1.Adams calculates costs under three alternative policies: (1) negotiate with the Barbary States; (2) wage war against the Barbary States; and (3) do nothing.Under the first two scenarios, his cost calculation represents projected cash outflows for the U.S. government.The "do nothing" scenario, however, includes some "costs" that would require no cash outlay by either the government or its citizens.What is the relevance of this third cost calculation, and what is the relationship of the cost of "doing nothing" to the other two costs calculated by Adams?

2.How does Jefferson derive the amount of 22,500 pounds sterling per annum, and what does he mean by the statement: "we have a right to say that only 22,500 pounds . . . should be charged to the Algerine War"?

3.Evaluate Jefferson's reasoning in his 1822 letter.Do you agree with his logic?This letter does not specifically identify the cost of building the fleet, but it does compare the construction cost to the cost of maintaining the fleet.If the U.S. had taken Jefferson's advice, and burned its fleet in 1822, the cost to build a new one might have differed from the cost of building the original fleet.What is the relevance of each of these costs in the decision of whether to burn the fleet?

4.Calculate the annual cost of fighting the pirates, based on the information Jefferson provides, using the accounting technique of asset capitalization and depreciation.First calculate the annual depreciation expense of the fleet by capitalizing the cost of construction, and depreciating this cost over the useful life of the ships.(Ignore the possibility that the pirates might sink any ships.)Then add to the depreciation expense the annual operating costs.

5.Adams advocates negotiating with the Barbary States, and Jefferson argues in favor of fighting them.In comparing Adams' letter to Jefferson's 1786 letter, where do these men agree, and where do they disagree?How does each man present cost data in a way that supports his position?Your analysis should distinguish between differences in underlying cost assumptions, and differences in the types of costs that each man proposes are relevant.Do you consider either man more "correct" in his analysis?

6.A complete cost-benefit analysis of the alternative courses of action for responding to the pirates requires a consideration of non-monetary factors.What non-monetary factors can you identify that you think Adams and Jefferson should consider in weighing the pros and cons of fighting the pirates?

John Adams, Thomas Jefferson, and the Barbary Pirates: An Illustration of Relevant Costs for Decision-Making Dennis Caplan Iowa State University Most Recent Update: August 7, 2002 Please address correspondence to Dennis Caplan Assistant Professor of Accounting College of Business Iowa State University 396 Carver Hall Ames, IA 50011 (515) 294-2839 dcaplan@iastate.edu I would like to thank Sue Ravenscroft for helpful comments, and Adam Bormann for his very capable research assistance. I would also like to acknowledge my former colleagues at Columbia University's Graduate School of Business, especially Nahum Melumad and Amir Ziv, for providing me considerable latitude in experimenting with the content and delivery of the core management accounting course at Columbia. John Adams, Thomas Jefferson, and the Barbary Pirates: An Illustration of Relevant Costs for Decision-Making ABSTRACT The concepts of incremental cost, opportunity cost, sunk cost, and cost allocation are identified and discussed in the context of early U.S. foreign policy. The case is derived from an authentic exchange of views between Thomas Jefferson and John Adams on how the United States should protect its merchant shipping against the Barbary Pirates. Both men compare the cost of waging war against the pirates with the cost of paying ransom for captured U.S. seamen and bribes to protect future shipping. Adams quantifies the opportunity cost associated with not taking any action against the pirates. Jefferson articulates an incremental costing argument, on the assumption that the U.S. should build a navy regardless of U.S. policy towards the Barbary States. The case constitutes a brief introduction to management accounting by illustrating different cost concepts, and also lends itself to a discussion of the historical origins of management accounting. 2 The beginning of wisdom in using accounting for decision-making is a clear understanding that the relevant costs and revenues are those which as between the alternatives being considered are expected to be different in the future. It has taken accountants a long time to grasp this essential point. R. H. Parker (1969, 15) BACKGROUND The Barbary Pirates Throughout the 17th and 18th centuries, the North African Barbary States of Morocco, Algiers, Tunis and Tripoli engaged in piracy of European merchant shipping. The Barbary pirates routinely captured and confiscated ships and cargo, and enslaved or ransomed their crews and passengers. England, France and Spain entered into treaties with the Barbary States, in effect, paying \"protection money\" for their merchant shipping. These powerful European nations preferred bribery to war, because they perceived an economic benefit from the threat the pirates posed to the merchant shipping of other European nations. Until the Revolutionary War, merchant ships from the American Colonies were protected by the British Royal Navy and by the treaties between England and the Barbary States. American shipping lost this protection in 1783, and within the next two years three American ships were captured, one by Morocco and two by Algiers. Morocco soon freed the American crew in exchange for a ransom of 5,000 pounds sterling (about $25,000).1 The crews held by the Algerians were captive throughout 1786 and for some time thereafter. 3 Historical Background The capture of American ships by the Barbary pirates created an early and important foreign policy crisis for the United States. The U.S. response to the Barbary crisis was strongly influenced by two factors, one military and the other financial. The military consideration was that the U.S. had no navy. The Continental Navy of the Revolutionary War was disbanded in 1784, and the navy was not reestablished until 1798. During the intervening years, the United States had minimal naval power. Disbanding the Continental Navy was primarily a cost-savings measure. However, there were also important non-financial arguments for and against the navy. Some Americans who favored reestablishing close ties with England feared that the presence of a U.S. navy on the high seas would lead to confrontations with the British Navy. Other Americans, including John Adams, viewed a strong navy as the best national defense against foreign threats. Many Americans preferred the prospect of building a navy over an army due to their general distrust of standing armiesthe result of their experience with the British occupation in America during the latter part of the Colonial Era. The financial factor that influenced the U.S. response to the Barbary pirates was that any effective response would require a significant expense relative to the government's available funds. The U.S. government found itself in a precarious financial condition in the years immediately following the Revolutionary War. The Continental Congress and individual states borrowed over $40 million to finance the war, including about $6 million from France. From 1781 to 1788, the period during which the United States operated under the Articles of Confederation, the federal government did not have the power to tax its citizens, levy tariffs, or regulate commerce. The cost of operating the government during this time was about $500,000 annually, not including funding the debt (Hicks et al. 1970, 103). Some income was generated by the post office and from sales of public lands, but the two principal revenue sources available to the government were 4 requesting support from the states and issuing paper money. State contributions to the federal government constituted only a small fraction of what was needed, and issuing paper money was an inflationary measure that had already been used extensively during the Revolutionary War. The financial plight of the new nation was sufficiently acute that during this period, the government borrowed from foreign sources just to meet the interest obligations on existing foreign debt. The ratification of the Constitution in 1788 greatly enhanced the powers of the Federal government, and allowed the new Congress to levy and collect duties and taxes. However, the ability of the new government to actually enact and enforce revenuegenerating measures was untested, and evolved over time. In 1786, during the Confederation period, and again in 1794, during Washington's presidency, popular opposition to taxation led to civil unrest. The first incident, Shays' Rebellion, arose in Massachusetts when the State Legislature levied taxes to pay off the war debt. The second incident, the Whiskey Rebellion, occurred in Western Pennsylvania when the federal government imposed an excise tax on distilled liquor. Also, although the Federal government had more potential resources under the Constitution than under the Articles of Confederation, it soon had more obligations. In 1790, under a plan advanced by Secretary of the Treasury Alexander Hamilton, the federal government assumed the remaining war debts that were owed by the individual states. However, despite financial tribulations at both the state and federal levels, economic conditions in the United States during this period were generally good. A short recession that occurred after the Revolutionary War was followed by a period of economic growth. The strong economy led to increased federal revenues, and that fact, combined with the success of American leaders in keeping the nation out of the growing conflict between England and France, enabled the government to become current on its obligations under the national debt during Jefferson's administration. 5 The Adams-Jefferson Correspondence In 1786, John Adams was the leading U.S. diplomat in London, and Thomas Jefferson was the U.S. ambassador to France. A few years earlier, in 1784, the Continental Congress had authorized Adams and Jefferson to negotiate treaties with the Barbary States (Kitzen 1993, 10). Consequently, the responsibility to negotiate the release of the captured American seamen, and to establish U.S. foreign policy that would protect U.S. shipping in the Mediterranean, fell largely to these two men. Against this backdrop, Adams sent Jefferson a letter that included the following analysis: Adams to Jefferson Grosvenor Square, June 6, 1786 Dear Sir ... The first Question is, what will it cost us to make Peace with all five [Barbary States]? Set it if you will at five hundred Thousand Pounds Sterling, tho I doubt not it might be done for Three or perhaps for two. The Second Question is, what Damage shall we suffer, if we do not treat. Compute Six or Eight Per Cent Insurance upon all your Exports, and Imports. Compute the total Loss of all the Mediterranean and Levant Trade. Compute the Loss of half your Trade to Portugal and Spain. These computations will amount to more than half a Million sterling a year. The third Question is what will it cost to fight them? I answer, at least half a Million sterling a year without protecting your Trade, and when you leave off fighting you must pay as much Money as it would cost you now for Peace. The Interest of half a Million Sterling is, even at Six Per Cent, Thirty Thousand Guineas a year. For an Annual Interest of 30,000 pounds sterling then and perhaps for 15,000 or 10,000, we can have Peace, when a War would sink us annually ten times as much. (Cappon 1959, 133-134) In the last paragraph of the excerpt, Adams states interest expense in terms of guineas. A guinea was worth about one pound sterling. Jefferson responded to Adams a few weeks later: 6 Jefferson to Adams Paris, July 11, 1786 Dear Sir ... I ask a fleet of 150 guns, the one half of which shall be in constant cruise. This fleet built ... will cost 450,000 pounds sterling. It's annual expence is 300 pounds sterling a gun, including every thing: this will be 45,000 pounds sterling a year. ... Were we to charge all this to the Algerine war it would amount to little more than we must pay if we buy peace. But as it is proper and necessary that we should establish a small marine force (even were we to buy a peace from the Algerines,) and as that force laid up in our dockyards would cost us half as much annually as if kept in order for service, we have a right to say that only 22,500 pounds sterling per annum should be charged to the Algerine war. (Cappon 1959, 142-143) Adams and Jefferson exchanged numerous letters in old age, after both men had retired from public life. One of these letters is relevant to the current discussion, because it reveals Jefferson's attitude towards the Navy, and more specifically, his assessment of the economic life of a ship: Jefferson to Adams Monticello, Nov 1, 1822 Dear Sir ... Yet a navy is a very expensive engine. It is admitted that in 10 or 12 years, a vessel goes to entire decay; or, if kept in repair costs as much as would build a new one. And that a nation who could count on 12 or 15 years of peace would gain by burning it's navy and building a new one in time. (Cappon 1959, 584585) Case Questions 1. Adams calculates costs under three alternative policies: (1) negotiate with the Barbary States; (2) wage war against the Barbary States; and (3) do nothing. Under the first two scenarios, his cost calculation represents projected cash outflows for the U.S. government. The \"do nothing\" scenario, however, includes 7 some \"costs\" that would require no cash outlay by either the government or its citizens. What is the relevance of this third cost calculation, and what is the relationship of the cost of \"doing nothing\" to the other two costs calculated by Adams? 2. How does Jefferson derive the amount of 22,500 pounds sterling per annum, and what does he mean by the statement: \"we have a right to say that only 22,500 pounds . . . should be charged to the Algerine War\"? 3. Evaluate Jefferson's reasoning in his 1822 letter. Do you agree with his logic? This letter does not specifically identify the cost of building the fleet, but it does compare the construction cost to the cost of maintaining the fleet. If the U.S. had taken Jefferson's advice, and burned its fleet in 1822, the cost to build a new one might have differed from the cost of building the original fleet. What is the relevance of each of these costs in the decision of whether to burn the fleet? 4. Calculate the annual cost of fighting the pirates, based on the information Jefferson provides, using the accounting technique of asset capitalization and depreciation. First calculate the annual depreciation expense of the fleet by capitalizing the cost of construction, and depreciating this cost over the useful life of the ships. (Ignore the possibility that the pirates might sink any ships.) Then add to the depreciation expense the annual operating costs. 5. Adams advocates negotiating with the Barbary States, and Jefferson argues in favor of fighting them. In comparing Adams' letter to Jefferson's 1786 letter, where do these men agree, and where do they disagree? How does each man present cost data in a way that supports his position? Your analysis should distinguish between differences in underlying cost assumptions, and differences in the types of costs that each man proposes are relevant. Do you consider either man more \"correct\" in his analysis? 8 6. A complete cost-benefit analysis of the alternative courses of action for responding to the pirates requires a consideration of non-monetary factors. What non-monetary factors can you identify that you think Adams and Jefferson should consider in weighing the pros and cons of fighting the pirates? Epilogue Negotiations between the United States and the Barbary States continued for fifteen years. Jefferson was involved in these negotiations, first as ambassador to France and then as Secretary of State, until his temporary retirement in 1794. At times, tensions between the U.S. and the Barbary States ran high. Additional U.S. ships and crews were captured in the early 1790's. In 1794, Congress authorized the construction of six ships the birth of the U.S. Navyin anticipation of fighting the pirates (Allen 1965, 48-50). Construction proceeded slowly, however, and negotiations again gained the upper hand. Diplomatic efforts ultimately failed and, during Jefferson's administration, the U.S. waged a successful naval campaign against the Barbary pirates called the Tripolitan War (from which are derived the words of the Marines' Hymn \"to the Shores of Tripoli.\"). 9