“This is as good a place as any for a comment on accounting for the investment credit. As nearly everybody undoubtedly knows from the recent news releases on the subject, the problem of the appropriate accounting for the investment credit under the Revenue Act of 1962 evoked a great deal of discussion and sharp differences of opinion in professional accounting and business circles.”
- March 23, 1963 Financial Statements – How Reliable? – Address by Andrew Barr, SEC Chief Accountant
In 1962, the Accounting Principles Board (APB) and the SEC had their first serious encounter with politics and the setting of accounting standards. They proved ill-prepared to deal with the reaction to accounting that was considered as inconsistent with political objectives.
The Revenue Act of 1962 included a measure sponsored by the Kennedy administration to encourage capital investment and thus spur economic growth. It provided for an investment tax credit (ITC) which reduced income taxes by a specified percentage of the cost of new equipment and machinery. For tax purposes, the ITC reduced the basis of the property that gave rise to the credit.
The accounting question was whether the ITC should be fully recognized in earnings in the year of the credit or, consistent with the tax treatment, reduce the depreciable cost of the property. Either way, the ITC found its way to earnings. However, the former method (flow-through) affected earnings immediately, whereas the cost reduction (deferred) method trickled the effect of the credit into earnings over the depreciable life of the property.
To provide guidance for 1962 financial statements, the APB hurried to issue APB Opinion No. 2 in December 1962. The APB opted for the cost reduction (deferred) method, to the dismay of many in both government and industry.
Opinion No. 2 was crippled from the start because four of the then “Big 8” firm members dissented, with three of them announcing that their firms would not follow the Opinion, believing they could justify the departure. That was followed by howls from both government and industry that the incentive to make capital investments would be diminished if the credit could not be reflected in profits in the year of the investment. In January 1963, the SEC announced in Accounting Series release (ASR) No. 96 that it would accept either method of accounting for the ITC. APB Opinion No. 2 was effectively dead on arrival.
ASR No. 96 was a significant body blow to the APB and private sector standard setting. The APB would not again issue an Opinion with important members vowing not to follow it. The Revenue Act of 1964 eliminated the basis reduction in the 1962 Act, further eroding the cost reduction concept of APB No. 2.
In March 1964, recognizing that general acceptability is fundamental to the authority of its Opinions, the APB acknowledged that the flow-through method is acceptable. In a stinging dissent, Board member Leonard Spacek said that he found no words of concern for the investor by either the Board or the SEC. He complained that the APB had approved “accounting of the type that precipitated the 1929 financial crisis, and that history is being repeated by actions of the very authorities created to prevent such catastrophes.”(26)
The APB tried in vain again when the ITC was reintroduced in 1967 and in 1971, finally relenting when Congress intervened and included a provision in the Revenue Act of 1971 that no taxpayer should be required to use any particular method of accounting for the credit in financial statements subject to regulation by a federal agency.
(26) March 1964 APB Opinion No. 4 (Amending No. 2), Accounting for the “Investment Credit.”
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