Search

Whether advertising is an investment and so should be treated like other parts of the capital budget is a question of moment to marketing managers. Viewing promotion as an investment could bring dramatic changes in decision-making, market-testing, measurements of effectiveness, and value judgments that are required in determining how much to spend on promotion. The economic case for an investment approach to the advertising budget is the theme of this article by a distinguished economist. [ABSTRACT FROM AUTHOR]

This article discusses the estimation theory in financial accounting, considering the single-asset situation which is the norm of most modern accounting theory. The authors argue that estimation theory is a practical model for handling multi-asset estimation problems, and they discuss the estimating horizon and allocation schemes in a decision-theory framework. The author discuss the problem with the estimating theory--predicting the future cash flows and internal rate of return, and consider the estimation procedure by assuming certainty about the future.

The article discusses the public disclosure of accounting information. A book called "The Allocation Problem in Financial Accounting Theory," by Arthur L. Thomas provides the backbone of the author's criticism on financial data reporting. Thomas promotes the idea of using market value oriented reports as a solution to allocation problems. A book by Lloyd R. Amey, which is called "The Efficiency of Business Enterprise," focuses on business efficiency and also discusses the matter of providing accounting information to investors.

This article examines the relationship between the accounting and internal rate of return measures. The authors attempt to synthesize the independent studies within the field in order to analyze a basic set of internal rate of return (IRR) and various measures of accounting rate of return (ARR) relationships. The authors feel that it is not sufficient to study the effects of the variables one at a time because these variables are known to interact. Also, they have found that a constant reinvestment rate lends itself to a constant gross investment growth rate.

The article analyzes the implications of portfolio theory in accounting. The authors state that three general areas are discussed in the article, namely capital budgeting, divisional planning and reporting, and external reporting. They state that they explain that the normative implications of portfolio theory for capital budgeting are important and state that it is clear that the required rate of return on an investment will differ according to risk. The authors believe that there is no point in applying the same rate of return criterion to all projects unless they carry identical risk.

The article discusses the long-term credit determined through financial ratios and reports on the paper "The Determination of Long-Term Credit Standing with Financial Ratios," by James O. Horrigan. Horrigan states, in his paper, that the best variable of an independent nature in the study of default risk is one which can be scaled on a continuum which ranges from certain repayment through certain default; however, he says such a variable does not exist. The author believes an alternative measure of default risk may very well be bond yields or the risk premium on bonds.

Although many different kinds of techniques can aid in the more effective allocation of marketing effort, renewed interest has recently been shown in the possible contribution of tools developed in the functional areas of accounting and finance. The nature, areas of application, and limitations of some of these profit-oriented aids to decision making and control are discussed in this article. [ABSTRACT FROM AUTHOR]

An accurate price forecast is crucial when deciding on a new investment proposal for capital intensive commodities. In such industries as metals, plastics, and fertilizers, the sale price is the key profitability factor. New investments are too often based on specious forecasts which use historical price trends to predict the future. Another way to forecast prices which can provide more meaningful results is presented in the article. [ABSTRACT FROM AUTHOR]

The article attempts to provide empirical evidence on the information content of accounting numbers. The author states that estimates of systematic variability conditional upon market price data were gathered via the market model. He explains that analogous linear models were applied to accounting income numbers. He states that the documented income number series associated with a firm's operations can be treated in a manner that is similar to the manner in which the market model treats market-determined rates of return.

The article presents a commentary on the article "An Empirical Study of the Cost of Convertible Securities," by Peter H. Knutson. The author acknowledges that the market value of convertibles is not determined solely by the nominal rate of return. He notes that the market value of convertibles is influenced by present and expected future earnings in the same way that common stock is influenced. The author agrees with Knutson that earnings per share and cost of convertibles are often misstated. He disagrees with Knutson's real cost theory.

The authors describe how management might approach the problem of systematically measuring the effects of certain long-range promotional activities. Little published research exists on this widely discussed topic. A mini-case study is presented describing the approach taken by Anheuser-Busch management regarding specific aspects of the promotional measurement problem. [ABSTRACT FROM AUTHOR]

This article discusses the accounting practices that contributed to the imperfection of securities market. Accounting reports are sources of financial information on the present position and past performance of individual firms according to the author where investors can calculate the rate of return on total assets employed in the firm's operations and the rate of return on shareholder's equity. Evidence is presented to show that accounting reports do not necessarily represent the position and performance of firms and that audit reports are ambiguous indicators of the quality of accounting information.

Focuses on the concept of accounting based on the book 'The Economic Theory of the Location of Railways,' by A.M. Wellington. Use of the concept of rate of return on investment; Discussion on the profitability of investment in railways; Illustrative examples. [ABSTRACT FROM AUTHOR]

The article examines the use of the concept of the rate of return on capital in accounting. The use of the concept has a long history. The post-war growth of awareness of and literature on the subject is symptomatic of a changing attitude of accountants away from bookkeeping and towards an operational understanding. Contemporary accounting authors acknowledge the fact that similar methods have been used throughout the financial community for computing bond yields, insurance premiums and rates on leased facilities. However, the author of this article finds little reference in accounting literature to the debt that is owed to engineers and economists who wrote about this topic in the late nineteenth century and prior to the Second World War. Alfred Marshall, the eminent economist, discussed the concept in his principles. Possibly recent writers on capital budgeting have been too engrossed in the constant money value convention. The so-called cut off point is also explicitly mentioned by Marshall. The entrepreneur will push investment of capital until there seems to him no good reason for thinking that the gains resulting from any further investment in that particular direction would compensate him for his outlay.

The uses of regression analysis to estimate market yield curves for U. S. Government securities are considered in this paper. Several possible regression models for this purpose are examined. It is found that models which regress either the before-tax yield or the after-tax yield of governments on the number of days remaining to maturity and the square of the logarithm of the number of days remaining to maturity can fruitfully be applied to actual market data in determining yield curves. [ABSTRACT FROM AUTHOR]

Discrete optimization subject to one constraint is attacked by Lagrangian analysis. Incremental allocation schemes are given that generate undominated allocations. In an important special case, the complete family of undominated allocations is generated. [ABSTRACT FROM AUTHOR]

This article presents a reply to a comment on the efficiency of corporate investment. The comment by I. Friend and F. Husic (F-H) makes a valuable contribution by calling attention to two problems in authors' paper, "Earnings Retention, New Capital, and the Growth of the Firm." Friend and Husic deflate our equations by the book value of assets. For a variety of reasons the book value of assets bears little relation to the size of the company. Such factors as the use of accelerated amortization, pooling-of-interest accounting for mergers, and various book write-ups and write-offs make the asset value on the books a rather irrelevant figure for judging the size of the company. A much more reasonable figure is the market value of assets, which may be determined by simply taking the number of shares of equity and multiplying by the price per share. This gives the market value of the company's equity or, what is the same thing, the company's net assets at market value. F-H argue that authors should look at the group of companies that issued new equity in more than minimal amounts. When this is done, the three estimated rates of return are approximately equal, and the estimated rate of return to blowback is raised to quite respectable levels.

This article presents information on some empirical result related to tax allocation and depreciation methods. The evidence indicated that deferral earnings had the highest association with security price changes. This unexpected finding is consistent with two rather different interpretations, either the market is efficient and deferral earnings is more consistent with the underlying information set impounded in security prices, or the market is inefficient in the sense that security prices reflect only the very narrow set of reported earnings numbers. Being intolerant of ambiguity, we conducted a further analysis, which attempts to explain a result we felt to be anomalous. In fact, the ratio will be equal to the internal rate of return on the asset. The analysis reported here discards the currently prevailing views of deferred taxes as a deferred credit or deferred liability and treats tax allocation arising out of differing depreciation methods for tax and reporting purposes as a form of depreciation.

The article highlights the report of the Committee on Corporate Financial Reporting of the American Accounting Association. The charge of this committee is to identify, examine, and report contemporary problems in financial reporting; to recommend appropriate research projects as well as to critically evaluate both organized and individual proposals for research on financial reporting, and to issue broad position statements in specific areas when appropriate. In this approach, accounting data are used to attach subjective probabilities to previously developed quantitative estimates of relevant variables. For example, past turnover data, gross margin percentages, or rates of return on investment are calculated because they are thought to reflect managerial efficiency. Some take the position that changes in value of bonds held as long-term investments are irrelevant to the income of the holder of the bond if the changes are caused by changes in market interest rates. They point out that although the changes in interest rates affect the current market price of the bond, they do not affect the amounts or the timing of the future cash flows expected by the bond holder. Meaningfulness, like relevance, is difficult to define in specific terms for all readers of financial statements. Nevertheless, notes deserve careful screening by management to assure that they contain informative material.

The article reports that in the October, 1971 issue of "The Accounting Review," professor Harold Bierman presented a discussion of a situation in which the application of general price-level adjustments to basic historical cost data results in an adjusted historical cost number which is significantly different from "value." "Value" for purposes of the Bierman discussion is estimated using discounted cash flow analysis. Bierman examined two cases. In the first case, the company incorrectly forecasts changes in the general price level and subsequently determines that increases in the general price level have occurred and are anticipated to occur in the future. In the second case, the company correctly anticipates movements in the general price level and adjusts its acceptable rate of return criterion accordingly. In both, Bierman assumes that cash flows from the project under analysis are "perfectly positively" correlated with movements in the general price level. Bierman's analysis uses discounted cash flow and annuity depreciation methods. He demonstrates that a difference exists in the net value of an asset when the investor ignores price-level change in the estimate of cash flows and the discount rate, and when he properly estimates the effect on both variables.

This article presents information on financial accounting. The net realizable value of an asset is defined as the maximum net amount, which can be realized from the disposal of that asset within a short period of time. Net amount is defined as the selling price less disposition costs including tax effects discounted to the point of measurement. Basically, the issue is whether or not society is better served by the valuation of assets for public reporting at the cash they command upon sale or at the cash required to have them available for use by the firm. It might appear that under pure and perfect competition, with equally well-informed actors, the gap between the net realizable value and the replacement cost would be minimal and could be ignored. This is not the case due to the existence of frictions in the market place, such as commissions, transportation costs and the like. A stronger argument favoring net realizable value is based upon the frequent reference by statement users to a rate of return computation. The measurement of assets influences both elements of this computation since this measurement affects the denominator directly and the numerator through the depreciation charge.

This article focuses on the effects of Accounting Principles Board Opinion (APB) No. 15 on earnings per share. To date the few research studies con ducted on the effects of APB No. 15 are entirely concerned with an analysis of the validity of the two-thirds rule, a cutoff point established by the Board to deter- mine the number of common stock equivalents of convertible debt which are to be used in the calculation of primary earnings per share. The Opinion concluded that a convertible security should be considered a common stock equivalent at the time of issuance if, based on market price, it has a cash yield of less than 664 percent of then current bank prime interest rate. The time issuance is then defined as the date when agreement as to terms has been reached and announced. In addition to the firm's capital structure, information about all possible relationships between the prime rate and the cash yields on the three types of bonds is input in matrix forth. For our purpose this matrix is predetermined by three rows corresponding to straight debt, convertible debt and debt with warrants and eight columns corresponding to eight possible economic conditions which are described later.

The article discusses some of the limitations of residual income in internal reporting and then describes interest-adjusted income, a modification of residual income, which mitigates some of these limitations. The residual income of a division is the net income of the division less the product of the capital of the division times a required rate of return. Despite its many advantages there are at some limitations of residual income. This can be that residual income is subject to all the imperfections of historical cost net asset valuation. There are some pitfalls in using residual income in conjunction with generally accepted accounting rules for performance evaluation. However, residual income can be used in conjunction with other accounting rules, eliminating some of the problems associated with it. Moreover, the allocation of imputed interest to accounting periods is arbitrary under residual income in that all imputed interest is expensed. But some imputed interest may have future service potential and therefore should be capitalized.

Accounting information influences many decisions, but little is known about the way in which this influence is exerted in particular classes of decisions. If the facilitation of decisions is taken as the purpose of accounting, then accounting measurement methods ought to be evaluated in terms of their influence on the decision-making process. The article looks at permitted rates of return for privately owned natural gas distribution utilities. It attempts to relate differences in these rates of return with differences in accounting methods used. It is observed that as compared to many other decisions, the regulatory decision is fairly well standardized. In addition, the output of the decision is a single unambiguous number. For these reasons the regulatory decision is studied with expectations of a greater probability of obtaining meaningful results than would be the case with well-structured decisions. Finally, whether decision-makers are influenced in their decisions because of fixation or because of their choice of a particular method of measuring an accounting variable, the fact that decisions may be influenced by the related accounting process points to a need for greater research efforts directed at finding objective criteria for selection among alternative accounting methods for particular purposes.

The article represents a study of one effect on issuers of financial statements in the airline industry which the use of alternative reporting practices has had. A discussion of the results of the study briefly considers the consequences of being able to observe this effect for organized public accounting practice and authority. Capitalists, in such economy in which both good and bad financial statements circulate, face investment decisions in which the results of selecting given alternatives are known with more or less certainty depending on whether the related financial statements are good or bad. The degree of uncertainty can be affected by the form and content management chooses for the financial statements. The author states that firms with bad financial statements would be penalized because capitalists would require a higher return from their equities than from the equities of firms with good financial statements. Financial statements are surely among the devices available for the firm to minimize its purchase of capitalist ignorance within the meaning of the profit-maximization constraint.

This article focuses on a study which examined the effects of alternative interperiod tax-allocation methods on regulatory rate-of-return decisions affecting the electric utility industry. It is intended to evaluate the extent to which different decisions are associated with alternative tax-allocation methods, and to find reasonable explanations for any such differences that are found. For many years accountants have tried to find criteria for selecting accounting methods that are best for particular decision-making purposes. The lack of knowledge about decision-making has been a major obstacle in determining which accounting methods are best for different purposes. Electric utility companies in most areas of the U.S. are under the jurisdiction of state regulatory agencies. Regulatory agencies prescribe the accounting methods to be used by the electric utility companies under their jurisdiction. The choice of accounting methods by regulatory agencies affects the amount of the net operating revenue and the rate base used for the rate-of-return computation.

The article examines various aspects of the concept of replacement value accounting. Replacement value theory is a particular measurement concept employed in ascertaining what constitutes that maintenance of a capital for the entire entity. Income is the residual that exists after capital is maintained in that sense dictated by this special measurement concept. In some cases it is possible that the capital to be maintained is measured in terms of current replacement costs. Historical cost accounting and the general or specific price level adjustments to it are restricted in the amount of their charges against revenue to the historical or price-level adjusted historical costs of those assets which the entity presently holds. In order to provide a detailed contrast with the price-level adjustments, it is necessary to leave the conceptual level of replacement-value accounting. However, whenever the individual-asset-and-liability-levels are selected for the purposes of brief comparisons, certain simplifying assumptions are required.

The article focuses on the establishment and use of investment loss reserves by long-term broadly diversified corporate bond investors. Long-term bond investment consists essentially of making long-term loans to various types of obligors giving due consideration to appraisal of degree of risk and timing of purchases. These loans may or may not be repaid in their entirety depending upon the fortunes of the particular obligors. It is necessary to develop a general measuring device by which to anticipate credit losses, which might be applied to corporate bonds acquired either through direct placement or through open market transactions. The criterion that would seem to best serve this purpose is the market rating. The market rating is the yield spread or risk premium defined as the difference between the promised yield of a given issue and the promised yield of outstanding issues of the highest-grade bonds that have the same term to maturity. The differences between the averages of promised yields and the modified averages of realized yields, or the modified average of loss rates, indicate roughly how much of the interest receipts would have had to be reserved in order to compensate for losses on the portion of the portfolio that defaulted and on the portion suffering from decline in market value at the end of the study because of credit deterioration.

The article focuses on the significant advances in accounting for income models, book yield and the rate of return of companies. The author considers the characteristics of the compound-interest investment model. He also explains the apparent differences between book yield and the project rate of return. The underlying difference is that the project rate and the book yield are calculated under two different sets of conditions, and with two purposes in mind. In addition, the author observes that many of the problems that arise in the use of book yields stem from the attempt to oversimplify the given situation.

History provides many instances of artists and thinkers in a variety of fields whose work has not been adequately appreciated at the time it was carried out. The instinctive opposition of people to radical change may be overwhelmed by a work of genius, but provides a stubborn barrier to the acceptance of the findings of the patient seeker after truth. No matter how logically sound the new ideas may be, there is almost certain to be opposition both to the ideas and to the changes in practice which would flow from them. The history of accounting research in the last five years provides further evidence of this. Accounting practice has followed the double entry system, and historical costs, for so long that it has worked its way into a rut. Now a rut is a comfortable thing so long as one stay in it. The accountant who is operating "comfortably" in the double entry and historical cost ruts does not think sufficiently about the adequacy of his objectives. Nor has he much time to think about basic objectives, for the pressures of the business world make heavy demands.

From an accounting viewpoint, business combinations are categorized into purchases or poolings. Many corporate executives, who have actually participated in business combinations, are still unaware of just what makes a pooling. A study of poolings indicates that the accounting profession itself has undergone an evolution in its concept of poolings that might have contributed to the state in business information. Accountants themselves are not certain of the criteria that distinguishes pooling from purchasing. The dividing line which distinguishes pooling from purchasing is narrow. In many instances, purchasings are made and recorded that have all the earmarks of poolings, and vice versa. This article examines the present-day pooling concept in the light of its development in the last decade. The significance of the concept is important because from it stems changes in reported earnings, changes in rates of return on investment, interpretation of financial reports by investors and other reactions.

The purpose of the paper is to draw attention to one of the sharpest expressions of the cleavage of attitudes between economists and businessmen, and to advance some tentative suggestions for improvements in both analysis and application. This relates to the use by business of a method of cost-volume-profit analysis, and of pricing and volume adjustments, which is referred to as break-even analysis and which, prima fade, ignores the economists' generalized theorems of cost and revenue behavior. The arguments which the paper has developed, however, set a program of research and development by the cost accountant, and suggest that economists now give their attention to examining the shape and stability of aggregate revenue and cost functions over time and over output ranges, applying their resources of statistical analysis to the reconstruction of empirical microfunctions and variables. For the financial manager in industry, the lesson of the analysis is that he cannot rely with the same degree of confidence on the more naive forms of his break-even charts.

The article focuses on the concept of profit planning. Business profits can ye planned with a reasonable degree of success. The objective of profit plan is to maximize the long run financial health of the enterprise. Profit planning implies the predetermination of objectives and the preparation of plans to meet those objectives. Budgeting often involves only a representation of what the results will be if present plans and policies are carried out in the forecasted economic climate. Profit planning, like budgeting, extends to all phases of producing, selling, and financing activity for the coming period and it anticipates needs beyond operations for the coming period through means of the capital expenditures plan. A very popular means for expressing the financial objectives of profit-seeking businesses is the return on investment. Profit planning involves setting long range corporate objective, and determining means of achieving them. A very popular means for expressing the financial objectives of profit-seeking businesses is the return on investment.

This article presents the price-level study of the American Accounting Association. The rate of return on the total investment is probably the most important single calculation which can be made from financial statements. The second set of percentages shows the rates of return for 1941, for 1951, and the average for the period 1941-1951. In general, the rate of return on the total investment on a constant-dollar basis was about half of the reported rate. One of the common complaints about income taxes is that they make no allowance for the changing value of the dollar. They tax reported income without taking into account that the amount needed to maintain capital in terms of its purchasing power has substantially increased. Also, firms having a relatively large investment in depreciable assets are discriminated against as compared with other industries whose costs are much dozer to current figures. It is important to note, however, that neither the company as a business entity nor the common stock interest was worse off than if the issuance of the preferred stock had been postponed until the very day on which the funds were needed.

It is the responsibility of management to know what is happening to the investment with which it is entrusted. What the real economic investment is, what real earnings on it are, and what real rate of return it is producing for stockholders are matters management should know. When prices are rising, accounting reports on these three matters are not likely to be correct. Conventional reports can be seriously in error and thus produce an illusion, an inflation puff, that can lead management astray. Measurement of a company's real economic earnings has great practical usefulness. And it can be done. It cannot be done simply, as in the case of personal income, by dividing one single index number into the reported accounting earnings, instead it must take the form of restating each asset or each group of assets in terms of dollars of constant purchasing power. This can be done with tolerable accuracy and applied with economic and statistical sophistication. [ABSTRACT FROM AUTHOR]

In the July 1952, issue of the "Accounting Review,"under the title "Some Notes on the Bond Yield Problem," the author discussed the application of a modified or improved Newton's correction formula to the problem of finding the accurate yield on a bond, the improved formula having been briefly set forth in an earlier paper by Hugh E. Stelson,' who had drawn it from one of the mathematical journals. This article includes the continuation of numbers of formulas and equations herein from where they stopped in the preceding article. With serial bonds, the problem of finding the initial approximation to the yield rate is more acute than it is with a single bond. This article also discusses the matter appearing in the thirteen pages of Mr. FitzGerald's article in the "Accounting Review," for January, 1953, on accounting for variations in gross profit.

The substantial fall in interest rates which began in the early 1930s resulted in a widespread exercise by corporations of the option to call bonds before maturity, where such provision had been incorporated in the bond terms. Even though a call premium had to be paid, the resulting saving in interest cost often was sufficient to make bond refunding appear mandatory. Other reasons which might have tipped the scales in situations where the interest saving may not have been significant, were the substantial saving in taxes based on income in a high tax year if a relatively large amount of unamortized bond discount and expense, applicable to the refunded bond, was present, and secondly, the opportunity to issue refunding bonds which omitted restrictive covenants found in the old bonds. The true nature of unamortized bond discount or bond premium and the correct presentation of the bond liability can be inferred from the ordinary compound interest computations used to arrive at the present worth of bonds.

The question whether premiums paid upon the redemption of an entire issue of preferred stock should be charged to earned surplus or capital surplus, has been the subject of difference of opinion among accountants for a long time. Even at present, many members of the accountancy profession seem to take opposite points of view in the matter. This study is based on the reasoning developed from the economic concept of profit and loss in business and from the single entry method of calculating profits. The conclusion, that the premium paid upon the redemption of an entire issue of preferred stock is properly chargeable to earned surplus to the extent that the total premium paid exceeds the amount of premium paid into the issuing corporation on the same issue of preferred stock at the time it was issued. The question under consideration does not deal with the treatment of discount on preferred stock when an entire issue is redeemed at a discount. Accordingly, no comment is made on that phase of the subject.

This article focuses on the relation between depreciation and rate base. Depreciation of capital assets and depreciation accounting in public utilities have long been the source of much controversy between the utilities and the state. The problem has been complicated by the unwillingness of some to recognize depreciation at all and by the insistence on the part of others that reproduction cost should be the fundamental element in the rate base determination, and in the decision made relative to the amount of the depreciation charge. It has been still further complicated by using one amount of depreciation for total charges to operating expenses and another, a smaller amount, or none at all, for deductions in calculating the rate base. A generalized statement of sound procedure has been hard to formulate, because the application to specific companies is so varied. One approach to the problem of understanding the relationship between depreciation and the rate base, consists of presenting thirteen examples which may be looked upon as thirteen cases handed down by a commission and which call for adjudication. Some of these examples represent undepreciated rate bases, some depreciated rate bases and some bases for which no names are given. Some follow the retirement method, some the depreciation method and some both the retirement and the depreciation methods. By no means are all of these examples equally satisfactory or typical. In fact some are quite the reverse.

The paper presents a system of external accounting reports which differs significantly from both presently existing financial statements and alternatives thus far suggested in the literature. The measurement inputs required for efficient allocation of resources is discussed. It is said that accounting, as presently constituted, does not adequately fulfill these informational requirements and an alternative system to meet such needs is presented. The period accounting reports are also analyzed. The recent literature and research on capital allocation decisions, especially decisions relating to investment in securities strongly suggest that these decisions are primarily based on prospective returns and prospective risks associated with the returns. If the capital markets are to perform their role of efficiently allocating the ownership of capital stock among the alternative investments, the fundamental or intrinsic value of the stock will coincide with the economic value of the firm. The accounting information does not explicitly deal with expectations about future cash flows. Nor does it explicitly deal with considerations of risk.

In recent years, the level of interest rates changed dramatically. During this period many investors who bought bonds with, say, a coupon believed that they would realize a; 9 percent return on their investment-not knowing that they can only attain a 9 percent rate of return if the cash flows from the bonds are reinvested at 9 percent. This article discusses the effects of reinvestment rates on the income derived from a bond. [ABSTRACT FROM AUTHOR]

The article presents a commentary on "A Statistical Model of Earnings Estimation," by M. N. Greenball. The author notes that if one series understates earnings by a factor of proportionality comparison of regression coefficients will be misleading. He recommends a more robust procedure such as comparing correlation coefficients. The author says it is not clear from Greenball's analysis whether dividend payments themselves are any more subject to error as measures of true earnings than are the alternative measures.