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Accounting and the Stock Market Crash of 1929

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Essay title: Accounting and the Stock Market Crash of 1929

Accounting and the Stock Market Crash of 1929

Susan Hart

Introduction

The 1929 stock market crash is one of the most significant financial crises in the history of the United States. The years following the crash would prove to be ground-breaking for the accounting profession. These years consisted of an increased awareness of the accounting profession and the most extensive changes in financial reporting requirements experienced in the United States. Financial reporting transformed from a management focused, unregulated activity to a series of requirements, strictly regulated by the federal government, with the purpose of protecting investors. This change was brought about by the combined efforts of the accounting profession and government. To understand the significance of these changes it is important to understand the economic, political and business environments leading up to and subsequent to the 1929 Crash.

Environment leading up to the 1929 crash

There was real growth during the 1920’s. Total real income rose by 10.5% per year from 1921 to 1923 and by 3.4% per year from 1923 to 1929. This growth was fueled by new technologies and industries including automobiles, electricity, telephone, telegraph, radio, appliances and aviation. Additionally, there was an increase in causal activities such as highways and airports. Demand for capital was fulfilled by issuing equity securities. The government had a laissez faire attitude with a hands-off approach. An unregulated environment combined with high optimism and speculation was an inevitable formula for high prices in the stock market. The period was described as an “orgy of speculation and over optimism” by Samuel Eliot Morison, an American historian and Harvard graduate. However, not all stock prices increased at the same rate. Most of the significant increases related to industries where there was the most cause for optimism such as utilities and others previously mentioned.

Published audited financial statements were not required for publicly traded companies but it was informally encouraged by the New York Stock Exchange (Exchange). In fact, in 1926, 90 % of the industrial companies listed on the Exchange were audited. However, there was great variation in financial reporting even for basic disclosures such as revenue and expenses. Further, financial reports were more for the benefit of management than for stockholders. Actually, audited financial statements were criticized by many prominent people of the day, including accounting professionals and academics. With no regulations, management could choose which valuation and accounting methods to use without disclosure. Moreover, since audits were voluntary and accountants could only persuade management, it was common that auditors would support management’s decisions.

Accounting professionals were state certified and services consisted of accounting, auditing and taxation. Various consulting services, such as installation of cost systems and review of possible business investments, were delivered in conjunction with audits. However, there were no standard accounting principles or standards for disclosures. Generally accepted principles were shared informally among the profession and consisted of norms developed in practice and influenced by case law. Many audits were in response to creditor’s requests and banking regulators were concerned with the lack standard accounting policies. The Federal Trade Commission (FTC) and the Federal Reserve Board (FRB) advocated for rules regarding asset and liability valuations along with uniform accounting. To address these concerns, increase public confidence, and show control over the competency of practitioners in the accounting profession, The American Institute of Accountants (now known as the AICPA) organized in 1916. There was a qualifying examination and experience required for admission and certification. Also, a “Rules of Professional Conduct” was published and a committee on professional ethics established, with disciplinary powers, for self regulation.

The AIA did gain the respect of the federal agencies and at the request of the FTC and FRB, the American Institute of Accountants (AIA) submitted a document called “Uniform Accounts” which was published in the FRB bulletin of 1917. “This represented the first authoritative guidance on auditing procedures published in the U.S. “ It recommended auditing procedures and the format of the balance sheet and profit/loss statement but it did not address uniform accounting. The AIA was composed of an elite group from the top auditing firms that felt uniform auditing practices would reduce

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