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
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
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
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
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)
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)
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-
i >L ~C '-` L.~i~Ir'
BJ LI : I ;Y
BiQ} .] Ii
LIST OF TABLES
Income Account for 1902 . . .
Profit and Loss Account for 1902.
Valuation Schedule for 1902 .
Summary of Financial Operations
for all Properties . . .
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 . . . .
Surplus of United States Steel
Corporation and Subsidiary
Companies . . . . . .
LIST OF TABLES (continued)
TABLE 1. Comparative Consolidated Statement
of Income and Surplus for the
Year Ending December 31, 1936
and 1935 . . . . . . .
Consolidated Statement of Income . .
Notes to Accounts . . . .
References for Conclusions in
Chapter VIII . . . . . .
Page References to the Annual
ReDorts of the United States
Steel Corporation . . . ..
LIST OF FIGURES
FIGURE 1. How the Corporation Earned
its Living in 1939 . . . . 300
FIGURE 2. Balance Sheet in Chart Fashion . 302
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
Richard G. J. Vangermeersch
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
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
INTRODUCTION TO THE PROTLE'I'
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
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
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.
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
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
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
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
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
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.
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
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,
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.
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
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),
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 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
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
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.
n aM -1
1 Cori o
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,
n f cOc
C:il Cea t
1 '; -
or I 1V t1 byt the
W",. 1 it P f
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.
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
1935 to the pr
doc- onts 7 re'
in financial a
ServicU wrcric U
Ien"Vca l1a'vs I
:ouantin- Series releases, and its oth
"" C ] ", %it
to zovoi er.
I ct- Co
d of the In
;'tlno the e
ta 'v ccn'
St. Ut" s
1 1' 1a ,
'CL j I S 01-
Jial acS un i ... _L ]
tis P ari1 A cop,
s froc, leY5/ tt I
. 1 1
S" a C i S a *
mo C u
i? r *
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
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
Mr. Marco Vestich, Assistant to the Research
Director of the United States Steelworkers, was
interviewed in June of 1969.
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
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.
ThE FIRST FULL-YEAR ANNUAL R. OR. T
OF TiE U:-ITED STATES STEEL
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
To o tc: 1
1 CotLe I- t
.d Q, : jot
SC-ty 1 ): Yo : and
-a y, 1 ), 22-
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
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.
Arthur Stone Dewing, The Financial Policy of
CorDorations (3rd ed.; New York: Ronald Press Company,
1926), p. 236.
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.
view of the importance of earnings for financial writers.
Two editorials from the Wall Street Journal highlighted
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
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
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.
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
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
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.
lo (ly paid fru:: profits. 2Even n
boncc, the vital factor was hold tlo be
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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
Sinking and Reserve Funds:
Sinking Fund on U. S. Steel
Sinking Funds on Bonds of
Improvement and Replacement Funds
Contingent and Miscellaneous
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
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.
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:
Securities, Inventories 18,491,145.85
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
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.
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.
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.
Greendlinger, Accounting Practice, p. 366,
quoting Arthur Lowes Dickinson.
Ibid.. p. 367.
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.
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
2Seymour Walton, "Sinking Funds and Reserve
Accounts," The Journal of Accountancy, 6 (October, 1908),
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.
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
2Ibid., p. 15.
23Ibid., p. 44.
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
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
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),
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 .
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
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
27John H. Armstrong "Depreciation Reserves," The
Accountant, 29 [New Series] (August 8, 1903), 1014-18.
Seymour 'Walton, Auditing, Modern Business Series,
Vol. XI (New York: Alexander Hamilton Institute, 1911),
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
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
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.
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
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
Henry Rand Hatfield, Modern Accounting: Its
Principles and Some of its Problems (New York and London:
D. Appleton and Company, 1910), p. 79.
Ibid., pp. 161-2.
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,
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
Ibid., pp. 170-1.
3Dickinson, "The Profits of a Corporation," 185.
Walter A. Staub, "Mode of Conducting an Audit,"
Official Record: Congress of Accountants, 1904 (New York:
George Wilkinson, 1904), p. 210.
35U. S., Industrial Commission, Preliminary Report
on Trusts and Industrial Combinations, pp. 12-6.
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-
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
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
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.
burden of proof. The dissident stockholders could not even
meet the minimum requirements for proving their point as to
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
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:
39William H. Lough, Corporation Finance, Modern
Business Series, Vol. VI (New York: Alexander Hamilton
Institute, 1913), p. 81.
including blast furnaces $250,000,000.
Transportation properties 91,500.000.
Coal and Coke properties 80,000,000.
Natural gas and limestone
Current assets 136,500,000.
Ore properties 100,000,000.
The estimated amount of water and intangibles as of April
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
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.
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
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
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
Meade, Trust Finance, p. 292.
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
vwa on t
indi v id i
ex c f', 0
the a cc
Bri 1i h
a u o.
fi;;t r a
to forn; th
2l cc: any's
u.ntin: a 5r
;r rent of Jo
Thus the Uni
ior U 'ni1, e
: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 '. ,
_. : -1 - ---
''" ) ,
, n *
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
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- -
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
"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
"Give it out, Mr. Rogers, give it
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.
factor in the United States Steel Corporation's public
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
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
4DeMPond, Price, Waterhouse & Company in America,
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.
United States, Industrial Commission, Preliminary
Report on Trusts and Industrial Combinations, p. 6.
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.
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
Arthur Lowes Dickinson, "Notes on Some Problems
Relating to the Accounts of Holding Companies," The
Journal of Accountancy, 1 (April, 1906), 487.
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
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
5Dicinson, "The Profits of a Corporation,"
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
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
It appeared that a funds statement was included in
the 1902 Annual Report. The Summary of Financial
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
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.
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
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
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
There were other influences on financial accounting
besides the accounting forces. The editor of the W'all
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
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
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.
THE LAISSEZ-FAIRE YEARS AND THE IMPOSITION
OF THE FEDERAL CORPORATE INCOME TAX
Historical Resume and Synopsis of Financial
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
Justice Department on antitrust matters. The muckrakers
severely attacked the big business power structure.1 The
Bureau of Corporations urged that annual reports be
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
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.
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.
"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),
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
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
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
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.
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.
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
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
Montgomery, ed., Administration, pp. .1003-4.
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
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
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,
Ibid., p. 159.
William M. Lybrand, "The Accounting of Industrial
Enterprise, Part III," The Journal of Accountancy, 7
(January, 1909), 231.
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.)
Montgomery, ed., Administration, pp. 1006-7.
Report of the Commissioner of Corporations on the
Steel Industrv: Part I, pp. 328-9.
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
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.
Bishop, Charles H. Dow and the Dow Theory,
p. 124, paraphrasing an August 9, 1902, editorial from the
Wall Street Journal.
Poor's Manual 1903, pp. 1138-39.
Ibid., pp. 19-307.
1George Lisle, Accounting Theory and Practice
(Edinburgh and London: William Green & Sons, 1900),
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
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
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,
Matheson, The Depreciation of Factories, p. 39.
19ixley, Accountanc, 212.
Pixley, Accountancy, p. 212.
you know, If you don't run your plant, your depreciation
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
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,
appeared as an amount not affected by the Other Income
items. This clear portrayal of operating income had been
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
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
2Lisle, Accounting in Theory and Practice,
Dickinson, "The Profits of a Corporation,"
3DeMond, Price, W'aterhouse & Company in America,
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
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,
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.
Herbert G. Stockwell, "Depreciation, Renewal and
Replacement Accounts," The Journal of Accountancy, 9
(January, 1910), 197-203.
2U. S., Department of the Treasury, Office of the
Commissioner of Internal Revenue, T. D. 1571, pp. 9-10.
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
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
Accounts. The Bureau of Internal Revenue administration of
the federal corporate income tax apparently influenced a
revamping of the United States Steel Corporation's
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
WORLD WAR I AND THE RETURN TO NORMALCY
Historical Resume and Synonsis of Financial
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
compliance rather than administrative edict.1 Almost all
schedules of fixed prices were reached by negotiation
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
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.
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.
Board established a Committee on Labor to aid the Board in
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
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
Wright, Economic History of the United States,
Soule, Prosoeritj-yDecade, pp. 83-107.
common stock transactions, and the use of the Undivided
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
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
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
T. H. Sanders, "Some Variations in Inventory
Valuations," The Journal of Accountancy, 42 (December,
and the base stock method of inventory which this reserve
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: