Question

How did the principles of Accounting Research Study #3 change historical cost and the realization principle? Were these changes more in line with GAAP today?

Answer 1

Accounting Research Study No.3
There are eight broad principles in ARS 3.

It is interesting to note that the summary of the eight principles covers some four and one-half pages, two and one-half of which are devoted to Principle D, the asset valuation principle. Deinzer very appropriately noted that Principle A—which states that revenue is earned by the entire process of operations of the firm rather than at one point only, usually when sale occurs—was not reasoned from any of the 14 postulates.15 It would appear, then, to belong in the B group of postulates. More importantly, Sprouse and Moonitz apparently needed it to pave the way for their value-oriented principles because it underlies the recognition of changes in replacement cost, which leads to holding gains or losses (Principle B-2). One of the most pointed criticisms of the asset valuation measures prescribed in Principle D was that they are not additive. That is, although current value dollars are being used, different attributes or characteristics are being measured; hence, they cannot theoretically be combined by addition because Sprouse and Moonitz advocated different current-value characteristics for different asset classes. For example, if inventory can easily be sold at a given market price, net realizable value (selling price less known costs of disposal) should be used (D-2). On the other hand, the value of fixed assets, which are not intended for sale, is rooted in terms of the service they can provide over present and future periods. As a result, Sprouse and Moonitz opted for replacement cost as the appropriate characteristic of measurement for this class of assets (D-3). Obviously, the additivity question, where different attributes are being measured, has strong overtones of measurement theory. Chambers was the principal critic of the lack of additivity of asset values put forth by the broad principles of ARS 3.16 Chambers strongly advocated the exit-value approach illustrated in Chapter 1, although his position is blurred by his acceptance of replacement cost as a secondary valuation if exit values were unavailable.17 However, it should be clear that Chambers was attempting to separate conceptual or theoretical issues from measurement problems. Hence, it would almost appear that the additivity issue can be breached only if one’s heart is in the right place. The basic theoretical system should be unified in terms of one primary characteristic of assets and liabilities to be measured. However, a less desirable measurement must be employed where the primary measurement system falls short of being able to provide the needed numbers. Nevertheless, the primacy of conceptual issues over measurement problems cannot be ignored. The answer probably lies in determining which current value elements have the most utility for financial statement users, an issue not addressed by Sprouse and Moonitz. A last criticism to be leveled at ARS 1 and ARS 3 was that a set of postulates should be complete enough to allow no conflicting conclusions to be derived from them. Postulate C-4 says that the monetary unit should be stable. From it, Principle D was derived advocating various current values for different categories of assets. The various choices espoused in Principle D cannot be justified to the exclusion of other possibilities. Hence, the postulate system is not theoretically tight enough to justify it, whether or not one agrees with the resulting principles.