ACCOUNTANTS’ HANDBOOK VOLUME ONE: Financial Accounting and General Topics pot

He previously was the first secretary eral of the International Accounting Standards Committee, director of the Technical ResearchDivision of the American Institute of Certified Public Acc

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Accountant’s handbook / [edited by] D.R Carmichael, Paul Rosenfield.—,

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ABOUT THE EDITORS

D R Carmichael, PhD, CPA, CFE, is the Wollman Distinguished Professor of Accountancy

at the Zicklin School of Business, The Stan Ross Department of Accountancy at Bernard M.Baruch College, The City University of New York Until 1983, he was the vice president, au-diting, at the AICPA, where he was in charge of the development of professional standards

Dr Carmichael has written numerous professional books, college texts, and articles in sional as well as academic journals He has acted as a consultant to CPA firms, state and federalgovernment agencies, public corporations, and attorneys He has dealt with issues related toaccounting, auditing, ethics, and controls standards and practices He has testified as an expertwitness in civil and criminal litigation and proceedings

profes-Paul Rosenfield, CPA, was director of the Accounting Standards Division of the American

In-stitute of Certified Public Accountants for 14 years He previously was the first secretary eral of the International Accounting Standards Committee, director of the Technical ResearchDivision of the American Institute of Certified Public Accountants, and a member of the staff

gen-of its Accounting Research Division He has authored two books and numerous articles on nancial reporting in professional and academic journals

fi-v

ABOUT THE CONTRIBUTORS

James R Adler, PhD, CPA, CFE, is founder of Adler Consulting Ltd., which specializes in

forensic accounting He has 40 years of public accounting and academic experience workingwith generally accepted accounting principles (GAAP) and generally accepted auditing stan-dards (GAAS) He has had a diversified clientele, including public and private entities as well

as governmental bodies such as the SEC, the U.S Department of Justice, and the FDIC He haswritten and lectured extensively on the professional standards and other accounting and eco-nomic issues

Juan Aguerrebere, Jr., CPA, is a founding member of Perez-Abreu, Aguerrebere, Sueiro LLC

in Coral Gables, Florida He has served on numerous AICPA and FICPA committees, includingthe AICPA Technical Issues Committee, Group of 100, AICPA Joint Trial Board, and FICPA Ac-counting and Auditing Committee He has over 13 years of experience in public accounting andauditing and over 20 years of experience in accounting for financial institutions He has lectured

on numerous accounting and auditing issues He is a member of the AICPA, FICPA, a Diplomat

of the American Board of Forensic Accounting, and a Neutral/Arbitrator for the American tration Association

Arbi-Vincent Amoroso, FSA, is a principal in the employee benefits section of Deloitte & Touche

LLP’s Washington National Office He has published and spoken frequently in the employeebenefits accounting area, both on pensions and retiree medical care

Ian J Benjamin, CPA, is a managing director in the Not-for-Profit Services Group of American

Express Tax and Business Services, Inc Prior to joining American Express, Mr Benjamin was apartner at Deloitte & Touche in their Tri-State Not-for-Profit and Higher Education ServicesGroup He is currently a member of the FASB working group on not-for-profit organizations andthe Professional Ethics Committee of the New York State Society of CPAs He is a former mem-ber of the International Accounting Committee and the Not-for-Profit Organizations Committee

of the New York State Society of CPAs

Martin Benis, PhD, CPA, is a professor and former chairman of The Stan Ross Department of

Accountancy at the Zicklin School of Business, Bernard M Baruch College, CUNY He is rently a consultant on accounting and auditing matters to more than 50 accounting firms and or-ganizations throughout the United States His articles have appeared in major accounting andauditing journals

cur-Andrew J Blossom, CPA, is a senior manager in the Public Services line of business of KPMG

Peat Marwick LLP He is assigned to KPMG’s Department of Professional Practice, where he isresponsible for handling technical inquiries related to governmental accounting, auditing, andreporting Mr Blossom is a member of the AICPA Government Accounting and Auditing Com-mittee He received his BS degree from the University of Kansas

Stephen Bryan, MBA, PhD, is an associate professor of the Stan Ross Department of

Accoun-tancy at the Zicklin School of Business, Bernard M Baruch College, CUNY He received hisdoctorate in accounting from New York University

vii

Luis E Cabrera, CPA, is a technical manager with the AICPA’s Professional Standards and

Ser-vices Team Mr Cabrera was previously responsible for technical research activities as a senioraccountant in the national office of Pannell Kerr Forster, PC He was also an audit senior withCoopers & Lybrand and has served as an adjunct professor of Accountancy at the Zicklin School

of Business in the Stan Ross Department of Accountancy at Bernard M Baruch College, CUNY

Joseph V Carcello, PhD, CPA, CMA, CIA, is a William B Stokely Distinguished Scholar and

an associate professor in the Department of Accounting and Business Law at the University of

Tennessee Dr Carcello is the coauthor of the 2003 Miller GAAP Practice Manual Dr Carcello

has taught professional development courses and conducted funded research for three of the Big

4 firms He also has taught continuing professional education courses for the AICPA, the tute of Internal Auditors, the Institute of Management Accountants, and the Tennessee andFlorida Societies of CPAs

Insti-Peter T Chingos, CPA, is a principal in the New York office of Mercer Human Resource

Con-sulting and a member of the firm’s Worldwide Partners Group He is the U.S leader for thefirm’s Executive Compensation Consulting Practice For more than 25 years he has consultedwith senior management, compensation committees, and boards of directors of leading globalcorporations on executive compensation and strategic business issues He is a frequent keynotespeaker at professional conferences, writes extensively on all aspects of executive compensa-tion, and is often quoted in the press He is a member of the advisory Board of the National As-sociation of Stock Plan Professionals and currently teaches basic and advanced courses inexecutive compensation in the certification program for compensation professionals sponsored

by Worldatwork

Walton T Conn, Jr., CPA, is an SEC Reviewing Partner in the Silicon Valley office of KPMG

Peat Marwick LLP, where he works in the information, communication, and entertainment tice He has spent four years in his firm’s Department of Professional Practice in New York and

prac-is a former practice fellow of the AICPA Auditing Standards Board

John R Deming, CPA, is a partner in the Department of Professional Practice of KPMG Peat

Marwick LLP in New York He is a former member of the AICPA Accounting Standards tive Committee and has served on a number of FASB task forces and EITF working groups Mr.Deming has written numerous articles on a variety of accounting issues, including leases, busi-ness combinations, pensions, and employee stock-based compensation

Execu-Jason Flynn, FSA, is a senior manager in the employee benefits section of Deloitte & Touche

LLP’s Detroit office

Martha Garner, CPA, is a director in the national office of PricewaterhouseCoopers LLP,

where she is the firm’s industry specialist for healthcare accounting and financial reporting ters She has served on numerous AICPA, FASB, and Healthcare Financial Management Associ-ation task forces and committees dealing with healthcare financial reporting issues She is a

mat-contributing author on healthcare matters for Montgomery’s Auditing and the Financial and

Ac-counting Guide for Not-for-Profit Organizations, and has authored numerous healthcare articles

and publications

Frederick Gill, CPA, is senior technical manager on the Accounting Standards Team at the

AICPA, where he provides broad technical support to the Accounting Standards ExecutiveCommittee During 19 years with the AICPA, he participated in the development of numerousAICPA Statements of Position, Audit and Accounting Guides, Practice Bulletins, issues papers,journal articles, and practice aids He was a member of the U.S delegation to the InternationalAccounting Standards Committee, represented the U.S accounting profession on the United

Nations Intergovernmental Working Group of Experts on International Standards of Accountingand Reporting, and was a member of the National Accounting Curriculum Task Force Previ-ously he held several accounting faculty positions.

Alan S Glazer, PhD, CPA, is professor of Business Administration at Franklin & Marshall

College, Lancaster, Pennsylvania He was associate director of the Independence StandardsBoard’s conceptual framework project and has been a consultant to several AICPA committees.His articles on auditor independence, not-for-profit organizations, and other issues have beenpublished in academic and professional journals

Andrew F Gottschalk, CPA, is a senior manger in the public services practice of KPMG Peat

Marwick LLP He has over 13 years of experience serving state and local governments He is amember of the Government Finance Officers Association, the Association of Government Ac-countants, and the New York and Illinois Societies of CPAs

Richard P Graff, CPA, is CEO of The Graff Consulting Group He serves as a financial and

business adviser to the natural resources industry and has coauthored numerous publications.Prior to that, he was a partner in the international accounting firm of PricewaterhouseCoopersLLP, where he served as audit leader of the U.S Mining Industry Group

Dan M Guy, PhD, CPA, is a writer and consultant Formerly he served as a vice-president of

Professional Standards and Services at the AICPA He is a coauthor of Practitioner’s Guide to

GAAS and Ethics for CPAs (John Wiley & Sons); Guide to Compilation and Review ments (Practitioners Publishing Company, 1988); and has published numerous articles in pro-

Engage-fessional journals, an auditing textbook (Dryden Press), and an audit sampling textbook (JohnWiley & Sons)

Wendy Hambleton, CPA, is an audit partner working in the National SEC Department in BDO

Seidman LLP’s Chicago office Prior to joining the SEC Department, Ms Hambleton worked inthe firm’s Washington, DC, practice office She works extensively with clients and engagementteams to prepare SEC filings and resolve related accounting and reporting issues Ms Hamble-

ton coauthors a number of internal and external publications, including the AICPA’s Guide to

SEC Reporting and Warren Gorham & Lamont’s Controller’s Handbook chapter on public

of-fering requirements

Philip M Herr, JD, CPA, is the director of Advanced Planning of Kingsbridge Financial

Group, Inc., Point Pleasant Beach, New Jersey, and is an adjunct professor at Fairleigh son University, School of Continuing Education, Certified Employee Benefits Specialist Pro-gram and Certified Financial Planner Program He is admitted to the New York and U.S TaxCourt Bars and is a member of the New York State Bar Association, New York State Society ofCPAs, New Jersey Society of CPAs, and Association for Advanced Life Underwriting He spe-cializes in the areas of: tax; estates and trusts; estate, business, and financial planning; ERISAissues and transactions; retirement, employee benefit, and executive compensation planning;and use of life insurance and insurance products He also holds the NASD 7, 24, 63, and 65 se-curities licenses

Dickin-Karen L Hooks, PhD, CPA, is a professor of accountancy at Florida Atlantic University

(FAU) Her primary research areas are the public accounting work environment, sociology ofprofessions, gender, ethics, and communication She teaches undergraduate classes, as well as

in the Master of Accounting, MBA, and Master of Science in International Business at FAU

Professor Hooks has been published in Accounting Organizations and Society, Behavioral

Re-search in Accounting, Auditing: A Journal of Practice and Theory, Accounting Horizons, ical Perspectives on Accounting, Advances in Accounting, Advances in Public Interest

Crit-Accounting, Journal of Accountancy, among others She received her PhD from

Georgia State University

Keith M Housum, CPA, is a senior manager in the tax consulting practice of Ernst &Young

LLP He specializes in the Financial Services area Mr Housum has over six years of experienceassisting financial services clients with a variety of tax issues Clients have ranged in size fromsmall community-based banks to large regional financial institutions He began his career withErnst & Young LLP upon graduation from Case Western Reserve University with a bachelor’sdegree in Accounting He is a member of the Ohio Society of Certified Public Accountants

Henry R Jaenicke, PhD, CPA, is the C D Clarkson Professor of Accounting at Drexel

Uni-versity He is the author of Survey of Present Practiced in Recognizing Revenues, Expenses,

Gains, and Losses (FASB, 1981) and is the coauthor of the 12th edition of Montgomery’s ing (John Wiley & Sons, 1998) He has served as a consultant to several AICPA committees, the

Audit-Independence Standards Board, and the Public Oversight Board

Richard C Jones, PhD, CPA, is an assistant professor in the Accounting/Taxation/Business Law

Department of Hofstra University Dr Jones’s teaching interests include managerial accounting andfinancial reporting His research interests focus on auditing and the international self-regulatory ac-counting environment Dr Jones has also contributed extensively to AICPA publications

Richard R Jones, CPA, is a senior partner in the National Accounting Standards Professional

Practice Group of Ernst & Young LLP, where he is responsible for assisting the firm’s clients inunderstanding and implementing today’s complex accounting requirements Mr Jones’s partic-ular fields of expertise are in the areas of impairments, equity accounting, real estate, leasing,and various financing arrangements

Allyn A Joyce has been a business appraiser for 40 years He is principal of Allyn A Joyce & Co.,

Inc., which specializes in litigation support appraisals and litigation support appraisal reviews

Alan M Kall is a principal in the tax consulting practice of Ernst & Young LLP specializing in

the Financial Services area Mr Kall has over 17 years of experience assisting financial servicesclients with a variety of tax and accounting issues His clients’ range in size from small commu-nity-based banks to large regional financial institutions He began his career with Ernst & YoungLLP upon graduation from Cleveland State University with a BBA in Accounting He is a CPAand a member of the Ohio Society of Certified Public Accountants

Eric Klis, ASA, is a manager in the employee benefits section of Deloitte & Touche LLP’s

Min-neapolis office

Margaret R Kolb, CPA, is a senior manager in Litigation Consulting Department of the New

York office of American Express Tax and Business Services, Inc., where she provides litigationconsulting, forensic accounting, and expert witness services to law firms and insurance compa-nies She has prepared expert reports and provided testimony in a variety of forums Ms Kolb is

a certified public accountant in the State of New York, a member of the American Institute ofCertified Public Accountants and the New York State Society of Certified Public Accountants.She recently served for two years on the Litigation Consulting Committee of the New YorkState Society of Certified Public Accountants

Debra J MacLaughlin, CPA, is a partner and the Deputy National SEC Director in BDO

Sei-dman LLP’s Chicago office She has over 23 years of professional accounting experience andhas served clients in both the public and private sectors As Deputy National SEC Director, Ms

MacLaughlin assists the firm’s clients and engagement teams in preparing SEC filings, performsprerelease reviews of registration statements and selected Form 10-Ks, and consults on relatedaccounting and reporting issues.

Susan McElyea, CPA, is a director in PricewaterhouseCoopers Transaction Services Group.

Her 22 years of industry experience includes corporations owning real estate not used in theirbusiness, commercial and industrial developers, home-builders, hotel owners, operators, syndi-cators, property managers, and retail clients with substantial real estate properties Experienceincludes off balance sheet structuring, lease and transaction structuring, lease analysis, securiti-zation and bulk sales transactions, cash flow modeling, due diligence services, private and pub-lic debt offerings, development of cash flow projections related to real estate syndications, andconsultation regarding accounting and reporting matters with clients in structuring various realestate transactions Additionally, she has served as an instructor for many real estate accountingand auditing continuing education courses and contributed significantly to the 1995 John Wiley

& Sons technical research book entitled Real Estate Accounting and Reporting.

Benjamin A McKnight III, CPA, is a retired partner at Arthur Andersen LLP in its Chicago

of-fice He specializes in services to regulated enterprises, is a frequent speaker, and provides pert testimony on utility and telecommunication accounting and regulatory topics

ex-Francine Mellors, CPA, is a director in Ernst & Young’s National Department of Professional

Practice in New York Her duties include consulting and writing on various accounting topics, cluding employee benefit issues, as well as serving as knowledge leader and publications directorfor the National AABS Practice Prior to this role, Ms Mellors served as a vice-president in theAccounting Policy Group at the Chase Manhattan Bank and as an auditor at Deloitte and Touche.She holds a BA and an MA in Hispanic Studies and an MBA in Accounting and Management

in-John R Miller, CPA, CGFM, is a partner and member of the board of directors of KPMG Peat

Marwick LLP He is partner-in-charge of the firm’s Public Services Assurance and ResourceManagement Services Mr Miller is a member of the Comptroller General’s Audit AdvisoryCommittee and a former chairman of the AICPA’s Government and Auditing Committee and is

a recognized authority on governmental financial management

Lailani Moody, CPA, MBA, is a partner in Grant Thornton LLP’s Professional Standards

Group Her responsibilities are primarily in the area of accounting and financial reporting, and,

in particular, stock compensation, equity transactions, and newly issued accounting ments from the FASB and the FASB’s Emerging Issues Task Force She was formerly a techni-cal manager in the AICPA’s Accounting Standards Division

pronounce-Richard H Moseley, CPA, is a managing director in the Chicago Metro office of American

Ex-press Tax and Business Services, Inc and the co-director of the Quality Assurance Department

Mr Moseley is responsible for providing consultation services on accounting technical issuesand preparing implementation guidance for new accounting standards He is a member of theAICPA’s Accounting Standards Executive Committee and a former member of the PCPS Tech-nical Issues Committee

Anthony J Mottola, CPA, CFE, is president of Mottola & Associates, Inc., a consulting firm

in areas such as litigation support, financial services, strategic planning, corporate oversight,transactions structuring, and systems and business evaluation Previously he was a partner withCoopers & Lybrand, Spicer & Oppenheim, and EVP, and a member of the board of directors ofShearson Lehman He was special assistant to New York City’s Deputy Mayor of Finance dur-ing its fiscal crises and served as the first Practice Fellow at FASB

Dennis S Neier, CPA, is a partner in the accounting firm of Goldstein Golub Kessler LLP, a

managing director in the New York office of American Express Tax and Business Services, Inc.,and the associate director of the New York Litigation Consulting Department Mr Neier pro-vides litigation consulting and support, expert witness, and forensic accounting services to lawfirms, insurance companies, and in-house counsel He assists in all phases of the litigationprocess, from precomplaint through posttrial, and has testimony experience in a variety of fo-rums He is certified in New York and Louisiana and is a member of the American Institute ofCertified Public Accountants, the New York State Society of Certified Public Accountants, theAmerican Arbitration Association, the Association of Certified Fraud Examiners, and the Amer-ican College of Forensic Examiners, and is a diplomat of the American Board of Forensic Ac-counting

Grant W Newton, PhD, CPA, CMA, is a professor of accounting at Pepperdine University He

is the author of the two-volume set Bankruptcy and Insolvency Accounting: Practice and

Proce-dures: Forms and Exhibits, Sixth Edition (John Wiley & Sons, 2000), and coauthor of ruptcy and Insolvency Taxation, Second Edition (John Wiley & Sons, 1994) He is a frequent

Bank-contributor to professional journals and has lectured widely to professional organizations onbankruptcy-related topics

Paul Pacter, PhD, CPA, is director, Deloitte Touche Tohmatsu IAS Global Office, Hong

Kong His responsibilities include IAS technical questions, developing his firm’s commentletters to the IASB, advising the Ministry of Finance of China on developing accounting

standards, and managing the web site, www.iasplus.com From 1996 to 2000 he was

Interna-tional Accounting Fellow at the InternaInterna-tional Accounting Standards Committee, London Inthat capacity, he managed a number of IASC’s agenda projects, including financial instru-ments recognition and measurement, interim financial reporting, segment reporting, and dis-continued operations Previously Mr Pacter worked for the U.S FASB from its inception in

1973 and, for seven years, as commissioner of Finance of the City of Stamford, Connecticut

He has published nearly 100 professional monographs and articles He received his PhDfrom Michigan State University and has taught in several MBA programs for working busi-ness managers

Don M Pallais, CPA, has his own practice in Richmond, Virginia He is a former member of

the AICPA Auditing Standards Board and the AICPA Accounting and Review Services tee He has written a host of books, articles, and CPE courses on accounting topics

Commit-Ronald J Patten, PhD, CPA, is the dean emeritus of the College of Commerce and Kellstadt

Graduate School at DePaul University He was the first director of research for the FASB and a

former associate in the firm of Arthur D Little International He is the coauthor of CPA

Re-view: Practice, Theory, Auditing and Law, First and Second Edition (John Wiley & Sons, 1974,

1978)

Laura J Phillips, CPA, is a senior manager in the Cleveland office of Ernst & Young LLP She

was formerly assigned to the firm’s national offices in New York and Cleveland, specializing inthe financial services industry She has been a Technical Audit Advisor to the Auditing Stan-dards Board of the AICPA as well as a member of the AICPA Auditing Financial Instruments

Task Force Her articles have appeared in Bank Accounting and Finance and Commercial

Lend-ing Review She currently serves commercial bankLend-ing clients.

Ronald F Ries, CPA, is the managing director in charge of the Not-for-Profit Services Group

in the New York office of the American Express Tax and Business Services, Inc Prior to ing American Express, Mr Ries was controller, treasurer, and vice president of finance for Spi-

join-ral Metal Company, Inc He is an active member of the Accounting for Non-Profit tions Committee of the New York State Society of Certified Public Accountants and active in

Organiza-the AICPA He is a contributing editor to Organiza-the Practical Accountant and lectures and writes

fre-quently on various business and financial matters in both the commercial and not-for-profitsectors

Jacob P Roosma, CPA, is director of the New York office of Willamette Management

Associ-ates, specializing in business valuation He was previously a partner in the New York office ofDeloitte & Touche LLP and, before that, vice president of Management Planning, Inc

Mark R Rouchard, CPA, MBA, is a partner in Ernst & Young’s financial services practice.

Mr Rouchard has spent his entire career serving financial institution clients and has provided

a wide range of accounting and auditing services to some of Ernst & Young’s largest bankingclients Mark currently serves on the AICPA’s Regulatory Task Force He has spoken at

AICPA conferences and written for Bank Accounting and Finance magazine.

Robert L Royall II, CPA, CFA, MBA, is a partner in Ernst & Young’s National Professional

Practices Group in New York City, specializing in accounting for derivatives and hedging ities and financial instruments Mr Royall has authored or edited all of his firm’s technical liter-

activ-ature related to FASB Statement No 133, Accounting for Derivative Instruments and Hedging

Activities He regularly works with the FASB staff and SEC regulators to monitor emerging

in-terpretations in this rapidly changing area Mr Royall is a member of the Association for vestment Management and Research

In-Steven Rubin, CPA, is a firm director in the national assurance, accounting and advisory

services department of Deloitte & Touche LLP Previously he was the director of accounting

at another national firm and a principal and the director of quality control at a local firm.Prior to that he held key staff positions at the AICPA and taught accounting as an adjunct as-sistant professor at Brooklyn College of CUNY, his alma mater A frequent writer and lec-turer, he is active in the New York State Society of Certified Public Accountants, where hechairs its Financial Accounting Standards Committee, and is former member of its board ofdirectors

Warren Ruppel, CPA, is the assistant comptroller for accounting of the City of New York,

where he is responsible for all aspects of the city’s accounting and financial reporting Hehas over 20 years of experience in governmental and not-for-profit accounting and financialreporting He began his career at KPMG after graduating from St John’s University, NewYork, in 1979 His involvement with governmental accounting and auditing began with hisfirst audit assignment—the second audit ever performed of the financial statements of theCity of New York After that he served many governmental and commercial clients until hejoined Deloitte & Touche in 1989 to specialize in audits of governments and not-for-profitorganizations Mr Ruppel has also served as the CFO of an international not-for-profit orga-nization Mr Ruppel has served as instructor for many training courses, including special-ized governmental and not-for-profit programs and seminars He has also been an adjunctlecturer of accounting at the Bernard M Baruch College, CUNY He is the author of four

books, OMP Circular A-133 Audits, Wiley GAAP for Governments, Not-for-Profit

Organiza-tion Audits, and Not-for-Profit Accounting Made Easy Mr Ruppel is a member of the AICPA

as well as the New York State Society of Certified Public Accountants, where he serves onthe Governmental Accounting and Auditing and Not-for-Profit Organizations committees

He is also a member of the Institute of Management Accountants and is a past president ofthe New York chapter Mr Ruppel is a member of the Government Financial Officers Asso-ciation and serves on its Special Review Committee

Clifford H Schwartz, CPA, is a consultant Formerly he served as a senior technical manager

at the AICPA and a manager at Price Waterhouse LLP (now PricewaterhouseCoopers LLP)

E Raymond Simpson, CPA, is a project manager at the FASB He served as project manager

for SFAS No 109, “Accounting for Income Taxes,” and SFAS No 52, “Foreign CurrencyTranslation.”

Gary L Smith, CPA, is an Ernst & Young senior manager in the National Accounting

Stan-dards Professional Practice group with over 13 years of experience serving clients in a wide riety of industries and development stages He is responsible for assisting the firm’s clients inunderstanding and implementing today’s complex accounting requirements His particular fields

va-of expertise are in the areas va-of inventories, income taxes, consolidations, financial instruments,pensions, and commitments and contingencies Prior to joining national, he spent 10 yearsworking in the Washington, DC area serving multinational, middle market, and entrepreneurialclients in the technology, communications, manufacturing, distribution, professional services,and real estate industries

Ashwinpaul C Sondi, PhD, is president of A C Sondi & Associates, LLC, a financial

consult-ing firm and a member of the Accountconsult-ing Standards Executive Committee (AcSEC) of the

AICPA He is a coauthor with G I White and Dov Fried of The Analysis and Use of Financial

Statements, Third Edition, 2001 His consulting and research activities include the analysis of

financial statements, use of accounting data in capital markets, analysis of the financial industry,and international accounting differences

Joel O Steinberg, CPA, is partner at Goldstein Golub Kessler LLP in New York City, where he

specializes in accounting and auditing standards He is a member of the New York State Society

of CPA’s Financial Accounting Standards Committee He has authored several articles, and heprovides continuing professional education in accounting and auditing

Reva Steinberg, CPA, is a director in the National SEC Department in BDO Seidman LLP’s

Chicago office She has over 30 years of professional accounting experience and has servedclients in both the public and private sectors She works extensively with clients and engage-ment teams to prepare SEC filings and resolve related accounting and reporting issues

Reed K Storey, PhD, CPA, had more than 30 years of experience on the framework of

finan-cial accounting concepts, standards, and principles, working with both the Accounting ples Board, as director of Accounting Research of the AICPA, and the FASB, as senior technicaladviser He was also a member of the accounting faculties of the University of California,Berkeley, the University of Washington, Seattle, and Bernard M Baruch College, CUNY, and aconsultant in the executive offices of Coopers & Lybrand (now PricewaterhouseCoopers LLP)and Haskins & Sells (now Deloitte & Touche, LLP)

Princi-Dale K Thompson, CPA, is a senior manager in the Asset Management Services Group at

Ernst &Young He is responsible for accounting, regulatory, and business analysis of currentdevelopments effecting mutual fund, alternative products, and investment advisory organiza-tions He is a frequent speaker on regulatory matters at industry and firm-sponsored events He

is a member of the AICPAs and the Massachusetts Society of CPAs

Judith Weiss, CPA, received her MS in Accounting from Long Island University, Greenvale,

New York, and holds an MS in Education from Queens College, CUNY After several years inpublic accounting and private industry, she became a technical manager in the AICPA’s Ac-counting Standards Division, where she worked with industry committees in the development

of Audit and Accounting Guides and Statements of Position As a senior manager in the tional offices of Deloitte & Touche LLP and Grant Thornton LLP, she was involved in proj-ects related to standard setting by the FASB and the AICPA Since 1993 Ms Weiss has con-tributed to several books in the area of accounting and auditing She has coauthored articles

na-on accounting standards for several publicatina-ons, including the Journal of Accountancy, The

CPA Journal, and The Journal of Real Estate Accounting and Taxation.

Gerald I White, CFA, is the president of Grace & White, Inc., an investment counsel firm

located in New York City During the past 30 years he has engaged in numerous professionalactivities relating to the use of accounting information in making investment decisions He is

coauthor of The Analysis and Use of Financial Statements, Third Edition (John Wiley & Sons,

2003)

Jan R Williams, PhD, CPA, is the Ernst & Young Professor and Dean, College of Business

Administration, at the University of Tennessee He is past president of the American ing Association and a frequent contributor to academic and professional literature on financialreporting and accounting education Most recently he has been involved in the redesign of theCPA examination and is a frequent speaker on this and other topics of professional signifi-cance

Account-Alan J Winters, PhD, CPA, is director of the School of Accountancy and Legal Studies at

Clemson University Previously the director of auditing research at the AICPA, he has writtenmany articles for professional and academic journals and an auditing textbook He is a formermember of the AICPA’s Accounting and Review Services Committee

Margaret M Worthington, CPA, is a government contracts consultant Prior to her retirement

from PricewaterhouseCoopers LLP, she was a partner in the firm’s Government Contract sulting Services practice She has over 35 years of experience in federal contracting matters

Con-She is coauthor of Contracting with the Federal Government, Fourth Edition (John Wiley &

Sons, 1998) and has published numerous articles on a variety of federal contracting topics Sheearned her BS at UCLA

Gerard L Yarnall, CPA, is a partner in the New York Office Dispute Consulting and Forensic

Investigations Practice of Deloitte & Touche LLP Mr Yarnall was previously Director of Auditand Accounting Publications at the AICPA He has published and spoken frequently on a widevariety of accounting and auditing topics

The tenth edition of Accountants’ Handbook has the same goal as the first edition, written over

79 years ago: to provide in a single reference source answers to all reasonable questions on counting and financial reporting that might be asked by accountants, auditors, executives,bankers, lawyers, financial analysts, and other preparers and users of accounting information

ac-The Accountants’ Handbook is accounting’s oldest handbook and has the longest tradition of

providing comprehensive coverage of the field to both accounting professionals and als in other fields who need or desire to obtain quick, understandable, and thorough exposure tocomplex accounting-related subjects

profession-This edition of the Handbook continues the presentation initiated in the ninth edition of

two soft-cover volumes; the current edition contains a total of 44 chapters To provide a

re-source with the encyclopedic coverage that has been the hallmark of this Handbook series,

this edition again focuses on financial accounting and related topics, including auditing dards and audit reports, that are the common ground of interest for accounting and businessprofessionals

stan-This edition was prepared during the unfolding of the Enron and WorldCom collapses, thelargest bankruptcies in U.S history, accompanied by severe financial reporting breakdowns.The collapse and the breakdown at Enron destroyed Arthur Andersen & Co., one of the fivelargest international CPA firms WorldCom’s breakdown was called “the most sweeping book-

other reported large-scale breakdowns, for example, at Adelphi, Cedant Corporation, GlobalCrossing, Qwest Communications, Rite Aid, Waste Management, The Baptist Foundation,Vivendi Universal (a French company), and Xerox

Though the breakdowns led to the Sarbanes-Oxley Act of 2002, described in Chapter 2, atthis writing, only a hint of the eventual effects of those events on financial accounting and re-porting is available Nevertheless, this edition contains a chapter on the lesson of those eventsfor accountants In addition, earnings management became a topic of regulatory interest sincethe ninth edition was published A chapter on this form of abuse has also been added Further, a

chapter on price change reporting, a topic formerly covered by the Handbook, has been added in

connection with the problem of earnings management, plus a chapter on producers or tors of film

distribu-The explosion in the scope and complexity of accounting principles and practice that nated the preparation of the eighth and ninth editions has not abated Though the FASB contin-ues to be the primary source of authoritative accounting guidance, other sources of guidance areprominent Pronouncements by the AICPA, SEC, GASB, and EITF are considerably important

domi-in particular areas It is necessary to look to the EITF and to the AICPA SOPs and guides forguidance in specialized areas All of those sources of accounting guidance are included in this

edition of the Handbook.

The tenth edition of the Handbook is divided into two convenient volumes:

xvii

1Daniel Kadlec, “Worldcon: The Fall of a Telecom Titan,” Time, July 8, 2002, p 21.

Volume One: Financial Accounting and General Topics includes:

involved in its development, including the development of international standards

dis-closure, and analysis

sharehold-ers’ equity, including coverage of financial instruments

Volume Two: Specialized Industries and Special Topics includes:

con-siderations for key industries, including, for the first time, a chapter on the film industry

employee stock compensation and other capital accumulation plans

bank-ruptcy, and forensic accounting

For convenience, the pronoun “he” is used in this book to refer nonspecifically to the countant and the person in business We are aware that many women are also active in account-ing practice and business We intend the traditional choice of pronoun to include women.The specialized expertise of the individual authors remains the critical element of this edi-tion as it was in all prior editions The editors worked closely with the authors, reviewing andcritically editing their manuscripts However, in the final analysis, each chapter is the work andviewpoint of the individual author or authors

ac-Some of the chapters in this edition have been prepared by university professors However,over two-thirds of the chapters have been prepared by partners in accounting firms, financial ex-ecutives, or financial analysts Every major international accounting firm is represented amongthe authors These professionals bring to bear their own and their firms’ experiences in dealingwith accounting practice problems All of the 67 authors are recognized authorities in their

fields and have made significant contributions to the tenth edition of the Handbook.

Our greatest debt is to these 67 authors of the 44 chapters of this edition We deeply ate the value and importance of their time and effort We also acknowledge our debt to the edi-

appreci-tors of and contribuappreci-tors to nine earlier editions of the Handbook This edition draws heavily on

the accumulated knowledge of those earlier editions Finally, we wish to thank Judy Howarthand Sujin Hong at John Wiley & Sons, Inc., for handling the many details of organizing and co-ordinating this effort

VOLUME ONE: FINANCIAL ACCOUNTING AND GENERAL TOPICS

1 The Framework of Financial Accounting Concepts and Standards

REEDK STOREY, PhD, CPA

Financial Accounting Standards Board

2 Financial Accounting Regulations and Organizations

JOSEPHV CARCELLO, PhD, CPA, CIA, CMA

University of Tennessee

3 SEC Reporting Requirements

DEBRAJ MACLAUGHLIN, CPA

BDO Seidman LLP

WENDYHAMBLETON, CPA

BDO Seidman LLP

4 Earnings Management

PAULROSENFIELD, CPA

5 Forgetting Our Duties to the Users of Financial Reports: The Lesson of Enron

PAULROSENFIELD, CPA

6 Management Discussion and Analysis

STEPHENBRYAN, MBA, PhD

The Stan Ross Department of Accountancy

Zicklin School of Business

Bernard M Baruch College, CUNY

7 Global Accounting and Auditing

RICHARDC JONES, PhD, CPA

9 Income Statement Presentation and Earnings per Share

JUANAGUERREBERE, JR., CPA

Perez-Abreu, Aguerrebere, Sueiro LLC

xix

10 Accounting for Business Combinations

PAULPACTER, PhD, CPA

Director

IAS Global Office

Deloitte Touche Tohmatsu

11 Consolidation, Translation, and the Equity Method

STEVENRUBIN, CPA

Deloitte & Touche LLP

12 Statement of Cash Flows

JUDITHWEISS, CPA

13 Interim Financial Statements

ANTHONYJ MOTTOLA, CPA

Mottola & Associates, Inc.

14 Analyzing Financial Statements

GERALDI WHITE, CFA

Grace & White, Inc.

ASHWINPAULC SONDHI, PhD

A C Sondhi and Associates, LLC

15 Price-Change Reporting

PAULROSENFIELD, CPA

16 Cash and Investments

LUISE CABRERA, CPA

American Institute of Certified Public Accountants

17 Revenues and Receivables

ALANS GLAZER, PhD, CPA

Franklin & Marshall College

HENRYR JAENICKE, PhD, CPA

Drexel University

18 Inventory

RICHARDR JONES, CPA

Ernst & Young LLP

Ernst & Young LLP

19 Property, Plant, Equipment, and Depreciation

RICHARDH MOSELEY, CPA

American Express Tax and Business Services, Inc.

20 Goodwill and Other Intangible Assets

LAILANIMOODY, CPA, MBA

Grant Thornton LLP

21 Leases

Adler Consulting, Ltd.

22 Accounting for Income Taxes

E RAYMONDSIMPSON, CPA

Financial Accounting Standards Board

23 Liabilities

FREDERICKGILL, CPA

Senior Technical Manager

Accounting Standards Team

American Institute of Certified Public Accountants

24 Derivatives and Hedge Accounting

ROBERTL ROYALLII, CPA, CFA, MBA

Ernst & Young LLP

FRANCINEMELLORS, CPA

Ernst & Young LLP

25 Shareholders’ Equity

MARTINBENIS, PhD, CPA

The Stan Ross Department of Accountancy

Zicklin School of Business

Bernard M Baruch College, CUNY

26 Auditing Standards and Audit Reports

Clemson University

ALANJ WINTERS, PhD, CPA

Clemson University

VOLUME TWO: SPECIAL INDUSTRIES AND SPECIAL TOPICS

27 Oil, Gas, and Other Natural Resources

RICHARDP GRAFF, CPA

The Graff Consulting Group

JOSEPHB FEITEN, CPA

28 Real Estate and Construction

CLIFFORDH SCHWARTZ, CPA

PricewaterhouseCoopers LLP

SUZANNEMCELYEA, CPA

PricewaterhouseCoopers LLP

29 Financial Institutions

LAURAJ PHILLIPS, CPA

Ernst & Young LLP

MARKR ROUCHARD, CPA

Ernst & Young LLP

DALEK THOMPSON, CPA

Ernst & Young LLP

Ernst & Young LLP

KEITHM HOUSUM, CPA

Ernst & Young LLP

30 Producers or Distributors of Films

PAULROSENFIELD, CPA

31 Regulated Utilities

BENJAMINA MCKNIGHTIII, CPA

Arthur Andersen LLP, Retired

32 State and Local Government Accounting

ANDREWJ BLOSSOM, CPA

WARRENRUPPEL, CPA

DiTomasso & Ruppel, CPAs

33 Not-for-Profit Organizations

RONALDF RIES, CPA

American Express Tax and Business Services, Inc.

IANJ BENJAMIN, CPA

American Express Tax and Business Services, Inc.

34 Providers of Health Care Services

MARTHAGARNER, CPA

PricewaterhouseCoopers LLP

35 Accounting for Government Contracts

MARGARETM WORTHINGTON, CPA

36 Pension Plans and Other Postretirement and Postemployment Benefits

VINCENTAMOROSO, FSA

Deloitte & Touche LLP

Deloitte & Touche LLP

Deloitte & Touche LLP

37 Stock-Based Compensation

PETERT CHINGOS, CPA

Mercer Human Resources Consulting

WALTONT CONN, JR., CPA

39 Personal Financial Statements

DENNISS NEIER, CPA

Goldstein Golub Kessler LLP

JOELO STEINBERG, CPA

Goldstein Golub Kessler LLP

40 Partnerships and Joint Ventures

GERARDL YARNALL, CPA

Deloitte & Touche, LLP

RONALDJ PATTEN, PhD, CPA

DePaul University

41 Estates and Trusts

PHILIPM HERR, JD, CPA

Kingsbridge Financial Group, Inc.

42 Valuation of Nonpublic Companies

Allyn A Joyce & Co., Inc.

JACOBP ROOSMA, CPA

Williamette Management Associates

43 Bankruptcy

GRANTW NEWTON, PhD, CPA, CIRA

Pepperdine University

44 Forensic Accounting and Litigation Consulting Services

DENNISS NEIER, CPA

American Express Tax and Business Services, Inc.

MARGARETR KOLB, CPA

American Express Tax and Business Services, Inc.

Index

IMPORTANT NOTE:

Because of the rapidly changing nature of information in this field, this product may be

updated with annual supplements or with future editions Please call 1-877-762-2974

or email us at subscriber@wiley.com to receive any current update at no tional charge We will send on approval any future supplements or new editions when

addi-they become available If you purchased this product directly from John Wiley & Sons, Inc., we have already recorded your subscription for this update service.

CHAPTER 1

THE FRAMEWORK OF

FINANCIAL ACCOUNTING

CONCEPTS AND STANDARDS

Reed K Storey, PhD, CPA

Financial Accounting Standards Board

(a) The FASB and General Purpose

External Financial Accounting

(a) Special Committee on

Co-Operation with Stock

(i) “Accepted Principles of

(iii) Securities Acts and the

(d) The FASB Faces Defining

(i) Were They Assets?

Mr Storey wishes to acknowledge the assistance of Sylvia Storey, MBA, in the research for and ing of this chapter

writ-This chapter was updated from the Ninth Edition by the editors

1.1 FINANCIAL ACCOUNTING AND REPORTING

The principal role of financial accounting and reporting is to serve the public interest by providinginformation that is useful in making business and economic decisions That information facilitatesthe efficient functioning of capital and other markets, thereby promoting the efficient and equitableallocation of scarce resources in the economy To undertake and fulfill that role, financial account-ing in the twentieth century has evolved from a profession relying almost exclusively on the expe-rience of a handful of illustrious practitioners into one replete with a set of financial accountingstandards and an underlying conceptual foundation

An underlying structure of accounting concepts was deemed necessary to provide to the tions entrusted with setting accounting principles or standards the requisite tools for resolving ac-counting problems Financial accounting now has a foundation of fundamental concepts andobjectives in the Financial Accounting Standards Board’s “Conceptual Framework for FinancialAccounting and Reporting,” which is intended to provide a basis for developing the financial ac-counting standards that are promulgated to guide accounting practice

institu-The FASB’s conceptual framework and its antecedents constitute the major subject matter ofthis chapter Some significant terms, organizations, and authoritative pronouncements need to beidentified or briefly introduced They already may be familiar to most readers or will become so indue course

(a) THE FASB AND GENERAL PURPOSE EXTERNAL FINANCIAL ACCOUNTING AND

RE-PORTING Financial accounting and reporting is the familiar name of the branch of accounting

whose precise but somewhat imposing full proper name is general purpose external financial

ac-counting and reporting It is the branch of acac-counting concerned with general purpose financial

statements of business enterprises and not-for-profit organizations General purpose financial ments are possible because several groups, such as investors, creditors, and other resource providers,have common interests and common information needs General purpose financial reporting pro-vides information to users who are outside a business enterprise or not-for-profit organization and

state-(iii) An Overdose of Matching,

Nondistortion, and

(i) Information Useful in

Making Investment, Credit,

(ii) Representations of Things

and Events in the

lack the power to require the entity to supply the accounting information they need for decision ing; therefore, they must rely on information provided to them by the entity’s management Othergroups, such as taxing authorities and rate regulators, have specialized information needs but also theauthority to require entities to provide the information they specify.

mak-General purpose external financial reporting is the sphere of authority of the Financial

Ac-counting Standards Board, the private-sector organization that since 1973 has established ally accepted accounting principles in the United States General purpose external financial

gener-accounting and reporting provides information that is based on generally accepted gener-accountingprinciples and is audited by independent certified public accountants Generally accepted account-ing principles result and have resulted primarily from the authoritative pronouncements of theFASB and its predecessors

The FASB’s standards pronouncements—Statements of Financial Accounting Standards (oftenabbreviated FASB Statement, SFAS, or FAS) and FASB Interpretations (often abbreviated FIN)—

are recognized as authoritative by both the Securities and Exchange Commission and the American

Institute of Certified Public Accountants.

The FASB succeeded the Accounting Principles Board, whose authoritative pronouncements were the APB Opinions In 1959 the APB had succeeded the Committee on Accounting Proce-

dure, whose authoritative pronouncements were the Accounting Research Bulletins (often

abbre-viated ARB), some of which were designated as Accounting Terminology Bulletins (often

abbreviated ATB)

With respect to the long name “general purpose external financial reporting,” this chapter doeswhat the standards-setting bodies also have done: for convenience, it uses the shortcut term “finan-cial reporting.”

(b) MANAGEMENT ACCOUNTING AND TAX ACCOUNTING Financial accounting and

re-porting is only part of the broad field of accounting Other significant kinds of accounting includemanagement accounting and tax accounting

Management accounting is internal accounting designed to meet the information needs of agers Although the same accounting system usually accumulates, processes, and disseminates bothmanagement and financial accounting information, managers’ responsibilities for making decisionsand planning and controlling operations at various administrative levels of a business enterprise ornot-for-profit organization require more detailed information than is considered necessary or appro-priate for external financial reporting Management accounting includes information that is normallynot provided outside an organization and is usually tailored to meet specific management informa-tion needs

man-Tax accounting is concerned with providing appropriate information needed by individuals, porations, and others for preparing the various returns and reports required to comply with tax lawsand regulations, especially the Internal Revenue Code It is significant in the administration of do-mestic tax laws, which are to a large extent self-assessing Tax accounting is based generally on thesame procedures that apply to financial reporting There are some significant differences, however,and taxing authorities have the statutory power to prescribe the specific information they want tax-payers to submit as a basis for assessing the amount of income tax owed and do not need to rely oninformation provided to other groups

cor-1.2 WHY WE HAVE A CONCEPTUAL FRAMEWORK

“Accounting principles” has proven to be an extraordinarily elusive term To the nonaccountant (aswell as to many accountants) it connotes things basic and fundamental, of a sort which can be ex-pressed in few words, relatively timeless in nature, and in no way dependent upon changing fash-ions in business or the evolving needs of the investment community

The Wheat Report

Principle A general law or rule adopted or professed as a guide to action; a settled ground or basis

of conduct or practice

Accounting Research Bulletin No 7

A recurring theme in financial accounting in the United States in the twentieth century has

been the call for a comprehensive, authoritative statement of basic accounting principles It

has reflected a widespread perception that something more fundamental than rules or tions of methods or procedures was needed to form a basis for, explain, or govern financialaccounting and reporting practice A number of organizations, committees, and individuals inthe profession have developed or attempted to develop their own variations of what they have

descrip-diversely called principles, standards, conventions, rules, postulates, or concepts Those

ef-forts met with varying degrees of success, but by the 1970s none of the codifications or ments had come to be accepted or relied on in practice as the definitive statement ofaccounting’s basic principles

state-The pursuit of a statement of accounting principles has reflected two distinct schools of thought:that accounting principles are generalized or drawn from practice without reference to a systematictheoretical foundation or that accounting principles are based on a few fundamental premises that to-gether with the principles provide a framework for solving specific problems encountered in prac-tice Early efforts to codify or develop accounting principles were dominated by the belief thatprinciples are essentially a “distillation of experience,” a description generally attributed to George

O May, one of the most influential accountants of his time, who used it in the title of a book,

Finan-cial Accounting: A Distillation of Experience (1943).1However, as accounting has matured and itsrole in society has increased, momentum in developing accounting principles has shifted to those ac-countants who have come to understand what has been learned in many other fields: that reliance onexperience alone leads only so far because environments and problems change; that until knowledgegained through experience is given purpose, direction, and internal consistency by a conceptualfoundation, fundamentals will be endlessly reargued and practice blown in various directions by thewinds of changing perceptions and proliferating accounting methods; and that only by studying andunderstanding the foundations of practices can the path of progress be discovered and the hope ofimproving practice be realized

The conceptual framework project of the Financial Accounting Standards Board represents themost comprehensive effort thus far to establish a structure of objectives and fundamentals to under-lie financial accounting and reporting practice To understand what it is, how it came about, and why

it took the form and included the concepts that it did requires some knowledge of its antecedents,which extend back more than 60 years

(a) SPECIAL COMMITTEE ON CO-OPERATION WITH STOCK EXCHANGES. The origin

of the use of principle in financial accounting and reporting can be traced to a special committee

of the American Institute of Accountants (American Institute of Certified Public Accountantssince 1957) The Special Committee on Co-operation with Stock Exchanges, chaired by George

O May, gave the word special significance in the attest function of accountants That significance

is still evident in audit reports signed by members of the Institute and most other CPAs attestingthat the financial statements of their clients present fairly, or do not present fairly, the client’s fi-nancial position, results of operations, and cash flows “in conformity with generally accepted ac-counting principles.” The committee laid the foundation that has been the basis of bothsubsequent progress in identifying or developing and enunciating accounting principles andmany of the problems that have accompanied the resulting principles

1George O May, Financial Accounting: A Distillation of Experience (New York: The Macmillan

Company, 1943)

In 1930 the Institute undertook a cooperative effort with the New York Stock Exchangeaimed at improving financial disclosure by publicly held enterprises It was widely believedthat inferior accounting and reporting practices had contributed to the stock market decline anddepression that began in 1929 The Exchange was concerned that its listed companies wereusing too many different accounting and reporting methods to reflect similar transactions andthat some of those methods were questionable The Institute wanted to make financial state-ments more informative and authoritative, to clarify the authority and responsibility of audi-tors, and to educate the public about the conventional nature of accounting and the limitations

of accounting reports

The Exchange’s Committee on Stock List and the Institute’s Special Committee on operation with Stock Exchanges exchanged correspondence between 1932 and 1934 The specialcommittee’s report, comprising a series of letters that passed between the two committees, was issued

Co-to Institute members in 1934 under the title, Audits of Corporate Accounts (reprinted in 1963) The

key part was a letter dated September 22, 1932, from the Institute committee

(i) “Accepted Principles of Accounting.” The special committee recommended that an

authori-tative statement of the broad accounting principles on which “there is a fairly general agreement” beformulated in consultation with a small group of qualified persons, including accountants, lawyers, andcorporate officials Within that framework of “accepted principles of accounting,” each companywould be free to choose the methods and procedures most appropriate for its financial statements, sub-ject to requirements to disclose the methods it was using and to apply them consistently Audit certifi-cates (reports) for listed companies would state that their financial statements were prepared inaccordance with “accepted principles of accounting.” The special committee anticipated that its pro-gram would improve financial reporting because disclosure would create pressure from public opinion

to eliminate less-desirable practices

The special committee did not define “principles of accounting,” but it illustrated what it had inmind It gave two explicit examples of accepted broad principles of accounting:

It is a generally accepted principle that plant value should be charged against gross profits over theuseful life of the plant

Again, the most commonly accepted method of stating inventories is at cost or market, whichever

is lower .2

It also listed five principles that it presumed would be included in the contemplated statement of

“broad principles of accounting which have won fairly general acceptance”:

1 Unrealized profit should not be credited to income account of the corporation either directly or

indirectly, through the medium of charging against such unrealized profits amounts whichwould ordinarily fall to be charged against income account Profit is deemed to be realizedwhen a sale in the ordinary course of business is effected, unless the circumstances are suchthat the collection of the sale price is not reasonably assured An exception to the general rulemay be made [for industries in which trade custom is to take inventories at net selling prices,which may exceed cost]

2Audits of Corporate Accounts: Correspondence between the Special Committee on Co-operation with Stock Exchanges of the American Institute of Accountants and the Committee on Stock List of the New York Stock Exchange, 1932–1934 (New York: American Institute of Accountants, 1934), p 7 [Reprinted (New

York: American Institute of Certified Public Accountants, 1963), and in Stephen A Zeff, Forging

Account-ing Principles in Five Countries: A History and an Analysis of Trends (Champaign, IL: Stipes PublishAccount-ing

Company, 1972), pp 237–247.]

2 Capital surplus [other paid-in capital], however created, should not be used to relieve the

income account of the current or future years of charges which would otherwise fall to bemade thereagainst This rule might be subject to the exception that [permits use of quasi-reorganization]

3 Earned surplus [retained earnings] of a subsidiary company created prior to acquisition does

not form a part of the consolidated earned surplus of the parent company and subsidiaries; norcan any dividend declared out of such surplus properly be credited to the income account ofthe parent company

4 While it is perhaps in some circumstances permissible to show stock of a corporation held in

its own treasury as an asset, if adequately disclosed, the dividends on stock so held should not

be treated as a credit to the income account of the company

5 Notes or accounts receivable due from officers, employees, or affiliated companies must be

shown separately and not included under a general heading such as Notes Receivable or

The Institute submitted the committee’s five principles for acceptance by its members in 1934,

and they are now in ARB No 43, Restatement and Revision of Accounting Research Bulletins (issued

1953), Chapter 1A, “Rules Adopted by Membership” (paragraphs 1–5)

The special committee’s use of the word “principle” set the stage not only for the Institute’s forts to identify “accepted principles of accounting” but also for future confusion and controversyover what accountants mean when they use the word “principle.”

ef-But Were They “Principles”? The special committee’s examples of broad principles of counting were much less fundamental, timeless, and comprehensive than what most people per-ceive to be principles They had little or nothing in them that made them more basic or lessconcrete than conventions or rules Moreover, the special committee itself referred to them asrules in describing exceptions to them, the Institute characterized them as rules in submitting themfor approval by its members, and the chairman of the special committee later conceded that theywere nothing more than rules:

ac-When the committee undertook to lay down some of the basic principles of modern accounting,

it found itself unable to suggest more than half a dozen which could be regarded as generally ceptable, and even those were rules rather than principles, and were, moreover, admittedly subject

ac-to exception.4

Not surprisingly, the special committee’s use of the word “principles” was soon challenged

In a contest sponsored by the Institute for its fiftieth anniversary celebration in 1937, Gilbert

R Byrne’s essay entitled “To What Extent Can the Practice of Accounting Be Reduced to Rulesand Standards?” won first prize for the best answer to the question posed in the title He com-plained about accountants’ propensity to downgrade principle by equating it with terms such as

“rule,” “convention,” and “procedure.”

[R]ecent discussions have used the term “accounting principles” to cover a conglomeration of counting practices, procedures, conventions, etc.; many, if not most, so-called “principles” maymerely have to do with methods of presenting items on financial statements or technique of audit-ing, rather than matters of fundamental accounting principle.5

ac-3Audits of Corporate Accounts, p 14 Lengthy exceptions in items 1 and 2 are summarized rather than

quoted in full

4George O May, “Improvement in Financial Accounts,” The Journal of Accountancy, May 1937, p 335.

5Gilbert R Byrne, “To What Extent Can the Practice of Accounting Be Reduced to Rules and

Stan-dards?” The Journal of Accountancy, November 1937, p 366 [Reprinted in Maurice Moonitz and

A C Littleton, eds., Significant Accounting Essays (Englewood Cliffs, NJ: Prentice-Hall, Inc., 1965),

pp 103–115.]

Stephen Gilman made the same point in his careful analysis of terms in five chapters of his book,

Accounting Concepts of Profit.

With sublime disregard of lexicography, accountants speak of “principles,” “tenets,” “doctrines,”

“rules,” and “conventions” as if they were synonymous.6

Gilman also quoted an excerpt from the Century Dictionary that he thought pertinent “because

of the confusion noted in some accounting writings [about] the distinction between ‘principle’and ‘rule’”:

There are no two words in the English language used so confusedly one for the other as the words

rule and principle You can make a rule; you cannot make a principle; you can lay down a rule; you

cannot, properly speaking, lay down a principle It is laid down for you You can establish a rule; you cannot, properly speaking, establish a principle You can only declare it Rules are within your power, principles are not A principle lies back of both rules and precepts; it is a general truth, need-

ing interpretation and application to particular cases.7

Byrne, Gilman, and others pointed out that the form of accountant’s report recommended bythe special committee made accountants look foolish by requiring them to express opinionsbased on the existence of principles they actually could not specify In that form of report, an ac-

countant expressed the opinion that a client’s financial statement is “fairly present, in

accor-dance with accepted principles of accounting consistently maintained by the company during the year under review, its position and the results of its operations ” According to

Byrne, that opinion presumed that accepted principles of accounting actually existed and countants in general knew and agreed on what they were In fact, “While there have been sev-eral attempts to enumerate [those principles], to date there has been no statement upon which

That diagnosis was confirmed by Gilman as well as by Howard C Greer:

the entire body of precedent [the “accepted principles of accounting”] has been taken forgranted

It is as though each accountant felt that while he himself had never taken the time nor the ble to make an actual list of accounting principles, he was comfortably certain that someone elsehad done so

trou-[T]he accountants are in the unenviable position of having committed themselves in their cates [reports] as to the existence of generally accepted accounting principles while between them-selves they are quarreling as to whether there are any accounting principles and if there are howmany of them should be recognized and accepted.9

certifi-There is something incongruous about the outpouring of thousands of accountants’ cates [reports] which refer to accepted accounting principles, and a situation in which no onecan discover or state what those accepted accounting principles are The layman cannotunderstand.10

certifi-Byrne argued that lack of agreement on what constituted accepted accounting principlesresulted “in large part because there is no clear distinction, in the minds of many, between thatbody of fundamental truths underlying the philosophy of accounts which are properly thought

of as principles, and the larger body of accounting rules, practices and conventions which

6Stephen Gilman, Accounting Concepts of Profit (New York: The Ronald Press Company, 1939), p 169.

7Gilman, Accounting Concepts of Profit, p 188.

8Byrne, “To What Extent Can the Practice of Accounting Be Reduced to Rules and Standards?” p 368

9Gilman, Accounting Concepts of Profit, pp 169 and 171.

March 1938, p 25

derive from principles, but which of themselves are not principles.”11His prescription for countants was to use “principle” in its most commonly understood sense of being more fun-damental and enduring than rules and conventions.

ac-If accounting, as an organized body of knowledge, has validity, it must rest upon a body of ples, in the sense defined in Webster’s New International Dictionary:

princi-“A fundamental truth; a comprehensive law or doctrine, from which others are derived, or onwhich others are founded; a general truth; an elementary proposition or fundamental assump-tion; a maxim; an axiom; a postulate.”

Accounting principles, then, are the fundamental concepts on which accounting, as an organizedbody of knowledge, rests [T]hey are the foundation upon which the superstructure of account-ing rules, practices and conventions is built.12

Gilman, in contrast, could find no principles that fit Byrne’s definition He concluded that most, ifnot all, of the propositions that had been put forth as principles of accounting should be relabeled “as

that there were no accounting principles in the fundamental sense and to waste no more time and fort on attempts to identify and state them

ef-May’s Attempts to Rectify “Considerable Misunderstanding.” In several articles and abook, George O May responded to those and other criticisms of “accounting principles” andexplained what the special committee, as well as several other Institute committees of which

he was chairman, had done and why He detected, in the criticisms and elsewhere, what he scribed as “considerable misunderstanding” of both the nature of financial accounting and thecommittees’ work on accounting principles and thought it necessary to get the matter back onthe right track

de-Although he acknowledged that “in the correspondence the [special] Committee had used

consid-ered questions such as whether the propositions should be called rules or principles not to bematters “of any real importance.” As Byrne had pointed out, if there were any principles thatfit his definition, “they must be few in number and extremely general in character (such as

more concrete principles illustrated by the special committee Those who scolded the specialcommittee for misusing “principles” had apparently forgotten that “accounting rules and prin-

May urged the profession and others to focus efforts to improve financial accounting, as had thespecial committee, on the questions “of real importance”—the consequences of the necessarily con-ventional nature of accounting and the limitations of accounting reports He explained the philoso-phy underlying the recommendation of the special committee and summarized that philosophy in theintroductory pages of his book:

In 1926, I decided to relinquish my administrative duties and devote a large part of mytime to consideration of the broader aspects of accounting As a result of that study I becameconvinced that a sound accounting structure could not be built until misconceptions had been

11Byrne, “To What Extent Can the Practice of Accounting Be Reduced to Rules and Standards?” p 368

12Byrne, “To What Extent Can the Practice of Accounting Be Reduced to Rules and Standards?” pp 368and 372

13Gilman, Accounting Concepts of Profit, p 257.

14May, Financial Accounting, p 42.

15George O May, “Principles of Accounting,” The Journal of Accountancy, December 1937, p 424 [The

article was a comment on Byrne’s essay.]

16George O May, “Terminology of the Balance Sheet,” The Journal of Accountancy, January 1942, p 35.

cleared away, and the nature of the accounting process and the limitations on the significance

of the financial statements which it produced were more frankly recognized

It became clear to me that general acceptance of the fact that accounting was utilitarian and based

on conventions (some of which were necessarily of doubtful correspondence with fact) was an dispensable preliminary to real progress

in-Many accountants were reluctant to admit that accounting was based on nothing of a higherorder of sanctity than conventions However, it is apparent that this is necessarily true of ac-counting as it is, for instance, of business law In these fields there are no principles, in thefundamental sense of that word, on which we can build; and the distinctions between laws,rules, standards, and conventions lie not in their nature but in the kind of sanctions by whichthey are enforced Accounting procedures have in the main been the result of common agree-ment between accountants .17

He also reiterated and amplified a number of points the special committee had emphasized

in Audits of Corporate Accounts concerning what the investing public already knew or should

understand about financial accounting and reporting, such as, that because the value of a ness depended mainly on its earning capacity, the income statement was more important thanthe balance sheet and should indicate to the fullest extent possible the earning capacity of thebusiness during the period on which it reported; that because the balance sheet of a large mod-ern corporation was to a large extent historical and conventional, largely comprising the resid-ual amounts of expenditures or receipts after first determining a proper charge or credit to theincome account for the year, it did not, and should not be expected to, represent an attempt toshow the present values of the assets and liabilities of the corporation; and that because finan-cial accounting and reporting was necessarily conventional, some variety in accounting meth-ods was inevitable

busi-The Special Committee’s Definition of “Principle.” May not only identified the definition

of “principle” the special committee had used but also explained why it had chosen that ular meaning In his comment on Byrne’s essay, he recalled the committee’s discussion andsearching of dictionaries before choosing the “perhaps rather magniloquent word ‘princi-

partic-ple’ in preference to the humbler ‘rule.’” The definition of “principle” in the Oxford English

Dictionary that came closest to defining the sense in which the special committee used the word

was the seventh definition:

A general law or rule adopted or professed as a guide to action; a settled ground or basis of conduct

or practice

The time and effort spent in searching dictionaries was fruitful—the committee found exactly the finition for which it was looking:

de-[The] sense of the word “principle” above quoted seemed to fit the case perfectly

Examina-tion of the report as a whole will make clear what the committee contemplated; namely, that each

corporation should have a code of “laws or rules, adopted or professed, as a guide to action,” and

that the accountants should report, first, whether this code conformed to accepted usages, and ondly, whether it had been consistently maintained and applied.18

sec-Thus, the special committee opted for the lofty “principle” rather than the more precise “rule” or

“convention” because the definition that best fit the committee’s needs was a definition of ple,” albeit an obscure one, not a definition of “rule” or “convention.” Moreover, “rule” and “con-vention” carried unfortunate baggage:

“princi-[The] word “rules” implied the existence of a ruling body which did not exist; the word vention” was regarded as not appropriate for popular use and in the opinion of some would

“con-17May, Financial Accounting, pp 2 and 3.

18May, “Principles of Accounting,” pp 423 and 424, emphasis added

not convey an adequate impression of the authority of the precepts by which the accountswere judged.19

Whereas “principle” conveyed desirable implications:

It used to be not uncommon for the accountant who had been unable to persuade his client toadopt the accounting treatment that he favored, to urge as a last resort that it was called for by

“accounting principles.” Often he would have had difficulty in defining the “principle” andsaying how, why, and when it became one But the method was effective, especially in deal-ing with those (of whom there were many) who regarded accounting as an esoteric but wellestablished body of learning and chose to bow to its authority rather than display their igno-rance of its rules Obviously, the word “principle” was an essential part of the technique;

“convention” would have been quite ineffective.20

Rules were elevated into principles because the committee thought it necessary to use a wordwith the force or power of “principle” to prevent the auditor’s authority from being lost on the client

(ii) The Best Laid Schemes. The special committee’s program focused on what individuallisted companies and their auditors would do Each corporation would choose from “acceptedprinciples of accounting” its own code of “laws or rules, adopted or professed, as a guide to ac-tion” and within that framework would be free to choose the methods and procedures most ap-propriate for its financial statements but would disclose the methods it was using and wouldapply them consistently An auditor’s report would include an opinion on whether or not eachcorporation’s code consisted of accepted principles of accounting and was applied consistently.The Stock Exchange would enforce the program by requiring each listed corporation to comply

in order to keep its listing

The Institute was to sponsor or lead an effort in which accountants, lawyers, corporate cials, and other “qualified persons” would formulate a statement of “accepted principles of ac-counting” to guide listed companies and auditors, but it was not to get into the business ofspecifying those principles The special committee had explicitly considered and rejected “the se-lection by competent authority out of the body of acceptable methods in vogue today [the] de-tailed sets of rules which would become binding on all corporations of a given class.” The specialcommittee also had avoided using “rule” because the word implied a rule-setting body that didnot exist, and it had no intention of imposing on anyone what it considered to be an unnecessaryand impossible burden “Within quite wide limits, it is relatively unimportant to the investor whatprecise rules or conventions are adopted by a corporation in reporting its earnings if he knows

Moreover, the committee felt that no single body could adequately assess and allow for the ing characteristics of individual corporations, and the choice of which detailed methods best fit acorporation’s circumstances thus was best left to each corporation and its auditors Because fi-nancial accounting was essentially conventional and required estimates and allocations of costsand revenues to periods, the utility of the resulting financial statements inevitably depended sig-nificantly on the competence, judgment, and integrity of corporate management and independentauditors Although there had been a few instances of breach of trust or abuse of investors, thecommittee had confidence in the trustworthiness of the great majority of those responsible for fi-nancial accounting and reporting

vary-In the end, the special committee’s recommendations were never fully implemented.Nonaccountants were not invited to participate in developing a statement of accepted account-ing principles In fact, although the Institute submitted the special committee’s five principlesfor acceptance by its members, it attempted no formulation of a statement of broad principles,

19May, Financial Accounting, p 42.

20May, Financial Accounting, p 37.

21Audits of Corporate Accounts, pp 8 and 9.

even by accountants Nor did the Exchange require its listed companies to disclose their counting methods.

ac-The Special Committee’s Heritage ac-The only recommendation to survive was that each company

should be permitted to choose its own accounting methods within a framework of “accepted ples of accounting.” The committee’s definition of “principle” also survived, and “accepted princi-ples of accounting” became “generally accepted.”

princi-The special committee’s definition of “principle”—“A general law or rule adopted or fessed as a guide to action; a settled ground or basis of conduct or practice”—was incorporated

pro-verbatim in Accounting Research Bulletin No 7, Report of the Committee on Terminology (George O May, chairman), in 1940, but it was attributed to the New English Dictionary rather than to the Oxford English Dictionary When Accounting Research Bulletins 1 to 42 were re-

stated and revised in 1953, the same definition of “principle,” by then attributed only to

“Dictio-naries,” was carried over to Accounting Terminology Bulletin No 1, Review and Résumé.

“Generally” was added to the special committee’s “accepted principles of accounting” in

Examination of Financial Statements by Independent Public Accountants, published by the

In-stitute in 1936 as a revision of an auditing publication, Verification of Financial Statements

(1929) According to its chairman, Samuel J Broad, the revision committee inserted ally” to answer questions such as “ accepted by whom? business? professional accountants?the SEC? I heard of one accountant who claimed that if a principle was accepted by him and a

In retrospect, the legacy of institutionalizing that definition of “principle” has been that theterms “principle,” “rule,” “convention,” “procedure,” and “method” have been used interchange-ably, and imprecise and inconsistent usage has hampered the development and acceptance of subse-quent efforts to establish accounting principles Moreover, within the context of so broad adefinition of “principle,” the combination of the latitude given management in choosing accountingmethods, the failure to incorporate into financial accounting and reporting the discipline that wouldhave been imposed by the profession’s adopting a few, broad, accepted accounting principles, and thefailure to enforce the requirement that companies disclose their accounting methods gave refuge tothe continuing use of many different methods and procedures, all justified as “generally acceptedprinciples of accounting,” and encouraged the proliferation of even more “generally accepted” ac-counting methods

Finally, despite the reluctance of the Institute to become involved in setting principles orrules, it eventually assumed that responsibility after the U.S Securities and Exchange Com-mission was created

(iii) Securities Acts and the SEC—“Substantial Authoritative Support.” The SecuritiesExchange Act of 1934 established the Securities and Exchange Commission and gave it au-thority to prescribe accounting and auditing practices to be used by companies in the financialreports required of them under that Act and the Securities Act of 1933 The SEC, like theStock Exchange before it, became increasingly concerned about the variety of accountingpractices approved by auditors Carman G Blough, first Chief Accountant of the SEC, told around-table session at the Institute’s 50th anniversary celebration in 1937 that unless the pro-fession took steps to develop a set of accounting principles and reduce the areas of difference

in accounting practice, “the determination of accounting principles and methods used in ports to the Commission would devolve on the Commission itself The message to the profes-

In April 1938, the Chief Accountant issued Accounting Series Release No 4, Administrative

Policy on Financial Statements, requiring registrants to use only accounting principles having

22Zeff, Forging Accounting Principles in Five Countries, p 129.

23Zeff, Forging Accounting Principles in Five Countries, p 134.