RichardVangermeersch THE UNIVERSITY OF RHODE ISLAND
and
MarkHiggins THE UNIVERSITY OF RHODE ISLAND

THE NATURAL BUSINESS YEAR: A SHIFT FROM PROACTIVE TO REACTIVE BEHAVIOR BY ACCOUNTANTS

Abstract: There has been a noticeable decline in accounting publications and research on the natural business year since the early 1960’s, the same time that the AICPA Committee on Natural Business Year ended. Accountants and accounting institutional bodies up to that date had taken a strongly proactive stance on the topic. Since then, and especially since 1970, almost all of the literature on the natural business year has been reactive to IRS pronouncements. This article traces these changes from proactive to reactive behavior, and from financial/managerial accounting considerations to taxation issues. The article ends with support for accountants to be proactive once again on the natural business year and to regain the vitality of the financial/ managerial accounting literature on the topic.

The recent absence of the Natural Business Year (NBY) as a topic in a leading intermediate accounting text indicated to the authors of this article that a lack of theoretical interest existed for this topic.1 This apparent lack of theoretical interest seemed significant in light of the United States Congress mandating individuals and “flow through” entities to report on a calendar year basis in the Tax Reform Act of 1986 (TRA86). This study was undertaken to ascertain why interest in a once highly-touted financial/ managerial accounting topic apparently declined and to try to draw some inferences from this apparent decline to the significant changes caused by TRA86.

The natural business year, for any business enterprise, is that period of twelve consecutive calendar months which coincides with the annual cycle of the operations of the enterprise. Generally speaking, the natural business year for

The authors used the following four-step approach in conducting this project. First, 50 articles and reports pertaining to the NBY were selected from The Accountants’ Index for the period 1920 through 1987. Fifty articles and reports were judged to be sufficient to observe the trend in the NBY literature. Second, various tax sources discussing the impact of the TRA86 and the Omnibus Budget Reconciliation Act of 1987 with respect to the NBY were analyzed. Third, the reported activities of the NBY Committee of the AIA/AICPA (American Institute of Accountants became the American Institute of Certified Public Accountants in 1957) were reviewed as further background for the article. This review led to a search for information on the NBY Council. Finally, evi-dence was collected on a significant contributor to the early literature on the NBY — Ralph S. Johns.

RESEARCH APPROACH

Table 1 discloses the number of NBY items in The Accoun-tants’Index from 1920 through 1987. The authors noted 674 items, which were classified as being either financial/managerial or taxation in orientation. This classification was based on an analysis of the title of the item and the type of publication in which the item

any enterprise will end when its business activities are at the lowest point in their annual cycle, and when inventories and liabilities have been reduced to their annual minimum. In order that receivables also may be as low as possible at the closing date (the inventory factor having the greater weight), it is customary to consider the natural business year as ending just before the beginning of heavy inventory replenishment rather than just after heavy inventory reduction.

2From 1928 through 1950-51, reports from the Committee on NBY were included in the AIA annual reports. Starting with the 1951-52 year, the AIA no longer included committee reports but rather provided only abbreviated coverage in its annual report. Committee reports were in mimeo form only and were never in the AICPA Library. Mrs. Karen Hegge Neloms, Director, Library Services Division of the AICPA, reported that the AICPA published a Natural Business Year Promotion Kit in 1960. Mrs. Neloms was of the opinion that the Committee on NBY lapsed in 1960 or 1961, as stated in a letter to the writers. Newland in 1987 reported that the Committee on NBY became defunct in the 1950’s [p. 383]. However, the writers found that the Committee on NBY was included in the AICPA Committee list for 1961-62. The Committee had this description — “Advisory Committee appointed by the president — chairman is member of senior committee on specialized audits [p. 15]. From the description of the status of the Committee, it would appear to have been quite easy for the President of the AICPA to not reappoint it, even though the Committee on NBY had been in existence for 35 years. There was no reference to the Committee on NBY in the 1962-63 list of AICPA Committees in its January, 1963 newsletter [p. 15].

Table 1 Natural Business Year Items

Without duplications and without obvious references to monthly and quarterly reporting issues in the sections “Period,” “Natural Business Year,” “National Business Year Council,” and Taxation — United States — Accounting Period” [The Accountants’ Index 1920-1987].

Fin./
Years Mgr. Tax Items
Year(s) Covered Items Items Items Sampled
1920 400+ 1 1 0 1
1921-23 3 1 1 0 0
1923-27 4 22 22 0 7
1928-31 4 32 31 1 1
1932-35 4 24 23 1 3
1936-39 4 105 99 6 6
1940-43 4 49 43 . 6 7
1944-47 4 8 5 3 0
1948-49 2 18 13 5 1
1950 1 8 4 4 2
1951-52 2 18 10 8 2
1953-54 2 18 13 5 1
1955-56 2 12 7 5 1
1957-58 2 9 3 6 1
1959-60 2 15 11 4 1
1961-62 2 15 5 10 1
1963-64 2 20 12 8 1
1965-66 2 5 2 3 1
1967-68 2 15 6 9 1
1969-70 2 15 3 12 1
1971 1 6 0 6 0
1972 1 9 2 7 0
1973 1 12 2 10 1
1974 1 10 1 9 0
1975 1 3 0 3 1
1976 1 15 2 13 1
1977 1 14 2 12 1
1978 1 7 0 7 0
1979 1 8 1 7 0
1980 1 6 1 5 0
1981 1 12 4 8 0
1982 1 7 1 6 1
1983 1 13 1 12 1
1984 1 14 1 13 1
1985 1 27 0 27 1
1986 1 51 0 51 1
1987 1 50 0 50 2
674 332 342 50

appeared. The authors sampled 50 items from the NBY literature listed in The Accountants’ Index and drew conclusions from the review of the sampled items. The authors are of the opinion that a good balance was chosen in the sample both time-wise during the years from 1920 through 1987 and content-wise in terms of the classification into financial/managerial and taxation items.

THE EARLY YEARS

The early ground work for the NBY was conducted in 1915 by the Special Committee on Distribution of Work of the American Association of Public Accountants (AAPA) [later the American Institute of Accountants (AIA) in 1916] chaired by Robert H. Montgomery [AAPA, 1915, p. 6]. His committee report reflected the dilemma facing accountants of being proactive on a topic for which they had a special interest, that is, a better spreading of their workload. Would clients question whether the change to the NBY was more in the auditor’s interest than their own? The committee’s solution to the dilemma was to recommend that accountants lobby each of the great industries to change its accounting period to better reflect its NBY [p. 3]. Perhaps what is most fascinating was this comment by the committee:

Primarily, of course, the most important relief to be obtained is an amendment of the income tax law which will enable firms, co-partnerships and individuals to adopt a fiscal year other than the calendar year. At the present time this privilege is offered to corporations and in order to take advantage of it a business must incorporate. In all probability the law will be amended so as to include all businesses whether individual or corporate and when this has been done it will be the duty of every accountant to encourage his clients to take advantage of the privilege under the laws [pp. 3-4].

The report then listed some classic reasons for rationalizing the change to the NBY. They were: in most cases, December 31 is a most illogical time to take inventory; industry statistics are better collected by having all companies within an industry have the same business year; accountants may either have to refuse work or to rush their work in the busy season; the Treasury Department would benefit by spreading its workload; and better people would be attracted to the accounting profession, as full-time employment could be guaranteed [pp. 4-5]. The report gave credit to “great effort in 1913 and vigorous protest” as the reason why Congress amended the 1909 Excise Tax law and allowed corporations to choose a fiscal year. This report illustrates the very proactive position taken by the AAPA.

In July of 1921, Elijah Watt Sells described the NBY:

… by natural is meant the time when the bulk of the annual business is passed, when the busy season has given its best, when the harvest time of the greatest sales activity is over” [Reprinted in 1924, p. 3].

Within the constraints of a specific business classification, a company should have freedom of determining its NBY [pp. 4-5]. Sells also discussed the broad scope of public accounting:

.. . Public accountants are called upon not alone for the periodical audits and certification of accounts, but in helping to solve problems connected with annual reports and to bring their knowledge and experience to bear on questions of taxation [p. 9].

It is important to note that John R. Wildman, the editor of Sells’ posthumously published book, chose the NBY as both the lead chapter and as the title of the book, The Natural Business Year and Thirteen Other Themes. These choices are indicative of the importance of the NBY in the early 1920’s.

Several editorials pointed out that it was only blind behavior by businessmen that did not allow (1) more logical timing of taking the year-end inventory and (2) accounting workload issues for being the reasons for adopting the NBY [AIA, 1924, pp. 280-1]. One such editorial was based on a presentation by Cherry at the 1924 annual meeting of the AIA, in which he labeled the calendar year as a “fetish” [AIA, 1924, p. 280]. Cherry, in a subsequent writing, also suggested the following reasons for using an NBY: (1) the most appropriate closing date is “from thirty to sixty days after the heaviest selling period …” [p. 126]; (2) the taxpayer can easily change its year end [p. 126]; and (3) bankers are also overburdened in the first two or three months of the year [p. 127]. A second editorial expressing the benefits of using the NBY over a calendar year also provided encouragement for the future of the NBY [AIA, p. 6]. An interesting version of better people being attracted into the accounting profession was this comment in a 1927 editorial. “The man who telephones once in a great while or perhaps even sneaks into the house late at night, only to depart at the break of the next day, is a stranger who seems reminiscent of one who was a father in the summer; but there is no opportunity to identify this fly-by-night person” [AIA, 1927a, p. 33]. The final editorial examined from the 1920’s lamented the failure of the Chamber of Commerce of the United States to support a NBY motion from the Chicago Association of Commerce [AIA 1927b, pp. 450-1]. This aggressive use of editorials again illustrates the proactive position that existed in the profession toward the NBY.

The definitive research project, in the authors’ opinion, on the NBY is Bulletin 11 The Natural Business Year, published by the Bureau of Business Research of The University of Illinois. The Bulletin was compiled in 1926 under the leadership of A. C. Littleton, then the Assistant Director of the Bureau. This Bulletin was based on a questionnaire and set forth the following advantages of adopting a NBY:

Advantages to Management
—Seasonal activity would be completed.
—Low stocks of goods would remain at closing.
—New contracts, etc., would be discussed between sea-sons.
—More time would be available for the firm’s auditors.
—Statistical data would be collected for a natural period. Advantages to Bankers
—Work of the Credit Department would be better dis-tributed.
—Congestion in making loans would be relieved.
—Temptation to “dress” financial statements would be reduced.
—Comparisons would be facilitated. Advantages to Accountants
—More permanent and experienced staff would be pos-sible.
—Long hours at high pressure would be avoided.
—Technical difficulties of “rush seasons” would be minimized.
—Verification would be easier because of low invento-ries, etc.
—Client’s statements would be less delayed.
—More time would be had for consultation with the
client. Advantages to the Bureau of Internal Revenue
—Some of the temporary extra help now required would be eliminated.
—Collections would flow in more evenly. [p. 50]

Other reasons for adopting the NBY were that slow moving inventory is easier to spot and markdown, and “The dull season is also a logical time to consider plans for the ensuing year” [p. 6]. The Bulletin also discussed the importance of the 1918 law per-mitting individuals to choose the NBY for tax purposes [p. 13] and provided a long discussion and examples of NBY’s by industry type [pp. 18-25].

Bulletin 11 was based on Ralph S. Johns’ 1926 thesis at the University of Illinois. Because Johns is a key figure in the history of the NBY (see subsequent references), the authors also reviewed Johns’ thesis entitled The Natural Business Year. A. C. Littleton was listed as “In charge of thesis, and H. T. Scovill as ‘Head of Department’ ” on the signature page of the thesis. While the body of Johns’ thesis and Bulletin 11 are very similar in form and content, certain points were only mentioned in the thesis. In compiling data on the NBY, Johns sent questionnaires to businesses, accounting firms, and bankers. Only 68 replies were received from the 500 public accounting firms, “invariably due to the fact that the questionnaire was sent out during the accountants’ busy season” [p. 51]. However, 469 responses were received from about 1,000 questionnaires mailed to businesses in 62 industries. Johns reported that 67 replies were received from 155 credit bankers surveyed from a list provided by Robert Morris Associates. Of the 67 replies, 24 were favorable to the NBY; 33 were favorable to the calendar year; and 10 respondents indicated no preference [p. 17]. Johns concluded that the NBY topic was only in its infancy [p. 85]. He stated:
It is fairly safe to assume that if all businesses adopted their proper fiscal years, such fiscal years would be pretty well distributed over the year. December would still have about double the number of any other month, June and November would be next in popularity, February would probably have about the fewest number [p. 92].

Johns cited “Perennial Pressure,” an editorial in the April, 1916 Journal of Accountancy. The editorial noted a ten percent increase in activity for public accountants in the first part of 1916 compared to the first part of 1915 [p. 281]. It also noted that accountants had accomplished the first step of changing the tax law but it was now necessary to take the second step towards the NBY.

We believe that a large portion of the failure to encourage the distribution of labor is due to accountants themselves. If every accountant would endeavor to induce his clients to adopt a fiscal year that must be suitable to the businesses in which they are engaged, it would be found that only a small number of the total clientele would close their books at December 31 [pp. 281-2].

Spurred by Johns’ work in Bulletin 11, the Special Committee on NBY was founded by the AIA in 1928.3 Its first report traced a brief history of the topic, giving much credit to H. T. Scovill, Ralph S. Johns, A. C. Littleton, and Elijah Watt Sells [p. 175]. The Special Committee gave a call for action to each accountant.

… Each accountant must assume the initiative with his clients, while the American Institute as a body should attempt to present the proposition continuously and persistently to bankers and businessmen through timely articles in Banker’s magazines and trade periodicals of all sorts [p. 176].
In 1929, the Special Committee disclosed that it had contacted numerous trade and class publications in an effort to spread the word on the advantage of the NBY [p. 184]. It is interesting to note that H. T. Scovill was the Chairman of the Special Committee in 1929 [p. 185].
Pinkerton in 1929 wrote a rehash of Bulletin 11. He did in-clude an interesting example of an improvement in the profits of the fur industry by changing to a March 31 closing, citing that it was no longer necessary to slash prices of stock just at the busiest period of sales in December [p. 1065].

FINANCIAL/MANAGERIAL ACCOUNTING ISSUES IN THE 1930’S

In 1932, the Special Committee on NBY strongly urged that a calendar year closing be chosen only after a company has conducted a study to see if a fiscal year closing would not be more advantageous [p. 244]. In its 1934 report, the Special Committee called for different groups interested in financial accounting to make a concerted nationwide effort to get the NBY adopted [p. 282]. However, Fedde was unhappy with the failure of Bulletin 11 to have the effect it should have had [p. 441]. The cornerstones of the 1936 Report of the Special Committee on NBY were the announcements that a NBY Council had been formed in November of 1935 and that by August of 1936 over 89,375 pamphlets and other material had been distributed by the NBY Council [pp. 466-7]. In addition, the report cited a gale of new activity concerning the NBY [pp. 467-71].

A good description of the composition of the NBY Council was provided in a news item in The Certified Public Accountant in October, 1937 [p. 23]. It is important to note the composition of the Council, as it was both broad-based and included top level participants from prestigious organizations.

A meeting of the Natural Business Year Council was held at New York on September 21st. Henry H. Heinmann, executive manager of the National Association of Credit Men and chairman of the council, presided. Others attending were:

John L. Carey, Secretary of the American Institute of Accountants
Arundel Cotter, Wall Street Journal
Alvin E. Dodd, President American Management Association
William R. Donaldson, Director-in-charge, National Association of Cost Accountants
Frank A. Gale, Assistant Secretary of the American Institute of Accountants
Ralph S. Johns, Chairman of the American Institute of Accountants Special Committee on Natural Business Year
William Walker Orr, Secretary, New York Credit Men’s Association
Joseph Rubanow, President, New York Credit Men’s Association
William S. Swingle, Comptroller, National Association of Credit Men
David A. Weir, Assistant Executive Manager, National Association of Credit Men [p. 23].

Local committees were formed in 32 cities [p. 23] and articles on the NBY were clipped from leading newspapers [p. 24]. A press campaign was waged, and Dun & Bradstreet conducted studies on the NBY of selected industries [pp. 24-5]. The NBY Council was administered by the AIA [Carey, p. 15].

The use of editorials was still prevalent. A 1934 AIA editorial, “A Good Time for Reformation,” stressed that a change in the legal form of business organization, caused by the dire economic times of the Great Depression, was a good time to choose the NBY. Robert Montgomery claimed in 1936 there was a natural cycle for almost every business enterprise [p. 306]. For instance,

September 30 is the logical year-end for automobile manufacturers, but they use a December 31 closing [p. 308]. Ralph S. Johns became publicly active in the NBY campaign in the mid-1930’s, when he was appointed by then AIA President, Robert H. Montgomery, as Chairman of the Committee on NBY for 1937 and
1938 [Zimmerman, 1976, p. 40]. On June 24, 1938, Johns pre sented a paper at the Regional Chapter Conference of the New York State Society of CPA’s. This paper was then published in the New York Certified Public Accountant in the following month and was reprinted in Written Contributions of Selected Practitioners:

Volume 1: Ralph S. Johns. Johns traced a brief history of the topic, focusing on the Revenue Act of 1934. This Act permitted fiscal year taxpayers to file under one Tax Act by deferring tax changes until the start of the new fiscal year [p. 32]. Johns stressed the need for informative statements and called for serious consideration to be given to the NBY concept, in that fewer estimates will be needed to prepare the financial statements [pp. 34-5]. The NBY concept also applied to non-profit organizations [p. 38]. Johns made much of the active cooperation given to the NBY Council by the Treasury Department [p. 41]. He closed his presentation with a plea to each accountant.

This is a program in which each of us, whether em-ployer or employee, whether associated with a large or small organization, can take part, and every calendar year client large or small, is a prospective convert to an NBY. This is to a great extent a matter of education; we should not hesitate, therefore, to advocate the NBY though the fruits of our efforts may not be apparent until several years hence [p. 51].

It is interesting to note that Zimmerman considered Ralph S. Johns so important a contributor to the accounting literature, that he was chosen for the first volume of the Written Contributions of Selected Accounting Practitioners series.4 “His career as a successful accounting practitioner also generated a written record of his intellectual creativity” [Zimmerman, preface].

The importance of the NBY is again illustrated in the June
1939 issue of The Journal of Accountancy, “Testimony of Expert
Witnesses at S.E.C. Hearings,” which discussed the McKesson &
Robbins matter. C. Oliver Wellington felt that the adoption of the
4Volumes on the writings of Paul Grady and Andrew Barr followed in that series.

Vangermeersch and Higgins: The Natural Business Year 47
NBY would lead to a very significant improvement in auditing practices [p. 357]. In a related S.E.C. matter, its Chief Accountant, William W. Werntz, endorsed the NBY in Accounting Series Release No. 17 in 1940. Werntz wrote:
…. Among the more important advantages there may be mentioned the probability of obtaining more complete and reliable financial statements since at the close of the natural business year incomplete transactions, and such items as inventories, would ordinarily be at a minimum … [S.E.C, p. 418].

FINANCIAL/MANAGERIAL ACCOUNTING ISSUES FROM 1940

The first 20 years of this period marked the end of the proactive institutional support of the NBY. The 1940 mid-year report of the Special Committee indicated that over 180,000 pieces of NBY literature had been distributed to companies across the country. However, the Special Committee’s 1940 Annual report revealed that Dun & Bradstreet had found publishing the NBY bulletins too costly and would cease publication of them [pp. 249-251]. While 1941 saw the resumption of the NBY bulletins by Dun & Bradstreet, this resumption was short lived as a result of World War II [p. 131] and, apparently, the NBY Council ended in about 1947.5 In an effort to have broad representation on the Committee on NBY, there was a member from each of the 48 states on it during the 1943-44 fiscal year of the AIA [pp. 11-2]. This grass roots effort illustrated the importance the AIA placed on the NBY. The representatives from each state membership policy ceased in 1947 [p. 10]. A list of suggested fiscal closing dates was given in December 1955 by the Committee on NBY [p. 59]. Harry F. Reiss, Jr., Chairman of the Committee on NBY, cited 1958 figures of the IRS which showed that over the preceding 30 years the number of corporations filing on a fiscal year basis increased from 13% to

5Dun & Bradstreet published 29 Bulletins on the NBY for various industries. Its last one was in January 1943 which was the last listing for the NBY Council in The Accountants’ Index. The writers have contacted the AICPA, the National Asso-ciation of Accountants (NAA), the National Association of Credit Management (NACM), Dun & Bradstreet, the American Management Association (AMA) and the Wall Street Journal for further information on the NBY Council. The AICPA, NAA, NACM, AMA, and the Wall Street Journal responded that there were no files remaining on the NBY Council in their records. The AMA sent one “mimeo-graphed” publication of the NBY Council from 1946.

Mitchell, in 1940, urged that a careful analysis be done before adopting an NBY [p. 361]. Cady, in 1941, urged purchasing agents to become advocates for the NBY. For example, he wrote, “At the natural closing period, incomplete transactions within the company may be lowest. The purchasing agent therefore has to do the least guessing about the true immediate position of inventory value” [p. 67]. He provided a list of benefits:

1. The time of least demand for finished goods.
2. The time of least availability of raw materials.
3. The season least suitable for processing.
4. The least availability of seasonal labor.
5. The time when style changes have the greatest influence on markets.
6. The most convenient time for plant overhaul and annual vacations.
7. The time when the most skilled employees will beavailable for taking inventory.
8. The time when accounting figures will have the greatest usefulness to management.
9. The time when inventory evaluation will be most accurate, and least dependent on estimate or guesswork (p. 68).

Three editorials from the 1940’s were reviewed. An editorial in The Journal of Accountancy in January 1941 stated “The greatest friend of the unnecessary calendar-year closing is the apathetic auditor” [p. 3]. Another reason for the NBY was that World War II called for more efficient use of time for both the auditors and their clients [AIA, 1942, p. 390]. Concern about a clear statement of the business reasons for choosing a fiscal year was stressed in 1943 and led to one more call for the NBY (AIA, pp. 391-2]. A letter in the Technical and Professional Notes section of The Journal of Accountancy used the accountants’ exhaustion from Christmas activity as being a reason for avoiding calendar year closings [Rosenthal, 1949, p. 237].

Mezner, in 1950, called for the public accountant and the banker to educate the businessman on the NBY [p. 397]. Gabrielson related in 1950 the success his CPA firm had in flattening out its workload using the NBY concept [p. 35]. Cox made two interesting observations in his 1952 article in the N.A.C.A. Bulletin:

1. Many companies are so diversified that it is impossible to determine a natural business year common to all divisions of the business.

2. Meeting the requirements of the various tax authori-ties is perhaps one of the most important factors in determining when the books are to be closed [p. 616].
O’Malley wrote a light piece on a dialogue between nine different parties about the NBY [1957, pp. 13-8].

The end of the proactive stage of the NBY movement oc-curred about 1960. The authors conclude that much was accomplished by the first 45 years of literature on the financial/managerial accounting benefits of the NBY. Much of this was accomplished by the institutional support given by the AIA Committee on NBY and by the NBY Council.

There were two more financial/managerial items reviewed. Chatfield’s 1964 piece on “The Natural Business Year and Ac-counting Theory” is a classical scholarly endeavor. He theorized “A good accounting time period should not be static or arbitrarily chosen; it ought to be determined by the investment and production processes themselves, based on the actual circulation of money and goods within the company” [p. 13]. He attempted to tie together the operating cycle with the NBY. The NBY “incorporates cyclical flexibility while preserving calendar regularity” [p. 17]. Chatfield then presented a series of financial statements to illustrate his points [pp. 21-3]. If progress is to be made in rejuvenating the NBY concept, Chatfield’s work is an excellent theoretical base.

Fogg and Ovadia, in 1982, conducted an empirical study on the NBY by using the COMPUSTAT Industrial Tapes. Their research approach was a “more modern look” at the NBY topic with limited findings. The major finding of the study was that “… most companies select a year-end date that results in the highest amount of sales showing up in the last quarter. This conclusion was consistent across December and non-December year-end firms” [p. 23]. Although individually-owned corporations and partnerships are rarely found on the COMPUSTAT Industrial Tapes, the type of analysis may be quite useful to those concerned about the NBY.

THE IMPACT OF TAXES FROM 1930

Preinreich argued in 1933 that a company which switches to a NBY will enjoy a one-time lump-sum tax savings. He raised the question of whether switching to a NBY is ethical and proper for the purpose of saving taxes. He concluded that a company switching to a NBY should be treated no differently by the IRS than a company which adopts a NBY upon formation [p. 318]. The Undistributed Profits Tax of the mid-1930’s was given by Donaldson as a reason to adopt the NBY [p. 285].

Klanderman, in 1939, pointed out that the failure of companies to understand properly the impact on the NBY of the changes in the 1939 Code can result in increased tax liabilities. He notes that while the 1939 Act now allowed all taxpayers to carryforward net operating losses from a trade or business for two years, a corporation which switches to a NBY during the carryforward period would be required to count the short year tax return as one year [p. 389]. Therefore, companies which have large losses should avoid switching to an NBY since the company might not be able to fully utilize the tax loss carryforward. Hence, a switch to a NBY could dramatically increase a company’s tax liability. While this illustrates only one of the many tax issues that Klanderman addressed, it indicates that the emphasis on the tax consequences was of paramount concern.

Holzman in 1942 focused on the tax aspects of switching to a NBY. He refers to a change in philosophy under the Revenue Act of 1940 toward changes in accounting year-ends [p. 213]. Prior to the 1940 Act, the IRS required that taxpayers apply for a change in fiscal years only after they closed their books for the “new” year end. The 1940 Tax Act now required IRS approval for a change in fiscal year. This subtle change is the first example the authors found that the IRS might question a company’s request to change year-ends.

The IRS appeared to become increasingly concerned that the overriding reason corporations were changing to a NBY was to minimize taxes. In The Journal of Accountancy’s February 1952 Tax Clinic, readers were warned of the difficulty that government-regulated industries were having in selecting a year end other than a calendar year. [“Natural Business Year…,” p. 214]. Kuhn, in 1953, pointed out that the IRS would not authorize a company to change to a different year-end solely for the convenience of the firm or the accountant [p. 414].

Tax reasons, not business reasons, appeared to be the principal concern of entities. This became the reason exclusively mentioned in a number of articles in the 1960’s [“Change of Taxable Year … “; “Timely Election … “; and “Change of Accounting Period … “]. There seemed to be more of a reactive attitude toward IRS pronouncements than the previous proactive behavior of getting entities to adopt the NBY. For instance, a short (three para-graph) item in the Tax Clinic section of The Journal of Accoun-tancy discussed an accounting firm’s handling of an appeal to the IRS denial of permission to change year ends [“Change of Accounting Period …, ” p. 66].

The articles reviewed from the 1970’s [Schwab, 1970; “Opportunities and Problems,” 1973; Hasselback, 1975; “Tax Motives . ..,” 1976; and McMahon and Arias, 1977] continued the trend of 1960’s articles with tax avoidance or tax minimization as the overriding objective for choosing the NBY. In an effort to moderate entities from enjoying tax benefits without valid business reasons, the IRS in the late 1960’s and early 1970’s issued a series of Revenue Procedures and Rulings (i.e., Revenue Procedure 66-6, 1966-1; 74-33, 1974-2; and Revenue Ruling 76-43, 1976-6) which carefully delineated the facts and circumstances under which a taxpayer could change taxable years. The Revenue Rulings now required that the taxpayer provide a substantial business purpose in order to change the year end. While “substantial business purpose” was not defined, the IRS indicated that the business reasons for adopting a NBY would constitute a substantial business purpose.

Since greater manipulation of taxes can be accomplished by “flow through” entities (i.e., partnership and S corporations), the primary emphasis of the Revenue Procedures and Revenue Rul-ings was in this area. However, as the authors’ research indicates, as soon as the IRS issued a pronouncement, editors of accounting journals were publishing “tax planning” techniques to avoid the pronouncement.

In the 1980’s, the IRS continued its efforts to reduce the number of taxpayers that could defer income as a result of their interest in “flow through” entities with a different taxable year. Revenue Procedure 83-25, 1983-1, required S corporations, even those which had a substantial business purpose (i.e., NBY) to meet mathematical tests in order to have a taxable year other than December 31. All of the articles reviewed from the mid-1980’s represent updates and explanations of the IRS’s attempt to have all “flow through” entities on a calendar year [“IRS Indicates How …, ” 1983; “S Corporations…,” 1984; and Robin, 1985].

With the adoption of the TRA86 also came the end of the NBY for individuals and “flow through” entities. A brief history of TRA86 should shed some light on the downfall of the NBY. The origin of TRA86 can be directly traced to Secretary of the Treasury Donald Regan’s 1984 proposal entitled Tax Reform for Fairness,

Simplicity and Economic Growth (commonly referred to as Treasury I). In the Spring of 1985, Treasury II, a watered down version of Treasury I, was then submitted to Congress and became the foundation for TRA86. As a result of the long political process, the TRA86 does not present itself as being simple or equitable but only revenue neutral. It is in this neutrality, the authors believe that the NBY saw its demise.
Section 806 of TRA86 requires that all S corporations, partnerships, and personal service corporations use a calendar year. This section was passed without debate or hearings [“Fiscal Year Legislation…,” 1987, p. 84]. A review of the 1986 legislation reveals that this legislation was designed to raise $725 million dollars over 5 years [U.S. Senate, 1986, p. 167].

Less than six months after TRA86 became law, legislation was introduced and subsequently passed in the Omnibus Budget Reconciliation Act of 1987 which repealed the requirement that partnerships, S corporations and personal service corporations must keep their books and records on a calendar year [“Fiscal Year Legislation …, ” 1987, p. 84]. This bipartisan legislation allowed individuals and “flow through” entities to maintain a fiscal year, provided they prepay the taxes which result from not having a calendar year. The AICPA utilized its July, 1987, CPA Letter to relay an action alert on this issue.
The Institute encourages all members to contact their senators and congressmen to ask them to cosponsor and vote for the legislation. Letters should explain the serious problems that the current law is creating for small business owners and for CPA firms,… [Ibid.].

It is important to note that there continues to be interest in the NBY in the accounting literature. There were reported 78 items on the NBY in The Accountants’ Index: 1988 [pp. 1427-1429]. All were taxation items.

CONCLUSION

Where does the NBY stand today? Ironically, it is back to where it was 70 years ago. While Congress and the Treasury were successful in stripping away the tax advantages associated with having a fiscal year for proprietorships, partnerships and “flow through” entities, the financial/managerial advantages still remain. The advantages of adopting the NBY, while not as instantaneous or permanent as the tax deferral, could, over time, result in a substantial savings to businesses in terms of efficiency and productivity. Therefore, accountants should still advocate the need for corporations, partnerships, S corporations, and personal service corporations to adopt a business year that is suitable for them.

The authors have an uneasy feeling that accountants may have contributed significantly to an overall lack of awareness of the NBY. For instance, there is almost a complete absence of financial/managerial items about the NBY during the last 20 years. The composition of NBY items from 1969 through 1988 consists of 336 taxation items and only 21 financial/managerial publications. This significant change in emphasis may have caused the NBY changes in TRA86. The authors believe that this lack of balance can lead legislators and government administrators to take a more cynical view toward accountants and accounting issues than they would if a more balanced approach between financial/managerial accounting and taxation accounting was taken.

Five of the early NBY contributors are members of The Accounting Hall of Fame [Burns and Coffman]. Montgomery, Sells, Scovill, Littleton, and Werntz contributed significantly to the NBY movement. These contributors and others, like Ralph S. Johns, gave the NBY a strong theoretical beginning. The authors believe that a continued renewal of this rich literature would have kept the NBY concept a vital financial/managerial accounting consideration for entities. This lack of continued vitality might also have been a cause for the NBY changes in TRA86. The authors once again want to highlight the excellent theoretical work on the NBY done by Chatfield. Also, the NBY deserves decent coverage in intermediate and financial accounting texts.

Another example of this overall lack of awareness of the NBY is the relatively complete switch from a proactive to a reactive stance taken by the AICPA, by accountants and by accounting academics. The authors are of the opinion that the AICPA and its Committee on NBY grew too content when about one-half of U.S. corporations were filing on a fiscal year basis by 1958, as reported by Reiss. Perhaps this might explain the eventual dropping of the Committee, which with the NBY Council had achieved a great change in accounting. The authors believe that “proactive” will once again become a word that describes accountants’ behavior towards the NBY concept, as one can observe in the AICPA lobbying for the Omnibus Budget Reconciliation Act of 1987. This may mean the reconstitution of both the AICPA Committee on NBY and the NBY Council. Since the authors were not able to find any organizations with documentation on the internal workings of either the AIA Committee on NBY or the NBY Council, they urge that an oral history effort be made while members of the Committee and the Council may still be available.

REFERENCES

AAPA, Report of Special Committee on Distribution of Work (New York: AAPA,
1915) pp. 3-6. AIA, “A Good Time for Reformation,” Editorial, The Journal of Accountancy,
January 1934, pp. 7-8.
AIA & AICPA, Annual Reports 1916, 1919, 1928-62/63. AIA, “Changes to Natural Fiscal Years,” Editorial, The Journal of Accountancy,
May 1943, pp. 391-2. AIA, “Natural Business Year,” Editorial, The Journal of Accountancy, June 1927,
pp. 450-2. AIA, “Natural Business Year,” Editorial, The Journal of Accountancy, May 1942,
pp. 390-1. AIA, “Natural Business Year Reminder,” Editorial, The Journal of Accountancy,
January 1941, p. 3. AIA, “Natural Versus Calendar Year,” Editorial, The Journal of Accountancy, June
1926, pp. 446-8. AIA, “Opposing an Unnatural Fiscal Year,” Editorial, The Journal of Accountancy,
October, 1924, pp. 280-1. AIA, “The Annual Fever,” Editorial, The Journal of Accountancy, January 1927,
pp. 33-4. Bureau of Business Research, University of Illinois, The Natural Business Year,
Bulletin No. 11, (Urbana: University of Illinois, 1926). Burns, Thomas J. and Edward N. Coffman, The Accounting Hall of Fame: Profiles
of Thirty-Six Members (Columbus, OH: The Ohio State University, 1976). Cady, E. L. “The Business Year Goes Back to Nature,” Purchasing, February,
1941, pp. 65-8. Carey, John L., The Rise of the Accounting Profession: From Technician to
Professional, Vol. 1 (New York: AICPA, 1969). “Change of Accounting Period for Sub-chapter S,” Tax Clinic section, The Journal
of Accountancy, March 1968, pp. 66-7. “Change Limitations,” Tax Briefs section, The Journal of Accountancy, December
1986, p. 104. “Change of Taxable Year May Prove Advantageous,” Tax Clinic section, The
Journal of Accountancy, May 1961, p. 74. Chatfield, Michael, “The Natural Business Year and Accounting Theory,” U.S.
Army Audit Agency Bulletin, September 1964, pp. 11- 23. Cherry, Gladstone, “Fetish of the Calendar as a Fiscal Year,” The Journal of
Accountancy, February 1925, pp. 125-30. Cox, R. Carson, “Another Look at the Natural Business Year,” N.A.C.A. Bulletin,
January 1952, pp. 610-6. Donaldson, William R., “Tax Advantages of the Natural Business Year,” Our
Open Forum section, N.A.C.A. Bulletin, November 1, 1936, pp. 285-6. Fedde, A. S., “Advantages of a Natural Fiscal Year,” The Journal of Accountancy,
June 1933, pp. 439-42. “Fiscal Year Legislation Introduced in Congress,” Washington Update section,
Fogg, Stephen L. and Arie Ovadia, “An Examination of Possible Factors
Influencing the Choice of a Calendar or Non-calendar Fiscal Reporting
Period,” The National Public Accountant, March 1982, pp. 20-3. Gabrielson, C. C, “Here’s Where We Stand on Using the Natural Business Year
to Flatten out Yearly Peaks,” The Journal of Accountancy, July 1950, pp. 34-
5. Hasselback, James R., “How to Change a Tax Year; Permission of the IRS is Not
Always Needed,” Taxation for Accountants, May 1975, pp. 282-8. Holzman, Robert S., “Calendar v. Fiscal Year: Factors to be Considered in
Selecting a Corporate Accounting Period,” Taxes — The Tax Magazine, April
1942, pp. 211-3, 249. “IRS Indicates How, and When, an S Corporation May Report Income Using a
Fiscal Year,” Taxation for Accountants, June 1983, p. 325. Johns, Ralph S., The Natural Business Year, Unpublished Thesis, University of
Illinois, 1926, p. 105. Klanderman, Gerald E., “Changing from Calendar Year to Natural Business
Year,” The Journal of Accountancy, December 1939, pp. 386-92. Kuhn, Harold A., “Better Service to Clients Good Reason for Change to Natural
Business Year,” Letters section, The Journal of Accountancy, April 1953, p.
414. “Meeting of Natural Business Year Council,” The Certified Public Accountant,
October 1937, pp. 23-7. McMahon, Joseph M. and Alfonso V. Arias, Jr., “Should a Corporation Change Its
Tax Year?: An Analysis of Tax and Nontax Considerations,” Taxation for
Accountants, February 1977, pp. 106-110. Mezner, Edward, “Advantages to a Business Which Result from Abandoning a
December 31 Closing Date,” The Journal of Accountancy, November 1950, pp.
392-7. Mitchell, Walter J., “Flexibility of the Natural Business Year,” The Journal of
Accountancy, May 1940, pp. 361-2. Montgomery, Robert H., “The Natural Business Year,” N.A.C.A. Bulletin,
November 15, 1936, pp. 305-23. Newland, D. Alden, “How Can a Client Retain Its Fiscal Year After TRA ’86,” The
Journal of Taxation, December 1987, pp. 382-8. Natural Business Year Committee of the AIA, “Suggested Fiscal Closing Dates
(Revised, 1955),” The Journal of Accountancy, December 1955, pp. 59-60. “Natural Business Year Must Cope with Tax Year Held in Strait Jacket,” The Tax
Clinic section, The Journal of Accountancy, February 1952, p. 214. O’Malley, John T., “Nine Viewpoints on a Natural Fiscal Year,” N.A.C.A. Bulletin,
September 1957, pp. 13-8. “Opportunities and Problems in Partnership Fiscal Year Changes,” Federal
Taxation section, The CPA Journal, August 1973, p. 675, 678. “Perennial Pressure,” Editorial, The Journal of Accountancy, April 1916, p. 281-2. Pinkerton, Paul W., “The Natural Business Year: Its Advantages and
Disadvantages and The Progress made in Obtaining Its Adoption,”
International Congress on Accounting: 1929 (New York: International
Congress on Accounting, 1930), pp. 1056-65. Preinreich, Gabriel A. D., “Taxation and The Natural Business Year,” The
Accounting Review, December 1933, pp. 317-22. Prentice Hall, Federal Taxes: Bulletin 41 Extra, The Tax Reform Act of 1986:
Conference Committee Report, September 20, 1986, Bulletin 41 Extra, pp. II- 317 to II-320.
, Federal Taxes: Technical Corrections Act of 1987 (H.R. 2636 and S.
1350): Description Prepared by the Staff of the Joint Committee on Taxation and Text of IntroducedBill, June 18, 1987, Bulletin 26, pp. 69-71.
, Federal Taxes: General Explanation of the Tax Reform Act of 1986:
“Blue Book” Prepared by the Staff of the Joint Committee on Taxation, May 11, 1987, Bulletin 20 Extra, pp. 533- 9.
Federal Taxes: A Complete Guide to the Tax Reform Act of 1986,
October 18, 1986, pp. 824-6.
, Federal Taxes: Tax Provisions of Omnibus Budget Reconciliation Act of
1987, …, November 2, 1987, Bulletin 45 Second Extra; pp. 1540-45.
, Miscellaneous Revenue Act of 1988: Report of the Committee on Ways
and Means …. August 3, 1988, Bulletin 30 Extra.
_, Federal Taxes: Prentice Hall’s Complete Guide to the Tax Law of
1987. . . , January 7, 1988, Bulletin 1 Second Extra, pp. 20-4, pp. 684-6.
, Federal Taxes: Prentice Hall’s Explanation of the Technical and
Miscellaneous Revenue Act of 1988, November 5, 1988, pp. 66-71. Reiss, Harry, F. Jr., “Trend Continues to Natural Business Year,” News Features
section, The Journal of Accountancy, August 1960, pp. 25-6. Robin, Kenneth L., “IRS Issues Change in Accounting Period Guidelines,”
Federal Taxation section, CPA Journal, October 1985, pp. 70-1. Rosenthal, Arnold B., “More Thought Should Be Given to Establishment of
Natural Business Year,” Technical & Professional Notes section, The Journal
of Accountancy, March 1949, p. 237. “S Corporations and Automatic Change of Year-End,” Federal Taxation section,
CPA Journal, pp. 48-9. Schwab, Frederick J., “Which Fiscal Year to Use: Tax and Nontax Factors that
Must be Considered,” Taxation for Accountants, December 1970, pp. 492-6. Securities and Exchange Commission, Natural Business Year, Accounting Series
Release No. 17, March 18, 1940, as reprinted in The Journal of Accountancy,
May 1940, p. 418. Sells, Elijah Watt, “The Natural Business Year for Inventories and Fiscal
Closings” in The Natural Business Year and Thirteen Other Themes (Chicago
& New York: A. W. Shaw Company, 1924), pp. 3-16. Shenkin, Arthur F., “Timely Election of Fiscal Year,” Tax Clinic section, The
Journal of Accountancy, September 1966, pp. 77-8. “Tax Motives Do Not Justify Change in Taxable Year,” Taxation for Accountants,
March 1976, p. 145. “Testimony of Expert Witnesses at S.E.C. Hearings,” The Journal of Accountancy,
June 1939, pp. 350-63. U.S. Senate, Tax Reform Act of 1986: Report of the Committee on Finance United
States Senate To Accompany H.R. 3838. . . (Washington: U.S.G.P.O., 1986),
pp. 163-7. Weiner, Alan E., “The ’87 Revenue Act’s Option to Retain a Fiscal Year: Making
the Decision,” The Practical Accountant, March 1988, pp. 43-59. Zimmerman, Vernon K., Written Contributions of Selected Accounting
Practitioners: Volume 1: Ralph S. Johns (Urbana Champaign, IL: Center for
International Education and Research in Accounting, 1976).