TEE EVG WE SN 0:? SELECTEQ ARNWLL CQRPCE Esta; LLRUYCERE BE PURHflG ‘FLLLCHVEA EN CAN-13%: 1900 - 1970 Thesis {tos- fiie 5:139?“ a? pit. D. fiECHEGAE‘E STIILTE UKEflESETY George Joseph Murphy 35?? O \‘HE‘3IS 0-169 M...“ .24 LIBR/l RY 3 Michigan Suit: This is to certify that the thesis entitled THE EVOLUTION OF SELECTED ANNUAL CORPORATE FINANCIAL REPORTING PRACTICES IN CANADA: I900 - I970 presented by George Joseph Murphy has been accepted towards fulfillment of the requirements for ADELE—degree inmflllns 8 Fin. Adm. fl 3%” Majél/pr‘ofessor Date Nov. 18, I970 University w: OH .~A This s . V h...~A.A" “.‘H u Qq“ E;s.ecss cc u "3. .L\ a... n .U ABSTRACT THE EVOLUTION OF SELECTED ANNUAL CORPORATE FINANCIAL REPORTING PRACTICES IN CANADA: 1900 - 1970 By George Joseph Murphy This study represents a history of the evolution of selected annual corporate financial reporting practices in Canada from 1900 to 1970. Corporate annual financial statements are a common means of business communication and are used for the allocation of resources within an economy. Knowledge of how corporate annual financial reporting practices evolved and what influenced their evolution should be helpful both in understanding present practices and in influencing further change. The selected annual practices examined include: the evolution of the mandatory audit and the content of the auditor's standard report; the evolution of various aspects of the balance sheet and the profit and loss statement; and lastly, the evolution of cor- porate depreciation practices. These particular practices were chosen for observation because they involve important accounting practices and because it was thought that they would reveal the various influen- ces that have shaped corporate reporting practices in Canada over the years. , . . ._~.-.o- ~-----'a; statc._c:... : a . ......npo _- ,. 1’1"- r 7C. ' «I: .74.} L0 “.2, ‘ v 1 I ...-'O‘A in .F T .t....Cu u Lu t‘ n I Q 2.332.112 828 1123-512 . . ,4 :"';V¢--~-. -"~~ may“. :“I ‘ .Iu.-.‘ “Vvv q .. v " . ‘bd " ‘t - ‘ u... h -A- P ~~sa«\.:s C: CCVuA,_ * ~ v.(‘ . ‘ :‘1; 0'. _ 01A 1‘ but “m . ° d“~"I-Asl“z ” It ‘1 It. 1 U. u. 'U \n. ' U \.‘I ‘rkgls'. .4 and E“, i L 5-,. , v «Q‘ h: 53 tile 1 . re‘at‘ \,, ' at 'M ;;..__ “:CS;C‘ ‘ ~ SO t T; r :g.‘ aL r1- George Joseph Murphy The history attempts to document the changes in the selected corporate practices and to place those changes in their economic and social background. Various sources of evidence are used. Samples of financial statements of industrial companies were reviewed for the years 1900 to 1970, as were empirical studies and compilations reported in the literature. Other evidence includes various incor- porating and regulating statutes, debates of the Senate and House of Commons, proceedings of governmental committee hearings, reports of governmental-appointed inquiries, briefs and submissions made by vari- ous parties to committees of inquiry, and lastly the considerable professional, academic and financial literature. The path of change has been charted as a somewhat slow, evolutionary one - influenced in various degrees by the legislation, instances of corporate malfeasance, English and American institutions and the accounting profession itself. In turn, these influences have taken place within an economic and social environment wherein there has come to be an increasing recognition of business as an acceptable and responsible social institution and wherein the ready means of communication exist such that the various publics of business can influence business practices. Early Canadian corporate practices were influenced by the English legal tradition, by the early public accounting firms formed by Scottish and English chartered accountants and by the use of English accounting texts. This English source of influence began to wane as the relative size of the American investment in Canada increased - so that by the mid-1930 period the proximity and articul— ateness of the American Institute and of American academic o .o- -q AV'Q. a -6. 'Q-vayhO ”F .cdgd- ' at.“ p- .— w” .a 115 p l 5 ..-.-,..-,; - ems... 3’1 vfiun George Joseph Murphy contributions were having a relatively much greater effect on the Canadian scene. The companies act legislation itself has both fol— lowed and led good corporate reporting practices. Instances of the latter are noticeable in the mid—1930 and mid-1960 federal legis- lation. Tax legislation has heavily influenced corporate depreciation practices. Apart from the banking failures in the first two decades of the century and the financial failures of the mid-1960 period, Canada has been largely free of grand scale financial scandals. However the Canadian financial press and academic literature have been greatly concerned with such instances that have arisen in England and America. The financial press itself has been conspicuous in its attempts over the years to change annual corporate reporting practices. The Canadian Institute of Chartered Accountants has been more notable since the 1930 period in accepting the increasing and arduous burden of representing the profession and of promoting changes in corporate reporting practices. THE EVOLUTION OF SELECTED ANNUAL CORPORATE FINANCIAL REPORTING PRACTICES IN CANADA: 1900 — 1970 By George Joseph Murphy A THESIS Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Accounting and Financial Administration 1970 ii‘ Copyright by GEORGE JOSEPH MURPHY 1970 L1971 To Angela . ii .——4 '.'i h to CI: ‘. :ar-cs J. - ' ’ ‘1 r‘ ::a.: A. . her a..- ..ize :26 extra“ ' ~va" . . I . "l‘ I‘“A".~’*fi‘ y.’ mt» Mtacb unitetL I n‘\- the Callege of CE" ,. uh...“ . :f the Canadian '1' F,"‘ L in). “Y7- m‘- ;' ' . ICseVib aims at C:.< .mch'CZ-c” ACKNOWLEDGEMENTS I wish to express my appreciation to my thesis supervisor Professor Charles J. Gaa and to committee members, Professors Donald A. Taylor and Floyd W. Windal. I would also like to acknow- ledge the extraordinary generosity, throughout the whole of the doctoral program, of the Department of Accounting and Financial Administration, Michigan State University and of the members of that department. Acknowledgement must also be made to members of the College of Commerce, University of Saskatchewan, staff members of the Canadian Institute of Chartered Accountants, and members of various firms of Chartered Accountants. The library facilities and arrangements with the Alberta Institute of Chartered Accountants, with the Universities of Manitoba, of Saskatchewan, of Toronto and of Western Ontario, with the Toronto Public Library (Business Reference Section) and with Professor Georgia Goodspeed were most helpful and particularly appreciated. Lastly, I would like to thank my own employer, the College of Commerce, the University of Saskat- chewan, for continual encouragement and assistance. iii ..- an — “v "F V n 1“ '\ a... in A‘W"-'*‘ . P" w . . A ‘JuP—S p A \ ~s-s .o-Q 1n n- 1’ . 2‘ Dr vhuvub .‘. _.\ 7‘--m ‘,“\vvr"l .\ -’.'uu TI a. .nvu...‘ A “L 0“ so A .qi .3. Q. . ‘A R u 1 A Per h a .5 C u ‘ .LS ‘ Eng = Ca r“~- Ei‘u c (1&4 V‘ AA . . . s .4 .( u . A 5-; .. 1.. a. a a J“ ..r. T. 1; Pk. tee .i W . rid h\u ‘ ‘ FPL FL n‘U ‘ v . . C S .1 2 . L Q E. 2. e .0 n... I 3: he. L i .,I. 1 «C wirh Y” A L E -_.. TIA I TABLE OF CONTENTS Page LIST OF TABLES . . . . . . . . . . . . . . . . . . . . . . . . vii LIST OF FIGURES . . . . . . . . . . . . . . . . . . . . . . . viii Chapter I INTRODUCTION . . . . . . . . . . . . . . . . . . . . . 1 Purpose of Study Specification of Selected Annual Corporate Financial Reporting Practices and the Time Period 1900 - 1970 English and American Evolution Canadian Evolution Methodology Perspective of the Study II THE EVOLUTION OF THE AUDIT AND THE AUDITOR'S STANDARD REPORT 0 O O O O O O I C O O O O O O I O O O 14 Purpose Legislation and Auditors' Reports Prior to 1910 Early English Legislation Early Canadian Legislation Attitude Towards the Audit Form and Content of Auditor's Report Legislation and Auditors' Reports, 1910 - 1920 General Outline Banking Legislation The Companies Act Amendment Act, 1917 The Effect of the Companies Act Amendment Act, 1917 Report Wording Beyond the "Legal" Minimum Legislation and Auditors' Reports, 1920 - 1940 Background English and Canadian Legislation United States Legislation and Stock Exchange Requirements The Auditor's Duty Respecting the Profit and Loss Statement Concern for Report Wording iv .1538! ,. ,u I I .L. .9. A“ L . . L G r. . . 2 C we 7; an ,. .. at o. .A r. u L ..A r. a .U . . wk 6 L” a .3 LL 9. 4-. a w L .nd a C an .L t .3 C Tr. n v» S .3 is A3 »u a.. nu TL . e C. 4‘ Y. S .»-u «k {a a . . .0. 1 .C :i . . a 9; C . _ .1 s: «5 :A T... a 3... ~ \ . up. u . .8 ul rt .1. a. W C ~ . Ad ..-. 1 a r; n .\ r 3: .u «5 e p. 9L L . u 35. ru C «A, e p. e u T. .J 2 a E Z I C ~L 3 a a Z .3 Lu Q. D. rub C nub ~. A C FL C B T... I T. —-m i z. .— ..A “It 1,. «.i v s 9 s v A if CCIP. Ta Chapter Form and Content of the Auditor's Report Legislation and Auditors' Reports, 1940 - 1970 Background The Pronouncements of the American Profession English Legislation and Professional Pronouncements Canadian Legislation Pronouncements of the Canadian Institute of Chartered Accountants Form and Content of Audit Report Summary III THE EVOLUTION OF FINANCIAL STATEMENTS, 1900 - 1920 . Purpose . English Legislation Canadian Legislation English and American Influence The Theory Relating to Corporate Reporting Practices Attitude of the Times Corporate Reporting Practices IV THE EVOLUTION OF FINANCIAL STATEMENTS, 1920 - 1940 . English and American Legislation Canadian Legislation Background to the Canadian Legislation English and American Influence The Theory Relating to Corporate Reporting Practices The Rise of the Canadian Accounting Profession Corporate Reporting Practices V THE EVOLUTION OF FINANCIAL STATEMENTS, 1940 - 1970 . English and American Legislation Canadian Legislation Background to the Canadian Legislation English and American Influence Professional Activity The Theory Relating to Corporate Reporting Practices Corporate Reporting Practices Summary of the Evolution of Financial Statements, 1900 - 1970 VI THE EVOLUTION OF DEPRECIATION . . . . . . . . . . Purpose Professional and Academic Commentary on Depreciation Theory Page 76 119 153 200 f‘...» -y “6.”. ('0'!— ‘1 an...— .' "7' ' “"I C'IAHV IAA Uvuunu»o ‘ _...7 n“ 7" n " Walrus 7 ..._.«v-'—“ no I I 0 I new-1"" aw- A L. .z , ~'—'-‘ Lu. |q--‘.- . I'- u - tOQ-l-I Car” U L-L. A“ Ar v: '...\ Chapter Page Depreciation for Tax Purposes Corporate Depreciation Practices Summary VII SUWARY o o I o o o o o o o o o o o o o o o o o o o o 226 BIBLIOGRAPHY O 0 O I O O O O O O O O I O O O O O O 0 O O O O O 232 APPENDIX A LIST OF AUDIT REPORTS EXAMINED . . . . . . . . . 248 APPENDIX B LIST OF FINANCIAL STATEMENTS EXAMINED . . . . . 249 APPENDIX C SELECTED HISTORICAL STATISTICS . . . . . . . . . 250 APPENDIX D SELECTED ILLUSTRATIVE FINANCIAL STATEMENTS . . . 256 APPENDIX E SELECTED SECTIONS OF THE CORPORATIONS ACT, 1953 OF ONTARIO O O O O O O O O O O O I O O O O O I O 2 78 vi o 5-. o I" I l .~.:.a.j:sis of Pi SHCtec’ H . r L.‘ of a Faus". ‘ F “‘Av LCZZDn Cb- “LC-Cg Table LIST OF TABLES Analysis of Financial Statement Disclosure to 1940 . . Analysis of Financial Statement Disclosure, 1940 - 1970 Selected Historical Statistics - Estimated Population, Gross National Product, Gross Value of All Production Manufacturing . . . . . . . . . . . . . . . . . . Selected Historical Statistics — Estimates of Non Resident and Total Capital Invested in Canada . . . Selected Historical Statistics - Number of Establishments and Gross Value of Production by Size of Establishment . . . . . . . . . . . . . . . Selected Historical Statistics - Commercial Failures in canada 0 O O O O O O O O O O O O O I O 0 Selected Historical Statistics - Price Index Numbers of a Family Budget, Consumer Price Index, Index of Common Stock Prices . . . . . . . . . . . Selected Historical Statistics - Membership in the Canadian Institute of Chartered Accountants . . vii Page 111 191 250 251 252 253 254 255 J. ‘1 s‘. In I Q‘. The Joint S: Exienditure . v- . ,- ‘T .L Una- d'vubsIs ~ilb‘,_ DECEIIEY 3: ”L “Li" ; Canadiar. 3alance She. Figure 10. 11. 12. 13. LIST OF FIGURES Page Table B of Joint Stock Companies Act, 1856 . . . . . . 79 The Joint Stock Company of Canada Limited, Balance Sheet December 31, 1917 . . . . . . . . . . . . . . . 96 The Joint Stock Company of Canada Limited, Income and Expenditure and Profit and Loss Account for 12 months Ending December 31, 1917 . . . . . . . . . . . 97 Ontario People's Salt Manufacturing Company (Limited), Statement of Profits and Losses and of Resources and Liabilities, May 30, 1892 . . . . . . . . . . . . 100 Balance Sheet of the ........... Manufacturing Co. as at ........... 1898 . . . . . . . . . . . . . . . . 102 The Canadian Salt Company Limited, Balance Sheet December 31, 1905 . . . . . . . . . . . . . . . . . . 256 The Canadian General Electric Company, Limited, Balance Sheet and Profit and Loss, December 31, 1905 . 257 The MOntreal Cotton Company, Balance Sheet, Manufacturing Account and Profit and Loss Account, December 31, 1910 . . . . . . . . . . . . . . . . . . 258 The Carter—Crume Company, Limited, Balance Sheet and Profit and Loss Account, December 31, 1910 . . . . 260 Canadian Consolidated Rubber Company Limited, Balance Sheet and Income Statement, December 31, 1919 262 The Steel Company of Canada Limited, Balance Sheet and Profit and Loss Account, December 31, 1919 . . . . 264 Canadian Locomotive Company Limited, Balance Sheet and Shareholders Report, June 30, 1921 . . . . . . . . 267 Penmans Limited, Balance Sheet and Profit and Loss Account, December 31, 1933 . . . . . . . . . . . . . . 269 viii '_ v ' ',. Pursazzs L121L '\ .. Account, act ant ; P D. - ”V .. kkbuue A .L and Less at: ~ ' ‘ '7‘ ' .. IzchlaL .33; Sweet, JCCCT. Figure Page 14. Penmans Limited, Balance Sheet and Profit and Loss . Account, December 31, 1925 . . . . . . . . . . . . . . 271 15. Cockshutt Plow Company Limited, Balance Sheet and Profit and Loss Account, December 31, 1925 . . . . . . 273 16. Cockshutt Plow Company Limited, Balance Sheet, Profit and Loss and Earned Surplus November 30, 1934 . . . . 275 17. Imperial Tobacco Company of Canada Limited, Balance Sheet, December 31, 1947 . . . . . . . . . . . . . . . 277 ix The put-pf s trite into the ‘ - ~1 h seemed arm.“ K 5:: l9OC~ to 1970 Ccrpcrate a:. business ccmunicati :5 resources within fizancial reporting evclution should be '70 t, 'tf-uL A lies and in irx :3“. ; ' . cuss IHCIUCen 5;“. . “H:“I:l CHAPTER I INTRODUCTION Purpose of Study The purpose of this study is to document the changes and to inquire into the background and processes that have influenced changes in selected annual corporate financial reporting practices in Canada from 1900 to 1970. Corporate annual financial statements are a common means of business communication and are both used and useful in the allocation 0f resources within an economy. Knowledge of how corporate annual financial reporting practices evolved and what influenced their evolution should be helpful both in understanding our present Praetices and in influencing further change. Specification of Selected Annual Corporate Financial Reporting Practices and the Time Period 1900 - 1970 The kinds of things that are envisaged in the phrase "the evolution of selected annual corporate financial reporting practices" are, to some extent, akin to what is included in the concept of dis- clOSure of more and better financial information. The selected p1‘actices include: the evolution of the mandatory audit and the financial statements included thereunder; the evolution of the content of the auditors' standard certificate; the evolution of the balance 1 ':—‘ profit as; .l -- v 223:. U“ ' “‘" “‘ c:r::ra CITES...“ bl _ : edbv CIithS of at“! 3;, 52 present an: 3€PYECiati_ insete agcp USE of Seer Inadeqlate cu‘ ‘arly in Plus; fail; Sizi stating Statutes c “ff-v '_ I .|-« tde years ~' ’ And "‘K m. ‘_'.‘ ..';te ann‘lal f‘ .L. . D \.~ . 5‘» a 'v‘ ' ‘ ‘ I N 'r- - , .‘t“ .1: 2 sheet and profit and loss statements - including their content, classification, and general valuation base; the evolution of the earned surplus statement, footnotes to financial statements, secret reserves and extraordinary items - inasmuch as they bear upon the balance sheet and profit and loss statement; and finally, the ervolution of corporate depreciation practices. The foregoing topics .1riclude most of the items that Littleton and Zimmerman suggest were cszted by critics of American accounting practices up to the early ]_SL30's: l. U'I-l-‘UJN Plant, equipment, patents, and goodwill often shown as one amount; similar combined treatment of depreciation and maintenance amounts. Failure to report total sales or operating costs. Bases of asset valuations not disclosed. Publication of only the balance sheet. Stock dividends not disclosed by issuer; shown as income by the recipient. Upward asset revaluations justified on the basis of present and expected future profits. Depreciation charges seemingly used to smooth annual income amounts. Use of secret reserves. Inadequate or unreported net worth accounting, parti- cularly in allowing direct charges or credits to sur- plus; failure to separate earned and capital surplus. Similar to England, but unlike the United States, the incor- Pol‘ating statutes of Canada and of its constituent provinces have, over the years, made provisions for the presentation and content of corPorate annual financial statements. This study is concerned, in the main, with the federal legislation, (if companies intend to oPel‘ate in several provinces they normally incorporate under the federal statute) and will attempt to deal with that broad group of \ 1 A. C. Littleton and V. K. Zimmerman, Accounting Theory; Skflflginuity and Change (Englewood Cliffs: Prentice Hall Inc., 1962), ‘p. 138. .' :.- r;-l a‘c—qlfin .l..:I..a (it—rd“ ". J p..: . 5‘-.. .1: .1. “B LL-....': . . . 1 7!“ ‘V‘ ‘ “Flt ‘ . " L a. I; ,..G-~ “ 53C 26321113165 at —. , "" n‘x .- Auc Ely.“ . a VA. ' ‘ n- ‘ yefibblbcs “(:5 :C: ltduotECS, I "‘ :a‘fi .;':9v "’. "v . v5.5}. tank-1:15, "“5“ 5 ' INN-2.1:; a: . Harold “3:“ o I " n . ‘Stlt; I “3 2.. . - F. E ..—:t A n 1055 A20?“ ‘-:.':.‘."v h '5 \’ M21 ‘1’ I J] s YC- .‘. U a Y “5": 13‘ n 4.4 \Ef‘ «can 3 industrial companies that the federal companies acts contemplate. The inquiry commences at the turn of the twentieth century when cor- porate annual financial statements were beginning to be made public and terminates at the present date of 1970. English and American Evolution The evolution of some of the English corporate reporting 2 and Rose,3 and of some American practices has been outlined by Stacey, practices, by Hawkins,4 May,5 Littleton and Zimmerman, Storey, and Carey.8 Hawkins, in commentary upon the evolution of financial report- illg; practices in America between 1900 and 1935 cites four principle factors: First, gradual recognition by some managers of their public responsibility. Second, increasing criticism of management accounting and reporting practices by a number of influential 1Banks, insurance companies, railroads, utilities, and trust ‘31161 loan companies are generally excluded from such legislation. 2N. A. H. Stacey, English Accounting; A Study in Social and .EESEEQomic History 1800 to 1954 (London: Gee and Company Limited, 1954). 3Harold Rose, Disclosure in Company Accounts ("Eaton Paper"; ]¥<)ndon: Institute of Economic Affairs, 1965). 4D. F. Hawkins, "The Development of Modern Financial Reporting Eyractices Among American Manufacturing Corporations,” Business History Review, Vol. 37 No. 3 (1963), pp. 135 - 168. 5George 0. May, Improvement in Financial Accounts (Dickinson I«ecturer; Cambridge, Mass: Harvard University Press, 1938). 6Littleton and Zimmerman, Accounting Theory: Continuity and Change. 7R. K. Storey, The Search for AccountingiPrinciples (New York. American Institute of Certified Public Accountants, 1964). 8John L. Carey, The Rise of the Accounting Profession (New York: American Institute of Certified Public Accountants, 1969). :::er::a1 prac' ‘ ‘ L¢v There e:-:i s :- - . .Lzanczai reccrtir ‘:-_J‘ 1 a P . ..-:-y mat cent p. ‘ v .L‘C.T:122 uracil v u ' v. ]: .v- ‘ I... ‘6‘ S‘ .L. .5 ‘ l . nae 5.."er na- k“"\_c 4 groups and individuals outside of the management class. Third, direct federal government regulation, such as the so-called Securities Acts of 1933-34. Fourth, the recognition by the American accounting profession and acceptance by the business c immunity of some common accounting and reporting standards. Hawkins goes on to state that ”underlying and contributing to tflnese forces for change have been a number of social, political and economic factors such as the emergence of a large number of small irrvestors, the evolution of big business, and the increasing willing- ness of the public to seek government action to reform undesirable 2 ccwnunercial practices." Canadian Evolution There exist no outlines of the evolution of annual corporate financial reporting practices in Canada. This study will attempt to lTelnedy that deficiency. It is proposed that the evolution of Canadian reporting practices has been, over the years, an interesting interplay ofEnglish and American influence acting upon, and together with, the ‘lrtique elements of the Canadian scene. The English influence is felt largely in the legal tradition of the Canadian Companies Acts that have set forth minimum disclosure requirements. The American influence 143 felt through large American investment and ownership and the I’roximity and articulateness of such strong professional organizations €18 the American Accounting Association and the American Institute of <3ertified Public Accountants. The uniquely Canadian influence is felt through the pronouncements of the Canadian Institute of Chartered F Hawkins, "The Development of Modern Financial Reporting Practices," p. 136. 2 Ibid. :~”‘1::a:ts» the "at: '1 “v ' "WIS responc .35. It. ..... ' I '-- :4 (rampal. -fior‘, on: thASUV‘QL A "p: A me a;pr:a::. Lixe that of the C V me Home cf tne . 15 not a sac-toe? a ' n I "am. _ ~y ... ummg :0 cl .1”. me eapenewe .; o: tne Dast as 1 guides to actic: There is ac 511; b etween the 07: . in“? o . .....:15 and testin; 5 Accountants, the various income tax acts and the business and financial critics responding to reporting practice inadequacies and business failures. Methodology ITie Historical Approach The approach of the historian, in broad perspective, is not unlike that of the scientist. E. H. Carr suggests: The world of the historian, like the world of the scientist, is not a photographic copy of the real world, but rather a working model which enables him more or less effectively to understand it and to master it. The historian distils from the experience of the past, or from so much of the experience of the past as is accessible to him, that part which he recognizes as amenable to rational explanation and inter— pretation, and from it draws conclusions which may serve as guides to action. There is no attempt here to suggest that the close relation— ship between the observer and what is observed, and the manner of ‘1lfauwing and testing conclusions, do not constitute methodological di‘fferences between the approach of the historian and that of the Iiiitural scientist. However, the general concept in science of a simplified version - that is, a model - of the real world which ‘Eitplains and predicts is consistent with the historical approach.2 Historical analysis has a relatively minor but quite 1E. H. Carr, What is History_(New York: Alfred A. Knopf, Inc. and Random House, Inc. 1967), p. 136. 2For commentary upon the methodology of history and its limitations see Carr, What is History and W. H. Walsh, An Introduction 39 Philosophy of History (3rd ed. rev.; London: Hutchinson & Co. Publishers Ltd., 1967). v . n ’ '.'.. ““1"" '5 a“‘" ‘. ‘v . ‘ \. v‘Ln ~¥'“'“ v n -. *‘ Lizfirv we lccm *‘ . ' , j . :13 €?C-Ctlonar}' uc'i 52:13:15 can :axe C“: ' a I ‘ a:.:'.‘:tlr.2 crlt‘ “‘ "- - Axuob- .-' i . s 5‘: ‘ha ”‘ V .g5:::S tudt C‘VC azi it is not t:- be 252:5 into wholly ne ;r:;ec:ion of the s: -. n) Feat. 6 distinguished tradition in accounting scholarship. The general con- viction of the usefulness of the historical approach is attested to by both economists and accountants. Schumpeter has stated that through history "we learn to understand why we are as far as we actually are .and.also why we are not further. And we learn what succeeds and how axnd.why . . ."3 Littleton and Zimmerman argue that "a perspective of ‘tlie evolutionary development of the ideas behind known accounting .axztions can make current accounting theory more understandable and accounting criticisms more intelligently debatable." While Stans SUggests that "evolutionary steps always have a certain consistency and it is not to be expected that sudden turns will divert past move- Infatrts into wholly new directions. The future is to a large extent, a Projection of the significant events which have comprised the recent past.'ls This study attempts to trace the changes that have occurred in 1Notable contributions have been made by B. S. Yamey, N. A. H Stacey in England and E. Peragalio, G. 0. May, J. D. Edwards, J. L. (3élrey'and A. C. Littleton in America. A bibliography of Accounting 1”118tory has been written by R. H. Parker. A "Accounting History: Select Bibliography," Abacus, Vol. I, No. 1 (1965), pp. 62 - 84. . The Committee on Accounting History of the American Account- :Ltlg Association has suggested that the Association should deliberately eltlcourage the historical type of research. "Report of the Committee <>t1Accounting History," The Accounting Review, Supplement to Vol. 45 (Evanston, Illinois: American Accounting Association, 1970), p. 55. 3J. A. Schumpeter, History of Economic Analysis (New York: (3xford University Press, 1954), p. 4. 4Littleton and Zimmerman, Accountinngheory: Continuity and Change, p. 9. 5M. H. Stans, "The Future of Accounting," Handbook of Modern Accounting Theory, ed. M. Backer (Englewood Cliffs: Prentice Hall Inc., 1953), p. 583. "'""e annual fir. :.."i‘c. 1.22255 111 [3811' ecc- ' I "'4" '\ an sou-MI. -‘ ‘ bf CV.‘tiotu.b - n- . vub u c ”at-r ‘uvl. - . .. at '“i'h5fi th..u l”e s’lA" : “1 5 up .1. . mw-‘I- n‘v " n - ,..:.:c, bae:.chu..c. .. ‘. b.‘::‘ " V" LCA‘I on the c lave " .- , .5 I' )II ‘KCIJC -. ‘5. Na, .4? L .55., ale :a‘e': ~ 'A. 4 \I‘ t. _ 3e weird Pujl final3E: 7 corporate annual financial reporting practices, to place those changes in their economic and social back-ground and to find the threads of continuity which give meaning to history. Chapter Outline The study falls into five divisions: Chapter I includes pHJIpOSE, background, scope, and methodology; Chapter II includes tl1e evolution of the mandatory audit and the content of the auditors' standard certificate; Chapters III to V include the evolution of the balance sheet and profit and loss statements, including their content, Calaissification and general valuation base, and involving related CKJnnmentary on the earned surplus statement, footnotes to financial Statements, secret reserves and extraordinary items; Chapter VI Iltlczludes the evolution of corporate depreciation practices; and Chapter VII includes the summary and conclusions. Within each Qhapter, the material is handled on a chronological basis. SiSflirce Documents and Evidence The chief sources of evidence concerning changes in financial =3tlatement reporting practices is the annual publication, The Annual .Etinancial Review - Canadian2 for the years 1901 to 1939. This IJemiodical invited all incorporated companies to send in copies of tfheir annual statements and provides what is likely an unequalled and concise source of evidence for early Canadian annual financial ¥ 1W. H. Walsh refers to this process of locating events in their context as "colligation" in An Introduction to Philosophy of History, p. 25. 2The Annual Financial Review - Canadian, Standard Publications, 1901 to 1941.) (Toronto: Houston's szazezents. The st 3‘ taxzsare, in sub: :Lalreports for t 'I 1 . ,urgn ' ‘U I :1» .C..»C.C31 Light? 1. k1aany its: tae riz*t : on the left CCY'r‘érate r liauilities 7 L- The profit aCCOuzt f3: COYPCrate a 3' In 30:2 139. s. ' \ f _- n ' r - ~..:!‘..~.u , lj . I 8 statements. The style and format of the financial statement presen- tations are, in substance, consistent with a sample of actual corporate annual reports for the years 1901 to 1939.1 The only alterations that the Periodical makes to the corporate annual reports are: 1. In many instances, the Periodical places the assets on the right hand side of the balance sheet and the equities on the left hand side. In some instances, the annual corporate report, itself, displays the assets and liabilities in this "English" fashion. 2. The profit and loss accounts are realigned into a "T" account form if not portrayed in this fashion in the corporate annual reports. 3. In some instances, the number of authorized shares is omitted in the Periodical's presentation. However this information, though not contained in the Periodical's presentation of the corporate financial statements proper, is otherwise given in a general company description that precedes each corporate financial statement representation. 4. The auditors' report or certificate is not given. 5. The annual statement by the corporate president that is normally included in the corporate annual report is not repeated completely. However, extracts of the more 1The following corporate annual reports for the years indicated, were checked to the periodical: Cockshutt Plow Company Limited, 1920, 1930, 1939; Penmans Limited, 1925, 1934; Canadian Locomotive Company Limited, 1912, 1915, 1918, 1921, 1924, 1927, 1930; Canadian Canners Limited, 1923, 1925, 1926, 1931, 1932, 1934, 1936, 1938; Canadian Westinghouse Company Limited, 1904, 1908, 1916; Steel Company of Canada Limited, 1910, 1915, 1917. . h o ‘I ‘ "‘ J"‘ “.1" 1 “an up: .Ctgbuaca Lb“; 5m r-- I .clsusv b..- h a . . ,. u up» On. h aq- ‘n h‘ in: -1'.t..d..;.C AAA 1 ' .n u ‘. ’ y 6 - “f5 the auditor were an elaboration of the provisions of the 1862 Act ‘3!“; the "full and fair" phraseology was dropped and the "true and Q(arrect" wording, retained. Every auditor of a company shall have a right of access at all times to the books and accounts and vouchers of the company and shall be entitled to require from the directors and officers of the company such information and explanations as may be necessary for the performance of the duties of the auditors, and the auditors shall sign a certificate at the foot of the balance sheet stating whether 1Great Britain, Statutes, Joint Stock Companies Act, 1856, 19 and 20 Vict., C. 47. 2Great Britain, Statutes, Companies Act, 1862, 25 and 26 Vict., CO 89. 3Great Britain, Statutes, Companies Act, 1900, 63 and 64 Vict., C. 48, Sec. 21. or not all with, and s drawn up 5: of the cc: I I. ’9 an 1' - .2 .3: carat... " 1 .. Lam Candelan M "‘54." '¢~«zled. The at: 9933 the be IEport he 1 Shéet is a up 30 as ti of t 1 ae CC», ”Hepatic: 16 or not all their requirements as auditors have been complied with, and shall make a report to the shareholders on the accounts examined by them, and on every balance sheet laid before the company in general meeting during their tenure of office; and in every report shall state whether, in their opinion, the balance sheet referred to in the report is prOperly drawn up so as to exhibit a true and correct view of the state of the company's affairs as shown by the books of the company;. No substantive changes arose in the relevant audit provisions irithe Companies Act, 1908.2 Early Canadian Legislation The Province of Ontario reflected the English legislation more cthickly than did the federal Canadian legislation. The Ontario Chonnpanies Act of 1897 stipulated inspection clauses similar to those C>fi the English enactment of 1862.3 Additionally, the annual share- 11C£1ders' audit, while not made mandatory, was contemplated if the letters patent or the by-laws of the company so directed. In the eVent that an audit did take place, the duties of the auditor were Specified. The auditor shall make a report to the shareholders upon the balance sheet and accounts, and in every such report he shall state whether in his opinion, the balance sheet is a full and fair balance sheet and properly drawn up so as to exhibit a true and correct view of the state of the company's affairs, and in case he has called for explanation or information from the directors or officers of the company, whether such explanations or information has been given by the directors and whether it has been satisfactory. lIbid., Sec. 23. 2Great Britain, Statutes, Companies (Consolidation) Act, 1908, 8 Edward VII, C. 69. 3Ontario, Statutes, The Ontario Companies Act, 1897, 60 Vict., C. 28, Sec. 77. 4Ibid., Sec. 91 The On e English en a: the duties .5 tse English u 9'- .'-:\ l. .1; Inddl 1:: i:- valde Of (a. 1 ‘I- aspect-or to w- ‘36 ragtirezen' r—o‘ it such meg. 3374 : “MUS :cti' & 17 The wording of this legislation is almost identical with that of the "model articles" of the English legislation of 1856. The Ontario Companies Act of 1907, following the pattern of the English enactment of 1900, made the shareholders' audit mandatory and the duties set forth in the enactment were identical with those ()f the English Act.l As late as 1900 there were no inspection or audit provisions 111 federal legislation. However, the Companies Act of 1902, in the nuanner of the English Companies Act of 1862 and the Ontario Companies .szt of 1897, allowed shareholders (representing at least one—fourth 21:1 value of the issued capital) to petition a judge to appoint an inspector to investigate the affairs and management of the company. The requirement that the judge be assured that good cause be shown fO‘rsuch investigation and that the applicants "are not actuated by IDelicious motives in instituting" the action marks the period as one <>f5 transition between the business freedom of the nineteenth century and the growing legislative concern and regulation that characterizes tZ'he twentieth century.3 Legislative debate that preceded the passing (If the Act was concerned with whether such inspection clauses would 1>e used "to embarrass the company."4 The inspection clauses also included provision for the company, if it so wishes, to appoint \ 1Ontario, Statutes, The Ontario Companies Act, 1907, 7 Edward VII, C. 34, Sec. 123 and 130. 2Canada, Statutes, The Companies Act, 1902, 2 Edward VII, C. 15, Sec. 79. 31bid. 4Canada, House of Commons Debates, Vol. 2 (1902), p. 5059. drums 9y I ‘I‘WK u! 5’.\ " " l - s: r! arenas 1:5.3 4. v ‘ . py-‘np t~y~ ba- ..u¢\- thin-S, . t . a ‘h! f‘ no ‘ r in 5.4: .06.“. -C ‘ ‘IA‘ 1— .2 .616 3-...CSt ' . a '. ~ ‘5‘ “‘V\ ‘:5¢Soab.yuo L n . '_ {JV 0! f..- , vex-3 .d.t. :. I Q. YH‘ "vs-'- e. 5.1! tuuc‘: SC 2"":nn'q‘ ’ ”1.... cl Seer '5 303K: 3:21" a. av "1.; _ r‘C'dens :cr “A; the In t" ¢ L Ire t'r . tubs and Iii-'1‘.— 3.2: ‘rr, ‘1. .- u«: :a" a kt tacit n o ': . “11,36 of ‘ L l8 inspectors by resolution at the annual meeting. By 1910, therefore, Ontario legislation, but not the federal Canadian legislation, had provisions for mandatory audits and outlined, in broad terms, the duties of the auditor with respect to his report on the financial affairs of the company. These provisions are seen to have almost identical wording with that of antecedent English legislation. Two underlying influences can also be detected at this early date. Firstly, one influence might be inferred from the comments of the Under Secretary of State (Canadian) and former Assistant Provincial Secretary of the Province of Ontario, Mr. T. Mulvey. In his book, Dominion Company Law, he indicated that the legislative provisions for detailed disclosure of assets, liabilities and equities as required in the 1917 Companies Acts ". . . were first suggested by the Board of the Institute of Chartered Accountants of Ontario in the drafting of the Ontario Companies Act, 1907 . . ."l The inference is that the Institute of Chartered Accountants of Ontario would also be mwre than moderately interested in advocating the compulsory audit provisions of The Ontario Companies Act, 1907. The second influence that attempts to explain the fact that the mandatory audit require- Inents and minimum balance sheet disclosure of The Ontario Companies .Act, 1907 predated federal Canadian legislation by some ten years is the fact that ". . . the commercial and financial history of Canada for the past dozen years reveals the fact that there has been but one collapse of a large corporation in that time and this was in con- nection with a business, which, at the same period, suffered similar lT. Mulvey, Dominion Company Law (Toronto: The Ontario Publishing Co., 1920), p. 54. .t L . 9.. r. :— v .\ y ' a V,‘ v '11“ u. (“‘1 “at. V.‘ a a,” Ct-“LJI’ L‘ l9 reverse in other countries . . ."l The combination of factors — the early influence of the Ontario Institute of Chartered Accountants on the Ontario legislation and the general lack of any company failures - may help to explain this lead-lag relationship. No evidence was located to indicate that federal Canadian legislators were content to have less strict regulation, since this would tend to increase, relative to Ontario, the numbers of companies that would incorporate under their jurisdiction.2 In later years, this was certainly a con- cern of the federal Canadian legislators when they began to lead the way in regulatory legislation. Attitude Towards the Audit The idea of the audit - though not mandatory in England for general companies until 1900 and in Ontario until 1907 - was, none- theless, beginning to be fairly well established by the turn of the century. J. D. Warde, in his book, "The Shareholders' and Directors' Manual," in 1900 states that: The value of a thorough and systematic audit of the accounts and books of a company has not hitherto been adequately appreciated. The investing public are now, however, paying more attention to the importance of periodical audits and examinations by the professional accountant and auditor. The resulting advantages are increased freedom from fraud, greater security for share— holders and more confidence on the part of the public, in the management of companies through being furnished with evidence of their safety and prosperity from an independent source. 1The Financial Post, February 16, 1907, p. 1. 2However some concern existed in Ontario in this regard. See p. 83. 3J. D. Warde, The Shareholders' and Directors' Manual (Toronto: The Canadian Railway News, Co., Limited, 1900), p. 104. w hen-«gv’: stuthtr, setter. c: the sire“ . ‘ P I‘H «.4 “.V" ---— 6.... LL... T‘ A ' I'lc ’ an s ?&ILEC Drier P::.1c auditi rescrts were A. H reflect or H on the 190.; f ‘;-. V alliec. 3,: "“3'1 1t Subs 20 Similarly, T. Mulvey in his book, Canadian Company Law, states in reference to existing federal legislation, that: Under this act . . . the appointment of an auditor and the making of an annual audit of the books of the company are not required. Proper business methods, however, demand periodic audits, not only for the infor- mation of the shareholders, but also for the benefit of the directors.1 Form and Content of Auditor's Report The form and content of the auditor's report were quite varied prior to 1910. According to C01. H. D. Lockhart Gordon of the public auditing firm of Clarkson, Gordon and Dilworth, early auditors' reports were extremely brief either in the form of "audited and found correct" or "examined and found correct."2 Just such wording appears on the 1904 financial statements of Canadian Westinghouse Company Limited. By 1908, the auditor's report of that company took a form which it substantially held until 1917. I have audited the books of the Company for the twelve months ended Blst December, 1908 and have been furnished with vouchers for all expenditures, and certify to the accuracy of the above statement, which agrees with the company's books. In this instance the statements referred to were a "General Balance Sheet" and a "profit and Loss Account." The latter statement was much more akin to our present-day retained earnings statement - adding together the opening balance and the current net earnings and 1Thomas Mulvey, Canadian Company Law (Montreal: John Lovell and Sons Limited, 1913), p. 102. 2Col. H. D. Lockhart Gordon, "Fifty Years Ago", The Canadian Chartered Accountant, Vol. 79 (July, 1961), p. 97. 3Canadian Westinghouse Company Limited, Annual Report, 1908. arrive at the 1" .28 a C) (J' C) . lfi-e.-yabt 1” Celtic”... 0 A... . . . VF' Pr“ .q 1.33 but ¢;-¢ . ,, , CZ: EELS»)! S l- ‘ “'8‘: ,‘ .1..¢,;;-GA 3lst. Mar . . D“?‘ n \‘£ Ad; COI‘IECtl': Eursezenz 1.26 : ..,\ 1 -: s‘r?‘ it; 21 deducting from this, the dividends and a reserve for depreciation to arrive at the closing balance. The auditor's report of The Dominion Textile Company Limited testify to both the variety of reports as well as the fairly detailed enumeration of audit techniques. The latter feature continued well into the 1920's and 1930's for many companies. Additionally, though the auditor's opinion or certification is implied in some of the para- graphs, there is no explicit articulation of an Opinion. We beg to report having completed our audit of the financial transactions of your Company for the year ended 3lst. March 1906. During the year our audit has been carried on monthly at which periods we have reported to your Directors. The financial transactions have been carefully and correctly incorporated in the Books of Account and the dis- bursements and purchases have been verified by vouchers. The monthly Cash Statements from the various Mills, duly supported by vouchers, have been correctly incorporated in the financial records. The Cash on hand, Bank balances, and Loan Accounts have been checked from time to time and the latter verified by certificates from the Banks. The Inventories of Raw Cotton, Merchandise on hand and in process of manufacture, supplies &c. at the various Mills, have been prepared in detail and the summaries signed and approved by your General Manager. The annual Financial Statements setting forth the trans- actions both of the subsidiary Companies purchased and those under lease have been correctly drafted from the Books of Account and we have signed the same as being in order. The clerical work during the year has been satisfactorily carried out and the manner in which the systems of Accounting have been adjusted to meet the requirements of the Company reflects much credit upon your Secretary and office staff. The auditor's report of Ogilvie Flour Mills Company, Limited in 1909 renders an opinion only on the balance sheet (in this instance the abbreviated Profit and Loss Account contains trading profits, and 1The Dominion Textile Company Limited, Annual Report, 1906. . .‘I-.. -‘_-A (.1 . fl . ...~..¢-.' c~-»¢.eb - was or 13,0 fiéa‘Jllv 22 deductions for bond interest, dividends, and transfers to reserve accounts), and provides, additionally, some information concerning asset valuation. We beg to report that we have audited the books of the Company in Montreal, Winnipeg and Fort William for the year ending Blst August, 1909, and that the Balance Sheet which we have signed is a correct statement of the Company's Assets and Liabilities on that date. The provision made in respect of the Open Accounts and Customers' Notes covers, in our Opinion, every possible contingency, and the Stocks on hand are valued on a perfectly safe and conservative basis. The increase in Property and Plant accounts is for additions and extensions only, all ordinary Repairs, Alterations and Improvements being included in the Working Expenses Of the year, and depreciation (if any) is in our opinion fully covered by the addition Of $100,000 to Property Reserve. The auditor's report of The Steel Company Of Canada Limited of 1910 is similarly concerned with asset valuation but bears more heavily the imprint Of the influence of the English and Ontario legislation. Most of the wording of the last paragraph is taken directly from those sources.2 It can be noted in this report that the Opinion is expressed twice — in both the first and last para- graphs - and that while the Opinion is rendered on the profit and loss account as well as the balance sheet, the former account is in the abbreviated form mentioned previously; that is, it merely includes earnings, depreciation, dividends and the closing balance. lThe Ogilvie Flour Mills Company, Limited, Annual Report, 1909. 2The English influence on early American auditor's reports is acknowledged in The Independent Auditor's Reporting Standards in Three Nations, a Report prepared by the Accountants International Study Group (Toronto: The Canadian Institute Of Chartered Account- ants, 1969), paragraph 22, and in George Cochrane, "The Auditors' Report — Its Evolution in the U. S. A." The Accountant, Vol. 123 (November 4, 1950), p. 448. KB huV' Ca2pany of six :ccths balance sh acetunt ar The in 93351316 0 the ba.an: 943.11g OI t: 23 We have examined the books and accounts of The Steel Company Of Canada Limited and subsidiary Companies for the six months ending December 31, 1910 and certify that the balance sheet as at that date, and relative profit and loss account are correctly drawn up therefrom. The inventories of stock on hand as certified by res- ponsible officials Of the Company have been made on a basis Of approximate cost. We certify that we have Obtained all the information and explanations which we have required, and that in our Opinion, the balance sheet is prOperly drawn up so as to exhibit a true and correct view Of the state Of the affairs of the Steel Company of Canada Limited and its subsidiary companies as at 3lst December, 1910.1 Legislation and Auditors' Reports, 1910 - 1920 General Outline Littleton and Zimmerman have outlined the contrast in the evolution of auditing between England and the United States.2 In the granting Of the privilege of limited liability to corporations, English law has required that, in the public interest, there be dis- closure of financial information and that such disclosure be attested to by auditors. As previously mentioned, this tradition in English law commencing in 1844, was temporarily abandoned in 1856 and sub- sequently put into full force in 1900. The continuing strength Of the "laissez-faire" attitude in business and the lack of a sufficiently strong auditing profession probably accounts for the interruption of the mandatory audit provisions between 1856 and 1900. Littleton and Zimmerman postulate the assumptions of the English tradition: . . . that adequate accounts were a basic source Of know— ledge Of enterprize financial affairs; that audited 1The Steel Company of Canada Limited, Annual Report, 1910. 2Littleton and Zimmerman, Accountinngheory: Continuipy and Change, p. 81. .11‘4 Eve‘ub‘on of The :1 an El. 3'15 5 05“ 'C the he 24 balance sheets, widely circulated, would be in the public interest because the data reported by the company directors could be searchingly scrutinized as to its dependability and that the directors of that day would benefit from a recommended arrangement of balance sheet data which could guide them tO an adequate and understandable accounting disclosure of company financial status.1 (Italics mine.) The American tradition for auditing did not evolve through legislation on behalf of the "public interest", but rather out of the need for an external independent commentary on credit-worthiness. As Littleton and Zimmerman suggest: . . . the strongest motivating factor [for audits] seems to have been the need of creditors, particularly banks, for dependable financial information as a basis for their extension of credit to businesses in the form of short- term promissory notes. Similarly, G. Wilkinson, in 1914 commented on the American evolution Of the auditing function. The necessity to borrow capital with which to transact an extensive business, has brought very many corporations to the necessity Of having their accounts audited and their balance sheet certified by independent accountants of known standing. The use by a business concern of an accountant's certificate in this connection is one Of the highly valued develOpments Of the last ten years. This is on the increase. Bankers are demanding it even among companies whose credit rating is of the best.3 In Canada a number of events led to the mandatory audit provisions of The Companies Act Amendment Act, 1917. It is likely that when these events occurred and the question Of mandatory audits was raised that the English tradition for legislative action was inevitable. There is, as well, some evidence to indicate that the lIbid. 21bid., p. 109. 3George Wilkinson, "The Auditor's Standing in England and America," The Canadian Chartered Accountant, Vol. 3 (April, 1914), p. 239. - _'. eta" .C--’d~ 5.7.51 '3 fav- are". an {nc'l .._—.‘ s~ Q Hy“ 0" A. afl‘ (I. .l C « l l‘.‘ o t I .: .Cc .- 25 American concern for credit-worthiness was also influential in supporting the acceptance Of the audit function. BankingrLegislation Certainly, one of the events that led to a concern for mandatory audits for all federal Canadian companies was the series of bank failures that precipitated The Bank Act, of 1913. The ability of Canadian businesses in avoiding failures has been commented on previously; however, that ability did not extend to the banking industry. More Canadian banks have failed than are now in existence and some failures have been disastrous to the public, both depositors and noteholders, as well as shareholders. Within the last five years, seven banks have failed.1 English legislation had prescribed mandatory audits for banks in 1879 and equivalent Canadian legislation followed some 34 years later in 1913 upon the occasion of these bank failures.2 Similar legislation for the "near—banks" - the loan companies and the trust companies - followed in 1914.3 It should be noted that The Bank Act required auditors to render an Opinion on both the balance sheet and the profit and loss. The Loan Companies Act, 1914 and The Trust Companies Act, 1914 are less clear with regard to the financial state- ments on which the auditor must provide an opinion. l"Bank Audit or Inspection Compulsory from Outside: Is it Justifiable and Expedient?", The Canadian Chartered Accountant, Vol. 1 (July, 1911), p. 24. 2Canada, Statutes, The Bank Act, 1913, 3 and 4 George V, C. 9, Sec. 56. 3Canada, Statutes, The Loan Companies Act, 1914, 4 and 5 George V, C. 40, Secs. 59 and 60 and The Trust Companies Act, 1914, C. 55, Secs. 47 and 48. 035E212 at-‘n L "Voc p v , e-« M- “PILL.“ . . . De 5%.. 5.“; .A lECCZ::‘ 26 An editorial in The Canadian Chartered Accountant acknowledged the influence of public Opinion in the new legislation. The banks themselves, while not appreciating the necessity for any form of external inspection, accepted the principle of a shareholders' audit as a concession to public opinion, which it was realized had become aroused owing to the dis- closures respecting the Ontafio, Farmers and Others of the then recently defunct banks. (Italics mine.) Frequent editorials in The Journal of Accountancy expressed great interest in the mandatory audit provisions.2 In particular, the competence, size and prestige of the Canadian accounting profession were acknowledged as necessary forerunners to mandatory audits. Ten years ago it would probably have occurred to no one to suggest the compulsory audit Of banks, for the number Of reputable accountants in Canada was very small. At present, however, the chartered accountants are well organized in most of the provinces and held in high esteem among business men. The plan that contemplates their employment for the audit of the Chartered Banks will not be Opposed on the ground that Canadian accountants are incompetent, untrustworthy or insufficient in number.3 The Companies Act Amendment Acgyyl917 Legislation The audit provisions of the English Companies Consolidation Act of 1908 with respect to the mandatory audit and the duties of the auditor relating to the financial statements were substantially the same as in the predecessor English Companies Act of 1900. Canadian legislators in 1917 transplanted these provisions word for word in 1"Bank Auditing," editorial, The Canadian Chartered Accountant, Vol. 12 (May, 1923), pp. 450 - 451. 2See "Canadian Bank Audits," The Journal of Accountaney, Vol. 16 (October, 1913), pp. 309 - 312. 3"Bank Examinations in Canada," The Journal of Accountancy. Vol. 8 (May, 1909), PD. 41 - 42. ”A :Jvl 1" .9. 55 Ali. .s“ 1 .‘ ‘.'“ «st; (L ‘U- * s- *t'lngcc r. o 27 The Companies Act Amendment Act, 1917. Every company shall at each annual general meeting appoint an auditor or auditors to hold Office until the next annual general meeting. Every auditor of a company shall have a right Of access at all times to the books and accounts and vouchers Of the company, and shall be entitled to require from the directors and officers of the company such information and explanation as may be necessary for the performance Of the duties of the auditors. The auditors shall make a report to the shareholders on the accounts examined by them, and on every balance sheet laid before the company in general meeting during their tenure of office, and the report shall state;- (a) whether or not they have Obtained all the infor— mation and explanations they have required; and, (b) whether, in their Opinion, the balance sheet referred to in the report is properly drawn up so as to exhibit a true and correct view Of the state of the company's affairs according to the best of their information and the explanations given tol them, and as shown by the books of the company. It should be noted that the legislation requires the auditor to provide an Opinion on the balance sheet but not on the profit and loss statement. The Background A sizeable increase in the number of commercial and industrial failures in 1914 and 1915, (see Appendix C), undoubtedly stimulated concern for a wider extension of mandatory audits. M. Goodman commented that: When the crisis through which we are now passing was first felt [the early war years of 1914 and 1915], hundreds of well known concerns were thrown to the wall, the stock markets were closed, and thousands of small and large investors lost their all. After a series of investigations by accountants, it was shown that a majority of these con- cerns failed because of insufficient accounting, over- Optimism and lack of foresight. lCanada, Statutes, The Companies Act Amendment Act, 1917, 8 George V, C. 25, Sec. 11. c. v... C or .L 2: .7. be 55 ualu a» 3 U a »t a p95 7.; PO. - ~ ‘ 'V‘untar eu' 28 The bankers, the principal and largest sufferers again sought a cure and prevention with the result that today they are demanding statements . . . prepared and signed by Chartered Accountants. Some concern for audit compulsion was also expressed by J. L. Apedaile. I am sure that if the auditor would . . . take a greater interest in the problems Of the manufacturer, he would be able to assist the manufacturer to such an extent that we would require no legislation to make auditing compulsory, rather would we have the manu- facturer consider it essential.2 Though the foregoing quotations indicate some general concern for industry-wide compulsory audits, no additional evidence of commercial or professional concern was located in a scanning of articles and editorials in The Canadian Chartered Accountant and The Financial Post up to 1917. A Bill introduced in the federal parliament was never acted upon.3 Seeming lack of commercial and financial concern for the mandatory audit may be partially explained by the fact that a great number of public companies had already voluntarily accepted the idea Of an independent audit.4 Undoubtedly lM. Goodman, "The Chartered Accountants of the Dominion - A Discussion and Suggestion," The Canadian Chartered Accountant, Vol. 7 (July, 1917), p. 44. 2J. L. Apedaile, "The Management Of a Manufacturing Concern or a Plea for the Manufacturer," The Canadian Chartered Accountant, Vol. 5 (October, 1915), p. 146. 3V. E. Mitchell, A Treatise on the Law Relating to Canadian Commercial Companies (Montreal: Southam Press Limited, 1916), p. 1143. 4Of 147 companies listed as "Industrials" in the Annual Financial Review - Canadian, 1916, only 18 did not indicate who the auditors were. Of the 147 companies, only 11 indicated that they were incorporated under the laws Of Ontario, where by this time, mandatory audits were compulsory. r4 " "“7" 4., .1“. .‘S¢\,g. one ~‘:“ bu inc“). 29 a concern for credit—worthiness motivated a voluntary audit. J. Parton indicates that: . . it was some time in 1912 (as I recollect) that the banks began a general practice of requiring an independent audit of all businesses which asked for loans or bank accommodations. This caused resentment from the heads of such businesses, who complained about the cost; but the banks persisted in their idea, and it is gratifying to look back after all those years and remember how heads of businesses very soon changed their minds and realized the value of audits, not only so far as banks were concerned, but also for themselves. The speech that introduced the legislation to the House of Commons and the subsequent House debates provide little explicit reasoning for audit compulsion other than the fact that federal legislation lagged behind English and provincial legislation. The purpose of the bill is to amend the Companies Act so as to embody in it principles that of recent years have been embalmed in legislation in Great Britain in their Companies Act and for the most part have been accepted by our provinces. When attention was drawn to the fact that mandatory audit provisions and minimum corporate disclosure requirements - two of the main features of The Companies Act Amendment Act, 1917 - would be burdensome to the smaller companies, the Minister of Finance replied that this legislation had been operative in Ontario for ten years. 1John Parton, "Fifty Years Ago", The Canadian Chartered Accountant, Vol. 79 (July, 1961), p. 95. 2Canada, House of Commons Debates, Vol. 6 (1917), p. 5920. 31bid., p. 5935. ¢ 4- s.u. 1:00 s . ‘m .auat‘ . ‘A? 3. .1», _ I--. 1"»: .- C 5552. r\ d. 1.4(\ 3 3.. .t; «U S 3 .C ,6 pl» .._ .I . a .2 .2 9.. 5-. .i P C . .u .: t C a“ L. a. e 4.. a. T. ..\ J u .lu . u . . a: A c «G .G .d . fly it .: at 71 .3 .C a u .w a a c 4 a .. . o r .1 a» J a a M i. S J a . . ‘L Y. n v . t 6. .Q a» .Fu 3 “U. .2 .~\ 2. .3 . . Q. .: 2. .. J a .. . .aw .J. .J. . a .‘ s s.» .\. is .L . .. . . c .2 .3? .. J!» J... .. as v . . a E .G 2 . . Y“ . .. Z 4 Wu L. 23 1k ,. . . c «L .l. AV .9» . s . é. a: a: . \~ A -. .rb 5C 0... .C -5... C a y u. t .A .\~ I. u . . 30 The Taxation Acts of 1916 and 1917 The Business Profits War Tax Act, 19161 and The Income War Tax Act, 19172 undoubtedly influenced the enactment of the Companies Act Amendment Act, 1917. In 1916 the federal parliament found it necessary for war purposes, to levy a tax on corporate profits in excess of a stipulated percentage return on capital. The tax was applied only to those companies whose capital was in excess of $50,000. Sir Thomas White, the Minister of Finance, in response to questions in the house, indicated on several occasions that his department would be hard pressed in terms of sufficient staff to administer the tax regulations if all businesses were taxable.3 Additionally, he acknowledged that "field auditors" would be needed. Under these circumstances the desirability of the mandatory audit and minimum disclosure provisions of the 1917 Act is beyond doubt. Firstly, corporate accounting would be made more uniform and comparable, thereby satisfying the tax need for "equity"; secondly, corporate accounting as reflected in audited financial statements would be attested to by a respected professional, thereby decreasing the need for an expanded tax-audit department since there would be an independent and objective witnessing to the corporate financial statements. The complementarity of the Companies Act Amendment Act, 1917 lCanada, Statutes, Business Profits War Tax Act, 1916, 6 and 7 George V, C. 11. 2Canada, Statutes, The Income War Tax Act, 1917, 7 and 8 George V, C. 28. 3 Canada, House of Commons Debates, Vol. 3 (1916), p. 2630. 31 and the taxing legislation was reflected in remarks relating to corporate annual reports by Mr. Carvell. We have had a business profits tax for the first time in our history and now we have the income tax. It is these incorporated companies who are the very ones that will contri- bute under the new methods of taxation and I think it quite proper that the very fullest publicity should be given.1 Similarly, Parton reflects this complementarity relationship between taxation and corporate auditing: . . . it has been very gratifying to find the ready way in which the Minister of Finance and his assistants have accepted the statements signed by chartered accountants for the purpose of their assessment. Encouragement has been given to clients to have their auditors interview the inspectors of taxation and generally, business men have been led to obtain a much higher realization of the services of the profession than ever before. United States Influence The coincidence in time of the Business Profits War Tax Act, 1916, the Income War Tax Act, 1917 and that of the Companies Act Amendment Act, 1917, has already been noted. The latter legisla- tion undoubtedly muted the effect in Canada of another event that was of great significance in the United States. That event was the publication of the statement Uniform Accounting by the Federal Reserve Board of the United States. This statement was reprinted in The Canadian Chartered Accountant3 and its merit referred to the consideration of "leaders of accountancy in Canada . . . and to 1Canada, House of Commons Debates, Vol. 6 (1917), p. 5937. 2John Parton, "Merchandise Inventories and the Auditor's Responsibility Therefor," The Canadian Chartered Accountant, Vol. 7 (October, 1917), p. 99. 3United States Federal Reserve Board, Uniform Accounting (Washington: Federal Reserve Board, 1917), reprinted in The Canadian Chartered Accountant, Vol. 7 (May, 1917), pp. 5 - 33. 4. o. J. V. .r .1 .c ".1 .C .. .L La .. r. 9.. 06 I10. u d . , q A. A v . ,q~ - -...'. .C L" 1 . .. . 3. .L a S .1 ... :L I ~--.. H ‘ I» an: ‘ l ‘l «.5 «L .C ab 2 .. . C. ... . .C ”a v. 3‘ u I '1». 1 . .3 £184 r i ‘ at fly .54 on» on» 32 the young accountant."l The statement prescribed in fair detail the accepted auditing procedures for the "balance-sheet" audit and also provided a model auditor's report. I have audited the accounts of Blank & Co. for the period from to and I certify that the above balance sheet and statement of profit and loss have been made in accordance with the plan suggested and advised by the Federal Reserve Board and in my opinion set forth the financial condition of the firm at and the results of its Operations for the period. It seems likely that the audit provisions of the Companies Act Amendment Act, 1917 pre-empted the effect that Uniform Accounting might otherwise have had with regard to the duties of the auditor in respect to financial statements and the form and content of the auditor's report. Certainly the Canadian audit reports, subsequent to 1917, bear the heavy imprint of the Canadian legislation. The Canadian concern for American events, as evidenced in the reprinting of Uniform Accounting, was in the established tradition of The Canadian Chartered Accountant.2 Similarly, Thomas Mulvey, the Undersecretary of State, acknowledged the awareness of Canadian legislators of the early statutes of New York State.3 1Unsigned commentary "Uniform Accounting" The Canadian Chartered Accountant, Vol. 7 (May 1917), p. 49. 2A3 a rough measure of Canadian concern, it was found that of the 37 signed articles of three pages or more in volumes 7 and 8 of The Canadian Chartered Accountant, 12 of these were written by Americans, 6 by English and 19 by Canadians. The non-Canadian articles were invariably reprints from the American and English accounting journals. 3Thomas Mulvey, "The Companies' Act", The Canadian Chartered Accountant, Vol. 8 (October, 1918), p. 129. 33 The Effect of the Companies Act Amendment Act, 1917 The variety in content of auditors' reports continued through the early part of the second decade of the twentieth century in Canada. Cockshutt Plow Company Limited's Report of 1911 was: I have made an audit of the books, accounts and records of Cockshutt Plow Company for the financial year ended June 30, 1911. I have examined the charges to capital accounts, have verified the cash and other current assets as of June 30th, 1911 and have also verified the profit and loss. I hereby certify that in my opinion the statements of assets and liabilities submitted herewith reflects the financial position of the Company at June 30, 1911 and that the accompanying statement of profits is correct. In this instance, some auditing techniques are delineated and the profit and loss statement is included in the opinion. The abbreviated profit and loss includes net profit after depreciation, interest, merchandise reserve, capital reserve, and contingent reserve. Similarly, the report of Penmans Limited attests to both the balance sheet and the abbreviated profit and loss statements as well as drawing attention to the inventory valuation basis and the management certification of inventories. I have examined the books and vouchers of Penmans Limited for the year ended 3lst December, 1913 and certify that the accompanying balance sheet and profit and loss account agrees therewith. I have been furnished with all the information required by me, and the inventories of stock on hand have been taken approximately at cost, as certified by responsible officials of the company. The statements appended hereto represent, in my Opinion, a true and Sorrect view of the Company's position as at the above date. lCockshutt Plow Company Limited, Annual Report, 1911. 2Penmans Limited, Annual Report, 1913. 1.}. ,1 by“ . I .3-; hi” va?;;r’ .u- o Céft l. at: ) hie 9. I 34 The report of Ogilvie Flour Mills Company, Limited, provides a great deal of accounting and auditing information. In this instance, the report to the shareholders does not contain the auditor's opinion; rather, the latter is given in a small note at the bottom of the balance sheet and signed by the auditors. The report to the share- holders reads: We beg to report that we have audited the Books of the Company in Montreal, Winnipeg, Fort William and Medicine Hat, for the year ended 3lst August, 1916, verifying the Cash and Bills Receivable on hand, the Bank Accounts, the Investments, and the Accounts Receivable, in respect of which ample provision has been made for all Contingencies. The Stocks on hand of Wheat, Flour and Supplies are certified as to quantities by the Superintendents of the various Mills, confirmed by the Mill Reports, and are valued on a safe and conservative basis, taking into con— sideration the unusually high price of wheat and the con- tingencies of the markets. No provision is made for general depreciation, but the cost for repairs and maintenance of the various Plants has been included in the Working Expenses of the year. The fulfilling by the auditor of the duties imposed by the Companies Consolidation Act, 1908 and the Companies Act Amendment Act, 1917 in Canada provided a ready format for the form and content of his report. R. Kettle indicates that legal advice, secured by the Institute of Chartered Accountants of England and Wales in 1908, suggested that the auditor's report take the following form: We have audited the balance sheet of ABC Ltd., dated the Blst December, 1908 as above set forth. We have obtained all the information and explanations we have required. In our opinion, such balance sheet is properly drawn up so as to exhibit a true and correct view of the state of the Company's affairs according to the best of our lOgilvie Flour Mills Company, Limited, Annual Report, 1916. 35 information and the explanations given us and as shown by the books of the Company. Companies such as Steel Company of Canada Limited, Canadian Locomotive Company Limited and Cockshutt Plow Company Limited incor- porated most of this "legal" wording in their auditors' reports several years prior to the Canadian legislation of 1917. The audit report of Cockshutt Plow Company Limited of 1914 is a good example of strong adherence to the "legal" wording. We have examined the foregoing balance sheet as at June 30, 1914 and the accompanying profit and loss account for the year ended on that date, with the books of the company and the accounts from the company's branches and we have obtained all the information and explanations we have required. In our opinion, such balance sheet and profit and loss account are properly drawn up so as to show a true and correct view of the state of the company's affairs as at June 30, 1914 and the results of its operations for the year ended at that date, according to the information and explanations given to us and as shown by the books of the Company. For other firms, such as Canadian Westinghouse Company Limited, Penmans Limited, Ogilvie Flour Mills Company Limited and Dominion Textile Company Limited, the change-over to a stronger acknowledgement of the "legal" wording occurred immediately subsequent to the 1917 legislation. J. C. Gray suggests that sometimes a time-lag in observance of such wording existed since "it is still the practice of many accountants to issue their accounts with notations of 'audited 3 and found correct,‘ 'certified correct,‘ 'audited' etc. attached." lRussell Kettle, "Qualifications in Auditor's Reports", The Canadian Chartered Accountant, Vol. 17 (May, 1928), p. 337. 2Cockshutt Plow Company, Limited, Annual Report, 1914. 3J. C. Gray, "Standardization of Shareholders' Accounts and Auditors' Reports and Certificates," The Canadian Chartered Accountant, Vol. 8 (January, 1919), p. 199. 36 He goes on to state "needless to say, these offenders are seldom Chartered Accountants."1 Nor would it appear, are they the normal auditor's report that attached to large public company financial statements! Cochrane has provided us with an example of the kind of wording which was used in the United States in this time period. We have audited the books and accounts of the ABC company for the year ended December 31, 1915, and we certify that in our opinion, the above balance sheet correctly sets forth its position as at the termination of that year, and that the accompanying profit and loss account is correct. It is fairly evident from a comparison of the foregoing example and the model report offered in Uniform Accounting by the Federal Reserve Board with the Canadian Company audit reports previously illustrated that the form and content of the Canadian auditor's report were styled after the Canadian and English legislation. Report Wording Beyond the "Legal" Minimum A good number of the audit reports inspected provided additional information with respect to inventory valuation, fixed asset capitalization policy, non-existence of depreciation, inability to segregate goodwill from the other fixed assets, management certi- ficates testifying to asset-recording propriety, and descriptions of audit techniques relating in particular to cash and securities. It is impossible to know whether these represented substantive qualifications lIbid. 2George Cochrane, "The Auditor's Report, Its Evolution in the U. S. A.", The Accountant, Vol. 123 (November 4, 1950), p. 450. 37 in the minds of the auditor, whether they were simply additional information being passed along for the shareholders benefit, or whether indeed, it was felt that these kind of things should form part of the auditor's standard report wording. Certainly they were very common features of the auditor's report during this period of time. Their widespread existence is likely a testimony to the uncertainty that attached to the state of the art of accounting and auditing principles and practices. An additional source of uncertainty flowed from the necessity to comply with the minimum disclosure requirements of the 1917 Canadian legislation. An example of this latter situation is the 1917 audit report of Steel Company of Canada Limited which indi- cated that the company was unable to segregate goodwill from the property accounts as required by the new legislation. This auditor's report is fairly typical of the reports inspected following the 1917 legislation. We have examined the Books and Accounts of The Steel Company of Canada, Limited, for the year ending December 31st, 1917, and certify that the Balance Sheet as at that date, and relative Profit and Loss Account, are correctly drawn up therefrom. The Inventories of Stock on hand, as certified by res- ponsible officials of the Company, have been valued on a conservative basis. We have checked the Cash on hand, and certificates verifying the Bank balances have been produced to us. The Investments in which the Company is interested we have verified by actual inspection of the securities. No recent physical appraisal of the several Plants has been made, which would indicate to what extent Goodwill is included in the Cost of PrOperties, and the Balance Sheet therefor shews these Assets in the same manner as they have appeared in all previous statements. We certify that we have obtained all the information and explanations which we have required, and that, in our opinion, the Balance Sheet, as at Blst December, 1917, is properly drawn up so as to exhibit a true and correct view of the state of the Company's affairs according to the best 38 of our information and the explanations given to us and as shewn by the Books of the Company. The legislation of 1917 required that an audit Opinion be rendered only on the balance sheet. Seven of the eight auditors' reports inspected throughout this period, rendered an opinion on the profit and loss statement as well as the balance sheet prior to the 1917 legislation. Only two of these seven reports which happened to be by the same auditor, Canadian Westinghouse Company Limited and Penmans Limited, did not have Opinions rendered on the profit and loss statement in the years subsequent to 1917 and prior to 1920. Little evidence, at this point therefore, is adduced to support the contention that the general effect of legislation tends to decrease the standard of reporting practices. The profit and loss statement at this point of time is typically abbreviated as previously described. Legislation and Auditors' Reports, 1920 - 1940 Background The first decade of the inter-war years of 1920 - 1940 were, for England, United States and Canada, the time of "normalcy" - for "business-as-usual." However, the stock market crashes and the depression altered the attitude of society towards the capitalist system prevalent in all three countries. Though England and Canada in slow, measured and evolutionary steps had, since 1850, led the way in respect to statutory, mandatory audits and the elaboration of auditors' duties relating to the financial statements, the American 1The Steel Company of Canada Limited, Annual Report, 1917. 39 Securities Acts of 1933 and 1934 brought the United States quickly abreast. In Canada, by the beginning of this period, much of the audit aspects we are concerned with had been settled. Still to be debated, however, remained the problems of the inclusion of the profit and loss statement in the auditors opinion, the introduction of the word- ing "according to generally accepted accounting principles applied on " the use of a basis consistent with that of the preceding year, "generally accepted auditing standards," and the elimination of word- ing beyond the "legal" minimum. Some progress was made on all four issues during this period - particularly with respect to the elimina- tion of the extra wording that so characterized auditors' reports of the earlier era. The period 1930 to 1940, may well mark the trans- itional decade for Canada as it turned more towards the influence of the United States and largely away from that of England. The geographic proximity, the increasing investment of the United States in Canada and the articulateness of the American Institute of Accountants were all compelling reasons for this transition. World War II, commencing in 1939, interrupted the increasing concern of the Canadian accounting and auditing profession - a concern which was quickly rekindled in the immediate post-war years. d ' . ‘5.— r -... V ‘- a ,. a..- 1 L...“ . L-_ '9‘ an» _HP«. “11'. - H’ Mb. 4- '1-“ u-'—~ nan” - o'..- baohv .m- an: . n .93 a..&r t . p g, at .C E L. O C. I .1 T. .i - . . D. t u .G a r C S .t l C l .r. 0 O n a t A1 u .. E E .t a .o. .J E E . 1 .l : . S t .1 r; E PL he CL a n5 3 an :1 .D u t 7.. .n h I A (v A s .. A .h. 0 a; 4» - .Q A-» o s 1. a p L f v 40 English and Canadian Legislation Neither the English Companies Act, 19281 nor the Canadian Companies Act, 19342 made any significant changes in the statutory audit provisions under examination. The changes in Canadian legis- lation dealt mostly with increasing the information content of the annual financial statement. Professor R. G. H. Smails, writing at the time, implied the influence of the English legal case involving the Royal Mail Steam Packet Company, which arose in 1930, shortly after the English legislation. The case related to the profits as represented by the Company and whether the augmenting of these profits through the use of secret reserves should be disclosed in the state- ment. Though the influence of the case was recognized, that influence did not extend to the requirement to have the auditor render an opinion on the profit and loss statement; rather the influence seemed to find expression in a desire for more disclosure in the profit and loss and earned surplus statements. Smails states: The hand of the auditor would seem to be greatly strengthened by the specification of the items that are to be shown separately in the general statement of income and expenditure and the statement of surplus respectively, to be laid before the company in general meeting. Certainly, these statutory requirements will relieve auditors of such grave responsibility as lay upon the auditor of the Royal Mail Steam Packet Company, full advantage having been taken by the authors of the new act of the costly experience gained from this case. The only new auditing provision relating to the form and 1Great Britain, Statutes, Companies Act, 1928, 18 and 19 George V, C. 45. 2Canada, Statutes, Companies Act, 1934, 24 and 25, George V, C. 33. 3R. G. H. Smails "Students' Department," The Canadian Chartered Accountant, Vol. 25 (September, 1934), p. 283. A... t «a. .y'nbcub - ‘l q Ac- luv".- an d- nafififl thuau - H- EX? AA- 5»— h,_ 5‘ n o a: I. 41 content of the auditor's report that found its way into the new Companies Act, 1934 was in respect to treatment of subsidiaries not consolidated in the parent's financial statements. Where the assets and liabilities and income and expenditure of any one or more subsidiaries of the holding company are not so included in the balance sheet and the statement of income and expenditure and statement of sur- plus Of the holding company, there shall be annexed to the balance sheet of the holding company a statement signed by the auditors of the holding company stating how the profits and losses of such subsidiary or, if more than one, the aggregate profits and losses of such sub- sidiaries, have, so far as they concern the holding company, been dealt with in, or for the purposes of, the accounts of the holding company, and in particular how, and to what extent, (a) provision has been made for the losses of a a subsidiary, either in the accounts of the subsidiary or of the holding company or of both; and (b) losses of a subsidiary have been taken into account by the directors of the holding company in arriving at the profits and losses of the holding company as disclosed in its accounts; provided that it shall not be necessary to specify in any such statement the actual amount of the profits or losses of any subsidiary, or the actual amount of any part of any such profits or losses which has been dealt with in any particular manner. The foregoing provisions are identical with the provisions of the English Companies Consolidation Act, 1929 with the exception that in the latter Act, the statement must be signed by the directors rather than the auditors.2 The provisions are repeated here at length because from this time to the next legislation in 1965, frequent and repeated references to the treatment of profits and losses in non- consolidated subsidiaries are found in auditors' reports. 1Canada, Statutes, Companies Act, 1934, Sec. 114 (2). 2Great Britain, Statutes, Companies Consolidation Act, 1929, 19 and 20 George V, C. 23, Sec. 126. 42 United States Legislation and Stock Exchange Requirements The American Securities Acts of 1933 and 1934 made the audit of both balance sheet and profit and loss statement mandatory. George 0. May expressed some doubt about the concommitant features of this legislation. Whether the time was then ripe for making audits by independent accountants of statements filed under the Acts mandatory seemed to me to be doubtful. But if audits were to be required and a heavy liability placed upon the profession for the proper discharge of the duty thus imposed upon it, there could be no reason for striking at its professional character by taking the responsibility for accounting rules and principles out of its hands and placing it in those of a policy-making body that was not expert, especially as there was not even any provision for a hearing or right of appeal to the courts against rules so made. As is known, over the years, the SEC has effectively handed back to the profession the task of determining accounting and auditing standards. Some tradition for advocating mandatory audits had existed from earliest times in the United States. An editorial in the Journal of Accountancy in 1905 states that: The time is also ripe for an agitation in favor of private publicity - that is for the rendering by cor- porations of complete reports of their financial con- dition to their stockholders and the certification of such reports by independent public accountants. Similarly, five years later in 1910, J. E. Sterrett, the president of the American Association of Public Accountants proposed external 1George 0. May, Financial Accounting A Distillation of Experience, (New York: The Macmillan Company, 1943), p. 62. 2"The Public Accountant and Publicity," editorial, Journal of Accountancy, Vol. 1 (December, 1905), p. 137. S ;-- h. '\ J'VES . I . -.— . ww . 11c >5 .V I I C 1 i. 5 nos 1 q‘“‘ ,,Jn' Ci ,-“$L :? ‘ O MC CT. 315. c-“- C" U.‘ C . . .a .. r n? 43 examination of corporate affairs by competent accountants.l Predating the American Securities Acts somewhat, the New York Stock Exchange in January of 1933 required that corporate auditors furnish the Exchange with a statement indicating whether in their Opinion the balance sheet and profit and loss statement are drawn up fairly, whether they are in conformity with "accepted accounting practices" and whether these practices have been used consistently. These Exchange requirements (though not necessarily conceptually originating with the Exchange) gradually found their way into the auditor's report. The Auditor's Duty Respecting the Profit and Loss Statement The English Tradition As indicated by the Amendment Committee in 1906, early English sentiment did not favor the requirement that the profit and loss statement be audited.3 Similarly, the English Companies Act, 1928 made no mention of this need. The Royal Mail Steam Packet case of the early 1930's awakened interest in this particular provision. As reported by H. Morgan, opinion of Counsel sought at the time indicated that the "auditors cannot dissociate themselves from all responsibility for the correctness of that account and there may be 1J. E. Sterrett, "Legislation for the Control of Corporations," Journal of Accountangy, Vol. 9 (February, 1910), p. 245. 2Cochrane, "The Auditor's Report, Its Evolution in the U.S.A.", pp. 451 - 455. 3Leonard W. Hein, "The Auditor and the British Companies Acts," The Accountinngeview, Vol. 38 (July, 1963), p. 517. .ra hes oft SS! 1.-..1 ‘- '4‘. “ A..q9 'CA-tulg f‘fis 2"“ “it “.1; .__Q ..= is ti‘ A s}.' ‘54 1 ‘ N ‘c -2--c 44 cases in which it would be incumbent upon them to draw the attention of the shareholders to any feature of that account which in their view involved anything of any imprOper or misleading character."1 Morgan himself goes on to advocate that: . . . the duties of the auditor regarding the profit and loss account should be defined as in the case of the balance sheet. Responsibility for the profit and loss account certainly exists, and to discharge it, the auditor should be required to report specifically on the profit and loss account as well as on the balance sheet. The public is entitled to the valuable protection which would be afforded by enacting, in effect, that the auditor's report should relate tozall accounts required to be sub— mitted to shareholders. According to Morgan the only accounting body in England at this time that advocated that the profit and loss statement be included in the auditor's report was the Society of Incorporated Accountants and Auditors.3 It should be noted that it was only in the English Companies Act, 1928, that a general statement of profit and loss was required to be submitted to shareholders - the details of which were left to the discretion of management. Similarly, it was not until the English Companies Act, 1947 that the profit and loss statement was required to be audited. 1Henry Morgan, The Auditor's Responsibility in Relation to Balance Sheets and Profit and Loss Accounts, an article given at the Fourth International Congress of Accounting, 1933 (London: Gee & Co., Ltd., 1933), p. 510. 21bid., p. 518. 31bid., pp. 512 - 513. 45 The American Tradition The evidence with regard to American auditors' statements on the information contained in the profit and loss statement may be some- what conflicting. George Cochrane has indicated that audited reports up to 1929 usually included an opinion on the profit and loss state- ment.1 However he acknowledges that "the profit and loss statement . . . was usually one figure, shown on the balance sheet as the amount added to prior year's surplus, without any supporting statement."2 George Benston, however, in a review of financial statements for the years 1926 to 1934 indicates that a majority of corporations provided such detailed profit and loss information as sales and cost of sales.3 In 1929, the Federal Reserve Board in conjunction with the American Institute of Accountants issued their bulletin, The Verifica— tion of Financial Statements. This publication placed much more emphasis on the importance and verification of the profit and loss statement than did their earlier statement of 1917, Uniform Accounting. As previously mentioned, stock exchange listing rules of 1932 and the Securities Acts of 1933 and 1934 required that the auditor comment on the profit and loss statement. The Canadian Tradition Canadian concern for audited profit and loss statements, during this period of time, was quite active. Both the English and 1Cochrane, "The Auditor's Report, Its Evolution in the U.S.A.," p. 450. 2Ibid. 3George Benston, "The Value of the SEC's Accounting Disclosure Requirements," The Accounting Review, Vol. 44 (July, 1969), p. 519. F- «fa-E’s ,_ Lug-.‘ga I ‘ 1 ""V xv £61-: L Lila“ «.5. f< Yin- H‘a f' (T) l 9‘ r? 13 l Eads 46 American traditions were carefully reported and scrutinized in The Canadian Chartered Accountant. As previously indicated it was not uncommon in earlier times for auditors to render an opinion on the profit and loss. The latter statement was usually something more than what Cochrane has suggested existed in the United States. It was invariably a separate statement, and besides showing the opening and closing balances representing accumulated undistributed profits to date, it usually indicated depreciation, interest, net operating profits, transfers to reserves and dividends. Commencing in the early 1920's and following the 1917 legislation that required the auditor to report only on the balance sheet, it became the exception rather than the rule for the auditor to comment on the profit and loss statement. This reduction in the opinion may well have been due to a certain unwarranted caution on the part of the Canadian auditor for it seems that there is evidence to indicate that even from earliest times, sufficient audit work was being done to render that opinion. In 1912, George Grant indicated that verification procedures must extend to the profit and loss statement. . . . since the balance sheet must incorporate in some form or other the balance of the profit and loss account, the audit must extend to that account also. Indeed, it is in this particular account that manipulation can be made and it is this account which has to be especially carefully scrutinized. Editorial commentary, relating to the "Balance Sheet Audit" that according to Montgomery was so common in the United States, 1George W. Grant, "Auditing Balance Sheets," The Canadian Chartered Accountant, Vol. 2 (October, 1912), p. 111. 47 indicated that the profit and loss statement must be searchingly scrutinized before the auditor can certify the balance sheet. But every balance sheet contains a balance of the profit and loss account, . . . and how can an auditor certify to that balance without laboriously going over the year's Operations.l George 0. May, in 1937, acknowledged a difference in the auditing procedures between the United States and Canada. In refer- ence to the audit report's assertion that the balance sheet shows a "true" and "correct" view of the "state Of the affairs" of the Company, he mentions: . . . the certificate was commonly used in America with even less justification, as I see it, for many years. I do not think that the amount of work that was done justified it to the extent to which it was justified here [Canada] and in Great Britain. I have always thought that we American accountants were overselling accountancy to the American public, as well as running considerable risks, in the use of that certificate. There was cer- tainly no distinguishing between the English and American certificate, alEhough the character of the work done was very different. Differences in opinion regarding the Canadian auditors legal responsibility existed. R. G. H. Smails, in his well-known text book, Auditing, in 1933 indicated that: . . . since the auditor has no statutory knowledge of the form or content of the profit and loss statement which directors propose to publish he cannot be saddled with this further responsibility. But, of course, if the profit or loss for the year is stated in the balance sheet and not merely the accumulated surplus, the auditor will admittedly be responsible for the correct- ness of the profit or loss so stated. l"Auditing Balance Sheets," commentary, The Canadian Chartered Accountant, Vol. 1 (April, 1912), p. 208. 2George 0. May, "Wider Horizons," The Canadian Chartered Accountant, Vol. 30 (April, 1937), p. 299. 3R. G. H. Smails, Auditing, (Toronto: The Commercial Text Book Co., 1933), p. 232. A differ in cementing u" ffected Englis?‘ I It is 1?" English pra- permissible regarded as from the fa; accountants companies f2 details of :- error as war. the degree ;' ments has b' APart f: . taste was growl: annual meeting ”1‘1 indicated 1 ' ’ ' thEI'e With his 81; I requirement particular: 5101], there auditor's p required t; profit and 48 A different interpretation was presented by H. D. Clapperton in commenting upon the Royal Mail Steam Packet (Kylsant) case as it affected English and Canadian practice. It is interesting to note that it used to be the English practice to regard not only secret reserves as permissible but to draw on these without what might be regarded as sufficient disclosure. This attitude arose from the fact that, mistakenly, the professional accountants who reported on the accounts of the companies felt that they had no responsibility for the details of the profit and loss account. This was an error as was shown by the Kylsant case. In any event, the degree of disclosure made in the financial state— ments has been greater since that court case.1 Apart from whatever legal responsibility may have existed there was growing concern that legislation should explicitly require that the profit and loss statement be audited. Commentary at the annual meeting of the Canadian Institute of Chartered Accountants in 1941 indicated that: . . . there appeared also to be substantial agreement with his suggestion that for the present, while the requirements of good auditing practice are ill defined, particularly in the minds of those outside the profes- sion, there would be a desirable strengthening of the auditor's position with his client if custom or statute required the addition of phrases to the effect that the profit and loss and surplus accounts were also covered by his certificate, and that the accounts were drawn on a basis consistent with accepted practice and with that used in the previous period. 1H. D. Clapperton, "What Are Profits?", The Canadian Chartered Accountant, Vol. 39 (July, 1941), p. 81 2"The Form of the Auditor's Report," Summary of Round Table Discussion at Annual Meeting, The Canadian Chartered Accountant, Vol. 39 (October, 1941), p. 242. Concern for Ret‘ —__________‘_ Canada for clar; - -: 7.- Tie anantral 1. _____ The peri The ver' rather fave- fern of p‘nr, arbiguity. corrected a: reports shc and no 0pm: intended. Professor C. A, indicated that :rOfESSiOn Wire “W qualiric it"entCIies , he a O . it is liabilities P “OE-Zen} was al: EL'emfiental a: thraugh an "an 49 Concern for Report Wording The period 1920 to 1940 evidenced an increasing concern in Canada for clarifying and making more uniform the auditor's report. The Financial Times in 1927 indicated a need for this concern. The very strength of the accountant's position has rather favoured the growth in his statements of a loose form of phraseology which is not free sometimes from ambiguity. It is very necessary that this should be corrected and that the wording of certificates and reports should be such that double meanings are impossible and no Opportunity given for drawing deductions not intended. Professor C. A. Ashley, writing in The Financial Post in 1933, indicated that the general public and some members of the accounting profession were greatly disturbed about auditors' reports. Regarding report qualifications on depreciation, receivables, reserves and inventories, he states: . . . it is becoming fantastic. Soon we shall be reading without surprise 'subject to the assets and liabilities being correctly stated.‘2 Concern was also expressed both for auditor independence through governmental appointment3 and for auditing procedures and methods through an "audit clearing house."4 Undoubtedly, as well, the Royal Mail and the International Laboratories legal cases affected the auditors' concern for the scope of his audit. The former case, which 1As reported in The Canadian Chartered Accountant, Vol. 16 (November, 1927), p. 193. 20. A. Ashley, "Audit Reports Fail in Too Many Cases," The Financial Post, May 27, 1933, p. 9. 3"Election of Auditors Versus Appointment by Governments Discussed," The Financial Post, February 25, 1933, p. 11. 4F. W. Wegenast, "Audit Clearing House Would Aid Investor," The Financial Post, January 24, 1934, p. 9. has already beer content on the : inl93l in Cans. :alled for only mage,houever proisions in t. decreased from tions in ela'nor: By 1929 n \*;P:-A w recc. control. In 1' dCCCUIltaHCS on I of a note sugg; cut that no de: be included in acce . As N tie C re OS.A ') 3S ~= . se 1.. 50 has already been discussed, affected the auditor's willingness to comment on the profit and loss statement. The latter case, arising in 1931 in Canada, supported the argument that a balance sheet audit called for only a series of tests, not a detailed audit.1 Clamor for change, however, was not sufficient to alter the relevant auditing provisions in the 1934 legislation and any criticisms were likely decreased from 1934 on by the spirited activity of American institu- tions in elaborating stronger guidelines. By 1929, in the United States, Verification of Financial Statements recommended a test audit based upon review of the internal control.2 In 1932, the Special Committee of the American Institute of Accountants on COOperation With Stock Exchanges recommended inclusion of a note suggesting: that the accounting records had been tested but that no detailed audit was made; that the profit and loss statement be included in the audit; and that the statements should reflect accepted principles of accounting consistently maintained during the year under review.3 With regard to the use of this model auditor's report, the Committee indicated that "the certificate is appropriate only if the accounting for the year is consistent in basis with that of the preceding year."4 The inclusion of verification procedures 1"Low Audit Fees Lead to Inadequate Check," The Financial Post, March 25, 1933, p. 9. 2As reported in Cochrane, "The Auditor's Report, Its Evolution in the U.S.A.," p. 450. 3See Walter A. Staub, Auditing Develqpments During the Present Century, (Cambridge, Massachusetts: Harvard University Press, 1942). p. 74. 4Ibid., p. 75. relating to cas: report was late: booklet Audits . Institute of Ac. suggested that :- year" be incorr ing the report ; the lichesson an; on the recomenc be revised to a< | V31“. generally The inf in The Canadian N particular. wit accounting con. clscus31011 per of ' 51 relating to cash and securities was also contemplated. This model report was later included in the American Institute of Accountants' booklet Audits of Cogporate Accounts in 1934.1 By 1939, the American Institute of Accounting pamphlet Extensions of Auditing Procedures suggested that the concept of "consistency with that of the preceding year" be incorporated into the audit report itself.2 In 1941, follow- ing the report of the Securities and Exchange Commission inquiry into the McKesson and Robbins fraud, the American Institute of Accountants on the recommendation of the Commission recommended that the wording be revised to acknowledge that the audit was performed "in accordance with generally accepted auditing standards."3 The influence of American events is evidenced in an editorial in The Canadian Chartered Accountant in 1937 that discusses the merits of a model report recommended by the American Institute in 1934 - in particular, with regard to "a general review being made but not a detailed audit" and "in accordance with accepted principles of accounting consistently maintained."4 Similarly the topics for discussion pertaining to the auditor's report at the Annual meeting of the Canadian Institute in 1938 outline features which had already 1Audits of Corporate Accounts (New York: American Institute of Accountants, 1934), p. 47. 2American Institute of Accountants, Extensions of Auditing Procedure (New York: American Institute of Accountants, 1939), p. 12. 3American Institute of Accountants, The Revised S.E.C. Rule on Accountants' Certificates (New York: American Institute of Accountants, 1941), p. 39. 4Editorial The Canadian Chartered Accountant, Vol. 30 (May, 1937), p. 178. See also editorial The Canadian Chartered Accountnng, Vol. 32 (May, 1938), p. 325. been agreed upcz‘ concern for tes audit, certifyi: "true and corre application of . related to she: tee 511311511 CCIT' 53??“ for nine inerican audit ] Canauian legi ~ 1. Listitute annua aCKHMEdEEment l the auditcr's 1 instruction of affa lrs 0f the Lie. It Was "1 bulletin 0 AL: and CCTt: Relatj 5:5: 52 been agreed upon in the United States.1 These topics related to a concern for testing transactions rather than providing a detailed audit, certifying the profit and loss statement, replacing the "true and correct" wording, and acknowledging the consistency of application of accepted principles of accounting. Additional topics related to whether the Canadian Institute should defer action until the English Companies Act had been revised (an event which was not to happen for nine more years!) and whether the existing wording in the American audit report should be adopted in its entirety in the Canadian legislation. Debate on these matters continued at the Institute annual meeting of 1941.2 Here there was additional acknowledgement that the report wording related less to delimiting the auditor's legal duties or responsibilities and more to the general instruction of the reader. The war had, by this time, intervened so completely in the affairs of the country that no Institute action was possible at that time. It was not until 1951 that the Institute was able to issue its own bulletin on the auditor's report. Form and Content of the Auditor's Report Relative to the earlier period, 1900 to 1920, the variety in audit report wording decreased during 1920 - 1940. However, relative 1"The Auditor's Report to the Shareholders," Memorandum Regarding Roundtable Discussion at Annual Meeting, The Canadian Chartered Accountant, Vol. 33 (July, 1938), pp. 63 - 65. 2See "The Form of the Auditor's Report, "A summary of round- table discussion at Annual Meeting, The Canadian Chartered Accountant, Vol. 39 (October, 1941), p. 242. to the situatiC: as indeed strc Decrease in \‘ar By t‘n . l inspected had c and was, to a g perfumed, cor: :ent certificat+ illustrates thi We have Canners, 11' and we can is drawn u: the state < Of our kno'. Shown by t‘ the inform 53 to the situations in England and America, the variety that did persist was indeed strong and of increasing concern to the Canadian profession. Decrease in Variety By the mid-1920's, the wording in some of the audit reports inspected had centered simply around the wording in the legislation and was, to a great extent, devoid of a listing of audit techniques performed, commentaries on asset valuation and notations of manage- ment certificates. The 1925 report of Canadian Canners Limited illustrates this point. We have examined the books and accounts Of Canadian Canners, Limited, for the year ended December 3lst, 1925, and we certify that in our opinion the above balance sheet is drawn up so as to exhibit a true and correct view of the state of the company's affairs according to the best of our knowledge and the explanations given to us and as shown by the books of the company. We have obtained all the information and explanations we have required. Similarly, the reports of Canadian Locomotive Company Limited and Penmans Limited were equally simple. On the other hand, listings of audit techniques, notations of asset valuation and management certificates did persist. The 1933 report of the Steel Company of Canada Limited includes: Inventories of stock-in-trade, certified by res- ponsible officials of the Company, have been valued on a conservative basis. We have verified the cash on hand, bank balances and all securities. The qualifications in the Massey-Harris Company Limited report of 1932 were fairly extensive and with regard to inventories lCanadian Canners Limited, Annual Report, 1925. 2The Steel Company of Canada, Limited, Annual Report, 1933. and accounts I: | resucnse to the S in AV —n. Part of 1 Net Cur: which have ' funds, aggr» foregoing a: receivables 8‘] the relatively unen: valuation tonne and set tended to c used the a PYiDCiples of Yassey-Harris soze attentio: the need to t 05 the latter 54 and accounts receivable were not atypical of corporate and auditor response to the uncertainty that existed in the depth of the depres- sion. Part of that report reads: Net current assets including cash in foreign securities which have placed certain restrictions on the export of funds, aggregate approximately $4,500,000. Subject to the foregoing and to the adequacy of the reserves against receivables, inventories and fixed assets, we report that . . By the late 1930's all auditors' reports inspected were relatively unencumbered with listings of audit techniques and asset valuation commentaries. The wording of each report was fairly similar and tended to center about the legal wording. None of the reports as yet used the accepted American wording, "according to accepted principles of accounting consistently applied." As in the case of Massey-Harris Company Limited and Howard Smith Paper Mills, Limited, some attention was being given, implicitly, to internal control and the need to test rather than to perform a detailed audit. The report of the latter company in 1936 was: We have made an examination of the Consolidate Balance Sheet of Howard Smith Paper Mills Limited and its sub- sidiary companies as at 3lst December, 1936. In connection therewith we examined or tested the accounting records and other supporting evidence of the Howard Smith Paper Mills Limited and one of its subsidiaries and have received all the information and explanations required by us; we have been furnished with certified statements as at the same date of the other sub- sidiary companies not examined by us. As required by the Dominion Companies' Act, Section 114, we report that the profits of two small subsidiary companies are not included in the attached statements. In our opinion, based upon the examination and certified statements referred to above, the attached Consolidated Balance Sheet as at Blst December, 1936, of Howard Smith Paper Mills Limited and its subsidiary companies is properly drawn up so as to exhibit a true and correct view of the state of their combined affairs as at that date, according to the 1Massey-Harris Company Limited, Annual 3929321 1932. best of our as shown by the stateme- 0n the ,- to Russell Induj ignoring of the We have Limited for certify tha‘_ cozplied toil he also in accord of states the . It has "Eglslation and #7.: , ' huc-r Opln10n C .1 :18 (“I ‘ 3C8 sheet . g . U F‘b , ' '£ eight 3 StatEZEnt. s1 "1.17- .- r 'S‘St durine Eater . c ateq t'w‘e :21». ‘ lien on the atiOn of Iis the S \\\‘\\“‘-~ 1 55 best of our information, the explanations given to us and as shown by the books of the coTpanies examined by us and the statements furnished to us. On the other hand no company audit report examined came close to Russell Industries Limited in its simplicity, brevity and its ignoring of the legal wording. We have audited the books of Russell Industries Limited for the year ending December 31, 1939 and we certify that our requirements as auditors have been complied with. We also certify that the foregoing balance sheet is in accord with the books and, in our Opinion, correctly states the position of the company on that date. It has been previously mentioned that both prior to the 1917 legislation and immediately thereafter, auditors usually rendered their opinion on the profit and loss statement as well as on the balance sheet. During the period 1920 to 1940, however, the practice of including the profit and loss statement in the report ended. None of the eight audit reports examined represents an exception to this statement. Similarly, in a report on the variety in wording that did persist during this period, The Canadian Chartered Accountant, in 1938, enumerated twelve auditors' reports, of which only two rendered an opinion on the profit and loss.3 It would seem therefore that the legislation of 1917 and 1934 did eventually have the effect of reducing the scope of the auditor's Opinion. 1Howard Smith Paper Mills Limited, Annual Report, 1936. 2Russell Industries Limited, Annual Report; 1939. 3"The Auditor's Report to the Shareholders," commentary, The Canadian Chartered Accountant, Vol. 33 (August, 1938), pp. 135 - 139. Increasing Cone Despite was taking piac tion that relat Dersist was of on this and on In Eng: deviated fr one fem is number of a rapidly dej: the POSitie I‘fierican pr. Canada of A the Amel—iCa that form C! Comply vi ch been a ten: Canecliar1 Col arranging f e an aggro, “Fleet.l In 1937 56 Increasing Concern for Variety Despite the decrease in the absolute amount of variety that was taking place in Canada during this period, there was a realiza- tion that relative to England and America, the variety that did persist was of some significance. K. W. Dalglish, in 1938, commented on this and on the force of American influence. In England one form of certificate is very rarely deviated from . . . so that in the United States also one form is being generally accepted. . . . a large number of annual reports . . . indicate that we are rapidly departing from uniformity. We of course are in the position of being influenced to a great extent by American practice. Auditors in subsidiary companies in Canada of American companies are sometimes asked to use the American form of report, and they have wound in with that form certain additional phraseology so that it will comply with the Dominion Companies Act. There has also been a tendency to use it or some similar form for purely Canadian Companies. For these various reasons, in arranging for this annual meeting it seemed that it would be an appropriate time to have a discussion on this subject. In 1937, Professor R. G. H. Smails in commenting on the phrase "drawn up in accordance with accepted principles of accounting con- sistently maintained during the period" evidenced his concern for greater uniformity. The auditors of a few Canadian companies (presumably those with a large number of shareholders in the United States or with extensive connections of other kinds in that country) have incorporated a similar clause in their reports. There would seem to be much to commend this practice but the extent to which it is voluntarily adopted during the next few years might be taken as an index to 1K. W. Dalglish, "Should the Statutory Form of the Auditor's Report to the Shareholders be Changed?", The Canadian Chartered Accountant, Vol. 33 (December, 1938), p. 454. the desira‘f statute. The IR: Canadian Charte problem of vari techniques, cor .. 2 I ticates. In : tolication of i: only one ins of accounting" The con' 73:: the unfavora to indicate to statenents, the able to take 5: late l930 peric a": 'n Lq‘tl‘g Pract; asset Valuatio‘ t.“ ‘: balaHCe 5"} “'5' abOut th rtceil’ables ’ ‘Il 53 at tendanCe Ezie . 57 the desirability of having it made obligatory by statute. The twelve auditors' reports that were presented in Eng Canadian Chartered Accountant in 1938 in an attempt to illustrate the problem of variety indicated a persistence in the listing of audit techniques, commentaries on asset valuations and management certi- ficates.2 In three instances there was either reference to or implication of the fact that "no detailed audit" was carried out and in only one instance was there mention made that "accepted principles of accounting" had been "consistently" used. The concern for greater uniformity was undoubtedly stimulated by the unfavorable comparison with England and America and the desire to indicate to the public, in particular the readers of financial statements, the kind of work that auditors perform. This concern was able to take some expression because, relative to prior periods, the late 1930 period saw some decrease in the alternative accounting and auditing practices that were acceptable. By this time bases of asset valuations and management certificates were invariably found in the balance sheet proper and accepted auditing standards left little doubt about the verification of cash, banks, securities, accounts receivables, and inventories. Confirmation of accounts receivable and attendance at inventory taking had been made mandatory in the United States following the McKesson and Robbins fraud of 1939. 1R. G. H. Smails, "Students' Department," The Canadian Chartered Accountant, Vol. 30 (February, 1937), p. 165. 2"The Auditor's Report to the Shareholders," The Canadian Chartered Accountant, Vol. 33 (August, 1938), pp. 135 - 139. Ibo Effect of I The le- legislation cor‘ audit reports E statecents not requirements cf eczentarv on : that vere not c w..‘.‘ ~ cated to dlSEC not obliged to ‘1 3‘" v ‘ rlcilfldSly sent .Wfl', A hleJch an 0" L) Le \ Jaiizr 58 The Effect of the 1934 Legislation The legislation had four main effects: Firstly, since the legislation contemplated the issuance of consolidated statements, audit reports began to refer to acceptance of subsidiary financial statements not audited by them; secondly, in conformity with the requirements of the legislation, the audit report began to include commentary on the treatment of the profits and losses of subsidiaries that were not consolidated; thirdly, comments on asset valuations tended to disappear from the audit reports since this information was now obliged to be given in the financial statements; and fourthly, as previously mentioned, auditors continued not to render an opinion on the profit and loss statement. This last outcome began to change by the mid—1940 - 1950 period and by 1951 — even though federal legis- lation did not require it until 1965 - virtually all audit reports included an opinion on the profit and loss statement. Legislation and Auditors' Reports, 1940 - 1970 Background World War II served to interrupt the deliberations of the Canadian profession in its pursuit of a standard auditor's report. It was not until 1951 that the Canadian Institute of Chartered Accountants was able to make recommendations in this regard. The Canadian auditor was, of course, not bereft of guidelines. He con- tinued to do what he had started to do during the 1930's; that is, he used the wording of the legislative statutes and interwove into this, often in a somewhat unmethodical manner, the changes that had been and were being introduced in the United States. 59 During this period, the increasing strength and prestige of the Canadian accounting profession manifested itself in its research bulletins, begun in 1946, and in the influence it demonstrated in altering the legislation affecting both auditing and accounting matters. The Pronouncements of the American Profession At the beginning Of the period presently under review, the American Institute of Accountants recommended that the standard wording of the auditor's report take the following form: We have examined the balance sheet of the XYZ company as of February 28, 1941, and the statements of income and surplus for the fiscal year then ended, have reviewed the system of internal control and the accounting procedures of the company and, without making a detailed audit of the transactions, have examined or tested accounting records of the company and other supporting evidence, by methods and to the extent we deemed appropriate. Our examination was made in accordance with generally accepted auditing standards applicable in the circumstances and it included all procedures which we considered necessary. In our Opinion, the accompanying balance sheet and related statements of income and surplus present fairly the position of the XYZ company at February 28, 1941, and the results of its operations for the fiscal year, in conformity with generally accepted accounting principles applied on a basis consistent with that of the preceding year. In 1947 the American Institute issued Tentative Statement of Auditing Standards which described in detail what generally accepted auditing standards were. This allowed the Institute in 1948 to delete reference to both the reviewing of the system of internal control and the acknowledging that no detailed audit was performed. The recommended wording is repeated here because it has been basically 1American Institute of Accountants, The Revised S.E.C. Rule on Accountants' Certificates (New York: American Institute of Accountants, 1941), pp. 40 - 41. inchafiged Sim: excell'ion’ the carefully SUD" We ha)” of 9903356" 1112039 and tion 5‘35 3“ auditing 5: of the ace. cedures as In our statements financial . and the re- in confort‘ ciples 8P9} preceding 3. More r1 that the audit cation of fund financial stat «H. Banish Leeis‘ DUNK V I ..u..oun:e::ent' 60 unchanged since that time and because it represents, with one exception, the identical wording toward which the Canadian Institute carefully struggled from 1951 to 1968. We have examined the balance sheet of X Company as of December 31, l9__, and the related statements of income and surplus for the year then ended. Our examina- tion was made in accordance with generally accepted auditing standards, and accordingly included such tests of the accounting records and such other auditing pro- cedures as we considered necessary in the circumstances. In our Opinion, the accompanying balance sheet and statements of income and surplus present fairly the financial position of X company at December 31, 19__, and the results of its operations for the year then ended, in conformity with generally accepted accounting prin- ciples applied on a basis consistent with that of the preceding year. More recently, an American Institute committee has recommended that the auditor should express an opinion on the source and appli- cation of funds statement whenever it forms part Of the corporate financial statements. English Legislation and Professional Pronouncements The English Companies Act of 19473 provided the first changes since 1908 in the statutory requirements relating to the content and wording of the standard auditor's report. Where previously the auditor had been required to state whether or not he had received all the information and explanations he had required and to state whether the 1American Institute of Accountants, Revision in Short-Form Accountant's Report or Certificate (New York: American Institute of Accountants, 1948), p. 164. 2Accountants International Study Group, The Independent Auditor's Reporting Standards in Three Nations, paragraph 14. 3Great Britain, Statutes, Companies Act, 1947, 10 and 11 George VI, C. 47. Eaiance sheet -. correct view of best of his inf by the books cf “Pitt an opini balance sheet a 13116! {Equirei | Vnet‘nex EXPIEnatie: beliéf Were Whethez have bean l their 3X5: acfesuare fg 61 balance sheet was properly drawn up so as to exhibit a true and correct view of the state of the company's affairs according to the best of his information and the explanations given to him and as shown by the books of the company, he was now obliged to include in his report an Opinion on the profit and loss statement as well as the balance sheet and to comply with the Ninth Schedule of the Act. The latter required an explicit statement by the auditors as to: Whether they have obtained all the information and explanations which to the best of their knowledge and belief were necessary for the purposes of their audit. Whether, in their opinion, proper books of account have been kept by the company, so far as appears from their examination of those books and proper returns adequate for the purposes of their audit have been received from branches not visited by them. Whether the company's balance sheet and . . . profit and loss account dealt with by the report are in agree— ment with the books of account and returns. Whether, in their opinion and to the best of their information and according to the explanations given them, the said accounts give the information required by the Act in the manner so required and give a true and fair view - a) in the case of the balance sheet, of the state of the company's affairs as at the end of its financial year; and b) in the case of the profit and loss account, of 1 the profit or loss for its financial year; . . . The foregoing clauses do not require an expression concerning con- formity with "generally accepted accounting principles applied on a basis consistent with that of the preceding year." The latter wording was recommended by a noted accountant, F. R. M. de Paula, but was not 2 introduced into the statutes. The rather lengthy wording required by the 1948 Act was 1Ibid., Ninth Schedule. 2Hein, "The Auditor and the British Companies Acts," p. 517. drastically re. hrethe auditI sheet and prof theprovisions h2d:5chedule nuedby he Jenkins Cotrii: ions at audit. the Companies .. Sluiar lines v. ‘4'! ,- atLOaIliailtS an; wks. Under ”1 '5tliUte of C :lefolloving Ill 0“ \ g {or loss) with the x0: .4 :14 v 62 drastically reduced in the provisions of the Companies Act, 1967. Here the auditor was simply required to state whether the balance sheet and profit and loss were "properly prepared in accordance with the provisions of the principal Act."1 The items contained in the Ninth Schedule of the 1947 Act are presumed to hold unless otherwise stated by the auditor.2 Hein reports that recommendations to the Jenkins Committee that preceded the enactment included such abbreviated forms of auditors' reports as "audited in accordance with section X of the Companies Act, l96__."3 I similar lines were made by the Association of Certified and Corporate According to Hein, suggestions along Accountants and The Institute of Chartered Accountants in England and 4 Wales. Under the requirements of the Companies Act, 1967, the Institute of Chartered Accountants in England and Wales recommended the following standard report: In our Opinion, the accounts set out on pages to give a true and fair view of the state of the company's affairs at and of its profit (or loss) for the year ended on that date and comply with the Companies Acts 1948 and 1967.5 No recommendations exist with regard to the presentation of or the rendering of an opinion on the source and application of funds 1Great Britain, Statutes, Companies Act, 1967, 15 and 16 Eliz. II, C. 81, Sec. 14. 2Ibid. 3 Hein, "The Auditor and the British Companies Acts," p. 518. 4Ibid. 5International Study Group, The Indnpendent Auditor's Reporting Standards in Three Nations, paragraph 100. 63 statement. In England this statement, relative to Canada and the America, is largely unused.1 Canadian Legislation The Corporations Act, 19532 of the province of Ontario represent the first modern corporate legislation in Canada relating to accounting and auditing matters. The audit requirements of that Act together with an amendment in 19643 requiring insertion in the report of the wording acknowledging adherence to "generally accepted accounting principles applied on a basis consistent with that of the preceding period" constitute the identical legislation enacted federally in 1964 — 1965 under the Canada Corporations Act. The Ontario Corporations Act, 1953 reads: The auditor shall make a report to the shareholders on the financial statement to be laid before the company at any annual meeting during his term of office and shall state in his report whether in his opinion the financial statement referred to therein presents fairly the finan- cial position of the company and the results of its operations for the period under review. The auditor in his report shall make such statements as he considers necessary (a) if the company's financial statement is not in agree- ment with the accounting records; (b) if the company's financial statement is not in accordance with the requirements of this Act; (c) if he has not received all the information and explanations that he has required; or (d) if proper accounting records have not been kept 1Ibid., paragraph 13. 2Ontario, Statutes, The Corporation Act, 1953, l Eliz. II, C. 19. 3Ontario, Statutes, An Act to Amend the Conpanies Act, 1964, 12 and 13 Eliz. II, C. 10, Sec. 2. so far I The Act also r siders necessa financial stat It shc' tatenent incl 3 statenents. that the finar. Acts of an attention. disclosure Institute uendations in l933,3 ‘19-. . wre Particulg *L ..e:.* are with 64 so far as appears from his examination.1 The Act also requires the auditor to make such statements as he con- siders necessary if adequate provision has not been made in the financial statements for losses of non-consolidated subsidiaries.2 It should be noted that according to the Act, the financial statement includes the balance sheet, the profit and loss and surplus statements.3 In 1966 an additional amendment to the Act requires that the financial statement include a source and application of funds statement and that this statement be included in the auditor's opinion.4 The 1967 Interim Report of the Select Committee on Company Law commented: The research which the Committee carried out revealed that the financial disclosure provisions of the Ontario Act, as amended in 1966, are without a peer in the Companies Acts of any other jurisdiction which came to the Committee's attention. The credit for this high standard of financial disclosure for Ontario companies must be shared with the Institute of Chartered Accountants of Ontario, whose recom- mendatiogs were incorporated into the Act when it was passed in 1953. More particularly, with regard to the auditing provisions of the Act, they are with exception of subsection (b) as recommended by the 1Ontario, Statutes, The Corporation Act, 1953, Sec. 82(2) and (3). 21bid., Sec. 89 (2)(d). 3lbid., Sec. 83 (1). 4Ontario, Statutes, An Act to Amend the Corporations Act, 1966, 14 and 15 Eliz. II, C. 28, Sec. 6 (2). 5Province of Ontario, Select Committee on Company Law, Interim Report of the Select Committee on Company Law (Toronto: Queen's Printer, 1967), p. 88. Institute of C Canadian Insti The Cs‘ the Ontario Cc of the Ontari; acknowledged ‘9 was appointed Canadian feder stantive ieder tines, since EPZTESlZed the t0 render an ( hair-century ( 3 ~3 Can. and 1‘ E l 4 65 Institute of Chartered Accountants of Ontario in 19521 and the Canadian Institute of Chartered Accountants in 1953.2 The Canada Corporations Act, 1964 - 1965 is identical with the Ontario Companies Act as amended in 1964.3 The heavy influence of the Ontario legislation and the Canadian Institute was explicitly acknowledged by the Standing Committee on Banking and Commerce that was appointed to consider changes in corporate legislation.4 The Canadian federal legislation of 1964 - 1965 provided the first sub- stantive federal changes in the auditing matters presently under review, since the audit was made mandatory in 1917. It should be emphasized that it was in this Act that the auditor was first obliged to render an Opinion on the profit and loss statement. However, this half-century did not actually represent a stagnation in the auditing matters under consideration for at least three reasons: firstly, many corporations were required to report under the Ontario juris- diction; secondly, the Canadian Institute of Chartered Accountants began issuing auditing recommendations in 1951; and thirdly - and possibly more fundamentally - the pronouncements of the American Institute acted as guidelines. 1The Special Committee of the Legislature of the Province of Ontario Charged with the Revision of the Companies Act (Ontario) and Related Acts, Proceedings, Vol. 15 (October 6, 1952), p. 2032. 2The Canadian Institute of Chartered Accountants, "Report of the Committee on the Canadian Companies Act" (1953), reprinted in The Canadian Chartered Accountant, Vol. 62 (April, 1953), pp. 166 - 167. 3Canada, Statutes, Canada Corporations Act, 1964 — 1965, 13 and 14 Eliz. II, C. 52, Sec. 124 (l) (2) and (3). 4Canada, Senate Debates (1964), pp. 515 - 518. 66 Pronouncements of the Canadian Institute of Chartered Accountants In September of 1951, the Committee on Accounting and Auditing Research Of the Canadian Institute issued its first recommendations on auditors' reports in Bulletin NO. 6. The recommended wording was: I have examined the balance sheet of the Company Limited as at l9___and the state- ments of profit and loss and surplus for the year ended on that date and have obtained all the information and explanations I have required. My examination included a general review Of the accounting procedures and such tests of accounting records and other supporting evidence as I considered necessary in the circumstances. In my Opinion the accompanying balance sheet and statements of profit and loss and surplus are prOperly drawn up so as to exhibit a true and correct view of the state of the affairs of the company as at l9__ and the results Of its Operations for the year ended on that date, according to the best of my information and the explanations given to me and as shown by the books of the company. The second sentence of the scope paragraph represents a careful selection and paraphrasing of similar portions of the American Institute recommended wording of 1941 and 1948 with the exception of the phrase relating to "generally accepted auditing standards." The Committee gave a strong recommendation that the profit and loss statement be included in the auditor's Opinion. In 1959 a revised Committee recommendation, Bulletin No. 17, called for substitution of the phrase, "presents fairly" for "exhibits a true and correct view" and also for the inclusion of the phrase "in accordance with generally accepted accounting principles 1Committee on Accounting and Auditing Research, The Auditor's Report, Bulletin No. 6 (Toronto: The Canadian Institute of Chartered Accountants, 1951), p. 3. applied on a b Cmittee indi implication 01 that it shoulc Ccmittee rec. the statement has included fetente betue énetitan ln31 standards .“ on S'nare‘nold and Auditing 9 4..., SLanudes, l mended , 1' f 67 applied on a basis consistent with that of the preceding year."1 The Committee indicated that the recommendation of 1951 contemplated the implication Of the phrase and that upon reconsideration it was felt that it should be more positively disclosed.2 In 1967 a revised Committee recommendation called for the rendering of an Opinion on the statement of source and application of funds when this statement was included in the financial statements.3 The only remaining dif- ference between the standard wording recommended by the Canadian and American Institute was the phrase "generally accepted auditing standards." In this regard, the Report of the Special Committee on Shareholders' Audits in 1968 recommended that when the Accounting and Auditing Research Committee completes its study of auditing standards, the standard "Canadian short form report could then be amended, if thought desirable" to include this phrase.4 Form and Content Of Audit Report Variety in audit report wording, relative to the United States and England, persisted throughout the 1940's; however, the publications Of the Accounting and Auditing Research Committees on auditors' reports commencing in 1951 strongly influenced the movement towards 1Committee on Accounting and Auditing Research, The Auditor's Report, Bulletin No. 17 (Toronto: The Canadian Institute of Chartered Accountants, 1959), p. 3. 21bid., p. 2. 3The Accounting and Auditing Research Committee, The Auditor's Report, Bulletin No. 25 (Toronto: The Canadian Institute of Chartered Accountants, 1967), p. 3. 4The Canadian Institute of Chartered Accountants "Report of the Special Committee on Shareholders' Audits" (1968), reprinted in The Canadian Chartered Accountant, Vol. 93 (November, 1968), pp. 350 - 351. 68 uniformity. It has been noted that in the period 1920 to 1940, none of the audit reports examined rendered an opinion on the profit and loss statement. However, by 1943 five of the ten reports inspected did render an opinion and with one exception the remainder followed the Institute recommendation of 1951 at that time. The results of an analysis of 280 firms by the Canadian Institute in 1951 revealed that two-thirds of the auditors' reports included an Opinion on the profit and loss statement.1 By 1956, only 19 of 300 firms analyzed in Financial Reporting in Canada did not do 80.2 One of the ten companies inspected, George Weston Limited, fell into this category. It was only in 1953 that the province of Ontario and in 1964 - 1965 that Canadian federal legislation required that the auditor give an opinion on this statement. That portion of the ”scope" paragraph that relates to the "review of accounting procedures and tests of the accounting records and other evidence" underwent a drastic and speedy change. In 1940 only two of auditors' reports inspected provided some commentary on this matter. One of these companies was Distillers Corporation Seagrams Limited which was listed on the New York Stock Exchange at that time and which, since at least 1940, has observed the American wording of the auditor's report. By 1951 - 1952, all audit reports 1The Canadian Institute of Chartered Accountants, The Auditor's Report, a Report prepared by the C.I.C.A. Research Depart- ment reprinted in The Canadian Chartered Accountant, Vol. 63 (July, 1953), p. 35. 2The Canadian Institute of Chartered Accountants, Financial Reporting in Canada (2nd ed., Toronto: The Canadian Institute of Chartered Accountants, 1957), p. 106. 69 inspected, except Dominion Bridge Company Limited, used the recommended "scope" wording of the Institute. By 1956, only 12 of 300 firms examined did not refer to the "extent of the examination."1 In 1959, Bulletin No. 17 of the Canadian Institute required the insertion of the phrase "prepared in accordance with generally accepted accounting principles applied on a basis consistent with that of the preceding year." Only one Of the firms inspected had adopted this phrasing prior to 1959 and by 1962 only approximately twenty firms out of 300 had not.2 In 1965, Bulletin NO. 25 of the Canadian Institute recommended that the auditor render his opinion on the source and application of funds statement when it was presented in the financial statements. In 1963, only 4 per cent of the firms presenting such statements supplied an auditor's opinion on them; in 1964, 43 per cent; in 1965, 77 per cent; in 1966, 90 per cent; in 1968, 99 per cent.3 The influence of the Canadian Institute's pronouncements can be gauged by the fact that likely less than one—quarter of the 325 firms in the survey would be required under Ontario legislation in 1966 to provide such an Opinion. Wording beyond the standard audit report during this period related mostly to qualifications, reliance on other auditors and the lIbid. 2The Canadian Institute of Chartered Accountants, Financial Reporting in Canada (5th ed.; Toronto: The Canadian Institute of Chartered Accountants, 1963). P. 79. 3The Canadian Institute of Chartered Accountants, Financial Reporting in Canada (7th and 8th eds.; Toronto: The Canadian' Institute of Chartered Accountants, 1967 and 1969), pp. 132 and 133 respectively. 70 treatment of profits and losses of non-consolidated subsidiaries. The 1964 - 1965 federal legislation required the auditor to make a statement only if adequate provision has not been made for losses of non-consolidated subsidiaries. This requirement led to a considerable reduction in auditors' comments on non-consolidated operations because prior to this time the auditor was obliged to explicitly state how such profits and losses were treated. By 1968, as reported in Financial Reporting in Canada, only 11 per cent of the 325 firms analyzed did not conform to the Institute wording.1 In most of these instances, and similar to the years 1965 through 1967, the reason for non-conformity was that the company inserted the American Institute wording in the scope paragraph that relates to "generally accepted auditing standards." Financial Reporting in Canada implies the strong American influence on this point. The number Of occurrences of this type of departure is not surprising in view of the fact that Canadian companies associated with American companies or selling their securities in the United States are required to comply with the rules of financial reporting in that country. ‘ Similarly, with regard to one of the auditors' reports inspected, the Canadian firm, British American Oil Company Limited, in the same year that it became associated with the American firm of Gulf Oil, incorporated into the audit report the American Institute phrasing relating to "generally accepted auditing standards" and to "generally accepted accounting principles applied on a basis consistent lIbid., 8th ed., p. 130. 21bid., p. 131. with that of Since after 1951 no Catac'ian Inst for the peric follow. In t. Lizited illus statutory wor: ‘a‘e be for the 3' with the 1 have [0 Ti and EXPIa: the appen- Properly View of t 25. 1940, the expla 0f the Co In t': as at tai led and: the audit re1. We h; Bridge c. Olpanie: thEreOn he 71 with that of the preceding year."1 Since the kind of auditor's report that was typically used after 1951 normally took the form of the recommended wording of the Canadian Institute, there is no need to provide illustrative examples for the period 1950 to the present. Examples of the 1940 decade follow. In the first instance, the audit report of Burns and Co. Limited illustrates an unqualified report that closely follows the statutory wording. We have examined the accounts of Burns & Co. Limited for the year ended December 26, 1940, and in accordance with the provisions of The Companies Act (Dominion) we have to report that we have obtained all the information and explanations we have required and, in our Opinion, the appended Balance Sheet as at December 26, 1940, is properly drawn up so as to exhibit a true and correct view of the state of the Company's affairs as at December 26, 1940, according to the best of our information and the explanations given to us and as shown by the books of the Company. In the second instance, the 1949 report of Dominion Bridge Company Limited likely illustrates one Of the last times that detailed audit procedures are listed and asset valuations given in the audit report. We have examined the books and accounts of Dominion Bridge Company, Limited and its entirely owned Subsidiary Companies for the year ended Blst October, 1949 and report thereon as follows: The Inventories of Stock on hand, as certified by responsible officials of the various companies, have been valued on a conservative basis. The Investments in which your Company is interested have been verified by actual inspection of the Securities or by certificates from the Depositaries in the cases where the Securities are deposited for safe custody or as security. 1British American Oil Company Limited, Annual Report, 1956. 2Burns and CO. Limited, Annual Report, 1940. In at Companies subsidiar the enter. We rt' and expia: the accorj is proper I nwoft according tions giy. Companies he 1945 r€poi acre typical q fiateaent andl We ha Sugar Co: Products and The C year and; the info] IE790“ t‘ balance FYOEit a drawn up State of 1943 and Ending 1 thE EX?‘ Cozpan; A 72 In accordance with Section 114 of the Dominion Companies Act, we report that profits of partly owned subsidiaries are included in these accounts only to the extent of dividends declared by these subsidiaries. We report that we have obtained all the information and explanations we have required and, in our Opinion, the accompanying Balance Sheet as at 31st October, 1949, is properly drawn up so as to exhibit a true and correct view of the state of the combined companies' affairs, according to the best of our information and the explana- tions given to us and as shown by the books of the Companies. The 1945 report Of Canada and Dominion Sugar Company Limited is more typical of the period in its inclusion of the profit and loss statement and in its exclusion of any reference to the extent Of the examination made by the auditor. We have audited the accounts of Canada and Dominion Sugar Company Limited and its subsidiaries, Montreal Products Company Limited, Dominion Sugar Company Limited and The Canada Sugar Refining Company Limited for the year ending Blst December, 1945 and have received all the information and explanations we have required. We report that, in our Opinion, the above consolidated balance sheet and the related statements of consolidated profit and loss and earned surplus have been properly drawn up so as to exhibit a true and correct view of the state of the combined companies' affairs at Blst December, 1945 and of the results of their operations for the year ending that date according to the best of our information, the explanations given us and as shown by the books of the companies. Summary The provisions for the mandatory audit and the auditor's responsibilities in regard to financial statements as initially set out in the federal legislation of 1917 were heavily influenced by lDominion Bridge Company, Limited, Annual Report, 1949. 2Canada and Dominion Sugar Company Limited, Annual Report, 1945. the English I legislation ; begin, until vexing paring statutory wo: 598m in the iron that son We the fol ' l 03 in the Can '33 beE‘lnni at, to the Point 73 the English legislation of the preceding decade. No changes in legislation occurred, nor did Canadian Institute pronouncements begin, until the early 1950's. During the early part of that inter- vening period, audit report wording tended to follow closely the statutory wording. After the American Institute pronouncements had begun in the 1930's, there was an increasing tendency to be influenced from that source. All of the many American audit pronouncements during the formative 1930 - 1950 period were reprinted and commented on in the Canadian journal and the wording which the American Institute was beginning to formulate was gradually creeping into the Canadian audit reports. This influence has increased up to the present time to the point that by 1970 the only remaining difference between the recommended standard wording of the American and Canadian Institutes is the reference to "generally accepted auditing standards." The influence of the Institutes Of Chartered Accountants in Canada has become of increasing importance in shaping the auditor's report, particularly since their first recommendation in 1951. Committees appointed to enquire into changes in the Companies Acts have, since 1950, carefully requested the views of the Institutes. The current legislation illustrates this influence since there is no minimum prescribed form which the report must take. Items with which all Canadian Companies Acts have concerned themselves since 1907 - whether the financial statements agree with the records and with the requirements of the Act, whether prOper accounting records have been kept and whether the auditor has received all the information and explanations he has required - now need auditor commentary only if they are not being Observed. The recommended Institute report wording is non menu; that, at two history - ti}: sheet in I907 influence of been achnon El the nrevineia least ten yea it h; Institute Of ‘NIEI and Sl 0' Cflrporatt— aCCEPIEd 8C: adVCCaEP—d ir L- H. Nelso rePort is e 74 is now uncomplicated by statutory wording. It is interesting to note that, at two of the most fateful junctures in Canadian auditing history - the introduction of the mandatory audit on the balance sheet in 1907 and on the profit and loss statement in 1953 - the influence of the Ontario Institute on the Ontario legislation has been acknowledged to be of the greatest importance. In each instance the provincial legislation predated the federal legislation by at least ten years. It has been noted that the recommended report wording of the Institute of Chartered Accountants in England and Wales is extremely brief and simple, containing no reference to the extent of examination of corporate procedures, nor to the consistent application of generally accepted accounting principles. Similar brief wording has been advocated in Canada by Ken LeM. Carter in 19431 and more recently by L. M. Nelson.2 Similarly, some American tendency toward a briefer report is evidenced by Mautz and Sharaf3 and anticipated by Stettler as that "millennium" when "further growth and develOpment of the public accounting profession . . . results in almost universal meaning and application for generally accepted auditing standards and generally accepted accounting principles."4 However given the geographic 1K. LeM. Carter, "Statutory Duties of Auditors," The Canadian Chartered Accountant, Vol. 43 (July, 1943), pp. 7 - 8. 2L. M. Nelson, "The Statutory Report," The Canadian Chartered Accountant, Vol. 91 (July, 1967), pp. 40 - 41. 3R. K. Mautz and H. A. Sharaf, The Philosophy of Auditing (American Accounting Association, 1961), p. 203. 4Howard F. Stettler, Auditing Principles (2nd ed.; Englewood Cliffs, New Jersey: Prentice Hall Inc., 1961), p. 614. proririty articulate anadian a unlikely t toward the 75 proximity and industrial influence of the United States, the articulateness of the American Institute and the need for some Canadian audit reports to observe American Institute wording, it is unlikely that Canadian audit report wording would move independently toward the English position. CHAPTER III THE EVOLUTION OF FINANCIAL STATEMENTS, 1900 - 1920 Purpose The purpose of Chapters III, IV and V is to describe the evolution of financial statements in Canada from 1900 to the present by reference to corporate legislation, financial press commentary, the professional and academic literature and a sample of corporate annual financial statements. Primary attention will be devoted to the evolution of the balance sheet and the profit and loss statement, including their content, classification and general valuation base; there will also be some attempt to comment on the evolution of the earned surplus statement, footnotes to financial statements, secret reserves and extraordinary items - inasmuch as they bear upon the balance sheet and the profit and loss statement. The examination of these selected areas helps to illustrate the influences that have shaped corporate reporting practices in Canada. The understanding of the evolution of financial statements is aided by brief reference to the selected series of economic statistics provided in Appendix C. Between 1900 and 1966 the popu- lation, aided considerably by immigration, almost quadrupled; and the gross national product rose from approximately one billion to fifty-seven billions. During this period the relative proportions 76 77 of investment in Canada by the United States and Great Britain almost reversed. By 1966, eighty per cent of total non-resident investment of thirty—two billions has its source in the United States. The price indexes during this period reflect a significant rise during World War I and through to 1920 as well as the considerable drop during the depression years. Together with other major countries, stock prices rose markedly during the late 1920's and then plunged disastrously during the depression. Subsequent to World War II, stock prices began their long post-war ascent. The first years of World War I, 1914 and 1915, and the first three years of the 1920's witnessed a large relative increase in the number and value of com- mercial failures. Especially since 1940 the relative proportion of business transacted by larger firms has increased significantly. Firms having an output valued at less than one million dollars in 1965 accounted for eighty-five per cent of the firms but only twelve per cent of the total value of output. English Legislation Though the English Joint Stock Companies Act of 1856 abandoned the provisions for the mandatory audit and the preparation of the balance sheet for the annual meeting that the 1844 Act had imposed, it set forward a set of model articles that were to apply in the event that an incorporating company did not register its own parti- cular articles.1 The model article provisions for profit and loss 1H. C. Edey and Prot Panitpakdi, "British Company Accounting and the Law 1844 - 1900," in Studies in the History of Accounting, ed. by A. C. Littleton and B. S. Yamey (London: Sweet and Maxwell Limited, 1956), p. 362. state: are re they 1 En ' 2 LU 1 I L I C) CHE S were in be In I‘ 'm. -&:ur \. r-r U) n: :5: TI €L cm U) rry 91‘ :1 ’ / I" (U 0’ (I) w (j r? l) I] t_< J m .‘ : r t .‘b E ' U ( fr #1 n) n r-r 78 statements and balance sheets and the elaboration of their contents are remarkably modern and though these provisions were not mandatory, they undoubtedly served as guides in corporate reporting practices in England, Canada and the United States. Hatfield in 1911 acknowledged the significance Of these model articles on American practices. Because some portions of the model articles relating to disclosure were in advance of legislative requirements one hundred years later in both Canada and England they are reproduced here below and in Figure l. 70. Once at the least in every Year the Directors shall lay before the Company in General Meeting a State- ment of the Income and Expenditure for the past Year, made up to a Date not more than Three Months before such Meeting. 71. The Statement so made shall show, arranged under the most convenient Heads, the Amount of gross Income, distinguishing the Several Sources from which it has been derived, and the Amount of gross Expenditure, distinguishing the Expense of the Establishment, Salaries, and other like Matters: Every Item of Expenditure fairly chargeable against the Year's Income shall be brought into Account, so that a just Balance of Profit and Loss may be laid before the Meeting; and in Cases where any Item of Expenditure which may in Fairness be distributed over several Years has been incurred in any One Year the whole Amount of such Item shall be stated, with the addition of the Reasons why only a Portion of such Expenditure is charged against the Income of the Year. 72. A Balance Sheet shall be made out in every Year, and laid before the General Meeting of the Company, and such Balance Sheet shall contain a Summary of the PrOperty and Liabilities of the Company arranged under the Heads appearing in the Form annexed to this Table, or as near thereto as Circumstances admit.2 1H. R. Hatfield, "Variations in Accounting Practice," gflyurnal of Accounting Research, Vol. 4 (Autumn, 1966), p. 172. See.also Hawkins, "The Development of Modern Financial Reporting Practices Among American Manufacturing Corporations," p. 154. 2Great Britain, Statutes, Joint Stock Companies Act, 1856, 19 and 20 Vict., C. 47. .4 a u..~..<:<..<. P‘w r \ Oran ..._C< Hatfixruhcc rhythm 327.». a 79 HI 4.6.9:: 5.293 s. H onswwm 1.... it}: 0.95: .560 \o .caoEV 2: .2 43.8.: 3 8:2 3... 2.25.62: 3 9.332 2: .a £3.59;— ..u:...:2~h g :3 .> £22.. 52333 on o. ASKEOU w... \o .850 #50 .o 3.99....Q B So... 03‘ Sufi acv. . o 3 V...» 25.33. urcwmuco... .35 .~ $3.55 2. 36.. A5! .33 u a u .3 3 on w.» .53... ~35 K D «ushtfiosh “an 3‘53“. 32‘ xi . 38500 £80 22 £93... cox noon $28.29.. .35 .0 I: 3 3.30 “59.393. ED .2 .264 V...» Eoi to 3.3% 9:032 22 2 ‘38.... a 2:9— 5 89:29:35 La 2.02 auto .3... we... 2. e .86 a... u o . - . . EOE A3 . - . . «V2 .... «use. A3 . . heist: . 223$ Snooze: .n . . . .. 32.8.3 3 o o . . «usmfin Eonooi MM 939300 ' . . - ~ . . uni-Butte «got £328.55 .‘ .5 3 2!. i .u u. i .u w "”5303. rug-t .B 5 02¢ Fro—mag: .6 . 2 a a: are .8 HI .‘du .fifiu . A :39. a do... a ASK-cob is «flung? was“: . 5on6 a Vat: o 33.3.3 1.3.39. 3.. 535.80 .5 =ch 3.30 562500 .3. £52.15 ‘9 32:5: sex Brain .3265? 2: o 33 9: 3530.3. E .E 430525.300 32.. . 2 ”act tax .33 son 2505‘ 2h 0 .. 95K 3:33.... :5 .5 Cacao 33.25:.» 3.. «Sufi s 4332;..Q 125593» a». 5.84 tic so nvsaaeasq to 36.25 so“ =an «5V .thtunum 10d .3 CouQ any .nuttsv. .33 3 33¢ .... .389. ‘6 33526 sex 5.5.38: 2 "Sufi 3v £235 noon :3 eucuaoooV £93... .a .3ch S L...:3:u...=u.i ii .500 2% AA ~53. ech \o 232.3. .1 h .n 6‘55 3:336 hug-IOU 05 to 02.383 .3 2.5 \o 336...... I.» .N uo 3:355 .. 5.1.33” g .59 .= .353. \2??& A... ‘9 323.50% 2: a! 4.88... 3.33.38. 3 2 539.80 22 \o .uuSQ so 3303 A... lat 2:. root—x .2... . . . . asuzactfl 22 F 92.32 I: 3... .fith 22 \o 2.32 05 53V ‘0 {estux .2... = 3 .. 2.5. 3.... 232.... 3.." S. . 1 in. ‘0 2.5.2 2: s .. 9.3 2.33.. .563 . in. I. E as? 252.... ~82 15 .~ .. 8......» . .350 .— 8555; 92 .553 05 no hum—«m 83a . £0 .nghssgufiggnuog on: .34 £2.33 0.88 .23.. .8 m mag 80 The Companies Act, 19001 contained neither mandatory nor optional provisions for financial statement disclosure — although the requirement to provide a balance sheet at each annual meeting can be inferred from the mandatory audit provisions that pertained to the balance sheet. Edey and Panitpakdi suggest that evidence given to the Committee that made recommendations for changes in the Companies Acts indicated that "the cost of assets and accumulated depreciation thereon should be disclosed; that goodwill should be valued separately; and that the main classes of assets and liabilities should be distin- guished."2 The Committee itself, recommended that there be stated "the bases on which assets were valued: whether at cost, by valuation or otherwise; the percentage or amount of depreciation which had been written off; and what other provision, if any, had been made for depreciation."3 However the Act of 1900 incorporated none of these requirements. The Companies (Consolidation) Act, 1908 differed in two ways from the 1900 Act with respect to financial statements. Firstly, the profit and loss statement was required to be prepared for the annual meeting - but only if the by-laws and regulations of the company so directed. Secondly, a balance sheet "giving such particulars as will disclose the general nature of those liabilities and assets, and how the values of those fixed assets have been arrived at" must be 1Great Britain, Statutes, Companies Act, 1900, 63 and 64 Vict., C. 48. 2Edey and Panitpakdi, "British Company Accounting and the Law 1844 — 1900," p. 374. 3Ibid. 81 forwarded to the Registrar of Companies. By 1908 therefore, there were no mandatory provisions requir— ing that the profit and loss statement be prepared for the annual meeting; nor no mandatory provisions outlining the detail to be con- tained in the audited balance sheet that was to be submitted to the annual meeting. The statement that was to be forwarded to the Regis- trar of Companies had merely to contain some notation on asset and liability valuation. No changes of consequence took place in England in this regard until the corporation legislation of 1928. Canadian Legislation As indicated in the preceding chapter, the early Canadian legislation concerning the mandatory audit and the auditor's duty respecting the financial statements corresponded directly with that of the English legislation. However, the early Canadian legislation with regard to balance sheet and profit and loss disclosure was in advance of the actual English legislation. The Canadian legislation may, on the other hand, have drawn on the optional disclosure require- ments of the model articles of the English Act of 1856 and upon the rejected recommendations of and evidence submitted to the Committee that, immediately before 1900, enquired into changes that should be made in the English Companies Act.2 1Great Britain, Statutes, Companies Lgonsolidation) Act, 1908, 8 Edward VII, C. 69, Sec. 26(3). 2See preceding page. 82 Ontario and Canadian Federal Legislation The Ontario Companies Act of 1897 called for the preparation of a statement of income and expenditure which was to be laid before the annual or general meeting.1 Additionally, if the by-laws of the company so directed, the accounts to be presented at the annual meet- ing were required to include an audited balance sheet.2 The Ontario Companies Act of 1907 made the audited balance sheet provisions man- datory and elaborated certain disclosure requirements to which the balance sheet must adhere.3 These disclosure requirements are impor- tant for at least four reasons: Firstly, according to T. Mulvey, the Under Secretary of State (Canadian) and former Assistant Provincial Secretary of the Province of Ontario, they constituted the model upon which the Canadian 1917 legislation was based;4 Secondly, according to Mulvey again, and indicating the early influence of the accounting profession, these provisions were made upon the recommendations of the Institute of Chartered Accountants of Ontario;5 Thirdly, these provisions represent the most advanced corporate regulation of the time as between Canada, England and the United States federal govern- ment; and lastly, the passing of these provisions by the Ontario legislature gave rise to a concern that was later to be re-echoed in 1Ontario, Statutes, The Ontario Companies Act, 1897, 60 Vict., C. 28, Sec. 75. 2Ibid., Sec. 84. 3Ontario, Statutes, The Ontario Companies Act, 1907, 7 Edward VII, C. 34, Sec. 36, SS 2 and 3. 4T. Mulvey, Dominion Company Law, p. 54. SIbid. the Canadi I: point4 by th conga all t inhos Ontaz requiring shareholt financiaj 83 the Canadian parliament in 1934. In regard to other clauses of companies (Act) it was pointed out that the concurrent jurisdiction exercised by the Dominion makes such control impossible. These companies would simply get incorporation at Ottawa to do all they desired to do and the only effect of trying to impose conditions here would be that the Province [of Ontario] would be deprived of revenue. On the federal Canadian level, the first disclosure provision requiring that "the directors of every company shall lay before its shareholders a full and clear printed statement of the affairs and financial position of the company at or before each general meeting . ." was enacted in 1877.2 The more specific requirement that such statements be presented annually was incorporated in the 1902 Act.3 While it may be felt that some ambiguity attaches to the meaning of "a statement of the affairs and financial position," many companies between 1902 and 1917 - when the presentation of the profit and loss statement became mandatory — interpreted these provisions to apply only to the balance sheet. The next federal change in disclosure occurred in the 1917 Act which is repeated here because it represents the first attempt, at the federal level in Canada, England or the United States to delineate the components of financial statements and because it represents with the exception of (3) (j) and 3(m) similar disclosure 1Abstracted from the February 6th, 1907 Ontario Scrap Hansard, in the Ontario Legislative Library in Toronto, and representing a chronological filing of newspaper clippings relating to the Debates of the Ontario Legislature. A formal record of the Debates was not maintained until the 1940's. 2Canada, Statutes, Canada Joint Stock Companies Act, 1877, 40 Vict., C. 43, Sec. 87. 3Canada, Statutes, The Companies Act, 1902, 2 Edward VII, C. 15, Sec. 88. 84 already in force under the Ontario legislation since 1907. Relevant parts of section 105 read: (2) At such [annual] meeting the directors shall lay before the company,- (a) a balance sheet made up to a date not more than four months before such annual meeting: Provided however that a company which carries on its undertaking out of Canada may, by resolution at a general meeting, extend this period to not more than six months; (b) a general statement of income and expenditures for the financial period ending upon the date of such balance sheet; (c) the report of the auditor or auditors; (d) such further information respecting the company's financial position as the special Act, letters patent or by-laws of the company require. (3) Every balance sheet shall be drawn up so as to distinguish severally at least the following classes or assets and liabilities, namely:- (a) cash; (b) debts owing to the company from its customers; (c) debts owing to the company from its directors, officers and shareholders respectively; (d) stock in trade; (e) expenditures made on account of future business; (f) lands, buildings, and plant; (g) goodwill, franchises, patents and copy rights, trademarks, leases, contracts and licenses; (h) debts owing by the company secured by mortgage or other lien upon the property of the company; (i) debts owing by the company but not secured; (j) amount of common shares, subscribed for and allotted and the amount paid thereon, showing the amount thereof allotted for services rendered, for commissions or for assets acquired since the last annual meeting; (k) amount of preferred shares subscribed for and allotted and the amount paid thereon, showing the amount thereof allotted for services rendered, for commissions or for assets acquired since the last annual meeting; (1) indirect and contingent liabilities; (m) amount written off on account of depreciation of plant, machinery, good-will and similar items. 1Canada, Statutes, The Companies Act Amendment Act, 1917, 3 George V, C. 25, Sec. 105, SS 2 and 3. ad :1; .Hr 85 Background to the Canadian Legislation Several factors were influential in the promulgation of the 1917 Act: the Taxation Acts of 1916 and 1917, the concern for mergers and the profit in corporate promotions, the bankruptcies at the beginning of World War II, the bank failures culminating in the bank legislation of 1913, and the existence of a pattern for legislation in the Ontario Companies Act of 1907. No evidence was uncovered from any source - the financial press, the debates of the House of Commons, economic and legal histories nor accounting literature existing in The Canadian Chartered Accountant - to indicate exactly why this legislation was passed at a time when the efforts of the whole economy were devoted towards the War. However, an analysis of the foregoing factors allows the legislation to be placed in its economic and social perspective. The significance of the Taxation Acts of 1916 and 1917 have been commented on in the preceding chapter.1 The complementarity of the new requirements in the 1917 Act relating to profit and loss dis- closure and to the segregation and delineation of assets, liabilities and equities in the balance sheet with the need for an equitable and successful tax collection system is fairly evident. The Taxation Acts were therefore likely the strongest and most immediate of the factors influencing the 1917 Companies Act legislation. Earlier anti-combines legislation at the turn of the decade had reflected the willingness of the Canadian public to have the government regulate business. Andre Raynauld indicates that: 1Above, pp. 30 - 31. In eccma States in ca: epinic tot tt and Pf. I MW“ fud‘iC C0 86 In 1909 a wave of mergers swept through Canadian economy shortly after a similar movement in the United States: fifty-eight business firms and $361 million in capital were involved. Faced with an aroused public opinion, Parliament in 1910 passed an Act to provide for the Investigation of Combines, MonOpolies, Trusts and Mergers.1 The historian, O. D. Skelton, gives us some insight into the public concern for the merger movement not only in its monOpoly aspects but also in its promotional aSpects. This latter point is of some importance since changes in legislative requirements relating to balance sheet and profit and loss disclosure have often been accompanied by stricter legislative requirements relating to corporate stock promotion. In this regard, it is notable that prospectus legis- lation emulating the 1908 English Act was also enacted in the 1917 Act.2 More characteristic of the period [1896 - 1912] was the growth of out and out consolidation, following some 8 or 10 years after the main movement in the United States. The usual arguments were put forward as to the economies in operation which would result from combination, the specializing of product, the saving in executive and sales force, the elimination of cross- freights. The regulation of prices was usually an object, whether this involved an increase of prices already giving adequate profit, or merely an ending of cut-throat competition. There was however a new factor involved of greater potency: it was not so much the profit of operation as the profit of promotion that was sought. In increasing degree, the initiative in the formation of mergers came from financial promoters unconnected with the industry, and the motive lay in the possibility of selling the bonds and stocks of the greatly overcapitalized new companies formed, to a public as ready to rush to share in the hoped-for lAndre Raynauld, The Canadian Economic System, (Toronto: The Macmillan Company of Canada Limited, 1967), pp. 149 - 150. 2J. Peter Williamson, Securities Regulation in Canada, (Toronto: University of Toronto Press, 1960), p. 14. I C) in: 87 monopoly of a specific trust as to denounce trusts in the abstract. Similarly, the concern for control by both the public and the government was evidenced in 1910 by W. L. M. King, the sub- sequent long-time prime-minister of the country: The discussion which has been going on in the press in regard to these large combinations, that the largest industrial combinations of all in this country have escaped criticism all together, namely, the great rail— way concerns of Canada. I think that fact is of parti- cular significance in connection with the legislation we are contemplating at the present time . . . what the public is looking to this government to do in connection with the large industrial concerns is something along the line of what we have already done in regard to these great railway interests.2 [By this time there was relatively close regulation concerning the railways, involving detailed reporting of financial statements and operations.] The bank failures culminating in the Bank Act of 1913 have been commented on in the preceding chapter.3 Mention was also made of a rash of bankruptcies (see Appendix C), in 1914 and 1915. M. Goodman indicated the importance of and necessity for proper financial statements in these instances. 1O. D. Skelton, General Economic History of the Dominion 1867 - 1912, (Toronto: The Publishers Association of Canada Limited, 1913), pp. 259 - 261. Skelton goes on to list some well- known and extant corporations that found their strength if not their origins in these mergers: Dominion Steel Corporation Limited, Canada Cement Company Limited, Canadian Car and Foundry Company Limited, Steel Company of Canada Limited, Dominion Canners Limited, Penmans Limited, Canadian Consolidated Rubber Limited (Dominion Rubber), Dominion Textile Company Limited, Sherwin Williams of Canada Limited, and Maple Leaf Milling Company Limited. 2A8 reported in L. A. Skeoch, Restrictive Trade Practices .£E~Q§2§d§, (Toronto: McClelland and Stewart Limited, 1966), p. 24. 3Above, pp. 25 - 26. Act innit mm an‘ "e: Iliient SEC. 133 88 These business houses [of finance] began to realize the inefficient business methods of their customers when failures took place . . . and that the majority of these customers had submitted false statements, made from improperly kept accounts and records, that accounts receivable were bad or fictitious, stock was overestimated, . . haphazard methods of costing and selling existed; waste in manufacture and extravagance in expenditure was rampant. When the War hit us it brought down hundreds of these small and dozens of large concerns. It was there- fore, proven that the basis of commercial success . . . is good management, accurate accounting, accurate costing, strict methods of selling and truthful financial statements. The foregoing description of the decade preceding the 1917 Act indicates the kind of events that influenced the passage of this important legislation. Though the contribution of the Ontario Institute of Chartered Accountants with respect to the Ontario Act of 1907 was acknowledged by Mulvey, no indication of concern was located in The Canadian Chartered Accountant for the federal legislation in the years immediately preceding 1917. The president of the Institute, Mr. John Hyde, at the Annual Meeting in 1918, drew attention to the passage of the Act but made no further comment.2 It may well have been that the profession felt that the provisions which they had recommended for the Ontario legislation of 1907 represented a suf- ficient guide for the federal legislation. Mulvey indicated that Sec. 105 of the 1917 Act "was first suggested by the Board of the Institute of Chartered Accountants of Ontario in the drafting of the Ontario Companies Act of 1907 and was taken with a few verbal lM. Goodman, "The Income Tax," The Canadian Chartered Accountant, Vol. 7 (October, 1917), pp. 123 - 124. 2John Hyde, "The President's Address," The Canadian Chartered Accountant, Vol. 8 (October, 1918), pp. 93 - 103. wb a? . the 89 alterations from that Act."1 Certainly the 1907 Ontario legislation relating to profit and loss and balance sheet disclosure was not only well ahead of other legislation but also well ahead of corporate reporting practices at the time. It is also evident that the concern for corporate regulation respecting financial statement disclosure at the federal level stems directly from the English tradition. English and American Influence While the influence of England and its traditions seem to pre- dominate in Canada for most of the 1900 - 1920 period, the increasing American influence became quite noticeable towards the end of that period. Several areas of English influence were important: firstly, the early part of this period represents the high point of the rela- tive size of English investment - 85 per cent of all foreign invest- ment in Canada being English, but declining to 53 per cent by 1920; secondly, the Chartered Accountancy profession itself was in its formation, strongly influenced by English and Scottish accountants who immigrated to Canada2 and according to one author, Geo. Edwards, the personnel of the accounting profession in 1921 could be described as "wholly Canadian or British";3 thirdly, as described in the ‘— 1Mulvey, Dominion Company Law, p. 54. 2J. E. Smyth, "Notes on the Deve10pment of the Accountancy I’l‘ofession," The Canadian Chartered Accountant, Vol. 63 (December, 1953), p. 291. 3Geo. Edwards, "The Educational Responsibilities of the ClLartered Accountant Societies," The Canadian Chartered Accountant, V01. 11 (September, 1921), p. 157. 90 preceding section the Canadian Companies Act legislation was largely in the English tradition. Between 1900 and 1920 the relative prOportion of American investment in Canada had increased from 14 per cent to 44 per cent. Though Thomas Mulvey, the under Secretary of State, acknowledged the inspiration of the legislation of New York State,1 the mandatory audit provisions and detailed disclosure required in the financial state- ments of The Ontario Companies Act of 1907 were far in advance of the New York legislation existing at that time.2 The American influence however, was felt in the publication of The Federal Reserve Board's Uniform Accountigg and its subsequent reprinting in the July, 1917 edition of The Canadian Chartered Accountant. Magazine commentary in the same issue recommended the bulletin "as a guide to the young accountant"3 and E. J. Bennett4 and J. C. Gray5 acknowledged this influence of American reporting practices. It should also be noted that the general requirements of the English Companies Acts were of some influence in the American scene. The President of the American lThomas Mblvey, "The Companies Act," The Canadian Chartered Agpountant, Vol. 8 (October, 1918), p. 129. 2Letter to the author from Ernest H. Bruer, State Law Librarian, The New York State Library, Albany, New York, April 22, 1970. 3See Commentary, "Uniform Accounting," The Canadian Chartered W. Vol. 7 (July, 1917), p. 49. 4E. J. Bennett, "Some Points for Consideration in Connection “fifith.a Customer's Balance Sheet," The Canadian Chartered Accountant, V01. 11 (March, 1922), p. 327. 5J. C. Gray, "Standardization of Shareholders' Accounts and Audi‘tors' Reports and Certificates," The Canadian Chartered Accountant, Vol. 8 (January, 1919), p. 194. 91 Association of Public Accountants, J. E. Sterrett, in 1910 indicated that: Everyone familiar with the subject has noted that a rapidly growing number of the best American corporations conduct their affairs according to standards that are in practical conformity with the requirements of the Companies Acts of England, thus demonstrating that the form of con- trol embodied in the law which merely gives legal authority to good established business custom in that country would be equally applicable to American conditions. It is significant also that probably without exception, the corporations whose courses of conduct have been made the subject of severe criticism within the past few years have failed to follow a policy in accord with the prin- ciples just outlined.1 The influence of both England and America was felt in the accounting literature in Canada. Of 37 signed articles of three pages or more in volumes 7 and 8, 1917 - 1919, of The Canadian Chartered Accountant, 12 of these were written by Americans, 6 by Englishmen and 19 by Canadians. Similarly an advertisement by The Accountancy Book Publishing Company of Toronto in The Canadian Chartered Accountant in 1920, lists sixteen texts, all of which are American with the exception of the first and last four. They are reproduced here because they likely represent the most scholarly and frequently- used contributions of each country at the time: Accountancy - Pixley Accounting in Theory and Practice - Lisle Advanced Accounting - Dicksee Bookkeeping and Accounts - Spicer and Pegler Accountancy of Investment - Sprague Philosophy of Accounts - Sprague Accounting Practice and Procedure - Dickinson Accounting Problems - Greendlinger Applied Theory of Accounts - Esquerre Auditing Theory and Practice - Montgomery 1J. E. Sterrett, "Legislation for the Control of Corporations," ll!§_;lgurnal of Accountancy, Vol. 9 (February, 1910), p. 246. 92 Company Accounts - Coles Principles of Depreciation - Saliers Auditing, Accountancy and Banking - Dowlen Companies and Company Law - Connell Joint Stock Company Accounts - Hoskins Manufacturing Accounts - Eddis and Tindalll The Theory Relating to Corporate Reporting Practices Littleton and Zimmerman have suggested the particular and more immediate reasons for the existence of corporate annual reports: "periodic reports were the consequence of the acceptance of the idea of enterprise continuity,"2 and again, "permanent capital, transferable shares, and the continuity of operations made periodic accounting reports a necessity."3 On a more general level of reasoning, periodic corporate reports were a function of wider-spread ownership, dependence on financial markets and a slowly emerging acknowledgement of corporate social responsibility.4 Balance Sheet and Profit and Loss Emphasis The development of the relative significance of the profit and loss statement as Opposed to the balance sheet has been hypo- thesized by Prof. J. E. Smyth. When a country is developing rapidly as was true of both Canada and the United States in the early years of this century, investment is made for appreciation 1Advertisement of "The Accountancy Book Publishing Company Of Toronto," The Canadian Chartered Accountant, Vol. 9 (April, 1920), back cover . 2Littleton and Zimmerman, Accounting Theory: Continuity W. p- 56- 3Ibid., p. 57. 4Ibid., p. 80. 03E: p... 1. uflmh 3 at u .48 In): 1 ‘W L l. . . 93 and not for a steady return of income. In this stage, the balance sheet has a significance it does not have in a more mature economy. After things settle down the measurement of income, rather than the appreciation of assetsi becomes the criterion of success in business ventures. Support for this hypothesis is indicated by B. S. Yamey, one of the foremost English accounting historians, who draws atten- tion to the importance of the profit and loss statement in the relatively well-industrialized England of the late nineteenth century and by C. Brown who indicates that the tendency to emphasize the profit and loss statement in America for external purposes occurred only in the early twentieth century. Yamey states that: The profit and loss account and the calculation of periodic profits acquired a new status in the course of the nineteenth century in company accounting. The cal- culation of profits, and particularly of the profit figure to appear . . . in the accounts presented to shareholders, came to dominate the accounting scene. In this metamorphosis, the valuation of assets, as they were to appear in the final accounts, was made subservient to the calculation of profits. This was so, even though the publication of profit and loss accounts was not made compulsory [by the Companies Act] until 1929. While Brown indicates that: . there were essentially two shifts in emphasis from balance sheet data to income statement data. There was an internal or managerial shift and an external shift by stockholders, creditors and other parties outside the firm. The former shift . . . probably occurred with the advent of the corporate form of business organization characterized by the separation of owners and managers, between 1880 and 1925. On the other hand, the latter shift began in the 1920's, accelerated in the 1930's and 1Smyth, "Notes on the Development of the Accounting P1‘0fession," p. 204. 2B. S. Yamey, ”The Development of Company Accounting Con- Ventions," Accountants' Magazine, Vol. 65 (October, 1961), p. 757. 94 was essentially completed by the early 1940's.1 It is likely that in Canada the change in emphasis towards the profit and loss statement occurred only slightly earlier than the change-period indicated by Brown for the United States. It has been previously mentioned that the Ontario Act of 1897 required that a profit and loss statement be prepared annually for companies coming under its provincial jurisdiction and that the Companies Act Amend- ment Act put forth the same requirements in 1917 for the federal jurisdiction. Fleming's text of 1892 provides interesting commentary on the times and seems to give at least as much prominence to the profit and loss statement as it does to the balance sheet. There are a great many varieties of financial state- ments published, as to the form and arrangement. Usually, however, there are only three kinds, viz., Resource and Liability statement, Loss and Gain statements and state- ments [of] Receipts and Payments of Cash. Sometimes a company will publish all three kinds at once - usually ‘Egg, sometimes only one. Where the company is a trading corporation, such as a Joint Stock Company, formed for the purpose of making profit for the shareholders, it would be expected that a Loss and Gain statement would be made to show the profits from various sources and the losses and expenses. This statement shows the progress of the business. The Resource and Liability statement is made to show the actual standing on a certain day. (Italics mine.) Several other texts3 of the times were reviewed but only 1C. Brown, The Balance Sheet to the Income Statement: A Study in.the Histogy of Accountipg Thought, Ph.D. dissertation, (Ann Arbor: lpublished on demand by University Microfilms, 1968), pp. 167 - 168. 2C. A. Fleming, Expert Book-keepipg_(0wen Sound: Northern Iiusiness College Steam Press, 1892), p. 164. 3Such as: W. C. Eddis, Manual for Accountants (Toronto: W. C. Eddis, 1899); W. C. Eddis and W. B. Tindall, Manufacturers' Accounts (Toronto: Published by the authors, 1904); David Hoskins, Joint Stock SZSEgpany Accounts (Toronto: The Shaw Correspondence School, 1907); 'V- H. Shaw and P. McIntosh, Bookkeeping (Toronto: The Central Business Cc>911ege, 1903); David Hoskins, Bookkeeping (Warwick Bro's & Rutter, 1901). 95 J. D. Ward's Shareholders' and Directors' Manual in 1900 indicated that one statement was relatively more important than the other. The balance sheet is the most important statement laid before the shareholders, as, if properly drawn up, it shows the exact financial position of the company. These sentiments were echoed much later in 1919 by J. C. Gray, in a review of financial statement disclosure.2 The form of the profit and loss statement advocated by Gray could hardly be much less than the statement legally required by the Companies Acts - specifying only depreciation, interest income and expense, and profit thereafter.3 On the other hand Mulvey's Dominion Company Law incorporates a model set of financial statements prepared by the chairman of the committee of the Institute of Chartered Accountants of Ontario that made recom- mendations for changes in the Ontario Companies Act of 1907.4 This model set of statements places somewhat more emphasis on the profit and loss statement by providing much more detail. These statements are reproduced in Figures 2 and 3.5 It should be noted that the statement heading of Income and EXpenditure is what we presently refer to as an income or profit and loss statement and that the Profit and Loss Account is what we presently refer to as a statement of retained earnings. A sanguine interpretation of The Companies Act 1J. D. Warde, Shareholders' and Directors' Manual (Toronto: The Canadian Railway News Co., Limited, 1900), p. 113. 2Gray, "Standardization of Shareholders' Accounts and Auditors' Reports and Certificates," p. 194. 31bid., p. 202. 4Mulvey, Dominion Company Law, pp. 54 - 65. 51b1d., pp. 56 - 59. 96 GO QQthbfl. . . . . . . . . . “2.36933 some: was 33.32: 8 833.; 8 9.3.53 BOGV.®HH o.................... Q3~QL§Q . meat: :32 mass 3:22 25.83 82 .5 .25 3 8:32 8 25de prepare .e... see eesm 33.6 832 .. :3 «526 3:22 25.83.. 23 .3 .89 8 3:22 8 Scamp . 58:80 .3. see seem seeps co oomfima cooomaflm coo-ooooeocoooooo.fi—mBH-Hvooc 8 Sea. Zea wee 852:5 “somgmoeapfi co Sofia . 8 03.3. . . . . . . . . . . cacoedfi 9.22.35 8 8m.» . . . 333330 ~38 «egaeoflfi 8°QQQV ego-cocooooo.fiuQQQ~3KQQ3°Q 32:33.. 333230 8 893 III]! . QQQQRAHW. .oooooooooooooooeeoomNQH 6H .83. 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