Influence of the Corporation

        During the nineteenth century, the effects of the Industrial Revolution were being felt on a widespread basis.  The inventions which grew out of the Industrial Revolution created a demand for capital investment which could not be fulfilled by one or a few investors.  An extensive growth of the corporate form of business organization resulted.  As stated  by Brown, "The large scale operations that resulted from the Industrial Revolution provided the impetus necessary to bring the corporate form of enterprise to the foreground." (Brown, Accounting Review, October, 1962)

        By 1900, the corporate form of business organization was in common use.  A renewed emphasis on the concepts of continuity and permanency of capital emerged as the corporate form of organization grew in prominence.  The protection of the equities function of accounting received its major impetus from the development of the corporation. Brown states that "As management passed from individual owners to hired professionals the owners in absentia became concerned over the proper protection of and growth of their capital investment." (Brown, Accounting Review, October, 1962)

        Permanency of capital and the separation of owners from managers created the need for a measure of operating efficiency of the firm for periodic intervals.  The completed venture accounting no longer provided sufficient information on a timely basis.  Irish has expressed this point as follows:
 

Accounting had been directed previously at periodical settlements from each venture, from which each subscriber was paid a sum representing capital and profit without distinction.  Permanent capital changed all this and produced the difficulties of determining true profit while retaining capital intact.  (Irish, in Contemporary Studies in the Evolution of Accounting Thought, 1968)
        As the corporate form of business organization increased in use, there was a corresponding growth in the separation of owners and managers.  Such separation created a demand for information concerning the stewardship of management.

Capital vs. Income

        As the corporate form of business organization grew in prominence, there was a renewed emphasis on  "earnings" as opposed to "divisions."  Separation of capital from income became a matter of  paramount importance.  Littleton states this idea as follows:

     . . . a corporation is a continuing enterprise, and . . . money invested in the corporation's stock is not a venture from which a profit or loss will materialize when a "division" is made, but is rather a long-lived "investment" from which periodic returns will flow.  If the corporation lives up to this expectation it must constantly and carefully distinguish that which is capital and that which is income.  (Littleton, Accounting Evolution to 1900, 1966)

    The primary emphasis evolving out of the corporate form of business organization was on maintaining a proper distinction between capital and income in order that the amount of profit available for dividend distributions might be ascertained.  In the words of Littleton, "It is at this point that the corporation influences accounting most."


 
 

Influence of Income Taxation

    Income taxation became a permanent part of the environment with he passage of the sixteenth amendment in 1913. According to Gilman, the event was ". . . the most powerful of all forces which have influenced accounting practices. . . . since the tax was based upon income . . . it was only natural that greater attention should be given to proper determination of earnings, costs, expenses and losses." (Gilman, Accounting Concepts of Profit, 1939)


 
 

Balance Sheet Theory of Profit

    Even though the focus of attention was being shifted to the concept of income during the nineteenth century, there remained a reluctance to depart from the so-called " balance sheet theory of profit."  The balance sheet was still used as a medium through which the amount of income for the period was determined.  Income was viewed in the sense of a final liquidation of a company in that it consisted of the assets remaining after discharging the liabilities and reimbursing the shareholders for their capital contributions.  This liquidation viewpoint, although a dominating force in accounting thought throughout the nineteenth century, became increasingly difficult to reconcile with the concepts of permanency of capital and the going concern.

Influence of Railroad Growth

Railroad growth in Europe and the United States during the 1800's had a definite influence on the development of accounting thought.

Railroads required large amounts of capital to be invested in long-lived assets. These facts accentuated the need to distinguish between capital and income.

The rapid growth of railroads had a definite effect in helping clarify the concepts of capital and income  and was influential in developing the concept of depreciation.

Railroad executives were reluctant to recognize depreciation.  Their contention was that if equipment and road beds were kept in a good state of repair, then no depreciation was occurring. Additionally, no cash expenditure was being made for depreciation.  By not recognizing depreciation, income, and dividend payments, could be larger.  Failing to recognize depreciation resulted in dividends being paid out of not only the income earned, but from the invested capital.