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The Origin and Evolution of Nineteenth-Century Asset Accounting*

Published online by Cambridge University Press:  11 June 2012

Richard P. Brief
Richard P. Brief
Affiliation:
Assistant Professor of Business Statistics, New York University
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Abstract

The methods used to account for business assets in Britain and the United States during the nineteenth century are here examined in a context of interplay between “internal economic criteria” and “external constraints.”

Type
Research Article
Information
Business History Review , Volume 40 , Issue 1 , Spring 1966 , pp. 1 - 23
Copyright
Copyright © The President and Fellows of Harvard College 1966

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References

1 Veblen pointed out an additional factor which complicates the analysis when he noted that “the interest of the managers of the modern corporation need not coincide with the permanent interest of the corporation as a going concern.” Veblen, Thorstein, The Theory of Business Enterprise (Mentor ed., New York, 1958), 78.Google Scholar

2 Morgenstern, Oskar, On the Accuracy of Economic Observations (2nd. ed., Princeton, 1962), 25.Google Scholar

3 One would not expect to find diversity in accounting practices only if there were a set of accounting procedures that was actually optimal.

4 Accountant, May 2, 1885, 5. Statement by the Chartered Mercantile Bank of India.

5 The treatment of both British and American material may be justified on several grounds. First, there was a transfer of accounting knowledge and jurisprudence between the two countries. Many of the early British texts were sold in the United States and many of the early British accountants emigrated to this country. See, for example, Edwards, James Don, History of Public Accounting in the United States (East Lansing, 1960).Google Scholar Second, as a practical matter, the amount of information available on accounting practices in the United States during the nineteenth century is very limited. For these reasons the two sources of evidence are dealt with more or less simultaneously.

6 Schumpeter, Joseph, Capitalism, Socialism, and Democracy (Harper Torchbook ed., New York, 1962), 123n.Google Scholar

7 Dicksee, L. R., Advanced Accounting (2nd ed., London, 1905), 130.Google Scholar Dicksee also stated that “the system [Double-Account] may be well applied, not merely to the accounts of Railway, Gas, Water, and Electric Light Companies, but also to Tramway, Canal, Shipping, Telephone, and Mining Companies, and to Companies owning property from the letting of which they derive regular income.” Ibid., 133; Kehl, Donald, Corporate Dividends (New York, 1941), 58n, 63n.Google Scholar

8 Littleton believed that “there was a certain logic in the contention of railroad men that adequate renewal of parts would keep the equipment up to standard operating efficiency.” Accounting Evolution to 1900 (New York, 1933), 233.

9 Hungerford supports this view. “In those days [1872] railroad accounting was a weird and uncertain thing. The great modern gods of accurate finance, obsolescence and depreciation, had hardly begun to show their heads.” The Story of the Baltimore and Ohio Bailroad: 1827–1927 (New York, 1928), 165.

10 Apparently, investors showed little concern over protecting their capital. According to Evans, “British investors were not so much interested in return of principal lent as in the receipt of interest.” He pointed out that no provisions for default on mortgages were usually found in the Parliamentary Acts. British Corporation Finance: 1775–1850 (Baltimore, 1936), 48.

11 Pollins, Harold, “Aspects of Railway Accounting before 1868,” Studies in the History of Accounting, ed. by Littleton, A. C. and Yamey, B. S. (Homewood, 1956), 343–49.Google Scholar Perry Mason, “Illustrations of Early Depreciation Practices,” Accounting Review, Vili (Sept., 1933).

12 Replacement accounting is discussed by some nineteenth-century accountants, “No provision has been made in the Acts of Parliament for depreciation. The usual course is to see that everything is well kept up out of revenue and to charge all replacements as they occur against revenue.” Accountant, May 17, 1885, 13. The “usual course adopted,” however, was condemned in no uncertain terms. “It is not the practice of ordinary trading companies which is bad … but the practice of railway companies … a practice as vicious and full of temptation to managers and directors to manipulate accounts for their own ends and purposes as can well be imagined. It is, in fact, little short of an inducement to fraud.” Ibid., November 14, 1885, 30.

13 One might also distinguish between replacement accounting and retirement accounting. For the purpose of this discussion it is not necessary to make such a distinction.

14 Pollins, “Aspects of Railway Accounting,” 349.

15 This subject is dealt with at greater length in my paper, “Nineteenth-Century Accounting Error,” Journal of Accounting Research, III (Spring, 1965).

16 Matheson, Ewing, Depreciation of Factories (4th ed., London, 1910), 40.Google Scholar

17 Auditing (2nd ed., London, 1895), 229, 230 (italics added); (10th ed., London, 1915), 260.

18 Advanced Accounting, 130–32. For similar criticisms, see Garcke, E. and Fells, J. M., Factory Accounts (4th ed., London, 1893), 95.Google Scholar

19 About 50 per cent of the track mileage constructed in the United States prior to 1900 was placed in receivership. Poor's Manual of Railroads, 1900, lxxii. In England over £100 million in the par value of the capital stock was written off in 1921. Encyclopedia Britannica (1946), XVIII, 930. The method of accounting for assets could have been one of the factors that contributed to this instability.

20 Pollard, Sidney, “Capital Accounting in the Industrial Revolution,” Yorkshire Bulletin of Economic and Social Research, XV (November, 1963)Google Scholar; Yamey, B. S., “Some Topics in the History of Financial Accounting in England, 1500–1900,” Studies in Accounting Theory, ed. by Baxter, W. T. and Davidson, S. (Homewood, 1962)Google Scholar; Littleton, Accounting Evolution to 1900.

21 Bonbright, James C., Valuation of Property (New York, 1937)Google Scholar; Commons, J., Legal Foundations of Capitalism (New York, 1924).Google Scholar

22 Littleton, Accounting Evolution to 1900, 225; Mason, “Illustrations of Early Depreciation Accounting,” 209 ff; Schumpeter, Capitalism, Socialism and Democracy, 123n.

23 Perhaps the most authoritative reference to the indeterminacy of nineteenth-century accounting procedures is found in Marshall, Alfred, Principles of Economics (8th ed., New York, 1948), 354–55n.Google Scholar For other evidence on this subject see: Foster, B. F., The Merchants Manual: The Principles of Trade, Commerce and Banking (Boston, 1838), 164Google Scholar; The Book Keeper (New York), September 14, 1880, 65; Soulé, George, Soulé's New Science and Practice of Accounts (6th ed., New Orleans, 1901), 91Google Scholar; Clark, Victor S., History of Manufactures in the United States, 1607–1860 (3 vols., New York, 1949), I, 373.Google Scholar

24 Roover, Raymond de, “Early Accounting Problems of Foreign Exchange,” Accounting Review, XIX (October, 1944), 398.Google Scholar

25 Pollins, “Aspects of Railway Accounting,” 346, quoting from Railway Times, November 6, 1841, 1167. This statement implies that assets might be maintained permanently in working order; this contention was criticized later in the century. “We are continually faced with the argument that the property is kept fully up to the mark, and is, indeed, in a much better condition than ever, and the amounts expended upon repairs and renewals charged to the trading account is put forward as the proof.” Accountant, December 10, 1894, 41. In the United States the same point was made. “If, in the case of plant, it is kept in perfect working order and all expenses connected there with charged to revenue the question of setting aside a sum annually for depreciation must depend upon the fact whether it has depreciated or not; … On this question it is impossible to lay down any fixed principles, although, as a rule, I believe the safest plan is to assume depreciation and make an allowance for it in the annual balance sheet.” Book Keeper, July 5, 1881, 147.

26 Accountant, January 6, 1876, 6. In addition, the auditor should insure that “no ordinary repairs had been charged to plant” and he also should receive explanations which would satisfy him “when the item of depreciation was omitted or seemed insufficient.”

27 Accountant, April 10, 1880, 5. Many of the references cited in this section include discussions of methods by which depreciation is to be calculated. See also, Book Keeper, January 2, 1883, 6. This article was based on a lecture made in England by Joseph Slocome of the Birmingham Accountants' Student Society on November 28, 1883. The communication between English and American accountants was evidently very rapid.

28 Accountant, April 21, 1883, 6–7. It is also interesting to note that depreciation was defined for the purpose of replacement of capital. On this subject see: Yamey, “Some Topics in the History of Financial Accounting,” 39–40.

29 Accountant, November 5, 1887, 610–11. Similar views are expressed in ibid., November 12, 1889, 692; Dicksee, Auditing (1895), 178.

30 Accountant, September 1, 1883, 10. He argued, “I fail to see how the bringing in of such appreciation in land and goodwill can be escaped.”

31 Accountant, November 5, 1887, 610. Some economists also viewed depreciation as a change in the value of assets; others discussed depreciation in terms of original cost. Tucker, G. S. L., Progress and Profits in British Economic Thought: 1650–1850 (Cambridge, 1960), 83–89.Google Scholar These early economists might not have seen any difference between the methods. In any event, the early economists probably did not have much influence on the business community. According to one accountant, economics was “a subject for the most part relegated to whitewashed rooms wherein the gas flickers, and to Public Houses on a Sunday evening. … The students of Economics are few and far between. … Economic science is practically in chaos.” Accountant, December 15, 1888.

32 Some writers said that the rate of depreciation should include a factor for obsolescence as well as wear and tear. Accountant, June 16, 1894, 547.

33 Accountants' Handbook, ed. by Wixon, Rufus (4th ed., New York, 1956), Ch. 19, p. 22.Google Scholar For an interesting historical reference to the meaning of “going concern value,” see Dicksee, Auditing (1915), 184–87.

34 Garcke and Fells, Factory Accounts, 103; Guthrie, Edwin, “Depreciation,” Encyclo pedia of Accounting (London, 1903), II, 373Google Scholar; Accountant, November 12, 1887, 617. For references to accounting practices as distinguished from accounting theory see my “Nineteenth-Century Accounting Error.”

35 Arthur Andersen and Co., Accounting and Reporting Problems of the Accounting Profession (2nd ed., 1962), 128.Google Scholar

36 Kehl, Corporate Dividends, 4.

37 Evans, British Corporation Finance, 103. “As to the publication of false balance sheets and including in them debts which were hopelessly bad, it was difficult to say where a debt was hopeless; and besides, if any shareholders were deceived into buying shares he might have his separate remedy, but each would have a different case and the whole body could not sue” Turquand v. Marshall, 20 LT 766 (1869). The debtor in this case was the Confederacy.

38 Accountant, January 16, 1886, 13. The exception was MacDourgall v. Jersey Imperial Hotel Co., 2 Hem and M. 528 (1864), a case which did not involve fixed assets.

39 Accountant, June 18, 1887, 356.

40 50 LJ (Ch) 192n, 193.

41 Basil S. Yamey, “The Case Law Relating to Company Dividends,” Studies in Accounting History, 431n; Reiter, Prosper, Profits, Dividends and the Law (New York, 1926), 32.Google Scholar

42 In one text, Hatfield states “at least so far as material wear and tear is concerned the early case of Davison v. Gillies … gives clear expression to the doctrine that depreciation must be reckoned.” Modern Accounting (New York, 1922), 124. Later, he qualifies this remark in a footnote. “The oft-quoted decision in Davison v. Gillies was subsequently said to have rested entirely on special articles and not on general law,” ibid., 201n.

43 In discussing nineteenth-century depreciation Littleton says that “allowance for depreciation in calculating profits available for dividends was also given support at this time by the courts. …” Accounting Evolution to 1900, 220. He mentions Davison v. Gillies and Dent v. London Tramway, 50 L J (Ch) 191, which grew out of the Davison case. The directors, based on the Davison ruling, passed the preference shareholders* dividend. However, in the Dent case profits were defined [wife respect to preference shareholders] as “the surplus in receipts after paying expenses and restoring capital to the position it was in on the first of January of that year.” Thus, by this rule, if depreciation is neglected in past years, it becomes a capital loss not affecting the dividend rights of preference shareholders. Although the decision is not unreasonable, the case hardly supports an allowance for depreciation. The case of Knowles v. McAdam, 3 Ex D 23 (1877), also mentioned by Littleton, does provide some support for depletion allowances. Here depletion was allowed for tax purposes. However, the case was held wrongly decided in Coltness Iron v. Black, 6 LR App (1881).

44 Reiter, Profits, 33–34. The case was Kehoe v. The Waterford and Limerick Railway Company, 21 L.R. Ir. 221 (1881).

45 Reiter, Profits, 28–29, 33. The decision referred to is In re. Ebbw Vale Steel, Iron and Coal Co., 4 Ch D 827 (1877). Here depreciation was due to a fall in the value of iron and not wear and tear. However, the Ebbw Vale case is said to have arisen because the directors originally tried to reduce the company's capital before declaring a dividend; and after being unsuccessful they declared a dividend that was enjoined. Then the Act of 1877 was passed. The Accountant for June 18, 1887, states that the Companies Act of 1867 prevented directors only from “expressly” intimating that dividends are being paid out of capital. This statement apparently refers to the Ebbw Vale decision.

46 “The Company Clauses Act, 1845, prohibits paying dividends out of capital but the Companies Act, 1862, contains no such prohibition. Such a prohibition is contained in Table A, but a company is not bound to adopt Table A, and if it does it can alter it by a special resolution.” L. J. Cotton in Guiness v. Land Corporation of Ireland, 22 Ch D 366 (1882). The British tax law of 1878 permitted a deduction for “diminished value by wear and tear.” Prior to 1878 the tax law permitted only a deduction for repairs and renewals, not to exceed “what is usually expended for such purposes during an average of three years preceding.” Matheson, Depreciation of Factories, 26, 28.

47 Accountant, April 23, 1881, 6.

48 Accountant, April 30, 1881, 6; June 4, 1881, 5.

49 Matheson, Depreciation of Factories, 167; H. C. Edey and Prot Fanitpakdi, “British Company Accounting and the Law,” Studies in the History of Accounting, 375n.

50 Edey, H. C., “Company Accounts in Britain: The Jenkins Report,” Accounting Review, XXXVIII (April, 1963), 262.Google Scholar Prior to 1900 there were no compulsory audit provisions in Britain except for banks although it was not unusual for a company to provide for an audit. Dicksee noted, however, that the accounting certificate led to a misconception as to the “fact” of a balance sheet. Auditing (1915), 310–15. He also discussed “so-called auditors whose extreme ignorance is only equalled by their utter inability to appreciate the moral responsibility of their position.” Ibid., p. 360. There were a few legal cases involving the liability of auditors in England prior to 1900, but “so far as we are aware, no reported case in America has yet dealt with the liability of professional auditors.” Dicksee, , Auditing, ed. by Montgomery, R. H. (New York, 1905), 326.Google Scholar

51 41 LR Ch. 1 (1889); Reiter, Profits, 38–42; Bonbright, Valuation of Property, 937; Hatfield, , Accounting (New York, 1908), 264–65Google Scholar; Berle, A. and Fischer, F., “Elements of the Law of Business Accounting,” Columbia Law Review, XXXII (April, 1932), 619.Google Scholar

52 Reiter indicates that “it would not be unreasonable for a court of law to include leases under this classification,” Profits, 174. But assuming an inexhaustible mineral deposit the term of the lease would determine the minimum amortization of the cost of the lease.

53 These facts are not certain but are consistent with the information found in Acct. L. R. (1889), 29; reprinted in Dicksee, Auditing (1915), 656–63. This information is not found in the law reports.

54 Ibid., 12. The significance of the Lee case was commented on in the accounting literature. The important fact is that “capital be represented by nominal assets, and that is sufficient unless there is fraud.” Accountant, December 14, 1889, 677.

55 63 LJ Ch 246 (1894). This decision has been misinterpreted. One writer, commenting on this decision, said that the ruling meant “that price level decrease did not produce loss in a dividend sense.” Littleton, , Essays on Accounting (Urbana, 1961), 249.Google Scholar This was not the issue here. Moreover, few accountants would argue that an investment trust should disregard portfolio losses if the firm's capital included debt. One contemporary accountant commented on the Verner decision. “There is and often has been a wide distinction between the authorized interpretation of the statutes and the principles of sound accountancy, and, while respecting the former, we confess that we always regard the latter of more importance.” Accountant, XX (1894), 176.

56 64 LJ Ch 516 (1895).

57 1 Ch D 353 (1902). Hatfield maintained that this case was “a clear expression of the same view” held in the Davison decision. This is not an accurate statement. Accounting, 135.

58 Dicksee, Auditing (1915), 258. A similar statement was made in the 2nd ed. (1895). Even in a case where it was almost certain that bondholders were going to lose their principal, the payment of a dividend was approved. Yamey, “The Case Law Relating to Company Dividends,” 437n.; reference is to Lawrence v. West Somerset Mineral, Ry., 2 Ch. 250 (1918).

59 Edwin Guthrie, “Depreciation,” Encyclopedia of Accounting, II, 365; Accountant, August 8, 1903, 1014. There was a debate on the question of whether the “unwritten” law should be written. One of the debaters held that “if we were to apply such an amendment, you could stop all such enterprise, because it would be absolutely impossible for companies to pay dividends in the early years of their existence.” Accountant, March 18, 1893, 254. Another said that “I have various addresses here from eminent men who regard the law as quite settled, that a provision for substantial depreciation is not necessary.” Ibid., 257. In this connection the following example is of interest. The Powayan Steam Tramway Company in its Prospectus of April 18, 1887, estimated profits and included depreciation; but when profits were less than estimated, no depreciation was charged. Certain legal opinion maintained that the dividend should not be paid but this “in no way shook the opinion of Lovelock and Lewis, the auditors” who put the question before the President of the Institute of Chartered Accountants. He said that “the dividend was permissible.” Accountant, August 19, 1892, 393.

60 Leake, P. D., Depreciation and Wasting Assets (London, 1911), 5.Google Scholar

61 Eyster v. Centennial Board of Finance, 94 US 503; quoted in Reiter, Profits, 123. In an earlier case a state court refused to allow a charge for depreciation. Tutt v. Land, 50 Ga. 339 (1873).

62 U.S. v. Kansas Pacific Railroad, 99 US 459 (1878); Windal, Floyd W., “Legal Background for the Accounting Concept of Realization,” Accounting Review, XXXVIII (January, 1963), 29–31.Google Scholar

63 Reiter, Profits, 126; Bonbright, Valuation of Property, 933. It is extremely interesting to note that the British courts permitted a deduction for depreciation in a rate case as early as 1838; and in a decision on a similar issue allowed a depreciation allowance even though the company did not set aside a “depreciation fund.” Accountant, February 12, 1910, 232. This was 70 years prior to the Supreme Court's ruling on depreciation in Knoxville v. Knoxville Water Company, 212 US 1 (1909), a rate case which is often heralded as marking the legal recognition of depreciation. For Montgomery, see Dicksee, Auditing(American ed.), p. 207; Hatfield, Accounting, p. 140.

64 There were several legal cases in which profits were defined as the change in the value of net assets without specifying the valuation procedure. Birney v. Ince Hall, 35 LJ 363 (1865); Spanish Prospecting Case, 1 Ch 92 (1911).

65 22 LT 840 (1870); Littleton, Essays, 249.

66 Dicksee, , Goodwill and Its Treatment in the Accounts (2nd ed., London, 1900), 17.Google Scholar

67 Bonbright cites the tax decision of Gray v. Darlington, 82 US 63 (1872), where unrealized appreciation was not considered income. Valuation of Property, 923. Windal cites the case of U.S. v. Schillinger, 27 Fed 973 (1876), in which a similar conclusion was arrived at. “Legal Background of Realization,” 30. See also: Hatfield, Accounting, 283; Reiter, Profits, 70–73.

68 Bonbright, Valuation of Property, 924. The following remark about present-day British Company law is strikingly similar. “It is a moot point (although some British accountants do not realise this) whether a British company can legally distribute a profit arising from the revaluation of unrealised fixed assets.” Edey, “Company Accounts in Britain,” 264; see also, American Accounting Association, “A Tentative Statement of Accounting Principles underlying Corporate Financial Statements,” Accounting and Reporting Standards for Corporate Financial Statements and Preceding Statements and Supplements (1936), 61.Google Scholar

69 Montgomery, Robert H., Auditing, Theory and Practice (New York, 1912), 194.Google Scholar

70 3 Ch App. 377 (1868).

71 6 S.L.T. 63 ( 1898 ); Glasgow Herald, June 17, 1898, extracted in Dicksee, Auditing (1915), 719.

72 Hubbard v. Weare, 44 NW 915 (1890); Mackintosh v. Flint and Pere Marquette Ry., 34 Fed 609 (1888).

73 Union Pacific Railroad Co. v. US, 99 US 402 (1878).

74 For example, in 1869 the Erie Railroad appealed to the New York State Legislature for permission to issue bonds and stock for the purpose of restoring the roadway. Josephson, Matthew, The Robber Barons (Harvest Book ed., New York, 1962), 136.Google Scholar

75 Hatfield, Accounting, 70.

76 Brief, “Nineteenth-Century Accounting Error.”

77 For example, one eighteenth-century text warns that “more gentlemen are lost by total negligence of the accounts than by vice.” Done by a person of Honour, The Gentleman Accomptant. … (London, 1714), 85. Another text advises, “at proper times inspect your affairs; one design of keeping books is … that men may know the state of their affairs,” Ford, John, A Serious Address to Men in Business Concerning the Right Ordering their Affairs; with Advice to those who have Unhappily Mis-Managed (London, 1733), 22.Google Scholar

78 See Pollard's conclusion in “Capital Accounting in the Industrial Revolution,” 91.

79 Clark, J. M., The Economics of Overhead Costs (Chicago, 1923), 7.Google Scholar

80 Hawkins, David F., “The Development of Modern Financial Reporting Practices among Amercian Manufacturing Corporations,” Business History Review, XXXVII (Autumn, 1963), 168.Google Scholar

81 Accountants' Magazine, XII (June, 1908), 313.

82 Hawkins, “The Development of Modern Financial Reporting,” 166.

83 Dicksee, Advanced Accounting, 130.

84 New York Times, October 4, 1964. Statement made by Mr. Leonard Spacek, chairman of Arthur Andersen & Co. More recently, Mr. Spacek warned that “the profits reported for the year 1964 have a greater lack of comparability and are further removed from a reflection of the true facts than at any time in the last 30 years.” Ibid., February 21, 1965.

85 Edey, “Company Accounts in Britain,” 263.

86 Hawkins, “Development of Modern Financial Reporting,” 166 (italics added).

87 In a study of the auditing provisions of the British Companies Acts, a similar question is raised. “The question further arises as to whether the control exercised by the statutes; have had a stultifying effect upon the development of auditing theory and practice. These controls without a doubt set a lower level below which the practice cannot sink. Some have argued that this also sets a ceiling above which the practices cannot rise.” Hein, Leonard W., “The Auditor and the British Companies Acts,” Accounting Review, XXVII (July, 1963), 520.Google Scholar Hein goes on to say that the “ceilings” have been periodically raised.