San Fernando Valley State College
ACCOUNTING FOR INVESTMENT TAX CREDIT
. A thes i s s ubmitted in partial s ati s fac tion of the
requirements for
the degree
of
Mas ter
Bus iness Adminis tration
by
Gary Goodman Stone
June, 1967
of Science in
The thesis of Gary Goodman Stone is approved:
6
eamffiittee
c6airman
San Fernando Valley State College
June,
1967
TABLE OF CONTENTS
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ABSTRACT
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Chapter
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INTRODUCTION .
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LEGI S lATIVE HIST ORY OF INVESTMENT TAX CREDIT
Ne ed f or Tax Inc ent ive
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Bu s ine s s World D i s agre e s
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H ou se Way s and Me ans Comm i t tee
S enate F inanc e Comm i t te e
Summary
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100 Percen t Fl ow Throu gh
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INITIAL.AC COUNTING TREATMENT PROPOSALS
Inc ome Trea tment
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Cost reduction
C ontributi on t o c apit a l
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Compara tive Analy s is .
Opinion N o. 2 o f the Acc ount ing
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Princ iples Board
I ni tia l Af termath o f Opinion N o. 2 .
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S ecuri tie s and Exchange Commi s s i on's P o s i ti on . 26
Argumen t s ·Advanced f or the C os t Re duc t i on
Method
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Argument s Advanc ed f or the 100 Perc ent
F l ow Throu gh Me thod
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Argument s advanc e d f or the "48-5211 Me thod
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Balance Sheet Treatment
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Meth ods A c tually U s e d in 1962 and 1963
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Excerpts from 1962 and 1963 Annual Reports
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C o s t Re du c t i on Me thod
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Other Me thods
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Re f lec t i ons on the C o s t Re duc t i on and
"48 - 5 2" Me th ods Use d Du r ing 1 9 6 2 and 1 9 63 . 49
Re f lec t ion s on O ther Me thods U s e d
Dur ing 1962 and 1963 . . . . . . . . . . . . 5 0
Su mmary
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S I GNIF IC ANT EVENTS OCCURRING IN 1964
Revenu e Ac t o f 1964
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The Ac c oun t ing Pr inc iple s Board
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Me thods Ac tu a l ly Us ed in 1 9 64
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c o s t re duc t i on me thod
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SuiTJ?lary
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ANALYS IS . AND DETE RMINAT ION OF THE PROPER
METHOD OF AC C OUNT ING F OR THE INVEST MENT CREDI T
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F e dera l .Incame T ax Ac c ount ing
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F ixe d A s s e t s and Deprec i a t i on Ac count ing
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ABS T RACT
AC C OUNTING F OR INVES TMENT TAX C RED I T
by
Gary Goodman Stone
Ma s te r of S c ienc e in Bu s ine s s Admin i s tra t i on
June ,
1967
The inve stment t ax c red i t int r odu c e d by the Revenu e
Ac t o f 1 9 6 2 c au s e d a gre a t de a l of fu ror wi thin the ac c oun t ing
pr o fe s s ion in tha t there wa s not in i t ia l ly ,
or even t oday ,
genera l c on s ensu s a s t o it s p r oper acc ount ing trea tmen t .
a l ly ,
Bas i c­
the inve s tment tax c re d i t provi s i on s a l l ow pu rcha s e rs o f
e qu i pment f or bu s ine s s u se ,
inc ome taxe s .
the
any
c os t
a d irec t c re d i t aga ins t federa l
The amount of the c re d i t dep ends primar i ly on
o f the equipment and it s estimated useful l i fe
.
Thi s pape r d i s cu s s e s the proper ac c ount ing treat ­
men t t o be rendered the inve s tmen t tax c r e d i t and the c ontro­
ver s ie s whi c h i t provoke d in the ac c ount ing profe s s i on.
The
leg i s la t ive h i s t ory of t he inve s tmen t tax c re d i t is reviewe d
in an a t temp t t o de t e rmine the intent of i t s c re a t or and the
C ongre s s which enac ted i t .
The p aper t hen eva lu a t e s t he var i­
ous su gge s t e d tre a tmen t s and the i r e f fec t on inc ome and finan­
c ia l c ond i t ion .
It goe s on t o inve s t igate me thods us ed in
prac t ic e and ind ic a t e s whi ch me thod s were suppor t �d by var i ous
informe d in divi du a l s .
Fi na l ly ,
t he paper re l a t e s the pro­
posed met hod s to basic accounting theory and concludes that
1
the
"100 percent flow through" method is the treatment which
is in accordance with acceptable and sound accounting
principles.
CHAPTER I
INTRODUCTION
The Revenue Act of
19 6 2
introduced a new method
for stimulating American industry into purchasing additional
machinery and equipment by allowing a credit against federal
income taxes for investment in certain depreciable personal
property.
The credit,
which reduced the income tax liability,
i·Jas computed as a percentage of the cost of the property pur­
could not agree on the
finan­
cial treatment to be accorded this investment credit.
There
chased.
Accountants,
however,
were several methods proposed,
but they varied to such an
extent that the resulting net income and balance sheet pre­
sentation would be materially different depending on the
method utilized.
The
methods ranged from treating the entire
credit as income in the year that the property was purchased,
to allocating the credit over the estimated useful life of
the property.
With the possible exception of the introduction of
the Federal Income Tax Law itself,
few tax innovations have
had the impact or created the controversy within the account­
ing
\ tax
profession that resulted from enactment of the investment
credit.
duction,
To this date,
almost five years after its intro­
the investment credit remains an unsolved issue in
terms of the
proper accounting treatment which it should
rec eive.
In the succeeding chapters an attempt will be made
4
to resolve this controversial issue by
(1)
reviewing the
legi slative history of the investment credit in terms of the
intent o f its creator and the Congress which introduced it,
in order to determine which method con forms thereto,
(2)
evaluating the different methods which are presently in use
on the basis of the effect on reported income and reported
financial position,
(3)
investigating the methods which were
actually used by the business community including the reac�
tion of the independent accountants in rendering their
opinions on the financial statements,
(4)
presenting what
members of the accounting profession and business community
have said about accounting for the investment credit and
analyzing their position and
( 5)
finally,
relating the pro-
posed methods to basic accounting theories such as fixed
asset and depreciation accounting,
income recognition and
accounting for income taxes to determine which method is in
accordance with acceptable and sound accounting principles.
CHAPTER I I
LEGIS LATIVE HIS TORY OF INVESTMENT TAX CRED IT
Dur ing the win ter of 1960-61 the United S ta te s '
The Lab or Depar tment
e con omy app eared t o b e lagg ing.
rep o r ted s ix percent unemployment in January 1961, and
ind ica ted tha t 76 o f 150 major labor mar ke t areas had sub­
s tant ia l labor surp lus e s .
This was no t a me re recurr ing
s eas onal typ e p rob lem , but rather the wors t labor s ituation
s ince the rece s s ion o f 1958.
A " s ho t in the arm" was ne eded
to s timulate indus try which , it was reas one d , wou ld induc e
a dd i tiona l emp loyment and thus he lp e limina te the labor
surp lus .
To s o lve this prob l em , Pres ident Kennedy had e s tab­
lished a committee on tax po l ic y which was headed by a
Harvard Law p r o fe s s or , S tanley
s.
Surrey , who la ter was
app o inted As s is tant S e cre tary o f the Treasury for tax
matters .
Rep. Wi lbur D . Mi l ls (D-Ark . ) , chairman of the
Ways and Means Committe e , was a ls o c o l labora t ing with
Surre y's tas k force and the Treasury Depar tmento
There was
general agreement among leaders in gove rnment and c omme rc e ,
excep t for the AFL- CIO, tha t the ans wer was to s timulate
c ap i ta l s pending .
Ne ed for Tax Incent ive
Initial thinking on the me thod to be us e d re lated
to
a tax incent ive which would bene f i t tho s e who would
inve s t in new plant and equ ipment.
The f irst p rop o s a l was
6
to allow a tax credit of anywhere between ten and twenty
percen t of the excess of capital investment over deprecia­
tion during a taxable year.
On April
20, 1 9 6 1,
1
President Kennedy sent to Congress
his plans comprised of proposals which would result in an
estimated
$1.7
billion in tax incentives,
but this tax pack-
age also included measures which would raise revenues in the
same amount,
thus keeping the Treasury in balance.
The
major
tax incentive included in these proposals was the brainchild
of Stanley Surrey and related to encouraging capital spend­
A
ing.
tax credit,
not to exceed thirty percent of the
total tax liability,
for purchases of� equipment with
at least a six year tax life was presented and was computed
as
follows:
(1)
Ten percent of the first $ 5,00 0 spent for new
plant and equipment, plus
( 2)
Six percent of the excess of purchases of new
plant and equipment over fifty percent of
depreciation, not to exceed fifty percent
of the depreciation allowance, plus
(3 )
Fifteen percent of additional investments in
new pla nt and equipment.
Answering his critics
tax cut),
(who would have preferred a straight
the President pointed out that this method forced
spending in order to reap benefits from the proposed tax
law.
2
1 961,
He believed that the proposed credit would have a
111Tax Changes in the Works," Business Week, February 11,
Volume 1641,
2
pp.
35-36.
"Kennedy Lays Out His Tax Plan," Business Week,
April 22, 1961, Volume 1651, pp. 25-26.
7
double
e ffec t:
(1) s timulation to the economy and (2)
greater
competitio n with fore ign p r oduc ts be c aus e of mode rn.
3
e q u1.pme nt .
.
izl.ng
Business
Wo rld Dis agree s
Firs t reac tions of the bus ine s s world indic ate d
that, in general, they did not be l ieve the p r op e r ap p roac h
Some o f
was be ing fo llowe d .
their criticisms and suggested
alte rnative s inc luded the fol l owing:
(1) No t fair to c omp anies whic h have
taine d the ir
capital
(2) Dep rec iation,
no t
to the problem .
spending .
tax credits,
(3 ) Co mpanie s with low
ar e favor ed .
is the answer
depreciation allowances
(4) No t he l pful to companies
men t is people .
(5) Purc has e s
a lwa y s main­
whose primary invest•
in one year could be bunche d in
a dvan tage of the fifteen per­
order to take
c e nt brac ke t .
(6) Companie s with tempor ary
loss years will not
during subse­
be . able to us e the cr edits
quent p r o f itable years.
(7)
Growth companies,
benefit.4
In
May
1961
not sick companies will
t he President's propositions
revie we d by the Co n gr e ssi ona l
we re
Joint Economic Committee,
Se cretary o f the Tre asur y , �ouglas D i l lon , p res ented
3
Jacob Mertens,
(Chicago :
Ca l l ag han
:hap. 32A·p. 2.
4
and
a
Jr., The Law o f Federal Income Taxati on ,
& Company, 1963 Revision of Volume 5),
"Businessmen Spurn Tax Credit Plan As A Ginunick,"
3usiness We ek , Apr il 29, 1961, Volume 1652, pp. 30-31.
8
r e por t on the prop o s e d tax c hange s
M e an s C omm i t t e e .
t o the H ou s e Ways and
D i l l on p o inted ou t how s ome o f the
t i o n s o f the bu s ine s s wor l d c ou l d b e o f f s et .
obje c ­
H e indica ted
tha t he f av ored a p r op o s a l to a l l ow a f ive -year carry for­
ward of unu s ed credits,
and also proposed a method to pre­
vent bu nc h ing of expenditure s
in an a t tempt at utilizing the
maximum f i ft e e n perc en t c re d i t .
5
Hou s e Ways and Me ans C omm i t tee
.
The H ou s e Way s and Means C omm i t tee i n May 1961
s t arted h o ld ing hearings whi c h genera l ly ind ic a t e d that the
bu s ine s s wor l d s t i l l d i d n o t agree w i th the cu rrent inve s t ment c re d i t p r op os a l .
The y fe l t tha t there wa s de f ini tely a
be t ter way t o acc omp lish the
s ame pu rpo s e .
were pre s ented by var i ou s fac t i ons .
w e wi l l
Numerous i de a s
The one idea wh ic h ,
l a t e r s ee rec eive d the mo s t a t ten tion wa s
as
sugge s ted
by Ge orge Terb orgh wh o re pre s en t e d a g r ou p whi c h wou l d
ce r t a in ly bene fit f r om the inve s tment c redi t
and Al l ied Pr odu c t s
Ins t i tu te .
- t he Mac hinery
Terb orgh s aid tha t dep re c ia -
'tion shou ld n o t b e inc lu de d in the c ompu tat i on ,
a f l a t rate ,
not le s s
the c apit a l s p end ing .
than ten p erc ent ,
but r a ther
s hou ld be appl ied t o
6
The Americ an Ins titu te o f Certif ied Pub lic Ac countan t s a l s o wa s repre s en t e d dur ing the Hou s e Way s and Means
S
"Two-Way Fire on Kennedy Pr ogram," Bu s ine s s Week,
May 6, 1961, Volume 1653, pp. 32-34.
6
"Tax Plan Draws More Brickba ts," Business Week ,
May 20, 1961, Volume 1655, p. 36.
9
commi t t ee hearings ,
and offered var i ou s a lt e rna t ive s t o the
prop osed investment tax c re d i t .
They be l ieve d tha t the
propose d law wa s ove r ly c omp lex and suggested that the
answ er wa s a more flexib le depre c ia t i on a llowanc e .
They
too rec ommended t ha t if t he c re d it were to be a d op t e d ,
its
c ompu t a t i on be b a se d ent ire ly on inve s tmen t in qu a li f i e d
prop er t .1.e s . 7
The House Ways and Me ans C ommit t e e h e ld pu b lic
hearings f or twenty-e ight day s ,
ranking as one of the mo st
e xhau s t ive hearings held on admin istra t ive tax a t i on prop o s­
als in mode r n t ime s.
Sub se quent ly ,
thir ty-two me e tings were
he ld in execu t ive se ssi on to c onsider and d i scu ss the t e st i monies heard.
In S e p t embe r
19 6 1, when it bec ome apparent
that an a c c ep tab le b i l l c ou ld not be dra f t e d and p re sent e d
to the H ou se o f Re pre sen ta t ive s pri or t o adjou rnment , a d i s ­
cu ssi on dra f t wa s rele a s e d t o the pub lic .
C ha i rman , Wilbu r Mi lls ,
8
The Commit t e e
sta t e d that the pr opose d le g i sla t i on
wou ld be " t he f i r st order of bu siness i n the next s e ssi on of
II
C ongre ss .
9
The 87th C ongre ss rec onvened f or i t s sec ond se ssi on
and in e a r ly March
19 6 2, the Way s and Means min ori ty member s
dra fted a sub st i tu t e f or the inve stment t ax c r e d i t , replac ing
7
" 0f f i c ia l Re leases , " The Jou rna l o f Ac c ou n t anc y , Ju ly ,
1961, p p. 6 1-64.
8"what 'a Ahead in F•deral Ta� Legislation,"
of Ac c ou nt anc y , January, 1962, p. 42.
1961,
The Journal
9
11News Fea tures, " The J ou rnal of Ac c ou nt anc y , D e c ember,
p.
25 .
10
i t with a c c e lera ted depre c ia t ion p lus an inventory a llowance.
The
la t ter would be twen ty per c ent o f the F ir s t $ 10 0 , 0 0 0 o f
invento ry p lus thre e per c en t o f inventory over $ 100 , 000.
The
add i ti ona l deprec ia tion would be gradua ted up to twen ty per­
cent b a s e d on the e s tima ted us e ful l i fe of the proper ty and
This
wo ul d be appl ied to o therwis e a l lowab le depr e c ia tion.
pro pos a l d id no t provide for taxpaye rs having any more depre­
cia t ion than in the pas t; it merely ac c e lerated a l lowable
deprec ia t ion .
This add i t iona l deprec iat ion me thod d id not
exc lud e p roper ty outs ide the Uni ted S ta te s as did the inve s t­
(The
ment tax c redit propo s a l in its form a t tha t s tage .
inve s tmen t tax credit propo s a l exc luded proper ty ou ts ide the
Unit ed S tates becaus e , c oupled with the fore ign tax c redit ,
10
a doub le a l lowance c ould r e sul t . )
The minor ity members' propos a ls were no t incor porated in t o the fina l dra f t and o n Mar ch 1 6 , 1 9 6 2 , the
Committe e on Ways and Means submit ted its repor t (Hous e o f
·Repres enta tive s Repor t No . 144 7) t o the Hous e.
Mr.
Mi l ls
·po inted out tha t the ent ire b il l , H . R . 1 0 6 5 0 , repr e s ented a
1
major revis ion and re form o f the federa l tax s ys tem . He
,s tated tha t the investment cred it in the b i l l " is des igned
to provide a s timulant t o the ec onomic growth o f this
·country" .
Mi l ls repor ted tha t the Committee propo s e d r e tro­
; active to January 1 9 6 2 , a c redit agains t taxe s o f e ight
10
Tax Repo r t No . 43 , The Bure au o f Nat iona l Affair s ,
pp. G-1, 2 .
tnc., March 2, 1 9 6 2 ,
ll
pe r cen t on inve stment in new t angible pe rsonal p r operty ,
ce r t ain deprec iab le re al proper ty and limit ed amount s o f
use d property.
The e ight perc ent inve stment c redit was for
pro perty wi th exp ec t e d u se fu l life of e ight years or mor e ,
and wa s gradu at e d down t o one -third o f the e igh t percent for
property with estima ted useful lives of four years.
The
cre d i t was t o be limit ed t o t he amount o f the tax and c ou ld
not exc e e d $ 100,000 plu s f i f ty percent of t he tax ove r
Mr. Mills fu r the r reported that "The tax c re d i t
$100,000.
inc re a se s th e pro f i tab i lity o f produ c t ive inve st ment by
.
.
.
re duc .1ng t he ne t c ost o f a c qu 1r1ng new e qu 1pment .
On March
passed H.R.
,11
29, 1962, the H ou se of Repre sen t a t ive s
10650.
The sec t i on r ela t ing t o the investment
cre dit wa s sub stant ia lly unchang ed exc ep t tha t t he c r ed i t was
redu c e d from e ight percent t o seven perc ent and the $100,000
limi t p l us fi f ty percent exc ess was cu t t o $25,000 plus
twenty-f ive perc en t .
The H ou se Way s and Me ans Co mmi t t ee h a d sp ent t en
mon ths on the ent ire b ill ,
and on Apri l 2 , 1962 i t was r e­
ferred t o the Sena te Financ e Commit t e e.
c ommit te e ,
S enat or Harry F.
was i ndeed a major tax b i ll ,
The c ha irman of t he
Byrd (D-Va . ) ind i c a t e d tha t thi s
and p re d i c ted t ha t t he S ena te
Fina nc e Commit t ee hear ing s wou ld la st mor e than a month.
12
11
U. S . , I nterna l Revenu e Bu lle t in , Ju ly -De c ember , 1962,
U.S. Government Print ing Off ic e , 1963), p p .
(Wa shing t on :
405-41 1.
12
H.R.
u.s., Congr ess , S ena t e , Financ e Commi t t e e , Hearings,
10650, 87th Cong., 2nd S e s s., 1962, Part 1, p. 1.
·
12
Se nate Finance Commi t t e e
Se cre tary Di llon was the f ir s t witne s s and again
stre sse d that the inve s tment tax cre d i t was the mos t impo r t ­
an t par t of the H. R. 1 0 6 50 .
He pointed out tha t i n lieu o f
the se ve n pe r c e nt credit , a four te en per c e nt tax deduc t ion
could have be en al lowe d wh ich wou ld ha ve g iven the s ame
gene ral tax reduc t ion ( for companies
c e nt t ax b racke t).
in
the f ifty-two p e r­
Howeve r , he s ta ted, the advantage o f
the flat c re d i t was t o give a l l taxpaye r s the s ame advantage ,
r e gar d le s s of the ir type o f organiz.a tion o r tax bracke t.
D i llon emphas ized the fa c t tha t a l though the inve s tment tax
c redit had been c rit ic ized becaus e it was a sub s idy , in
fac t, the generally r eques ted alterna t ive o f a c c el e ra t ed
deprec ia t ion was als o a subs idy .
He fur ther s tres s ed the
idea tha t a l lowing unrea lis t ic dep recia tio n tax deduc tions
tended to d is tort cos ts for tax , and in many ins tances for
financ ia l ac counting purp os es where the tax deprec ia t ion was
, u sed for f in anc ia l acc oun t ing and r ep o r ting.
The S ecretary
s tate d that this might r e su l t in s etting higher p r i c es to
compens a te for higher c o s ts , and thus the inves tment cred it
was a pre fe rable method bec aus e it wou ld no t be r ef lected as
a
c os t.
He a l s o urge d that the credit be ra is ed bac k to the
e i ght perc ent or igina lly p r o pos e d by the Hous e Ways and Me ans
13
Commi ttee .
S ecretary D i llon wa s suc c e eded by approx imately
200 witnes s e s , and s ome o f their te s timonies are recorded
13
Ibid., Part 1, pp. 79-87.
13
in
the fol lowing paragra phs .
Le s l ie Mi l ls , a par tne r in the ac c ount ing firm o f
price
Wa terhous e
Institute
·
F ed e ral
set
&
C o . , and the Cha irman o f the Ame rican
of C e rtified Pub l ic Ac c ountants C ommi ttee o n
Taxa tion , s ta ted that "the inve s tme nt tax c re d i t a s
f or th in H . R . 1 0 6 5 0 is a s a tis fac to ry ver s ion of a n
allowanc e for s t imulation o f growth i n inve s tme nt and pro­
ductive
in
plan t and e quipment" .
He fur ther r emarked that this
no way s hou ld be c ons idered as an a lternative for fur ther
re form in the deprec ia tion p o l ic ies o f the· Internal Revenue
Code.
14
Maur ice
E.
Peloubet , a c er tified pub lic ac c oun tan t ,
re pr e s en t ing the Na t iona l S mal l Bus ines s As s o c ia t ion o f
Was hington ,
D.
C . agreed with
Mr.
Mi l ls as t o the need for
reform in dep r ec ia t ion laws , and a ls o ind ica ted tha t the
15
inves tment tax c r ed i t was an exc el lent tax inc en t ive.
The f irs t witnes s to rais e the ques t ion o f acc ount­
.
ing
trea tmen t for the inves tment cred i t was a gentleman who
plays a lead ing ro le in the rema inder o f this pre s en ta t ion ,
Leonard S pa c ek , manag ing p ar tner o f Ar thur Ander s en
pub l ic acc ountants .
&
Co. ,
He exp la ined tha t he was no t p r es en t to
d ispute or pra is e the p ropo s ed inves tment tax c red it , bu t
rather to re ques t tha t its purpo s e be c lear ly s ta ted s o tha t
the
p rop er acc oun t ing method c ould be dec ided up on .
14
15
Ibid.,
Part
2,
pp.
541-542.
Ibid.,
Part 2,
pp.
803-810.
-
He
14
poin ted out tha t the re c ould be only two reas ons for a l low­
ing
the inves tment credit:
" (a) To grant a s e le c tive r educ­
t i on of the fifty- two pe rcen t tax ra te on c orpora te income;
or (b) to gran t a reduc t ion in the c o s t of the proper ty , the
acqu i s i tion of wh ich is in tended to be s t imula ted."
Mr.
Spa c ek was qu ite vehemen t in his apparent d is tas te for
rea s on "a" , in tha t, he ra t iona l ized , it resul ted in a d ifferent tax ra te for pra c t ica l ly a l l U. S . companies and wou ld
"dis tor t and overs tate " current earnings which would, in
t urn, affe c t s tock market pr ices .
Spacek fur ther s ta ted
t ha t profe s s iona l s pe cula tors would bene f i t from this to the
detr iment of the sma l ler inve s tors .
As a proo f tha t the
inves tment credit wou ld ma teria l ly affe c t earnings , and thus
s tock pr ic e s , he pre s ented a s che dule o f c ompanies on the
New York S to c k Exchange , s e le c ted a t random , s howing results
of
ope ra t ions fo r 1 9 60 , adjus ted for the propos ed inves tment
credit.
Mr. Spac e k qui te defin i te ly preferred rea s on "b "
and fe l t tha t this wa s the in tent o f bo th Pres iden t Kennedy
and the Committee on Hous e Ways and Means.
He indica ted that
he ha d brought the s ame po ints to the a t tent ion o f the
Treasury Depa r tmen t and Congres sman Mil l s , but to no ava il.
He
r e i tera ted that a c le ar - cut s ta temen t o f the purpos e of
the inve s tmen t tax credit would as sure prop er a c counting.
16
(A review of the Comm i t te e's r e c ommenda tions indic a ted tha t
Mr.
S pace k's p leas were ignored.)
16
Ibid.,
Par t 2 ,
pp.
823-827.
15
Secretary Dillon returned in the closing days o f
the
he a ring s to propose several changes based on the various
te s t imonie s
that the
percent
during the hearings.
Among others, he sugge s t ed
investment tax credit limitation of twenty f iv e
-
of
the
f e d era l
to f ifty percent.
income tax in any one year be raised
He pointed out that this change would
have
little, if any, e f fect o n pro fitab le companies, but
would be significant to les s p r o f i tab le c omp anie s . 1 7
On August 16, 1962, the Senate Finance Committee
presented it s rep ort (Senate Rep o r t No. 1881) to the Senate;
the p ro vis ions re la t ing to the investment tax credit we re
subs tant ia l ly the s ame as thos e pas s ed by the Hous e o f
Rep re s entat ive s exc e p t tha t two new "wr inkles " we re added -
the tax bas is o f the as s e t for dep re c ia t ion purp o s e s was to
be reduc ed by the amount of the inve s tment credit , and the
·
cred i t was manda tory bec aus e bas is was re duc ed whene ver the
18
credit wa s a va i lab le .
The Senate app r oved the b i l l with
only minor changes from tha t rec ommended by the F inance
Commi ttee , and on Oc tober 1 6 , 19 6 2 , Public Law 8 7-834 (H . R.
.
10650)
The Re ve nue Ac t of 19 6 2 was app roved by Pres ident
-
1
Ke nnedy . 9
As p as s ed , the inve s tment tax credit was app l icab le
to
taxab le years end ing a f ter 1 9 6 1 , and was s even pe rcen t of
17
18
Ibid., Part 10, p. 4375.
Internal Revenue Bulletin,
-
pp.
7 0 7- 709.
19
� -,
p.
111.
July-December,
1962,
16
qualified inve s tment in c e r t ain depreciab l e pr ope rty . The
qualified inve s tment wa s b a s e d on c o s t , and f or mos t indu strial
c ompanie s was a s fo l l ow s :
useful
One -third if the e s tima t e d
life wa s f our years o r more , b u t le s s than s ix ye ars;
t''>vo-thirds if s ix or mor e , bu t le s s than e ight years and 1 00
perc ent if eight year s or more .
The reduc tion o f ba s i s and
th e $25 , 0 0 0 p lus twenty-five perc ent limita tion a s previou s ly
des c rib e d were inc lude d , and a three year c arryback and five
20
The
year c arryf orward wer e a l s o made a par t of the l aw .
cr edit wa s t o be redu c e d and po s s ib ly e limina t e d if the qua l i­
fied inve s tment was d i s p o s e d o f pre matu re ly .
The inve s tment
cre dit wa s de s c ribe d in var i ou s terms in c lu ding , "a c ash
reba t e bec au s e it is a direc t redu c t ion of the tax due.1121
Summary
The tax b i l l was s igned into law a lmos t 18 mon ths
after Pre s iden t Kennedy firs t introduced it to C ongre s s .
It
was apparen t tha t there we re s ever a l purp o s e s envis ioned by
its creator s , inc lud ing the fo l lowing:
(1) To s timu late cap i ta l s p end ing by g�v�ng a tax
inc ent ive to thos e who wou ld inves t in p lan t
and equipment.
(2) To modernize equipment by making the United
Sta tes mo re comp e t itive in fore ign and
domes tic mar ke ts .
20Revenue Act of 1962 w i th Explanation, ( Chic ago:
Commerce Clear ing House, Inc., 1962), pp. 5-7.
21 "What
the '62 Tax Law Means
The Research Instj.tute of America,
to Bus ines s ,
Inc., 1962),
" (New Yor k:
p. 5.
17
(3) To reduce taxes.
h
Alt ough the law was clear,
chapter,
we will learn,
in the succeeding
of the controversies that ensued within the account­
ing profession as a- result of the passage of the investment
tax credit.
CHAPTER III
INITIAL ACCOUNTING TREATMENT PROPOSALS
The investment tax credit,
Revenue Act of'
if any,
19 6 2,
an integral part of the
was now an accomplished fact,
and few,
accountants realized the uproar which was about to
begin within their profession.
This chapter will be devoted
t o d iscussing the initial methods proposed to account for
the investment tax credit,
the theory behind each method,
the American Institute of Certified Public Accountants'
recommendations,
the accounting profession's reactions and
the methods actually followed in practice.
w ith these methods,
In connection
statistics will be presented to show the
trend of treatment afforded the investment credit and finan­
cial statements of selected companies will be included to
indicate how specific companies handled the investment credit.
Income Treatment
From the point of view of income treatment,
there
were basically four different accounting methods proposed;
'these methods are briefly discussed in the following
·paragraphs.
100
percent flow through
Proponents of this method stated that the invest­
ment credit was
in
merely
a reduction in federal income taxes
the year that the qualified property was purchased.
thus concluded that no special accounting treatment was
They
19
ne c e s s i ta ted , ra the r , the provis ion for taxe s s hou ld be
redu c e d to re f le c t the ac tual tax c omputed , ne t of the
inve s tmen t credit .
being
There fore , this re sul ted in ne t earnings
inc rea s e d to the extent of the en t ire inve s tment
credit.
For examp le (igno r ing , for s imp l ic i ty , the e ffec t
of not be ing a llowed to dep rec ia te p o r t ions o f the qua l i f ied
inve s tment) , as suming earnings be fore taxe s of $ 100 , 000 ,
t axes be fore the computa tion o f the inves tmen t credit o f
$4 6 , 500 and an inve s tmen t credit o f $ 10 , 000 , the repor ted
net
ea rnings in the f irs t year wou ld be $ 63 , 500 as fo l lows :
Earnings be fore Federa l income taxes
Fe dera l inc ome taxes ($46 , 500 - $ 10 , 000)
$ 100 , 000
3 6,500
Ne t earnings
$ 6 3 , 500
"48-52" me thod
Ba c kers o f th is me tho d were bas ica l ly in agre ement
wi th the 100 percent f l ow through app roach , i . e . , tha t the
inve s tment c redi t was a reduc tion in taxe s , however they wen t
one s tep fur ther .
They p o inted out tha t s ince the inves tmen t
credi t reduc e d the deprec iable tax bas is o f the prop e r ty
invo lved , the inve s tment credit s hould be taken in to curren t
ye ar earnings only to the exten t tha t the re wa s a ne t tax
saving .
As suming a federa l inc ome tax rate o f f i f ty- two
pe rcent ( the then prevai ling corp ora te tax on year ly income
in
exc e s s o f $ 2 5 , 000) , the only ne t tax bene f i t would be
forty- e ight percent o f the inve s tment c red i t .
This would
occur becaus e deprec ia t ion exp ens e on the inves tmen t c redit
20
which was not allowable would normally have been a deduc tion
over the life of the property with a resulting net tax
savings of fifty- two cents on the dollar.
Thus,
the ration­
ale was that forty- eight percent of the investment credit
should be reflected as a decrease in the tax provision and
t he remaining fifty- two percent be deferred over the esti m­
ated useful life of the property offsetting the unallowable
dep reciation.
Using the same example as above,
and as suming
th at all the qualified property had a· ten- year life,
an d
including one year amortization of the investment credit,
net earnings would be
$ 5 8 , 820
reported as follows:
Earnings before federal income taxes
Federal income taxes ( $4 6 , 5 0 0 )- ( $ 10 , 0 0 0
times forty- eight percent ) - ( $ 10 , 0 0 0
times fifty-two percent, times ten
p ercent )
$ 100 , 000
Net earnings
$ 58,820
41 , 180
Cost reduction
The cost reduction theorists contended that the
investment credit resulted in a reduction in the costs of
the qualified property and thus future depreciation costs
were reduced.
They recommended spreading the investment
credit over the life of the property.
example,
under
Using the above
the cost reduction concept, the reported net
earnings would be
$ 54 , 5 00
as follows:
Earnings before federal income taxes
Federal income taxes ( $ 4 6 , 5 0 0 )
( $ 10 , 000 times ten p ercent )
$ 10 0 , 000
Net earnings
$ 54,5 00
45,5 00
21
contribution to c ap i tal
-
A small segment of the profession felt that the
investment credit resulted in a subsidy by the Government
and thus should be treated as a contribution to capital.
This method received relatively little support and was
quickly disposed of by the Accounting Principles Board of
the American Institute of Certified Public Accountants.
They
stated that this method was in contradiction to the general
conclusion that net income is increased by the investment
ered.�t.
1
Comparative an alys i s
Assuming that there is no change in income,
the tax rate remains the same,
that no additional property
is purchased and utilizing the previous examples,
below
c ompares
1 0 0%
the three
me thods f or
flow through
Net earnings
the table
a ten-year period.
First
year
Earnings before federal
income taxes
Federal income tax ( net of
the investment credit )
that
Second
through
tenth
years
Total
$10 0, 0 0 0
$ 1 0 0, 0 0 0
$1, 0 0 0, 0 0 0
3 6�5 0 0
4 6l5 0 0
4 5 5� 0 0 0
$ 6 3 ,5 0 0
$ 53,5 0 0
$
545,0 0 0
111Accounting for the 'Investment Credit'," Opinions
Qf the Accounting Principles Board, No. 2, (New York:
American Institute of Certified Public Accountants, 1962),
p. 6.
22
F irs t
ye ar
" 48- 5 2 "
Earn in gs be fore federa l
inc ome taxe s
F edera l income tax (ne t o f
inve s tment credit and
amor t iza tion )
N e t earnings
Second
through
ten th
years
Total
$ 100 , 00 0
$ 100 , 0 0 0
$ 1 , 0 00 , 000
41�180
45�9 80
4 5 5 l0 0 0
$ 5 8282 0
$ 5420 2 0
$
$ 100 , 00 0
$ 100 , 00 0
$ 1 , 0 00 , 000
45,5 0 0
45�5 0 0
455,0 0 0
$ 54 , 5 00
$ 54,5 0 0
54520 0 0
Cos t reduc t ion
Earn ings be fore federa l
income taxes
F ederal income taxe s (ne t of
amortiza tion o f the
inve s tment credit)
Ne t earnings
$
545,0 0 0
A s can be s e en in the above tab le , in to ta l for the ten- year
period there is no d if ference in net earn ings .
This examp le ,
however , as sumes no add i tiona l purcha s e s o f proper ty which
is high ly unlike ly .
of
Continua l acquis ition o f prope rty wou ld ,
cours e , caus e a more or les s permanent difference in ne t
earnings , as long as dif ferent me thods o f ac c ounting for the
inves tment c redit were in us e .
Op inion No . 2 of the
Acc ounting Princ iples Board
The Acc oun ting Pr inc ip les Board me t in late 19 6 2
to dete rmine the proper me thod to be us ed in accounting for
the inve s tment credit .
The Board s ta ted that:
"There is no s ignificant d is agreement wi th the view
that the inves tment cred it is a fac tor which inf lu­
enc es the determ ina t ion o f ne t income . The bas ic
23
accounting issue before us therefore is not whether
the investment credit increases net income but,
rather, the accounting period(s) during which it
should be reflected in the operating statement.
Resolution of the accounting issue, in large part,
rests upon the accounting principles relative to
the realization of income".2
They went on to state that:
"We believe that the interpretation of the invest­
ment credit as a reduction in or offset against a
cost otherwise chargeable in a greater amount to
future accounting periods is supported by the weight
of the pertinent factors and is based upon existing
accounting principles
"
•
•
•
"In reaching this conclusion we have evaluated the
pertinent portions of the legislative history of
the investment credit, which we regard as signifi­
cant but not decisive.
[Italics added]
We also
evaluated the pertinent provisions of the Revenue
Act of 1962 which, as earlier stated, require that
the investment credit be treated as a reduction in
the basis of the property which gives rise to the
credit and which contain recapture and other provi­
sions the effect of which is to make realization of
the credit dependent to some degree on future
events."3
The Board, spearheaded by Leonard Spacek, Arthur Andersen
Co.
&
(from whom we previously heard during the Congressional
hearings), thus concluded that the investment credit should
be
spread over the life of the qualified investment (cost
reduction method), except for regulated companies required
by
public bodies to treat the credit differently for rate­
making purpdses.
Dissenters to this conclusion felt that
the "48-52" method was an equally acceptable method.
Bevis, Price Waterhouse
2
Ib i d
.
,
3rbid.,
p. 5.
p.
6.
&
Co., Powell, Haskins
&
Messrs.
Sells, and
24
ippit,
T
Ernst & Ernst,
indicated that:
" • . • the
pertinent factors preponderantly support
the view that the investment credit is in substance
a reduction in income taxes.
They consider that
the generally accepted accounting principles appli c ­
able (including the pronouncements of the former
Committee on Accounting Procedure, especially those
relating to the accounting for income taxes and to
the reporting of income , which are still in ef fect)
preponderantly su p p or t the treatment of the inves t­
ment credit as a reduction of the provision for
current income taxes in the year in which the credit
arises.
They believe specifically, that the genera­
tion of taxable income for the year in and by itself,
rather than the future productive use of the related
property, effects the realization of the credit.
They point out that opinions received by the Board
from practitioners and businessmen make it clear
that the "48-52" method discussed in p aragraph 7 of
the Opin ion has at least as wide acceptance among
these groups as the method s pon so red by the major­
ity of the Board.
They believe that, in the circum­
stances, the " 48 - 52 " method must also be c ons ider ed
to have substantial authoritative supp ort and,
therefore, to be gener al ly ac c eptable. ' �
Initial aftermath of
Opinion No. 2
The Board had reached its decision by a vote of
fourteen to six.
What was particularly significant,
however
,
was that of the eight major certified public accounting firms
in the United States,
Board,
all of which were represented on the
four voted with the minority;
thus the "big eight" of
public accounting had split on the issue.
The dissenters
indicated that they generally pr e ferred the "48-52" method ,
and would allow their clients maximum leeway as long as
was
full disclosure of the method utilized.
4
Ibid.,
pp.
6-7.
( The
there
latters'
25
clients inc lud ed ove r one- ha l f o f the companie s l is ted o n the
Ne W
York
Stock
5
Exchange .)
rhe inve s tment tax cre d i t dis pute cl ear ly c aus ed a
major cr is is in the a ccount ing pro fe s s ion.
Thomas
G.
Higgins , o f Ar thur Yo ung
& Co.,
Tempe rs f lare d;
wa s quo ted as
s aying angr i ly tha t the minor ity 's pos i t io n was " pre his to r ic :
Thi s i s the f irs t t ime in my memory tha t a major f irm has
thumbe d its nos e a t the reco gnized au thor i ty in the
profe s s �on. ..
.
6
Bus ines s We ek s ta ted tha t:
"The r e 's no denying tha t the gul f tha t s e para tes
the warr ing fact ions is a d e ep o ne. The men
invo l ve d a l l have s trong bel i e fs , and they are not
s wayed e as i ly. Des pite the impas s e , though ,
a ccounting prob l ems con tinue to ar is e - and com­
panies and their ac5ountants are s o lv ing them the
bes t way they can. "
The Journa l o f Accountancy included comments such
as
"The controver s y over the proper account ing trea tment o f
the 7 per cent inves tment cred it provided by the Revenue Act
of
1 9 6 2 has focus ed mor e journa l is t ic a t tentio n on account­
i�g than any s ingle event in year s . "
8
Empha s izing the
publ ici ty that the inves tmen t cr ed i t is sue had received , the
Journal wen t on to quo te var ious pub lica tions which had
re por ted on the even ts , includ ing the f o l lowing:
5
"A Matter o f Pr inciple S pl i ts CPA's , " Bus ines s We e k ,
January 2 6 , 1 9 6 3 , Vo lume 1743 , pp . 50-5 7.
6
rb id , p . 5 5 .
•
7 Ibid. , p . 60.
8
" Spo t l ight on Accoun ting , " The Journal of Acco untancy ,
Februar y , 1 9 6 3 , p. 3 9 .
.
26
Business Week
•
.
.
•
•
"This week,
the accounting pro­
fession laid down some guidelines on what has been a ticklish,
awkward problem for industry:
how corporations should treat
the new 7 percent inv�stment credit on their books."
The Wall Street Journal.
vote, an influential accountants'
•
•
.
•
"By barely the required
board passed
a
disputed
"guide rule" on treatment of the new tax credit on equipment
purchases in companies'
financial reports."
The Chicago Daily News Service
•
•
•
.
•
"Big fights are
shaping up in the accounting profession".
The profession,
to a certain extent,
seemed to enjoy its
newly acquired notoriety, but at the same time realized that
9
a real problem was on the scene.
Securities and Exchange
Commission's position
Adding more "fuel to the fire",
the Securities and
Exchange Commission appeared to prefer the minority's "48-
52" method,
but stated that it would also accept the method
approved by the Accounting Principles Board.
The Commission
indicated that although they generally did not accept quali­
fied opinions by independent accountants,
they would in
instances where the qualification was a result of use of the
1148-5
2" method.
The Commission did set up some groundrules.
They wanted the property accounts
the balance sheet
to be stated at cost on
(regardless of the fact that the
9
The Journal of Accountancy,
February,
investment
1963, p. 40.
27
c re d i t reduc ed the tax bas is ) , and ind ic a ted tha t in come tax
10
s hould no t be s tated at more than the ac tua l amoun t p ayab le .
Argun1e nts advanc ed for
the c o s t reduc t ion me thod
The p oin ts ra is ed in favor of tre a t ing the inves t­
men t tax c redit as a reduc t ion in c ost and s p reading the
c r e d i t o ver the life o f the as s e t can be br ie f ly summarized
as
fol l ows :
(1) The p urp o se of the c r e dit wa s t o stimul ate acqui­
s it i on of machine ry and e quipment by reducing
the ne t c os t of inve s ting therein, the re f ore
thi s reduc t i on sho uld be rec ognize d ove r the
life of the a s s e t . l l
(2 ) The c redi t i s earned only i f the proper t y i s
re taine d f or the r e qui red holding period, and
thus the c re dit should be s pread over th i s
p e r i od . l2
(3 ) I nc ome is not earned mere ly b y the purcha se of
e quipment b ut ra the r from it s us e ; there f ore ,
the inc ome should be rec ognized ove r the life
of the e quipment . l3
(4 ) S p re ading the c redit e qual ly ove r the l i fe of
the a s s e t prec lude s man ipulat ion 9f earning s
by t iming of e quipment purcha s e s .l 4
10
"Acc oun ting for the 'Inve s tment Credit' , " Acc oun t ing
Serie s Re le as e No. 96 , S e cur i t ie s and Exchange Commis s ion ,
January 1 0 , 1 9 6 3 .
11
Rona ld M. Horwi tz, "The Inve s tment Cred i t , 'De ferred
Inc ome Taxe s • and Ac c oun t Me as 1:1rement , " The Acc ount ing
Revie w , July , 1 964 , p . 6 2 1 .
12
Kenne th B . Berg and Fred J . Mue l le r , "Accounting for
Inve s tment Cre dits , " The Ac count ing Re vie w , July , 1 96 3 , p.561.
13
0p in ions o f the Ac c ounting Principle s Bo ard , No . 2 ,
p. 7 .
14
The Ac c ount ing Review , July , 1963,
p.
556.
28
Arguments advan c ed
100 p erc e nt flow
for the
through method
S in ce the 100 percent fl ow through meth od wa s not
g e nerally acc epted, other than f or regulated companies, it
will
no
t be examined any further in this chapter .
Arguments advanced for
the "48-52" method
Because the Ac coun t ing Princ ip les Boa rd had
recommended the cos t reduc t ion me thod , many o f the reas ons
advanced for the "48 - 5 2 " me thod were ac tua l ly in the form of
re futing the cos t reduc t ion me thod sugge s ted by the Ac count­
ing P r inc ip les Board .
The major points ra ised by the pro­
ponents of the "48 - 5 2 " me thod are brie f ly d is cus s ed be low:
(1) There is subs tantial authoritative support
for the " 48 - 5 2 " method inc lud ing: l 5
( a ) Numerous respons e s to the Ac coun t ing
Pr inc ip les Board's exposure draf t .
( b ) The recommendation o f the D irec tor o f
Res earch o f the Amer ic an Ins titute
of Ce rtified Pub lic Acc ountantso
( c ) Ac c ounting prac tice o f o ther c ountrie s
which p revious ly had s im ilar cred its .
( d ) The op inion o f the Secur i t ies and
Exchange Comm is s iono
( 2 ) Although the intent o f the Congres s shou ld be
cons idered, it is no t the de term ining
fac tor . l6 Fur thermore , a c are ful reading
of the Congres s iona l Hearings and s e le c t ions
therefrom of var ious por tions of the records
The
p.
15
Herman W. Bevis, "On Adopting Acc ounting Principles ' 11
Cal ifornia CPA Quar terly , March , 1964, p. 13.
6.
16
op inions o f the Ac counting P r inc ip les Board , No . 2,
29
would support almost all of the proposed
accounting treatments. l7
(3) While the Accounting Principles Board wants to
treat the credit effectively as a subsidy, it
is not a subsidy, but rather a complicated
method of computing taxes, not too unlike the
depletion provisions of the tax law where
deductions in excess of cost are allowed. l8
(4) The credit was not intended as a subsidy since
it is only available if a profit is made,
and profitable companies are normally not
subsidized by the government.
( 5 ) The fact that the credit must be repaid if the
property is prematurely disposed of should
not be considered an argument against the
1148 -52" method because equipment is not
normally purchased with the idea of disposi­
tion prior to full use, and justification
based on future assumptions can not be con­
sidered valid. Furthermore, the "going
concern" concept, i.e., anticipated contin­
uity of existence, followed extensively in
accounting literature would also tend to
refute considerations of early disposal.
(6) It can be contended that purchases of machin­
ery and equipment do affect income, since a
wise choice of equipment can have a material
effect on future revenues. l 9
Balance Sheet Treatment
Although not receiving as much publicity, there
ipparently existed some question in the minds of the account­
lug profession as to the proper balance sheet presentation
)f the investment tax credit.
The Revenue Act of 19 62
stated that the basis of the qualified asset be reduced by
17
18
19
�T�h�e�A_c_c_o_u_ n_t_i�n�g�R� e�vL- ·� _we�,
Ibid. , p. 5 5 9.
Ibid.,
p.
556.
July, 1 9 63,
p.
5 5 7.
30
the
20
.
�nve s tment ere d �. t .
Literal c omp lianc e with this
requirement wou ld result , a t leas t initially , as suming a
s even
p er c ent cred i t , in showing the as s e ts on the balanc e
s h.e e t
at nine ty- three p er c ent o f c o s t e
Th is me thod was no t
21
accep tab le to the S e cur i t ies and Exchange Commis s ion
(see
0 age
l
26) .
The Ac c ounting Pr inc ip le s B o ard o f the Amer ic an
Ins t i tute o f Cer t i f ied Pub l ic Ac c ountants ind ic ated tha t
22
as fo l lows :
there were two accep tab le alterna t ive s ,
( 1 ) Re duc t ion in the prope rty d irec t ly , or in ­
d irec t ly by inc lus ion in a r e s e rve account
which was deduc ted f rom the p r op e r ty.
( 2 ) Tre a t ing the inves tment credit as de ferred
inc ome to b e amortized ove r the life o f the
app l ic ab le p rop erty.
In add it ion to the above al terna tive s , there were
s everal o ther me thods o f fered as " the " s o lut ion .
The s e
2
me thods inc luded treating the credit a s de ferred taxe s , 3
24
as a deferred liab i l i ty
and even s p l i tting the credit into
two p ar ts - f if ty - two p er c ent as de ferred taxes to be amor­
t i zed over the l i fe o f the as s e t and forty - e ight percent as
de ferred inc ome to be amor tized over the required tax ho ld ­
ing per iod e
For examp le , an as s e t wi th a f if teen year l i fe
20
s e c tion 4 8 ( g ) ( l ) , Interna l Revenue Code , ( Chicago :
C omrr£ r c e C learing Hous e , Inc o , 1 9 6 2 ) , P o 3 8 9 1 .
21
s e cur i ties and Exchange Commis s ion , January 10 , 1 9 6 3 .
22
.
. .
. 1 e s B oar d , No . 2 ,
op �n�ons
o f t h e Ac c oun t �ng P r �nc
. �p
p. 7.
2 3 The Acc oun ting Review , July , 1 9 6 3 , p . 55 6 .
24
Porter w . Henders on and Horace R . Bro c k , "Wha t the
Inves ·tment Credit :Means to the Management Acc oun tant , " NAA
Bu l le t in , D e c emb e r , 1 9 6 3 , p . 3 1 .
31
wou l d on ly have a r e qu i r e d
to
e arn
t ax h o l d ing p e r i od
of e i ght y e a r s
the maximum cred i t . 2 5
Me thods Ac tually Used in 1 9 6 2 And 1 9 6 3
·
-
in
The fo l lowing tab les summa rize ac tual me thods used
26
27
19 6 2
and 1 9 6 3
as reported to the Amer i c an Ins ti tute
of Cert i fied Publ i c Ac countants :
Number o f comp anies in
survey which d i s c losed me thod o f
reporting inves tment tax c redit
Income tre atment
Cos t reduc tion me thod
"48 - 5 2 " me thod
1962
1963
1 58
__2.§.
144
117
256
261
Balance shee t treatment
Res e rve for de ferred
taxes ( 19 6 3 a l s o
inc ludes res erve for
taxes )
99
Reserve for deprec iation
23
1
'
De ferred income
19
no t d is c losed
Other ways
·
·
241
15 0
85
no t d i s c los ed
�
261
As c an b e seen in the above tables , there was
a
wide d ivers ion o f op inion in terms of the me thods ac tual ly
us ed dur ing 19 6 2 and 1 96 3 .
25
26
It appeared that generally
The Ac counting Review , July , 1 9 6 3 , p . 5 6 0 .
Acc oun ting Trends & Techniques , (New York : American
Ins titute o f Certified Pub l i c Acc ountants , 19 63 ) , p . 123 0
27
Acc ounting Trends & Techniques , (New York : Amer ican
Ins t i tute of Certified Pub lic Ac c o un t an t s , 1964) , pp . 118 - 119 .
32
the
involved followe d the methods wh ich the ir
c omp an i e s
ind e p e nden t
accountants had supp orted during the d iscussions
o f the A c c ou n t i n g
tha t
on
Principles Board .
It is not surprising
exp e r ts in the profession could not reach an agreement
one
S imilar si tuat ions in other areas of
me tho d .
a c c oun t ing t h in k in g
have ex isted for years .
For example ,
on e comp any may depreciate property, plant or equ ipment
e qua l l y
over its li fe, wh i le another comp any may choose to
ac c e l e r a te
de preciation charges in the earlier years with
gradual decreas es in later years .
is
E i ther of these methods
cons idered to be generally accep ted since circumstances
from comp any to company may vary .
ing p r o fe s s ion
there
is
Today within the account-
a movement to narrow areas of differ -
ences within accounting principles, however , the more astute
p rofes sional accountants have pointed out the dangers
28
inherent in moving too quickly in this direction .
Excerp ts from 1 9 6 2 and 1 9 6 3 Annual Repor ts
The following p aragraphs illustrate examples of
1962
and
1963
investment cred it reporting practices .
In
those ins tances where the independent accountants qualif ied
c�eir opinion due to the method of accounting for the
inves tment cred it , there is a reference to the opinion .
In
order to simp l ify the presentation , the terminology has
b een s t andardized .
2 8 The C a l i f o rn i a C PA
Quarterly , March , 1 9 64 , p . 3 0 .
33
Cos t Reduc t ion Me thod
2
Dairy Produc ts Corporat ion 9
i independent accountan ts - Ar thur Anders en
Na t i ona l
Co . )
&
In c ome s tatement E arn in gs be fore inc ome taxe s
$ 11 0 , 444 , 3 58
Provis ion for inc ome taxes
Provis ion for deferred taxes
re latin g t o inves tment credit
(See no te )
54 , 7 3 6 , 0 0 0
1 , 6 9 0 , 00 0
5 6 , 426 , 000
Ne t e arnings for the year
$ 54 , 0 18 , 3 58
Ba lance s he e t De ferred income . taxes
( s eparate c ap t ion af ter
long- term deb t c ap t ion)
$ 13 , 6 5 7 , 8 04
Note s to f inanc ial s tatements In ac cordanc e with the Company ' s p o l icy o f amor­
t i z ing the inves tment credit over the us e ful l ife o f the
rela ted prop e r ty , $ 18 5 , 0 00 of the credi t ava ilable for 1 9 6 3
has been re f le c te d in earnings in 1 9 6 3 and $ 1 , 6 9 0 , 00 0 has
been de ferred to future operations .
D is cus s ion The $ 18 5 , 00 0 amor t ization was apparent ly inc luded
in
o ther inc ome , and the $ 54 , 7 3 6 , 0 0 0 appears to be the taxes
ac tual ly payable , ne t o f the inves tment credit .
of
The portion
the inves tment credit to be re f lec ted in income of future
years was added back to the $ 54 , 7 3 6 , 0 0 0 to e liminate the
29
Adap ted from 1 9 6 3 Annual Report o f National Dairy
Pr oduc ts Corpora t ion .
34
e f f e c t o f the reduc t ion in taxe s
cre di t .
due to the
inve s tmen t
Th is is a c le ar and accep tab le manner
of re p o r t ing
t he inves tment credit.
R.
30
J . Re yno lds Tobac c o Comp any
( Inde pendent accountants - E rns t
&
Erns t )
In c ome s ta tement $ 1 19 , 803 , 1 6 5
Ne t earnings for the ye ar
No te s to f inanc ial · S tatements -
The 1 9 6 2 p rovis ion f o r income taxes i s a f ter
d e duc t ing the inves tmen t credit of $ 1 , 12 1 , 58 7 , and an equi­
valent amount has been inc luded as add it ional deprec iation
for the year.
D is cus s ion Al though no t indicated , the p o r t ion o f the inve s t men t cre d i t amortized to income was app arently credi ted to
o the r inc ome as in the previous examp le , however , in stead
of a s eparate l ine in the tax s e c t ion , the inve s tment cred i t
was inc luded with deprec ia tion exp ens e.
Bas ed on the no te ,
it wou ld app ear tha t the inves tment cred it was inc lude d on
the balanc e s he e t in the ac cumulated depre c iation account.
,
This is als o an ac ceptab le reporting pract ice.
30
Adap ted from 1 9 6 2 Annual Rep ort
Tobacco Company .
of
R . J . Re yno lds
35
31
L o c kheed Aircraft Corporat ion
iindependent accountants - Arthur Young
&
Company)
In c ome s ta tement $ 3 7 , 1 9 9, 0 00
Ne t e arnings for the year
Ba lanc e shee t -
$ 14 , 4 06, 00 0
De ferred inc ome (No te 4 )
( s ep arate c ap t ion after current
l iab i l itie s c ap t ion)
N o tes to f inanc ia l s tatements -
De ferred inc ome inc lude s a de ferred inves tment
credit o f $ 8 3 2 , 0 0 0 resul ting from the acquis ition and leas e
of equipment .
This amount wil l b e amor tized over the pro ­
duc t ive l ife o f the re lated equipmen t .
D is cus s ion The balance s he e t treatment is quite c le ar ; how­
ever, there is no t enough information to identify the
inve s tment credit on the income s tatement .
This rep or t ing
pr ac tice is cons idered accep tab le although i t wou ld have
been pre ferable to ind ic ate the income s tatement treatment
accorded the inves tment credit .
32
Peabody Coal Comp any
( Independent acc ountants - Ar thur Ander s en
&
Co . )
Income s tatement Ne t e arnings for the year
$ 1 7 , 2 45 , 7 6 0
31
Adap ted from 19 6 2 Annu al Report of Lockheed Aircraft
Co rpo ra tion .
32
Adap ted from 19 6 3 Annual Repor t of Peabody Coal
Company .
37
b a l ance o f the credit has been inc luded under ac cumu lated
d ep rec iat ion in the acc omp anying balanc e s hee t .
D is c us s ion In the previous cos t reduc tion me thod examp le s ,
t h e re were no re ferenc es to an "ul t imate s aving " .
It is
int eres t ing to no te ment ion of the for ty - e ight percent s av­
ing s , one of the arguments advanc ed for the "48 - 5 2 " me thod ,
in a rep ort where the co s t reduc t ion me tho d is f o l lowed .
Again , i t is d i f f icu lt to d e te rmine how the inve s tment
cred it was tre a ted on the income s tatement , p ar t icu lar ly
in
light o f the d is c losure of a s avings , and the fac t that
only the "s avings " amor tization was d is cus s ed .
Us e o f the
accumulated deprec iat ion account however might imp ly inc lu­
s ion w ith depre c i a t ion. expens e .
• The treatment is , in any
event , accep tab le .
"48 - 5 2 " Me thod
Ju
34 Indep endent
(
Newberry Co .
accoun tants - Peat , Marwick , Mitche ll
J.
&
Co . )
Op inion o f independent acc ountants Qua lif ied due to us e o f "48 - 5 2 " me thod .
Inc ome s tatement E arnings before income taxes
$
Provis ion for inc ome taxes (No te 1)
Current
D e ferred
3 , 639 , 203
930 , 000
7 25 , 000
1 1 655 1 000
Ne t e arnings for the ye ar {Note 1)
34
$
1 1 98 4 � 2 0 3
38
:B a lanc e she e t D e ferred inc ome taxe s
(S ep arate cap t ion after
current liab i litie s cap t ion)
$
3 , 7 60 , 000
No tes to f inanc ial s tatements The Comp any i s ent it led to c laim an inve s tment
credit of $ 3 9 0 , 0 0 0 in its 1 9 6 2 income tax re turn .
Manage -
ment is o f the op inion , however , that the maximum inves t ­
ment credit a l lowab le in repor t ing current e arnings should
b e b as ed on de ferred income taxes p ay�b le as we l l as on
inc ome taxes current ly p ayab l e o
Acc ord ingly , $ 2 9 1 , 0 0 0
( for ty- s ix p ercent o f the inves tment credit o f $ 6 3 0 , 0 0 0
c omputed under this me thod) was ap p l ied a s a reduc t ion o f
inc ome taxes charged t o current e arn ings .
I f the inves tment credit had been based on inc ome
taxes current ly p ayab le and its abs orp t ion in ne t e arnings
s pread over th,e us e ful lives of the re lated as s e ts ( c os t
reduc tion me thod ) , ne t e arnings would have b een reduc ed by
approx imately $ 2 7 0 , 0 0 0 o
D is cus s ion The Comp any was ap p arently - entit led to an inve s t ­
ment cred it c arry forward and b e l ieved that s inc e it charged
de ferred taxe s agains t current e arnings , it would be con­
s is tent to compute the inves tment credit bas ed on the
reported to tal provis ion for inc ome taxes o
The latter pro ­
cedur e along with the us e o f the "48 - 5 2 " me thod caus ed the
independent ac countants to render a qua l i f ied opinion .
The
39
qu al ificat ion appears reas onab le s ince the $ 2 70 , 000 was
ma t er ial ( appr oximate ly four teen p er cent ) in re lation to
ne t earnings .
35
No r th Amer ican Car Corp orat ion
( Independent acc ountants - Ar thur Young
&
C omp any)
Op inion o f independent acc ountants Qua lified due t o us e o f "48 - 5 2" me thod .
Income s tatement E arnings be fore income taxes
$
Provis ion for income taxes (Note 1)
Current
D e f erred
7 . 549 , 9 9 3
1, 8 2 1 , 0 00
1 , 6 0 8 , 00 0
3 J 42 9 J O O O
Net earnings for the year
$
4 2 1 20 2 9 9 3
No tes to f inanc ial s tatements An
amount equal t o for ty- e ight percent o f the
inves tment credit (after provis ion for app lic ab le inc ome
t axes p ayab le in future years ) was reflec ted in earnings
through r educ tion in the provis ion for income taxes , thereby
increas ing repor ted ne t earnings by $ 3 11 , 000 o
Dis cus s ion ·
I t app ears that the Comp any fo l lowed the s ame p ro ­
cedure a s in the p r evious examp le , al though the independent
acc ountants app arent ly res tr ic ted the ir qualification to us e
of
the "48 - 5 2 " me thod and ignored (or accep ted ) the concep t
3 5Adap ted from 19 6 2 Annua l Report of Nor th Amer ic an Car
Cor p oration .
40
o f repo r t ing the credit bas ed on current and de ferred
in c ome taxe s .
The e f fec t on ne t e arnings was e ight p ercent
wh ich is mate r ia l enough to re sult in a qual ifie d op inion .
36
Gran ite C i ty S te e l Company
( Indep endent accountants - Pr ice Waterhous e
&
Co o )
Income s ta tement -
$ 1 4 , 6 30 , 4 19
Earnings be fore inc ome taxe s
Provis ion for inc ome t axe s
Current year
Inc ome tax deferment resul t ing from
acce lerated me thod o f deprec ia­
tion and inves tment credit (No te 2 )
Income taxes de ferred in prior
years , current ly p ayab le
5 , 742 , 00 0
2 , 450 , 0 0 0
( 9 9 2 :. 000 )
7 :. 20 0 :. 000
Net earnings f or the ye ar
$
7 2 430 2 4 1 9
B a lance s he e t $ 22 , 475 , 000
De ferred inc ome taxes (No te 2 )
(S eparate cap tion af ter
long- term deb t c aption)
No te s to f inanc ia l s tatements -
The Company i s enti t le d t o an inves tment credit
of app roximately $ 4 7 0 , 0 0 0 which is a reduc t ion o f the
current provis ion for inc ome taxes .
An
amount o f $ 244 , 000
has been provided for inc ome taxes which wi l l be p ayab le
in
fu ture ye ars becau s e the law requires app l ic a t ion o f the
inves tment cred it agains t the tax bas is of the property .
3 6Adap ted from 19 6 2 Annua l Rep or t of Granite City S tee l
Comp any .
41
The balance o f $ 2 2 6 , 00 0 , repre s ent ing the pe rmanent tax
s avings , is inc luded in ne t earnings for the ye ar .
D is cus s ion The $ 244 , 000 is inc luded in the $ 2 , 45 0 , 0 0 0 and the
$4 7 0 , 0 0 0 is e l imina ted from the current ye ar income tax p ro ­
vis ion , there fore , the $ 2 2 6 , 0 0 0 , ne t s avings , automatic a l ly
f lows into net earnings .
This is cer tainly a s imp le , ye t
c lear and accep tab le manner o f reporting the inves tment
credit .
37
Wes tinghous e E lec tric Corporation
( Independent acc ountants - Main and Company)
Inc ome s tatement E arnings be fore income taxes
Provis ion for income taxes (Note 3)
$ 98 , 6 6 1 , 8 15
4 1 , 6 00 , 0 0 0
Ne t earnings for the year
$ 5 7 , 0 6 1 , 8 15
Balance she e t Deferred income taxes inves tment credit
( S eparate c ap tion afte r current
liab i l itie s cap t ion )
$
98 0 , 6 3 6
·
No tes to f inanc ial s tatements The p ermanent tax s aving (48% o f the inves tment
cred i t , equal to $ 1 , 00 7 , 5 8 2 ) re �uced income tax expens e in
the year 19 6 2 .
The balanc e o f the inves tment credit was
deferred to the subsequent acc ounting perio ds dur ing which
deprec iation al lowance s for tax purp os es wil l be reduced .
37
Ad ap t e d from 1962 Annua l Rep o r t o f
E le c tr ic Corp oration .
Wes tinghous e
42
D i s cus s ion This tre atment resul ts in the s ame net e f fe c t as
tha t in the previous examp le .
3
Genera l Cab le Corp orat ion 8 ( Independent
ac c oun tants - Peat , Marwic k , Mitche l l & Co . )
Inc ome s tatement Net e arnings be fore inc ome taxes
Provis ion for inc ome taxe s (No te 2 )
Ne t earnings fo r the year
$ 21 , 692 , 170
10 , 5 5 0 , 0 0 0
$ 1 1 , 14 2 , 1 7 0
No te s to f inanc ia l s tatements The portion o f the inves tment credit equa l t o the
tax that may be p ayab le in the future becaus e o f reduc tion
in
future deprec iat ion has b e en credited to accumulated de ­
prec iation and the rema inder o f $ 6 7 , 0 0 0 has been app lied in
the reduc t ion o f the p rovis ion for income tax .
D is cus s ion S imi lar to the two p revious examp les , the p rovi ­
s ion for income taxes . was reduced by the p ermanent tax
s avings , however , the ba lance s he e t tre atment is dif ferent
in that accumulated deprec iat ion no t de ferred income taxes
is credited by the portion of the inves tment credit which
is no t a tax s avings .
This is an equa lly accep tab l e repor t ­
ing prac t ic e .
38
Adap ted from 1 9 6 3 Annu al Report o f General Cab le
Corp oration .
43
s.
39
Kre s ge Comp any
( Indep endent accountants - Pr ice Waterhous e
s.
&
Co , )
Income s ta temen t Earnings be fore inc ome taxe s
$ 18 , 1 17 , 163
Provis ion for income taxe s inc lud ing
de ferred income t axe s , les s 48%
o f inve s tment credit
9 , 1 03 , 0 0 0
Ne t earnings for the year
$
9 , 0 14 , 163
Ba lanc e she e t D e ferred income taxe s
( S e p arate c ap t ion af ter long­
term deb t c ap t ion)
$ 1 1 , 940 , 3 9 6
Notes to f inanc ial s tatements The inve s tment credit will reduc e federa l income
tax p ayments by approx imately $ 4 9 5 , 8 0 0 of which 48% has
been re f l ec ted in inc ome and 5 2% de ferred to future years .
D is cus s ion This treatment is vir tual ly identic a l to that us ed
by Granite C ity S te e l Comp any o
40
Kopp ers Comp any , Inc .
( Independent ac countants - Ar thur Young
&
Comp any)
Inc ome s tatement Earnings be fore p rovis ion for
inc ome taxe s
$ 13 , 8 2 3 , 040
Provis ion for income taxe s (No te 6 )
5 , 9 9 7 , 6 14
Ne t earnings for the ye ar
39
Adap ted from 1 9 6 2 Annual Rep or t o f
Comp any o
Inc o
$
s.
s.
7 , 8 25 , 426
Kre s ge
40
Adap ted from 19 6 2 Annu al Repor t o f Kopp ers Comp any ,
44
No te s to f inanc ial s tatements The Company ' s inve s tment credit amounted t o
$ 5 14 , 0 0 0 .
Of the cred i t , 4 8% , which was immater ial in r e l a -
cion to ne t income , was re f lec ted in income as a reduc tion
of
federal income tax exp ens e and the balanc e was credi ted
t o d e ferred inc ome taxes o
D is cus s ion This is e s s entially the s ame tre atment as us ed by
We s t inghous e E le c tr ic Corp o r a t ion .
41
Anchor Ho cking Glas s Corporation
( Independent ac c ountants - Price Wa terhous e
&
Co . )
Inc ome s tatement Ne t e arnings for the year (No te 2 )
$
6 , 63 3 , 104
$
5 64 , 50 1
Balanc e she e t De ferred income taxe s (No te 2 )
( S eparate c ap t ion af ter current
liab il i t ie s c ap t ion)
No tes to f inanc ial s tatements The inves tmen t credit reduc es inc ome taxe s curren t ly
p ayab le b y $ 3 7 2 , 0 00 o
Ne t earnings inc lude $ 1 78 , 0 0 0 , or 4 8 %
o f the inve s tment credit , and the remaining 5 2% has been
p r ovided as de ferred inc ome taxes p ayab le over the es t ima ted
s ervice l ives of the equipment add it ions o
Dis cus s ion -
41
Adap ted from 1962 &�nua l Rep ort o f Anchor Hocking
Glas s Corporation .
45
This treatment is qui te s imi lar to the Granite
Ci ty S te e l Comp any r ep or t .
O ther Methods
42
Tenne s s ee Gas Tr ansmis s ion Comp any
( Independent accountants - Ar thur Anders en
&
Co , )
Income s tatement Earnings be fore inc ome deduc tions
Inc ome deduc t ions
Charge equivalent to inves tment
credit income tax deduc tion
(No te 7 )
Interes t and o ther income deduc t ions
$ 1 1 6 , 7 5 5 , 400
4 , 98 5 , 000
4 5 , 945 , 3 7 2
50 , 9 30 , 3 7 2
Ne t e arnings for the ye ar
$ 6 5 , 8 2 5 , 028
No tes to f inancial s ta tements The inves tment credit genera lly has been rec orded
pursuant to an order of the Federal Power Commis s ion pre ­
s cr ib ing inter im acc ount ing which p rovides for a char ge to
" Income Deduc t ions " equivalent to the reduc t ion in curren t
federal income taxes and a corres p onding cred i t to "De ferred
Cred i ts " p end ing a f inal de termina tion o f the p rop er ac c ount­
ing treatment by the Commis s ion o
At Decemb er 3 1 , 1 9 6 3 , the
c omp anie s ' unus ed ' inves tment credit aggregated app roximate ly
$ 3 , 8 0 0, 0 00 .
42
Adap ted from 1 9 6 3 Annual Report of Tenne s s e e Gas
Transmis s ion Comp any .
46
D is cussion This treatment results in the entire i�vestment
cr e dit being deferred to future p eriods, with no p art being
r e corded as income in the current year .
43
G e neral Tele phone Company of California
(Indep endent ac countants - Arthur Andersen
&
Co . )
Income statement Provision for income taxes (Note 4)
$ 2 2 , 390 , 0 0 0
Net earn ings for the year
$ 2 4 , 48 6 , 2 5 5
Notes to financial statements The investment tax credit applicable to eligible
property add itions amounted to $ 1, 728 , 0 0 0 in 1963 and
$ 1, 0 7. 0, 0 0 0 in 196 2 .
In accordance with the requirements of
the uniform system of accounts prescribed by the California
Public Utilities Commission , these amounts have been
deducted from the provisions for income taxes, thereby
increasing reported net · earnings by the same amount .
F or
income tax purposes , depreciable property is being reduced
by the investment credit resulting in lower depreciation
allowances and higher income taxes in future years .
These
higher taxes will be charged to expense as they arise .
Discussion As can be seen from the note, the entire investment
credit was recorded as income (10 0 percent flow through
method) .
43
Adapted from 1963 Annual Report of General Telephone
Company o f California .
47
44
T e l e pho n e & E le c tronics C orp o r a t i on
lindependent a c c oun t an t s - Ar thur Anders en & Co . )
�ne r a l
rnc ome s tatement Net earnings for the ye ar
$ 105 , 08 6 , 0 0 0
No t es to f inanc ial s tatement s The es t ima ted amount o f the inve s tmen t cred its as
reco rded in the accounts o f cons o l idated subs id iar ie s ,
to t a l ing $ 6 , 2 2 2 , 0 0 0 in 1 9 6 3 and $4 , 0 6 5 , 0 0 0 in 1 9 6 2 , has
b een re f lec ted in the c ons o lidated f inanc ial s tatemen ts as
fo l lows :
Manufac tur ing Comp anies - The inve s tment credits
of $ 8 3 3 , 0 0 0 in 1 9 6 3 and $ 5 8 1 , 0 0 0 in 1 9 6 2 have been app lied
as reduc t ions· in the ne t cos t of the app l icab le proper ty
add it ions and are b e ing amo r t ized over the es t ima ted s ervice
life of the p rop er ty through reduced deprec iat ion exp ens e .
The amount o f s uch amor t iz a t ion was $ 154 , 0 0 0 in 19 6 3 and
.
$45 , 0 0 0 in 19 6 2 .
Telephone Op er a t ing Comp anies - The inve s tment
cred i ts app licab le to r e gula ted te lephone op erating comp an­
ies amounted to $ 5 , 38 9 , 0 0 0 in 1 9 6 3 · and $ 3 , 484 , 0 0 0 in 1 9 6 2 .
At Dec emb er 3 1 , 19 6 2 , the Federal Commun ic a t ions
Commis s ion and mos t o the r regulatory agenc ie s had no t ye t
de te rmined the p ermanent acc ounting treatment which s ubj e c t
comp anies would b e required t o fo llow .
For this reas on , the
to tal amount of the inves tment credits app l icab le to a l l
&
44
Adap ted from 19 6 3 Annu a l Rep ort o f Gene ral Te lephone
E le c tronics Corpora t ion .
regulated telephone companies was deferred in the c onso li ­
da t e d financial statements, including $ 1 , 2 1 6 , 0 0 0 applicable
to
the
c omp anies operating in two states which had accounted for
inves tment credit as a reduction in the prov ision for
inc ome taxes in accordance with orders or notices received
from regulatory commissions .
The accounts of all companies
were adj usted to interim procedures authorized by the Federal
Communications Commission o
In the 1 9 6 3 consolidated financial statements, the
investment credits for all telephone operating companies
have been accounted for in substantially the same manner as
recorded by the individual companies (including those
amounts applicable to 19 6 2 which had been adj usted) .
The
investment credits for companies which are subj ect to the
Federal Communications Commission or which have not received
p ermanent accounting orders from other regulatory agencies
h aving j urisdiction have been deferred in the same manner
as in 1 9 6 2 Q
The investment credits for companies which have
received permanent · accounting orders from regulatory agencies
h aving primary j urisdiction have been reflected in the con­
solidated f inancial statements in accordance with such
orders .
Pu�suant to this accounting treatment, investment
�redits of telephone operating companies totaling $ 3 , 3 1 7 , 0 00 ,
)f which $ 1 , 2 16 , 0 00 applies to 1 9 6 2 , are included in net
�arnings for 1 9 6 3 .
49
As
o f D e c emb e r 3 1 ,
1963 ,
inve s tmen t c r e d i t s o f
$ 5 , 5 5 6 , 0 0 0 are inc lud e d in r e s erve s and d e fe r r e d c r e d i t s .
D is cus s ion I t would ap p e ar tha t a t leas t thr e e d i f f erent
me thods wer e in us e ,
inc lud ing the c o s t r e duc t ion me thod ,
1 0 0 p er c ent d e f er r a l and the
Th is
is
1 0 0 p e r c en t f l ow thr ough me thod .
ind e e d an in t e r e s t in g bu t s omewhat c onfus ing p r e s en-
ta t ion .,
Re f le c t ions on the C o s t Reduc t ion and "48 - 5 2 "
Me thods Us e d Dur ing 1 9 6 2 and 1 9 63
As has b e en p r evious l y s tated ,
gene r a l ly the var ious
on
i t wou ld ap p e ar tha t
c omp an i e s r e p o r te d the inve s tment c r e d i t
the b a s is sup p o r te d by the ir ind ep endent a c c ountant s .
In
the p r e c e d ing examp le s , b o th Ar thur Young & C omp any and P e a t ,
Marwic k , Mi t che l l & C o .
rende r e d qua l i fied op in ions ;
the y
a l s o gave o p inions without qua l i f ic a t ion on c omp an i e s wh ich
had in one ins tance fo l lowe d the c o s t r e duc t i on me tho d and
in ano the r the " 48 - 5 2 " me tho d .
& Co .
qua l i f i c a t ion ap p ea r s
The P e a t ,
Marw ic k ,
Mi tche l l
incons i s ten t w i th the ir p r e v ious ly
s ta t e d p o s i t ion of al lowin g the ir c l ients max imum leeway .
Ar thur Young & C omp any , howeve r , had b e en r a ther out s p oken
in its
sup p o r t o f the c o s t r e du c t ion me tho d ,
but as
ind i c a t e d
in the no te to the Kop p e r s Comp any ' s f inanc i a l s t atement s ,
the e f fe c t on inc ome was
g iven ,
imma te r ia l .
( Bas e d on the amoun ts
i t wou ld ap p e ar tha t the var iat ion f r om the Ar thur
Young & C omp any s t ated p o s it ion had an ap p r o x ima te thr e e
5(
perc ent e f fec t on � e t inc ome - ac c ountants traditionally use
a
five to ten percent ru l e of t humb f or ma teriali ty in
rela tion t o net inc ome. )
Al th ou gh not incl uded in any of the
prec eding examples , no doubt other certi fied pu blic a c c ount ­
ants f ound themselves in p ositions similar t o Arthu r Young &
C omp any .
Re flec tions on Other Meth ods
Used Du ring 1 9 6 2 and 1 9 6 3
I t is interes ting t o note that the three example s
o f o ther me thods ( all regul a t e d c ompanies )
produc e d three
c omple tely opp osing ac c ounting trea tments.
These me thod s
inc lu ded 100 perc ent deferra l o f the investmen t c r e dit in
'
the firs t ins tance (Tennesse e Gas Transmissi on C ompany ) ,
100 percen t fl ow thr ou gh t o inc ome in the sec ond ins tanc e
( Gene ral T el e phone C ompany o f C alif ornia )
ins t anc e
and , in the third
( General Telephone & Elec t r onics C orp ora tion ) ,
a
combination of severa l di f fe ren t me thods used by the paren t 1 s
var i ou s subsidiar i e s .
All
of the lat ter three c omp anies '
financial
s t a t ement s we re rep o r t e d on by Ar thu r Andersen & C o.
eac h ins t anc e an unqu ali fied opinion was given.
first tw o ins t anc es ,
I n the
the inves tment c redi t was ove r seven
perc ent of ne t inc ome ,
ma teriality c oncep t ,
and in
and thus ,
a � suming t he ten pe rcent
the independent a c c ount ant app arent ly
felt tha t no qu ali fi c a tion a s t o use of "generally a c c e p t e d
acc ount ing pr inc ip le s 11 wa s ne c e s s ary.
In any even t ,
the re
s:
Has adequate d is c losure o f the me thods us ed .
I t would
ap pear that the ma ter iality c onc ep t was the reas on for the
' ' c lean " op inions s inc e the f irm invo lved was managed by
Le onard S p acek , p robab ly the acc ounting p r o fe s s ion ' s lead ing
advo c a te o f the c o s t reduc t ion me thod , even in ins tanc es
45
.
.
wh ere regu 1 ate d comp an�es we re �nvo 1 ve d •
Summary
Al though the Ac c oun t ing Pr inc ip les Board of the
Amer ican Ins t i tute o f Cer t i f ie d Pub l ic Ac c ountants had
o f f i c i a l ly gone on record as rec ommending the c o s t reduc tion
me thod o f ac c ount ing for the inve s tment credit , i t is
app ar ent tha t compe tent c e r t i f ied pub l ic acc ountants and
leading exe cut ive s o f the bus ine s s c ommunity did not agree
that this was the only and / or bes t me thod o f acc ounting
there for .
As a result of this d is agreement , we w i l l d is -
cover in the next chap ter that the Ac c ounting Pr inc ip les
B o ard dramatic a l ly recons idered and altered its or iginal
s tated p o s i t ion .
We wi l l als o s ee how the p rovis ions o f
the Revenue Ac t o f 1 9 6 2 related to the inve s tmen t cred it
wer e amended .
45
Leonard S p acek, "Ac c oun t ing Tr e atment o f Inves tmen t
Credit , " Speech p r e s ented befor e the Gre a t Lake s Conf erenc e
o f Ra ilroad and Util ities C ommis s ions , White Sulphur S p r ing s ,
Wes t Virg inia , June 2 1 , 1 9 6 3 and before The Mountain-Pac if ic
S t ates C onferenc e of Pub l ic S ervic e C ommis s ions , S anta Fe ,
New Mexic o , June 26, 1 9 63 Q
CHAPTER I V
S I GNIF ICANT EVENTS
OC CURRING I N 1 9 64
The prev i ou s cha p te r de s c r ib e d event s oc curring
du r i ng 19 6 2 ,
1 9 6 3 and e a r ly 1 9 64 .
s i de ra t i on w i l l b e g iven
In th i s cha p ter ,
1 9 6 4 amendment s t o the or i g ina l
to
provis i ons of the investmen t tax c redi t .
tha t in 1 9 64 ,
We wi ll a l s o s e e
a s a re su l t o f the ac c ou nt ing prac t ic e s d i s ­
cu s s ed in Chap ter I II ,
Publ ic Ac c ou n t ant s
its
c on ­
the Ame r i c an I ns t i tu te
of C e r t i fied
in s p i te of nu mer ou s c r i t ic i s m s ,
mod i f ie d
ini t i a l s tand on ac c ount ing f or the inve s tment c re dit .
The rema inder o f th i s cha p t e r wi l l de a l w i th the e f fec t
th i s change
of
in terms o f the me thods u s ed t o rep or t the
investment c re d i t dur ing 1964 .
Revenu e Ac t o f 1 9 6 4
S inc e the int r odu c t i on o f the inve s tment t ax
c re d i t ,
the bu s ine s s c ommu n i ty and a c c o un t ing p r o fe s sion had
been .h i gh ly c r i t ic a l of S e c t i on 48 ( g )
Code .
Thi s
of the Int erna l Revenu e
s e c ti on requ ire d tha t the de prec iab l e t ax b a sis
of . the qu a l i f i e d inve s tme nt b e redu c e d by the inve s t ment
c re d i t t aken there on .
1
The r equ i rement resu l t e d in a gre a t
dea l o f c le r ic a l work and ,
o f c ou r s e ,
redu c e d the ac tu a l t ax
bene f i t s t o app r ox ima t e ly one -half of wha t they wou l d have
otherwi s e been .
1
H ou s e ,
The C ongre s s a c c e p te d the l a t te r c ompla int s
Interna l Revenu e C ode ,
Inc . , 1964) , p . 3920 .
( Chic a g o :
2
C omme rc e Clearing
53
as
b e ing fac tu a l and introdu c e d the Revenu e Ac t o f 1 9 6 4
·wh ich
inc lu d e d an amendment t o the Interna l Revenu e C ode repea l ing
s e c t i on 48 ( g ) .
la\v
as
2
The Revenu e Ac t of 1 9 6 4
Public Law
ment t o
reduce
wa s
enac t e d int o
8 8 - 2 7 2 on F eb ru ary 2 6 , 1 9 6 4 .
the
basis was
3
The requ ire -
e l iminated , b a s ic a l ly ,
p r op e rty p lac e d in s ervic e a f t e r Dec ember 3 1 , 1 9 6 3 .
As
soon as the Revenue Act of
1 9 64
s upporters of both the cost reduction and
claimed victory.
as
to
4
was announced,
"48 - 5 2 "
method
E ach side stated that elimination of the
basis reduction proved that its method had been right from
the start.
"48 - 5 2 "
Proponents of the
100
percent flow through
and
method argued that now quite clearly the Internal
Revenue Code supported the contention that the investment
credit was,
taxes .
and always had been,
a selective reduction in
Those who preferred the cost reduction method dis ­
puted this and indicated that the change was to further
reduce the net cost of dep rec i ab l e pr o per ty by ef fect ive ly
allowing a larger tax redu ct i o n .
As a result of the change,
became the s ame as the
100
the
"48 - 5 2 "
method
percent flow through method
s ince the only dif ference between the two methods was the
deferral of the lost depreciation benefits which no longer
existed .
2 Ib id .
3 rb id . , p .
4
ii.
Ib id o , P • 3 9 2 0 .
54
The Ac c oun t ing Pr inc ip l e s B o ar d
Rev i s e s Op in ion No . 2
In e ar l y
in an unp re c e dent e d ac t ion ,
1 9 64 ,
Ac c oun t ing P r inc ip l e s
B o a r d o f the Ame r i c an Ins t i tu t e o f
Ce r t i f ie d Pub l ic Ac c ountan ts me t t o aga in d is cus s
ac c oun t ing t r e a tmen t of
:9 64
the
r e l e a s e d Op in ion N o o
tha t d e s p i t e
the
the
inve s tment c r e d i t and in Mar c h
4o
The new Op in i on p o in t e d ou t
the p rev ious ly r e c o r d e d p r e f e r enc e f o r
the
r e duc t ion me tho d ,
a s ign i f i c an t numbe r o f c omp anie s had
chos en to us e
100
the
p e r c en t f l ow through
The Op in ion a l s o acknow l e d ged tha t
e l imin a t e d the b as is
r e duc t i on ,
\vay c hange d the natur e of
t ion in b a s is ,
p e r io d o f
change
19 64
in no
th e inve s tmen t c r e d i t and was no t
tha t r e gard l e s s
the bas ic
me tho d .
the Revenue Ac t o f
bu t s t a t e d tha t th is
the r e as on f o r revis ing Op inion No .
r eas on ing was
( "48 - 5 2 ' ' )
cos t
of
2o
App ar en t ly ,
the
the r e quir emen t for r e duc ­
ac c ount ing ques t ion re l a t e d
to
the
inc ome r e a l i z a t ion which was no t a f f e c t e d by the
in b a s is o
The Ac c ount in g P r inc ip le s
tha t the main r e a s on f o r
B o ar d ind ic a t e d
the amendment w a s due
to
tha t s ub s e quen t exp e r ienc e s howe d that Op inion No o
the f ac t
2
had no t
. ve d gener a 1 ac c ep t ab �
. l�
. ty o 5
rece �
Op in ion No .
4 which p as s e d by a v o t e o f f i f teen t o
f ive r e i t e r a t e d tha t the c o s t r e duc t ion me thod w a s s t i l l
p r e f e r ab le ,
but c onc lud ed that " the a l t e rnat ive me thod o f
tr e a t ing the c r e d i t
as
a r e duc t ion o f F e d e r a l inc ome
taxe s
5 "Ac c ount ing for the ' Inve s tmen t C r e d i t ' , " Op in ions o f
�he Ac c ounting P r in c i p l e s B o ard , No . 4 ( amend ing No . 2 ) ,
(�ew Y o r k : Amer i c an Ins t i tu t e o f C e r t i f ied Pub l ic Ac c ount ­
an ts , 19 64 ) , p . 2 2 o
55
o f the ye ar in which the c re d i t aris e s is a ls o accep table . "
Typ ical o f a l l the previous fur or ove r the inve s tment
c red i t , there were e igh t as s ents with qua l i f ic a t ion , and
the s e as s ents a � ong with the f ive dis s ents we re app roxi­
mate ly twice as long as the Op in ion its e l f .
Much o f the
as s ent ing with qualific a t ion and dis s .en t ing re lated to
fears tha t the current emphas is within the account ing p r o ­
fe s s ion on narrowing the are a o f accoun t ing p r inc ip le s was
undermined by author i z ing accep tanc e . o f two dif ferent
ac c oun ting p r inc ip le s for the inve s tment credit .
F ive o f
the as s ente r s fe l t that the order o f pre ference s hou ld b e
reversed .
Leonard Spacek in a ve ry lengthy di s s ent
s tated , among o the r is s ue s , that "Alterna t ive proc edure s
under this op inion c an inc reas e by up to 2 5 p e r cent the
e arn ings o the rwis e repor ted
•
•
•
this Op inion app rove s
accoun ting o f the typ e that p re c ip itated the 1 9 2 9 financ ial c r is is , and that his tory is be ing rep eated by ac tions
of the ve ry authoritie s created to preven t such c a tas tro ­
phe s . "
7
I t would app e ar that
Mr .
Spacek ' s main concern
was not s o much his dis agreement wi�h the a lternat ive
me thod , bu t rathe r tha t the amended op inion , ins tead o f
narrowing the are a o f accounting d i f ferenc es ac tua lly
. accomp lished the oppos ite e f fec t by "authorizing" two
d i f ferent me thods .
6
7
He app arently bel ieved tha t the 1 9 2 9
Ib id .
Ibid . ,
pp .
22- 25.
6
56
c r isis was
p a r t i a l ly
caused by a lack of uniformity in
accounting principles.
The Accounting Princip les Board ' s acceptance of
the alternative method raised the question as to how the
independent accountant should report upon companies which
changed their methods of accounting for investment credit.
It appeared that since the Revenue Act of 1964 essential ly
made the "48 - 5 2 " and 100 percent flow thro ugh methods
identical , changing from the former to the latter method
was due to changed conditions and , therefore , no mention
need be made in the accountant ' s report ( opinion) ; however ,
if a material effect resulted , footnote disclosure would
be required.
A change from the cost reduction to the 100
percent flow through method , however , was a change in
accounting principles , much the same as a change from
straight line to accelerated depreciation would be , and
should be covered in the report
the f �nanc�a
.
. 1 statements .
8
if it material ly affected
9
As a result of the Accounting Pr inciples Board ' s
new stand on the accounting treatment of the investment
credit , three federal regulatory agencies , the Federal
Power Commission , the Federal Communications Commission and
8
"Accounting and Auditing Problems , " The Journal of
Accountancy , May 1964 , p . 7 1.
9
"Auditing Standards and Procedures , " Statements on
Auditing Procedure No. 3 3 , (New York : American Institute of
Certified Public Accoun tants, 1 9 6 3 ) , p . 4 2 .
57
th e C iv i l Aeronautic s Bo ard author ized the us e o f e i ther
of
the ac c e p tab le me thods r e c o gnized by Op inion No . 4 . 10
Me thods
A c t u a l ly
Us ed in 1 9 64
lhe fo l lowing tab l e s summar ize ac tua l me thods us e d
in
1 9 64 as r ep o r ted to the Amer ic an Ins t i tute o f Cer t i f ied
Pub lic Ac c ountants .
11
Numbe r of c omp anies in
survey which d is c lo s e d
me thod o f rep o r t ing
inve s tmen t tax cred i t
Inc ome treatment
1 0 0 p e r c ent f low through me thod
C o s t r e duc tion me thod
O ther ways
30 2
68
7
_
377
Ba lanc e s he e t treatmen t
D e ferred inves tment c r e d i t
Re s erve for dep r e c iation
D e ferred income taxe s
O ther ways
40
17
12
3
72
=
As c an b e s e en from the ab ove tab le s , ther e was
a dec ided switch from the c o s t reduc t ion me thod as c omp ared
to 1 9 6 2 and 1 9 63 (see p age 31 ) .
Very few balance s he e t
tre a tments are ind icated becaus e o f the 30 2 c omp anie s whi ch
r e c orded the inv e s tment c r e d i t as income .
10
"News Rep or t , " The Journal o f
p p . 1 2 - 14 .
Ac c oun t an c y , March ,
1965 ,
1 1Ac c oun t ing Trend s & Techn iq ue s , (New York : Amer ic an
Ins t i tute o f Cer t i f ie d Pub lic Ac c oun tants , 1 9 6 5) , p . 1 3 7 .
58
E xcerp ts from
1 9 64 Annual Reports
The following p ar agraphs i llus trate examp les of
s ome of the
1 9 64 disclosures of changes to the 100 p ercent
f low through method of accounting for the inv estment credit .
'
Excerpts from the independent accountant s opinion are shown
only where t here was a qualification relative to the invest­
ment credit .
As in the p revious chapter , the accounting
terminology has been standardized .
Change from Cost Reduction Method
12
S outhern California Edison Comp any
( Independent accoun tants - Arthur Andersen & Co . )
Income statement Net e arnings for the year
$ 7 7 , 053 , 122
Notes t o financial statements '
Inasmuch as the Company s rates were reduced in
1964 , on the b asis of the investment tax credit "flowing
through
"
for the benefit of customers,
commencing in
the Company,
19 64 , discontinued further prov isions to
normalize the effect of the investment tax credit .
The
amount of the investment t ax credit is es timated to b e
$ 3 , 5 64 , 0 0 0 for 1 9 64 .
Other income includes a credit of
$ 4 , 49 5 , 0 0 0 as of Decemb er 3 1 , 1 9 64 , for the deferred amount
o f the inves tment tax credit which was charged to miscellan-
12
Adapted from 1964 Annual Report o f S outhern Cal i fornia
E dison Company .
59
eous deductions
( $ 1 , 2 28 , 0 0 0
in
1962
$ 3 , 2 67 , 000
and
in
1 9 63 )
according to regulatory r e qu i r emen t s .
D iscussion The disclosure o f the
inve s tmen t credit ap pear s
change in accounting for the
ade qt.:a te ,
the indep endent accountants '
but i t is no t c lear why
opinion is not q ualified.
S ince net earnings for the year appe ars to be increased by
approximate ly ten percent
$ 7 7 , 000 , 000)
(.approximately
as a result of the chan ge,
$8 , 00 0 , 000
out of
an opinion q ualified
as to consistency would app e ar ap propriate.
13
( Independen t
Kennecot t Cop p er Co rporation
ac c oun t ants - Lybrand , Ro s s Bros . & Montgomery )
Income statement Ne t earnings before provis ion for
income taxes
Provision for income t axes
Net earnings for the year
( Note
$ 14 0 , 4 9 8 , 2 7 9
8)
74 , 40 0 , 0 0 0
$ 6 6 , 0 98 , 2 7 9
Notes to financial statements Prior to
1 9 64 ,
the Comp any reflected the investment
credit in earnings over the p ro duc t ive lives of the related
p roperties .
Beginning in
1 9 64 ,
the investmen t credit is
being acco unted for as a reduction of income taxes in the
year in which the credit arises .
As a resul t of this change,
net earnings for - the year have b e en in c re a s e d by app r ox im a t e ly
13
Adap ted from
Corp o r a t ion .
1 9 64
Annual Report of Kennecott Copp er
60
$ 9 0 0 , 000 .
The inve s tment credit provided in pr ior years
( $ 2 , 100 , 000) was trans ferred to taxe s ac crued to provide
f or p os s ib le pr ior years ' as s e s sments .
D is cus s ion The d is c losure o f the ac counting change app e ars
ad e quate , and s ince the inve s tment credit is no t material
in
relation to ne t · earnings , no cons is tency qualificat ion is
nec es s ary .
I t is intere s t ing to no te that the de ferred
p o rt ion of the inve s tment credit ( from pr ior ye ar s ) was
trans ferred to the tax liab i lity account , thus byp as s ing
the inc ome s tatement .
.
"14
Drap e � Corp orat�on
( Independent ac countants - Price Wate rhous e
&
Co . )
Op inion o f indep endent accountants Qua l i f ied as to c ons is tency re lative to the change ,
app roved by the indep endent acc oun tants , in acc ount ing for
the inve s tment credit .
Income s tatement Ne t earnings for the year
(Dep r eciation and p rovis ion for
inc ome taxe s were e ach
re ferenced to Note 3 )
$
6 , 04 6 , 12 7
Balance she e t De ferred credits - No te 3
( S ep arate c ap t ion a f ter current
l iabil ities c ap t ion)
14Adap ted from
$
-
o
-
19 64 Annua l Report o f Drap er Corp oration .
61
N o te s to f inanc ial s tatements In p r ior years the Comp any fo l lowed the prac t ic e
o f taking the inves tment tax cred i t into earnings over the
es timated us e fu l l ive s o f the re la ted as s e ts .
In 19 64 the y
ch an ged to the 100 p ercen t f low through me thod , whe reby
inve s tment tax cred its are taken into e arnings in the year
in which the re lated as s e ts are acquired .
This change in
a c co unting me thod had the e f fe c t o f increas ing 1 9 64 ne t
ea rnings by abou t $45 0 , 0 0 0 , which amount inc lude s $ 28 0 , 0 0 0
app licab le to p r ior years .
Dis cus s ion Bo th the dis c losure and the qual i f ied op inion
re lative to the change in ac c oun t ing for the inves tment
credi t app ear proper .
15
P o laro id C orp oration
( Ind ependent ac countants - Leonard Lev ine
&
Co . )
Opinion o f independent ac c ountants C ons is tency qua l i f icat ion due to change , concurred
in by the indep endent accountants , in ac c ount ing for the
inves tment credit .
Income s tatement Ne t e arnings for the year (No te G)
$ 18 , 3 2 3 , 0 9 6
No tes t o f inanc i a l s tatements In pr ior years the Comp any e le c ted to amor tize
inve s tment credit ove r the l ife o f prop e r ty to which it
15
Adap ted from 1 9 64 Annual R eport of Po laro id Co rPoration .
62
ap p l ied .
With a change in the Interna l Revenue Code for
1 9 64 , a dec is ion has been made to re fl e c t the full credit
in
the p e r iod in which the equipmen t to which it p e r ta ins
is
put into us e .
The provis ion for 1 9 64 income taxes is
a f t er deduc tion o f $ 1 , 18 9 , 0 0 0 .
O f this , $ 28 1 , 5 1 2 rep re s ents
c r e d i t for c ap i tal add i tions in 1 9 64 .
The remainder ,
$ 9 0 7 , 48 8 , is an adj us tment o f p r ior years ' unamortized
ba lanc e s , resulting in non- recur r ing e arnings from this
s ource of 5 . 8 ¢ p e r s hare .
Dis cus s ion The rep or t ing me thod app ears adequa te , but it may
be
more informa t ive to d is c lo s e within the inc ome s ta tement ,
rather than by footno te on ly , that there is an extraordinary
income item inc luded in the ac counts .
16
Goodman Manufac tur ing Company
( Independent ac coun tants - Pr ic e Waterhous e
&
Co . )
Op inion o f independent ac countants Qua l ificat ion as to change , approved by the
independent ac countants , in ac c ount ing for the inves tment
cred it .
· Inc ome s tatement Ne t e arnings for the year
(Provis ion for inc ome taxe s was
re ferenced to No te 2 )
$
3 68 , 454
16
Adap ted from 19 64 Annual Repor t of Goodman Manufac tur ­
ing Comp any .
63
N o te s to f inanc ial s tatements S inc e the Revenue Ac t o f 1 9 64 provides tha t the
inves tmen t tax c redit no longer reduce s the deprec iab le bas e
o f the re lated as s e ts , the C omp any has adop ted the account­
in g me thod which re f l e c ts such credit in earnings in the
y ear in which i t ar is e s .
Ac c ord ingly , the 1 9 64 p r ovis ion
fo r inc ome taxes has been reduced app roximate ly $ 4 2 , 5 0 0 for
th e inves tment cred i t aris ing from quali fied proper ty add it i ons dur ing the years 19 6 2 , 1 9 6 3 and 1 9 64 .
D is cus s ion An
accep tab le rep or t ing me thod , and a l though
re lat ive ly more o f a mate r ia l change , it is identical to
t he p rac tice fo l lowed by the Draper Corp o r a t ion in a previous examp le •
Change from "48 - 5 2 " Me thod
17
Jone s & Laugh l in S te e l C orporat ion
.
( Independent ac c ountants - Price Waterhous e
&
Co . )
Income s tatement Ne t earnings for the ye ar
(Las t c ap t ion under c o s ts
and expens e s was - Provis ion
for income taxes , le s s inve s t ­
men t tax cred i t o f $ 7 , 2 3 5 , 00 0
in 1 9 64 and $ 1 , 5 3 7 , 00 0 in 1 9 63
(No te F) )
$ 6 0 , 0 78 , 00 0
No tes to f inanc ial s tatements 17
Adap ted from 19 64 Annual Report of J one s
S tee l Corporat ion .
&
Laughl in
64
The Revenue Ac t o f 1 9 64 e l iminated , re troac tive ly ,
the
p rovis ion o f the tax law requiring a reduc tion in the
deprec iab le bas is of prop er t ies which qua l ified for the
inve s tment tax credit .
The rema in ing balance o f amounts
1e ferred ( 5 2 p e r c ent ) in 1 9 6 2 and 1 9 6 3 , $ 2 , 4 5 4 , 0 0 0 , was
tr ans ferred to curr ent l iab i l ities to pr ovide for add it ional
:axes that may ar is e re la t ing to pr ior years .
The en t ire
i_nve s tment tax credit of $ 7 , 2 3 5 , 00 0 app licab le t o p r op e r t ie s
1 lac ed in s ervic e dur ing 1 9 64 i s inc lude d in ne t e arn ings as
. reduc t ion of the pr ovis ion for income taxe s .
> is cus s ion An ac c ep tab le rep or t ing p rac tice , and s imi lar to
Kenne c o t t Copp er Corp o r a t ion , in a pr ior examp le , the previ­
ous ly de ferred p o r tion o f the inves tment credit was trans ferred to the tax l iab i l ity ac c ount to p r ovide for p o s s ib l e
pr ior ye ars ' as s e s sments .
18
Gene s co Tnc
( Indep endent
acc oun tan ts - Pe at , Marwic k , Mi tche l l
.
&
Co. )
Inc ome s ta tement Ne t e arnings for the year
(Provis ion for income taxe s was
re ferenced to Note 2 )
$ 13 , 2 2 1 , 9 18
Balance she e t D e ferred income taxes (No te 2 )
(S ep arate c ap t ion after curr ent
l iab il ities c ap tion)
18
$
4 , 28 3 , 00 0
'
Adap ted from 1 9 6 4 Annua l Rep o r t o f Gene s c o , Inc .
65
N o tes to f inanc ial s tatements The p rovis ion for inc ome taxes is after deduc t ing
the inves tment cred it for the current year of $40 2 , 19 3 and
$ 198 , 046 de ferred in pr ior years .
D is cus s ion The me thod o f rep or t ing is acc ep tab le .
19
The Gene ral Tire & Rubber Comp any
( Indep endent ac countants - Pr ic e Waterhous e
&
Co . )
Income s tatement Ne t e arnings be fore provis ion for
inc ome taxes
Prov is ion for inc ome taxe s (No te H)
Ne t e arn ings for the year
$ 65 , 13 3 , 4 6 5
28 � 2 10 � 0 0 0
$ 3 6 2 923 2 465
Notes t o f inanc ial s tatements Due to revis ions in 19 64 of the Internal Revenue
Code , the entire inves tment tax c red i t for 1 9 6 4 of
$ 1 , 940 , 0 0 0 and the de ferred p o r t ion o f the inve s tment tax
credit provided in 1 9 6 2 and 1 9 6 3 o f $ 1 , 4 9 7 , 00 0 are inc luded
in the ne t earnings for 1 9 64 as a reduc t ion o f the p rovis ion
for inc ome taxes and a reduc tion of the dep re c ia t ion exp ens e ,
resp e c t ively .
D is cus s ion Ac cep tab l e rep or t ing prac t ice is f o l lowed , however ,
this is the f irs t c ited examp le where the inve s tment cred i ts
19
Adap ted from 19 64 Annual Rep or t o f The Gene ral Tir e
Rubber Comp any .
&
66
o f pr ior years are taken in to e arnings by reduc ing deprec i-
a t ion expens e .
20
The Budd C omp any
( Inde pendent
ac c ountants - Peat , Marwic k , Mi tche l l
&
Co . )
I ncome s ta tement Ne t earnings be fore ex traordinary items $
Extraord inary items :
Gain ( los s ) on s a le s o f cer tain
p rop er t ie s and inves tments , les s
tax e f fe c t
Pr ior year ' s inc ome tax adj us tments
2 , 527 , 991
$
3 , 709 , 0 72
Ne t earnings for the ye ar
3 7 2 , 298
8 08 , 78 3
No tes t o f inanc ial s ta tements As the Revenue Ac t o f 19 64 now permi ts the fu l l
r e c overy o f the inve s tment cred i t , the unamo r t ized inves t­
men t credit o f $458 , 78 3 repres enting the 5 2 percen t that
was de ferred at the be.g inning o f the year was taken in to
e arnings and is in c luded under "Extraordinary items " in
the inc ome s tatement .
S inc e the Comp any has no federal
inc ome tax l iab i l ity for 1 9 64 , an inve s tment credit o f
approx imate ly $ 8 5 0 , 0 0 0 rela t ing t o current year ' s cap ital
additions is availab le to reduce future tax provis ions .
D is cus s ion The me thod o f rep or t ing is acc ep tab le , and s ome ­
what s imilar t o that fo l lowed b y Po laro id Corporation in a
p revious examp le exc ep t that The Budd Comp any c le ar ly identi­
fied the extr aord inary item in the income s tatemen t rather
than by a fo o tno te .
2 0Adap ted from 1964 Annual
Report of The Budd Company .
67
Change from Other Methods
2
Tenness ee Gas Transmis s ion Comp any 1
( Independent ac c ountants - Ar thur Anders en
&
Co . )
Op inion o f indep endent acc ountan ts Qualified as to cons is tency relative to the change
in acc ounting for the inves tment credit .
I t was noted that
the new me thod was an accep tab l e me thod .
Income s tatement Ne t earnings be fore p rovi s ion
for income taxes
Provis ion for income taxes (Note 7 ) :
Curren t
D e ferred
$ 9 1 , 3 19 , 2 7 7
9 , 220, 300
4 , 3 19 , 6 00
13 , 5 3 9 , 9 0 0
$ 7 7 2 7 79 2 3 7 7
Ne t earnings for the year
No tes to f inanc ial s tatements -
Prior to 19 64 the inves tment tax credit was
recorded as a de ferred cred i t pursuant to an in ter im order
o f the Fed�ral Power Commis s ion .
In 1 9 64 the Commis s ion
is sued a final order with resp e c t to the account ing for such
credi t and as p ermit ted in such order the f low through
me thod o f acc ount ing was adop ted whereby the bene f i t o f the
inves tment tax credit is re f lec ted in the income s ta tement
in the p e r iod in which the credit is util ized .
The inves t­
ment tax credit s o utilized in 19 64 amounted to $ 4 , 0 2 0 , 60 0 .
For the year 1 9 63 such credit amounted to $ 4 , 6 6 5 , 8 0 0
21
Adap ted from 1 9 64 Annual Rep or t of Tenne s s e e Gas
Transmis s ion Company .
68
and the f inanc ial s tatements for 1 9 6 3 have been res tated
a c cord ingly for such amount .
At December 3 1 , 19 64 the
comp anies ' unus ed inves tmen t tax credit aggregated approximate ly $ 5 , 4 0 0 , 000 .
D is cus s ion The me thod o f rep o r t ing is accep tab le and is the
fir s t c ited examp le where rather than inc lus ion in the 1964
inc ome s tatemen t , the pr ior years ' de ferred portion o f the
inves tment credit was re troac t ive ly recorded in the 1 9 63
income s tatement .
Ref le c tions on the Me thods Us ed in 1 9 64
As was previous ly d is cus s ed , the re was no need for
.
the independent accoun tant to qual ify the c ons is tency p or t ion o f his op inion where c omp anies had changed from the
.
" 48 - 5 2 n me thod to the 100 p ercent f low through me thod , and
no such qualifications we re noted in the preceding examp les .
Where the inves tment credit was mate r ial and there was a
change from other than the " 48 - 5 2 1 1 me thod to the 100 p ercent
f low through me thod , a qualified op inion would be expec ted .
In the preceding examp le s , as noted , the only change s o f the
latter typ e where the op inions o f the independent ac count ­
ants were no t qua lified were S outhern California E d is on
Company and Kennecott Copper Corporat ion .
The Kennec o t t
change was p o inted out t o be n o t mate r ia l , there fore , no
qualificat ion appeared neces s ary .
However , as p revious ly
69
. men t ione d ,
me n t r e f le c t e d ne t e a rn ings
$8
1 9 64 inc ome s ta t e ­
S ou the rn Ca l i f ornia E d is on ' s
mi l l ion o f which was
of
op in ion w a s no t rendered
is
c e d ing examp l e s
ap p r ox ima te ly
a re s u l t o f the c hange
It
for the inve s tmen t c r e d i t .
It
mi l l ion ,
$77
is no t kno wn why a qua l i f ie d
in the
inter e s t ing
latter
to no te
ins tanc e .
tha t in a l l
whe r e op in ions we r e qua l i f ie d ,
p enden t ac c oun t an t exc e p t Ar thur And e r s en & Co .
his
app r ova l o f the change
me thod .
was
the
an a c c e p tab le me thod ,
Transmis s ion C omp any
but no t tha t the
Th i s
that Op in ion No .
Revenue Ac t of
2,
two
ind e p endent
is undoub te d ly in keep ing
p o s i tion taken in c onne c t ion with
Ano ther p o int o f in te r e s t was
No .
e x p re s s ed
4 o f the Ac c oun t ing Pr inc ip l e s Board .
O p in ion No .
f ac t
e ac h inde ­
1 0 0 p e r c ent f low through me thod
ac c ountant ap p r oved the r e o f .
w i th Leonard S p a c e k ' s
pre­
qua l i f ie d op in ion o f the
of Tenne s s e e Gas
ind i c a t e d tha t the
the
1 0 0 p er c en t f l ow through ·
In Ar thur Ande r s en & Co . ' s
f inanc i a l s ta t ements
it was
to
in ac c oun t ing
tha t in s p i te o f the
4 ind i c ated tha t the change in the
1 9 64 was no t the r e as on for revis ing Op in ion
( Po l ar o id
and Go odman )
of
the
f ive c i ted c omp an i es
chang ing from the c os t r e duc t ion me thod made re fe r enc e s
to
the new Revenue Ac t .
Summary
As
c an be s e en ,
1 9 64 s aw a s e r ie s o f even ts which
b e gan to sup p o r t the p o s i t ion p revious ly taken by the
70
minor ity with a de f inite movement away from the cos t
reduc t ion me thod of acc ounting for the inves tmen t tax credit .
This , of c ours e , is no t proof in i ts e lf o f which me thod is
bes t , and in the next chap ter c ons iderab le analys is wil l be
under t aken to determine which me thod s tands up when it is
cr i t ic ally evaluated and re lated to bas ic ac count ing
theor ies .
CHAPTER V
ANALYS I S AND DETERMINATI ON OF THE PROPE R METHOD
OF AC COUNTI NG F OR THE INVES TMENT CREDIT
Thi s chap ter wi l l be devo ted to de t e rmin in g wh ich
o f the p r op o s e d me th ods
of ac c oun t ing f or the inve s tment
c redi t i s in ac c ordanc e w i th ac c e p t ab le and s ou nd ac c ount ing
p r inc ip l e s .
Thi s wi l l be acc omp l i s hed by re la t ing the
var i ou s a lternat ive me thod s t o ba s i c ac c ount ing the ory .
S inc e the p revi ou s ly d i s cu s s ed c hange in the Reve nu e Ac t of
1964 made the "48 -52" me thod ident i c a l with the 100 perc ent
f l ow throu gh me thod ,
thi s chap ter w i l l l imi t the eva lu a t ion
a s be tween the l a t ter and the c o s t reduc t i on me thod .
On ly the c os t re du c t ion me thod wi l l requ ire d i s ­
cu s s i on a s t o proper ba lanc e she e t tre a tment s inc e . the 100
perc ent flow thr ou gh me thod re su l t s in n o inc ome de ferra l t o
£u tu re p e r i o d s .
F ixed As s e t and Deprec i a t i on Ac c ount ing
Ac c ount ing for f ixe d a s s e t s and deprec i a t i on has
l ong been a p r ob lem to ac c ountant s ; however ,
hi s t or ic a l c os t
i s the p reva i l ing ba s i s for f inanc i a l s t atemen t pre s ent a t i on
of f ixed a s s e t s .
1
S ome of the advantage s o f hi s t or ic a l c o s t
are i t s obj e c t ivity ,
ava i lab i l ity ,
ana ly t i c a l u s e and fac t
1The Me a su rement of Pro erty 1 P lant , and Eau ipment in
3
F inanc ia l S t a t ement s , Harvar
Bu s 1ne s s S chool AC c ount ing
Round T able , ed . Robe r t T . S pr ou s e , ( Bo s t on : Harvard Un ive r ­
s i ty , 1964 ) , p . 26 �
72
that i t i s n o t ove r ly subj ec t t o manipu lat ion .
2
Depre c i a t i on
has tradi t i ona l ly been b a s e d on c o s t and i s vi ewe d a s a
p r oc e s s o f a l l oc a t ing the c o s t t o the p r o du c t or p e r i o d tha t
u t i l iz e d the s ervi c e s o f the f ixe d a s s e t .
3
C o s t i s gene r a l ly me a sured by a current expend i ture
of
c a sh or when there is a de l ay in the c a sh p ayment , c os t
shou ld be c on s idered a s tha t amount o f c a sh which wou l d b e
requ ir e d t o e f fec t f i n a l s e t t lement .
4
I t i s g enera l ly c on ­
ceded that purcha s e di s c ount s shou ld b e treated a s a redu c t i on
in c o s t r ather than a s inc ome .
5
The l a t t er c onc e p t i s p r o ­
bab ly one o f the ma in rea s on s that vari ou s org ani z a t i on s ,
inc lu d ing the Amer ic an In s t itu te of C ert i f ied Pub l i c Ac c ount ­
ant s ,
6
have c on s idered the inve s tment c r e d i t a s a r e duc t i on
in c o s t under the c o s t redu c t i on me thod .
Thi s i s a highly
que s t i onab le p o s i t i on b e c au s e a l though p r op onen t s of the
c o s t reduc t i on me th od wou ld argue that there i s s ome s imi ­
lar i ty in the fac t that there i s a redu c t i on in the ne t
2
I b id . , p p . 2 6 - 2 8 .
3
Robert T . S prou s e and Maurice Moon i t z , A Tenta t ive S e t
o f Broad Ac c ount in Princ i le s f or Bu s ine s s Enter r i s e s ,
New York : Ame ric an In s t i ­
Ac c ount ing Re s e arch S tu dy N o . 3 ,
tu t e o f C e r t i f ie d Pub l i c Ac c ount ant s , 1 9 6 2 ) , p . 8 .
4
w . A . Pat on and A . C . Lit t le t on , An Introdu c t i on t o
C or orate Ac c ount in S tandar d s , (Mad i s on , Wi s c on s in : Ame ric an
Ac c oun t ing As s o c i a t i on , 1 9 6 2 , p . 2 6 .
5
Handb o ok of Modern Ac c ount ing The ory , e d . Mort on Backer ,
( Eng l ewood C li f f s , New Jer s ey : Pren t ic e -Ha l l , Inc . , 19 5 5 ) ,
p p . 2 34 - 2 3 5 .
6
op ln
. l. on s o f th e
A cc ount lng P r lnc
.
. 1e s
lp
.
B oar d , N o . 2 , p . 7 .
73
ou t lay o f c a sh for the a s s e t s in qu e s t i on ,
the pu rc ha se di s ­
c ount re su l t s i n a redu c e d periodic charge on the inc ome
s t a tement whi le the inve s tment c re d i t re su l t s in a one - t ime
t ax redu c t i on in the year o f pu rcha s e .
Fu rthe rmore ,
any
s imi lar i ty which might have ex i s ted be tween the inve s tmen t
c redit and the pu rcha s e di s c oun t wa s e l imina ted when the
Revenu e Ac t of 1964 dropp e d the requ i rement tha t the a s s e t
bas i s b e re du c ed b y the amount of the inve s tment c re d i t .
Another f a l l acy i s tha t u t i l i z ing thi s me thod c ou l d re su l t
i n the ident ic a l p ie c e o f e qu ipment ,
t o var iou s c ompan ie s ,
s o l d a t the s ame pric e
or the s ame c ompany a t vari ou s p o int s
in t ime , be ing ini t i a l ly rec orde d a t d i f f e ren t amount s .
Thi s c ou ld happen bec au s e a c omp any mu s t have t axab le inc ome
b e f ore i t c an t a ke t he inve s tmen t credit and a l s o ,
onc e
the inve s tmen t c re di t exc eeds $ 25 , 000 i t i s l imit e d t o 25
perc ent o f the tax l i ab i l i ty ove r tha t amount .
O f c ou r s e ,
a s suming ade qu a t e p r i or and / or current year t axab le inc ome ,
the ent ire c re d i t wou ld eventu a l ly be earne d throu gh the
u s e of c arrybac ks and c arry f orward s .
The fac t tha t an a s s e t ha s _ been de fine d a s repre s ent ing ec onomic re s ourc e s devot e d t o s p e c i fi c bu s ine s s
pu rp o s e s and s h ou ld b e rec orde d a t the requ ired c a s h ou t lay
7
or fair marke t va lu e if c a sh i s not invo lved , wou l d a l s o
t end t o d i s c re d i t any a t temp t a t rec ording l i ke a s s e t s at
J. sc on s in :
74
d i f f erent va lu e s .
in e f fe c t ,
Prop onen t s
o f t he c os t redu c t i on me thod ,
b e l i eve that the inve s tment cred i t i s a sub s idy
by the Government t o redu c e the c o s t of equ i pment .
Thi s
i s a d i ff i cu l t p o s i t i on t o su s t ain s ince the inve s tment
c re d i t
is
on ly ava i lab l e t o p r o f i tab le c ompani e s ,
and the
l a t t e r type o f c onc erns are no t norma l ly su bj e c t t o G ove rn ­
men t sub s i d i e s un le s s they a r e operat ing i n a f i e ld wh ich
b ene f i t s the nat i ona l int e re s t or are per f orming o ther
s e rvi c e s
f o r the Gove rnment .
Inc lu s i on o f the
inve s tment c r e d i t
lated deprec i ati on ac c ount
in the ac cumu ­
or any o ther ac c ount wh ich wa s
dedu c t e d fr om the a s s e t b a l anc e wou ld b e e qu a l ly obj ec t i on ­
ab le
s inc e the ne t e ffec t would be the s ame a s redu c ing the
as set c os t .
in
19 6 4
As c an be s een f r om · the s t a t i s t i c s
on ly s eventeen of
on page
57 ,
the c ompanie s u t i l i z ing t he c o s t
redu c t i on me thod tre a t e d the unearne d port i on o f the c redi t
as an a s s e t o f fs e t .
anc e o f the
Thi s ' wou ld appear
to be
tac i t ac c ep t ­
idea that the c re d i t wa s an aba tement o f t axe s
rather than a redu c t i on in a s s e t c os t .
Inc ome Rec ogn i t i on
A rev i ew o f cu rrent ac c oun t ing l i teratu re indic a te s
that a lmo s t a l l d i s cu s s i ons
r e a l i z a t i on )
o r s e rvic es .
t o be
o f inc ome re c ogn i t i on ( or
c enter aroun d the s a le or tran s fer o f g o od s
One c oncept o f rea l i z a t ion ,
h oweve r ,
app e ar s
broad en ou gh that i t might be app l ied t o the inve s t -
75
ment cred it .
This concept i s p r omu l g a t e d by th e American
Accounting Association and i s a s f ol l ows :
"The essential meaning of realization is that a
change in an asset or liab ility has become suffi­
cient ly defin ite and obj ective to warrant recog ­
nit ion in the accounts . This recognit ion may
re s t
on
an
exchang e t rans ac t ion b e twe en ind e p end ­
en t parties , or on e st ab l ished trade practices, or
on the terms o f a c on trac t p e r f ormanc e o f wh i c h i s
considered to be virtu a l l y certain. I t may dep e nd
on the stab ility of a banking system, the enforce­
ability of commercial agreements, or the ab ility
of a highly organi zed market to facilitate the
c onversi on of an a sse t i nt o an other f orm. " 8
The above de f in i t ion when c ou p le d with the " g o in g
c onc e rn " approach use d w i th in the framework of ac c ount ing
c onc e p t s would t e nd to c on f irm the
100 p erc ent flow through
me thod a s be ing the p roper app roach sinc e the pu rch a se of
eq uipment whi ch gene r a t e s ( a ssum ing adequa t e t axable i nc ome )
the inve s tmen t c r e d i t i s a c omple t e d t ransac t i on.
Prop on-
ent s of the c ost redu c t ion me thod t ake issue with the c omple t e d t ransac t i on viewpoint by ,
( 1)
sta t ing tha t inc ome is
not re a l i z e d by the pu rc ha se o f e qu ipment , bu t rather by
i t s u se , a nd (2 ) ma in t a i ni ng t ha t the inve stment c re d i t i s
on ly e arne d i f the eq uipmen t i s re t ained for the required
hold ing per i od.
inc ome
They ,
( t ax redu c t i on )
Whi le i t is
there fore ,
suppor t a lloc a t i on of the
ove r the li fe of the eq uipment .
generally true that the purcha se of eq uipme nt
d oe s not genera t e inc ome ,
it i s somewha t ou t of c ontext t o
r e la t e thi s st at emen t t o a transa c t i on involving the p ur­
chase of eq ui pment whi c h qua l i f i e s for the inve s tment
8Ibid . , p . 3 .
76
c re d i t .
The inve s tment c r e d i t i s a l l owe d in the year o f
pu rch a s e o f the equ ipment unde r the a s sump t i on t ha t the
equ ipment w i l l be he ld for the requ ire d p e r i o d .
( I f the
t ax ing au thor i t i e s - had on ly a l l owe d the c re d i t t o be taken
p r op or t i onate ly
then the
( annu a l ly )
over the requ ired h o l d ing per i od
1 0 0 percen t f l ow thr ou gh me thod w ou ld be more
d i f f icu l t t o sup p ort , bu t thi s i s not the c a s e . )
is
The c re d i t
subj ec t t o fu l l o r part i a l rec ap ture on ly i f the equ ip ­
men t i s he ld f or le s s than the requ ired period .
The
fac t
that the inve s tment c re d i t i s a l l owe d in i t s ent ire ty in
the year of pu rcha s e ,
and is subj ec t to rec ap tu re under
c e r t a in c ircums t anc e s
( t o prevent manipu la t i on ) ,
re fute s
s everal of t he ab ove c ontent i ons in support o f the c o s t
redu c t i on me thod and fu r ther supp or t s the
1 0 0 percent f l ow .
thr ou gh me thod and i s c ons i s tent with the "go ing c onc e rn "
c onc e p t s inc e i t i s n orma l ly ant ic ip a t e d tha t equ �pment
wi l l be u t i l i z e d dur ing Lt s u s e fu l l i fe .
tha t the
I t a l s o app ear s
10 0 perc ent f l ow t hrou gh me thod more c l o s e ly
acc omp l i she s
the b a s i c pu rpo s e o f the inc ome s t atemen t
wh ich i s t o show inc ome ac tu a l ly e a�ne d f o r a g iven period
and the amount avai lab le for d i s t r ibu t i on .
As suming . that the c os t reduc t i on me thod were the
. b e t ter me thod ,
and s inc e there appe ars to be genera l
accep tanc e tha t the inve s tment c re d i t inc re a s e s ne t inc ome
by redu c ing fe de ra l income taxe s ,
i t wou ld appear tha t the
unearne d port i on of the c r e d i t shou ld be c la s s i f i e d as a
de ferred c re d i t t o inc ome and be amort ized over the per i od
77
nec e s s ary t o e arn the
ent i re c re d i t
t aken f or tax pu rpos e s .
F ede r a l Inc ome T ax Ac c oun t ing
Ac c ou n t ant s ,
for y e ar s ,
have ac c e p t e d th e c onc ep t
that whe re f e dera l inc ome t ax p r oc e du re s ma ter i a l ly c onf lic t
wi th genera l ly ac c e p t e d a c c oun t ing princ ip l e s ,
the
lat ter
mu s t p reva i l f or financ i a l s t a t emen t pre s ent a t i on . 9
th e s e d i f fe r enc e s
do exi s t ,
the r e su l t ing
tax
When
l i ab i l i ty
might bear n o norma l re l a t i on s hip t o e a rning s rep or t e d on
the inc ome
s t a t ement .
As
a r e su l t ,
many a c c ountan t s
supp ort
a me thod of a l l oc a t ing t axe s b a s ed on r e p or t e d e a rn ing s wi t h
a r e su l t ant p r e payment o r ac c ru a l b e ing s h own o n t h e b a lanc e
shee t .
1
0
T he r e i s n o t genera l ac c ep tan c e ,
h oweve r ,
th i s typ e o f int e r - p e r i o d inc ome t ax a l l oc a t i on .
there
is
s ome d i s agre ement as
mos t ac c ount an t s ac c e p t
su pp or t o f the c o s t
the ory ,
Wh i le
to whe the r or n o t f e de r a l
inc ome t axe s a r e a c os t o f do ing bu s in e s s
of p r of i t s ,
11
as to
or a d i s t r ibu t i on
the c o s t the ory .
Herman Bev i s
In
s ta t e s :
" Be c au s e p r o f i t i s the me a s ure o f the t ax , s ome
have he l d tha t the t ax i s n o t a c orp ora t i on c o s t
9
Ac c ou n t in
Re s e ar c h and T e rmin o l o
e d . ; New Y or :
Ame r i c an I n s t 1 tu te o
Ac c ount an t s , 1 9 6 1 ) , p . 7 6 .
1
ic
0Ha r ry S imon s and W i lbe r t E . Karrenbroc k , I n t erme d ia t e
S ou th -We s t e rn
Ac c ou n t ing , ( 4 th e d . ; C inc inna t i , ' Oh i o :
Pub l i shing C ompany , 1 9 64 ) , p . 3 7 . ,
0
11
Pau l Grady , Invent ory of Gene ra l ly Ac c ep t e d Ac c ou nt ing
Princ i l e s for Bu s ine s s Ent er r i s e s , Ac c ount ing Re s e arch
,
New Y or :
Ame r i c an Ins t i tu t e o f Cert i f ie d
S tu dy N o .
Pub l i c Ac c ountan t s , 196 5 ) , pp . 1 1 3 - 1 14 .
I
78
bu t a d i s tribu t i on o f c orp ora t e pro f i t s , i . e . ,
in the s ame gene ra l c a teg ory a s d ivi dend s t o
s t ockh o lde rs .
Thi s i s a h i gh ly que s t i onab l e
p o s i t i on .
I t sugge s t s that the f inanc i a l ly
s i gn if ic ant index o f c orp ora t e r e su l t s i s t he
pro f i t b e f ore _ inc ome t axe s , and tha t how t h i s
amount i s d i s t r ibu t e d among g overnment , s t oc k ­
h o lders , and reinve s tment i s a s eparab le ma t t e r .
Ac tu a l ly , the s t ockh o lder , a s a supp l i er o f
c ap i t a l , mu s t l ook f or hi s r e turn a f t e r the levy
by the g overnment h a s been p a i d .
I f the c orp ora ­
t i on i s t o a t trac t new c ap i t a l , i t s pric ing
s tru c tu re and revenu e s mu s t be su f f i c ient ,
a ft e r deduc ing c o s t s inc lu ding in c ome t axe s , t o
provide the e arnin g s and dividend r a t e s requ ired
in the marke t p l a c e . " l 2
The Amer i c an I n s t i tu te
Acc ount ant s
supp o r t s
of C er t i f i e d Pub l ic
the the ory that inc ome t axe s
s h ou l d
be tre a t e d a s any othe r expens e and that i t shou ld be
a l l oc a t e d t o the cu rrent year rep orted e arning s a s ne c e s ­
s ary .
13
The Amer i c an Acc ount ing As s oc i a t i on t ake s
opp o s i te approac h ,
taxe s do not have
l iab i l i t ie s ,
howeve r ,
and c onc lu de s that inc ome
the norma l charac t e r i s t ic s
and du e t o unc e r t a int ie s
,
the
of as sets
or .
and c omp l i c a t i ons
shou ld be d i s c l o s e d in note s rather than by ac tu a l ent r i e s
i n the ac c ount s .
14
I t wou ld appear that the ma in re a s on f or the
introdu c t i on of the int e r -per i od inc ome t ax a l l oc a t i on i s
t he ac c ount ing pr o fe s s ion ' s de s i�e t o e l imina te any
12
Herman W . Bevi s , C orp orate F inanc i a l Repor t ing in a
The MacMi l lan C ompany ,
C om e t i t ive E c onomy , ( New Y ork :
196 ) ' p . 7 5 .
S
13
Ac c ount ing Re s e arch and Termin o l ogy Bu l le t in s ,
S tandards
p.
for Cor ora t e
88 .
79
d i st or t i on o f ne t e arnin g s .
15
T he Ame r i c an I n st itu te o f
C e r t i f ie d Pub lic Ac c ountan t s doe s not fe e l tha t inc ome t ax
a l l oc a t i on i s nec e ssary where d i f ferenc e s b e tween taxab le
inc ome and rep orted e arnings are expec t e d to oc cu r regu larly
ove r a l ong p e r i od of t ime .
16
An examp le o f the lat ter
s itu a t ion wou l d probab ly be a c omp any
with a s s e t s su bj e c t
(The cu rrent t ax law a l l ows dedu c t i ons f or
t o de p le t i on.
dep le t i on in exc e ss o f a ss e t c o st . )
A l t hou g h inve s tmen t c re d i t t ransac t i on s d o not f i t
d ire c t ly in t o the the ory o f inc ome t ax a l l oc a t i on ,
c oncep t a pp e ar s applic ab le .
I n fac t ,
t he broad
the ne t e f fec t o f t he
a f oremen t i one d dep le t i on provi s i ons o f t he tax law are not
a gre a t de a l unl ike the inve s tmen t c r e d i t sec t i on of t he law .
Gran t e d ,
one i s a de du c t i on and the o t her a credi t ; howeve r ,
they b o th ac c omp l i s h t he same end r e su l t ,
i. e . ,
inc ome t ax
bene fi t s in exc e s s o f the c o st of the app l ic ab l e a s se t , and
few,
i f any,
a c c ountan t s wou l d suggest redu c ing t he c ost o f
a dep le tab le a s s e t by exc e ss tax bene f i t s .
T he simi lar i ty o f the inve stment c r e d i t and dep le ­
t i on de duc t i on ,
along wi th t he a f orement i oned p o s i t i on of
t he Ame r i c an In s t i tu t e of C e r t i f i ed Pub lic Acc ountan t s in
regard to c onsi de r ing inc ome taxe s a s an exp en s e and not
u s ing in ter-p e r i od inc ome tax a l l oc a t ion f or regu lar ly
15
H . A . F inney and Herb e r t E . M i l ler , Pr inc i l e s o f
Ac c oun t ing I n t e rmedia te , ( 5 th e d . ; Eng lewood eli fs , New
J er sey :
Prentic e -Ha l l , I nc . , 1 9 5 8 ) , p . 621 .
16
t
Ac c oun t ing Re searc h and Termin o logy Bu l let ins , p . 8 7 .
80
recu rring di fferenc e s be tween taxab le inc ome and repor t e d
earnings , wou l d t end t o s trengthen the fac t tha t the 1 0 0
perc ent f l ow thr ough me tho d i s the the or e tic a l ly prop e r way
of ac c ou nting f or the inve s tment credit .
Regard le s s of which me thod i s u s e d , it doe s not
appear de sirab le t o rec ord a rec eivab le f or any inve s tment
c r e dit e ligib l e for c arryf orward t o fu ture ye ar s .
Thi s
wou ld be c on s i s tent with the ac c ou nt ing princip l e that
c arry f orward fe dera l inc ome t ax ope rating l o s s e s shou ld
only be rec orded in the year t o whic h such l o s s e s are
c arrie d .
17
In both ins t anc e s , adequ a t e f oo tnote dis c l o sure
wou ld be appropriat e .
Summary
Basic acc ounting the ory appe ar s t o support the
1 0 0 perc ent f l ow through t re a tment as t he prope r me t hod
to acc ount for the inve s tment c r e dit .
In the next ( fina l )
chapter , s ome c onc lu ding thought s wil l be offere d .
ll
Ibid .
,
p.
91 .
CHAPTER VI
C ONCLUS I ONS
As wa s d i s cu s s e d in the pre c e d ing chap te r ,
wou l d appear tha t the
it
1 0 0 p e rc en t f l ow thr ou gh me th od o f
ac c ou n t ing f or the inve s tment c re d i t more p r ope rly re f l e c t s
b a s ic ac c ount ing the ory than the c o s t redu c t i on me thod f or
the f o l l ow ing rea s ons :
( 1 ) F ixed a s s e t s shou l d be s t a t e d a t c o s t wi th ­
ou t regard t o the inve s tment c r e d i t .
( 2 ) A l thou gh proponen t s of the c o s t re duc t i on
me thod tre a t the inve s tmen t c re d i t a s i f
i t were a pu rcha s e d i s c ount , the change
introdu c e d by the Revenu e Ac t o f 1 9 6 4 ,
whereby the a s s e t b a s i s wa s no l onger
requ ired to be reduc e d , c le ar ly e l imina t e d
any s imi lar i ty b e tween t h e c re d i t and a
purcha s e d i s c oun t .
(3)
The inve s tment c re d i t i s no t a sub s i dy s inc e
i t i s on ly ava i lab le to p r o f i t ab l e c omp an ­
ie s wh ich are n o t norma l ly su b s i d i z e d .
(4 ) The inve s tmen t c re d i t re su l t s in a cu rrent
year inc ome bene f i t ( re du c e d fe dera l
inc ome t axe s ) . ,
(5)
The " g o ing c on c e rn " c on cep t r e fu t e s the
su gge s t i on th a t the c r e d i t s h ou l d be
rec orded dur ing the requ ired h o l d ing
p e r i o d s imp ly b e c au s e the u l t ima t e
rea l i z a t i on of t he c re d i t _ i s c ont ingent
u p on fu tu re e arnin g s and the va l i d i ty
o f t he orig ina l e s t ima te o f u s e fu l l i f e .
(6 )
The b a s i c pu rp o s e of the inc ome s t a t ement
is ac c omp l i she d by u s e of t he 1 0 0
p e r c e n t f l ow thr ou gh me th od .
(7 )
Genera l ly a c c e p t e d ac c ount ing pr inc ip l e s a s
they re late t o f e de ra l inc ome t ax ac c ount ­
ing , inc lud ing dep le t i on ac c ount ing ,
c on s idera t i on of federa l inc ome t axe s a s
expens e s and inte r -per i od inc ome t ax
a l l oc a t ion supp ort rec ord ing the c re d i t
in the ye ar tha t the c redi t is a l l owe d .
In re a l i ty ,
proponen t s
of the 1 0 0 perc ent f l ow thr ou gh
me thod have ma in t a ine d that the inve s tment cre d i t wa s me re ly
a c omp lex me th od of redu c ing f e de ra l inc ome t axe s w i thin the
framework of an a lready c omp l ic a te d s y s t em .
The fac t tha t
in order t o ob t a in thi s inc ome t ax re du c t i on ,
p r op er t ie s had t o be ac qu i re d ,
c er t a i n
in no way shou l d be r e la t e d
t o the c o s t o f thos e prope r t ie s .
I t rema ins
t o b e s e en how t he a c c oun t ing pro fe s ­
s ion w i l l reac t in the fu ture t o the s'e two me thods .
Ac c ount ing his t ory ha s trad i t i ona l ly shown tha t genera l
a c c e p t anc e i s needed by the p r ofe s s i on in order t o f i rmly
e s t ab l i s h any ac c ount ing princip le .
1
The re su l t s
of 1 9 6 4
did n o t ind i c a t e a n overwhe lming t rend t oward s one me thod ,
and a s
l ong a s the Americ an In s t i tu te of Cer t i f i e d Pub l i c
Ac c ountan t s re c o gni ze s two me thods ,
i t i s p o s s ib le tha t
the fu tu re wi l l s e e one me th od wi th more dominant , au th or i t a t ive su ppor t t o the eventu a l ext inc t i on of
the o the r .
The othe r p os s ib i l i ty i s tha t the dive r s i ty which ha s
exi s te d vo lunt ar i ly wi thin the p r o fe s s ion for many years
2
wi l l c on t inu e t o be supp or t e d and b oth me thods wi l l bec ome
_ gene ra l lr ac c e p te d .
I n l ine w i th the tu rmo i l created by the inve s tment
c re d i t ,
a s the ac c ount ing p r o fe s s i on c ont inu e s
to a t t emp t t o
1
A . C . Li t t le t on and V . K . Z immerman , Ac c oun t ing The ory :
C ont inu i ty and Change , ( Eng lewo od C l i ff s , New Jer s ey :
Prent i c e -Ha l l , Inc . , 1 9 6 2 ) , p . 2 2 0 .
f or Bu s ine s s Ent e rpri s e s ,
pp .
les
8
imp rov e financ ial acc ounting and rep or t ing , we wi l l perhap s
s ee a s t ru g g l e be tween th ose who w i sh t o a l l ow the pro fe s ­
s ion t o voluntari ly s teer its
own
c ou rse an d those who
wou ld prefer enforcement of acc ount ing p rac t i ces
forma t i on of a regu latory body . 3
through
Only time wi l l t e l l .
3c orporate Financ i a l Report ing in a C ompe t i t ive Ec on omy ,
P • 198 o
84
BI BLI OGRAPHY
Pub l i c D ocument s
q . s . , Interna l Revenu e Bu l le t in , Ju ly -Dec ember , 1 9 6 2 ,
(Wa shing t on :
U . S . G overnment Pr int ing O f f i c e , 1 9 6 3 ) .
U . S . , C ongre s s , S enate , F inanc e C ommi t te e , Hearing s , H . R .
1 0 6 5 0 , 8 7 th C ong . , 2nd . S e s s . , 1 9 6 2 , Par t 1 .
Books
Ac c ou n ting Trend s & Techniqu e s , (New Y ork : Amer ic an
I n s t i tu t e of C er t i f i e d Pub lic Ac c ountant s , 1 9 6 3 ) .
Ac c oun t ing Trends & Techni �u e s , ( New Y ork : Amer i c an
In s t i tu te of Certifie Pub l ic Ac c ountant s , 1 9 6 5 ) .
S t andards f o r C or ora t e F inanc ia l
Ac c ount in
S t a t ement s ,
revi s i on ; Ma i s on , Wis c on s in :
Americ an Ac c ount ing As s oc iat i on ) .
Ac c ount in Re s e arch and Termin o l o
Bu l l e t in s , (F ina l e d . ;
New Y or : Ame rican Ins t i tu t e o C e rt i f ie d Pub l ic
Ac c ountant s , 1 9 6 1 ) .
Bevi s , Herman W . , C or ora t e F inanc i a l
C omp e t i t ive Ec onomy , New Y ork :
1965 ) .
F inney , H . A . and Mi l le r , Herbert E . , Princ i p l e s o f
Ac c ount ing Interme d i a t e , ( 5 th e d . ; Englewood C l i f f s ,
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"Ac c ou nt ing f or the ' I nve stment C re d i t ' , " Opin i ons of the
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"Ac c ount ing f or the ' I nve stmen t Cre d i t ' , " Ac c ount ing S e r ie s
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·
" Bu s ine s smen S pu rn Tax Credi t P l an As A G irrnn i c k , " Bu s ine s s
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"News Rep or t , " The J ou rnal of Ac c oun t anc y , March ,
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"O f f i c i a l Re leas e s , " The J ou rna l o f Ac c oun t ancy , Ju ly ,
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l
( Chic ago :
19 6 1 .
C orrnne rce
"S p o t l igh t on Ac c ount ing , " The J ou rna l of Ac c ountancy ,
February , 1 9 6 3 .
"Tax Change s in the Works , " Bu s ine s s We ek , Febru ary
Volu me 164 1 .
"Tax P l an s Draws More Brickbat s , " Bu s ine s s Week , May
19 6 1 , Vo lume 1 6 5 5 .
1 1 , 19 6 1 , .
20 ,
Tax Report No. 4 3 , The Bureau of Na t i ona l Affair s , Inc . ,
March 2 , 1962 .
"Two -Way Fire on Kennedy Pr ogram , " Bu s ine s s Week , May 6 ,
1 96 1 , Vo lume 1 6 5 3 .
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Amer i c an Cyanamid C ompany
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196 2
Anchor Hocking Gla s s Corporation
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196 2
The
87
The Bu dd C omp any
-
Draper C orp ora t i on
1964
1964
-
Genera l C ab le C orpora t i on
1963
-
Genera l T e l e phone C omp any o f Ca l i f ornia
Genera l T e l ephone
The Genera l T ire
Gene s c o , Inc .
-
Rubb er C omp any
Gran i t e C i ty S te e l C omp any
&
-
1963
1 9 64
-
1 9 64
G o odman Manu fac tu ring C omp any
J one s
196 3
E le c t r onic s C orp ora t i on
&
&
-
1964
-
196 2
-
Laugh l in S te e l C orpora t i on
Kenne c o t t C opper C or p or a t i on
K opper s C ompany , Inc .
S . S . Kre s ge C ompany
-
1964
-
1964
-
196 2
1962
-
L ockheed Airc raft C orp o ra t i on
1962
-
Na t i ona l Dairy Produ c t s C orp ora t i on
-
1962
J . J . Newb erry C o . - 1 9 6 2
North Amer i c an C ar C orp ora t i on
Peab o dy C oa l C omp any
P o l ar o i d C orpora t i on
-
-
-
1962
1963
1964
R . J . Reyno lds T ob ac c o C ompany
-
196 2
S ou thern C a l i f orni a Edi s on C ompany
-
Tenne s s e e Ga s T ransmi s s i on C ompany
-
Tenne s se e Ga s Tran smi s s i on C omp any
We s t ingh ou s e E le c t r ic C or p ora t i on
-
-
1964
1963
19 64
1962
Other
S p acek , Le onard , "Ac c ount ing T re a tm en t of Inve s tmen t Credit , "
S peech pre s ented b e f ore the Great Lake s C onference o f
Ra i lr oa d and U t i l i t i e s C ommi s s i on s , Wh i t e Su lphu r
S p r ing s , We s t Virg in i a , June 2 1 , 19 6 3 and be f ore the
Mou n t a in -Pac i f i c S ta t e s C on f e renc e of Pu b l ic S e rv ice
C ommi s s i on s , S anta F e , New Mexic o , June 2 6 , 19 6 3 .