Excerpt from The Journal of Accountancy, Vol. 28: July, 1919
As almost every item of a balance-sheet affects directly or indirectly the computation of taxes, it is obvious that the greatest single influence which has ever been felt on balance-sheets is the federal excess or war profits tax.
Generally speaking, balance-sheets are accurate when tax rates are high and profits are substantial. It cannot be said that the average balance-sheet is accurate when tax rates are low or when tax rates are high and profits are not substantial. I am referring now to the balance-sheet as it is made up without supervision or certification from an outside source. The tendency to fool one's self has been so strong and so general that the ordinary balance-sheet in the pre-war period, when subjected to investigation by a disinterested third person, required drastic treatment.
Except in the comparatively few cases where special reasons existed for understating values or understating profits, most business men were unwilling to provide sufficient depreciation; they were unwilling to cut down inventory values; and they were reluctant to provide sufficient reserves against accounts receivable. They insisted on carrying "souvenirs" as perfectly good assets, and they borrowed large sums of money on the strength of such souvenirs. This tendency was so general that most bankers in scrutinizing balance-sheets mentally calculated additional reserves against the assets mentioned. The result was that the conservative business man who had provided sufficient reserves suffered the penalty of having, in effect, his actual quick assets reduced because the non-conservative man had neglected to provide sufficient reserves.
The attitude of the treasury department in the matter of federal taxation during the years 1909 to 1917 was not helpful from the point of view of conservative balance-sheets. The agents of the department were constantly disallowing depreciation and amortization charges; allowances for obsolescence were stricken out, and, in general, business men were encouraged to carry their assets on their books at inflated values.
Bankers' insistence upon accurate balance-sheets, supplemented by the action of another governmental agency, viz., the federal reserve board, offset the influence of the treasury department and worked for a constantly increasing improvement in the trustworthiness of balance-sheets.
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