

It is interesting to note the extent to which

management had de-watered the United States Steel

Corporation by the end of 1910. The Bureau of Corporation's

study traced the gradual de-watering of the assets of the

United States Steel Corporation through 1910. The ten

ending balance sheets and the April 1, 1901,balance sheet

were presented in a significantly different manner than in

the annual reports. The Bureau of Corporations adjusted

depreciation charges and arrived at an estimated "true"

depreciation figure for the year. The revised balance

sheets included no reserve or surplus accounts; the amounts

in these accounts were treated as being reductions of the

Intangible Considerations and Water classification. One

noted that from April 1, 1901, to December 31, 1910, the

United States Steel Corporation had reduced this

classification from $721,328,839 to $281,671,574.13

(Refer to Table 2 in the Appendix for this chapter.)




12
Montgomery, ed., Administration, pp. 1006-7.

13
Report of the Commissioner of Corporations on the
Steel Industrv: Part I, pp. 328-9.








72

It appeared that the United States Steel

Corporation's policy to normalize earnings and/or to de-

water was in tune with recommendations from a financial

writer and accounting writers. The United States Steel

Corporation took such action, even though the yearly

addition to the Undivided Surplus Account was materially

decreased over the amount that it would have been if a less

conservative policy were followed. The United States Steel

Corporation definitely did not attempt to create a feeling

of overconfidence in the stockholder with this policy. It

could have increased the dividends in the short run but it

chose another alternative.


Comparative Income Accounts


The 1903 Annual Report contained a comparison of

the Income Accounts for 1902 and 1903. (Refer to Table 3

in the Appendix for this chapter.) Such information was

probably available in such financial sources as Moody's

Manual of Cortoration Securities, Poor's Manual, and the

Financial Chronicle. Charles Dow referred his readers to

these manuals for an examination of past records, which

could be updated by the current earnings reports in the








73
14
Wall Street Journal. The aforementioned sample (refer

to page 23) of the first thirty industrial stocks listed

in the 1903 Poor's Manual showed that comparative data

for income was presented for seven of these thirty

companies.15 Of a non-selective sample of the data

included for ten railroad companies in the 1903 Poor's

Manual, eight of the railroads analyzed had at least a

two-year comparison of the Income Account and the other

two had just the current Income Account stated.1 An

accounting writer stressed the fact that the comparison of

one year's income statement to the preceding one would

yield clues as to profit improvement.17 It appeared that

the United States Steel Corporation's Comparative Income

Accounts was in line with the example set by the financial

services and the recommendation of an accounting writer.




14
Bishop, Charles H. Dow and the Dow Theory,
p. 124, paraphrasing an August 9, 1902, editorial from the
Wall Street Journal.

15
Poor's Manual 1903, pp. 1138-39.

16
Ibid., pp. 19-307.

17
1George Lisle, Accounting Theory and Practice
(Edinburgh and London: William Green & Sons, 1900),
p. 49.











The Relationship Between Depreciation and Production


An indication of the basis for the provision for

depreciation was noted in the Certificate of Chartered

Accountants in the 1908 Annual Report. The firm of Price,

Waterhouse & Company stated in their certificate that the

curtailment of operations during the year necessitated a

reduction in the amount of depreciation for the year. With

13,099,548 ingots of steel produced in 1907, depreciation

charges amounted to $27,719,744.44. With 7,838,713 ingots

of steel produced in 1908, depreciation charges were

$16,965,181.46.

The relationship between depreciation and production

had been stressed by such accounting authorities as Erving

Matheson and Francis Pixley. Both these writers presented

a case for the employment of what is labeled today as the

units-of-production method of depreciation. Matheson

stressed that the busy times brought on by the pressing

demands for goods forced the use of plant and machinery to

their utmost. Plant and machinery might even be run in

the face of possible breakdown so that firms could supply

the insatiable demand. For such instances, the amount










charged for depreciation should correspond with this use.18

Pixley stressed the importance of the length and severity

of usage as factors in the establishment of the annual

depreciation charge.


In considering the amount to write off
for depreciation in respect of engines and
boilers, other points have also to be borne
in mind. Both engines and boilers, if
worked at great pressure, cannot last the
same length of time as if more gently used.
The number of hours they are used must be
taken into consideration also, as where
double shifts of workmen are employed, the
engines cannot last as 1ong as where men
work only single shifts.1-


William J. Filbert, Comptroller of the United States

Steel Corporation, in an answer to a query during a

conference with the Commissioner of the Bureau of

Corporations reflected the United States Steel

Corporation's policy in regards to depreciation. He

stated, "Depreciation is not the same amount year by year,







18
Matheson, The Depreciation of Factories, p. 39.

19ixley, Accountanc, 212.
Pixley, Accountancy, p. 212.








76

you know, If you don't run your plant, your depreciation
,20
is not as great.20

It appeared that the management of the United States

Steel Corporation was in agreement with these accounting

writers on the issue of matching depreciation with

production. The statement of the policy of depreciation

gave the readers of the annual reports an important clue as

to management's depreciation policy.


Revision of the Condensed General Profit
and Loss Account


There was a major revision of the Condensed General

Profit and Loss Account in the 1908 Annual Report. (Refer

to Table 4 in the Appendix for this chapter.) This

revision gave one a clearer picture of operating income

than before. While a gross profit amount was not

highlighted, it undoubtedly was the result of subtracting

the Manufacturing and Producing Cost and Operating Expenses

amount from the amount of Gross Receipts. Operating income




20
Rough Memorandum of Conversation during
Conference between 'W. J. Filbert, of the United States
Steel Corooration, and the Commissioner Dr. Walker, and
Mr. Conant, May 24-26, 1911, Inclusive, Concerning the
Bureau's Investigation of the Steel Industry, File
2604-1-6, U. S., Bureau of Corporations, National Archives,
p. 21.








77

appeared as an amount not affected by the Other Income

items. This clear portrayal of operating income had been
21
stressed by George Lisle. The revised Condensed General

Profit and Loss Account resembled the form of the profit

and loss account recommended by Arthur Lowes Dickinson in
22
a 1904 article.2 It appeared that the United States Steel

Corporation's modification of its Condensed General Profit

and Loss Account was in tune with these accounting writers.


Financial Accounting Asnects of the
Federal Tax on Income


The Corporate Excise Tax of 1909 vas regarded as

the key event which officially recognized the practice of

depreciation.23 The United States Steel Corporation had

always recognized depreciation as an expense--or, more

accurately, as an appropriation of earnings. However, as




21
2Lisle, Accounting in Theory and Practice,
pp. 55-6.

22
Dickinson, "The Profits of a Corporation,"
188-9.

23
3DeMond, Price, W'aterhouse & Company in America,
p. 84.










78'

already mentioned (Refer to page 37), the depreciation

reserve accounts had been classified as a section of the

liability part of the Balance Sheet. Commencing with

1910 Annual Report, the United States Steel Corporation

reclassified these reserve accounts as a reduction from

the Property Account. It was explained thusly:


In the Consolidated Balance Sheet
included in this report as of December 31,
1910, a change has been made as compared
with previous years' balance sheets as to
location therein of the accrued depreciation
and replacement fund reserves and of the
account Bond Sinking Funds with Accretions.
These funds being reserved from earnings and
income to cover acquiring amortization and
depreciation in respect of the assets
included in the Property Investment Account,
it has been considered advisable to state
the balances thereof in the balance sheet
as a credit in connection with the gross
property investment rather than to show
them on the liability side of the balance
sheet, as has been done in previous years.

From where did the liability for depreciation arise?

When did it mature? For whom was the corporation liable

for these reserves? These questions typified the change

from the liability viewpoint of the depreciation reserves

to the contra-asset viewpoint. New emphasis was placed on








79

a plant ledger which included the cost of each fixed asset

item and accumulated depreciation on each item.24

It appeared that this change in accounting policy

was caused by the recognition that depreciation was a

function of the property account and not a function of the

funds or reserves needed to replace, restore, or modernize

such assets. This recognition was undoubtedly spurred by

the Bureau of Internal Revenue regulation that depreciation

should be an estimate based on the property's assumed life,
25
its cost, and its use.25

The United States Steel Corporation had adopted a

policy of treating appropriations for property as a

permanent part of the capital structure of the firm and, as

such, the account was not charged for the expenditures made

for property purchased for the appropriation. Since the

first appropriation under this policy was made from the

1909 Annual Report, it was probable that the desire to

maintain the property account on a cost basis for

depreciation purposes was the governing factor.



24
Herbert G. Stockwell, "Depreciation, Renewal and
Replacement Accounts," The Journal of Accountancy, 9
(January, 1910), 197-203.
25
2U. S., Department of the Treasury, Office of the
Commissioner of Internal Revenue, T. D. 1571, pp. 9-10.







80

It appeared that the corporate income tax

administration by the Bureau of Internal Revenue was a

factor in financial accounting changes in the United States

Steel Corporation.


Summary Assessment


Most of the topics of this era were matters of con-

cern for accounting groups. The warning of Price, Water-

house & Company's senior partner in America about concealing

charges in the surplus account was not heeded by the United

States Steel Corporation. Accounting writers contributed

to the climate of conservatism. The United States Steel

Corporation's presentation of the Comparative Income Accounts

was in line with the recommendation of an accounting writer,

as well as with the issues of matching the amount of

depreciation with the level of production and the format

of the Condensed General Profit and Loss Account.

A financial writer, the financial services, the

Bureau of Internal Revenue, and stockholders were also

involved with some of these financial accounting topics.

A leading financial writer contributed to the climate for

normalizing earnings and/or de-watering the original

valuation of the United States Steel Corporation by his

strong plea for surplus reserves. The financial services

set an example for the issuances of Comparative Income








81

Accounts. The Bureau of Internal Revenue administration of

the federal corporate income tax apparently influenced a

revamping of the United States Steel Corporation's

financial accounting.

The management of the United States Steel

Corporation was again very prominent in this era on such

matters as the utilization of the Undivided Surplus Account

and conservatism. Its financial accounting policies

undoubtedly did not cause overconfidence among its

stockholders.
















CHAPTER IV


WORLD WAR I AND THE RETURN TO NORMALCY

1916-1929


Historical Resume and Synonsis of Financial

Accounting Events


The United States experienced the beginnings of the

World War I boom in January, 1915, when war orders started

flowing in from Europe. Approximately five billion dollars

of foreign funds were poured into the economy. Very

ineffective measures of control of the wartime economy

were exercised by the federal government until we entered

the war in 1917. Some control was then required because

of the very significant increase in the demand for workers

and material. The chief governmental control agency was

the War Industries Board, which was founded on July 8,

1917. It had two very important functions--the rationing

of scarce material and workers and the fixing of prices.

Most of the price fixing was the result of voluntary








83

compliance rather than administrative edict.1 Almost all

schedules of fixed prices were reached by negotiation
2
between the government and the industry involved.2 Since

prices were set so that the higher cost producers would be

encouraged to produce, these prices led to very

significant profits for certain firms. The federal

government tried to tax away these profits by an excess

profits provision in the Revenue Act of 1917.

The increased demand for workers, the withdrawal of

4,000,000 men into the armed forces, and the cessation of

immigration led to a serious labor problem. The rapidly

rising cost of living and the labor turnover situation were

two other facets in the labor problem. The War Industries







1
George Soule, Prosperity Decade: From War to
Depression: 1917 to 1929, The Economic History of the
United States, Vol. VIII (New York and Toronto: Rinehart &
Company, Inc., 1947), pp. 8-22.

2
Chester W. Wright, Economic History of the United
States (New York and London: McGraw-Hill Book Company,
Inc., 1941), p. 935.

3Soule, Proserit Decade, pp. 18-20.
Soule, Prosverity Decade, pp. 18-20.








84

Board established a Committee on Labor to aid the Board in
4
labor problems in the industries with which it dealt.

The war boom continued after the war until the

middle part of 1921. However, a serious postwar depression

occurred in 1921. The wholesale price index fell from

227.9 in 1919 to 150.6 in 1921. There were 4,750,000

workers unemployed. Gross National Product in terms of

1914 dollars fell from $40.1 billion in 1920 to $37.6

billion in 1921. The nation began its recovery from the

1921 depression in 1922. The period from 1922 through 1929

was marked by a very stable price level. Industrial

production, according to the Federal Reserve Board Index,

rose from 58 in 1921 to 110 in 1929. National income

increased from $56.5 billion in 1921 to $87.1 billion in

1929.5

Topics discussed in this chapter are the financial

accounting adaptation made by the management of the United

States Steel Corporation, the question of price

justification and financial accounting, the treatment of



4
Wright, Economic History of the United States,
pp. 945-7.

5-
Soule, Prosoeritj-yDecade, pp. 83-107.







85

common stock transactions, and the use of the Undivided

Surplus Account.


Financial Accounting Events

Continuation of Conservatism


The wartime conditions brought a continuation of the

financial accounting policy of conservatism by the United

States Steel Corporation. An inventory reserve and a

direct credit to the property account for the excess cost

of fixed assets acquired during the high cost years from

1917 to 1920 were representative of balance-sheet

conservatism. (The income-statement effect of these two

examples of balance-sheet conservatism is discussed in the

section on Price Justification in this chapter.) The use

of a contingency reserve was probably indicative of the

desire to normalize earnings. The normalization of income

and/or de-watering policy was continued by the

appropriations from the Income Account and the Undivided

Surplus Account.

The first financial accounting indications by the

United States Steel Corporation of the economic effects of

World War I occurred in the 1916 Annual Report. A Reserve

for Amount of Actual Cost or Market Values of Stocks in

Excess of Normal Prices therefore of $13,524,794.00 vwas

established and credited to the inventory account. This








86

amount was treated as a deduction to arrive at total

earnings on the Condensed General Profit and Loss Account.

The reasoning for this reserve was that businessmen felt

that the inventory cost represented an amount that was

abnormal and that would not be sustained once normal

conditions returned. The additional inventory cost was not

held to be a permanent one. Price, Waterhouse & Company

noted in its certificate "that an adequate reserve has been

made in respect of all abnormal values." Additional

increases to this reserve were $16,746,000 in 1917,

$19,018,000 in 1918, $38,722,000 in 1919, and $5,000,000 in

1920. The substantial deflation of 1921 and 1922 resulted

in reductions of $34,289,746 in 1921 and $11,250,173 in

1922 in the inventory reserve account.

The annual reports gave no clue as to whether the

Bureau of Internal Revenue had accepted this method of

inventory valuation for tax purposes. It appeared that

the Bureau of Internal Revenue disapproved of this reserve







6
T. H. Sanders, "Some Variations in Inventory
Valuations," The Journal of Accountancy, 42 (December,
1926), 437.








87

and the base stock method of inventory which this reserve

implied.

It appeared that management reacted very quickly to

the matter of the inflation of this era. Management

appeared to be willing to take a financial accounting

position different from the position taken by the Bureau of

Internal Revenue on the question of tax-deductibility.

Management used this reserve to dampen stockholder

confidence during the high inflation years from 1916 to

1920 and buoy it during the two years of deflation.

In addition to the aforementioned reserve for

inventory costs, an additional charge vas made For Other

Contingent Reserves of $2,100,000 in 1916, and $13,000,000

in 1917. These reserve entries were undoubtedly made with

the goal of normalizing income.

In 1917, a charge was made to the General Profit

and Loss Account for $29,785,000 for an Allowance for

Estimated Proportion of Extraordinary Cost of Facilities

Installed by Reason of War Requirements and Conditions.

This amount was credited to the property account. This

practice was continued for the next three years:




7
Ibid., 437-8.




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