Management Accounting

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M A N A G E M E N T

A C C O U N T I N G

PUBLISHED BY THE NATIONAL ASSOCIATION OF ACCOUNTANTS /DECEMBER 1974

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FINANCIAL PERSONNEL RECRUITMENT

A SURROGATE MODEL FOR INCOME REPORTING

IMPUTED OPPORTUNITY COSTS

EXPLORING FORECAST DISCLOSURE

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� 1l Ii ,� I►Any chapter of NAA may now sponsor one or more top quality coursesor seminars for NAA members and nonmembers in its area.

COURSES

CA MANAGEMENT ACCOUNTING

CA -t Ba sic Concept s a nd T echniqu es for Ma na gement Accou nt ing

CA -2 Standard Costs and Flexible Budgeting for ProductionCA -3 Standard Costs and Flexible Budgeting for MarketingCA -4 Direct Costing and Contribution Reporting

CB DATA PROCESSING

CB -I Data Processing — Basic Computer Concepts and TechniquesCB -2 Data Processing Flow Charting and Block DiagrammingCB -3 Management Information Systems— Concepts and Techniques

CC - SPECIALIZED AREAS

CC -I Effective Inventory ManagementCC -2 Using Accounting Information for Pricing Policies and DecisionsCC -3 Financial Appraisal of Capital Investment ProposalsCC -4 Capital Budgeting and Project Control

CT— TAXES

CT -I Federal Income Tax Aspects of Business Operations

SEMINARS

S -1 Managing Corporate Cash

S -2 Direct Costing for Decision MakingS -3 Management Accounting for Small BusinessS -4 Managing Company Assets in Small BusinessS -5 Long -Range Profit PlanningS -6 Developing the Annual Profit PlanS -7 Maintenance Cost ControlS S Marketing and Distribution CostsS -9 Contribution Accounting for Marketing

and Production

If you are interested in more informationon this Local Education Activities Program(LEAP) series, ask your Chapter EducationDirector or Chapter President or write to:

HUGH M. SCOTT

National Associat ion of Accountants919 Third AvenueNew York, N.Y. 10022

Paovn'o (6rre #ingoAs an international organization, our Association includes women

and men of 81 nations and probably most races and creeds. By

concentrating on our major aims — professional education andfellowship —we are in a small way helping to make this a better, moreproductive world.

We try to achieve these objectives through communication,cooperation, and coordination, the underlying themes which run

throughout our activities. Without them, very li ttle can be

accomplished. With them, organizations, even entire societies,

can be built and prosper.

.J n this season of religious observances all over the world, your

officers and directors hope everyone will enjoy the Holiday Season

and have a productive and prosperous year.

4-P tJ-AxZx4 -President, 1974 -75

MANAGEMENT ACCOUNTING /DECEMBER 1974

Executive Director

MANAGEMENTACCOUNTING

15 THE LONER: A SMALL FIRM'S CONTROLLER SPEAKS OUTBy Raymond R. GearyThe "loner" is an individual in a small company who pays the bills, oversees a smalloffice, provides an annual budget, keeps the books of the corporation, acts the con-servative when the top man becomes too optimistic and the optimist when everyone

Cover: else is down in the dumps. Read about him in this article.Native dancers on Yap

Island. Even paradiseneeds accountants. 17 FINANCIAL PERSONNEL RECRUITMENT

See page 61.By Edwin W. Southerland

Photo courtesy d. As a specialist in the placement field, the author suggestions recruiting—

andRaymond. p P gives his su estions for recruibn —

and retaining —good employees.

4

19 EXPLORING FORECAST DISCLOSUREBy William G. Brown, Jr.The author looks into the attitudes of professionals toward forecasting and finds someacceptance for the idea, but the last word is not in.

23 A VOTE FOR PROFIT FORECASTINGBy Alice S. MarkwalderCondemned by some critics as a legal liability and a detriment to firm and investoralike, profit forecasting nevertheless has its defenders. The author of this article numbersherself among the defenders.

26 INVENTORY OWNERSHIP COSTSBy Albert WallaceWithout the ownership of inventory, there would be no ownership costs. The authormaintains that these costs, an extension of the "transportation in" concept, should beallocated to inventory and charged to earnings as the inventory is consumed.

29 CATTLE ACCOUNTINGBy John F. LoughlinThis article presents a review of certain considerations involved in accounting for cattleand an illustration of procedures developed to account for a large purebred commercialcattle operation.

36 DIRECT AND IDLE -TIME COST ACCOUNTINGBy David W. WycoffIt is no secret that production and profitability fall off as a result of idle facilities. Someof the idle time is necessary for maintenance, etc.; some is not. How to forecastrequired idle time and account for it in order to reduce costs is the subject of thisarticle.

39 IMPUTED OPPORTUNITY COSTSBy David M. StambaughAn example is given here to illustrate how the accountant may quantify imputedopportunity costs and thus meet his responsibility in advising management aboutalternative courses of action.


DECEMBER 1974

41 PERCENTAGE OF COMPLETION ACCOUNTINGBy Charles RachuiDeveloping an equitable and acceptable method of recognizing income as it is earnedis a problem common to many engineering contractors. In this article, the authorexplores some alternative methods for developing a useful and meaningful percentage -of- completion reporting system.

45 A SURROGATE MODEL FOR INCOME REPORTINGBy William R. SmithThere is a need by those not privy to the internal information system of the firm for amore meaningful measurement of corporate performance. The surrogate model forincome reporting to provide that measurement, as suggested in this article, is based onserious consideration of a number of fundamental propositions.

49 INCOME REPORTING AND APB OPINION NO. 18By Enrico PetriThis article sets forth a few situations where the equity method as suggested by APBOpinion No. 18 fails to achieve correspondence between income and equity.

53 FULL - ABSORPTION COST: A MANAGERIAL DILEMMA?By Kenneth G. HumerAs a result of the adoption of the "Full- Absorption Regulations," management isfaced with the dilemma of determining which costs are to be included in inventoryvaluation for tax and financial accounting purposes. The author suggests that thechange to full absorption will probably result in a substantial increase in taxable in-come and federal income tax liability.

61 IN THE WAKE OF 'HIS MAJESTY O'KEEFE'An NAA couple from Honolulu help businesses in Micronesia with accounting know -how during three -week visit to fabled islands of "stone money."

63 INFLATION RENEWS INTEREST IN LIFOTechnical Information Service Department sees increased requests for information onLIFO inventory accounting.

70 CLINTON M. FINNEY (1885 -1974)He was past national president of the Association and first president of Stuart CameronMcLeod Society.

DEPARTMENTS

10 LETTERS to the editor14 DATA SHEET items of interest for the businessman58 BOOKS for the management accountant64 CHAPTER /MEMBER NEWS all about chapters and members68 TIME OFF the lighter side of the ledger

Views expressed herein are authors' and do not represent Association policy unless sostated. Reprints of articles appearing in any issue Of MANAGEMENT ACCOUNTING areavailable from NAA's Reprint Department.

MANAGEMENT ACCOUNTING,Vol. LVI, No. 6. Published monthly by National Associationof Accountants, 919 Third Ave., New York, N.Y. 10022. Price $1.50 per copy. Secondclass postage paid at Lancaster, Pa.

MANAGEMENT ACCOUNTING /DECEMBER 1974 5

COMMENT MANAGEMENTACCOUNTING

VOL. LVI NO. 6 DECEMBER 1974

Published monthly, for members only,

Another Standards Committee! by the

NATIONAL ASSOCIATIONOF ACCOUNTANTS

A committee has been formed by the American Institute of CPA 's 919 Third Avenue, New York, N.Y. 10022

"to establish standards for schools of professional accounting." The (212) 759 -3444

Institute requested representatives of the American Accountingriin�

Assn., American Assn. of Collegiate Schools of Business, and National o

9Assn, of State Boards of Accountancy to serve on the committee.

There is a conspicuous absence of representation on this body 10from the management accounting field. Since three - fifths of all pro-fess iona l accountant s cur rent ly a re working wi th in indus t ry or com-

EXECUTIVE DIRECTORmerce, it seems only logical that the employers of professional W. M. Young, Jr.accounta nt s shou ld p lay a par t i n se t t ing s t an dards for the p repara-

tion of their careers.DIRECTOR OF PUBLICATIONS

James D. CollierThe establishment by NAA of the Certificate in Management Ac-

counting was in response to a perceived need on the part of business MANAGING EDITOR

management for better trained people in management accounting. Erwin S. Koval

The program is specifically designed to reflect the needs of industry SENIOR TECHNICAL EDITOR

by identifying the role of the management accountant, the under- Albert Cohen

lying body of knowledge, and by outlining a course of study by FEATURE EDITORwhich that knowledge could be acquired. Robert F. Randall

Doubtless, many students will continue to aim for the CPA cer- ASSOCIATE EDITORtificate, and public accounting, as the objective of their course study, Steve McCreabut jus t as many —if not more —wi l l go in to indus t ry. Accordingly,

EDITORIAL ASSISTANTthe new committee ought to be concerned about the lack of repre- Olive Kellysentation from business —and the potential impact that this may haveon the cur ri cula ul t imate ly des igned for s tudent s, many of whom wil l PRODUCTION COORDINATOR

Lucile Lawrencemake their careers in management accounting.

Much t ime and resources wi l l be was t ed i f t he educa t ion of man- CIRCULATION MANAGER

agement accountants is inadequate even at the corporate entry level. Raymond Goldstein

How much easier it would be to arrange for feedback input frombusiness on just what kind of education it requires for its corporate 9NApaccountants and incorporate that information into standards!

Second class postage paid at New York,

Coming Up in MANAGEMENT ACCOUNTINGN.Y., and at addit ional mailing offices. To

ensure uninterrupted mail service, pleasenotify us immediately of any change of ad-

George E. Youmans , in hi s a r t i cl e "A Look a t LIFO," expla ins why, dress. Send present address label and new

until recently, some companies switched out ... Come behind the address, including zip number, to Mem-

„scenes and review Accounting f o r Local Community Theaterbership Records Dept., NAA, 919 ThirdAve., New York , N.Y. 10022. Al low six

Groups" by Gerald N. Stevens ... In his "Primer on the Professional weeks for change. Price $1.50 per copy.Corp ora t ion, " C. Roy Mund ee , J r . out l ines advantages ava i l able to Single subscriptions available only to NAA

the professional individual who incorporates himself . . . In "Tax members and libraries. Subscription rates,

Considerations for a Small Business," John L. Rhoads, warns that per year: NAA members, $12.00 (included

more than a knowledge of current tax laws is required. El in annual dues); student members, $6.00(included in annual dues); libraries, $18.00.

ADVERTISING REPRESENTATIVESPeter Besheer, Sales Arm, Inc.,31 Union Square West,New York, N. Y. 10003, (212) 989 -6780James K. Millhouse, 919 N. Michigan Avenue,Chicago, 111. 60611, (312) 642 -6625.

Copyright © 1974 by the

National Association of Accountants


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Letters TO THE EDITOR

Farsighted Accountants

The article, "Proposed Budget - Auditing Standards," May1974, by Mr. Donald James, was well conceived. However, asa member of NAA, I would like to take exception in one minorarea.

The audits of projected reports should not be given equalstatus with audits of historical statements. The projections byinternal forecasting departments are mainly areas of informationbased on their own sought out data. These data are generallynot reported to the general public except in glowing terns orwith decreased emphasis. One company almost published anannual report with the phrase that "... divisions had a modestgain over projections and sales increases have good expectationsduring the coming year...." It would be less than candid topoint out that internal projection pointed out almost a $1million loss for this division, and the $800,000 actual loss wasin fact a modest gain.

It is great to have farsighted accountants, and I only hopeas we slowly progress to audits of other areas of importance thatthe public is given the proper orientation into what they areabout to receive. Someone who does not comprehend the"generally accepted accounting principles" will never under-stand "... on a basis consistent with the accounting practicesnormally adopted by the company."

Tom HughesWestern Carolinas

Taylors, S.C.

If Significant—Capitalize

The article by James B. Henry, "Cost Measurement and Dis-closure," in the May 1974 issue of MANAGEMENT ACCOUNTING,was very well done. I would like to take issue on two small,though important points:

The statement that "... lack of adequate disclosure mayresult in unwarranted credit extension for many firms," is avalid point but is resolved when the Securities and ExchangeCommission's Accounting Series Release 147 is applied to thelease. The Release says in essence that the financial lease inquestion must be computed using the present value interestamortization to determine how the outflows affect the income.If the outflows are significant, then capitalize. An empirical ob-servation of 1973's annual reports indicates that this is whatthe majority of the firms are doing.

The second area of comment is with regard to the conclusionwhere the comment is made, "If lease contracts are capitalized,then . .. it will increase percentage composition of debt toequity...." The comment, though justified, will reflect properleverage. But since the whole area of what is to be capitalizedand what is not to be capitalized is not clearly resolved at thistime (hopefully this will be resolved shortly by the FASB),why place additional burdens on the financial manager, whenhe must report to his superiors that their debt to total assetsratio has increased and possibly gone above the industry aver-age.

A recommended solution would be to apply a three to fivepercent limit on financial leases. If the financial leases in

question are above this limit, which indicates significance, thencapitalize; otherwise expense.

R. Joseph MostellerHagerstown Chapter

Hagerstown, Md.

Accountants Also Contributed

The December 1973 issue Of MANAGEMENT ACCOUNTINGcarried an article by Robert E. Feller titled, "Early Contribu-tions to Cost Accounting." The statement under the title read:"In each important area, management was in the lead, eitherasking the questions or writing the text and becoming expertin the new era." It is this statement, applicable to the 20thcenturv, that I do not accept. It appears that the word "manage-ment" includes mostly "efficiency or industrial engineers" andnot accountants. Indeed I wonder how the editor of our officialmonthly publication, MANAGEMENT ACCOUNTING, was per-mitted to include such a statement in our accounting magazine.

Our Association was organized for the purpose of obtaininguniformity in cost accounting methods as well as to developand give incentive for development of improvements to costaccounting theory and practice. The most convincing proof ofthe role of the accountant in cost accounting before 1925 andsince was the establishment of the National Association ofCost Accountants in 1919. Jerome Lee Nicholson, an outstand-ing authority on cost accounting, in every area, being a CertifiedPublic Accountant, Instructor of Cost Accounting at ColumbiaUniversity, a lecturer and author of books on Cost Accountingand related subjects, was the leader in organizing this Associa-tion. At the organization meeting in 1919 there were 37 promi-nent accountants from the public accounting and industrialfields. Mr. Nicholson was chosen to be the first President ofthe Association which has had sensational growth and its mem-bers have contributed outstanding articles on cost accountingand related accounting subjects. (In 1957 the name of theassociation was changed to the National Association of Ac-countants.) Mr. Nicholson established a correspondence coursein "Cost Accounting" known as the "J. Lee Nicholson Schoolof Cost Accounting" in Chicago, Illinois. I am a proud holderof a completion certificate from this school. Due to the illnessof Mr. Nicholson this school was discontinued about 1925.

In 1913, Mr. Nicholson authored the book, Cost Accounting—Theory and Practice, which became the "Bible of Cost Ac-counting" in the days before 1920 and thereafter. Due to theneed of industries to know production costs, the needs ofgovernment for taxation and defense contract purposes, andthe need to provide better education in accounting by schools,Mr. Nicholson and Mr. John F. D. Rohrbach, a partner in thepublic accounting firm of J. Lee Nicholson & Co., revised the1913 book in 1919. The new book, Cost Accounting, wasmore comprehensive in all respects, and discussed the latestpractices of the time. Mr. Nicholson was a strong advocate ofuniformity in cost finding methods. Other books authored byMr. Nicholson are: Factory Management and Costs (1909),Statistics Designed by J. Lee Nicholson (1910), and ProfitableManagement (1923) . In the book by S. Paul Gamer, Evolution

Continued on page 12

10 MANAGEMENT ACCO UNTING /DECEMBER 1974

Come to Atlanta /Feb. 24 -28 /Fairmont Colony Square. . . and start moving!REG IST RAT IO N IN F O R MAT IO N

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The fee for NAA Courses includes dailyluncheons, refreshments, comprehensiveworkbooks and technical materials.

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LETTERSContinued from page 10

of Cost Accounting to 1925, Mr. Nichol -son's ideas and theories of cost accountingare stated throughout.

When the United States Governmentbecame involved in the First World War,the Department of the Army drafted Mr.L. W. Blythe, a partner of Ernst & Ernst,Public Accountants, Cleveland, Ohio, andcommissioned him a Colonel responsiblefor organizing and administrating theCost Accounting Section of the ArmyOrdnance Division for the purpose of de-termining contract costs and certifyingthe reimbursements of contractors. Manycontractors had fixed price and cost pluscontracts in addition to their own prod-ucts. So it was essential to both the Gov-ernment and the contractor that propercost records be maintained and propercost accounting principles be applied.

The Ordnance Cost Accounting Sec-tion consisted of both military and civil-ian personnel which were recruited fromthe accounting field. I was one of thecivilians recruited for this work. The pro-visions in Government cost plus contractsfor the determination of proper costs

created a tremendous "boom" for cost ac-counting and the accounting field asmanufacturers wanting war contracts hadto comply with the terms of the contracts.This caused industrial concerns, through-out the country, to suddenly recognizethe importance of proper cost findingmethods. Since World War I, industryhas continued and improved its cost find-ing methods due to trade competitionfrom others. Thus, World War I and theGovernment have brought about out-standing progress for cost accounting inbusiness administration.

In 1920,another excellent book, CostAccounting Principles and Practice, waspublished. The authors were two promi-nent authorities in cost accounting, JohnP. Jordan, Lecturer in Factory Organiza-tion at New York University, and GouldL. Harris, Instructor of Cost Accounting,Ohio State University, and later Professorof Cost Accounting at New York Uni-versity. He is now Professor Emeritus ofthat institution. This book presents op-posite views on some subjects covered inMr. Nicholson's book. This book becamevery popular, making the best- seller listwith accountants, and was adopted as atextbook by many schools of accounting.

On the subject of "labor costs" the bookdiscussed the reporting and classificationin greater detail than other authors up tothat time. In the preface of this book isstated, "The credit for slowly but surelyforcing the issue of cost accounting be-longs chiefly to the accounting profes-sions." I am in accord with this statementby the authors.

I have cited the above to indicate someof the outstanding contributions by ac-countants to cost accounting before 1925not covered by Mr. Feller.

Cecil D. Marshall, CPAPast President

New York ChapterNew York, N.Y.

Are New Standards Required?

I read with great interest Mr. DonaldJames' article, "Proposed Budget- Audit-ing Standards," in the May 1974 issue ofMANAGEMENT ACCOUNTING.

The author proposes a format for ex-pressing an opinion on the presentation offorecasted financial performance. The au-thor has done this well and I agree withhis conclusion. However, the main thrustof his article is that traditional auditingstandards should be revised to supportthis new type of opinion. While I do notdisagree with the author on this point, Ido question whether audits of forecasts,when analyzed into their constituentparts, are really anything new and whethernew auditing standards are required.

As presented in this article, the audi-tor's opinion will be supported by (1) anaudit of the budget system,(2) an auditto ascertain that the budget assumptionshave been fairly applied and are consis-tent with the company's established ac-counting principles, and (3) present forthe reader the assumptions on which theforecast is based.

With respect to item (1), an audit ofa budget system would be no differentthan an audit of a computer system, anMIS system or of historical financial rec-ords. No revision of auditing standards isrequired in this instance. With respect toitem (2), the same audit procedures canbe used to ascertain that it has been fairlyand consistently applied according to gen-erally accepted accounting principles, abthough the data from item (2) is forecastrather than historical. Here again, there isnothing new that would require a revision



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Data Sheet DECEMBER 1974

R & D Costs Must Be Treated as Expense, Says FASB Statement

Research and development costs must be charged to expense as incurred, according to thesecond Statement of Financial Accounting Standards, issued by the Financial AccountingStandards Board. Research conducted for other parties under contractual arrangements, however,was excluded from the provisions of the statement. The statement issued by the Boardgenerally reflects the Management Accounting Practices Committee's recommendations, butthe MAP Committee did suggest some capitalization of R &D expenses be permitted understringent criteria.... In another development, the Board has issued for public comment aproposed statement of a standard which, if adopted, would limit the diversity of practice withregard to accounting for and disclosure of loss contingencies. The proposed standard wouldpermit an estimated loss from a contingency to be accrued by a charge to income when, butnot before all of the following conditions have been met: "(1) information available at thedate of the financial statements indicates that it is probable that an asset has been impaired or aliability has been incurred; (2) one or more events are reasonably expected to occur that willconfirm the fact and amount of the loss; (3) the amount of the loss can be reasonablyestimated."

SEC Proposes Increased Disclosure of Auditor - Corporation Disagreements

Under a proposed new disclosure procedure of the SEC, any disagreement between registrantsand auditors required to be reported in monthly reports to the Commission must also beincluded in the annual financial statements and in proxy statements to stockholders. Theagency also proposed that disagreements within the last two years which related to accountingdisclosure matters be reported in a note to the financial statements. The deadline for commentson the proposals to the agency was November 30.

FTC Commissioner Criticizes Regulatory Agencies

In a surprising turn - about, Federal Trade Commission Chairman Lewis A. Engman joined theranks of those critics who have been focusing on the regulatory agencies and their possible"drag" effect on the economy. In an address before the Financial Analysts Federation, he said,"Though most government regulation was enacted under the guise of protecting the consumerfrom abuse, much of today's regulatory machinery does little more than shelter producers fromthe normal competitive consequences of lassitude and inefficiency." He added, "The fact ofthe matter is that most regulated industries have become federal protectorates, living in thecozy world of cost -plus, safely protected from the ugly specters of competition, efficiency andinnovation."

AICPA Establishes Committee to Study Role of Auditors

A seven - member commission headed by former SEC Chairman Manuel F. Cohen has beenestablished by the American Institute of CPAs to conduct a full -scale study of the responsibilitiesof independent auditors. The Commission is expected to carry out its task in the same manneras the two earlier study groups appointed by the AICPA: the Wheat Committee and theTrueblood Committee. It will seek answers to such questions as should auditors monitor allfinancial information released to the public and, if so, what should be the extent of theirresponsibilities? Should the auditor's standard report, particularly the phrase "present fairly,"be changed to express better the responsibilities of auditors? Is the mechanism for developingauditing standards adequate? The Commission was requested to complete its study by the endof 1975.... The Institute also published Statement on Auditing Standards No. 2 which requiresthat auditors disclose the nature and potential impact on the financial statements of anyuncertainties — pending litigation, possible expropriation of foreign subsidiaries or possiblelosses on receivables from customers approaching bankruptcy —which could affect the com-pany's statements.

U. S. Inflation Unlikely to Reach Acceptable Levels Before Late 1976, Says Conference Board

In an analysis of policy alternatives to dampen inflation, Dr. Michael E. Levy, director ofEconomic Policy Research at the Conference Board, concludes that assuming wage and pricecontrols are not reimposed, "a return to reasonable price stability is unlikely before late 1976at the earliest."

14 MANAGEMENT ACCOUNTING /DECEMBER 1974

THE LONER: A SMALLFIRM'S CONTROLLERSPEAKS OUTWhen you get home at night you know that you have put in a

good day's work and done your best. It kind of gives you a sense

of satisfaction to offset the daily frustrations. It's a good feeling.

By Raymond R. Geary

The "loner" is an individual in a small companywho pays the bills, oversees a small office, providesan annual budget, keeps the books of the corpora-tion, acts the conservative when the top man be-comes too optimistic and the optimist when every-one else is down in the dumps. His company is toolarge for a bookkeeper and too small for a financialvice president; therefore, he is called the controller,treasurer, personnel manager, credit manager, con-sultant, and budgeting expert. The hat he wearsdepends on the problem situation at the time.

The Controller

The picture that most people have in their mindsof a corporation controller or treasurer is that ofan individual ensconced in a beautifully paneledoffice high in the company's headquarters, wall towall carpeting, bar, private bathroom and a bevy ofpretty secretaries ready to serve him at the touchof a button. I think that many of you loners willagree with me that, "It ain't necessarily so." Mostof us operate out of a small office adjacent to thegeneral office and most of the time, the placesounds like a boiler factory with typewriters, addingmachines and bookkeeping machines banging awaywhile visitors and employees converse outside theopen door (open by necessity).

My first office contained a painted floor. I haveprogressed since then. My present office floor iscovered with serviceable asphalt tile; I share themen's room with 50 or 60 men from the plant; myprivate bar is an old electric coffee pot that I useto heat water for my instant coffee. If I wish tohave a letter typed or a piece of work done, I hollerout the door and hope that one of the girls workingout in the front office will have time enough to getit done.

The TreasurerI don't think a week passes that I don't have to

spend a half hour or so during the day listening to

a bright young man tell me that what our companyreally needs is a complete set of electronic calcu-lators (trade in or throw out the calculators wehave). Or another bright young man will try hisdamndest to convince me that I must put an orderthrough immediately for a "do -all" computer systemand credit service to service his special brand ofwidget —or our company is doomed. While I ambeing polite and listening to these pitchinen, mythoughts run like this:

1. Should I invest in this piece of equipment orservice?

Z. How can I justify the expenditure?3. Does it protect and further the stockholders'

interests?

The Personnel Manager

The nice things about being a "loner" in a smallcompany is that you get the opportunity to be in-volved. You have something to do with almostevery facet of the organization and structure suchas stock records, general ledger, inventories, costand sales. Consequently your overall knowledge ofthe operation of the company is much more basicthan your counterpart in a large corporation in hisplush office in the penthouse of the office building.I not only know all of my office staff, I know everyemployee in the company and all of their personalproblems.

Four months ago my accounts receivable clerkquit because she wanted to try working in the bigcity. I was fortunate and managed to hire an ex-cellent girl to replace her. Now this girl is a realwinner, sharp, efficient, fast and has an amazinggrasp of the job. When I hired her I asked her ifshe was expecting to have any more additions toher family within the next year or so (she is marriedwith one child) and she said, "Good Lord, no, notfor quite awhile." You guessed it —she told me theother day she is pregnant again. She is leavingwithin a month and a half, and won't be returningafter the baby is bom.

R. R. GEARY

Olean- Bradford AreaChapter 1958, is VicePresident — Financeat Conap, Inc.,Allegany, N.Y. Mr.Geary holds a B.B.A.degree from St.BonaventureUniversity.

This article wassubmitted throughthe Olean- BradfordArea Chapter.

MANAGEMENT ACCOUNTING /DECEMBER 1974 1s

" . . . the "loner' The Credit Manager

must know all

about

governmentreports and

auditingprocedures."

Our company is growing like Topsy and naturallyone of our growing pains is creating more space towork in, finding the right people to fill our expand-ing operations and keeping the gap narrowed downbetween our receivables and our payables whilestill maintaining a good credit rating wth our sup-pliers. In that respect, the "loner" must also be agood credit manager who has the guts to refusecredit to a customer whose finances are shaky (orwho does not pay his bills promptly) and who willstand his ground from the pressure above. As anexample, a customer will start with a small amountof purchases and payment will be prompt or rea-sonably prompt. Suddenly the customer's purchasesdouble or triple within a short period of time, some-times within a month. By the time the red flag goesup on his account, he is into your company for agood sum and you are getting lots of excuses butfew results from your collection letters, phone calls,etc. Now you are faced with the problem of tryingto get your money out of this non - paying customer.If his story is reasonably true, you don't want tolose him; on the other hand, uncollected receivableshave put many companies into bankruptcy. Youhave gotten the latest rating service reports on himand his condition is shaky but not hopeless; heneeds help in the form of time to pay. You have toknow, is your company strong enough to financean additional time period for this customer or willhard business policy dictate that you institute suitto collect? You get all the information you can andmake your decision; right or wrong, you are stuckwith it.

The Consultant

As the company's internal consultant, the "loner"must know all about government reports and audit-ing procedures. He must be able to immediatelydefine, for example, any or all of the following:

1. Federal withholding and F.I.C.A.2. State income taxes3. State unemployment insurance4. Disability compensation5. Economic employment opportunities6. Census and statistics7. Fair employment practices

Why don't our government agencies come upwith one form (report) which will coordinate allagencies, dates and reports into one complete reportcovering everything? After all, we do have photo-copying machines to give everyone concerned hisown copy to play with. Frankly, if the form is notmandated by law, I will rarely complete it. I justdon't have the time for anything that is not abso-lutely necessary.

In the business world, the best known and mostrespected statement is: "We have examined thefinancial statements of the XYZ Company for theyear ended 19 —. Our examination was made inaccordance with generally accepted auditing stand

-

ards and accordingly included such tests of theaccounting records and such other auditing pro-cedures as we considered necessary in the circum-stances, etc." In other words, you may now layyour bets on this horse. We have examined hishoof and mouth and we found no disease.

The common thought among small companieswho wish to expand and go public seems to be, geta big name auditing firm whose name will appearon the bottom of your annual statement; it lendsprestige. Yet we all know that most small publicaccounting firms are just as reputable and some-times better qualified to audit and guide the ac-counting functions of a small company than is alarger, nationally known accounting firm, especiallyif the closest office of the large firm is not nearby.Another point in favor of a smaller local firm is theease on consultation and the smaller fee.

Budgeting Expert

Ours is a standard cost system and the budgetis based on accounting by exception or the variancemethod. Our fiscal year ends September 30, atwhich time the new budget must go in to effect.Because of the work involved in completing a good,workable budget and because our office staff issmall, I like to start work on it at the earliest pos-sible date, say at least two to three months aheadof the end of the fiscal year. Naturally, the firsttiling I want is the sales projections for the newyear. Last year I got them one and a half monthsbefore the end of the fiscal year. As a result thebudget was done hurriedly and after four monthsof operation it reflected many errors which I feelwould not have been made had proper time beenallotted to completing it.

Capital expenditure projection is one of the areaswhere the people who present the figures do notseem to realize that a thorough analysis should bemade of all projected purchases before submittingestimates. All too often I receive capital expenditureestimates based on need. Later actual figures showme that purchases have been made, not necessarilyon need, but on want and get.

Labor estimates are perhaps the most importantitems in a workable budget, including overtime andbreakdown between direct and indirect labor. Some-times I wonder how many of our department headsuse a hat to pull their figures out of for staffingtheir departments on a projected basis. However, Ican forgive them when I know that the sales pro-jections are far too low and more personnel andmore overtime are needed to keep up with sales.Additional people means more money and less pro-duction per hour during the learning cycle. Badenough, right, but worse is the labor rate projection.I spend a great deal of budget preparation timeconsulting with department heads and checkingpersonnel records to complete the standard laborrates for the new budget, taking into considerationnew people, seniority, annual rate increases, meritincreases, hours to be worked and so forth. WhenI have finished this phase I review it with depart -


to MANAGEMENT ACCOUNTING /DECEMBER 1974

FINANCIALPERSONNELRECRUITMENTTo attract better people, the accounting profession needs better

public relations —to emphasize its strong points, its service toindustry, and its high income possibilities.

By Edwin W. Southerland

There are five basic ways of recruiting financialpersonnel. The first way is through a referral fromone of your trusted employees. The second way isthrough interviews on campus. (This is the waymost of the large international CPA firms get thetop accounting graduates.) The third way, if youare in no hurry and which may get you satisfactoryresults, is with an ad in your local newspaper.Because of the cost of time lost, however, the costof the ads, and often poor results, many companiesno longer use this method for securing professionalpersonnel. The fourth way is through an executiverecruiter who does a good job, especially in the$25,000 to $100,000 range. His fee is usually about25 percent of a year's salary plus expenses. As abroad "rule of thumb" you can plan on the totalbeing about one year's salary. The fifth, and possi-bly the best, way is to come to an employmentagency specializing in the financial area. Workingthrough experience, extensive advertising, and re-ferrals from satisfied clients, an agency may evenhave on file the person you are seeking.

Enter the Resume

However difficult it may be to judge the qualityof the candidate from a sheet of paper, the initialscreening is still usually done through a resume.Resumes are written by individual job- seekers, andsometimes by ghost writers. The resume is nothingmore than an advertisement which the job- seekercreates to present himself in the best possible light.And, as advertising often does, so will the resumefrequently present the facts to carefully conceal ordistort the truth. If the applicant is careless withhis resume, if he has it written entirely by someoneelse, if he has obvious flaws in his presentation, thecompany should by -pass him. On the other hand,is the company being fair to itself by not interview-ing certain people without resumes? Sometimesthe hottest candidate has not prepared a resume.

If you wish to use resumes here are a few tech-

niques in reading between the lines: Read theresume back - forward. The least flattering informa-tion usually goes at the end. Be cautious of thefunctional (no dates) resume, sometimes used tohide job- jumping or irrelevant experience. Assumethe words "knowledge of," "some experience in,""exposure to," "assisted the treasurer with," and"supervised" may mean the applicant does notreally know the subject. Assume that everything heleaves out of the resume he does not have.

Some people seem unaware that companies arein business to make money: read for any clues thatshow the applicant is interested in company profits.See if you can detect any evidence of his willingnessto devote time and effort to his job. Sometimes youcan detect an angry person by the way he writes hisresume. Be careful. Sometimes resume writers con-centrate on trivia. Example: More space given to adetailed health report or hobbies than to the sum-mary of experience. Often, the more space an ap-plicant devotes to education, the least amount offormal education is on his record.

Making Your Decision

Try to reduce hiring decisions to the least num-ber of people. The more interviews by differentpersonnel within your organization, the greater thechances for the compromise candidate: The "guywho doesn't make any waves;" the mediocre. If, forexample, Jones and Smith say they like candidateX, but Brown says, "He's OK, but I'm not sure,"he will not, in most firms, be hired. Brown holdsa club, so to speak, as the "second guesser." Ifcandidate X is hired and works out satisfactorily,Brown was "not against" him. If he fails on thejob, Brown can say, "I told you so." Jones andSmith recognize this, and fail to put pressure onBrown. What happens? After dozens of interviews,the three focus on a compromise candidate.

Good candidates get good offers. Hire fast.Don't wait for all reference results. Hiring shouldbe contingent upon the references checking out,but meanwhile, he can start. Some firms insist on

E. W.SOUTHERLANDBaltimore Chapter1967, is affiliated withRobert Half PersonnelAgencies. He ownsseveral franchises inAlexandria, Baltimore,and Washington, D.C.Mr. Southerland holdsB.S. and L.L.B. degreesfrom the University ofGeorgia and an L.L.M.degree with honorsfrom GeorgeWashingtonUniversity.

This article wassubmitted through theBaltimore Chapter.


"When

employees

leave a firm,

the good onesoften go and

the mediocre

ones remain."

a formal offer to the applicant: "We will send youan offer next week." But next week may be toolate. Avoid long -range starting dates because itgives the candidate too much time to change hismind. If the applicant is worthwhile, the chancesare that some other firm will recognize this andgive him a more attractive offer.

You may only get one pass at the best candidate.Take advantage of it, or be prepared to risk hiringa runner -up. just because the quality applicant hap-pens to be the first one interviewed is no reason notto offer him the job. (Letting the first ball pitchedgo doesn't work any better in employment than itdoes in baseball.)

You Can't Always Keep ThemWhen employees leave a firm, the good ones often

go and the mediocre ones often remain. To analyzethe problems of employee retention, we must havean understanding of why employees leave andwhere they go. For our purpose we will consider sixcauses of employee dissatisfaction.

RESPECT

The driving force that causes termination is theemployee's effort to gain greater respect from hisemployer, co- workers, from clients, from relativesand friends. You must inspire your staff with a feel-ing of respect for your corporation, for their pro-fession, and for themselves. Here are a few ideas:Confer with your staff people as individuals, notjust as a group. Get personally involved. Ask opin-ions. Make your employee feel he is a genuine partof the firm. Make him important. Compliment himon a job well done. You must create an atmos-phere which enhances his self- image.

TITLES

Employees sometimes leave accounting, orchange from one corporation to another, or makea lateral change merely to "buy" a better title. Isthe title treasurer, controller, or financial VP moreinviting than supervising senior? Many corporations—and their employees —are getting title conscious.(XEROX does not have any servicemen; they havetechnical representatives with calling cards.) Banks,as we all know, widely use the title vice president.And many companies no longer have salesmen, butmanufacturer's representatives.

Why not improve the accountant's titles? Isthere anything wrong with having many titleswithin a corporation to give the accountant dignityand individuality? For example, why not have adirector of finance, executive audit manager, execu-tive supervisor, executive manager, and others? Staffpersonnel should also have calling cards reflectingtheir titles.

SALARY

Do not ignore money as a motivating force tomake employees change jobs. You should re- evaluateyour salary structure periodically to make certainit is competitive. It has been our observation thatpublic accounting salaries, as a whole, are similar to

those in industry, except at the beginning and thehighest executive levels. The staff person in a me-dium size CPA firm earns about the same as hiscounterpart in a medium size corporation; and thestaff person in a large CPA firm earns a salarysimilar to what his experience would produce in alarge corporation.

SECURITY

Employees leave their positions to find greatersecurity. Some accountants do get fired and com-panies do go bankrupt, merge and relocate. So allof us from time to time enter the job market. Yet,there is always a demand for the skilled accountant,and his security is his own ability.

How can the employee be made to understandthat his job is secure? For one thing, you can tellhim. In other words, you should relay to him keyfacts about your firm, but make sure that your factsare accurate.

CHALLENGE

Employees will leave if the job lacks challengeand interest. Let's be realistic. Some accountingwork is boring, particularly at the first and secondYear experience level. There is still too much re-petitive, tedious work in accounting for the activemind. You should get as many boring details aspossible away from the staff and into hands of non-accountants or, if at all possible, to an outsidecomputer service.

FULFILLMENT

There are accountants who leave because theysense a lack of orderly progression. They feel thereis no one to whom they owe loyalty. They perceivethey are not really building anything; just finishingone job assignment and on to the next. This diffi-cult problem is apparent in most professions. Asfar as possible you should make every effort toadvance accountants to larger and more compli-cated assignments.

You Can Part TactfullyWhen an employee tells you that he has re-

ceived another job offer at a higher salary, youshould not make any effort to induce him to stayby raising his pay. It is better for overall employeerelations to wish him good luck and hire someoneelse. If you pay him more money under those con-ditions, you are creating a precedent. Meetingsalary increases under the threat of termination willcause staff resentment and unrest. Conjure up thelikely comments exchanged around the water cooler:"If you want more money here, you've got to get abetter offer elsewhere." "Of course, we're under-paid; I got a better offer and the firm finally matchedit." When you pay an increase on this conditionyou will invite a rash of meetings with others askingfor the same consideration. You will also find someof your staff spending part of their (your) timelooking for new employment in order to get abetter deal from you. It is much better to take your


is MANAGEMENT ACCOUNTING/DECEMBER 1974

EXPLORINGFORECASTDISCLOSUREFinancial executives and managers stand virtually shoulder

to shoulder against the future release of budget or forecasts.

By William G. Brown, Jr.

Should companies now be compelled to publiclyreveal their earnings projections and other financialforecasts? Among company executives and securityanalysts there has probably been no one subjectdiscussed more frequently during the past twoyears than the disclosure of company sales andearnings forecasts. Controversy aside, it nonethelessremains a fact that publicly held corporations inthis country publish and report to the investmentcommunity more information about their financialposition and operations than do any other corpora-tions in the world.

Early in 1972 the Securities and Exchange Com-mission felt compelled to reexamine its stand for-bidding the publication of earnings forecasts bycompanies under the federal securities laws., Atpublic hearings held in November and Decemberof the same year, the SEC discussed whether itshould require, permit, or forbid the revealing offorecast information by companies that are subjectto its rules. On February 2, 1973, the SEC an-nounced that it planned to relax its traditional ban,permitting voluntary disclosure of earnings fore-casts, but ruled that such disclosures would berequired only under special circumstances.

In the early clamor for forecast information therewas little or no perceptible evidence that any ofthose demanding the information had given suffi-cient thought to some of the inherent and basicquestions in complying. Several surveys concerningthese questions have been conducted since then:"Public Disclosure of Business Forecasts" by theFinancial Executives Research Foundation; a surveyof attitudes on forecast reporting conducted as partof an American Institute of Certified Public Ac-countants research project; and The ConferenceBoard survey of its 110 member Panel of SeniorFinancial Executives.

Each of these surveys reported company execu-tives overwhelmingly opposed to mandatory dis-closure. The AICPA survey conclusions indicated

that Chartered Financial Analysts ( CFAs) gen-erally believe publication of forecasts for the generalinvesting public should be encouraged, FinancialExecutives Institute (FEI) members disagree withthis, and CPAs tend to agree with the analysts.Securities analysts believe that forecast informationis of real importance to their professional position,but corporate management feels that forecasting isan internal management planning tool.

Overall, little sentiment exists for requiring thepublication of forecasts. A general concern existsthat the average investor may misinterpret thesignificance of a published forecast?

Securities analysts, however, strongly feel thatforecast information is vital to the determinationof a company's stock value. Price earnings trendsand levels of earnings are considerably importantin rationalizing the current and future price of acompany's stock in the marketplace. It is onlynatural that any securities analyst who is able toprovide his clients with creditable earnings, projecta favorable position with them for future business.

The corporate executive's position is that fore-casts serve as an internal planning and control toolonly, and at that, are usually confined to a selectlevel of management. This tool is frequentlychanged in response to various outside influences.

Types of Forecasts

Most companies of any size prepare forecasts.If the company is organized on a plant or divisionalbasis, the forecast is usually prepared on that basis.That is, it is consolidated on a corporate basis withthe addition of corporate office expenses and theconsideration of federal taxes. The types of fore-casts usually found include:

1. Sales or revenues2. Earnings by major products

' Richard J Asebrook and D. R. Carmichael "Reporting onForecasts: A Survey of Attitudes," The Journ;Y of Accountancy,

NET.16id. t 1973.

W. G. BROWN, JR.

Muskegon Chapter(Pittsburgh 1947), isVice President andGroup Controller,Gas TurbineComponents Group,Howmet Corp.,

Muskegon,

Mich.

Mr. Brown holds aB.S. degree from theUniversity ofPittsburgh where healso did graduatework.

This article wassubmitted through theMuskegon Chapter.


"Since the

forecast is a

goal or target,

managers tend

to make them

moreachievable

by being

conservative."

Exhibit 1YEARLY VARIANCE

Cumulative Percent Variance (2)

Rank(]) Type of forecast 5% 10% 15% 20% 21 -r %1 Corporate expense 65% 90% 97% 98% 2%2 Expenses by corporate chart of

accounts 55% 84% 92% 98% 2%3 Corporate sales 53% 84% 93% 95% 5%4 Changes in capital structure 53% 84% 92% 95% 5%5 Expenses by division 53% 82% 95% 97% 2%6 Changes in productivity 47% 77% 92% 97% 3%7 Sales by division 36% 74% 88% 94% 6%8 Corporate earnings 37% 70% 80% 87% 13%9 Earnings by division 22% 58% 73% 82% 18%

(1) Based upon cumulative variance at 10 %.(2) Percent variances represent plus or minus differences.

3. Expenses to develop earnings4. Capital expenditures5. Research and development6. Capacity review7. Cash forecasts

Most companies develop an annual forecast orbudget for each month of the fiscal year just priorto entering their fiscal year. At the beginning ofeach month they prepare an additional update ofthe expectations for the current month, and forthe next two or three months as well. This up-dating can usually take advantage of the currentbusiness trends within the company and its in-dustry, thus avoiding surprises.

Many companies extend the annual forecast toinclude a longer range projection, usually threeto five years in advance of the current year. Thisis used internally more for planning expansion offacilities, and cash requirements than for the usualelements of sales and income.

Very few companies now release such informa-tion to the public in any manner — formal or in-formal. Those companies whose business is cyclicalor seasonal would especially encounter greater diffi-culties in making projections and for this reasonwould be more reluctant to disclose such fore-casts.

Adequacy of Forecasts

Corporate management holds strong feelingsabout the risks in publishing incorrect forecasts.In its opinion there are innumerable factors beyondits control that can significantly affect accuracy.Major factors include economic changes in theindustry, country, or in the world, changes in thetax laws, introduction of new products or processesby competition, and changes in pricing by thecompetition.

When a responsible manager compares his actualexperience to the forecast he must explain thereasons for deviation. If they are beyond his con-trol they are usually acceptable. When dealing withthe investing public, however, this acceptance ofdeviations would not be present and could verywell result in a serious credibility gap and share-holder resentment. As one textile executive put it,

"If the forecasted earnings are higher than actual,then the buyers of stock will blame the companies;if the forecasted earnings are lower than actual,then the sellers of stock will blame the companies;if the forecasted earnings are accurate, then thebuyers and the sellers of stocks will pride them-selves on their own ability to accurately diagnosethe results." 8

To what degree are internal forecasts reliable?Most corporate and division managers attempt toset reasonable and achievable annual goals. Al-though the words "reasonable" and "achievable"sometimes appear to be incompatible most man-agers desire to make a fair assessment of their op-erations; thus the "reasonableness" is assured. Sincethe forecast is a goal or target, managers tend tomake them more achievable by being conservative.

Is this wrong? Is it merely human nature re-sponding? How inaccurate are such forecasts?

The Financial Executives Research Foundationsurvey indicates that for corporate sales 85 percentof the respondents indicated 90 percent accuracy;and on earnings 70 percent of the respondents in-dicated 90 percent accuracy. When attempting toidentify divisional accuracy in the same two itemsfor 90 percent accuracy it showed 74 percent onsales and 58 percent on earnings.* This would seemto indicate that a degree of accuracy of plus orminus 10 percent cannot be reasonably expected inthe eyes of the investing public. (See Exhibit 1.)

This same survey indicates that a deviation ofplus or minus 20 percent can be expected in only87 percent of the cases on corporate earnings, and82 percent on divisional earnings. This would seemto demonstrate unquestionably that forecasting isby no means precise, even though most large com-panies are employing it for their own planning.

This conclusion appears to be similar to othersreached on the same subject:

"The experience of the firms studied indi-cates that a reasonable doubt should existregarding the ability of firms to forecast

/bid.*Phyllis S. McGrath and Francis J. Walsh, Jr., "Disclosure ofFinancial Forecasts to Security Analysis and the Publ ic," A reportfrom The Conference Board, 1973.


operating results with the degree of accuracyand precision necessary to satisfy the require-ments of investors. Differences exceeding 15percent between forecasted net income andactual net income were present in one -third ofthe observations." 5

Legal Liabilities

A major concern of the vast majority of companyexecutives is that deviations from published fore-casts will result in legal action against the company,its officers, or the members of its board of directors.Such a possibility of risk becomes ever greater asmore and more decisions are based upon suchpublished forecasts. Regardless of the ultimate out-come, the cost of such laws suits could be burden-ing.

"With regard to legal liabilities of manage-ments and boards of directors the formal pub-lication of projected financial statements can-not help but increase legal exposure. Financialperformance significantly better or worse thanprojected seems clearly to be a basis for actionfor damages. Where they were able to estab-lish a deliberate attempt to mislead, thirdparties would have the same avenues forredress as they do now. One gets into a grayarea, however, when performance differs sig-nificantly from plan and there has been anhonest attempt to (1) plan properly (2 )make full disclosure (3) manage the companyas efficiently as possible. The recognition ofthis potential new source of legal complica-tions is one of the reasons why managementis not particularly enthusiastic about publish-ing forecasts in the form of projected financialstatements." 6

One thing, however, is certain. If forecast infor-mation is provided to securities analysts it should bea company's policy to immediately make a publicrelease of the same information. The SEC, in fact,has given notice that a registered company will berequired to file information on earnings forecastsonce that information has been given to any personsoutside the company. This would include securitiesanalysts or others who could be expected to use theinformation in the purchase or sale of securities, orin turn, pass it on to others who could use it forinvestment purposes.

No conclusion can be reached as to whether anyclass action suits by stockholders would ever takeplace, but given the way current standards are de-fined, the hazard is not worth the risk in the eyesof management.

Misinterpretation and Assumptions

In the Asebrook and Carmichael Survey of At-titudes on Forecasts (Exhibit 2), the item all threeprofessional groups agreed upon was that the aver-age investor would misunderstand or misinterpretforecasted income statements published by manage-ment.'

Exhibit 2ATTITUDES ON FORECASTING

Percent who feel

misinterpretation:Respondent Would Would not

groups take place take placeInstitute of Chartered

Financial Analysts 47% 31%Financial Executives

Institute 57% 21%American Institute of

Certified PublicAccountants 48% 36%

Source: Asebrook and Carmichael, "Reporting on Fore-casts: a survey of attitudes," Journal of Accountancy,August 1973 , pg. 43.

Interpreting the meaning of earnings and otherforecast data depends upon how well a reader under-stands the assumptions that are inherent in theforecast.

For internal planning purposes, the major as-sumptions that go into the forecast should bethoroughly and completely documented. Such docu-mentation usually comprises:

1. The industry outlook, including competitor ac-tions, the company's relative position withinthe industry, any penetration that is expectedfor the coming forecast period

2. The product line outlook and forecast, particu-larly where more than one product line may beinvolved in a division or corporation

3. Selling price assumptions, including the effectof price controls where they may be a factor

4. Wage increases, including the effect of wagecontrols and labor agreements where they areknown or can be anticipated

5. Other cost increases which can be documentedor anticipated

6. Governmental actions affecting the division, in-cluding such things as government spendingprograms, federal and state tax changes,O.S.H.A,. and pollution controls

7. Dollar exchange fluctuations where a companymay be in the international market place

8. Capacity studies, predicated upon industry out-look and sales projections, which may result inexpansion of current facilities or the require-ment for additional geographical outlets

9. Marketing strategy, including specific divisionor corporate objectives and plans to capitalizeon strengths and to reduce the impact of divi-sion weaknesses

10. Introduction of new products, or opening newmarkets

11. Major cost reduction programs which may bein progress or contemplated for the forecastperiod

I "T he Feasibility of Reporting Forecasted Information," TheAccounting Review, October 1971, p 666, 692.s R. Gene Brown, "Ethical and Other Problems in PublishingFinancial Forecasts," Financial Analysts Journal, March -April1972.r Asebrook and Carmichael, Op. Cit.

"A major

concern ... isthat deviationsfrom

publishedforecasts will

result in legal

action againstthe company


"The frequent

or periodic

changes

required can

then create a

credibility

gap

12. Major influencing factors that will tend tochange working capital

13. Progress and assessment of research and devel-opment projects —which are being dropped orwhich are being emphasized as most fruitful

Since companies preparing forecasts include agreat deal in their assumptions, it raises the questionof how much should be disclosed. Saying too littlemay render the forecast hard to understand, but dis-closing all of the details will subject it to interpreta-tion, and the average investor or stockholder is notsufficiently sophisticated in his interpretive endeav-ors to arrive at a likely conclusion.

Another significant argument raised by manyexecutives is that if detailed assumptions are dis-closed they will provide the competition with aninsight into company plans and strategy. Thecompetition thus has a preview and an earlieropportunity to counter. From this, one can con-clude that some compromising middle ground be-tween detailed assumptive disclosure and minimalinformation may be the final answer if voluntarydisclosure is the course a company feels it mustpursue.

Management's Use of Forecasts

Forecasting, as an internal too], primarily estab-lishes a reasonable estimate of sales and earningsfor the forecast period. Thus, it becomes a goal or atarget— something to strive to achieve. During thecourse of the year, management is usually interestedin comparing actual performance to this forecast —usually monthly, although in smaller companiescomparison may be quarterly.

Management is further interested in determiningthe causes of differences from forecast and decidingif these conditions will continue. This practiceusually results in periodic updates, giving all inter-ested levels of management the latest analyses ofsales and earnings expectations.

Public disclosure of forecasts could result in thedevelopment of data that is (and always was)"achievable." Thus, an element of complacencycould creep into management's philosophy, causedby conservative forecasts that in reality work to thedisadvantage of the company and shareholders.Management usually prefers to operate in an envir-onment of challenge, receiving the rewards andbenefits for risk - taking. Disclosure could dampenthis philosophy, by feeling the compelling need to"play it safe."

Credibility of Forecasts

Because of the inaccuracies inherent in forecasts,and the possibility of future forecasts leaning to theachievable side, there arises the question of credi-bility. Managers recognize that there are manyinternal and external factors which are subject tochange. They are in their positions precisely becauseof their ability to react to these factors in the bestinterests of the company. Most investors, however,

are not sympathetic to these factors, feeling thatforecasting is a relatively simple task of feedingorders into a computer ( that has its memory filledwith statistics on that order) capable of massagingthem to print out a sales and earnings projection.The frequent or periodic changes required can thencreate a credibility gap which could damage theconfidence of investors.

Summing Up

Almost all companies of any size prepare forecastsfor internal use. Most of them forecast in greaterdetail for the current year and in lesser detail for anextended period, usually up to five years. Thesecompanies further compare the actual results tothose that are forecast in the plan on a frequentbasis, usually monthly. In developing the forecast,companies document a series of assumptions whichusually encompass an economic outlook: competi-tive strategies; external, governmental, and otheragency factors; marketing strategies; and other finan-cial considerations. Companies seldom release suchforecasts to the financial community.

Financial executives and managers stand virtuallyshoulder to shoulder against the future release ofbudgets or forecasts. Although it is difficult toidentify any one factor which forms the basis formanagement's resistance to disclosure, two elementsare of primary significance: potential misinterpreta-tion by the investing public, and the potential legalliabilities. In addition to these factors there areothers: the public release of information would beadvantageous to competition; credibility implica-tions would arise whenever revisions to forecastswere necessary or whenever forecasts were missed;the cost of complying with disclosure might be high,particularly as it pertains to the requirements forrevision; and management now uses current fore-casts as tools for establishing goals rather than as ameans for informing investors.

Most managers feel that companies would tendto submit conservative or achievable estimates ifthey were required to make public disclosure. Suchaction would take place primarily to avoid thedamage to present stockholder relations and tobridge the credibility gap. Management would mostlikely feel a strong obligation to attain a sales orprofit level agreeing with the forecast released to thefinancial community. Such an obligation couldinfluence management to postpone desirable ex-penditures or possibly manage earnings to meet theprofit forecast.

The Securities and Exchange Commission an-nouncement to permit voluntary disclosure of earn-ings forecast probably will not induce many com-panies to publish their forecasts. Those companies,however, that do attempt to provide information inthis area of disclosure are likely to receive a favor-able response from securities analysts and the invest-ing public. Thus, the venturesome companies mayyet prove or disprove what would appear to beinherent problems that management fears.

22 MANAGEMENT ACCOU NTING DECEMBER 1974

A VOTE FORPROFIT FORECASTINGForecasting and management services are some of the peripheral

areas that will affect future - oriented accountants.

By Alice S. Markwalder

Throughout history man has based his decisions onexperiences of the past, although his overwhelmingdesire has been to base them upon knowledge of thefuture. He has consulted witches, astrologers, seers—yea, even financial analysts —in a quest for aglimpse of what lies ahead. Now, some 40 nearsafter the establishment of the Securities and Ex-change Commission, the investor (at least) is mov-ing ever closer to having a good estimate of thefuture. Now, forecasting gives shareholders informa-tion they would like to have, earlier than theywould have it without forecasting, and it gives theminformation formerly available only to insiders.

Before we look at the roles played by the partiesinvolved in forecasting, a few basic facts need to bestated about forecasts. We begin by assuming thatforecasting means projection of corporate activityfor a given future period, most likely a year. Gen-erally, the reference is to forecasting of profits, butin reality the prospect of losses should be alsoconsidered. Some firms make their predictions interms of earnings per share, and in some cases therehave been projections of sales with offsetting costsand expenses, and a net profit estimate. In othercases, figures are presented in a given range, plus orminus a given percentage. Also, forecasts are madepublic in several ways. For example, the 1972 Fuquareport stands out as the one with the broadestscope and widest printed circulation., More ofteninformation divulged by management is in the formof a statement made to a financial analyst, a groupof analvsts, or to the news media.

Are There Any Standards?

No generally accepted standards exist for thepreparation and dissemination of forecasts; however,accountants have been concerned with setting upguidelines for projections for at least five years. InNovember and December 1972, the SEC conductedextensive hearings on forecasting, setting the stagefor permission for voluntary disclosure in February1973. Prior to 1973, interpretation of the SecuritiesExchange Act of 1934 had been such that the SECforbade publication of statements of forecasts.2

Now, firms registered with the SEC are permittedto include statements of projection in their 10 -Kforms.3 The SEC in permitting publication of fore-cast information under the new policy set forth thefollowing proposals:

1. Disclosure of projections in Commission filingsshould not be required (except as noted in 7and 8 below) .

2. Reporting companies meeting certain standardsrelating to earnings histories and budgeting ex-perience should be allowed to include projec-tions.

3. Certain standards should be met in regard tosetting forth of underlying assumptions, use ofreasonably definite sales and earnings figures,and use of a reasonable time period.

4. The filing companies should be required to up-date projections regularly and when there is amaterial change in the projections.

5. An issuer should be allowed to stop filing fore-casts if it discloses its decisions and reasons fordoing so.

6. No verification or certification of the projec-tions will be permitted at this time.

7. If an issuer discloses projections outside theSEC, it should be required to file the same withthe Commission.

8. Anv issuer who discloses a projection must in-clude a statement of the projection, circum-stances of its disclosure and comparison of theprojection with actual results in its Form 10 -Kfor the fiscal year in which the projection wasmade.

9. The circumstances should be defined underwhich a projection is deemed to be not mislead-ing.

10. Standards should be set for the preparation anddissemination of projections.*

1 John K. Shank and john B. Calfee Jr., "Case of the FuquaForecast," Harvard Business Review, Rovember•Deeember 1973. Asimilar report for 1973 and 1974 was issued in February 1974. Thispreliminary, unaudited report shows per share earnings of $2.10compared to the prediction of $2.09.

Disclosure of Corporate Forecasts to the Investor, a monograph,The Financial Analysts Federation, New York, N.Y. March 1973.

"SEC Plans 'Gradual Change' in Forecasting )Policy," TheJournal of Accountancy, March 1973.

Ibid.

f

A. S. MARKWALDER

Is a recent graduate of

the University ofSouth Carolina whereshe received a Masterof Accountancydegree. She also holdsa Bachelor's degree inEducation from IllinoisState University. Mrs.Markwalder has hadseveral years'experience with apublic accountingfirm in Augusta, Ga.,and is currentlypreparing for the CPAexamination.

This article wassubmitted through theAugusta Chapter.


"On the Updating the Forecast

whole,

accountantshave expressed

themselves as

being rather

strongly in

favor of

forecast

publication."

Updating the forecast is a point on which allsources agree; periodic reports should reveal anyrevisions and updates required. Furthermore, thetime frame of reporting is ap important considera-tion. Past accounting practices, if applied to fore-casts, would result in a forecast for the coming yearat the end of the present year. At the end of eachquarter the forecast would be updated for the re-mainder of the year. The true purpose of fore-casting would, however, be better served if at eachreporting time the projection were made for theremainder of the fiscal year and for the year ending12 months hence. Corporate activity is a contin-uous process; business does not begin on the firstday of the fiscal year and end on the last. It followslogically then that internal planning and budgetingprocesses are not —and should not be— restrainedby the rigidity of the fiscal period.

The form in which projections are presentedshould clarify, not mislead. Forecasted informationshould be clearly differentiated from historical data,particularly when it concerns financial statements.Figures should be presented in form of a range orin probabilistic style. A flexible format should beallowed as dictated by circumstances, and thepresentation should be mandatory, not optional.

Management's budget provides much forecast in-formation. There must be, however, a modificationof the budget before it becomes a forecast. Thebudget is a plan of operation while the forecast is aprediction, albeit, a prediction based on the budget.The budget may, for example, embody certainaspirations such as cutting costs by improving in-ternal control. This goal, since it may or may not bereadily attainable, is not appropriate for disclosurein a forecast.

To Disclose or Not To Disclose

Publication of budget information, pro formastatements, and actual profit forecasts are a part ofdisclosure, an area in which corporations have al-ways been touchy. Until the early years of the20th Century little or no information was disclosedto stockholders. In the past, a forecast could con-stitute anything from a general statement that thecompany was expecting a good year in the comingtwelve months, to the detailed preliminary annualreport. Even with the mandatory requirements ofthe SEC and the subsequent improvement of re-porting of listed companies, the stockholders inunlisted companies have frequently received verylittle information, and what they have received has

; Op. Cit., Disclosure of Corporate Forecasts to the Investor,1.

Sol n d r a S. Singhvi, "Corporate Management's Inclination to

Disclose Financial Information," Financial Analysts Journal, July -August 1972.r IC. Fred Skousen, Robert A. Sharp, and Russell K. Tolman,"Corporate Disclosure of Budgetary Data," The Journal of Ac-countancy, May 1972, P. 51.s Harvey E. Kapnick "Will Financial Forecasts Really helpInvestors ?" Financial Executive, August 1972, p. 51. Mr. Kapnickhowever, feels that a bet te r job should be done on the historicalstatements before attempting to "... provide forecasts about theunknown future."

David F. Linowes, "Future of the Accounting Profession," TheAccounting Review, January 1965, p. 102.

been of poor quality." The same oppositions havebeen voiced each time a new class of informationdisclosure has been proposed: "Disclosure of .. .data would be useful to our competitors" and "theinvestor might be misled. "' In every survey re-ported on, executives were far more reluctant toreveal future prospects than either financial analystsor accountants felt they should be. Management hasthe information, but the question of disclosure ordegree of disclosure remains.

The Role of the Accountant

It is first necessary to differentiate between theroles assumed by the accountants involved. Thefirm's accountants will certainly have a part in thepreparation of the budget and any statement offorecasts. The area of controversy lies in whether orriot the independent accountant or auditor will becalled upon to review the content of the forecastand express an opinion thereon. Furthermore, itmay be questioned whether the same firm shouldaudit the financial statements and the statements ofprojections.

On the whole, accountants have expressed them-selves as being rather strongly in favor of forecastpublication." Their feeling has been that sinceforecasts are made, they should conform to acceptedguidelines. They see the forecast as part of theannual report, and generally assume that the attestfunction will extend to the forecast. It is the attesta-tion of the forecast which presents the thorniestproblem for the accountant." The audit report, asit applies to historical statements, is not necessarilyfully appreciated by the average investor. If theattest function is extended to forecasted reports,the limitations and tenuous nature of the forecastshould be clearly defined.

The Role of the Analyst

The financial analyst has been making forecastsfor a long time. Management's statements, formalor informal, are only a part of the information hehas assembled to prepare a forecast for a givensecurity. A management forecast, in a prescribedformat, will give him a much better base for com-parison than he has had in the past. He will alsobe better able to consider the trend of the economyas a whole, the state of the industry the firm is in,and peculiarities of the firm itself.

Since the analyst is an expert at forecast prepara-tion, and is independent of the company, he mightbe called upon to prepare the forecast. However,he does not have access to the quantity or qualityof information that management has. Although theaccountant has access to the information when heperforms the audit, he is not so well qualified as theanalyst at forecasting. It would, therefore, seemthat all three — management, the accountant (audi-tor), and the financial analyst— working togethershould be able to prepare a thorough and reasonablyreliable forecast.

One consideration, however, haunts all three: thefear of legal obligation. Could not investors, placingfaith in a forecast, sue all parties involved if a


security did not perform in accordance with theforecast? Financial analysts go to some lengths tocaution the investor that they are merely makingpredictions based on current knowledge. The au-ditor, on the other hand, extends an opinion thatthe statements, present fairly, in conformity withgenerally accepted accounting principles, consistent-ly applied, the financial position (at a given date)of the company based on the underlying informa-tion provided by the auditor's client. If he usessuch precision of words on historical statements, theauditor would be even more cautious with a fore-cast. Of course, the ultimate responsibility for theforecast lies with company management.10

Addressing the Investor

Ultimately we come to the user of the forecast,the investor. Who is he? An investor is someonewith one share of a mutual fund stock which has aportfolio of a large number of securities. An inves-tor is also the mutual fund itself. Thirty millionAmericans own stock directly; 70 million participatein ownership through trusts, pension plans, andvarious types of insurance. For the most part, theseinvestors represent an enormous but financiallyunsophisticated group. Nonetheless, forecasts mustserve this group as well as the more sophisticatedinvestor. As an owner, or prospective owner, of acompany the investor should be informed about thecompany. He now receives the annual report withthe balance sheet and income statements, but healso wants to know his company's prospects. Inreality, the investor should be far more interestedin a firm's future than its past.

Addressing the Market

If management has conscientiously prepared itsforecasts, independent accountants have auditedthem, financial analysts have placed them in per-

10 John G. Gillis, "Corporate Forecasts: Legal Aspects," FinancialAnalysts Journal, January February 1973.11 Eugene F. Fama, "Efficient Capital Markets: A Review ofTheory and Empirical Work," Journal of Finance, May 1970.17 Oldrich A. Vasicek and John A. McQuown, "T he EfficientMarket Model," Financial Analysts Journal, September- October1972, p. 75.13 Op. Cit ., Disclosure of Corporate Forecasts to the Investor,

U 5.p Cit., Vasicek and McQuown, pp. 75, 76.

's William F. Sh e, "Risk Sensitivity and Diversification,"Financial Analysts ournal, January February 1972. Vasicek andMcQuown, Loc. Cst., pp. 71-84; W.H. Wagner and S.C. Lau,"The Effect of Diversification on Risk," Financial AnalystsJournal, November - December 1971.

spective with other securities, and the potentialinvestor is ready to make his choice, there is onemore factor left to be considered: the market. Thereare hypotheses about the market which indicate thatby the time the average investor receives a pub-lished forecast, the market price of the stock hasalready adjusted to the news. These theories aregenerally known as the efficient market, randomwalk, and the martingale. In common, they implythat"...the price of any security at any moment intime should fully reflect all of the information aboutthat security which is available at that point intime." 11

In the "efficient market" all currently availableinformation about future prices is discounted intoday's prices. A "martingale" assumes that anyconfidently expected advance for tomorrow is dis-counted today, so that "...today's price becomesan unbiased estimate of `tomorrow's,' " discountedby the expected long -term growth characteristic ofthe market.12 And the "random walk," strongest ofthe three, assumes that at any time "...the priceof a security fully reflects the best possible evalua-tion of the firm which could be extracted from theinformation available at that time." 13 The "ran-domness" comes not from lack of causal reasons butfrom the fact that "...at any given moment intime, the next period price change is random withrespect to the state of knowledge at this mo-ment." 14 A number of writers disagree with thebroader application of the random walk theory.They have shown that with sophisticated screeningand selection of securities they can outperformthe market.15

Conclusion

Forecasted statements, when prepared along thesame lines as historical statements, can be an exten-sion of the statements now in use. Publication offorecasts is a logical step in the changing emphasisin the accounting profession from past (balancesheet) to present (income statements) to future(statements of forecast).

As accounting techniques have become auto-mated and computerized, the accountant has be-come more involved in areas formerly consideredout of his realm. Forecasting and managementservices are some of these peripheral areas that willaffect future - oriented accountants. ❑

"Publication offorecasts is aIogical step inthe changingemphasis in

the accountingprofession

from past...to future ..."


A. WALLACE

Augusta Chapter 1969,is a Cost - General

Accountant atUniroyal, Inc.,

Thomson, Ga. Mr.Wallace attendedthe University of

Cincinnati andIndiana University.

This article wassubmitted through the

Augusta Chapter.

INVENTORYOWNERSHIP COSTSOnce the decision has been made to allocate inventory

ownership costs and it has been decided which costs are to be

allocated, a suitable method of bookkeeping needs to be

established.

By Albert Wallace

The costs of owning an inventory are real, andsometimes significant, costs of doing business, andpart of such ownership costs should be allocated tothe inventory. These costs include: (1) the cost offloor space and insurance, (2) interest on dollarsinvested in the inventorv, (3) overhead in the formof inventory control personnel, and (4) other ex-penses incidental to owning an inventory. Suchallocated ownership costs would then be chargedto earnings as the inventory is consumed. Thiswould be particularly appropriate where dollar levelsof inventory fluctuate to any extent from period toperiod.

There are a number of very good reasons for con-sidering the allocation of ownership costs to in-ventory. One reason is that without ownership ofthe inventory, the ownership costs would not be in-curred. Indeed, such ownership costs are an exten-sion of the "transportation in" concept which addsto product purchase value the cost of transportingand locating the products in the owner's warehouse.Where ownership costs occur irregularly and in sig-nificant amounts they would seem to distort incomelevels should they be charged to a specific periodrather than income. t By reflecting ownership costsin current inventory value, the complete chargingof these costs against earnings is matched with theincidence of revenue.

The allocation of ownership costs to inventoryreflects the values of assets and expenses in thesame manner in which these costs behave. For ex-ample, if a company dealing in draperies and bed-spreads adds a line of mattresses and cushions, moreresources in the form of floor space, racks, cost ofcapital, and inventory management effort would berequired. Even though a large volume of the newproduct line would move through the businessduring an accounting period, the necessity of own-ing a substantial inventory would remain. Therefore,

while the mattress line remains in inventory, itsshare of ownership costs should be attached to it.When the mattress line inventory is liquidated, allownership costs attached to that line would becharged to expense. Where ownership costs areallocated, production and commercial utilization ofinventories (and inventory waste) are appropriatelycosted against earnings. Inventory and expense datawhere ownership costs are allocated to inventory aremore effective in production costing, price estimat-ing, and project evaluation since revenues are notdistorted with ownership costs charged on anirregular basis.

Ownership Costs and Decision- MakingManagerial decision- making would be enhanced

by the allocation approach in a number of areas.

1. Budgeting and forecasting would be made moreeffective. Inventories bearing their share ofownership costs and expense statements un-cluttered, by irregular ownership costs wouldfurnish a more consistent data base from whichto project future activity.

2. Measurement of operating performance would bemore meaningful. Imputed ownership costswould reflect directly as the responsibility of in-ventory managers as part of the inventory beingmanaged and not scattered through the earningsstatement at the time they are incurred.

3. Inventory control efforts would be directed tomore realistic dollar levels of inventory valueunder the allocation method.

4. Investment analysis would be more useful whereproduct divestiture or capital expenditures areunder consideration. Asset values and operatingprofit dollars for purposes of discounted cashflow analysis would be more precise.

I Edward L. Wallace, "Inventories," Aeeouniants Handbook,Fourth Edition Rufus Wilson, Editor, Ronald Press Co., NewYork, N.Y., 1969, Chapter 12, pp. 4 and 5.


When we allocate ownership costs against in-ventory, which costs should we allocate? We shouldat least add the "variable" ownership costs to theinventories being supported by these costs. Weshould also consider allocating fixed ownership costswhere feasible. By definition, fixed costs are relatedmore to a time period rather than value creationand as such would perhaps continue to be chargedto earnings since they are continuing and of a fairlylevel nature. Elements of inventory ownership coststo be allocated to inventory value should definitelyinclude:

1. Cost of money (interest) on dollars invested inthe inventory (The cost of capital incidental tothe ownership of a million dollar inventory is, ofcourse, quite different than the cost of capitalrequired to handle a two thousand dollar in-ventory.)

2. Variable costs of inventory acquisition and con-trol such as warehouse clerks, receiving personnel,and stores operating expenses

3. Insurance on the inventory4. Floor space and especially rented floor space or

space acquired for the specific purpose of ac-commodating an expanded inventory

These inventory ownership costs would be added toan inventory value which conventionally includesthe purchase price of the material and the costs oftransportation and handling. Frequently theseownership costs would be material in amount.What would be the result on the annual report ofa jet airliner factory, for example, if interest on in-vestment in inventory and insurance on the inven-tory were allocated to the inventory in processrather than expensed as incurred? In the case of aproducer who carries twenty planes in various stagesof work in process, the accounting treatment of in-ventory ownership costs as an addition to inventoryand a reduction of accounting period expense wouldsurely be a significant amount.

Once the decision has been made to allocateinventory ownership costs and it has been decidedwhich costs are to be allocated, a suitable methodof bookkeeping needs to be established. In manycases, the method can be quite complex if differentlevels of ownership costs are to be derived for differ-ent types and components of inventory. The sim-plest, workable, method would be to derive theownership costs from the company's operatingbudget or historical accounting records.

Example

Assume the following example where ownershipcosts are estimated as percentages of the total in-ventory value of $35,000.

Imputed interest on working capital 6% $2,100Insurance on inventory V2% 175Cost of inventory control V2% 175Cost of purchasing and expediting V2% 175Warehouse operating costs 2Vi% 875Total ownership costs 10% $3,500


The ten percent cost of ownership factor will beused to calculate the dollars to be added to in-ventory. The imputed interest on working capitaland insurance on inventory would be the currentcommercial rates. Other ownership costs could bederived by taking them on an annual basis as apercent to cost of sales and then applying thatpercent to the inventory values.

Assume the following data selected from a firm'soperating budget.

Annual sales dollars $350,000Cost of production $100,000Finished goods inventory $ 30,000Work in process $ 1,000Raw materials $ 4,000Total inventory $ 35,000Net operating profit (where all

imputed inventory costs arecharged to expenses as incurredand not allocated to inventory) $ 17,000

Imputed cost of inventory ownership $ 3,500

The $3,500 annual ownership cost would then bedivided between expenses and inventory values inthe following proportions:

Total Ownershipvalue costs

Cost of Production_

$100,000_

$3,500Inventory Values $ 35,000 - $1,225

The asset share of the $3,500 would then be addedto the various inventories in direct proportion totheir values:

AllocatedOriginal ownership Revised

value costs value

Finished goods $30,000 $1,050 $31,050Work in process 1,000 35 1,035Raw materials 4,000 140 4,140Totals $35,000 $1,225 $36,225

A comparison of operating statement data be-tween the original and revised amounts is shownin Exhibit 1. An analysis of the Exhibit indicates

Exhibit 1INVENTORY OWNERSHIP COSTSAND PROFITABILITY

Original Reviseddata data

Annual sales dollars $350,000 $350,000

Cost of production $100,000 $100,000Finished goods inventory $ 30,000 $ 31,050Work in process $ 1, 00 0 $ 1,035Raw materials $ 4,000 $ 4,140Total inventory $ 35,000 $ 36,225Operating profit (pre taxes) $ 17,500 $ 18,725Operating profi t (after taxes) $ 8,750 $ 9,364Profi t percent to sales 2.5% 2.7%

Total assets $100,000 $101,225

Asset turns 3.50 3.46

Return on investment 8 .8% 9.3%

"We should

also consider

allocating fixed

ownership

costs where

feasible."

27

"The method

works under

both direct

costing and

absorption

costing

systems."

that the method of treating inventory ownershipcosts can generate significant differences in extremeinstances.

The foregoing example indicates that the inven-tory ownership costs can be imputed to inventoryvalues arithmetically even though not specificallytraceable to inventory costs. The method worksunder both direct costing and absorption costingsystems. It also does not seem to be in conflict withgenerally accepted accounting principles as outlinedin ARB No. 43 2 which seems to leave a wide lati-tude as to which overhead elehients might be in-cluded as a proper charge to inventory values.

2 Examination of Financial Statements by Independent PublicAccountants, AR$ No. 43, AICPA, New York, N.Y., 1936.

Conclusion

The approach outlined above furnishes certainadvantages over the usual method of expensing allinventory ownership costs at the time of occurrence.Although to some, the additional bookkeeping ef-fort may present disadvantages and might appearto be a departure from generally accepted account-ing principles, we believe that the advantages to begained from adding an appropriate share of inven-tory ownership costs to the inventory value wouldoutweigh the disadvantages. Finally, the inventoryownership costs are related to the inventory value,since without an inventory the ownership costswould not exist. 1:1

THE LONER: A SMALL FIRM'S CONTROLLER SPEAKS OUT

Continued from page 16

ment heads and the head office and receive an OK.Everything works fine for awhile, until someoneconvinces the boss that our labor rates are too lowand not competitive with local industry. The endresult of this mid -year conference is a general in-crease, considerably larger than the normal amountof wage increases budgeted. It means more moneyexpended with no increase in production. My bud-get is now in trouble and the trouble is gettingworse. The next problem that arises is in the fringebenefit area. I don't believe that the average em-ployee realizes how much money is spent by acompany to provide fringe benefits for its em-

ployees. The company is required to provide disa-bility insurance, workmen's compensation, hospital-ization, life insurance and on and on. Quite a fewof these fringes are based on wages; therefore whenwages go over the budget, fringes follow along.

Conclusion

As I said before, the job in a small company doeshave its advantages too. I don't think that there ishardly an area of accounting that you don't getinvolved with. When you get home at night youknow that you have put in a good day's work anddone your best. It kind of gives you a sense ofsatisfaction to offset the daily frustrations. It's agood feeling. El

FINANCIAL PERSONNEL RECRUITMENT


chances. An employee may leave and find the newposition inferior to the one he had with you. Thenews will drift back to your staff as fast as a tele-phone call. If this happens, it can provide incentivefor employees to stay with you. If, on the otherhand, he happens to find the new position betterthan the one he left, your problem with the remain-ing staff is no worse that it was before he left.

How about the exit interview? After the em-ployee has notified you that he is leaving, why notinterview him without trying to convince him tostay. Ask why he is leaving, his opinions aboutyour staff, your quality of work, your reputation.You may be amazed at what he says. Departingemployees sometimes free themselves on the lastday. Much of what he says will be the cold truth;

if he feels he is jeopardizing a good reference, how-ever, he may not volunteer any opinion.

Conclusion

Competent people are always hard -to -find, be-cause the good ones are employed. To attract betterpeople, the accounting profession needs better publicrelations to emphasize its strong points, its serviceto industry, and its high income possibilities. Un-less the profession as a whole does a better job indeveloping and improving public image, the re-cruiting battle will increase. In general, retainingcompetent accountants narrows down to improvingemployee relations by giving the employee greaterprestige, letting him know he is a member of theteam and that you are glad he is aboard.

We wish you success in your recruiting and re-tention of financial personnel. E]

28 MANAGEMENT ACC OU NTING /DECEMBER 1974

CATTLE ACCOUNTINGAs in other physical inventories, it is necessary for the accountant

to control movement of the cattle during the inventory, and to

establish an accurate cut -off for comparison of quantities with

accounting records.

By John F. Loughlin

Realistic general and cost accounting methods andprocedures are as important to successful opera-tions in the cattle industry as they are in manu-facturing or other industries. The application ofaccrual basis accounting and cost accounting prin-ciples to a large cattle operation, however, raisesquestions and problems which differ from thoseencountered in other industries. Some questionsinvolved in accounting for the breeding, raising,and marketing of cattle are:

I. What are the components of the cost of a calf?2. How should the cost of breeding animals be

allocated?3. How should operating expenses be allocated?4. How may costs be allocated between purebred

and commercial operations?

The development of accounting procedures toanswer these and other questions presents a chal-lenge to the ingenuity of the accountant to preparemeaningful financial information, and to do so in apractical manner. This article presents a review ofcertain considerations involved in accounting forcattle and an illustration of procedures developedto account for a large purebred and commercialcattle operation.

The basic production of cattle operations isrepresented by the calves produced and the valueadded to commercial or immature breeding animals.Depending on operating considerations, calves maybe sold in their year of birth, they may be retainedfor breeding purposes, or they may be raised forfuture sale as commercial beef. Although operationsmay involve primarily raised animals, it is not un-common that they will also include purchase ofcommercial animals for short -term retention andsale, which would, of course, occur when pastureavailability and market prices indicate that suchoperations may be profitable.

Mature breeding animals represent the produc-tion facilities of a cattle operation. It is an acceptedpractice in the cattle industry that animals which

have completed their second year are considered tobe breeding animals. Breeding animals will normallyconsist of some top grade purchased animals andimproved animals developed in the breeding opera-tions. Upgrading of breeding herds may include theannual identification of less desirable animals andthe sale of substantial numbers of such animals asbreeding stock. Operations also include the annualidentification of nonproductive or substandardanimals which are culled from the herds for com-mercial sale. Considering the average productivelife of breeding cattle, it is generally agreed that alife of from seven to eight years from the two -yearold breeding classification is realistic as the averageuseful life of breeding cattle.

Valuation of Cattle at Cost

Depending on intended future disposition, calfproduction may represent finished inventory, inven-tory in process or productive facilities in process.Generally accepted accounting principles indicatethat in these circumstances, calves should be re-corded at cost in the year of birth. Costs of main-taining commercial animals after the year of birthalso represent inventory costs, and should be addedto initial animal costs. Similarly, costs of maintain-ing immature breeding animals represent additionalcosts of productive facilities, and should be addedto initial animal costs until the animals reach breed-ing age.

The cost of calves generally may be consideredto consist of the applicable costs of the breedinganimals which produced the calves. Calf cost, there-fore, should include operating expenses and depre-ciation of breeding animals. Although calves maybe born at various times during the year, it is mostexpedient for cost computations to be made on thebasis that all calves are born at year -end. Thisapproach is realistic since most operating expensesapply to breeding animals as opposed to beingdirectly applicable to calves. On this basis, operat-ing expenses are allocated to breeding animals,immature breeding animals and commercial in-ventory animals, and the amounts for breedinganimals are allocated to calf cost. Operating ex-

F. LOUGHLIN(Deceased) MilwaukeeChapter 1971, was aManager in theMilwaukee Office ofCoopers & Lybrand.Mr. Loughlin held aB.S. degree inAccounting from theUniversity of Detroit.

This article wassubmitted through theMilwaukee Chapter.


" . . . certainareas of the

Internal

Revenue Code

seem topresume that

only the cash

basis is used inaccounting for

cattle

operations."

penses so allocated should include only normalexpenses, and any abnormal expenses should beexpensed currently and excluded from allocationsto animal costs. Depreciation charges represent theallocation of the basic cost of breeding animals tothe calves produced, over the estimated useful livesof the breeding animals. With costs computed inthis manner, the net cost of breeding animals pro-duced internally would consist of their calf cost,plus maintenance costs in their first and secondyear, less accumulated depreciation thereafter.Purchased breeding animals would be valued attheir purchased cost, plus similar maintenance costs,if any, less accumulated depreciation.

Since generally accepted accounting principlesrequire the recording of inventory at the lower ofcost or market, an adjustment to this general basisof valuation is required when the computed cost ofinventory animals exceeds their net realizable value.In a profitable commercial operation, such a situa-tion would be unusual. If this were to occur, how-ever, it would be appropriate to write -down inven-tory animal costs to net realizable value.

Physical Inventory of Cattle

Accurate determination of the cost of cattleoperations requires physical vertification of cattlequantities on at least an annual basis. In orderthat accounting computations may represent aneffective control over operations, the physical in-ventory of cattle should be controlled and super-vised by the accounting function. The uniquenature of this inventory will present an interestingchallenge to the accountant, and certainly a radicalchange from normal accounting activities.

Considerations involved in the physical inventorywill be dependent on the nature of the particularoperation. The counting of purebred animals isnormally the easiest because they are maintained inrestricted areas and are subject to accurate record -keeping as required for breed registration purposes.Other breeding animals and commercial beef cattlemay be maintained in larger pastures or in largeareas of open range, presenting greater inventoryproblems. Since interim counts of births and deathsof these animals are normally reported for operatingpurposes on an estimated basis, an accurate physicalinventory is very important in determining the re-sults of operations.

When cattle are maintained in smaller pastures,it may be possible to obtain accurate counts by driv-ing a jeep through the pasture and having countsmade by several individuals as the cattle pass by.In other instances, it may be necessary to have thecattle herded into a corner of the pasture andcount them as they are cut out in a line along thefence. For large numbers of cattle maintained inlarger pastures or on open range, it is normallynecessary for riders to round up the cattle, movethem to pens, and count them as they are runthrough a chute. It is most expedient if such in-ventories are made in connection with a "round-up" when cattle are gathered for operating purposes.As in other physical inventories, it is necessary for

the accountant to control movement of the cattleduring the inventory, and to establish an accuratecut -off for comparison of quantities with accountingrecords.

Basis of Accounting

The breeding, raising and marketing of cattleis essentially an agricultural activity, and there-fore may often be accounted for on the cash basiswhich is predominantly used for federal income taxpurposes in the agricultural field. Indeed, certainareas of the Internal Revenue Code seem to presumethat only the cash basis is used in accounting forcattle operations. The cash basis, however, mayresult in material omissions or inaccuracies, andtherefore is not a proper basis for developing mean-ingful financial information. In order that the finan-cial information will be realistic and accurate, thefull accrual basis should be used in financial ac-counting for cattle operations. I

The accounting procedures discussed in thisarticle were developed to account for operationsinvolving production of purebred and crossbredbreeding cattle and commercial beef cattle, as wellas feeder operations for commercial beef cattle.2

The procedures consider allocation and accumula-tion of costs, including depreciation of breedinganimals, in herd cost centers, and allocations todetermine average costs of calves produced andcosts added to immature breeding cattle and com-mercial beef cattle. In financial statements, breed-ing cattle are reflected as fixed assets at cost lessaccumulated depreciation, and costs of commercialbeef cattle are reflected as inventory.

Cattle operating expenses may generally be classi-fied as labor, supplies and property cost. The natureand amount of expenses vary considerably, depend-ing on the nature of the operations. Purebred opera-tions, for instance, would involve higher cost oflabor, improved pastures and feed, which would bemuch smaller or not applicable for commercialcattle operations.

Cattle Accounting Procedures

The following discussion describes cattle account-ing procedures which apply accrual basis cost ac-counting principles to a purebred and commercialcattle operation. Illustrative examples of the majorsections of the cost computations are shown inExhibits 1 through 5. Operations involved in these

I Use of the accrual basis in the development of financial in-formation for reporting to management and owners does notpreclude the continued use of the cash basis for federal incometax purposes and related cash flow advantages which tnay result. Inthe use of the cash basis for tax purposes and the accrual basis forfinancial accounting purposes, care should be exercised to de-termine that all federal income tax requirements are met in themaintenance of the cash basis accounting records. In such in-stance, the effect of differences between the cash and accrualbases would be accounted for in accordance with Accounting Prin-ciples Board Opinion No. 11, Accounting for Income Taxer, forfinancial accounting purposes.s Cattle accounting procedures must be designed to meet theneeds and circumstances of the particular operation. In the case offeedlot operations, tax shelter programs or other cattle operations,these factors may vats considerably from the operations dis-cussed in this article. However, the development of reasonablecost information for calf production or maintenance of com-mercial cattle is important in any cattle activity as a basis forevaluating operating results and developing additional informationfor management control systems. With appropriate modificationto meet particular circumstances, the procedures discussed may,therefore, be beneficial in other types of cattle operations.


computations include two primary purebred herdsidentified as Herds A and B, and a significant cross-bred breeding herd identified as Herd D. Otherpurebred bulls which are used in crossbreeding arerecorded in Herd C, and the remainder of cross-bred breeding animals are recorded in Herd E.Commercial beef cattle are recorded in Herd F.As indicated by the description of the herds, theseoperations involve the production and sale of pure-bred and crossbred breeding animals as well ascommercial beef cattle.

In the design of these cost accounting procedures,it was apparent that significant differences in valuesexisted between the classifications of purebred andcrossbred breeding animals and commercial beefanimals. The herd designations and procedures forallocation of costs, therefore, were designed toreasonably allocate costs to these classifications.

The illustrated cost computations are preparedat year -end as a basis for adjusting amounts recordedduring the year. Computations are shown for pure-bred Herd A to illustrate the computations madeseparately for each herd classification. The costcomputations are supported by detailed asset recordcards containing the cost of raised and purchasedanimals by herd and year of birth. The asset recordcards are used to identify the costs of sales, mor-talities and transfers. In preparation for the costcomputations, quantities of transactions are deter-mined by month and year of birth for each herdfrom monthly operating reports and accountingrecords. These quantities are adjusted based on anannual physical inventory for use in the cost compu-tations.

HERD SCHEDULE

The herd schedule is used to summarize animalactivity and costs computed in the remainder of the

computations. Cost of sales, mortalities and trans- "Calves arefers are recorded in the total amounts reflected onthe herd schedules. A partial example of a herd treated as ifschedule is shown in Exhibit 1 for purebred Herd born at the endA. Allocation of operating expenses and deprecia-tion, including calf ratio allocations, are described of the year forin the following comments.

purposes ofALLOCATION FACTOR — ANIMAL MONTHS

expenseOperating expenses are allocated to the herdsbased on the number of animals and the time that allocations..."they were held during the year. This allocationfactor is known as an animal month, one animalon hand for one month. An example of the compu-tation of animal months is shown in Exhibit 2.Because of the volume of sales, mortalities, etc.,during the year, these transactions are detailed bymonth in order to more accurately allocate theexpenses. They are scheduled by year of birth be-cause animal months for sales and mortalities andtotal animal months for first and second year ani-mals are required for allocation of the expenses.Calves are treated as if born at the end of theyear for purposes of expense allocations, and there-fore no animal months are computed for calves.Transfers recorded on these schedules may consistof crossbred calves born in the purebred herd andtransferred to the other breeding or beef cattleherds. Mature breeding animals culled from thebreeding herds are also recorded as transfers to thebeef herd. In the animal month computation,animals transferred are treated as if held all yearin the herd to which transferred on the basis thatthey functioned as a member of the herd to whichtransferred.

In the month of purchase, sale, etc., animalmonths are computed as held one -half month. Thenumber of animals are multiplied by the months

Exhibit 1

HERD SCHEDULE —PUREBRED HERD A

Year of Birth 1966 1967 1971 1972 TotalAverage Cost $435.59 $428.24 $150.02

Animals Amount Animals Amount Animals Amount Animals Amount Animals AmountBalance, beginning of year 65 $28,313.35 53 $22,696.72 160 $24,003.20 1,100 $330,583.00Births 300 300Operating expenses 617.61 535.50 11,777.43 $41,580.78 $ 82,800.00Depreciation 540.00 422.80 20,000.00 25,300.00Calf ratio allocation:

Operating expenses (8,166.78) (8,166.78)Depreciation (5,819.00) (5,819.00)

Purchases 10 4,250.00 20 9,500.00Returned sales 1 428.24 1 428.24Transfers:

To other breeding herd (85) (13,485.25) (85) (13,485.25)To beef cattle herd (3) (1,284.72) (6) (2,595.00)

Cost of sales: (15) (10) (15) (20) (250)Animal cost (6,533.85) (4,282.40) (2,250.30) (3,173.00) (84,240.00)Operating expense (332.01) (321.30) (817.53) — (9,838.92)Depreciation (324.00) (211.40) (4,750.00)

Cost of mortalities: (10) (10) (30) (26) (80)Animal cost (4,355.90) (4,282.40) (4,500.60) (4,124.90) (18,850.00)Operating expense (285.60) (214.20) (1,106.70) — (1,931.37)Depreciation (216.00) (211.40) (550.00)

Balance, end of year 40 $17,423.60 41 $17,525.44 115 $27,105.50 169 $26,811.85 1,000 $298,384.92Average cost $435.59 $427.44 $235.70 $158.65


"Cost per

animal month

is the

computed

average cost

of maintaining

one animal for

one month in

the particular

herd."

held to compute the animal months. The animalmonths are subtotaled by type of transaction andby year of birth, and the total animal months aredetermined for the herd as shown.

CLASSIFICATION OF OPERATING EXPENSES

A partial trial balance of cattle expenses and anexample of the classification of the expenses areshown in Exhibit 3. Expenses are segregated intothree classifications: Feed costs, Special expensesand Ordinary expenses. Certain other expenses areclassified as selling expenses for statement purposesand are not allocated to the cattle costs. Feed costsare recorded by means of standing work orders byherd classification. Since the actual herd distribu-tion of feed costs is available, this expense is statedseparately. Of the remaining expenses some applymore to certain herds than to other herds, and otherexpenses apply equally to all animals. It is con-sidered that the Herds A, B, and D are given moreattention and care than are the other herds. There.fore, expenses relating to this preferential treat-ment are classified as special expenses. The re-maining expenses which are considered to apply toall animals equally are classified as ordinary ex-

penses.

ALLOCATION OF EXPENSES TO HERDSThe method of allocating the operating expenses

to the herds is shown in Exhibit 4. For allocationof special expenses, it has been determined that intotal these expenses apply to the animals in anaverage ratio of three parts to the special herdsto one part to the other herds. On this basis theanimal months for the special herds are weighted

three to one and the special expenses are dis-tributed to the herds in the ratio of the weightedanimal months. The ordinary expenses are dis-tributed in the ratio of the original animal months.As mentioned previously, feed costs are distributedto the herds based on actual usage.

The allocation of the special expenses as de-scribed above has been adopted as an averagemethod of allocating these expenses. Since eachof the special expenses would apply to the variousherds in differing degrees, it is not consideredpractical to allocate these expenses in a more exactmanner. It is considered that this method resultsin a fair and reasonable overall distribution, re-flecting the additional costs of maintaining thesespecial herds.

After the total operating expenses applicableto the herds have been determined, these totals aredivided by total animal months of the herds to com-pute the cost per animal month for each herd. Costper animal month is the computed average cost ofmaintaining one animal for one month in theparticular herd. This factor is used to allocate theoperating expenses to the animals within theherds.

Wi th the data available at this point, the op-crating expenses for all animals by year of birthand by type of transaction can be computed bymultiplying the cost per animal month by thenumber of animal months. The allocation of theoperating expenses within the herd is shown inExhibit 1, as computed from the animal monthshown in Exhibit 2, and the cost per animal monthas shown in Exhibit 3.

As mentioned above, operating expenses of ma-

Exhibit 2

COMPUTATION OF ANIMAL MONTHS-PUREBRED HERD A1966 1967 1971 1972 Total

Months Animal Animal Animal Animal AnimalHeld Animals Months Animals Months Animals Months Animals Months Animals Months

Balance, beginning of year 65 53 160 1,100Births, total 300 300Sales:

2nd month 1.5 (10) 15.0 (2) 3.04th month 3.5 (5) 17.5 (2) 7.06th month 5.5 (3) 16.5 (1) 5.5 (2) 11.08th month 7.5 (2) 15.0 (4) 30.0

10th month 9.5 (2) 19.0 (7) 66.5Total sales 46.5 (10) 45.0 (15) 114.5 (20) - (250) 1,378.0Mortalities:

2nd month 1.5 (2) 3.0 (3) 4.53rd month 2.5 (2) 5.0 (3) 7.5 (5) 12.54th month 3.5 (3) 10.5 (2) 7.0 (10) 35.06th month 5.5 (2) 11.0 (2) 11.0 (10) 55.0

11th month 10.5 (1) 10.5 (5) 52.5Total mortal i ties f l 4 0 .0 (10) 30.0 I � O j 155.0 (26) - (80) 270.5Transfers out, total

- - - (3) (85) - (91)Held all year 12.0 40 480.0 30 360.0 115 1,380.0 169 - 979 9,720.0Purchases:

1st month 11.5 5 57.52nd month 10.5 5 52.5

Total purchases 10 110.0 20 220.0Returned sales, 1st month 11.5 1 11.5 1 11.5Totals 40 566.5 41 556.5 115 1,649.5 169 1,000 11,600.0


ture breeding animals are components of the costof the calves produced, and operating expenses ofimmature animals are additions to the cost of theseanimals. The one exception to the statement isconsidered to be the operating expenses for salesand mortalities. In specific instances, the animalsmay or may not have taken part in calf production,but in general it is considered less likely that theyhave. Therefore, an assumption is made that salesand mortalities were not involved in calf produc-tion, and related operating expenses are chargedto the cost of sales or mortalities.

DEPRECIATION

The second component of calf cost is deprecia-

tion of the cost of mature breeding animals. De-preciation is computed by the straight -line methodin the same detail as shown in Exhibit 1. Thisallocation of the cost of breeding animals to thecost of calves is begun when the animals have com-pleted their second year, the age at which they areconsidered to be breeding animals, and is con-tinued based on an average estimated useful life ofeight years. Estimated salvage value of $90 perhead is deducted from the animal cost before com-putation of depreciation, In accordance with thehalf -year convention, one -half year's depreciation isrecorded for all additions and retirements duringthe year. Thus, depreciation for the 1966 animalssliown in Exhibit 1 is computed as follows:

Exhibit 3

CLASSIFICATION OF OPERATING EXPENSESTotal

Account Title Annual ExpenseCowhands $ 45,000.00 $

Supervision and clerical 20,000.00Servicemen 5,000.00Labor, maintenance of bui ldings 4,000.00Labor, maintenance of grounds 1,200.00Ferti lizer 85,000.00Feed and molasses 185,000.00Medical supplies 2,000.00General supplies 9,000.00Commissions 300.00Publicity and advertising 1,100.00Dues and subscriptions 150.00

Insurance 5,000.00Payroll taxes 800.00Materials, maintenance of fences 5,000.00Materials, maintenance of equipment 2,500.00Amortization of range pasture

improvements 33,000.00Amortization of water control

improvements 17,000.00Property taxes 78,000.00Depreciation 28,200.00Totals $615,000.00

Allocation

Selling Feed Special Ordinary5,000.00 $ 40,000.00

20,000.00$ 5,000.00

4,000.001,200.00

85,000.00$185,000.00

2,000.009,000.00

300.001,100.00

150.00

5,000.00800.00

5,000.002.500.00

33,000.00

17,000.0078,000.00

3.200.00 25.000.00$10,000.00 $185,000.00 $105,000.00 $315,000.00

"Depreciation

is computed

by the

straight -line

method."

Exhibit 4

ALLOCATION OF OPERATING EXPENSES AND COMPUTATION OF COST PER ANIMAL MONTH

Animal months Total Cost per

For ordinary For special Ordinary Special Feed operating animal

expenses expenses expenses expenses costs expenses month

Purebred:Herd A 11,600.0 X 3 = 34,800.0 $ 27,500.00 $ 21,500.00 $ 33,800.00 $ 82,800.00 $7.14/A.M.

Herd B 300 .0 X 3 = 900.0 700.00 500.00 800.00 2,000.00 6.67/A.M.

Herd C 3,100.0 X 1 = 3,100.0 7,300.00 1,900.00 3,800.00 13,000.00 4.19 /A.M.

Other breeding:Herd D 6,600.0 X 3 = 19.800.0 15,600.00 12,200.00 18,100.00 45,900.00 6.95/A.M.

Herd E 86,000.0 X 1 = 86,000.0 203,700.00 53,200.00 102,100.00 359,000.00 4.17 /A.M.

Beef cattle, Herd F 25,400.0 X 1 = 25,400.0 60,200.00 15,700.00 26,400.00 102,300.00 4.03 /A.M.

Totals 133,000.0 170,000.0 $315,000.00 $105,000.00 $185,000.00 $605,000.00

Allocation factors:Ordinary expenses $315,000.00

—

133,000.0 = $2.37/A.M.

Special expenses $105,000.00 — 170,000.0 = $.62 /A.M.


" . . . o n

average it

required 1.3

maturebreeding

animals to

produce one

calf."

Exhibit 5

CALF RATIO ALLOCATION —PUREBRED HERD AOperating expenses:

Operating expensesoriginally allocated tocalf cost

Annual operating expensefor one mature animalequals cost per animalmonth ($7.14) X 12mon ths =

Calf ratioOperating expense allocable

to one calfBirthsOperating expense allocable

to calvesExcess, allocated to calves

of other breeding Herd E

Depreciation:Depreciation originally

al located to calf costTotal depreciation, as aboveDivide by total mature

animals in herdAverage depreciation, one

mature animalCalf ratioDepreciation allocable to

one calfBirthsDepreciation allocable to

calvesExcess, allocated to calves

of other breeding Herd E

$41,580.78

$ 85.681.3

$ 111.38300

33,414.00

$ 8,166.78

$20,000.00$20,000.00

— 550

$ 36.361.3

$ 47.27300

14,181.00

$ 5,819.00

Asset balance, beginningof year $28,313.35

Less reserve balance,beginning of year (8,423.76)

Net asset amount $19,889.59Less salvage value,65 animals X $90 ( 5,850.00)

Value subject todepreciation $14,039.59

Divide by remaining life— 5

Total annual depreciation $ 2,807.92Divide by number of

animals — 65Annual depreciation per

animal $ 43.20Animals held all year 40Depreciation per animal X $43.20 $1,728.00Sales 15Depreciation for V2 year

per animal X $21.60 324.00Mortalities 10Depreciation for V2 year

per animal X $21.60 216.00Total depreciation for

1966 animals $2,268.00

Depreciation for sales and mortalities is includedin the cost of these retirements on the same basisas the operating expenses applicable to these ani-mals. The balance of the depreciation is allocated

to calf cost. As shown in Exhibit 1, of the totaldepreciation of $25,300 for the herd, $5,300 isrecorded as cost of sales and mortalities and thebalance of $20,000 is allocated to calf cost. De-preciation is credited to a separate general ledgerreserve account, and therefore the accumulateddepreciation is not shown on the herd schedule.

CALF RATIO ALLOCAT ION

Depreciation and applicable operating expensesof the mature breeding animals to this point areallocated to calf cost within each herd. This wouldresult in proper calf cost if all breeding animalswere employed only within their particular herds.Under the crossbreeding program, however, thepurebred animals are crossbred between the pure-bred herds, and are crossbred extensively with theother breeding herds. In this situation, a portionof the costs applicable to purebred animals shouldbe allocated to calf cost in the herd in which thecalves are born.

This situation is considered in the cost com-putation by reallocating the calf costs based onthe ratio of the total calves to the total maturebreeding animals, termed the calf ratio. The calfratio is computed as follows:

Total mature animals at year -endall breeding herds _ 4,000 _

Total 1972 calves, all herds — 5,200 — 1'3

This calf ratio indicates that on average itrequired 1.3 mature breeding animals to produceone calf. The effect of the crossbreeding is re-flected in the cost computations by limiting pure-bred calf costs by application of the calf ratio, inthis case by limiting calf cost to 130 percent ofthe costs of a mature animal in the particularherd. Application of the calf ratio is shown inExhibit 5. These allocations are also shown in theherd schedule, Exhibit 1. The calf ratio allocationresults in excess costs being allocated from HerdsA, B, C, and D to Herd E. Although this pro-cedure does not result in actual allocation of thecosts of breeding animals in the crossbreeding pro-gram, the overall results of the calf ratio allocationare considered reasonable.

COMPLETION OF COMPUT AT IONS

After the calf ratio allocations, the allocation ofcosts to the herds is completed. The costs of sales,mortalities and transfers are then determined inthe following manner. For calves, the average costof calves produced is computed, and is used torecord these transactions. For immature breedinganimals, transactions are recorded at the averagecost at the beginning of the year. Transactionsfor other animals are recorded at costs determinedfrom the asset record cards for the applicable ani-mals, generally representing average costs for ani-mals produced internally. As described previously,operating expenses and depreciation which havebeen allocated to sales and mortalities are addedto the cost of these sales and mortalities. No op-


crating expenses are involved in recording transfersbetween herds because, for allocation of operatingexpenses, transfers are treated as if the animalswere held all year in the herd to which transferred.The herd schedules are then completed by re-cording purchases at actual cost and any returnedsales at cost recorded in the year of sale. It shouldbe noted that the costs of sales, mortalities andtransfers in the herd schedule in Exhibit I do notinclude applicable amounts of accumulated de-preciation which are separately recorded based onthe depreciation computations previously described.

In addition to the previously described account-ing computations, operating personnel prepare anannual computation of the estimated market valueof the cattle by herd and age classification. Theonly accounting use of this market valuation is toassure that costs of beef cattle recorded in inven-tory are not stated in excess of net realizable value.Although realizable value considerations are notapplied to breeding animals which are recordedas fixed assets, market value comparisons for theseanimals are very useful to management in evalu-ating the overall results of operations and formulat-ing policy regarding the retention or sale of breed-ing animals.

Alternatives and Refinements inComputations

The cattle accounting procedures described hererepresent one approach to the problem of applyingsound accounting principles to a particular cattleoperation. In view of the many differences in thenature of cattle operations and the extent of finan-cial information desired, possible alternatives andrefinements in the computations are numerous.Some of these possibilities are discussed below.

A primary question in the design of cattle ac-counting procedures is the extent of detail con-sidered necessary. In the example cited, variousadditional cost computations are made by op-erating personnel, which are not considered prac-tical to include in the basic accounting computa.tions. In view of the increasing cost of purebredherd sires and their use in artificial inseminationbreeding procedures, it may be considered appro-priate to account for such animals as individual

cost centers. If warranted, purebred calf costscould be more accurately computed by individualallocation of depreciation and more specific alloca-tion of operating expenses.

As opposed to the average cost methods used inthe sample computations, it would be possible toconvert these procedures to a form of standardcost system. On this basis, standard calf costs andstandard costs per animal month could be used forinterim accounting and could be adjusted at year-end for significant differences from actual costs.

Various simplifications in the example computa-tions would be possible when such detailed com-putations are not considered necessary. For op-erations involving only the production ofcommercial cattle, computations for allocations tothe separate herd classifications would not be neces-sary. It would be possible to allocate operating ex-penses based on half -year convention, rather thancomputing animal months in detail. As opposedto maintaining detailed asset records for determin-ing retirement costs, it would be possible to main-tain separate records for only purchases at sig-nificantly different cost, and otherwise record re-tirements at the average costs determined in thecomputations.

As opposed to the illustrated practice of con-sidering the cost of mortalities as period chargesto operations, an alternative practice is to includethese costs in operating expenses which are al.located to calf cost. Although this approach is lessconservative, it has theoretical justification sincemortalities are a continuing occurrence in cattleoperations.

Conclusion

As in other industries, realistic and accuratefinancial information is important for successfuloperations in the cattle industry. In order to pro-duce such information, basic principles of accrualbasis cost accounting must be applied to the cir-cumstances of the particular cattle operation. Theprocedures illustrated in this article are consideredto produce the desired financial information in areasonable and practical manner. The applicationof these principles presents an interesting challengeto the accountant for a cattle operation. ❑

"... realistic

and accurate

financial

information is

important for

successful

operations in

the cattle

industry."


ti„ t

D . W . W YCOFF

Central PennsylvaniaChapter (BeaverValley 1958), isManager, Basic

Standards at StandardSteel Corp., Division ofTitanium Metals Corp.of America, Burnham,Pa. Mr. Wycoff holds

a B.S. degree inIndustrial Engineering

from the Universityof Pittsburgh.

This article wassubmitted through

the CentralPennsylvania Chapter.

DIRECTAND IDLE -TIMECOST ACCOUNTINGAs facility usage goes —so go these expenses. Their amountis dependent upon the degree of activity involved. Withoutactivity, some of these expenses should not be incurred.

By David W. Wycoff

Each hour a facility is out of operation is a doubleloss for the company. All fixed costs and manyvariable costs continue to be incurred and the op-portunity for the production of saleable products isdenied. When the facility is operating, such costsare covered and the profit picture is enhanced withsaleable products. The greater the facility usage inthe production of prime products, the greater theprofit opportunities. However, since a facility is notnormally in continuous use, it makes sense toseparate the operating and idle costs from eachother.

In direct costing there are two major categoriesof costs: direct (variable) and period (fixed) costs.Why not add a third category, "idle expense," toidentify that portion of the costs incurred becauseof unused capacity? Such costs would consist ofunabsorbed depreciation, taxes, maintenance, cer-tain utilities, and other similar annual expensestriggered by idle facility hours. These fixed costsare still the same each hour throughout the yearwhether the facility is utilized or not. They areexpressed on an annual hour basis and are allocatedon the basis of the hours expended. The greaterthese expenses, the more important it becomes toidentify their recovery through activity.

Exhibit 1 illustrates the three categories of costs.By retaining a separate identity for each categoryof costs, idle expenses are constantly in view andsubject to improvement, by reduction. It should benoted that the idle expenses, the cost of not beingused, decrease as the activity increases. These ex-penses become part of the direct cost portion asthe production and related hours increase. Thedirect costs include the variable expenses togetherwith the activity absorbed portion of depreciationand tax nature items. The period costs composed

of supervision, indirect labor, administrative ex-pense, and similar items continue to be handledas a constant in the usual fashion. The step featureshown in these period costs reflects additional forcerequirements at varying operating levels.

Example

An example of direct cost and idle -time accumu-lations utilizing facility hours and the associateddollars per hour is presented in Exhibits 2, 3, and 4.This example assumes the facilities involved incuronly a few expenses and operate but a small portionof the time. Both forecasted and actual con-ditions are presented to show the retention of idleexpense identity when the variances are generated.Accordingly, the cost of idleness is visible for correc-tion. While this example includes only a fewexpense items, many others such as certain main-tenance, fuels, supplies and transportation arereadily adaptable to the facility hour expression.As facility usage goes —so goes these expenses.Their amount is dependent upon the degree ofactivity involved. Without activity, some of theseexpenses should not be incurred. In the example,each of these expenses is expressed as the cost perfacility hour with the sum providing a convenienttotal of facility direct cost.

Advantages of Time - Oriented Accounting

When the cost per hour for each facility is multi-plied by the hours per job, product costs and jobestimates are readily obtained. These costs may befurther extended by the appropriate number ofunits produced, to develop budgets and essentialdata for business planning. In terms of hours alone,the information permits knowledgeable facilityloading. Thus, operational performance measure-ments would also be available.


4

The advantages of time - oriented accountinginclude:

1. Hours represent the most consistent vehicle forcost accumulations.

2. The accumulation of productive hours for de-preciation, taxes, etc., accentuates the positiveby identifying the recovery of these expenses.Identification and measurement of idle -timefacility costs, on the other hand, facilitate theirreduction.

3. Costs for varying activity levels may be readilydetermined via hours per unit, operating hours,and dollars per hour.

4. The dollars per facility hour expression permitsa ready comparison between facilities and be-tween time periods for the same facili ty. It cancontribute to improved operating costs.

5. hacility hours per unit can be the prime factorsfor product costing, estimating, budgeting, busi-ness planning, operation performance, facilityloading, and operations analysis.

6. Hours per unit and dollars per hour providebetter understanding and greater acceptancethan other expressions and would thus improvec o m m u n i c a t i o n s .

Exhibit 1THE THREE CATEGORIES OF COSTS

Dollars

Annual capacity

period costs

Total costs

Direct costs

Idle costs � -'—

0 Hours 8760

0 Number of prime uni ts produced

Notes:

1. The 8760 hours represents the capacity in total

annual hours avai lable.2. The stepped period costs disclose varied salaried

forces, and requirements at varying activity levels.3. Standard hours per prime uni t would convert

uni ts or hours to the term desired.4. Necessary outage time (e.g. maintenance) is

deducted from total avai lable hours for capaci ty

determ inations.

Exhibit 2

FORECASTED DIRECT COSTS

Forecasted di rect costs for Faci l i ty I

Job A Job B Totals

Estimated hrs. 150 60 210

Std. DL and oper. costsat $20 per hr. $3,000 $1,200 $4,000

Absorbed deprec.at $1.1416 per hr. 171 69 240

Total job costs (est.) $3,171 $1,269 $4,440

Idle -time cost equalstotal deprec. for 2weeks (336 hrs.) at$1.1416 per hr. $383Less absorb. deprec. 240 143

Total es timated cost forFacil ity 1 $4,583

Forecasted direct costs for Faci l i ty II

Job A Job B Totals

Estimated hrs. 50 50 100

Std. DL and oper. costat $15 per hr . $ 750 $ 750 $1,500

Absorbed deprec.at $.5708 per hr. 29 29 58

Total job costs (est.) $ 779 $ 779 $1,558

Idle -time cost equalstotal deprec. for 2weeks (336 hrs.) at$.5708 per hr . $192

Less absorb. deprec. 58 134

Total estimated cost forFacility 11 1,692

Total forecasted direct costs $6,275


"it should be

noted that the

idle expenses,

the cost of not

being used,

decrease as the

activity

increases."

37

facility Conclusion recovery of these costs, but also provides the basisfor successful gains. The cost accumulations via

time wisely Facility time once lost can never be regained. time determinants provide good solid yardsticks for

used not only Together with opportunities for gain, that time is business measurements. As time moves forward,gone forever. Gone too are the opportunities to recognition of its measures permits management to

insures the recover the incurred depreciation, taxes, etc. How- obtain much more realistic cost accumulations and

recovery ofever, facility time wisely used not only insures the better control. F-1

these costs,

but also

provides the

basis for

successful

gains."

38

Exhibit 3

ACTUAL DIRECT COSTS

Actual direc t costs for Facility I

Job A Job B TotalsActual hrs. 120 50 170Actual DL and oper. costs

at $25 per hr. $3,000 $1,250 $4,250Absorbed deprec.

at $1.1416 per hr. 137 57 194Total job costs (act.) $3,137 $1,307 $4,444

Idle -time cost equalstotal deprec. for 3weeks (504 hrs.) at$1.1416 per hr. $575Less absorb. deprec. 194 381

Total actual cost forFacil ity 1 $4,825

Actual direc t costs for Facility II

Job A Job B TotalsActual hrs. 70 50 120Actual DL and oper. cost

at $20 per hr . $1,400 $1,000 $2,400Absorbed deprec.

at $.5708 per hr. 40 29 69Total job costs (act.) $1,440 $1,029 $2,469

Idle -time cost equalstotal deprec. for 3weeks (504 hrs.) at$.5708 per hr. $288Less absorb deprec. 69 219

Total actual cos t forFacil i ty II 2,688

Total actual direct costs $7,513

Exhibit 4

VARIANCES

Facil ity I Estimated Actual Variances

DL and oper. cost $4,440 $4,444 $(4)Idle -time cost 143 381 (238)Total $4,583 $4,825 $(242)

Facil ity II

DL and oper. cost $1,558 $2,469 $(911)Idle -time cost 134 219 (85)Total 1,692 2,688 (996)

Overall costs and variance $6,275 $7,513 $(1,238)

MANAGEMENT ACCOUNTING/DECEMBER 1974

IMPUTEDOPPORTUNITYCOSTSThe profits sacrificed become legitimate costs of the

project being analyzed, and the profits so sacrificed can

be complex indeed.

By David M. Stambaugh

A primary responsibility of accountants is to providemanagement with sound advice about costs and ex-penses which affect corporate plans. It is their re-sponsibility to cover all factors which should beconsidered when weighing the merits of variousproposals. However, meeting this responsibility isbecoming increasingly difficult, because the account-ing profession is still tenaciously holding on tosome of the old concepts of cost while ignoringtwo very meaningful elements, the effects of whichshould be evaluated. These two elements are "im-puted" costs and "opportunity" costs. They areimportant because they are used in judging thevalue of alternative courses of action.

Imputed Costs

"When costs are actually being borne, but ina form not resulting in contractual outlays, theyare said to be imputed." 1 This is the accountingview. Compare it with what an economist meantwhen he said, "The cost of a producer -owned factoris usually termed an imputed cost and is equal towhat the factor could otherwise have earned in theopen market." 2 Although stated in different terms,these two men do not really differ in their basic ideaof what imputed costs are. The most commondenominator used to explain this term is interest.An entrepreneur's investment in his business, forexample, could instead have been used to earn ahigher interest income at current market value inother low risk investments. The amount of interestincome that would have been earned at competi-tive rates in the market is the imputed interest.

The fact that the entrepreneur is not earning theadditional interest from his capital is a demonstra-tion that he is bearing a loss even though theamount is nowhere stated as a loss in his books of

account. It is an understood loss or cost with re-spect to his choice of investment. The differencebetween this interpretation and the economist's in-terpretation is that the economist actually chargesthe amount of the imputed interest to the businessprofits of the entrepreneur. To the economist, noprofits are made in the actual business enterpriseuntil profits exceed the imputed interest.

It follows, therefore, that imputed costs can alsobe labor (what the entrepreneur could earn in theopen labor market), rent (what his income wouldbe if he rented his land, building, and equipment),and depending on the accounting system, deprecia-tion and taxes.a

Opportunity CostsIf a company has a stated objective that all new

capital projects should earn 35 percent in order tobe justifiable expenditures, then imputed interestof 35 percent per year is either stated or understooddepending on who is making the study. When acost accountant makes a study of a proposed projectand determines a profit of, say 40 percent, he saysthat the project is acceptable because it exceeds 35percent. The economist would say that the profitis only five percent because he has imputed the 35percent interest as a factor of cost. He considers it acost because somewhere in the organization thereare other projects which will also return 35 percent.The interest factor of 35 percent is imputed in theproject under study because it is the lost value ofan alternate opportunity. If the profits of a selectedproject are not at least equal to the profits of aproject not selected there will also be an opportu-nity cost.

I Dixon Fagerbers, Jr., "Unmeasured Costa: A Checklist,"a Man-m ment Accounlinq, February 1974.

Lloyd G. Reynolds Economics, Richard D. Irwin, Inc., Home-wood, Ill., revised edition 1966.

=Op. Cie.

D. M. STAMBAUGH

Chicago Chapter(North CentralIndiana 1965), isCost and BudgetDirector, Ball MetalDecorating and ServiceDiv. of Ball Corp.,Chicago, III. He holdsa B.S.C. degree fromInternational College,Fort Wayne, Ind.Mr. Stambaugh wasawarded a Certificateof Recognition forthis article (1973 -74).

This article wassubmitted throughthe Chicago Chapter.


"The cost

accountant ...should always

impute the

opportunitycosts of analternative

project.. ."

Sacrifice is a word which can be used to describeopportunity costs. Profits of some opportunitiesmust be sacrificed in order to achieve greater goalsthrough achievements of other opportunities. Oneauthor who uses the word sacrifice in his definitionof opportunity cost says, "An opportunity cost isthe measurable sacrifice in rejecting an alternative;it is the maximum amount foregone by foresakingan alternative; it is the maximum earning thatmight have been obtained if the productive good,service, or capacity had been applied to some alter-native use." 4

The concept of opportunity costs is certainlycompatible with the idea of sacrifice because thevery concept of "cost" itself entails the sacrifice ofsomething of value. The cost of anything is thevalue of whatever was given up in order to acquireit. The important point for cost analysts to remem-ber is the idea that profits can also be given up inthe hope of attaining even greater profits. Theprofits sacrificed become legitimate costs of theproject being analyzed, and the profits so sacrificedcan be very complex indeed. They do not needto be something as simple as rent or interest.

Imputed Opportunity Costs

The cost accountant, when analyzing and evalu-ating a proposed project, should always impute theopportunity costs of an alternative project to theproject under study because profits of the alterna-tive will be given up and will therefore be borne bythe subject project. Consider, for example, a pro-posal to start producing a new product in an exist-ing profitable enterprise. Cost analysis determinesthe following for the proposed project:

Marginal cost of sales $13,000Normal sales markup of existing products 35%Sales dollars would then be $20,000Gross margin is therefore $ 7,000Fixed costs on building and equipment $ 2,000Gross profit $ 5,000Expected production volume (in units) 2,000Selling price per unit $ 10Square feet of existing building 1,600Gross margin per square foot $ 4.38

The cost accountant has deducted the fixed costsof the building space used up, but he is forgettingthat 1,600 sq. ft. of that building is no longeravailable for current business. He is forgetting that1,600 sq. ft. of existing business is being sacrificed

Charles T. Horngren, "Cost Analysis for Non - routine Decisionand Long -Range Planning," Cost Accounting —A ManagerialEmphasis, second edition, Stanford University, p. 416.

to the new project. What he will lose is the profitsthat those 1,600 sq. ft. can earn in the currentestablished business through loss of inventory spaceand inefficiency caused by crowded conditions.

In order to assure management that the proposalis really as profitable as its present activities, thefollowing analysis should be prepared. Assume inthis example that gross margins currently amountto $5 /sq. ft.:

Marginal cost of sales $13,000Imputed opportunity costs

(1,600 sq. ft. @ $5) 8,000Fixed costs on building and equipment 2,000

Total cost of the project $23,000Sales at normal selling price 20,000

Gross loss on an economic basis $(3,000)

It is obvious that in order for the company tomake an equivalent profit on the floor space usedto manufacture the 2,000 new units, the projectmust yield $23,000 gross revenue. This is a sellingprice of not $10 but $11.50. The sales and market-ing departments must then determine whether theunits can be sold at $11.50. Of course, the im-puted opportunity costs in the example could havebeen only $3,/sq. ft. In that case, the use of theexisting space to produce the new product wouldbe the more profitable alternative.

Can more than one opportunity cost be imputedto any one particular project? The obvious answeris "no" because it would seem that the only justi-fiable cost of an alternate opportunity is the largestpossible lost profit from among all possible alterna-tives. However, in the example above, if the spacecould have continued to produce $5 gross marginper sq. ft., then the capital that was to be investedin equipment to manufacture the new productcould have been put to another use, even if onlyinvested in certificates of deposit. If the capital wasto have been borrowed then interest cost is also in-volved and only the gross margin imputed opportu-nity cost would be considered. The interest cost isof course an incurred cost.

Conclusion

The cost accountant has a great responsibilitywhen he advises management about alternativecourses of action. In spite of the highly sophisti-cated accounting system designed to provide anexcess of cost details, some of the most importantcosts are those which are not recorded. Those costsmust be imputed from the analysis of alternate op-portunities. ❑


PERCENTAGEOF

COMPLETIONACCOUNTING

In many respects, the type of firm considered in this article is

similar to a firm of certified public accountants or management

consultants. The work going into the design of a custom - designed

unit would closely parallel the work of a CPA or consulting firm

in that the special skills of the professionals involved are the items

of real value.

By Charles Rachui

Percentage -of- completion accounting methods per-mit contractors to report earned income as work ona contract is being done. It is recognized as thepreferred method, particularly where a substantialnumber of jobs are long -term in nature, or wherethe number of jobs completed in each accountingperiod is irregular. In contract, the completed con-tracts method defers all gross profit recognition untileach job is substantially complete. The principaladvantage of this method is that profit is not pickedup until the ultimate costs of completing the job areaccurately known. However, this method has majordisadvantages in that very few contractors consis-tently complete jobs on a uniform basis and thefact that contractors using the completed contractsmethod derive no benefit from work in process.Although this approach is acceptable to the account-ing profession, it does not seem to be a realisticapproach to financial statement presentation.

Percentage -of- Completion Procedures

There are several alternatives available under thepercentage -of- completion method, the most com-mon of which are as follows:

1. Accrual method2. Engineers' estimate of total completion3. Costs incurred to total costs

ACCRUAL METHOD

This method simply recognizes progress billings

as income with costs incurred to date being pickedup as cost of sales. Although this method is accept-able, the progress billings, generally, do not have adirect relation to the percentage of overall workdone, and can cause a serious mismatch betweensales and costs recognized on jobs in progress.

ENGINEERS' ESTIMATE OF TOTAL COMPLETION

In some situations, representatives of the con-tractor and the customer meet monthly and agreeon the overall percentage of project completion.This method is also acceptable in some situations,but has the disadvantage of not being practical inmost cases.

COSTS INCURRED TO TOTAL COSTS

The method most commonly used and which ispreferred in most cases is the relation of costsincurred to date to total estimated costs. A pre-requisite for effectively using this procedure is areliable cost estimating system. Without accuratecost estimates, profits recognized throughout thecourse of a job can vary significantly, particularly ifcost increases are not known until a job's latterstages. With a good cost estimate, income is recog-nized strictly on the basis of the percentage of totalcosts incurred, regardless of the amount of progressbillings.

Work Progression

In many respects, the type of firm considered inthis article is similar to a firm of certified publicaccountants or management consultants. The work

C. RACHUI

Tyler Area Chapter1969, is ChiefAccountant withHowe -BakerEngineers, Inc., Tyler,Texas. Mr. Rachuiholds B.B.A. and M.S.degrees from TexasA &I University.

This article wassubmitted through theTyler Area Chapter.


" . . . t h e

principal assets

of an

engineering

firm are the

professional

skills of its

employees."

going into the design of a custom - designed unitwould closely parallel the work of a CPA or con-sulting firm in that the special skills of the profes-sionals involved are the items of real value. Thetypical progression of work done on a job may bebriefly described as follows:

1. Process design engineers develop computationsand drawings of the overall equipment require-ments and layout of the plant.

2. Draftsmen, working under the engineers' super-vision, prepare detailed drawings of the entireplant.

3. Project engineers and buyers order all requiredequipment.

4. Project engineers, expeditors, and inspectors con-tinuously supervise the work of and assembly ofequipment by various suppliers to be sure thatstandards of both the customer and the processdesign are being met.

5. Project or construction engineers supervise theassembly of equipment which is routed by sup-pliers to the plant site (or for smaller plants tofabricating facilities) for final erection. Manyengineering companies use the services of inde-pendent construction or fabrication firms andare, therefore, responsible for supervising installa-tion only.

6. The engineers involved in design and erection ofthe plant with the assistance of permanentemployees of the customer (who assume respon-sibility for operating the plant upon acceptance)are responsible for the initial start -up of the plant.

Exhibit 1EXAMPLE OF COST ESTIMATES PREPARED FORA DESIGN AND CONSTRUCTION ORDERDate order received June 30, 1972Scheduled start-up date February 28, 1973Final bil ling on acceptance March 15, 1973

Bil ling dates per order:6 / 3 0 / 7 2 $100,000

10 / 31 / 72 100,00011 /3 0 / 72 200,000

1 / 31 /7 3 250,0002 / 28 /7 3 250,0003 / 1 5 / 7 3 100,000

Total sales price $1,000,000

Cost data:Engineering — process

design (1,400 hrs. X $10) $ 14,000Drafting (4,000 hrs. X $9) 36,000Engineering — project

(600 hrs. X $10) 6,000Purchasing, expediting, and

inspection (1,000 hrs. X $9) 9,000Engineering, construction

supervision and startup(1,000 hrs. X $10) 10,000

Total engineering costs $ 75,000Equipment cost, including

freight 425,000Construction cost to be

paid to subcontractor 200,000Total cost 700,000Gross profit $ 300,000

Percentage of Completion Alternatives

INCURRED COSTS

The most conservative approach would be torelate the costs incurred to expected total job costs— engineering plus equipment plus construction.The principal objection to this method is that littlein the way of gross profit would be recognized untilafter most of the engineering has been done. Thisapproach would not provide a relationship of profitearned in proportion to work done. On the otherhand, the most distinguishing advantage to theoverall cost approach is that the ultimate job costsare more accurately known before significantamounts of gross profit are recognized.

ENGINEERING COSTS

Since the preferred method is some measure ofcost incurred related to total cost, the questionarises: What is the most important segment of costto an engineering contractor? As mentioned earlier,the principal assets of an engineering firm are theprofessional skills of its employees. Other assetswould be the patent rights held and the ability todesign certain processes for specific applications. Itcould logically be said then, that the most importantmeasure of cost to an engineering contractor wouldbe the ratio of engineering costs incurred comparedto total estimated engineering costs for each job.

Example

The cost estimates shown in Exhibit 1 have beenprepared to illustrate by example the two methodsdescribed above. The order was received on June30, 1972, and was completed nine months lateron March 15, 1973. Most of the engineering wasdone during the first three months, tapering off toa lower level during the next six months. Althoughsome equipment was purchased during the earlystages, most expenditures were incurred later in thejob. Also, all construction costs were incurred afterthe equipment started arriving at the job site.Exhibit 2 is an analysis of the results which wouldbe recognized under each accounting method.

Method A would present the least problems, asonly accumulated billings would differ from salesrecognized, since cost would be based on amountsactually spent. In the example, the sales recognizedequal the progress billings at both the 9/30/72 and3/31/73 dates. A difference of $100,000 occurs at12/31/72, at which time sales of $500,000 havebeen recognized with progress billings of $400,000,and would be reflected as a current asset.

Method B presents the most realistic approach torecognizing profit as it is earned and is also themore liberal of the two. The major disadvantage toMethod B, however, would probably be the in-herent inaccuracies in predicting manpower require-ments precisely. Contractors also find it difficult toproject equipment costs exactly since items aresometimes substituted or added during late stagesof the job. This contributes to the problem ofobtaining an accurate manpower projection becausecomputations must be redone a number of times.


Exhibit 2ANALYSIS OF REPORTED PROFIT BY THE TWO ACCOUNTING METHODS

Bill ing dates

Actual bil lings and costs 9 / 3 0 / 7 2 12 /3 1 /7 2 3 / 15 /7 3

Sales price invoiced and collected $100,000 $400,000 $1,000,000

Engineering costs charged to job $ 50,000 $ 60,000 $ 75,000

Equipment purchased and charged 20,000 200,000 425,000

Progress payments to contractor - 0 - 90,000 200,000

Total costs incurred $ 70,000 $350,000 $ 700,000

Method A•Analysis based on incurred costs to dateSales $100,000 $500,000 $1,000,000

Cost of sales 70,000 350,000 700,000

Gross profit $ 30,000 $150,000 $ 300,000

Method B•Analysis based on engineering costs to dateSales $666,667 $800,000 $1,000,000

Cost of sales 466,667 560,000 700,000

Gross profit $200,000 $240,000 $ 300,000

Balance sheet presentation- Method ASales recognized $100,000 $500,000 $1,000,000Sales price billed 100,000 400,000 1,000,000Difference $ - 0 - $100.000 _$ - 0 -Cost recognized $ 70,000 $350,000 $ 700,000Cost incurred 70,000 350,000 700,000Difference $ - 4 D - _ - 0 -Net difference _ _ 0 _ $100,000 $ - 0 -

(Reflected as current asset -unbil ied receivables)

Balance sheet presentation - Method BSales recognized $666,667 $800,000 $1,000,000Sales price bil led 100,000 400.000 11000,000Difference 566 667 $400.000 A - 0 -Cost recognized $466,667 $560,000 $ 700,000Cost incurred 70,000 350.000 700.000Difference $396.667 $210.000Net difference $170,000 $190,000 $ - 0 -

(Reflected as current asset -unbilled receivables)

• The sales and costs recognized were obtained by multiplying total sales and cos ts by the fol lowing percentages:

Method A- 9 / 3 0 / 7 2Costs incurred to date _ $ 70,000

_ 10 %Total costs $700,000

Method B- 9 /30 /72Engineering costs to date _ $ 50,000

= 66 .7%-Engineering total costs $ 75,000

At 12 /3 1 /72 Method A is 50% and Method B is 80 %.

In spite of these problems, it is still important thatan engineering firm identify its revenue with man -hours and at the same time build enough conserva-tism into the system to make it realistic andacceptable, even though it would be recognizingincome as being earned before the money requiredto earn the income had been spent.

One method for the firm to protect itself againstcost overruns would be to apply cost reserves to thecompletion estimate in Method B. That is, thesystem could be established so that an amount equalto less than the percent actually completed could berecognized during interim periods. For example, at9/30/72, Method B would result in the followingprofit recognition if only 75 percent of the amounttheoretically earned were recognized:

Sales 66 2/3 % of $1,000,000 =$666,667 x 75% = $500,000

Cost 66 2/3% of $700,000 =$466,667 x 75% = 350,000

Gross profit to 9,/30/72 $150,000

The reserves required could fluctuate during thecourse of each job and it might be possible to use arecognition percentage of something greater than75 percent later in the job. It may be possible, afterall drawings are accepted, equipment ordering iscomplete and a firm construction price is known,that the recognition level could be increased to 90percent. Assuming this was true at 12/31/72, andthat engineering was then 80 percent complete, thefollowing would result:

" . . . it is still

important that

an engineeringfirm identify itsrevenue with

man -hours . . . "


"The cost

estimate . . .must be

reasonable

before any

type of

percentage -of-

completion

method can be

made to work

effectively."

Exhibit 3COST AND PROFIT ALLOCATIONS

9 / 3 0 / 7 2 12 /3 1 /7 2 3 / 1 5 / 7 3Engineering

Sales $208,333 $250,000 $ 312,500Cost 50,000 60,000 75,000Gross profi t $158,333 $190,000 $ 237,500

EquipmentSales (Cost plus 10 %) $ 22,000 $220,000 $ 467,500Cost 20,000 200,000 425,000Gross profit $ 2,000 $ 20,000 $ 42,500

ConstructionSales (Cost plus 10 %) $ - 0 - $ 99,000 $ 220,000Cost - 0 - 90,000 200,000Gross profit $ - 0 - $ 9,000 $ 20,000

Tota ISales $230,333 $569,000 $1,000,000Cost 70,000 350,000 700,000Gross profit $160,333 $219.000 $ 300,000

Sales 80% of $1,000,000 =$800,000 x 90% = $720,000

Cost 80% of $700,000 =$560,000 x 90% = 504,000

Gross profit to 12,/31/72 $216,000

By using the reserves as illustrated, profit recogni-tion for Method B in Exhibit 2 would be $50,000less at 9/30/72 and $24,000 less at 12/31/72.

Cost and Profit Allocations

Since an engineering firm's profits result from theskills of its professional staff, it would follow that thefirm's principal asset is its unique ability to designplants meeting customer requirements. The firm'sskills at buying and assembling equipment couldthen be considered to be incidental to its primaryobjective of designing plants. Therefore, since thefirm earns most of its profit from professional skills,a higher profit margin must apply to the engineeringcost than to the equipment and construction costs.If we assume that a 10 percent profit margin oncost is allowed for equipment and construction, thebalance would apply to engineering. In that case,the profit on the $625,000 of equipment and con-struction costs would be $62,500, meaning thatequipment and construction sales would be $687,-500. The balance of the sales price, $312,500, wouldall apply to engineering. See Exhibit 3. In this typeof situation, engineering, equipment, and construc-tion would be considered separately, with no profitbeing picked up in either category until costs wereincurred. However, cost reserves, as illustrated forMethod B, could also be applied to engineering inthis case as appropriate during the interim stagesof the job. The profit margins would be differentfor each type of sale, but information generatedwould provide the following benefits not availablefrom the other methods:

1. Engineering sales and costs would be shown

separately and would provide statement userswith a ready analysis of the gross profit marginfrom engineering, which is a critical guideline.

2. By establishing a uniform equipment and con-struction margin percentage -and with thesesales and costs being shown separately as well -management would be constantly aware of costoverruns when the gross margin fell below 10percen t.

Valuation Reserve

A valuation cost reserve - similar to a bad debtreserve -would complement virtually any percent -age-of- completion system adopted by an engineeringfirm. The balance in the reserve could be based onseveral factors -such as a percent of cost of each jobin process, a balance based on engineers' estimatesof potential additional cost on jobs in process, etc.This type of reserve has the principal advantage ofapplying general conservatism to the overall profitrecognition system, and can be used to level outpeaks and valleys caused by irregular work loadswithin engineering firms.

Conclusion

The cost estimate upon which the sales price isdetermined must be reasonable before any type ofpercentage -of- completion method can be made towork effectively. In addition, two factors are essen-tial to successful percentage -of- completion account-ing: an adequate cost estimating system and involve-ment in job accounting by the engineer in chargeof each project. Engineers in charge of each projectmust be thoroughly familiar with the percentage -of-completion system and should be responsible forworking with accounting in arriving at cost reservesand the amount of profit earned during each ac-counting period. The absence of effective commu-nication between accounting and engineering wouldbe a serious deficiency which could cause grosserrors in the amount of profit actually earned. ❑

44 MANAGEMENT ACCOUNTING ,DECEMBER 1974

A SURROGATE MODELFOR INCOME REPORTING. . .

current financial reporting provides information to decision-

makers —the consumers of the reporting process —that is timely,objective, verifiable, conservative, and generally irrelevant.

By William Robert Smith

There are two general approaches that may beadopted in setting forth the objectives of financialreporting. One approach is to assume that thereader is a member of a set of unknown usershaving multiple objectives. This approach has beenused by accountants for the past 50 or more yearsas evidenced by their insistence on issuing a singleset of financial statements and also their ignoranceregarding the needs of users.' The users may beany one or more of a coalition of shareholders,lenders, suppliers, management, customers, em-ployees, and the society in which the coalitionexists. Each segment of the coalition has ob-jectives. As the corporation performs, its per-formance is measured by each segment of thecoalition against that segment's objectives. Thecorporation, also, being a creature of the coalition— members whose objectives are often divergent —must of necessity communicate information con-cerning its condition and accomplishments in aneutral fashion. That is why current financial re-porting provides information to decision- makers—the consumers of the reporting process —that istimely, objective, verifiable, conservative, and gen-erally irrelevant? Strangely enough, accountantswho view reporting from this first approach sin-cerely believe they are providing information that isuseful for all decision - makers' models. This viewstems from the accountants' deep- seated belief thattheir primary function is one of stewardship re-porting.

The second approach, which is gaining momen-tum, is to focus on the utility of information forspecific decision models.3 Much research is underway in the academic and financial communities todetermine the nature of such models and theattendant information needs.4 It appears obvious,

that once the accountant turns away from hishistoric view of the reporting process as an end initself and develops a user orientation, the focus ofhis reporting will change.

The issues involved are many and varied. Thereis a need by those not privy to the internal informa-tion system of the firm for a more meaningfulmeasurement of corporate performance. Faced witha single information set, the best that the in-dividual member of the coalition can do is tocompare corporate achievement with his specificobjectives. Much discussion is under way as towhat these objectives should be. However, such adialogue is meaningless since most members of thecoalition have objectives that are often in directconflict with the objectives of other members. Evenmembers of a seemingly homogeneous group ofcoalition members can have opposing objectives aswitnessed by investors interested in growth andthose in steady sizable dividends. What is reallyneeded is information relevant to each decision -maker's model. Until this can be achieved, a modelof corporate performance measurement that em-phasizes current valuation of the total resources ofthe firm would provide a useful surrogate.

Some Fundamental Propositions

However, before such a model can be used,consideration must be given to a number of funda-mental propositions. Also, it is assumed that insti-tutional constraints will require that corporatefinancial disclosure include the three current pri-

1 Eldon S. Hendriksen, Accounting Theory, revised edition,Richard D. Irwin, Inc., Homewood, Ill. 1970, p. 102.1 This article adheres to the traditional in accepting the basicfinancial statements as the major devices for communicating cor-qo te condition and accomplishments to the corporate coalira tion.

o do otherwise is impractical in view of the institutional con-straints involved.s Op. Cit.' See for example, Committee on External Aeporting, "An Evalu-ation of External Reporting Practices," Accounting Review, Sup-plement to Volume pLIV, 1969.

1

W. R. SMITH

San Diego Chapter1973, is an Instructor inAccounting at theUniversity of SouthernCalifornia. He is a CPAand holds a B.B.A.degree fromNortheasternUniversity, an M.B.A.degree from StanfordUniversity and is aDoctoral Candidateat the University ofSouthern California.

This article wassubmitted through theSan Diego East CountyChap ter.


" . . . predictiveability is useful

only in thecontext of

decision-

making."

mary financial reporting devices— statements offinancial position, operating income for the periodunder consideration, and changes in financial posi-tion between the opening and closing of thatperiod.5 No serious constraints exist as to theform and content of financial reports beyond thedispleasure of the firm's auditors and the re-quirements of regulatory agencies. These condi-tions can be accommodated by presenting relevantdata as supplementary to the institutional data.In presenting the following propositions, no claimis made that the material is entirely original.Certain of these propositions have expressly orimplicitly appeared in the writings of one or moreaccounting theorist.

PROPOSITION 1

The primary objective of the external financialreporting process is to provide quantitative eco-nomic information to be used in decision - makers'models.

Recent authoritative writings have hypothesizedthat decision - making, or more specifically, the gen-eration of information useful as input to the de-cision- makers' models, is the most important endresult of corporate financial reporting. Themeasurement of corporate performance is usefulonly when such measurement provides informationwhich has predictive ability. Additionally, predic-tive ability is useful only in the context of decision -making. Predictive information without some re-sponse by the decision -maker raises questions as tothe relevance of the information. Corporate per-formance hopefully is measured to provide pre-dictive information to the corporate coalition.

PROPOSITION 2

The primary users of external financial reportsare investors. Secondary users include governments,labor, employees, tax collectors, and creditorsamong others.

The investor is in a position of primacy sofar as specific users are concerned. In this categorywe include those agencies of government andother institutions set up to protect investors,specifically agencies such as the Securities "and Ex-change Commission and institutions such as theNew York Stock Exchange. Creditors also areimportant users of financial reports, although cur-rent measures of corporate performance providethem much information that is dysfunctional dueto its conservatism. The needs of other govern-mental agencies and tax collectors usually consistof adjusted historical financial data prepared underrigid rules and for different objectives. Such ad-justments are not difficult for the accountant andsuch reporting adopts a secondary role.

Managers have other sources of information fortheir decision- making needs. They need not con-cern themselves with financial reporting except asit concerns their image with the directors andinvestors. The burgeoning field of management

accounting, unfettered by the chains of "generallyaccepted accounting principles," and free from in-stitutional constraints, draws heavily on the infor-mation and communications sciences, managerialeconomics, and behavioral sciences. Further, it pro-vides tailored information on demand to meetspecific needs for specific information to shed lighton specific decision questions. It is difficult to en-vision a situation where management faced with adecision would call for a copy of the latest financialstatement. Yet, as Anthony points out, many com-panies assume that managerial accounting must begoverned by financial accounting principles —ap-parently to avoid the necessity of rigorous thinkingabout the real needs of management.' Such atti-tudes reflect unfavorably on the capabilities ofmanagement. Accounting should not be called uponto abet this unfortunate deficiency.

PROPOSITION 3

Economic institutions are creations of the statedesignated as converters of society's resources, andthere is an overriding requirement to account tosociety on the financial health of those institutions.

It has been argued by many economic, manage-ment, and accounting theorists that profit maxi-mization is no longer the principal objective ofcorporate managers.,, While profit maximization wasonce a prime objective of the corporation, it hasevolved to a position of survival and growth and dueto its growth, shareholder influence has declined.As Ladd points out , ". . . once the stockholderswere relegated to a status which is, at best, co -equalwith virtually everyone else in the community, itbecame rather pointless [for the corporation] tocontinue striving to accumulate that which only he[the stockholder] could have." 9

As the focus shifted to survival and growth, thestewardship concept lost much of its relevance andthe concept of maintenance of position and growthreplaced it for the large corporation. Unfortu-nately, accounting did not keep pace and a crystalli-zation began to occur in which the relevant informa-

6 While results are conflicting, sufficient research as been ac-complished to cast doubt as to whether in fact corporate reportsare actually used by the public. For example, see Lyn D. Pankofrand Robert L. Virgil, "Some Preliminary Findings from aLaboratory Experiment on the Usefulness of Financial AccountingInformation to Security Analysts," Empirical Research in Account-ing: Selected Studies, 1970. The authors conducted an experimentin which experienced security analysts were able to purchase varioustypes of account ing and non- accounting information at a cost toaid rn decisions. The authors did not find much empirical sup -port for the belief that accounting information is generally andhighly useful for decision - making.s Report of the Study Group on the Objectives of Financial State.ments, Objectives of Financial Statements, AICPA, 1973.'Robe rt N. Anthony Planning and Control Systems: A Frame-work for Analysis, liarvard University, Division of Research,Boston, Mass., 1965, p. 107." Many management theorists have taken economic theory to taskbecause of its profit maximization assumption despite the fact thatthere is nothing in economic theory that claims that businessmenseek to maximize profit. Management theorists have mistakenlyassumed that the adoption of profit maximization as a simplifyingassumption implies that economic theory lacks validity. Nothingcould be further from the truth. All models require simplifyingassumptions if they are to have general predictive ability. Themore numerous and restrictive are any model's assumptions, theless general the theory becomes and the more limited is itspredictive ability. It is not necessary that assumptions be true oreven realistic, but merely that the model provide a high degreeof predictive ability. Assumptions that provide predictive abilityare more useful than those that do not even if those that do notare more realistic.Y Dwight R. Ladd, Contemporary Corporate Accounting and thePublic, Richard D. Irwin, Inc., Homewood, Ill., 1963, p. 21.


tion — current resource values —was ignored. In the1970's, corporate responsibility has become para-mount. All segments of corporate performance arecoming under the scrutiny of society. Corporatesocial responsibility is a must. Accounting now hasthe significant responsibility of providing a mean-ingful basis for communication between corpora-tions and an entire society which is dominated bycorporate power. It still has not realized thisresponsibility despite the repeated lawsuits andcriticisms to which the profession has been sub-ject.

PROPOSITION 4Quantitative economic information must be

worth at least as much as it costs. It must berelevant, reliable, timely, and provide optimaldisclosure. A secondary requirement is that it havesome reasonable degree of objectivity.

Proposition 4 follows logically from Proposition1. It is axiomatic that information for decision -making must be relevant to those decisions, andthat its expected value in reducing uncertainty mustbe greater than the cost of its acquisition. Thus,the most important quality of the information isits relevance to the decision at hand. The Proposi-tion also admits objectivity to the criteria forjudging information, but places it in a subordinateposition. This is due to the fact that data is onlydeemed to be objective when the data is based oncompleted transactions. Perhaps the most acceptedmeaning of the term among accountants is illus-trated by its use in conjunction with evidence. AsPaton and Littleton put it, " `Objective evidence' isevidence which is impersonal and external to theperson most concerned in contrast with that per-son's unsupported opinion or desire." 10

The ordering of objectivity as subordinate torelevance is, however, at odds with accepted ac-counting practice which appears to be firmly com-mitted to objectivity. It was not until 1970 thatthe AICPA gave notice that the concept of rele-vance had importance to accounting and then onlyin a quasi - official pronouncement. The most en-couraging thing about the pronouncement was itsspecific statement that the primary qualitativeobjective of accounting is relevance to decisions.1'

If in fact this concept is accepted and officiallyadopted by the profession, much of the argumentfor the perpetuation of historical cost will be under-mined since it is relatively easy to demonstrate theirrelevance of historical cost for making decisionsconcerning the future.

If information is to be relevant (i.e., if assets areto be properly valued) a relevant measurementmethod is dictated. Complete knowledge of thefuture would be ideal, and relevant. Unfortunately,information about the future is seriously deficient inobjectivity. In contrast, historical cost, informationabout the past, is objective but highly irrelevant.Thus, current values provide a proper mix of rele-vancy and objectivity. Further, current values alsoprovide the best measure of accountability from a

societal point of view since society's emphasis is onthe health of its institutions.

PROPOSITION 5

The responsibility of financial statement preparersis to insure that statements portray what they pur-port to portray.

Proposition 5 brings us to the crux of the matter.Information can be relevant only if it is complete.One of the most serious deficiencies of publishedcorporate reports is their incompleteness.

Balance sheets should measure the current fi-nancial position of the firm and income statementsshould measure the profitability of the firm as a re-sult of the operations of the period. Since net in-come by definition is the change in net assets fromoperations and external events, it is crucial thenthat all assets of the firm be included in the fi-nancial position statement and that all changes innet asset position be included in the income state-ment. In many cases some of the firm's most validresources are missing from their statements of fi-nancial position. The following is a list of a fewof these resources which accountants refuse to in-clude because their value is not objectively deter-minable. Despite their relevance, objective in thiscontext being defined by accountants as having beenpaid for.12

1. Technological advantage2. High managerial ability3. Exceptional selling capacity4. Personal credit5. Social and business connections6. General reputation7. Attractiveness of corporate personality8. In -house developed patents9. Trademarks

10. Copyrights11. Trade name12. Established clientele13. Location14. Favorable trade developments15. Value of the human organization16. Previously written -off assets that still exist17. Unrecorded value of leases18. Synergistic effect of assets working together19. Monopolistic position of the firm

These items are usually excluded from most listsof assets. This is very strange since the most populardefinition of an asset is the one suggested by Sprouseand Moonitz:13 "Assets represent future economicbenefits, rights to which have been acquired by theenterprise as a result of some current or past trans-

10 W. A. Paton and A. C. Littleton, An Introduction to CorporateReporting Standards, American Accounting Association, 1940, p.19.11 APB Statement No. 4, Basic Concepts and Accounting PrinciplesUnderlying Financial Statements of Business Enterprises, AICPA,October 1970, p. 36.>, For example, see G. A. Welsch, C. T . Zlatkovich, and J. A.White Intermediate Accounting, third edition, Richard D. Irwin,Inc., homewood, Ill., 1971 p. 574.ss Robert T . Sprouse ana Maurice Moonitz, "A Tentative Setof Broad Accounting Principles for Business Enterprise," Ac-counting Research Study No. 3, AICPA, 1962, p. 20.

"Information

can be relevant

only if it is

complete."


" . . . no onevaluation base

can cope withthe problems

of valuing all

individual

assets on aconsistent

basis."

action." Clearly the above items meet the termsof the definition.

Defining Income

To summarize our argument to this point, in-formation must be relevant and must be reasonablycomplete if it is to serve as an input for decisionsconcerning corporate performance. The key toachieving these ends is a complete list of assets sovalued to provide relevant information. Asset valua-tion is the key to a proper portrayal of corporateperformance due to the articulation of the account-ing model.

Accountants are fond of saying that one mustchoose between a "good" income statement or a"good" balance sheet and that since income mea-surement is more valuable to statement users thebalance sheet will be sacrificed when a conflict arises.This argument is easily demolished by examiningthe accountants' model. The familiar accountingidentity tells us that the money value of the assetsless the amounts due to creditors is a measure ofowners' equity or:

A — L =P

where A is the recorded assets of the firm ex-pressed in dollars, L is the amount due to creditors,and P is the residual attributable to the proprietors.

The above model is static and represents thefinancial position of the firm at a specific momentin time. Assuming no investment or disinvestmenton the part of the owners or other extraneous capi-tal transactions, income is then measured by netassets accruing to the firm during a discrete periodof time.

I = P 2 —Pl

where I is the net income for the period betweenpoints in time 1 and 2. Substituting for P, we find:

I = (AZ — Lz) — (At — Lt)

It is obvious from this last equation that incomemeasurement is totally related to asset measure -ment.14The values assigned to the assets determinethe amount of the income and vice versa. From thisit follows that if the asset list is complete and isproperly measured, a properly measured and com-plete income will result. Only if these conditionshold is corporate performance properly measured.In other words, an economic concept of incomewould be the most informative concept in reportingto society the free- enterprise system's conversion ofsociety's resources. This notion is in accordancewith the economic concept of income which focuses" There is little problem associated with the valuation ofliabilities. Liabilites must be paid in current dollars regardless oftime of incurrence. Further, the adversary relationship of debtorand creditor tends to guarantee a correct valuat ion for all excepta minimum number of items. The major exception to this wouldbe the rare instance of a liability erroneously recorded at itsmaturity value rather than its present value.I;L. R. Hicks, Value and Capital, Clarendon Press, Oxford, Ohio,1 p. 172.

o Adapted from George J. Staubus, "The Relevance of Evidenceof Cash Flows," in Asset Valuation and Income Determination,Scholars' Book Co., Lawrence, Kan., 1971, p. 53.

on capital maintenance and wealth. The concept wasdefined by Hicks as the amount a person can con-sume during a period of time and still be as welloff at the end of that time as at the beginning.15Therefore, income measurement is really a functionof the measurement of wealth increments, i.e., assetvaluation.

The Surrogate Model

The previous argument hopefully has broughtus to the conclusion that a complete list of assets,properly measured, will generate a set of informationfor use in the making of decisions regarding corpo-rate performance. Most accounting theoreticiansagree that the ideal measure of the value of anasset is the present value of the discounted futureexpected cash receipts or service potentials arisingfrom that asset. This is in accord with the notionthat the value of an asset is measured by the bene-fit to be received. However, this measure is notattainable for many assets. For example, it isimpossible in most cases to determine the specificcash flows provided by individual items of plantand equipment. A second possible base is currentmarket value of the asset. Here again, many assetsmay not have a market value. Many assets pricelessto the enterprise (e.g., unique special - purpose equip-ment) have a value of zero when severed from thefirm. A third possible base might be replacementcost, the cost to replace an asset in kind. Thismethod is fraught with problems since most assetsare not replaced in kind. Further, it is a horrendoustask to value remaining available services for manyassets. In the same way, other valuation bases sufferfrom similar disabilities.

A careful examination reveals that no one valu-ation base can cope with the problems of valuingall individual assets on a consistent basis. We turnthen to a scheme proposed by Staubus, who ex-amined valuation bases and ranked them in orderof their ability to measure the value of an asset asfollows:

1. Face value —face or nominal amount2. Future cash flows — contractual evidence of

future cash flow and the market price for theuse of money

3. Net realizable value— current market prices4. Current replacement cost — current input price5. Adjusted historical cost — original input price

adjusted for changes in the general price level6. Original historical cost — original input price18

Staubus' categorization of valuation bases shouldbe applied to financial reporting on the premisethat no one measure is applicable for all assets,that surrogates for value must be used, and that thebest accommodation to reality for meeting reportingobjectives is to adopt measure 1, face value wherefeasible, and if that is not possible, to then examineeach concept in turn, settling upon that measurewhich is first attainable. This would imply thefollowing bases for certain assets:



INCOME REPORTINGAND APB OPINION N0.18The "Interpretation" raised the question of whether, in applying

the equity method, all of the intercompany profit should be

eliminated or whether elimination should be limited to that

portion of profit related to the investor's common stock interest

in the investee.

By Enrico Petri

Prior to the issuance of APB Opinion No. 18 inMarch 1971, the official position of the AICPA, asreflected in ARB No. 51, was that profit for theparent resulting from an intercompany sale ofassets would be completely eliminated when con-solidation occurred, if such profit had not been"realized" by the subsidiary in reselling the assetto outside parties or by expensing it. Under theBulletin's caption, "Unconsolidated Subsidiariesin Consolidated Statements," it was also suggestedthat any unrealized intercompany gains and lossesarising from transactions with an unconsolidatedsubsidiary be eliminated to the same extent ".. .as if the subsidiary were consolidated." 1 It recom-mended complete elimination of the gain or lossregardless of which entity made the sale. However,the requirement for elimination was explicitlylimited to situations where the investment in thesubsidiary was recorded under the equity method.This elimination, implicitly limited to the incomereported on the consolidated statement, would notaffect the parent's separate financial statement.zHence, a correspondence did not exist between theparent's income and equity statements and theirpotentially consolidated counterparts.

In Opinion No. 10, issued in December 1966,the Board removed the explicit limitation by recom-mending that the equity method be used for un-consolidated subsidiaries. However, the implicationthat elimination of intercompany gain and losswould only occur on consolidated statements wascontinued. This action obviously did not bringabout the needed change; for the failure to extendthe elimination of intercompany profit and loss tothe parent company's books continued the non -correspondence.

APB Opinion No. 18, issued in March 1971,

extended the use of the equity method to all situa-tions where the investor has ". . . the ability toexercise significant influence over operating andfinancial policies of an investee even though theinvestor holds 50 percent or less of the votingstock." 3 To achieve some degree of uniformity inthe application of this rule, the Board stated thata presumption of the ability to exercise a significantinfluence will exist where the investor has an in-terest of 20 percent (or more) in the voting stockof the investee.4 Sub - paragraph 19a of APB OpinionNo. 18 expressed continued support for the elimina-tion of intercompany profit and loss under the "asif consolidated" approach. This sub - paragraph is oneof fourteen sub - paragraphs setting forth proceduresto be followed by investor corporations ". . . inapplying the equity method of accounting to in-vestments in common stock of unconsolidated sub-sidiaries, corporate joint ventures, and other in-vestees which qualify for the equity method." S Theinclusion of this elimination adjustment in para-graph 19 with the specific procedures to be followedin the absence of consolidation, appeared to parallelthe position of ARB No. 51 and Opinion No. 10.However, further examination discloses that this isnot the case. Paragraph 19 does not implicitly re-strict the elimination of intercompany profit andloss to consolidated statements. Instead, it is in-tended to expand the adjustments made with respect

' Accounting Research Bulletin No. 51, Consolidated FinancialStatements, August 1959, par. 14, p; 47.1 This latter limitation further implied consolidation with atleast one other ' bsidiary.8 APB Opinion No. 18, The Equity Method of Accounting forInvestments in Common Stock, par. 17, p. 355.4 The term "investor" and "investee' are defined in APBOpinion No. 18 as follows: Investor refers to a business entitythat holds an investment in voting stock of another company.Investee refers to a corporation that issues voting stock held byan investor.5 The exception in paragraph 19 is where the investor's share ofthe loss may equal or exceed the carrying amounts of an in-vestment accounted for by the equity method plus advances madeby the investor.

E. PETRI

Albany Chapter 1966,is Associate Professorof Accounting, StateUniversity of NewYork, Albany. He holdsB.5c., M.B.A. and Ph.D.degrees from NewYork University. Dr.Petri is a previouscontributor toMANAGEMENTACCOUNTING andwas awardedCertificates of Merit in1968 -69 and 1971 -72.He has also publishedin other accountingjournals.

This article wassubmitted through theAlbany Chapter.


"Intercompanybondholdings

may be treatedin two basic

ways."

to "... unconsolidated subsidiaries, corporate jointventures, and other investees ..." to the statementsof the investor as called for in paragraph 16.

Paragraph 19 also sets forth a general statementon the impact of the equity method which hassome interesting implications. In essence, the para-graph states (with one qualification) that, "thedifference between consolidation and the equitymethod lies in the details reported in the financialstatements." It then concludes that, (a) an in-vestor's net income for a period, and (b) its stock-holder equity at the end of the period are the samewhether an investment in a subsidiary is accountedfor under the equity method or the subsidiary isconsolidated.

The two points made in the paragraph, that theinvestor's net income and stockholder equity reflectthe same quantitative value under the equity methodas they would in consolidation need to be empha-sized. In holding that the investor's income andowner's equity under the equity method, as tradi-tionally conceived, would be equivalent to poten-tially consolidated net income (PCNI) and po-tentially consolidated stockholder equity (PCSE),the board has made a specific statement of fact.

At this point it appeared that the correspondenceof investor's income and equity with PCNI andPCSE would now be realized. The validity of thisconclusion becomes especially important in view ofthe purpose of paragraph 19 and its fourteen sub-paragraphs which, apparently, is to achieve the sameresult in the absence of consolidation with a specificinvestee, as would be achieved had consolidationoccurred. In November 1971, however, "AccountingInterpretation of APB Opinion No. 18" (hereafterreferred to as the "Interpretation ") was issued. The"Interpretation" raised the question of whether, inapplying the equity method, all of the intercompanyprofit should be eliminated or whether eliminationshould be limited to that portion of profit relatedto the investor's common stock interest in theinvestees The answer presented in the Inter-pretation distinguishes between situations wheremajority control of the investee is accompanied bya less than arm's - length transaction and what itrefers to as "other cases."

The Interpretation then maintained that onlyin the former situations (control accompanied byless than arm's - length dealings) should all un-realized intercompany profit or loss be eliminated."In other cases it would be appropriate for the in-vestor to eliminate intercompany profit in relationto the investor's common stock interest in the in-vestee." 7 It should be made clear that this Interpre-tation applies only to Opinion No. 18 concerningthe equity method of accounting for investments incommon stock and does not interpret recommendedtreatment in consolidated statements. To determinerecommended treatment in the latter situation onemust look to ARB No. 51 paragraph No. 14 whichstates:

"The amount of intercompany profit or lossto be eliminated .. . is not affected by the

existence of a minority interest. The com-plete elimination of the intercompany profitor loss is consistent with the underlying as-sumption that consolidated statements rep-resent the financial position and operatingresults of a single business enterprise." s

In short, ARB No. 51 states that all of the un-realized intercompany profit should be eliminated.

Opinion No. 18 (paragraph 19) states in essencethat the equity method will report an investor's netincome that corresponds with the net income thatwould be reported had consolidation occurred (orPCNI) . However, if the equity method is to gen-erate the salve net income as PCNI then the rulesfor consolidation must come into play, which meansthat the rule for elimination of unrealized inter-company profit in ARB No. 51 applies.

The Interpretation also specified two situationswhere the investor corporation should recognizea portion of unrealized intercompany profits (asso-ciated with outside interests), namely: (a) wherea majority interest is absent or, (b) where amajority interest is present and accompanied byarm's- length dealings. Since the Interpretationapplies only to Opinion No. 18 and not ARB No.51, a dilemma now exists. Compliance with theInterpretation violates paragraph 19 of OpinionNo. 18 and results in a non - correspondence betweeninvestor's net income and PCNI.

Intercompany Sales

In the following example sales by the investorto the investee, resulting in profits (or losses) wherethe assets sold are held by the purchaser at the endof the period, will generate both income and equitydifferences. In Exhibit 1, Corporation X owns 40percent of Corporation Y. Corporation Y holds in-ventory purchased from X during the period, ata profit to X of $10,000. The Interpretation ofAPB Opinion No. 18 requires the elimination of40 percent of the profit, corresponding to X'sinterest in Y. If consolidation were to occur, thefull $10,000 would be eliminated. There is a dif-ference of $6,000 between PCNI and the InvestorCorporation's net income. Of course, the dif-ference in net income will carry over to retainedearnings, causing a disparity between the investor'sstockholder equity and PCSE. It should be pointedout that a non - correspondence will still occur whena greater than 50 percent ownership exists, withrespect to unconsolidated subsidiaries, where trans-actions with such subsidiaries are at arm's- length andif the Interpretation is followed.

Intercompany Bondholdings

Intercompany bondholdings may be treated intwo basic ways. The essential difference betweenthem turns on whether or not the bond purchaser

I One writer observed that the practice goes both ways. See PaulPacter, "Applying APB Opinion No. 18— Equity Method,"Journal ofAccountancy, September 1971, p. 56.

Accounting Interpretation of APB Opinion No. 18, AICPA,November 1971, par. 1.9 At the time of this writing, paragraph 14 of ARB No. 51 hasbeen neither superseded nor amended by subsequent opinions.


Exhibit 1APPLICATION OF "INTERPRETATION" OF APB OPINION NO. 18

Corporation X Corporation Y Corporation Xinvestor investee consolidated Difference

Net income — Operations $100,000 $50,000 $150,000 $50,000Income from Y (40 %) 20,000

—

20,000Totals $120,000 $50,000 $150,000 $30,000*

Eliminate intercompany profi t 4,000—

10,000 6,000$140,000

Less outside interest 30,000 'Net income $116,000 $50,000 $110,000 $ 6,000

recognizes any of the gain or loss on acquisitionor is acting as agent for the issuer. In consolidation,both methods treat the bonds as essentially "re-tired" with the premium and/or discounts appli-cable to the "retired" bonds giving rise to a gain orloss in the year of acquisition.9 This gain or lossis only recognized in consolidation, and then onlyin the year the'bonds are acquired by a related en-tity. In consolidating in subsequent periods, theoriginal retirement gain or loss, as modified byamortization of related premiums and /or discounts,is treated as an adjustment to retained earnings.loOn the consolidated balance sheet the originalbonds outstanding are reduced by the related com-panies' holdings.

On their separate books, however, the relatedentities recognize their separate legal existence andhence, (a) do not record any gain or loss on thebond acquisition; and, (b) show the investmentin bonds and bonds issued as unmodified by theholdings of the related entity.

A rundown of the fourteen adjustments underparagraph 19 fails to disclose any specific procedurethat covers intercompany bondholding. In view ofthe omission of any specific elimination procedure,and the treatment of intercompany bonds outlinedabove, it can be seen that in the absence of con-solidation with the related entity involved in theintercompany bond transaction, the parent's netincome and owner's equity will not agree with PCNIand PCSE.

Mutual Stockholdings

Disagreement between the investor's stockholderequity and PCSE caused by the investor and in-vestee holding stock in each other, does not, by it-self, cause any disagreement between investor's netincome and PCNI.11 In mutual stockholding situa-tions, the absence of consolidation by the entitiesinvolved yields a larger investor's stockholder equity(and smaller earnings per share) than that whichwould result from consolidation. In consolidation,the investor's stock outstanding is reduced by thestock of the investor held by the investee.12 Anyexcess of the amount paid by the investee over thelegal value of the investor's stock may be treated asa reduction of consolidated retained earnings.

Of course, in the absence of consolidation, theinvestee's holdings in the investor are treated as aninvestment (an asset). This disparity in treatmentwill obviously cause a disagreement between stock-

holder equity on the statement of the investor andthe PCSE.

Disposition of Holdings by Investee

Following up on the last situation, if the investeeshould dispose of its investment in the investor, thetypical accounting treatment on the books of theinvestee would be to recognize a gain or loss ondisposition and for the investor to take up, via theequity method its share of such gain /loss. How-ever, in consolidation the effect of this transactionmay be quite different if one follows the suggestedtreatment of the American Accounting Association.Neither the Committee on Accounting Procedurenor the Accounting Principles Board has issued anystatement on how a sale of the parent's (or in-vestor's) stock by subsidiary (or investee) shouldbe treated. Therefore, the recommended treatmentby the American Accounting Association (whichapparently has substantial authoritative support) isa leading guideline for practice. Under the recom-mended treatment, the subsequent sale would betreated in consolidation as though it had been theact of the controlling company.13 This procedureimplies an elimination of the gain/loss recorded bythe investee and a credit (or charge) to the ap-propriate account on the investor's books that isproperly associated with a sale of treasury stock.Of course, this situation generates a disparity be-tween the investor's net income and stockholderequity with PCNI and PCSE.

Another View of Paragraph 19

Considering the above discussion one mustquestion whether paragraph 19 proclaims a fact oran intent. A case can be made for the 'intent"interpretation; that is, it conceivably may be arguedas an alternative that paragraph 19 has set forth a

' T h e consolidated balance sheet presentation usually is to showthe intercompany bondholdings as treasury bonds, offsetting bondsoutstanding;" T h e retained earnings may be either that of the consolidatedgroup, or the consolidated group and minority interest, dependingon the circumstances.u Even though both corporations may own over 20 percent ofthe other, only one is presumed to be the investor. The referencein APB Opinion No. 18 to the "primary reporting uni t" (par. 16)and the requirement of the presence of the ability to exercise asignificant influence over operating and financial policy (par. 17),appears to support this presumption. Reporting of separate andconsolidated earnings in mutual stockholding situations appear tobe unsettled and hence could generate a non - correspondence. SeeE. Petri and R. Minch, "Treasury tock Method and ConventionalMethod in Reciprocal Stockholdings," The Accounting Review,April 1974.u ARB No. 51, par. 13, p. 45. This position is also supported bythe American Accounting Association. See Accounting and Re-porting Standards for Corporate Financial Statements, p. 44.I J ]bi d. , p. 44.

"A case can be

made for the

'intent'interpretation

i t


"A subtle

caveat still

exists."

LETTERS

rule requiring, from that point on, that there shallbe agreement of net income and stockholder equityof investor with PCNI and PCSE. The fourteensub - paragraphs can then be viewed as an indicationof the procedure to be followed in certain situationsto accomplish this correspondence with respect tounconsolidated subsidiaries and other investees forwhich the equity method is in use. Hence, whensituations arise that have not been enumerated inthe fourteen sub - paragraphs (e.g., intercompanybondholdings) , the profession may feel free to takeaction to comply with the intent of paragraph 19.

To implement the adoption of the "intent" inter-pretation of paragraph 19 would require, as a mini-mum, that the following action be taken: A newinterpretation of Opinion No. 18 would be madewhich would; (a) rescind the previous "Interpreta-tion" of Opinion No. 18, and (b) state explicitlythat the "intent" of Opinion No. 18 is to achievecorrespondence of investor's net income and stock-holder equity with PCNI and PCSE. The re-sponsibility for such action would necessarily fallupon the Financial Accounting Standards Boardwhich has now superseded the Accounting Princi-ples Board.

An Academic Point

Some reflection will call to mind that ARBNo. 51 and APB Opinions No. 10 and 18 allenunciate certain adjustments that are to accompanythe use of the equity method. Each of these adjust-ments are made to bring about the "as if con-solidated" goal. The specific enunciation of theseadjustments implies that they are not part of thenormal mechanism accompanying the equitymethod. Hence, the equity method as traditionallyconceived, does not generate a correspondence ofinvestor's net income and owner equity with PCNIand PCSE.

Carrying this discussion one step further, itmay be argued that the intent approach, as proposedin this article, will now render all adjustmentsnecessary to bring about the desired correspondence,as a regular part of the equity mechanism. How-ever, even when read as a statement of intent, the


of established auditing standards. However, item (3) is a com-pletely new situation. The author points out that the assump-tions will be presented so that the reader will be able to makehis own evaluations. Although this is a new situation, it isreally not an audit procedure and therefore does not require arevision of existing standards.

alleged correspondence between the results of theequity method and consolidation cannot beaccepted as valid. A subtle caveat still exists. Care-ful reading of paragraph 19 discloses a limitationon the application of the adjustments and elimina-tions (necessary to achieve correspondence) tosituations where the investor will not be con-solidated with the investee. In introducing thefourteen adjustments, paragraph 19 states: "Theprocedures set forth below should be followed inapplying the equity method of accounting to in-vestments in common stock of unconsolidated sub-sidiaries ..."

Therefore, in situations where the investor andinvestee are to consolidate, adjustments and elimina-tionentries need not be made by the investor cor-poration to bring its separate financial report intocorrespondence with the results of consolidation.Hence, the proclamation that such correspondencedoes (or will) exist is not justified. To repeat, thisargument is purely academic, it will not affect the(hopefully to be proclaimed) spirit of paragraph19, to bring unconsolidated net income of the in-vestor into agreement with PCNI.

Conclusion

The major purpose of this article was to disclosethat the equity method of reporting income doesnot in certain situations produce a correspondencebetween an investor's unconsolidated net incomeand stockholder equity with potentially consoli-dated net income and potentially consolidatedstockholder equity. A second purpose was to suggestan alternative reading of paragraph 19 that focuseson an "intent" to create a correspondence ratherthan a factual existence of such a correspondence.We have also concluded with a purely academicobservation of paragraph 19, that theoretically theequity method did not and will not bring about thealleged correspondence. The validity of this aca-demic comment, however, will do no harm to aspirit of paragraph 19 which aims to achieve acorrespondence in unconsolidated situations, thatcan be accomplished under an "intent" interpreta-tion of Opinion No. 18. ❑

Since there are no new audit problems, I again questionwhether a revision of auditing standards need be considered.

Livonia, Mich.

Edgar P. MeltonDetroit Chapter

52 MANAGEMENT ACCOUNTING/DECEMBER 1974

FULL - ABSORPTION COST:A MANAGERIAL DILEMMA?

...the new Regulations may become an antecedent to a

Regulation that states in essence that what's good for

financial reporting is good for tax purposes....

By Kenneth G. Humer

With the enactment in 1913 of the federal incometax law, Congress decreed that the use of inventoriesfor tax purposes would be required whenever theSecretary or his delegate deemed them necessary inorder to clearly determine the income of any tax-payer. Since that time, accountants have sought amethod of inventory valuation which would beacceptable for internal managerial control, for ex-ternal financial reporting to shareholders and cred-itors, and to the Internal Revenue Service.

A problem in finding an acceptable method of in-ventory valuation which satisfies all of the aforesaidneeds is created by the lack of definition of thevarious costs to be included in valuing an inventory.In fact, the word "cost" itself is often used inrelationship to those charges which are customarilycalled "expenses" as soon as incurred or recognized(such as selling or general expenses). It is littlewonder then that differences of opinion have arisenboth in financial reporting and in tax accountingin attempting to meet the requisites of the account-ing definition and the income tax regulations.

Accounting Definition

The broad concept of inventory valuation for fi-nancial reporting purposes is expressed by Account-ing Research Bulletin No. 43. It states:

"A major objective of accounting for in-ventories is the proper determination of in-come through the process of matching ap-propriate costs against revenues." 1 (Emphasisadded.)

The determination of "appropriate costs" is amatter of judgment. In the exercise of this judg-ment no set guidelines were established. The onlyguidance given in ARB 43 with respect to appro-priate costs is couched in general terms stated asfollows:


" . As applied to inventories, cost meansin principle the sum of the applicable ex-penditures and charges directly or indirectlyincurred in bringing an article to its existingcondition and location." 2

Income Tax Regulations —PriorFor tax accounting purposes, prior to September

19, 1973, the income tax regulations provided thateach inventory must conform as nearly as may beto the best accounting practice in the trade or busi-ness, clearly reflect income and be valued at costor the lower of cost or market.3 In the case ofmerchandise produced by the taxpayer, cost wasdefined as: "(1) the cost of raw materials and sup-plies entering into or consumed in connection withthe product, (2) expenditures for direct labor, (3 )indirect expenses incident to and necessary for theproduction of the particular article, including insuch indirect expenses a reasonable proportion ofmanagement expenses, but not including any costof selling or return on capital, whether by way ofinterest or profit." 4 Although these regulations areindefinite and gave rise to judgmental decisions, theemphasis appeared to be more on accounting prac-tice and consistency rather than on the basis ofvaluation. This conclusion is supported by the Regu-lations which state that:

"... inventory rules cannot be uniform butmust give effect to trade customs which comewithin the scope of the best accounting prac-tice in the particular trade or business. Inorder clearly to reflect income, the inventorypractice of a taxpayer should be consistentfrom year to year, and greater weight is tobe given to consistency than to any particu-lar method of inventorying or basis of valua-tion so long as the method or basis used issubstantially in accord with Regs. sections1.471 -1 through 1.471 -9. An inventory that

All footnotes appear at the end of the article.

K. G. HUMERis Partner -in- Charge,Tax Department,Jackson, MississippiOffice of Ernst & Ernst.He holds a B.B.A.degree fromCase - Western ReserveUniversity and anL.L.B. degree (CumLaude) from ClevelandMarshall Law School.Mr. Humer is also aCPA and has beenadmitted to the OhioBar.

53

" . . . the term' f u l l

absorption'means the

inclusion of all

directproduction

costs and theinclusion orexclusion of

indirectproduction

costs..."'

can be used under the best accounting prac-tice in a balance sheet showing the financialposition of the taxpayer can, as a generalrule, be regarded as clearly reflecting his in-come." ( Emphasis supplied. ) b

From the foregoing, it can be seen that manage-ment was granted some latitude in determiningcost as it relates to inventory valuation. With re-spect to direct costs, such as labor and material,the judgmental factor was limited. However, man-agement had considerable latitude in the area ofindirect costs. Since management is charged witha profit objective, the extent and direction of theexercise of judgment in the area of indirect costsdirectly affects profits. For example, where currentprofit- sharing contributions are treated entirely asa period cost, the profit will be less than if the samecost were considered as an indirect cost to be in-cluded in the inventory valuation. Either treatmentmight be acceptable for both tax and financial ac-counting purposes.

Direct Cost

Another example of the judgmental factor is theuse of the "direct cost" method. This method ofinventory valuation treats controllable costs directlyattributable to production as an element of inven-tory valuation. However, fixed overhead incurred inthe current period, which is necessary to providemanufacturing capacity, is treated as a current ex-pense. This method, though controversial amongaccounting authorities, was judicially accepted forfederal income tax purposes if consistently applied.6

As a result of the confused state of the art ofinventory valuation, tax controversies have plaguedtaxpayers and revenue agents alike for many years.In order to reduce these controversies and to providegreater guidance to taxpayers in computing thecost of goods in inventory, the IRS on February13, 1973 issued the proposed regulations which in-troduced a new basic term, "full absorption" tothe inventory pricing area.

Full- Absorption Regulations

These proposed regulations, with some modifi-cation, were adopted on September 19, 1973. As aresult, management is again faced with the dilemmaof determining which costs are to be included ininventory valuation for tax and financial account-ing purposes. The new Regulations state that:

"In order to conform as nearly as may bepossible to the best accounting practices andto clearly reflect income ... both direct andindirect costs must be taken into account inthe computation of inventoriable costs in ac-cordance with the `full absorption' methodof inventory costing."'

The term "full absorption" cost may be mis-understood or misinterpreted to mean the inclu-sion of all direct costs irrespective of the existenceof abnormal conditions such as less than full pro-

duction, excess scrap or idle plants. It should meanthat direct material costs, direct labor costs andcertain items of indirect production cost must beincluded as inventoriable costs, and the appropriateamounts of all inventoriable cost elements —notnecessarily all dollars spent for these elements —should be included in inventories for tax as wellas financial accounting purposes.

Interpreted in light of the Regulations, the term"full absorption" means the inclusion of all directproduction costs and the inclusion or exclusion ofindirect production costs as set forth in the Regu-lations. These indirect production costs, whichare divided into three categories, are described asfollows:

CATEGORY 1

These items of cost must be included as an ele-ment of inventoriable cost to the extent they areincident to and necessary for production or man-ufacturing. They include repair expenses, mainte-nance, utilities, rent, indirect labor and productionsupervisory wages, indirect materials and supplies,tools and equipment not capitalized, and qualitycontrol and inspection.

CATEGORY 2

This category contains items of cost which arecurrently deductible and not included in inven-toriable costs regardless of their treatment for finan-cial statement purposes. It should be noted, how-ever, that if a taxpayer has consistently included anyof these in the amount of inventoriable costs, theirexclusion therefrom will constitute a change in ac-counting method requiring IRS approval with re-spect to the exclusion.

The Category 2 items are: marketing expenses,advertising expenses, other distribution expenses,interest, research and experimental expenses includ-ing engineering and product development expenses,losses under Section 165, percentage of depletionin excess of cost depletion, depreciation and amorti-zation for tax purposes in excess of depreciation forfinancial reporting purposes, income taxes attrib-utable to income received on the sale of inventory,pension contributions to the extent they representpast service costs, general and administrative ex-penses incident to and necessary for the taxpayer'sactivities as a whole rather than to production ormanufacturing operations or processes, and salariespaid to officers attributable to the performance ofservices which are incident to and necessary for thetaxpayer's activities taken as a whole rather thanto production or manufacturing operations or pro-cesses.

CATEGORY 3

The third category of indirect production costswill probably create numerous managerial account-ing decisions. The reason for this lies in the provisothat the inclusion or exclusion of these items ininventoriable costs shall be determined for taxpurposes based upon their inclusion in or exclusionfrom inventoriable costs for financial report pur-


poses — provided such treatment is not inconsistentwith generally accepted accounting principles(GAAP).

The items of cost to which this optional treat-ment applies include: nonincome taxes deductibleunder Section 164 (e.g., real property taxes im-posed on production facilities and personal prop-erty taxes imposed on inventory), depreciation re-ported in financial reports, cost depletion on assetsincident to and necessary for production or manu-facturing, pension and profit- sharing contributionsto the extent they represent current service costsunder qualified deferred compensation plans, otheremployee benefits incurred on behalf of labor inci-dent to and necessary for production or manufac-turing operations or processes, costs attributable torework labor, scrap and spoilage which are incidentto and necessary for production or manufacturingprocesses and costs attributable to strikes incidentto production or manufacturing operations or pro-cesses, factory administrative expenses and officers'salaries attributable to services performed incidentto and necessary for production or manufacturingoperations or processes, and insurance costs inci-dent to and necessary for production or manufac-turing operations or processes.

Special notice should be given to the items oftaxes otherwise allowable as a deduction underSection 164 and pension and profit- sharing con-tributions representing current service costs other-wise allowable as a deduction under Section 404.Although these items are specific statutory deduc-tions, if any part of them are includible in inven-toriable costs for financial statement purposes, thenew regulations would require a like deferral fortax purposes.

For example, ad- valorem taxes relating to thefactory building would be a part of fixed indirectexpenses included in inventoriable costs pursuantto GAAP. Even though Section 164 states thatexcept as otherwise provided, state and local, andforeign property taxes shall be allowed as a de-duction in the taxable year in which paid or ac-crued, they nevertheless would be deferred underthe Category 3 interpretation."

The IRS should be commended for striving toeliminate the judgmental factor from inventoryvaluation by specifying various cost categories.However, it would appear that it has succeeded onlyin causing the judgmental factor to be exercisedtoward tax considerations alone without regard tosound financial statement reporting. In imposing itsown opinion as to proper elements of direct cost,it may have pre - empted management from exer-cising sound judgment with respect to inventoryaccounting practices. Perhaps it might have beena better and more practical approach to providethat in matters of inventory accounting the practicesused by taxpayers for financial statement purposeswill be acceptable for tax purposes.

Conflict With APB Opinion No. 20

The "financial statement eligibility test" con-tained in Category 3 may result in a change of

accounting method requiring disclosure as providedin APB Opinion No. 20, which requires a dis-closure in financial reports where there is a changein accounting principle. Because the treatment ofCategory 3 costs depends upon the method of in-ventory costing for financial reporting purposes,any change in such reporting may be a change inaccounting principle as that term is defined inAPB Opinion No. 20. The impact of Category 3requirements on financial reports is of such momentthat the Financial Accounting Standards Board is-sued an interpretive statement in June 1974. TheBoard stated that the accounting effect of the newinventory regulations is as follows:

"A change in composition of the elementsof cost included in inventory is an accountingchange. A company which makes such achange for financial reporting shall conformto the requirements of APB Opinion No. 20,including justifying the change on the basisof preferability as specified by paragraph 15of APB Opinion No. 20. In applying APBOpinion No. 20, preferability among account-ing principles shall be determined on the basisof whether the new principle constitutes animprovement in financial reporting and not onthe basis of the income tax effect alone."s

Whether the provisions of Category 3 relating toa tax determination based upon the consistency oftreatment under GAAP will create new contro-versies remains to be seen. However, as previouslystated, the elements of cost under GAAP are ajudgmental matter. This judgmental factor has notbeen eliminated with respect to Category 3 costs.In fact, many companies may urge their accountantsto take a more liberal view for financial reportingpurposes in order to obtain tax advantages.

Non-Financial Statement Conformity

In the preceding discussion it has been assumedthat the taxpayer's method of accounting for pro-duction costs in his financial reports has beencomparable to his method of accounting for suchcosts for tax purposes. In those instances wherethey are not comparable for Category 3 items,specific items of indirect production costs must beincluded as inventoriable costs regardless of thetaxpayer's financial report treatment.lo

The lack of comparability is illustrated in theRegulations with respect to a taxpayer using "primecost" for financial reporting purposes. Such a meth-od has not been acceptable for either tax or ac-counting purposes and thus we are left with aninterpretation of exactly what comparability means.

If an internal revenue agent should decide thatthe comparability criteria are not met, then thetaxpayer must include the following Category 3costs in inventoriable costs: taxes otherwise allow-able as a deduction under Section 164, deprecia-tion and amortization reported for financial pur-poses and cost depletion, administrative costs ofproduction, officers' salaries and insurance costs.

"Such amethod hasnot beenacceptable foreither tax or

accountingpurposes ..."


"Such a change

will probablyresult in a

substantial

increase intaxable

income..."

Unless the comparability provision of the Regula-tion is clarified, management can look forward toa new area of inventory dispute with the IRS.

Other Substantive Changes

In addition to the classification of indirect costsby category, other substantive changes wert madein the Regulations. The full impact of these changeswill not be apparent until tax returns filed pur-suant to the new Regulations are examined by theIRS.

The areas to which we should specifically directour attention are the consistency rules, practicalcapacity concept and the standard cost method.

Consistency

Under the prior Regulations, consistency was tobe afforded greater weight than any method ofinventorying or basis of valuation so long as themethod or basis was substantially in accord withthe existing Regulations. The Regulations specifi-cally stated that as a general rule, an inventory thatcan be used under the best accounting practice ina balance sheet showing the financial position ofa taxpayer can be regarded as clearly reflecting hisincome."

The new Regulations have deleted this latterposition and have substituted in its place the pro-vision that the method used must conform exactlyto the Regulations and must be in accordance withgenerally accepted accounting principles or it isunacceptable.

The result of this would appear to say that theRegulations contain the only proper method ofinventory valuation. This appears to conflict withthe Courts' interpretation to the effect that wherethere is more than one accounting practice, theCommissioner's preference should not require achange if that accounting practice has been con-sistently used.12

It was probably this rationale that caused courtapproval of the "direct cost" method where it hadbeen used consistently. Today the consistency argu-ment may no longer be used because the Regula-tions have specifically decreed that the "direct cost"method is unacceptable. Thus, all taxpayers using"direct cost" must change to "full absorption."

Such a change will probably result in a substan-tial increase in taxable income and federal incometax liability. The full impact of this change maybe partially mitigated by the use of the practicalcapacity concept in determining the total amountof fixed indirect production cost allocated to in-ventory.

Practical Capacity Concept

For the first time the Regulations have autho-rized the use of the practical capacity concept.18

Pursuant to this concept, the percentage of practi-cal capacity represented by actual production (notin excess of 100 percent) is used in determiningthe total amount of fixed indirect production costsincludible in inventory cost.

The calculation of practical capacity may be

based upon the taxpayer's experience or upon theo-retical capacity. Theoretical capacity is the levelof production that could be attained if all machinesand all departments were operated continuously atpeak efficiency.

Where the practical capacity method is used, thedifference between the amount of fixed indirect pro-duction costs based upon actual production includedin the computation of inventoriable costs and thetotal amount of fixed cost is treated as a deductionin the current taxable year.

For example, assume that a plant has a theoreti-cal capacity of 105,000 units. Based upon estimateddown time, the theoretical capacity is reduced by5,000 units. Thus, the plant's practical capacity is100,000 units. If during the year only 80,000 unitswere produced, only 80 percent of the fixed indirectproduction costs would be included in the computa-tion of the amount of inventoriable costs. The bal-ance of the fixed indirect production costs would bededucted in the year paid or incurred.

From the foregoing example, it can readily beseen that although a taxpayer can no longer deduct100 percent of his fixed costs, he may be able todeduct some portion of them.

Standard Cost System Approved

The new Regulations also contain another "first"on the part of the Treasury Department. For thefirst time the standard cost method is approved fortax purposes. However, in granting approval theTreasury provides that the taxpayer must reallocateto the goods in ending inventory a pro rata portionof any overhead or direct production cost variances,unless such variances are insignificant in amount inrelation to the total actual indirect production costs.However, if an allocation is made for financial re-porting purposes it must also be made for tax pur-poses.

Once again, a new judgmental standard incapa-ble of definition is introduced by the use of theword "significant." There is no question that evenreasonable taxpayers and internal revenue agents aregoing to disagree on this.

A better provision might have been to permit acurrent deduction for standard cost variances,where such variances are a result of abnormal pro-duction costs. While the practical capacity methodmay be used in conjunction with standard costs, therequirement of allocating variances appears to be indirect conflict with this methods*

The basic purpose of the standard cost methodis the valuation of inventories on the basis of "nor-mal" costs, where abnormal material, labor or over-head costs appear as a variance. If variances are tobe allocated to inventory, then the result becomesan unsound actual cost accounting system —un-sound in that current profits may be overstated andinventories overstated due to the inclusion of coststhat do not represent normal conditions. Treasuryshould be urged to clarify this point.

Election

While the change to the "full absorption" meth-


od is mandatory for all taxpayers engaged in manu-facturing or production, including those using thelast -in, first -out (LIFO) method of inventoryidentification, the validity of the new Regulationswill not be court tested for some years to come.Presumably to induce taxpayers to "elect" tochange, certain very liberal adjustment rules wereincluded for transitional taxable years beginning onand after September 19, 1973 and before September19, 1975.

These transitional adjustment rules provide ingeneral for the exclusion of the "pre -1954 inventorybalance" and a ten -year spread for the remainderof the positive (income - increasing) adjustment re-sulting from the changel 6

For those taxpayers who have been including agreater amount of indirect production costs in in-ventory, an election to change to "full absorption"is also available. In this instance the pre -1954 in-ventory balance will be included and the income -decreasing adjustment will be spread over the years.

LIFO Conversions

It should be noted that the Regulations specifi-cally provide, in instances where the election is madeto change to the "full absorption" method, that theinventory costing for prior taxable years need not bechanged.1,, In this period of severe inflation, themanagement of those companies using direct cost(or some other method of inventory valuation)for tax purposes, which is less inclusive than "fullabsorption," might well consider converting toLIFO. Because of the aforesaid provision, it is be-lieved that no change in the "cost" of the base yearLIFO inventory (other than restoration of marketvalue reserves) will be required if LIFO is electedfor the year prior to the year in which the electionto use the "full absorption" method is made.

Additional Problems " . . . anThere is no question that the new Regulations election to

are on improvement over the old. However, no ade-quate provision has been included to provide for change to 'fullinventory write -downs and write -offs. The interjec-

absorption , istion of the financial statement conformity require-ment with respect to the determination of includ- alsoible costs would seemingly mandate a considerationin this area. Conservative accounting requires write- available."downs and write -offs of inventory where currentinformation indicates that recovery of full costthrough sale is unlikely. If CAAP is a criterion forinventory costing procedures, it should also becomethe criterion for write -downs and write -offs.

Conclusion

Perhaps, in retrospect, the old problem of inven-tory valuation is no nearer solution with the newRegulations than with the old. It may be, however,that the new Regulations may become an antece-dent to a Regulation that states in essence thatwhat's good for financial reporting is good for taxpurposes— statutory deductions excepted.

1 Accounting Research Bulletin No. 43, Committee on AccountingProcedure, AICPA, New York, N. Y., 1953, Chap. 4, Statement 2.2 Note 2 supra, Chap. 4, Statement 3.s Regs. Stectlon 1.471 -2(a) and (b).I Regs. Section 1.471 -3, 1.D. 6336, 12 -1 -58.° Regs. Section 1.471 -2(b), T.D. 6336, 12 -1 -58.° See Geometric Stamping Co., 26 TC 301 (1956), acq. 1958 -1 C.B.4.1 Proposed Regs. Section 1.471.11.° When Congress inserted the words "except as otherwise pro-vided," they probably were intended to mean "except as otherwiseprovided by Section 164" and not "except as provided by regula-tions dealing with inventory valuation."0 FASB Interpretation No. 1, effective July 1, 1974, Journal ofAccountancy, August 1974, p. 64.10 Regs. Section 1.471 -1 (c) (3).11 Regs. Section 1.471 -2(b).12 Van Pickrell & Sons, Inc. o. U.S . , 445 F.2d 921, 71 -2 USTCPara. 9550, 28 AFTR 2d 71 -5215 (CA -7, 1971).° Regs. Section 1.471 -11 d 4

1' Regs. Section 1.471 -11 d 3 ii) (b).1° Regs. Section 1.471 -11 e 1 iii).1e Regs. Section 1.471 -11 e 1 i) .

A SURROGATE MODEL FOR INCOME REPORTING


Asset MeasureCash 1Accounts receivable 3Inventories 3 or 4Plant and equipment 4 or 5Marketable securities 3Bond investments 2

Conclusion

We recognize that this model is far from com-plete since it does not adequately include sufficientmeasures of social responsibility and effectiveness.Research into these areas is still in the embryonicstage. We will merely identify some of these areaswhere corporate performance is of concern to society,

which areas are difficult to define and measure, andin which areas research is needed.

1. Some measure of the cost of pollutants added tothe environment by the firm,

2. Some measure of the use of dwindling resourcesby the firm where use of substitute resourcesmay be more in society's interests,

3. Some measure of the economic power of thebusiness entity,

4. Some measure of the firm's contribution to na-tional goals,

5. Some measure of the firm's contribution, positiveor negative, to the racial and sex discriminationproblem, and

6. Some measure of the firm's development ofhuman resources.

MANAGEMENT ACCOUNTING /DECEMBER 1974 5 7

Books FOR THE MANAGEMENT ACCOUNTANT

PRINCIPLES OF MANAGEMENT ANDORGANIZATIONAL BEHAVIOR

Third EditionJustin G. Longenecker

Charles E. Merrill Publishing Co., 1300 Alum Creek Dr.,Columbus, Ohio 43216,1973, 709 pp., clothbound, $11.95.

The focus of this book is on the work of managers and thebehavior of people in organizations. This edition blends recentdevelopments with older concepts of classical theory to providea strong conceptual foundation for successful managerial per-formance.

ACCOUNTING DESK BOOK

Fourth EditionInstitute for Business Planning, Inc., Two New York Plaza,New York, N.Y., 10004,1974, 444 pp., clothbound, $25.00.

A reference book with easy to get at check lists and referencesregarding the accounting treatment, financial statement pre-sentation and tax effects of various business transactions.

ACCOUNTANTS INDEX -1973

22nd SupplementAmerican Institute of Certified Public Accountants, 666 Fifth

_Ave., New York, N.Y. 10019, 1974, 1010 pp., clothbound,$35.00.An authoritative and useful index to English language period-icals, books, pamphlets and government documents in thefields of accounting, auditing, data processing, financial report-ing, financial management and investments, management andtaxation.

A HISTORY OF ACCOUNTING THOUGHT

Michael Chatfield

The Dryden Press, 901 North Elm St., Hinsdale, Ill. 60521,1974, 314 pp., clothbound, $11.95.

A chronological history of bookkeeping from Babylonian timesto the evolution of accounting principles.

CONTEMPORARY ACCOUNTING THEORY

Eldon S. Hendriksen and Bruce P. Budge

Dickenson Publishing Co., 16561 Ventura Blvd., Encino,Calif. 91316, 1974, 350 pp., paperbound, $7.95.

The authors provide a frame of reference, through readings, forthe development of accounting theory. They identify and ex-plain three different approaches, development based on generalacceptance, development through a sound method of valuation,and the predictive ability approach.

ACCOUNTING: THE LANGUAGE OF BUSINESS

Sidney Davidson, James S. Schindler and Roman L. Weil

Thomas Horton and Daughters, Inc., 22 Appleton Pl., GlenRidge, N.J., 07028, 1974, 57 pp., paperbound, $1.50, cloth-bound, $7.95.

The purpose of this book is to define some 1000 terms whichare used when describing accounting events and reporting theresults of them.

ACCOUNTING: BASIC PRINCIPLES

Third EditionHorace R. Brock, Charles E. Palmer and Fred C. Archer

McGraw -Hill Book Co., 1221 Avenue of the Americas, NewYork, N.Y. 10020, 1974, 550 pp., clothbound, $11.50.

A self - contained, post secondary accounting course which re-quires less than one year to complete. Attention is given to theprocedural aspects of accounting based on principles of theAccounting Principles Board using individualized performanceguides.

ACCOUNTING: PRINCIPLES AND APPLICATIONS

Third EditionHorace R. Brock, Charles E. Palmer and Fred C. Archer

McGraw -Hill Book Co., 1221 Avenue of the Americas, NewYork, N.Y. 10020, 1974, 1000 pp., clothbound, $10.95.

A basic one -year student resource text stressing basic principlesof accounting, reinforced with examples, illustrations and cor-related problems. Traditional workbooks have been supersededby two individualized performance guides that permit studentsto pursue a program of independent study at their own pace.

ACCOUNTING FOR BUSINESS

Second EditionJohn R. CerepakCharless E. Merrill Publishing Co., 1300 Alum Creek Drive,Columbus, Ohio 43216, 1974, 818 pp., clothbound, $12.95.

An introductory accounting course for undergraduate students.It provides procedural exhibits, problems, and solutions.

FUNDAMENTALS OF MANAGEMENT ACCOUNTING

Robert N. Anthony and Glenn A. Welsch

Richard D. Irwin, Inc., 1818 Ridge Rd., Homewood, Ill.60430,1974, 558 pp., clothbound, $10.95.

This book is divided into three types of accounting information,conventional or full cost accounting, differential (marginal orincremental cost) and responsibility accounting.

MANAGEMENT ACCOUNTING:

A Conceptual Approach

Lloyd R. Amey and Don A. Eggington

Longman, Inc., 72 FifthAve., New York, N.Y. 10011, 1973,704 pp., clothbound: $21.00, paperbound: $12.50.

As the title indicates, the emphasis on this book is on theconceptual aspects of the material. It brings out also the inter-relationship of management accounting with other disciplinesand provides an awareness of ideas which seem likely to have asignificant influence in the future.

58 MANAGEMENT ACCOUNTING/DECEMBER 1974

N B I NEBNIZERENEE-1975

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This is what Don L. Raymond and his wife,June, discovered when they spent three weeks oftheir vacation earlier this year in Micronesia help-ing the natives keep up their accounting records.Members of Hawaii Chapter, the Raymonds haveaccounting- related jobs. June is an accountant atHawaii Loa College and Don is marketing repre-sentative for accounting applications with The Ser-

vice Bureau Co., a division of Control Data Corp.As Mr. Raymond tells it, a member of the Small

Business Administration came to a Hawaii Chaptermeeting and asked for volunteers to go to Microne-sia to help native companies with their accountingrecords. "I simply was the first volunteer," he says.For a number of years, the SBA had wanted toprovide counseling services to businesses in Mi-cronesia as a prerequisite to help making loan moneyavailable. The chapter's Socio- Economic Programseemed an ideal vehicle for achieving this ob-jective.

Their travel expenses to Guam were paid by theSBA. The Trust Territory of the Pacific Islands


Don and June Raymond take a look at thefirst official guide to Yap. Also involved inthe planning for their trip were Lynn Burns(left), Hawaii Chapter public relationsdirector, and Ivan Holm of the SBA.

government paid their expenses to and from Yapand Palau and also paid them on a per diem basis.

The Raymonds spent three weeks in Yap andPalau, two districts in the Carolines Islands, atrust territory administered by the United Statesunder a United Nations mandate. Just east of thePhilippines, the archipelago consists of more than2,000 islands, only 98 of them inhabited.

"We found Micronesia to be a very beautifuland an enjoyable experience," Mr. Raymond re-ports. However, "From an accounting point ofview, one could get very discouraged. The formaleducation and knowledge level of the people is farbehind the times. Their culture is also much dif-ferent than ours. For example, if a high caste personwas to die, an employer might find himself withoutemployees for a few days until the proper obser-vance has taken place."

The islands have a romantic, sometimes tragic,history. When the Raymonds flew into Yap, theynoticed two abandoned Japanese Zeros just off therunway, mute reminders of the savage war in thePacific, 30 years ago. Yap also pays fond allegianceto a shipwrecked sailor named David Dean O'Keefewho helped open up the island to trade from theoutside world in the late 19th Century. "His Maj-esty O'Keefe," as the Yapese called him, discoveredthat the natives would work for stone money ratherthan the trade goods offered by the Germans. Ac-cording to local traditions, O'Keefe helped theYapese quarry the stone in Palau and bring it backto Yap. He disappeared in a storm at the turn of the

century but his name and fame have not beenforgotten. A popular bar in Yap is called O'Keefe'sOasis Community Club.

Six Months Worth of Accounting

During their visit to the Carolines islands, theRaymonds were able to help several local companies.On Yap, they worked with a fishing cooperative,grocery stores, a bus company, a constructioncompany, a restaurant, a cement block making plantand one of the island's two hotels. On Palau theyhelped put the books in order for the WesternCarolines Trading Co., adjusting entries and rec-onciling the accounts.

After they had returned, the Raymonds told thePacific Business Review, "We did what you mightsay was six months worth of accounting work forthe trading company. We showed the bookkeeperhow to make the basic journal entries and tried toleave her with enough knowledge to continue thejob on her own."

Mr. Raymond said that the trading company hadbeen close to bankruptcy but the economic de-velopment loan fund in Saipan guaranteed close to$200,000 worth of loans to the cooperative to getit back on its feet.

Yap is less advanced than Palau and the Ray -monds discovered that of the two hotels one didnot have running water and the other did not servefood. There are only 18 hotel rooms in the entireYap district, Don Raymond says.

In Yap, they worked with a fishing cooperativewhich has about 100 members. "The governmentfishing authority lends a member of the coopera-tive the money he needs to buy a boat so he can goout and catch fish. He sells the fish he catchesthrough the cooperative."

Because of the size of the businessess, their helpwas restricted to basic accounting procedures. "Weset up the very basic first -level accounting toolssuch as daily sales report, cash disbursementsjournal, and sales journals. Some businesses were sosmall we just set up one journal to take care ofeverything."

In addition, the Raymonds held a class on basicbookkeeping which was attended by 20 people fromabout five businesses, and Peace Corps volunteers.They gave out and reviewed sample sales reports,sales journals, accounts receivables ledgers, cashdisbursement journal, purchases journal, accountspayable ledgers, general ledger sheets, and a book offinancial statements. But, note the two NAA mem-bers, "The results of the class were only of a minorsuccess as it is impossible to start from almost zeroknowledge of accounting and educate peoplethrough financial statements in three hours."

Summing up, they reported, "Our time spent onYap was productive and very enjoyable. We werenot, however, able to assist and help knowledgeablebookkeepers with specific problems. We set upseveral first level basic requirements and not a com-plete accounting system at any business we saw."

Their recommendations? "First, we're recom-mending that the Trust Territory government set


up some type of bookkeeping instruction into theirlocal school system. Second, we're recommendingthat the Trust Territory government set up a pro-gram to teach accounting as an occupation —just asyou'd set up programs to teach bricklayers or mento make tile." The Raymonds recommended thatthis program be established at the Micronesian Oc-cupational Center in Palau, where the natives learnvarious trades.

Illustrating the lack of educational facilities, DonRaymond pointed out that the first high schoolclass graduation in Yap occurred in 1966."In Yap,"lie says, "the school curriculum is determined a fewdays before school starts by looking at availablePeace Corps volunteers. Experienced bookkeepersare almost nonexistent."

Language was not too much of a barrier for theRaymonds as English is spoken almost everywhere"but each district has its own native language and,many times, more than one."

As for the legendary "money," it is not used asa medium of exchange, Mr. Raymond says. But theYapese do include the huge stones in dowries andproperty valuations, and everybody knows who ownseach stone since they are kept in public view.

The Raymonds found their experience in theislands an unforgettable one. Don Raymond wouldlove to return if he can convince his wife to putup with some of the inconveniences of life in theCarolines Islands. Meanwhile, the SBA and HawaiiChapter are looking for some more volunteer ac-countants to carry on their work.

Inflation Renews Interest in LIFORenewed interest by industry in LIFO (last -in,first -out) inventory accounting is reflected in thenumber of queries received in recent weeks by theTechnical Information Service Department in theNAA office.

As noted in a lead Wall Street Journal story inOctober, a number of companies are changing theirinventory accounting from FIFO (first -in, first -out)or average cost to the LIFO system. Among a scoreof companies which have announced a switch toLIFO are Eastman Kodak, Du Pont and FirestoneTire & Rubber Co. At least 100 of the largest 500companies are contemplating a changeover to LIFOaccording to the article, but most are not expectedto announce it until the end of the year.

The villain in the story is, of course, inflation.FIFO and average cost tend to understate costsbecause inventories are valued at their older, cheaperprices. Under LIFO the cost of goods sold is basedon the most recent prices for raw materials andother inventory items. LIFO costing tends to re-duce profits —and income taxes but is said to morerealistically reflect the impact of inflation on a com-pany.

For members who request information on theLIFO method of inventory accounting, Donald G.Mackenzie, manager of the Technical InformationService Department, has compiled a LIFO bibli-ography. The list includes references to articles ina number of accounting journals. This bibliographysupplements NAA articles indexed in the TopicalIndexes.

A review of the references referring to LIFOaccounting indicates that the technique was invogue ,during the late Forties and early Fifties.Then, if the literature is any guide, interest seemedto decline in the method. In 1973, with inflationballooning profits, the LIFO method revived. Nearly20 percent of Big Board and American Stock Ex-change companies using LIFO changed to that

method in 1973, according to a study by one ofthe "Big Eight" accounting firms.

Questions about LIFO represent only a smallproportion of the inquiries the Technical Infor-mation Services Department receives every month.For example, members have written requesting in-formation on leasing, budgeting for local govern-ments, and hospital accounting. Others have re-quested assistance in doing research for articlesthey are planning to write.

Usually the Technical Information Service De-partment is able to help the member either bydirecting his attention to sources in the literatureor telling him where he can obtain the informa-tion.

The Technical Information Service staff isequipped to help members in four specific ways. Itcan locate articles or books illustrating alternativeapproaches to handling problems, it can providebibliographies on subjects a member needs to re-search in depth, it can suggest other sources whenthe information sought is out of the field of man-agement accounting, and it can refer to case mate-rial in the member's industry or one closely relatedto it.

Materials can be made available through mailphotocopies or, in the case of NAA materials andbooks, on a two -week loan basis. The major resourcefor these services is a well - maintained library ofsome 3000 volumes, including most of the foreignand domestic accounting periodicals, as well asa number in closely related fields. A file of severalhundred industry association manuals and otheraccounting publications is also maintained.

The Association publishes a compilation of cur-rent books in the accounting field with publishers'names and addresses. It is updated at least annuallyto incorporate newly published works in the field.This publication, titled Your Reference Library,is available from the Association for $1.50.

"... the

Yapese do

include the

huge stones in

dowries and

propertyvaluations."


Chapter/ Member News

James Don Edwards (right) research professor at the University ofGeorgia is presented the first Beta Alpha Psi OutstandingAccountant of the Year Award. Dr. Edwards, one of the outstandingaccounting educators in the U.S., is currently on the NAACommittee on Research. Making the presentation is Hollis Dixon,national president of the accounting fraternity.

At first Southern Maine Chapter meeting, the three majorcandidates for Governor of Maine spoke. L. -r., James Erwin,Republican; James Longley, Independent; Oliver Andrews 111,associate program director; chapter President Richard L. Roy, Jr.,and George Mitchell, Democratic candidate. Broadcast "live" onradio, the meeting was attended by 120. Longley won election.

Emeritus Life Associates

Th e designation of Emeritus Life Associateis made available to retired members whohave had 20 years of active service, or tenyears of active service including five yearsas an elected national or chapter officer ordirector. Those so designated are relievedfrom payment of annual dues. Th e intentof this provision of the By -Laws is to recog-nize the debt which the Association owes tomembers of long standing.

CARL G. BAUMES, New York, past presi-dent.BYRON F. BUNN, Dallas.TED C. CONRAD, Charlotte Gold, pastnational vice president. Stuart CameronMcLeod Society.ERWIN L. DOSCH, York.J. D. ELLIOTT, Detroit.RUSSELL G. HANDAYAN, New Orleans.CHARLES B. HEIM, Williamsport.PAUL M. HERRING, Reading, past na-tional vice president. SCMS.KENNETH J. MALTBY, Tulsa.JOHN MARTIN, Pittsburgh.THEODORE H. MCCONNON, Member -at-Large.C. J. MCVEY, Cape Canaveral.JULIAN P. MEADOWS, Pensacola.C. T. MORROW, San Francisco.JASON E. NEWTON, Tucson, past presi-dent.JOHN H. ROBERTS, St. Louis, past presi-dent. SCMS.

Promotions and New Positions

ARTHUR L. BENNETT, Baltimore, is nowassistant regional controller of Mid -At-lantic Region, Browning Ferris Indus-tries, Inc. . . . DALE PEDLAR was namedcontroller of Hittman Associates, Inc.. ..C. J. SELING, JR., has been promoted todivision administrator, Essex ChemicalCorp. . . . FRED J. WOOD has joinedRobert Half Personnel in Washington,D. C., as office manager.

O. CLAYTON DOBBINS, Birmingham, hasbeen elected vice president, cashier andcontroller for Bank of the Southeast.

JAMES D. ALGER, Boise, has been pro-moted to corporate internal auditor atBlue Cross. . . . LARRY D. HILL wasnamed manager of agriculture planning atOre -Ida Foods, Inc. . . . DUANE H.MCCRACxEN has been promoted to man-ager of the Land & Livestock Div., J. R.Simplot.S. JAMES KENTLEY, Boston, was ap-


pointed chief financial officer at theRitchie Organization.

EDWARD F. SLAWINSKI, JR., Buffalo, waspromoted to assistant vice president ofM &T Bank.

KENNETH A. ROYSE, Chattanooga, hasbeen named treasurer of Chattanooga GasCo., in addition to his current post asassistant vice president.

J. E. HALEY, Cincinnati, is now con-troller, Setco Industries, Inc.

GREGORY J. DAMON, Cleveland, has beenelected assistant secretary- treasurer ofWorld Shipping, Inc.

RONALD C. Fox, Columbus, recently wasappointed controller, Borden Chemical.

KENNETH R. SIBLEY, Cuyahoga Valley,has been appointed vice president offinance for Gregory Galvanizing andMetal Processing, Inc.

RONALD J. BORDui, Detroit, was ap-pointed controller, United Hospitals ofDetroit. . . . CHARLES W. FINGER hasbeen appointed vice president— finance,Fruehauf Finance Co.

F

CONNELL WALRATHMinneapolis Viking New York

JAMES A. BALDAUF, Erie, is.now divisioncontroller at the Pittsburgh Avenue plantof Zum Industries.... JAMES J. JOHNSONwas promoted to assistant vice presidentand comptroller at First National Bank.

FRANK VESPE, Essex County, recentlywas named controller for Tenneco Chem-icals, Inc.

Two Houston Members have been namedat Armco, Machinery and EquipmentDiv. RUDY W . PREMETZ was namedmanager, plant accounting, and CHARLESJ. SPIKER, manager, financial planninganalysis. . . . ARTHUR V. DEEKENS hasbeen named controller of Texas Alkyls.

ARLEN L. MCDONALD, Jackson, is nowassistant vice president of Deposit Guar-anty National Bank. . , . JOHNNY H.WILLIAMSON recently was elected vicepresident and treasurer of American Pub-lic Life Broadcasting.

MILTON B. CROSS, Jamestown- Warren,has been appointed controller of Knowles -Fisher Div., AVM Corp.

BRUCE W. POTTER, Lake Superior, Waspromoted to assistant vice president, FirstNational Bank of Duluth.

ARTHUR E. ERICSON, JR., Madison, hasbeen promoted to corporate financialplanning manager at Oscar Mayer & Co.,Madison office.... THOMAS R. SCHMIDThas joined Ohio Medical Products as as-sistant controller.

PELEFOTI FAILAUTUSI, Member -at- Large,has been promoted to manager of auditsin the Office of the Territorial Auditor ofthe Government of American Samoa.

ANTHONY FERGUSON, Member -at- Large,USA, has joined First National Bank ofMercer County (Pa.) as controller.

MICHAEL S. HOPE, Member -at- Large,USA, has been admitted to partnershipin Ernst & Ernst, New York office.

LORRAINE R. SHANNON, Miami, has beenelected treasurer of Florida Bancorp, Inc.,in addition to her present position ascomptroller for the holding company.

EMIL GLASBERG, Milwaukee, is now con-troller with Flagg Tanning Corp. . . .EDGAR J. Loomis now is vice presidentand general manager of Universal DataInc., a subsidiary of Center Street FuelCO. . . . CALVIN T. SHEARER has joinedRobyn D. Linder as a partner.

JOSEPH E. CONNELL, Minneapolis Viking,has joined the Republic National LifeInsurance Co. of Dallas as executive vicepresident and controller.

VERNON F. STONE, Mohawk Valley, hasbeen appointed controller of Faxton Hos-pital and Children's Hospital and Re-habilitation Center.

JOSEPH R. PETITE, Morristown, has beenpromoted to vice president finance of theConsumer Products Group, Warner -Lam-bert Co.

DOUGLAS S. POTTER, Muskegon, has beenpromoted to controller at Howmet Corp.

ROBERT A. HAVERSAT, New Haven, hasbeen appointed vice president and worksmanager of Sargent Co.... LAWRENCE P.SPELLACY, JR., has been named manager—cost accounting, Eyelet Specialty Co.GARY C. Fox, New York, has been ad-mitted into partnership at Ernst & Ernst.

...JOHN F. WALRATH has been elected

chairman of the board and chief executiveofficer of Andrew Jergens Co. He isexecutive vice president and chief op-erating officer of American Brands, Inc.,the parent company of Jergens. He is alsochairman and chief executive officer oftwo other subsidiaries.

THIS MAY BETHE BEST INVESTMENTYOU WILL EVER MAKE

ALL MATERIAL BY FREDERICK STAPLES, C.P.A.(California and W isconsin)

Member of American Institute of CPAs., National Associationof Accountants and American Accounting Association.

Stock No.ofNo. Pages Ea.

CORPORATE ACCOUNTINGC117S THE MONTHLY FINANCIAL STATE-

MENTS. For the accountants re-sponsible for devising or preparingmonthly financial statements forbusiness concerns. 72 Edition

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C116 MONTHLY FINANCIAL STATEMFORMS. In full size. Most appearin reduced size in C117 71 Ed . . 21 .95

F201 MASTER CHART OF ACCOUNTS. Har-monized with C116 and C117. 71Ed..........................

4 .95CI 13S THE INVENTORIES. Inventory taking,

valuation and testing by the out-side auditors, including activityanalysis which is rapidly comingto be regarded as lust as neces-sary as the aging of the customers'receivables. 72 Ed. . 104 3.15

C114 INVENTORY TAKING INSTRUCTIONS.May be used in many cases as isafter filling in a few spaces. 65Ed. 10 .65

C115 INVENTORY PRICING INSTRUCTIONS.With provision for merely checkingapplicable sources, etc. 74 Ed. 5 .50

C132 BOOK INVENTORY AND COST OFSALES EXAMPLE, includingentries. Keeps monthly inventoryand cost of sales off, but tied inwith, the general ledger. 74 Ed. 8 .75

C139 BOOKKEEPING FUNDAMENTALS.Good record keeping by client isgood for the client's business andreduces audit cost. 73 Ed.

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C119 THE FINANCIAL BUDGET. The neces-sary forms, with detailed concisepreparation instructions (includingsequence of the work). 69 Ed. 8 1.95

C140 CHARTING THE BUSINESS. Thechart paper to be used. The infor-mation to be charted and how tochart it, with 13 charts illus-trated. 73 Ed. 28 2.25

F202A THE SHORT CUT GENERAL LEDGER.With the accounts printed thereonin harmony with F201 above, andinstructions. 70 Ed.

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C150 COST ESTIMATING. A long timeneeded cost guide includingsample cost sheet. 70 Ed. 11 2.00

C105 PREPARING FOR THE AUDITORS.What the client can do to preparefor the audit and help reducecost. 66 Ed. 14 1.00

C107 SPECIMEN WORK SHEETS FOR THEAUDITORS. Showing some ached.ules the client ordinarily can pre-pare. 72 Ed . . . . . . . . . . . . . . . . . 31 1.35

C111A SUPPLEMENTAL INTERNAL CONTROLQUESTIONNAIRE. Deals largelywith matters beyond the usualaudit engagement but within thescope of the practicing accountant,the management consultant andthe company controller. 71 Ed. 6 1.85

C832 One of each (a saving of $3.80) 21.45All prices F.O.B. Thiensville, and subject to change with.

out notice. 5/1/74

THE COUNTING HOUSE PUBLISHING CO.,THIENSVILLE, WISCONSIN, U. S. A. 53092

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Stock No. C117S C116 F201 C113S C114 C115 C132 C139C119QuantityAmountStock No. C140 F202A C150 C105 C107 CIIIA C832QuantityAmountTOTAL AMOUNT OF ORDER = ........ (postage paid on cashorders) Add 50q, if order Is less than $5, and 4% tax, ifshipment to Wis.

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THE COUNTING HOUSE PUBLISHING CO.THIENSVILLE, WISCONSIN, U. S. A. 53092

MANAGEMENT ACCOUNTING/ DECEMBER 1974 Circle 3 on inquiry card.

PAT R I CK J . MC KE E , Northern Wisconsin,is now chief accountant and data process-ing manager with Hillshire Farm Co.P A T R I C I A M . S P A C K M A N , Oakland Coun-ty, has been elected treasurer and to theboard of directors, Integral Engineering& Mfg. Co.

D E N N I S K . W I L S O N , Peninsula -Palo Alto,was promoted to group controller forElectro Products Group, Beckman Instru-ments, Inc.

J . G . G U L B I N , Pennsylvania Northeast,recently was promoted to vice presidentat Schott Optical Glass. . . . WILLIAMP. MONTAGUE was promoted to vice pres-ident at Mark IV Mobile Homes, Inc.

Three Piedmont Winston -Salem mem-bers have been named at R. J. ReynoldsI n d u s t r i e s . R O B E R T B E N N E T T , J R . , w a s

named assistant treasurer and GEORGE K.Ross, director — business budgeting... .C H A R L E S C . S T Y R O N has been electedsecretary and treasurer of Triangle Broad-casting Corp.

R A Y M O N T . A L E Y , J R . , Pittsburgh, wasnamed controller of the Keystone Divi-s i o n o f D r a v o Corp. . . . K E N N E T H D .

NADER was appointed controller of RyanHomes, Inc.

c h a n g i n gyour

address?To insure - - - - - - - - - - - - - -uni nt er rupt ed ; Q D m̀ D i

service on <

M A N A G E M E N T D a

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Accountants 3 a919 Third Avenue 9:New York, N.Y. ; o N10022

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Na m e

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b

"Santa Claus must have taken a bath on Wall Street —I didn't even break eventhisyear!"

U.S. Hedges BetOn Gambling StudyThe Commission on the Review ofthe National Policy Toward Gamblinggot under way last year with $250,000from Congress. It assembled an 11-member staff and authorized severalresearch contracts.

This year the Commission asked fornine more staffers and a budget ofnearly $1.3 million. A Congressionalcommittee pared the request to aneven $1 million.

The request was cut back to $250,-000 after floor debate in the Houserevealed some examples of researchauthorized to date.

One contract included a study of thehistory, mythology and astrology ofgambling. One proposal called for awriter at $100 a day and a researcherat $50 a day, plus "overhead" of $63,-000 to study gambling in Las Vegas.

—Tax Foundation

Believe It or NotIn what surely must be a "first ", anNAA member has received nationwidepublicity in "Ripley's Believe It orNot" syndicated feature. The itemreads: "Cecil D. Marshall of KewGardens, N.Y., has not missed amonthly meeting of the New YorkChapter of the National Assn. ofAccountants in 42 years."


RICHARD W. KOENIG, Princeton, was pro-moted to assistant vice president andcashier of the New Jersey National Bankin Trenton.

WILLIAM S. BEUTEL, Raritan Valley, Iscontroller /financial manager at Pennwalt.. . . MORRIS B. KADIN was appointed ex-ecutive vice president and general man-ager, Franklin Data Information Corp., awholly -owned subsidiary of Franklin StateBank.

ROBERT A. CASTIGLIONE, Rochester, isfinance officer with the city of Rochester.. . . JOHN NASSE has been named assis-tant treasurer of C. P. Ward, Inc. . . .JOHN L. SUTER was appointed businessmanager of George Heisel Corp.

J. C. BARRETT, Rockford, has been ap-pointed assistant treasurer of J. L. ClarkMfg. Co.

FRANKLIN A. GIBER, Santa Barbara, is theassistant administrator and controller atCottage Hospital. . . . JOHN M. BRITTwas promoted to controller of the DiskHead Div., Informag.

ERNEST H. SHUMATE, Savannah, has beenpromoted to controller, Woodlands Div.,Union Camp Corp.HENRY A. SMITH, St. Louis, has been ap-pointed treasurer of Consolidated For-warding Co.

KEITH A. ROEPER, SIOUX City, Is nowcomptroller at the Security National Bankof Sioux City.

PETER BARNA, Union County, has joinedCrompton & Knowles Corp., as manager—corporate accounting.

RONALD R. JUTILLA, Washington Tri-Cities, has been promoted to vice presi-dent and manager of the Aberdeenbranch of the National Bank of Com-

merce.

DANA M. STONE, Waterbury, has beenpromoted to vice president of finance andoperations, Gavlick Machinery Corp.

WAYNE R. BUSKE, Waukesha Area, hasbeen named vice president of finance atWisconsin Centrifugal, Inc.

S. G. SPRINKLE, Wichita, has beennamed a partner of Peat, Marwick, Mit-cbell & Co. . . . MYRON L. UNRUH hasbeen promoted to assistant to the chair-man of the board, the Coleman Co.

DONALD E. HARSCH, Williamsport, ISbusiness manager at Warrior Run SchoolDistrict.

Organization ServicePHILIP L. DEFLIESE, Long Island - Nassau,


has been elected chairman of the Ameri-can Institute of CPAs. Mr. Defliese, amember of the advisory council of theFinancial Accounting Standards Board,had served as chairman of the AccountingPrinciples Board. He is managing partnerof Coopers & Lybrand.

In Memoriam

RICHARD F. ARMBRUST, 51, Calumet,1971.UMBERTO CAPALDI, 57, Providence,1961.HARRY CHUBAcK, 49, New York, 1968.EARLE G. FAItNSWORTH, 77, Bang,or -Waterville, 1945. Emeritus Life Asso-ciate.EDWARD A. FENKO, 53, Cleveland, 1953.JAMES P. GALLAGHER, 55, San Francisco,1963.ALFRED A. GAUTHIER, 52, West BergeV-Passaic County, 1965.WALTER D. KELLER, 50, Raleigh -Dur-ham Area, 1964.MASAO KIMURA, 71, Member -at- Large,USA, 1960.FRANCIS T. MAHONEY, 75, Springfield,1941. ELA.PHILLIP A. MARANGELLA, 79, Member -at- Large, Hong Kong, 1944. ELA.JOHN R. McKINNEY, 55, Mid - Hudson,1971.GEORGE J. MCKNIGHT, 64, Jacksonville,past president, 1965.RUSSELL W . MERRITT, 46, SouthernMaine, 1969.FRANK RODRIGUEZ, 44, Calumet, 1965.DENNY D. ROTRAMEL, 43, Indianapolis,1973.FRANK RUBIN, 56, Member -at- Large,USA, 1972.PHILIP F. SORRESSO, 48, Boston, 1967.JACKSON B. THOMAS, 64, Indianapolis,1963.VICTOR L. THOMPSON, 72, New York,1942. ELA.

JOYA. WALKER, 51, Toledo, 1957.ROBERT L. WILKES, 63, Cleveland, 1949.MARSHALL D. WINEGARD, 80, Albany,1946. ELA.JAMES A. ZIMMERMAN, 77, Buffalo, 1943.ELA.

CMA Winner Mis- identifiedOn page 64 of the Octobcr issue ofMANAGEMENT ACCOUNTING, one of themedal winners in the 1973 CMA exami-nation is not identified correctly. Thephoto at top left depicts William S.Madden, winner of the Beyer SilverMedal, and not Karl E. Fraedrich, BronzeMedal Winner.

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"He was oldest

surviving past

national

president."

Clinton M. Finney (1885 -1974)Clinton M. Finney, past national president of theAssociation, died last September in Orlando, Fla.,at the age of 89.

Until his death, C. M. Finney had the distinctionof being the oldest surviving president according toterm of office. He served as president of the As-sociation, 1926 -27.

Mr. Finney was one 6f the pioneering figures ofthe Association. He joined in 1920, served as presi-dent of the New York Chapter, 1921 -22, and alsowas elected president of the Brooklyn Chapter,1934 -35. Almost to the end of his life he continuedto take an interest in the Association, writing lettersto the current president and executive director onseveral occasions.

Born in Churchville, Pa., C. M. Finney attendedschools in Pennsylvania, including the University ofPennsylvania. His business career was extensive andvaried with numerous positions in top financialmanagement. Upon his election to NAA, for ex-ample, he was vice president and controller ofWorthington Pump & Machinery Corp.; later lieserved in positions at Westinghouse Electric &Manufacturing Co., Brockway Motor Truck Corp.,and Conde Nast Publications, Inc.

He was president of American Cities Power andLight Corp., Associated Music Publishers, andCamden Forge Co. He also was a director on anumber of corporate boards.

Known as "Chris" to his many friends in theAssociation, Mr. Finney was a close friend of"Doc" McLeod, the first secretary of the Associa-tion. He is given credit for the idea which led tothe organization of the Spot Club, now called theStuart Cameron McLeod Society. Mr. Finney waselected the first president of this organization ofpast national officers and directors. He vigorouslysupported its activities, even after his retirementfrom active business.

At a meeting of the Brooklyn Chapter on April16, 1952, C. M. Finney was honored at "ChrisFinney night." President Philip J. Warner pre-sented him with an engrossed resolution of appre-ciation and good wishes from the NAA Board ofDirectors. The resolution, citing his "wise counseland untiring efforts to promote the objectives ofthe Association," concluded, "In sincere apprecia-tion of his outstanding service since 1920, this testi-monial is presented to convey to `Chris' the ad-miration, affection and esteem of their best wishesfor a continuing and happy life."

Mr. Finney at honorary dinner given him in 1952.

Mr. Finney retired from active business andmoved to Florida that year but he did not applyfor Emeritus Life Associate status in the Associa-tion until 1964. He summed up his feelings aboutNAA in a letter published in the 50th Anniversaryissue Of MANAGEMENT ACCOUNTING.

"For whatever contribution I have made I havebeen rewarded and repaid many, many times by theinformation and knowledge which I received and toa tremendous extent by the numerous and lastingfriendships which have been of stimulating valueand satisfaction to me."

A man of wide and diverse interests, Mr. Finneybelonged to a number of clubs and fraternal or-ganizations, including the Masons. He also servedon industry groups concerned with accounting is-sues.

At "Chris Finney" Night, Mr. Finney expressedsome of his personal philosophy when he pulleda card from his pocket and read these words:

"Do more than exist —liveDo more than touch —feelDo more than look— observeDo more than hear — listenDo more than think — ponderDo more than talk —say something."

An outstanding member of the Association,Chris Finney will be remembered by those whoknew him and respected his great abilities. Hisservice to the Association was exemplary and hiscontinuing support after retirement an inspirationto all.

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BOSTON140 Federal St.(617) 423 -6440

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Management Accounting

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