Insights from Accounting History

Selected Writings of Stephen Zeff

Stephen Zeff

• Publisher: Routledge
• Year: 2010
• ISBN:
  9781136968419
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Negocios en general

Stephen Zeff has been a prolific researcher on the history of accounting and auditing in the twentieth century. He has written numerous papers on the history of standard setting and regulation, of accounting and auditing practice, of the accounting profession, of accounting thought, and of the intellectual contributions of major authors (such as Hatfield, Canning, Paton and MacNeal).

This volume brings together the greatest hits of Zeff's academic career, including several articles that were published in out-of-the way places, for easier use by students and researchers of the field. In an introduction, Zeff discusses the evolution of his research interests and explains the factors led to the writing of the papers and their intended contribution to the literature. The book also includes a complete list of his publications.

Accounting Horizons
Vol. 17, No. 3
September 2003
pp.189–205
Submitted: January 2003
Accepted: April 2003
Corresponding author: Stephen A.Zeff

How the U.S. Accounting Profession Got Where It Is Today: Part I

Stephen A.Zeff

Synopsis: Few would deny that the U.S. accounting profession is in a very troubled state. The aim of this two-part article is to explain how and why the profession evolved and changed during the 20th century, with particular emphasis on the last three decades. It is my hope that this article will illuminate the origins and consequences of these changes that collectively brought the profession to its current condition.

This paper reviews, examines, and interprets the events and developments in the evolution of the U.S. accounting profession during the 20th century, so that one can judge “how we got where we are today.” While other historical works study the evolution of the U.S. accounting profession,¹ this paper examines two issues: (1) the challenges and

Stephen A.Zeff is a Professor at Rice University.

The author expresses his appreciation to several accounting academics and to more than a dozen active and retired senior partners of major accounting firms for their comments on earlier drafts. He also appreciates the suggestions of the anonymous reviewers.

Editors note: Professor Zeff agreed to have this lengthy but very important article published in two parts. Splitting an article of this nature is judgmental and unavoidably somewhat arbitrary. We both believe that your appetite will be whetted for Part II, forthcoming in December 2003, beginning as it does with Professor Zeff’s discussion of “A Gradual Degeneration of Professional Values.” The complete set of references will appear at the end of Part II.

¹ Interested readers should consult Previts and Merino (1998), which paints on a much broader canvas than this paper. While their book treats a number of the developments in the evolution of the U.S. profession, it does not provide as extensive a discussion of the subject taken up in this paper. An article that traces the evolution of the Big Eight firms, focusing heavily on published data on their internal growth as well as their growth through mergers, is Wootton and Wolk (1992). Miranti (1990) has also written a valuable work on the development of the profession, but it extends only to 1940.

crises that faced the accounting profession and the big accounting firms, especially beginning in the mid-1960s, and (2) how the value shifts inside the big firms combined with changes in the earnings pressures on their corporate clients to create a climate in which serious confrontations between auditors and clients were destined to occur. From available evidence, auditors in recent years seem to be more susceptible to accommodation and compromise on questionable accounting practices, when compared with their more stolid posture on such matters in earlier years.

INTRODUCTION

The paucity of available evidence about actual changes occurring within the big firms, especially from the 1970s onward, poses a major difficulty in conducting this kind of research. Without statistical analysis, the court cases, regulatory investigations, and press reports of alleged audit failures can be dismissed by leaders of the profession as isolated instances, not representative of the general way in which the big firms fulfill their professional obligations. Of necessity, I relied on letters from those who do know, on public expressions of concern by leaders of the profession and by regulators, and on the writings by close students of the profession. I formed interpretations and conclusions based on the available evidence, and I welcome comments and reactions from readers.

Three major sections comprise this paper. The first section surveys the evolution of the profession prior to the 1940s, essentially a period of groundbreaking and early development. The second section, covering the 1940s, the 1950s, and the first half of the 1960s, displays the profession at the height of its reputation and influence. The third section, beginning in the mid-1960s, treats the scandals, court cases, the profession’s loss of its accounting standard setter and the impact of that loss on the vitality of professional discourse, Congressional criticism, pressures from government to alter the competitive climate of the profession, the burgeoning consulting services, and, in the end, the transformation of the big firms from organizations strongly imbued with professional values to ones that strongly pursue goals associated with commercial and business success. This reshaping of the firms as engines of growth, profitability, and global reach in turn placed added pressure on audit partners, already under pressure to generate fees and to placate clients. Such circumstances exert a severe strain on auditor independence. At the same time, top executives in publicly traded companies found themselves under greatly increased pressure for revenue and earnings performance, which they transmitted first to their accounting staff and eventually to their external auditors. The confluence of these developments inevitably led to the confrontations mentioned above.

PRIOR TO THE 1940s: SETTING THE STAGE

The U.S. accounting profession emerged during the last quarter of the 19th century, the first major accounting body being the American Association of Public Accountants, the lineal predecessor of the American Institute of Certified Public Accountants, established in 1887.² New York State passed the first law, in 1896, to recognize the qualification known as Certified Public Accountant, which, as Carey writes, “marked the beginning of an accredited profession of accounting in the United States” (Carey 1969, 44).

Scottish and English Chartered Accountants, who settled in the United States during the last quarter of the 19th century to report on British interests, performed much of the early auditing work. These pioneers from Britain included Edwin Guthrie, Arthur Young, James T.Anyon, John B. Niven, Ernest Reckitt, George Wilkinson, Arthur Lowes Dickinson, and George O.May. Americans who formed important accounting firms in the late 1890s and during the first two decades of the next century included Alwin C.Ernst, Charles Waldo Haskins, Elijah Watt Sells, Robert H. Montgomery, and Arthur E.Andersen.

Prior to the 1930s, no laws or regulations obliged corporations to have their financial statements audited. Quite a few companies had done so, however, for more than a decade, including United States Steel Corporation, E.I. duPont de Nemours & Company, General Motors Corporation, Eastman Kodak Company, and International Business Machines Corporation.

Early Professional Services and Ethical Norms

In 1913, following approval of the Sixteenth Amendment to the Constitution, Congress passed the first Revenue Act, which, coupled with “[r]ising tax rates, during and after the war, and the increasing complexities of the tax laws and regulations added enormously to the demand for accountants.” (Carey 1969, 146, and 67–71, 213–215; also see Sommerfeld and Easton 1987, 169–170). Previously, many companies had never kept adequate accounting records, and, as a result of the Revenue Acts of 1913 and 1918, many company executives came to appreciate the importance of recording depreciation, because it was deductible for tax purposes. The Bureau of Internal Revenue’s famous Bulletin “F,” Depreciation and Obsolescence, appeared in 1920 (Grant and Norton 1955, 208–211). Accountants responded eagerly to meet the burgeoning demand for their services. In 1924, the newly instituted Board of Tax Appeals authorized both lawyers and CPAs to practice before it, which represented a strong endorsement of the standing of CPAs to conduct tax practice (Carey 1969, 222–224).

² For an extensive treatment of this period, see Miranti (1990), Previts and Merino (1998, Chapters 5 and 6), and Carey (1969).

From the earliest days of the profession, accounting firms rendered consulting services. By the 1910s, they included the installation of factory cost systems, studies of organizational efficiency, investigations in connection with possible investments in other businesses, and an array of other services to management, which, as Carey writes, “were often rendered in conjunction with audits.” (Carey 1969, 146). But accounting, auditing, and taxation constituted the solid core of the firms’ services.

In 1922, the American Institute of Accountants, now known as the American Institute of Certified Public Accountants (AICPA), banned certain forms of self-promotion by accounting firms. The following year, A.C. Ernst and two of his partners in Ernst & Ernst, by then a national firm, were accused of violating the Institute’s rules against soliciting and advertising, and all three promptly resigned their Institute membership. Even after his firm no longer engaged in those practices, A.C.Ernst never rejoined the Institute (Carey 1969, 233–234).

Federal agencies sought the advice of the organized accounting profession because of its growing reputation. In 1917, at the request of the Federal Trade Commission (FTC) and the Federal Reserve Board, the Institute supplied a technical memorandum for publication by the Board as a bulletin on auditing procedures. The FTC sought to promote uniform accounting, while the Board wanted to apprise commercial bankers of the importance of securing audited financial statements from their borrowers. Despite the title of the bulletin, “Uniform Accounting,” it actually dealt with recommended auditing procedures and the format of the balance sheet and profit and loss statement. This represented the first authoritative guidance on auditing procedures published in the U.S. In 1929, at the request of the Federal Reserve Board, the memorandum was revised by the Institute and published anew (Carey 1969, 129–135, 159–160; Previts and Merino 1998, 229–234, 250– 251; Zeff 1972, 113–115, 118–119).

Audit work developed apace in the 1920s, as an increasing number of listed companies issued audited financial statements. By 1926, more than 90 percent of industrial companies listed on the New York Exchange were audited (May 1926, 322), even though the Exchange did not require audited statements by newly listed companies until 1933 (Rappaport 1963, 39–40). Yet the Exchange had informally encouraged companies to publish audited financial statements “for some years” before then (Staub 1942, 14–15).³

Initial Accounting Principles and Auditing Procedures, and the SEC

In 1930, following on the heels of the 1929 stock market crash, the New York Stock Exchange sought out the Institute for advice on the policies it should adopt with respect to the financial statements of its listed

³ The great increase in the frequency of appearance of audit reports occurred between 1920 and 1928 (Hawkins 1962, 364).

corporations. After three years of deliberations, a blue ribbon committee of the Institute provided the Exchange with a philosophy and a framework for dealing with the accounts of listed companies. The committee proposed a set of “five broad principles” of accounting that it regarded “as so generally accepted that they should be followed by all listed companies” (Carey 1969, 177). These, together with a sixth, were officially approved in 1934 by a vote of the Institute’s membership. The committee also recommended a standard form of the auditor’s report. The committee’s work quickly established the Institute as a body of stature in the field of corporate financial reporting. The leader of the Institute’s committee was George O.May, the senior partner of Price, Waterhouse & Co. (Carey 1969, 174–180).

In June 1932, Fortune magazine, the trumpet of American capitalism, acknowledged the growing importance of the accounting profession by devoting a major article to a profile of the largest firms (Certified Public Accountants, 1932).

Early in his first term, President Franklin D.Roosevelt signed into law two major pieces of reform legislation, the Securities Act of 1933 and the Securities Exchange Act of 1934, the second of which created the Securities and Exchange Commission. These Acts, as implemented by the SEC, required all new and continuing registrants to have their financial statements audited by independent CPAs, thus highlighting the importance of the accounting profession and generating an increased demand for its services. A government takeover of the auditing of publicly traded companies was averted, as Col. Arthur H.Carter, the senior partner of Haskins & Sells and the president of the New York State Society of Certified Public Accountants, succeeded in persuading the Senate Committee on Banking and Currency, during the hearings on the proposed Securities Act, not to assign the external audit function to a government agency, but instead to allow it to be done by firms in the private sector (Carey 1969, 186–187; Wiesen 1978).

In 1935, the SEC appointed a chief accountant, Carman G.Blough, who promptly began to work closely with the Institute and the American Accounting Association (the organization of academic accountants), and other accounting experts, to identify the norms of proper accounting and auditing practice. In 1937–38, Blough succeeded in persuading the Institute to empower the Institute’s Committee on Accounting Procedure to approve and publish bulletins constituting “substantial authoritative support” for accounting principles, known as Accounting Research Bulletins (Zeff 1972, 132–138; Seligman 1982, 197–201).

In 1939, the Institute established a similar standing committee to promulgate a seri...

Table of contents

• Routledge Historical Perspectives in Accounting
• Contents
• Foreword
• Acknowledgements
• Introduction
• REPLACEMENT COST: MEMBER OF THE FAMILY, WELCOME GUEST, OR INTRUDER?
• The Rise of “Economic Consequences”
• Paton on the Effects of Changing Prices on Accounting 1916–55
• Truth in Accounting: The Ordeal of Kenneth MacNeal
• Some Junctures in the Evolution of the Process of Establishing Accounting Principles in the U.S.A.: 1917–1972
• Big Eight Firms and the Accounting Literature: The Falloff in Advocacy Writing
• Arthur Andersen & Co. and the two-part opinion in the auditor’s report: 1946–1962*
• THE EARLY YEARS OF THE ASSOCIATION OF UNIVERSITY TEACHERS OF ACCOUNTING: 1947–1959
• THE EVOLUTION OF THE CONCEPTUAL FRAMEWORK FOR BUSINESS ENTERPRISES IN THE UNITED STATES
• John B.Canning: A View of His Academic Career
• THE WORK OF THE SPECIAL COMMITTEE ON RESEARCH PROGRAM
• Du Pont’s early policy on the rotation of audit firms
• ‘The apotheosis of holding company accounting’: Unilever’s financial reporting innovations from the 1920s to the 1940s
• How the U.S. Accounting Profession Got Where It Is Today: Part I
• How the U.S. Accounting Profession Got Where It Is Today: Part II
• The Primacy of “Present Fairly” in the Auditor’s Report
• THE SEC PREEMPTS THE ACCOUNTING PRINCIPLES BOARD IN 1965: THE CLASSIFICATION OF THE DEFERRED TAX CREDIT RELATING TO INSTALLMENT SALES
• The SEC Rules Historical Cost Accounting
• Appendix