John Richard Edwards
THE UNIVERSITY OF WALES COLLEGE OF CARDIFF

THE PROCESS OF ACCOUNTING INNOVATION: THE PUBLICATION OF CONSOLIDATED ACCOUNTS IN BRITAIN IN 1910

Abstract: The first known example of a consolidated balance sheet published by a British company was made available to shareholders of the Pearson and Knowles Coal and Iron Company Ltd. in 1910. This paper examines the reasons for this accounting change and investigates the source of the necessary expertise. The conclusion reached is that, in common with many other accounting innovations, evolutionary change occurred as the result of modifications to an existing business practice.

The process of change in accounting is a topic of both interest and importance; however, as a number of writers have pointed out, it remains a neglected area requiring further research [Hopwood, 1987; Previts, Parker and Coffman, 1990]. Change may come about as the result of an invention (revolutionary change) or the gradual development of a new technique as the result of numerous minor modifications to an existing practice (evolutionary change). The more widespread use of the new method may occur, in turn, either voluntarily or as the result of regulation. Parker [1977] has identified the following as important ‘change agents’: textbooks, teachers, companies, government agencies, accounting organizations, accountants and businessmen.

The purpose of this paper is to explore the process of accounting change by focusing on the decision made by the directors of the Pearson and Knowles Coal and Iron Co. Ltd. (PK Ltd.), in 1910, to publish a consolidated balance sheet. To achieve this objective, the paper:

1Parker was focusing principally on the international diffusion of accounting thought and practice, and his nomenclature has been amended and extended to cover intranational dissemination.

1. outlines relevant developments in Britain and parallel events in the United States as a background to the study;
2. examines the circumstances at PK Ltd. leading to the decision to publish a consolidated balance sheet;
3. analyzes the consolidation procedures employed and compares them with subsequent British practice; and
4. investigates the sources of the idea to publish a consolidated balance sheet and the associated technical expertise.

The study is based on the material contained in the Company’s archive2 evaluated by reference to available literature on the development of consolidated accounting practice.

BACKGROUND DEVELOPMENTS

The publication of a consolidated balance sheet by PK Ltd., starting in 1910, is noted by Edwards and Webb [1984, p. 38]. The years that followed saw experimentation in Britain with a range of different consolidation techniques and also other methods of group accounting. Following the passage of the Companies Act of 1948, the acquisition (purchase) method of consolidation became widely used by British holding companies, and was widely thought to be the only method permitted under the provisions of the Act. The detailed procedures to be followed were spelled out, much later, by Statement of Standard Accounting Practice 14 (1978), while the decision in Shearer v. Bercain (1980) confirmed suspicions that the use of the merger (pooling of interests) method3 by a small minority of companies contravened the Companies Act 1948. The Companies Act 1981 legitimized use of the ‘merger method’ of consolidation in Britain, and the procedures to be followed are now detailed in Statement of Standard Accounting Practice 23 (1985) and the Companies Act 1989. These permit, but do not oblige, holding companies to adopt merger accounting where certain conditions are met. These are designed to ensure that the merger represents a genuine “pooling of interests” — the shareholders of the merging companies continuing as joint shareholders in the combined enterprise — with a strictly limited amount of resources leaving the group.

2The internal accounting records and correspondence of the Pearson and Knowles Coal and Iron Co. Ltd. are located in the British Steel Corporation North-western Regional Records Centre, Shotton Works, Deeside, Clwyd, location Nos. 3248 and 9536.
3The differences between the acquisition and merger methods are discussed in the section headed ‘Distributable Profits’.

Corresponding developments occurred earlier in the United States and progressed at a faster pace.4 The first set of consoli-dated accounts is thought to have been prepared for the American Cotton Oil Trust in 1866 [Previts and Merino, 1979, p. 85], but it is the published accounts of the U.S. Steel Corporation for 1902 [reproduced in Previts and Merino, 1979, pp. 178-9]5 that have received close attention from accounting historians. The British accountant Arthur Lowes Dickinson was put in charge of Price, Waterhouse’s American operations in 1901 (their first office had been opened in New York in 1890) and “working with W. J. Filbert, controller of United States Steel, developed consolidated theory based on the entity premise” [Previts and Merino, 1979, p.
177]. Together with other British and American accountants, Dickinson worked hard to disseminate knowledge concerning the theory and practice of consolidated accounts in a series of lectures delivered and through books and articles published between 1904-

Historians’ pre-occupations with early events at U.S. Steel appears entirely justified, judging from Dickinson’s own comparison, made in 1924, of contemporary financial reporting practices among British and American companies. In his view, there were two major differences among the accounting practices of steel companies. First the comprehensive financial reporting practices introduced by the U.S. Steel Corporation had been followed by “other steel companies …. and to some extent by other large manufacturing companies” [1924, p. 475]. Second, the publication of consolidated accounts where “American companies are much in advance” of their British counterparts [1924, p. 477].

Further light is thrown on early developments in the United States by Sir Gilbert Garnsey, who is likely to have benefited from discussions with Dickinson at Price, Waterhouse where they were

4The development of consolidated accounts in the United States and the reason for their adoption by the United States Steel Corporation have been examined by Walker [1978, pp. 139-54] while Edwards and Webb [1984] have explored reasons for the slower adoption of this procedure in the United Kingdom.
5Younkins et al. [1984, pp. 252-3] have drawn attention to the fact that the advanced form and content of the financial statement adopted enabled the corpo-ration to continue publishing accounts in substantially the same manner until 1938.

6For further details of Dickinson’s contribution to accounting developments see, for examples, Edwards [1985] Previts [1975] and Walker [1978, particularly pp. 141-52].

partners from 1913, when Garnsey was admitted to partnership, through to 1923 when Dickinson retired. Garnsey [1923, p. 54] drew attention to institutional support for the preparation of consolidated statements provided by the New York Stock Exchange, which “laid special stress on the necessity of filing consolidated balance sheets,” and the Federal Reserve Board, which took the view that applications for credit should be supported by a consolidated statement. Legal recognition of the consolidation principle was first contained in the federal tax legislation, which required consolidated returns of net income and invested capital beginning in 1917. Garnsey [1923, p. 54] and Dickinson [1924, p. 477] agreed that the preparation of consolidated accounts was “almost universal” practice, while Dickinson further stated that this had been the situation “for more than fifteen years past.

It is interesting to note that, in the decades that followed, British consolidated accounting practices continued to follow developments in the United States. According to Lee, by the 1940s American companies generally used the acquisition (purchase) method, i.e. the method then given implicit approval by the Companies Act of 1948, and described in detail in the “1949 Notes” issued by the Institute of Chartered Accountants in England and Wales. By the time the British profession began to give serious consideration to use of the merger (pooling) method, in the early 1970s, American companies had already largely made this change [Lee, 1986, p. 394].

THE DISCLOSURE DECISION

PK Ltd. was incorporated to take over the assets and business activities of three existing enterprises from July 1, 1873. The company’s shares were first quoted on the London Stock Exchange in 1900 and, during the first two decades of the present century, PK Ltd. acquired the entire share capital of Rylands Brothers Ltd. (RB Ltd.) and the Wigan Junction Colliery Co. Ltd.; also £210,000 of the £218,600 share capital of the Moss Hall Coal Co. Ltd., while the Partington Steel & Iron Co. Ltd., was incorporated as a wholly owned subsidiary in 1910. PK Ltd. became a subsidiary of Sir W.G. Armstrong Whitworth & Co. Ltd. in 1920. Ten years later — at a time when the British steel industry was at a particularly low ebb — the steel making activities of PK Ltd. were merged with those of its principal competitor in South Lancashire, the Wigan Coal and Iron Co. Ltd., to form the Lancashire Steel Corporation Ltd.

Peter and John Rylands were directors of one of the three companies that came together to form PK Ltd. in 1873. They then became founder members of PK Ltd.’s board of directors and, together with Thomas Glazebrook Rylands, held 2,172 shares, representing 13.3% of the company’s initial share capital. The three brothers were, at this time, also in partnership under the name Rylands Brothers (subsequently incorporated with limited liability in 1874) as manufacturers of steel wire. This firm was PK Ltd.’s ‘largest and most important customer” [Bleckly, p. 31] taking 20% of the entire production of the iron works.

The brothers naturally had a personal interest in the smooth running of PK Ltd., but problems arose following the death of John Rylands in 1898 and Thomas Glazebrook Rylands soon after. Their property was transferred into trust, but with two of PK Ltd.’s directors — John J. Bleckly and the remaining Rylands brother — acting as trustees, a possible conflict of interest arose. The directors of PK Ltd. therefore decided that the only sensible solution was to acquire the shares from the trustees or else “run the risk of losing that part of the company’s trade that depended upon RB Ltd.’s orders” [Bleckly, p. 32]. Bleckly states that “after very difficult, intricate and protracted negotiations — to which, as there were so many interests involved, the Court of Chancery had to be made a party and had to consent — the transaction was finally completed in 1902.

The acquisition was made at par value with payment spread over the period 1902-06. Following completion of this transaction, the directors gave consideration to the possibility of including the assets and liabilities of RB Ltd. in the published balance sheet of PK Ltd. at June 30, 1907. A “joint” balance sheet for the two undertakings and the directors’ report thereon were printed, ready for circulation to shareholders, and the scheme was explained in the draft directors’ report as follows: “In order to make clear to the Shareholders the exact position of the Company at the present time, the Directors have decided to include the assets, liabilities and reserves of Rylands Brothers in this year’s Balance Sheet.

The directors were in some doubt, however, about whether the publication of a joint statement fully satisfied their contractual obligation to shareholders under article 152 of the company’s constitution, which stipulated that “A balance sheet shall be made out in every year and laid before the company in general meeting and such balance sheet shall contain a summary of the property and liabilities of the company.” The problem, as they saw it, was that the “joint” balance sheet was not confined to the property and liabilities of the company. Accordingly, the directors decided that “for the purpose of meeting any possible objection that this course does not strictly conform to the Articles of Association, a Resolution will be moved at the General Metting to confirm the Directors’ action.” The auditors Blease & Sons, chartered accountants, took no apparent exception to the proposed course of action. Their draft report merely explained that “The above balance sheet incorporates the assets and liabilities of Rylands Brothers Limited as certified by their auditors, Messrs. Stead, Taylor & Stead, Chartered Accountants, of Liverpool.” The directors abandoned their plan and, instead, continued for a while to print and circulate only a legal entity-based balance sheet (referred to below as “the legal balance sheet”).

Three years later the company included a consolidated bal-ance sheet in a circular announcing to members an extraordinary general meeting called to sanction amendments to the company’s constitution and approve a £140,000 share issue. The circular, which contained a “General Balance Sheet Incorporating the Assets and Liabilities of Rylands Bros. Ltd.,” drew attention to an important limitation on the usefulness of the legal balance sheet, namely that it failed to give a proper indication of the value of the company’s investments. In the Board’s view, “the surplus value of its assets over and above the price paid by the PK Co. for its shares now represents an internal reserve of at least £140,000 [the amount Rylands Brothers, Ltd.’s undistributed profit], no part of which is shown by the PK annual Balance Sheet.

The initial draft of the 1910 circular did not include a consolidated balance sheet, and one was inserted on the insistence of the company’s chairman, J.S. Harmood Banner,7 who argued that a joint balance sheet’ might help clarify the position. The chairman was senior partner of Harmood Banner & Son, chartered accountants, but the proposal was not his brainchild. In a letter to a fellow director, John J. Bleckly, Harmood Banner admits that “It [the joint balance sheet] was your suggestion at one time [1907], and I threw cold water upon it, but I think for the purpose of this circular a combined account might be useful.”
7J. S. Harmood Banner was a highly successful professional accountant who was president of the Institute of Chartered Accountants in England and Wales, 1904-5. He was the son-in-law of Thomas Knowles, one of the two founders of Pearson and Knowles and on Knowles’s death in 1884, he joined the board, as executor, to look after the family interest. He became chairman in 1899 [Daven-port-Hines, 1985].

Encouraged by this change of heart, Bleckly next explored the possibility of framing the annual balance sheet along similar lines. The plan is outlined in a letter, to A. Norman Hill of Hill, Dickinson & Co., solicitors, dated June 22, 1910, which acknowledged a perceived obstacle to the publication of a consolidated balance sheet.

Objection has been raised that the two Companies are legally distinct, and that the creditors of one in fact have no claim on the assets of the other, and circumstances may arise in case of winding up which would make this distinction of importance.
Having raised this objection, Bleckly answers it in the following terms.

Of course, it is conceivable that the Assets of the subsidiary Company might be inadequate to discharge its liabilities, and in that case there would be no claim on the Assets of the Parent Company to make good any such deficiency. The converse could hardly happen, as in any liquidation of the PK Company, the whole of the surplus Assets of Rylands Brothers Limited, would belong to the PK Co’s Estate, and be available for their creditors. The PK Balance sheet after all is only addressed to its own Shareholders and Creditors, and not to those of Rylands Brothers Limited, at all, who trust that Company on its own merits alone, and not because of its connection with PK Co.

Bleckly therefore inquired of Hill whether there was “any legal force in this objection under present conditions, and if so, how can it be got over.” According to Hill (letter dated June 23), “for the reasons to which you refer, your Official Balance Sheet … called for under Articles 152 and 153 and returned to Somerset House” (where it was made available for public scrutiny) should include only the assets and liabilities of PK Ltd. However, Hill acknowledged the fact that there would be no objection to publishing a consolidated balance sheet in addition to the legal balance sheet, and made the following suggestion:
If you adopt this course then the Official Balance Sheet could be published in a very condensed form and the supplementary Balance Sheet could I think, by the use of appropriate type, be made for all business purposes the Balance Sheet of the joint undertaking.

The directors rejected Hill’s advice and instead presented to shareholders a single statement, headed “Consolidated Balance Sheet, 30th June 1910. Incorporating Assets and Liabilities of Rylands Brothers Limited.

It is reasonable to assume that the directors concluded that no one was likely to object to what might have been construed as a technical infringement of the company’s articles and prevailing company law. The directors of some companies adopted a similarly cavalier approach concerning the format of balance sheets filed under the Companies Act 1908, s.26(3), and such consolidated statements were accepted by the Registrar of Companies [Garnsey, 1923, p. 17].8
The directors’ decision to publish a consolidated balance sheet is explained in their report, to the 1910 annual general meeting, as follows:

A circular accompanies this Report, explaining a proposal of the Directors, to which great importance is attached, that will require the issue of the remainder of the Share Capital of the Company. With a view of giving information regarding the effect on the value of the Company’s property and its resources, of its investment in Rylands Brothers Limited — which now forms an important part of the whole undertaking — it is considered desirable to present a combined balance sheet incorporating the assets and liabilities of Rylands Brothers’ business so as to show the position of the company as a whole. The balance sheet, therefore, is now submitted with the concurrence of the auditors on this basis.

The ‘proposal’ involved the incorporation of the Partington Steel & Iron Co. Ltd. to supply RB Ltd. with semi-finished steel for its products. Based on the assumption that investors take note of published financial information when making investment decisions, it is reasonable to conclude that the relatively stronger financial position displayed in the consolidated balance sheet was designed to improve the attractiveness of the planned share issue. The share issue was, indeed, a success, and the chairman announced to the 1911 AGM that the new development had helped create a ‘completely self-contained’ vertically integrated group of

8It may well be that the accounts filed by PK Ltd. were the first example of this treatment, though this cannot be confirmed as it has proved impossible to trace the Registrar of Companies file on PK Ltd. amongst the records of defunct companies deposited at the Public Records Office in London.

companies. Creation of the new company comprised the ‘largest single investment project in the Edwardian steel industry,” with production soon running at “300 tons weekly of billets, rails, joists and sections” [Davenport-Hines, 1985, p. 45].

The company continued to publish a balance sheet incorporating the activities of RB Ltd. but not PK Ltd.’s other subsidiaries, until 1927. For that year and for 1926, the directors made the additional voluntary decision to present to PK Ltd.’s shareholders the balance sheet of the Partington Steel and Iron Co. Ltd., which by this time was a far larger concern than even RB Ltd. The results of the Partington Steel and Iron Co. Ltd. were never consolidated, however, and following implementation of a Scheme of Arrangement dated July 12, 1928, the directors of PK Ltd. reverted to the practice of publishing only the legal balance sheet.

CONSOLIDATION PROCEDURES

The mechanics of the consolidation exercise will be described using the consolidated balance sheet published at June 30, 1910 (Table 1), although the procedures used when preparing the unpublished balance sheet in 1907 were little different. The procedures will be compared with current British practice, not for the purpose of criticism, which would be unfair, but to provide a yardstick for discussion and analysis.

To help understand the significance of these adjustments, it is necessary to say a few words about the nature of PK Ltd.’s two published documents — the director’s report and balance sheet — and the relationship between them. The balance sheet disclosed an interim position, giving financial effect to transactions undertaken during the year, but not the appropriations of profit recommended by the directors for approval at the annual general meeting. The narrative contained in the director’s report typically started with a statement of the profit brought forward, the profit reported for the year and the interim dividend already paid out. (This merely repeated items shown on the face of the balance sheet.) The directors report then moved on to outline the recommended appropriations of profit and to identify the net balance of retained profit to

9The fact is that there was little purpose in PK Ltd. publishing a consolidated balance sheet after 1920 when it became a wholly owned subsidiary of Sir W. G. Armstrong Whitworth and Co. Ltd. Armstrong Whitworth Security Company Ltd., the parent of Sir W. G. Armstrong Whitworth & Co. Ltd., commenced the practice of publishing a consolidated balance sheet in 1929.

Table 1 Consolidation Schedule, 30th June, 1910

CAPITAL AND LIABILITIES
Cumulative preference shares
Ordinary shares
Reserve fund
Loan
Debentures
Creditors:
On open accounts
Bills payable
M & LD Banking Co. Ltd. Creditors, P & K Ltd. Profit and Loss Account

PK Ltd. balance sheet
£. s. d
250,000. 0. 0
610,000. 0. 0
180,000. 0. 0
145,400. 0. 0
68,961.17. 4 1,887.17. 11

RB Ltd. balance sheet
£. s. d
40,000. 0. 0 (A)
80,000. 0. 0 (A)
137,500. 0. 0
21,000. 0. 0
21,083.15. 3 (F)
20,000. 0. 0 (E)
26,111. 3. 9 (H)
23,621.10. 3 (G)

Consolidated adjustments
Debit Credit
£. s. d £. s. d
40,000. 0. 0 80,000. 0. 0
16. 5. 1
20,000. 0. 0
26,111. 3. 9
23,621.10. 3

Consolidated
balance sheet
£. s. d
250,000. 0. 0
610,000. 0. 0
317,500. 0. 0
145,400. 0. 0
21,000. 0. 0
90,029. 7. 6 1,887.17. 11

67,645. 2. 8 1,503,462. 8. 1

Balance brought forward 14,517. 14, 5 752 19. 2 15,270. 3. 7
Add Profit for the year 44,822 15. 9 13,709 1. 10 (D) 2,448. 6. 8 (B) 12,417. 9. 0 66,617 13. 3
(C) 1,883. 6. 8
59,340. 0. 2 14,462 1. 0 81,887. 16. 10
Less Interim dividend paid 14,242 14, 2 1,883. 6. 8 (C) 1,883. 6. 8 14,242. 14. 2
45,097. 6. 0 12,578.14. 4
1,301,347. 1. 3 381,895. 3. 7

PROPERTY & ASSETS tjJ

1
547,108. 11. 6 198,142. 11. 4 (B) 12,417. 9. 0 757,668. 11. 10 The
199,324. 15. 5 8,384. 12. 11 (A) 120,000. 0, 0 87.709. 8. 4
11,615. 1. 11 11,615. 1. 11 8
245,267. 0. 2 81,382. 3. 4 326,649. 3. 6 1
170,345. 9. 6 93,969. 10. 11 (D) 2,448. 6. 8
(G) 23,621. 10. 3 238,245. 3. 6
16. 5. 1 (F) 16. 5. 1 1
127,686. 2. 9 (E) 20,000. 20, 0 81,574. 19. 0 s
(H) 26,111. 3. 9 S’
,301,347. 1. 3 381,895. 3. 7 1,503,462. 8. 1 Inn
ova
Freehold and leasehold land,
buildings, collieries,
ironworks, wire mills, cottages,
machinery, plant etc. Reserve fund investment account Mine rent suspense account Stock, as per stock books Sundry debtors
Debtors, P & K Ltd. Cash and Bills in hand and at bankers
Journal Adjustments £ £
(A) RB Ltd.: Preference shares 40,000. 0. 0
RB Ltd.:Ordinary shares 80,000. 0. 0
P&K Ltd.: Reserve fund investment account 120,000. 0. 0
Being book value of investment or RB Ltd. onset against the nominal value ot shares acquired.
(B) RB Ltd.: Freehold and leasehold buildings, etc. 12,417. 9. 0
RB Ltd.: Profit for the year 12,417. 9. 0
Being capital expenditure for year of RB Ltd. previously written off, now written back.
(C) RB Ltd.: Profit for the year 1,883. 6. 8
RB Ltd.: Interim dividend paid 1,883. 6. 8
Being interim dividend included in P&K Ltd. reported profit, offset against RB Ltd. reported profit.

Table 1 (Continued)
Consolidation Schedule, 30th June, 1910
£ £
D) P&K Ltd.: Profit for the year 2,448. 6. 8
P&K Ltd.: Sundry debtors 2,448. 6. 8
Being reversal of entry in the accounts of P&K Ltd. to record dividend proposed by RB Ltd.
(E) RB Ltd.: Bills payable 20,000. 0. 0
P&K Ltd.: Cash and bills in hand and at bankers 20,000. 0. 0
Being bills payable by RB Ltd. to PK Ltd.
(F) P&K Ltd.: Creditors on open accounts 16. 5. 1
RB Ltd.: Debtors, P&K Ltd. 16. 5. 1
Being amount due by PK Ltd. to RB Ltd.
(G) RB Ltd.: Creditors, PK Ltd. 23,621.10. 3
P&K Ltd.: Sundry debtors 23,621.10. 3
Being amount due by RB Ltd. to PK Ltd.
(H) RB Ltd.: M & LD Banking Co. Ltd. 26,111. 3. 9
P&K Ltd.: Cash and bills in hand and at bankers 26,111. 3. 9
Being RB Ltd. bank overdraft offset against P&K Ltd. bank balance.

SOURCE: The consolidation schedule and journal entries have been compiled from the draft balance sheet and draft consolidated balance sheet of P&K Ltd. at 30 June 1910, the audited balance sheet of RB Ltd. at 30 June 1910 and the published consolidated balance sheet of P&K Ltd. at the same date.

be carried forward. Following approval at the annual general meeting, the appropriations were recorded in the books and the net figure carried forward was shown as the opening balance in the following year’s balance sheet.

Distributable Profits: As noted earlier, two alternative methods of consolidation which have been the subject of discussion and practical application, in Britain and elsewhere, are the “acquisition method” and the “merger method.” The crucial difference between them concerns the treatment of profits earned by the subsidiary prior to the date of takeover. Under the acquisition method, pre-acquisition profits of the subsidiary are capitalized on the grounds that they “belong” to the former shareholders of the subsidiary who have received their value as part of the purchase price. Under the merger method, pre-acquisition profits remain available for distribution on the grounds that the subsidiary’s former shareholders continue as joint investors in the enlarged group.
The shares in RB Ltd. were purchased for cash and, applying the above rationale, the acquisition method would today be considered appropriate. The company never, in fact, made any distinction between pre and post acquisition profits, i.e., the entire profits and reserves of RB Ltd. were aggregated with those of PK Ltd. when preparing the consolidated balance sheet (see Table 1). The remote possibility that RB Ltd. had no profits at the acquisition date has been explored; there were indeed profits which were subsequently transferred to PK Ltd. in the form of dividends and credited to the latter company’s profits and loss account.

Cost of Control: In Britain, the difference, if any, between the price paid for shares and their fair value or book value, is today dealt with by entries in the consolidated balance sheet as goodwill/ capital reserve on consolidation (acquisition accounting) or as a capitalization of profits/merger reserve (merger accounting).

The directors minute book shows that, following the pro-tracted negotiations, shares in RB Ltd. were purchased at their nominal value of £25 per share, payable in the following installments: for the 3,200 ordinary shares, £12.10.0 (£40,000) initially and five further annual installments of £2.10.0 (£8,000) commencing June 30, 1902; and for the 1,600 preference shares, five equal annual installments of £5 (£8,000) commencing June 30, 1902. Interest was payable at 4% per annum on the ordinary shares and 5% per annum on the preference shares to be paid from June 30, 1901 on any amounts remaining outstanding. The directors’ report

for 1907 reports that “the purchase of the shares of Rylands Bros. Ltd. mentioned in the directors’ report in 1902, has now been completed, and the whole of the business transferred to this company.

Table 1 shows the capital of RB Ltd. at £120,000, made up of preference shares £40,000 and ordinary shares £80,000. The price paid by PK Ltd. is included in the reserve fund investment account at £120,000. These two amounts cancelled out neatly on consolidation (Journal entry A), giving rise to neither a debit nor credit balance requiring separate statement in the consolidated balance sheet.

Uniformity: The considerable up-turn in PK Ltd.’s profitability, associated with the general improvement in trading conditions throughout the industry, enabled the directors to introduce, in 1905, the policy of writing-off all expenditure on plant and machinery against profit for the year, “so the plant and machinery account was practically closed from 1905 onwards” [Bleckly, p. 45]. Each year additions were capitalized and recorded in the balance sheet, while the directors’ report contained a recommendation for the amounts involved to be written-off against reported profit.10 The directors of RB Ltd., by way of contrast, wrote off capital expenditure before striking the balances for profit and fixed assets reported on the face of the draft balance sheet. The function of journal entry B is, therefore, to write-back the capital expenditure of RB Ltd. for the purpose of preparing the consolidated balance sheet. In line with the previous practice of PK Ltd. the combined capital expenditure for the year of each company, amounting to £18,125.17.0, appeared as a recommended appropriation of profit in the directors report for 1910.

Inter-company Balances: Journal entries (c)-(g) have as their purpose to eliminate inter-company balances. This treatment is based on the notion that the consolidated balance sheet regards a group of companies as a single entity that cannot owe money to itself. The twin purposes of the adjustment are to avoid overstating reported balances and remove potential scope for window-dress-

10It was during this period that the understatement of reported profits, by British companies, became common practice, with an element of judicial approval implicit in the decision in Newton v. Birmingham Small Arms Co. Ltd. (1906). The directors of PK Ltd. seem to have accepted the idea that the understatement of a company’s financial position was a desirable business policy, but not the view that the process by which this objective was achieved should be concealed from shareholders.

ing. Two adjustments were needed in order to prevent double counting in relation to profits and dividends: Journal entry (c) removes the interim dividend paid by RB Ltd., that is already included in PK Ltd.’s reported profit for the year; Journal entry (d) removes, from PK Ltd.’s figures for profit and sundry debtors, the final dividend expected from RB Ltd., but unprovided, in the subsidiary company’s accounts. Journal entries (e)-(g) eliminate intercompany indebtedness arising from trading transactions between the two companies.

Bank Balance: The bank overdraft of RB Ltd. at the Manchester and Liverpool District Banking Co. Ltd. is offset against the larger bank balance of PK Ltd. (journal entry H), leaving a net balance to be reported to shareholders. Current best practice permits this adjustment only to the extent that debit and credit balances are maintained at the same bank. It is not known whether both companies used the same bank.

Inter-company Unrealized Profits: The existence of vertical integration gave rise to a debt outstanding, at the year end, of £23,621.10.3 for goods supplied by PK Ltd. to RB Ltd. As RB Ltd. traded as an independent concern, we can assume that goods were invoiced to that company at selling price. It is unlikely that all the goods supplied to RB Ltd. had been resold at the year end, but no adjustment was made to eliminate unrealized inventory (stock) profits.

PROCEDURES’ APPRAISAL

The main differences between the consolidation procedures employed by PK Ltd. and those in use today, in Britain, are that only one of its four subsidiary companies was consolidated, that intra group profits were not eliminated on consolidation and that the combination was accounted for as a merger (pooling) despite the fact that it was an acquisition.

No reasons were given by the directors for their failure to consolidate the activities of the Wigan Junction Coal Co. Ltd, a relatively minor investment, the Moss Hall Coal Co. Ltd. and the Partington Steel and Iron Co. Ltd. However, some of the known facts may help explain the director’s decision. During the period 1905-1914, no profits whatsoever were derived from any of these three investments [Bleckly, p. 47]. In 1908, the directors reported a devastating explosion at the main colliery of the Moss Hall Coal Co. Ltd., which destroyed the entire colliery and resulted in a serious loss of life. The cost of this disaster, to PK Ltd., had been put at £200,000 and, according to Bleckly, this subsidiary “continued to be a constant drain on the parent company’s resources” [Bleckly, p. 40]. The Partington Steel and Iron Co. Ltd. was fully operational by 1912, but it was not until the war years that much benefit accrued from this investment. Moreover, during the early years of its existence, the company incurred large amounts of capital expenditure, so that it might well have been considered undesirable to consolidate and extend to that company the group policy of writing off capital expenditure against revenue.

The failure to remove unrealized stock (inventory) profits would today be a matter for criticism, but these were early days, and it was clearly not the invariable practice even among leading American companies — such as the United States Steel Company (1902) — where the application of consolidation procedures was far more advanced than in Britain. Furthermore, the directors were preparing PK Ltd.’s first set of consolidated accounts some time before Dickinson’s authoritative Accounting Practice and Procedure acknowledged the fact that “the elimination of profits on sales or transfers between companies is a somewhat difficult and complicated matter” [Dickinson, 1913, p. 180].

The decision of the directors to “pool” the entire accumulated profits of PK Ltd. and RB Ltd. is more difficult to justify, even by reference to contemporary practice. The author has found no reference to the pooling of interests basis of accounting in the early literature — mostly American — on consolidated accounts, but the views expressed concerning the appropriate treatment of a subsidiary company’s pre-acquisition profits were unambiguous. According to Dickinson, “there is a clear rule of common-sense, and probably also of law, that a corporation cannot earn profits before it exists” [Dickinson, 1904, p. 452]. Any profits earned by a subsidiary prior to acquisition are assumed to be included among the assets purchased and any realization of those assets is “merely a return to the purchasing company of a portion of the purchase money — i.e., of the capital of the corporation” [Dickinson, 1904, p. 453].

SOURCE OF IDEAS AND EXPERTISE

From where did the directors get the idea to prepare a con-solidated balance sheet? There is certainly no evidence that professional accountants either internally — Harmood Banner, the chairman — or externally, Blease and Co., the auditors — were in any way responsible for the change. Instead, apparently it was

John Bleckly’s idea. Was there something in his personal experience that encouraged him to make the proposal? There is no evidence that he was in any way associated with iron and steel companies in the United States, where the preparation of consolidated accounts was already well established, or even that he visited the country, although he may well have. Also, there is no evidence that the expertise was transferred from local authorities, where the preparation of an “aggregated balance sheet” from separate balance sheets prepared for individual funds and trading activities, was common practice by the end of the nineteenth century. The more likely explanation is that it was in common with many other accounting innovations: a natural development out of an existing practice.

It was mentioned earlier that PK Ltd. was formed by the amalgamation of three existing businesses. The purpose of the amalgamation was to achieve a degree of vertical integration by combining the activities of a colliery, a forge and a wire manufacturer. Valuations were obtained for each of these organizations as the basis for fixing the number of shares to be issued to their shareholders. Revised balance sheets were prepared for the Pearson and Knowles partnership, which owned the colliery, based on valuations prepared by Elias Dorning, a Manchester mining engineer; for the Dallam Forge Co. Ltd. based on valuations by Walter May, a Birmingham consulting engineer; while for the Warrington Wire Iron Co. Ltd., a company of recent construction [1863] and modern design’ [Bleckly, p.6], the use of book values was considered appropriate. The share capital figures were as follows: Pearson and Knowles, £480,000; Dallam Forge, £170,000; Warrington Wire, £170,000; and £10,000 for what is described as “certain outstanding iron companies’ debentures” [Bleckly, p. 7]. The former activities of Pearson and Knowles were subsequently recorded separately, in the books of PK Ltd., as the collieries branch and those of the other two companies combined as the ironworks branch.

Bleckly’s history of PK Ltd. shows that a careful record was made of the profits earned by each branch and he expresses annual profits earned as a percentage of the original capital for each year between 1874-1920. He also tells us that the “two departments,1 1 though controlled in regard to finance and general policy by the same board of directors, bought and sold one to the other at market prices with little or no regard to anything but each one’s individual interest, so that the departmental results were quite simple and could be separately followed in detail and as a whole” [Bleckly, p. 35]. There are no early balance sheets for either of the two branches, but records have survived for each of the years 1908-17. Transactions between the two branches were recorded in an “adjustment account”12 that cancelled out on consolidation to produce the legal entity based balance sheet for PK Ltd. We know that PK Ltd. had worked closely with RB Ltd. for many years, and the preparation of a consolidated balance may be seen simply as the application of well established branch accounting procedures to incorporate the activities of what Bleckly described as “this new department” [Bleckly, p. 33].

REVIEW

The publication of consolidated accounts is, arguably, the major twentieth century innovation concerning external financial reporting procedures. The directors of PK Ltd. were pioneers in the application of consolidated accounting procedures to the financial results achieved by a British group of companies. They published a consolidated balance sheet a full decade before any other example that has so far come to light. The events at PK Ltd. attracted no press attention; The Accountant in a few brief references to the company’s affairs between 1910-27, makes no mention of its innovative financial reporting practice. Had one of the leading public companies, such as Lever Brothers Ltd., published a consolidated statement, in 1910, it would have been more likely to capture the attention of the business community and the investing public. Instead, it was necessary to await the publication by Nobel Industries of a far less sophisticated set of consolidated accounts, in 1922, and the lecture presented by Garnsey to the London members of the Institute of Chartered Accountants in England and Wales, later in the same year, before the group accounting debate took center stage in Britain.13

The purpose of this paper has been to improve the under-standing of the process of accounting change, and it has been

l2The term ‘adjustment account’ seems to have been in widespread use at the beginning of the century and the way that it could be used to make individual ledgers, dealing with a particular aspect of total business activity, self balancing, is described, for example, in Dicksee [1903, pp. 14-15 and p. 221].
13The significance of Garnsey’s lecture is examined in Kitchen [1972]. See also Edwards and Webb [1984].

argued that the adoption of consolidated accounts at PK Ltd. was a natural development out of existing practice (the evolutionary approach). There is no evidence that the directors’ actions had any significant influence on the general adoption of the technique of consolidated accounts by British companies. True, it was adopted by its successor company, in 1930, eighteen years before its use became a British statutory requirement, but no reference was made to previous usage by the chairman of Nobel Industries, who claimed his company’s action was “practically an innovation for large concerns so far as this country is concerned” [quoted in Kitchen, 1972, p. 127]. Indeed, the form of Nobel’s published statement — correctly described by the auditors as an “aggregated document”14 — suggests a quite different origin, namely the accounting procedures of local authorities. The change agent, on this occasion, may well have been that stern critic of secretive accounting practices during the 1920s, Sir Josiah Stamp, who was at this time the Secretary of Nobel Industries. As a distinguished economist, and former civil servant, he would no doubt have been fully familiar with accounting practices in the public sector.

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