HA History of Accounting in America: An Historical Interpretaton of the Cultural Significance of Accounting

The Eternal Debate Over Conservatism and Prudence: A Historical Perspective on the Conceptualization of Asymmetry in Financial Accounting Theory*

“…The banks demanded conservatively determined accounting figures as protection against inflated collateral values and excessive dividend payments (Chatfield 1977, 72, 127, 233). Hence, the early balance sheet was prepared as a “cash statistic” (Previts and Merino 1998, 125), which mainly provided lenders with information on liquidity and debt repayment ability rather than earnings power (Littleton and Zimmerman 1962, 92–95; Chatfield 1977, 72). Furthermore, US accounting practice at that time was deeply influenced by the British practice (Murphy 1961; Chatfield 1977, 150–51), in which asymmetric accounting procedures had been well established since the middle of the 19th century (Maltby 2000; Napier 2010; J. R. Edwards and Boyns 2022).…”

“…The rise of financial capitalism since the late 19th century, which involved the separation of ownership and control (Previts and Merino 1998, 183), made financial reporting information—which was broadly voluntarily published at the discretion of corporate managers (Chatfield and Vangermeersch 1996, 140–41)—the central basis for investment decisions (Smith and Sylla 1993; Moehrle and Reynold‐Moehrle 2011, 108–10). A wave of corporate abuses and trust failures in the 1890s, however, revealed the “eroded … moral base” (Berle 1963, cited in Previts and Merino 1998, 183) brought about by financial capitalism and the risks of unregulated financial reporting (Previts and Merino 1998, 182–84). This prompted calls for stronger governmental intervention to improve corporations' financial reporting; however, in the liberal environment, this was only hesitantly taken up until the federal regulations of the 1930s (Littleton and Zimmerman 1962, 94, 98–99; Hawkins 1963; Previts and Merino 1998, 182–87).…”

“…A wave of corporate abuses and trust failures in the 1890s, however, revealed the “eroded … moral base” (Berle 1963, cited in Previts and Merino 1998, 183) brought about by financial capitalism and the risks of unregulated financial reporting (Previts and Merino 1998, 182–84). This prompted calls for stronger governmental intervention to improve corporations' financial reporting; however, in the liberal environment, this was only hesitantly taken up until the federal regulations of the 1930s (Littleton and Zimmerman 1962, 94, 98–99; Hawkins 1963; Previts and Merino 1998, 182–87).…”

“…For instance, Hatfield, who was a leading pioneer in the theorization of financial accounting, was initially willing to accept the need for asymmetry due to the “incurably optimistic” nature of humankind when justifying why internally generated goodwill should not be included in the balance sheet (Hatfield 1909, 108–9), and regarded an “undervaluation of certain assets” as adequate if it “is merely an attempt to secure a more truthful conspectus of the entire situation” (Hatfield 1909, 84). On the same grounds, Montgomery, in one of his early pieces, advocated the asymmetric lower‐of‐cost‐or‐market principle, which requires the recording of losses from declining market prices, but prohibits the recognition of gains when market prices increase, asserting that “conservatism in valuation of assets, especially in inventory is the safest course since one could otherwise deceive both the banker and the creditor” (Montgomery 1912, cited in Previts and Merino 1998, 220; emphasis added) 13 . Hence, we observe that the FinAT literature started to develop forays into a new construct of asymmetry under the label of “conservatism”—that is, the notion of specified asymmetry .…”

“…However, when a short period of deteriorating prices (deflation) at the beginning of the 1920s 15 led firms to increasingly rely on capital markets for their financing (Littleton and Zimmerman 1962, 95–96), FinAT also began to challenge specific asymmetric accounting treatments (Previts and Merino 1998, 259–61). Since the purpose of financial reporting was now widely perceived as providing information to shareholders and investors rather than to creditors (Ripley 1926; Hoxsey 1930, 251–52; May 1953, 19–25), the determination of income was now regarded as the focal task of accounting to assess the firm's earning power (Littleton and Zimmerman 1962, 96–97).…”