UNIVERSITY OF CALIFORNIA 
 AT LOS ANGELES 
 
 GIFT OF 
 
 MRS. GEORGE II. U M CES
 
 29 
 
 Library 
 
 Graduate Sch~ol of Business Administration 
 
 Uni -^rsity of California 
 
 Los Angeles 24, California
 
 NET WORTH AND THE 
 BALANCE SHEET
 
 Net Worth and the 
 Balance Sheet 
 
 By 
 HERBERT G. STOCKWELL, C.P.A. 
 
 New York 
 
 The Ronald Press Company 
 1912
 
 Copyright, 1911 
 
 By 
 THE RONALD PRESS CO.
 
 Bus. Admin. 
 Library 
 
 EXPLANATION OF THE BOOK 
 
 C HREWD business men take pains to learn 
 
 enough about the accounts on their books 
 
 ;* to know where they stand at any time and 
 
 * whether the business is going forward or 
 
 backward, and why. 
 
 To such men the knowledge of the vital 
 facts of the business, as shown in their books, 
 provides means by which complete mastery 
 of the business may be obtained. 
 
 But these shrewd men are few in number 
 compared with the many who do not take 
 ^ the trouble to solve the meaning of the ac- 
 counts in which the history of the business 
 N^ is being recorded. 
 
 Such men, finding the study of facts ex- 
 | pressed in figures unattractive, too often 
 R leave the matter of bookkeeping entirely to 
 j>J:heir clerks, easily yielding to the difficulty 
 of obtaining the correct interpretation of 
 their accounts. 
 
 5
 
 6 Net Worth and the Balance Sheet 
 
 In many other cases the proprietors, with 
 little or no bookkeeping knowledge, yet 
 dimly seeing the advantages to be gained by 
 greater knowledge, continually struggle in 
 unavailing efforts to comprehend the figures 
 presented to them by their bookkeepers. 
 
 Whether the failure to grasp the impor- 
 tant facts of a business results from insuffi- 
 cient attempts on the part of the proprietor 
 or follows earnest efforts, ignorance of the 
 true financial conditions has been the cause 
 of many bankruptcies which might have been 
 avoided had impending danger been known 
 in time. 
 
 If there is one business law of more im- 
 portance than any other, it surely rests in 
 the common-sense principle that a business 
 man should know at all times where his busi- 
 ness stands in relation to his creditors, and 
 to his partners or shareholders. Within 
 reasonable approximation he should know his 
 "net worth." 
 
 In order fully to comprehend all that is 
 involved in his net worth, he must acquire 
 at least sufficient knowledge of the expres-
 
 Explanation of the Book 7 
 
 sion of business facts in figures to enable 
 him to read and understand the meaning of 
 his balance sheet, or statement of assets and 
 liabilities. 
 
 In obtaining this knowledge he will find 
 that, as his stock of accounting information 
 increases, along with each new comprehen- 
 sion will come a growing strength and ability 
 to grasp each business condition as it arises. 
 Besides the additional control over his own 
 business, obtained in the study of his ac- 
 counts, he will gain the power of analyzing 
 the balance sheets of other concerns in whose 
 financial condition he may, for one or more 
 of many reasons, be interested. 
 
 Few indeed are the concerns engaged in 
 banking, manufacturing, or trading to whom 
 credit for money or merchandise is not 
 granted, or who do not grant credit to others 
 upon signed statements or mercantile reports. 
 Moreover, the investor in the bonds or 
 stocks of corporations would be less depen- 
 dent upon quotations, rumors, or advice of 
 friends if he could himself understand the 
 balance sheets of the corporations whose
 
 8 Net Worth and the Balance Sheet 
 
 stocks and bonds are offered to him for in- 
 vestment. 
 
 Thus it appears that all men of indepen- 
 dent means as well as those in business 
 would find advantages in the possession of a 
 moderate amount of bookkeeping knowledge, 
 sufficient, at least, to enable them to under- 
 stand the accounts representing assets and 
 liabilities on a balance sheet, and the net 
 worth produced by the proper assembling of 
 those accounts. 
 
 The present work is intended to be of as- 
 sistance to all those whose duty or interest 
 compels either the preparation or inspection 
 of balance sheets of merchants or manu- 
 facturers. It endeavors to explain the na- 
 ture of the items involved, to point out what 
 the balance sheet does or should show; and 
 to furnish such information as will enable 
 those seeking further knowledge of the con- 
 dition of any concern than is shown by its 
 balance sheet to frame intelligent inquiries 
 of the management, tending to bring out the 
 information desired. 
 
 The present volume, as intimated, is con-
 
 Explanation of the Book 9 
 
 fined almost entirely to the ordinary balance 
 sheet of the merchant and manufacturer. To 
 interpret the business conditions shown by 
 the balance sheets of steam and electric rail- 
 road corporations, electric light and power 
 corporations, water and gas companies, and, 
 last but not by any means least, national, 
 state, and municipal governments, would re- 
 quire much more elaboration than can be 
 brought within the limits of the present work. 
 The wide and interesting field of accounting 
 methods involved when business and finan- 
 cial facts of these balance sheets are ex- 
 pressed in figures, will well repay investiga- 
 tion and may be the subject of a second 
 volume. 
 
 The definitions appearing in italics have 
 been framed in an effort to simplify some of 
 the terms commonly used by business men, 
 bookkeepers, and accountants. 
 
 H. G. S.
 
 CONTENTS 
 
 CHAPTER PAGE 
 
 I. Net Worth 13 
 
 II. Balance Sheets 17 
 
 III. Cash 23 
 
 IV. Notes Receivable 31 
 
 V. Notes Receivable (continued) . . 39 
 
 VI. Accounts Receivable 48 
 
 VII. Accounts Receivable (continued) . 56 
 
 VIII. Merchandise 62 
 
 IX. Finished Product 72 
 
 X. Partly Finished Product .... 78 
 
 XL Raw Materials and Supplies ... 83 
 
 XII. Real Estate 87 
 
 XIII. Machinery Fixtures 9l 
 
 XIV. Furniture and Fixtures .... 96 
 XV. Other Assets 98 
 
 XVI. Other Assets (continued) . . .107 
 
 XVII. Notes Payable 116 
 
 XVIII. Accounts Payable 120 
 
 XIX. Deposits 124 
 
 XX. Bonded Debt 127 
 
 XXI. Mortgages 130 
 
 11
 
 12 Contents 
 
 CHAPTER PAGE 
 
 XXII. Other Liabilities 134 
 
 XXIII. Capital and Capital Stock . . . .138 
 
 XXIV. Surplus Profits 147 
 
 XXV. Reserves 157 
 
 XXVI. Reserves (continued) . . . . .163 
 XXVII. Contingent Liabilities . . . .172 
 XXVIII. Analysis of Balance Sheet . . .178 
 XXIX. Comparison of Successive Balance 
 
 Sheets , 182
 
 Net Worth and the Balance 
 Sheet 
 
 CHAPTER I 
 NET WORTH 
 
 jpHE net worth of any business enterprise 
 consists of the excess of the amount of 
 its assets over its liabilities. 
 
 For example: 
 
 Total Assets $500,000.00 
 
 Total Liabilities 250,000.00 
 
 Net Worth $250,000.00 
 
 In a statement of assets and liabilities the 
 resulting balance is called net worth on the 
 theory that if all of the assets of the business 
 were sold for cash, and all of the debts were 
 paid out of that cash, the amount remaining 
 would constitute the real capital of the own- 
 ers of the liquidated business. 
 
 13
 
 14 Net Worth and the Balance Sheet 
 
 In other words, while a business man owns 
 numerous assets in various forms, many of 
 those assets may, and generally do, consist 
 of articles of commerce which he has pur- 
 chased, but for which at the time the state- 
 ment is prepared he has not yet paid. There- 
 fore, in order to ascertain how much of the 
 cash and other assets in various forms really 
 belong to him, he prepares a statement show- 
 ing all assets in his possession and all lia- 
 bilities for unpaid obligations. The balance, 
 produced by subtracting the sum total of all 
 of the liabilities from the assets, represents 
 what he may call the amount of his own 
 wealth or worth. 
 
 Since all assets constitute wealth, or worth, 
 we might, from one point of view, say that a 
 man is worth as much as the total value of all 
 of the lawfully acquired assets in his pos- 
 session, and this without regard to his lia- 
 bility to pay for such portion of those assets 
 as were purchased on credit. 
 
 But this aspect of wealth or worth does 
 not take into consideration the business 
 man's relation to those from whom he has
 
 Net Worth 15 
 
 purchased or borrowed wealth, so in business 
 statements we do not rest satisfied with in- 
 formation concerning the gross wealth or 
 worth. We deduct from the amount thereof 
 the total of his debts and thus ascertain his 
 net worth. 
 
 This process is referred to as producing 
 theoretical results, because as a matter of 
 practice no business is, or can be, liquidated 
 and wound up with a resulting cash balance 
 in hand exactly equalling the amount of the 
 net worth shown in a balance sheet prepared 
 prior thereto. 
 
 Valuation of Assets 
 
 With even the greatest amount of care and 
 expert appraisement of assets, it is impos- 
 sible to fix absolutely in advance of an actual 
 sale the cash value of such assets as mer- 
 chandise, machinery, or buildings. Until the 
 exchange of such assets for cash has actually 
 taken place, all calculations of value are but 
 expressions of opinion, more or less accurate, 
 according to the ability of the appraiser and 
 his experience with what has happened in the
 
 16 Net Worth and the Balance Sheet 
 
 past, on which he bases his judgment as to 
 future happenings. 
 
 It will thus be seen how important it is 
 that very careful estimates be made of all 
 assets in the balance sheet. Unless the esti- 
 mates are approximately correct, being 
 neither very much too high nor too low, the 
 business man may be deceived as to his real 
 financial position. 
 
 Moreover, a record of his progress and in- 
 crease in business is clearly indicated by the 
 increase in the amount of the net worth 
 shown on his balance sheet at the end of any 
 given period, as compared with the amount 
 shown on a similar statement prepared at 
 the beginning of that period, due considera- 
 tion being given to cash withdrawn from the 
 business between closing periods in the form 
 of profits. Thus the calculations of values 
 become the more important to the extent that 
 errors in under- or over-estimating his assets 
 at the beginning or ending of a given period 
 may create notions of his prosperity or pov- 
 erty not existing in fact.
 
 CHAPTER II 
 BALANCE SHEETS 
 
 V\7"HILE a balance sheet of a merchant or 
 manufacturer should represent his 
 true financial condition, some of the accounts 
 contained in the ledger from which the bal- 
 ance sheet has been prepared may undergo 
 considerable change and adjustment before 
 the assets represented by the accounts are 
 transformed into cash or its equivalent. 
 
 A clear example is furnished in the aggre- 
 gate of customers' debit balances, ordinarily 
 styled "Accounts Receivable." Some of 
 these debit balances may have been created 
 by charges for merchandise ordered, shipped, 
 and billed in the regular course of business, 
 and yet the goods may not be accepted at 
 billed value. Claims for errors or for dam- 
 aged or under-graded goods may be set up 
 before the account has been rendered to and 
 accepted by the customer. Furthermore, the 
 customer may fail to settle the account. 
 
 17
 
 18 Net Worth and the Balance Sheet 
 
 For these and other reasons, it is clear 
 that such accounts do not represent assets 
 in the same way as do accounts representing 
 the merchandise itself before it is sold. Un- 
 less sold for actual cash, the merchandise 
 asset is first exchanged for a claim against 
 the purchaser, to be again converted into a 
 cash asset, when he finally pays for the mer- 
 chandise. 
 
 If we keep fixed in our minds the fact that 
 some ledger accounts represent claims in 
 various stages of liquidation, as well as 
 actual assets, it should be possible to so dis- 
 tinguish these that an understanding of the 
 various items in a balance sheet will present 
 fewer difficulties. 
 
 Form of Balance Sheet 
 
 The following is an ordinary form of bal- 
 ance sheet, such as is recommended by the 
 American Bankers' Association to its mem- 
 bers for use in obtaining statements of the 
 financial condition of those applying for 
 loans at their banks. 
 
 In this statement form the assets and lia-
 
 Balance Sheets 19 
 
 bilities are shown in two columns the assets 
 in the column to the left and the liabilities 
 in the column to the right the total of the 
 items in the asset column and in the liability 
 column being equal each to the other. This 
 form is used largely by bookkeepers and ac- 
 countants in preparing written balance sheets 
 on regular ledger paper. It frequently hap- 
 pens, however, that when the balance sheet is 
 to be shown on the printed page there is 
 not sufficient room for this form, and what 
 is known as the report form is adopted. In 
 this the assets appear in one group or set 
 of figures, over the second grouping or set of 
 figures which represent the liabilities. This, 
 of course, is a mere matter of form ; the par- 
 ticular way in which a balance sheet is stated 
 being immaterial so long as all of the facts 
 are truthfully represented. 
 
 Among English accountants it is the prac- 
 tice to reverse the form usually found in this 
 country, the liabilities appearing in the col- 
 umn to the left and the assets in the column 
 to the right. This arrangement is based 
 upon the idea that the management charges
 
 20 Net Worth and the Balance Sheet 
 
 itself with all of its liabilities and credits 
 itself with its assets, while in this country 
 the balance sheet is thought of as a list of 
 debit and credit balances just as they are 
 found on the ledger, and as the debit balances 
 are shown on the ledger in a column to the 
 left, and the credit balances in a column to 
 the right, the same order is preserved in the 
 preparation of the balance sheet. 
 
 SCARBOROUGH MANU 
 
 Balance Sheet, 
 Assets 
 
 Cash $26,843 .90 
 
 Bills Receivable (net) 7,752.84 
 
 Accounts Receivable (net). 111,172.08 
 
 Merchandise 224,323.82 
 
 Land 50,000 . oo 
 
 Buildings 189,934.93 
 
 Machinery Fixtures 134,266.25 
 
 Reserve Fund Investments. 22,626.79 
 
 Other Investments 17,428.72 
 
 Miscellaneous ... $900.00 
 120.85 
 
 1,020.85 
 
 Total Assets $785,370. 18
 
 Balance Sheets 21 
 
 In order that the balance sheet recom- 
 mended by the American Bankers' Associa- 
 tion may be used by many different classes 
 of concerns, it is necessarily very general and 
 condensed. Only such accounts appear as 
 constitute the main or chief accounts of the 
 average concern, although many other ac- 
 counts with different names may also be 
 found on its books. The filled-in figures are 
 
 FACTORING COMPANY 
 
 December 31, 1911 
 
 Liabilities 
 
 Notes Payable $70,000.00 
 
 Accounts Payable 15,312.92 
 
 Deposits 3,026.67 
 
 Bonded Debt 100,000.00 
 
 Mortgages 5,000.00 
 
 Accrued Liabilities 1,177.09 
 
 Total Liabilities... $194,516.68 
 
 Capital 400,000 . oo 
 
 Surplus Profits 82,436. 50 
 
 Reserves 108,417.00 
 
 Total $785,370.18
 
 22 Net Worth and the Balance Sheet 
 
 taken from a typical case, the name at the 
 head of the balance sheet, of course, being 
 fictitious. In the blank official form the 
 names of the accounts are printed down the 
 asset side to and including "Machinery and 
 Fixtures." Below that are several blank 
 lines in which for the purposes of the pres- 
 ent consideration the accounts "Reserve 
 Fund," etc., have been inserted. The liability 
 side is given here as printed in the official 
 form. 
 
 The statement as presented is in the form 
 of a corporate balance sheet. The few differ- 
 ences between a statement of the net worth 
 of a partnership and that of a corporation 
 will be explained in later chapters. 
 
 In the chapters which follow, each item 
 shown on the statement of the Scarborough 
 Manufacturing Company is taken up in 
 order, and the nature of the debits and cred- 
 its which produce the balances set out against 
 the named accounts is considered.
 
 CHAPTER III 
 
 CASH 
 
 TV/T OST of us are fairly well informed as 
 to the paper currency and the gold, 
 silver, and copper coins received and paid in 
 the ordinary course of small tradings. The 
 balance of cash in one's pockets is the result, 
 so far as the handling of actual cash is con- 
 cerned, of all one's previous cash transac- 
 tions. Many of our personal instalments of 
 income are received in the form of checks 
 and coupons, as well as actual cash. The sur- 
 plus over and above the amount needed for 
 pocket expenditures is deposited in a bank- 
 ing institution of some kind. 
 
 So it is with a business concern. The cash 
 balance, as shown on the Cash Book, is the 
 difference between the receipts from all 
 sources on the one, or debit, side of the book 
 and the payments on the other, or credit, side. 
 The balance between the receipts and pay- 
 ments is the exact amount by which the re- 
 
 23
 
 24 Net Worth and the Balance Sheet 
 
 ceipts have exceeded the payments, and cash 
 should be found in the possession of the con- 
 cern to an amount equal thereto. 
 
 As a rule, a business man keeps little actual 
 currency and coin in his office or store. Checks, 
 money orders, and every other form of bank- 
 able funds received during the course of the 
 business day, and all actual cash, excepting 
 such as is needed for current expenses, are 
 deposited in his bank. 
 
 In the example given, the cash of the 
 Scarborough Manufacturing Company was 
 divided as follows : 
 
 Cash in Bank (deposits) $23,098.73 
 
 Cash on Hand (petty cash fund) .... 500.00 
 
 Cash in Hands of Branch Managers 3,245.17 
 
 Total $26,843.90 
 
 Cash in Bank 
 
 Cash in Bank means undrawn deposits in 
 solvent banks, trust companies, with bankers, 
 or in other depositories, payable by check 
 upon demand. 
 
 It is difficult to frame a concise definition 
 completely describing this asset. It would
 
 Cash 25 
 
 appear unnecessary to insist that the amount 
 said to be in bank must consist of the amount 
 deposited, less all checks issued against it. 
 With few exceptions, business men, book- 
 keepers, and cashiers understand and adhere 
 to this principle, but in some few cases busi- 
 ness men, in order to present favorable state- 
 ments, affect to think that the actual amount 
 standing to their credit on the books of the 
 bank is the amount which they may consider 
 as in bank, disregarding those checks which 
 have been drawn and issued and sent to such 
 distant points that in the ordinary course of 
 events several days must intervene before 
 they can return and be presented to the bank. 
 In one recent case of bankruptcy the treas- 
 urer of the corporation concerned had habit- 
 ually drawn and issued checks to an amount 
 greater than the balance to the credit of the 
 company in his bank, depending upon his 
 ability to collect funds and deposit them be- 
 fore the outstanding checks could be pre- 
 sented to the bank for payment. In other 
 words, his bank account, according to his 
 own check book, was continuously over-
 
 26 Net Worth and the Balance Sheet 
 
 drawn, while on the bank's books the com- 
 pany apparently always had a balance to its 
 credit. At least, it always had such an ap- 
 parent balance until one day the treasurer 
 was unable to provide the funds necessary 
 to meet the incoming checks, and a bank- 
 ruptcy was brought on which might have 
 been avoided by stricter accounting and more 
 businesslike methods. 
 
 It is much safer, and more honest, for a 
 business man to consider that his bank bal- 
 ance has immediately been reduced by the 
 amount of the checks issued, regardless of 
 the time which may elapse before the checks 
 are actually presented at his bank and de- 
 ducted from his credit balance. 
 
 "Cash in Bank" usually includes deposits 
 payable upon check or "order only after prior 
 notice" of such intention, according to con- 
 ditions under which the deposits were made, 
 but if the amount is large and not available 
 upon reasonably short notice, it would be 
 better to set out the amount of such funds 
 separately from the current checking ac- 
 counts.
 
 Cash 27 
 
 For instance, a manufacturer may have 
 $100,000 cash balance on which he is draw- 
 ing no interest ; he may find that $50,000 is 
 all that he needs for current working capital. 
 In such case he may have the remaining 
 $50,000 transferred temporarily to another 
 account in the bank on which interest may 
 be paid to him, and the amount of this deposit 
 be shown in a demand or time certificate of 
 deposit. As a general rule, certificates of 
 deposit, whether demand or time, are payable 
 on demand. The time element merely defines 
 the period during which the money must be 
 left in order to draw interest. There may, 
 of course, be other deposits the withdrawal 
 of which must be preceded by notice, as, for 
 example, in savings banks, where with- 
 drawals may be made only upon order with 
 a previous notice of such intention declared 
 a week, two weeks, or thirty days in advance. 
 
 Frequently checks, drafts, and other nego- 
 tiable instruments payable at distant places 
 are received by the banks as deposits and 
 credited at once to depositors, if in good 
 standing with the bank, it being understood
 
 28 Net Worth and the Balance Sheet 
 
 that these depositors will not draw against 
 the uncollected credits. Strict banking prac- 
 tice calls for the withholding of credits for 
 such instruments until collection is effected. 
 In a financial statement, if the amount of 
 such uncollected instruments is large, it 
 should not be included in "Cash in Bank," 
 but should be described as "Checks, Drafts, 
 etc., for Collection," and entered on the state- 
 ment as a separate item. 
 
 Cash on Hand 
 
 Cash on Hand means ready money in 
 drawer or safe, in office or store, in branches 
 or agencies; currency, coin, legal tender, or 
 bank notes; also checks cashable on demand, 
 money orders, or other instruments received 
 as money, which in the ordinary course of 
 business will be received by the bank as a 
 cash deposit. 
 
 It does not include promises to pay money 
 in the future, due bills, past due checks or 
 checks dated ahead, promissory notes or 
 memoranda of money loaned or advanced 
 for any purpose. Such items, if of value,
 
 Cash 29 
 
 should be stated under "Other Assets," and 
 listed separately, if important: but if insig- 
 nificant, included under the heading "Mis- 
 cellaneous." 
 
 Actual cash in the possession of branch 
 offices or stores may be included, but un- 
 settled accounts of cash in the hands of 
 agents or representatives to be accounted for 
 when expended should not be included as 
 "Cash on Hand." 
 
 Petty Cash and Imprest Fund 
 
 Ordinarily in a manufacturing business 
 very little actual cash is required. Such as is 
 needed for petty expenses which cannot con- 
 veniently be settled by checks is provided for 
 by means of the Petty Cash fund kept in a 
 desk drawer or safe. 
 
 Some concerns are accustomed to withhold 
 from the deposits of the day, for petty cash 
 purposes, a part or the whole of the currency 
 and coin received a practice not to be com- 
 mended while other concerns deposit in 
 bank all cash in whatever form it is received. 
 
 Those who deposit every penny of cash in
 
 30 Net Worth and the Balance Sheet 
 
 bank provide for petty cash needs by means 
 of checks drawn on their bank accounts, and 
 cashed. In such cases it is quite a common 
 practice to charge on the ledger, through the 
 cash book, the cash from the first check 
 to Petty Cash account under a system known 
 as an Imprest Fund, where the amount re- 
 mains as a fixed fund. The amount of this 
 fund is maintained thereafter by means of 
 subsequent checks to equal the total of the 
 depletions of the fund for expenses; the 
 amounts expended being periodically charged 
 to the proper accounts through the cash book. 
 At any given time the amount on the ledger 
 will be represented by actual cash and petty 
 cash vouchers.
 
 CHAPTER IV 
 NOTES RECEIVABLE 
 
 'HE term "Notes Receivable" means ne- 
 gotiable promissory notes or accepted 
 drafts received from customers in settlement 
 for goods sold, not discounted, transferred or 
 assigned. 
 
 Many people use the term "Bills Receiv- 
 able," meaning the same thing as "Notes Re- 
 ceivable," but as some of these confuse 
 "Bills" meaning promissory notes received 
 with bills for merchandise purchased, the 
 distinction is better preserved in the use of 
 "Notes Receivable." 
 
 When a merchant or manufacturer sells 
 goods to his customers, as a rule he expects 
 to be paid within a certain time, fixed accord- 
 ing to the terms of the particular sales or the 
 general custom prevailing in his line of 
 business. 
 
 Sometimes promissory notes are offered by 
 the customer, either before or after payment 
 
 31
 
 32 Net Worth and the Balance Sheet 
 
 is due by him for the goods purchased. If 
 the promissory notes are accepted by the mer- 
 chant or manufacturer the amount of these 
 notes is usually credited to the customer in 
 his ledger account and at the same time the 
 "Notes Receivable" account is charged. 
 
 Discounting Notes Receivable 
 
 If the concern receiving such notes is pro- 
 vided at the time with sufficient working 
 capital, it will retain these notes in its safe 
 until shortly before they become due, when 
 they are sent for presentation and collection 
 to the place where, by their terms, they are 
 made payable. In case it becomes convenient 
 to obtain funds before the maturity of the 
 notes, they are sent to the bank for discount ; 
 the bank discounting the notes by deducting 
 from their face the amount of interest from 
 the day of discount until the date set as the 
 time for payment by the maker. 
 
 The notes thus disposed of are credited to 
 the Notes Receivable account, the amount of 
 the discount is charged to Interest and Dis- 
 count account, and the difference between
 
 Notes Receivable 33 
 
 the interest deducted by the bank and the 
 whole amount of the notes, called the "pro- 
 ceeds," is charged to Cash. 
 
 There are other methods by which the dis- 
 counting of notes is placed on the books, but 
 this one answers the purpose of showing 
 that, under the ordinary procedure, the bal- 
 ance of the Notes Receivable account always 
 shows the amount of the notes on hand. 
 
 Notes received and subsequently dis- 
 counted at bank should not be stated as an 
 asset. The amount of such discounted notes 
 remaining unpaid by the maker at the time 
 the statement is prepared should be stated as 
 a contingent liability in a footnote to the 
 balance sheet. 
 
 In some methods of bookkeeping the notes 
 which have been discounted are not credited 
 to the Notes Receivable account according to 
 the method already described, until actually 
 paid by the makers. The general rule that 
 such notes should not be stated as an asset 
 must then be varied. It is correct as to prin- 
 ciple, but under the method of accounting 
 just referred to does not apply, as such notes
 
 34 Net Worth and the Balance Sheet 
 
 are carried as assets with an offsetting lia- 
 bility. 
 
 When a promissory note is received from 
 a customer the usual practice, as stated, calls 
 for a debit to Notes Receivable and a credit 
 to the customer of a like amount. Then 
 when the note is discounted at bank, it calls 
 for a credit to Notes Receivable of the full 
 amount of the note and a debit to Cash of the 
 proceeds received from the bank, and another 
 debit to Interest and Discount of the amount 
 of interest deducted from the face of the 
 note by the bank. 
 
 For example : 
 
 Method A: 
 
 Cash, Dr $940.00 
 
 Interest and Discount, Dr. . . 60.00 
 Notes Receivable, Cr $1,000.00 
 
 Under the other method referred to, the 
 course is similar until the note is discounted, 
 when another account is opened called "Notes 
 Receivable Discounted" and the discounted 
 note is credited to that account instead of to 
 the Notes Receivable account.
 
 Notes Receivable 35 
 
 For example : 
 
 Method B : 
 
 Cash, Dr $940.00 
 
 Interest and Discount, Dr. . . 60.00 
 Notes Receivable Discounted, Cr. .$1,000.00 
 
 Assuming that the Scarborough Manufac- 
 turing Company, whose Notes Receivable on 
 the balance sheet amounted to $7,752.84, had 
 received other notes to the amount of $20,000 
 not then due, but which it had discounted at 
 bank, under method B the balance sheet 
 would show as follows : 
 
 Under Assets : 
 
 Notes Receivable $27,752.84 
 
 Under Liabilities: 
 
 Notes Receivable Discounted 20,000.00 
 
 This condition would be just as intelligible 
 to the man who understands this method as 
 the other method in which the amount of con- 
 tingent liabilities is stated as a footnote on 
 the balance sheet. 
 
 Following the process a little further, 
 when the maturity date of the note dis- 
 counted arrives, and the note is found to have
 
 36 Net Worth and the Balance Sheet 
 
 been paid by the customer, a journal entry 
 is made as follows: 
 
 Notes Receivable Discounted. . .$1,000 
 To Notes Receivable $1,000 
 
 The object of this method is to have the 
 ledger show at any given time the amount 
 of customers' notes which have been dis- 
 counted, but which have not yet been paid 
 by the makers. 
 
 The only objection to be urged against this 
 method is found in the fact that it places on 
 the ledger a liability that is not, strictly 
 speaking, the kind of liability that should ap- 
 pear there. This liability is that of the in- 
 dorser of a note, and when such a note has 
 been received for goods purchased by the 
 maker of the note, the indorser is not liable 
 unless the maker fails to pay it himself. It 
 is a contingency which arises every time a 
 note is discounted by the indorser to the 
 extent that he may be compelled to pay back 
 to the bank the money advanced by the bank 
 on the note. 
 
 In a well-managed business, where the 
 general business standing of the customers
 
 Notes Receivable 37 
 
 is good, and their financial responsibility is 
 established, it is but seldom that the merchant 
 or manufacturer is compelled to pay the 
 notes he has discounted, and, except in un- 
 usual cases, it is not necessary to maintain 
 the Notes Receivable Discounted account, or 
 to make the extra double entry in the books 
 called for by this method. 
 
 "Good" Notes 
 
 Notes described as "good" should include 
 only such negotiable instruments as are not 
 due when the statement is prepared and 
 which the merchant or manufacturer actually 
 believes, after diligent inquiry, will be paid 
 by the maker at maturity. Overdue notes 
 should be stated in a separate amount under 
 the description "overdue notes." 
 
 It is sometimes very hard to look upon the 
 real value of notes in hand as being less than 
 the face value. But in order that the state- 
 ment of net worth may not contain any un- 
 certain elements it is necessary to scrutinize 
 this class of assets with care. We very often 
 hear the expression regarding; promissory 
 
 288458
 
 38 Net Worth and the Balance Sheet 
 
 notes, "They are as good as wheat," when a 
 further inquiry reveals some doubt of the 
 ability of the maker to settle his obligations 
 promptly. Unless fully secured either by col- 
 lateral or indorsement, or unless warranted 
 by absolute knowledge of the financial re- 
 sponsibility of the makers or indorsers, 
 Notes Receivable should not be appraised as 
 "good" for the full amount. 
 
 This applies especially to "Notes Receiv- 
 able" continuously renewed by the customers. 
 Such notes should not be stated at face 
 value unless amply secured by collateral or 
 by indorsements. It is easy to see that if 
 a debtor does not reduce the amount of his 
 indebtedness within a reasonable time, he is 
 not making good progress, and unless some 
 turn in his affairs should improve his con- 
 dition, his ability to meet his obligations may 
 fade away.
 
 CHAPTER V 
 NOTES RECEIVABLE (continued) 
 
 T/f/^RITTEN contracts or engagements 
 not negotiable, to pay money, or for 
 services or property, should not be included 
 in Notes Receivable. 
 
 Nothing should be called Notes Receivable 
 save legal negotiable promissory notes given 
 to the merchant or manufacturer who is pre- 
 paring the statement. All other contracts, 
 rights, patents, processes, and evidences of 
 property of more or less value to the concern, 
 should be shown in the statement, but not 
 under Notes Receivable. 
 
 Accommodation Notes 
 
 Notes Receivable given to the merchant or 
 manufacturer for his accommodation should 
 be stated separately and not as a part of the 
 total of Notes Receivable-from customers for 
 goods sold. 
 
 Such notes are the same in effect as if 
 
 39
 
 made by the party accommodated and in- 
 dorsed by the party issuing the paper, it 
 being expected that the merchant or manu- 
 facturer for whose accommodation the note 
 has been made will pay it at maturity regard- 
 less of his nominal position on the paper. 
 
 Any notes received in settlement or part 
 settlement of previous charges on open ac- 
 count should be deducted from such accounts 
 and stated as Notes Receivable. This is be- 
 cause the acceptance of the note changes the 
 legal form of the claim against the customer 
 from that of goods sold to that of note un- 
 paid. 
 
 Some bookkeepers charge back to the cus- 
 tomer's account a note received from him 
 but not paid at maturity. For the same 
 reason that a note is deducted from the open 
 account, it should not be charged back when 
 not paid. The mere failure in payment does 
 not again transform the note into a claim for 
 goods sold. 
 
 Sometimes when accounts due for mer- 
 chandise sold are difficult to collect, promis- 
 sory notes are accepted in lieu of the old
 
 Notes Receivable 41 
 
 account. This further extends the time of 
 payment, and in such cases the promissory 
 notes may not be worth face value as an 
 asset. 
 
 Notes Not in the Ordinary Course of Business 
 
 Notes received from officers, directors, 
 partners, clerks, or stockholders should not 
 be included in Notes Receivable, but should 
 be stated in a separate amount. 
 
 Sometimes loans are made to those directly 
 connected with the business, and memoranda, 
 due bills, or promissory notes are taken as 
 evidence of the loans, which are then carried 
 in Notes Receivable account. While these 
 may form legitimate assets, they should not 
 be included in the account Notes Receivable, 
 for the reason that such transactions are only 
 incidental to and not part of the main pur- 
 pose of the business. It may further be said 
 generally that all facts not forming a neces- 
 sary part of the business should be stated 
 separately from those facts which are di- 
 rectly connected with and form part of the 
 business itself. If this is not done the bal-
 
 42 Net Worth an'd the Balance Sheet 
 
 ance sheet may lose much of its meaning and 
 value. 
 
 Thus the fact that the Scarborough Man- 
 ufacturing Company has on hand a small 
 amount of notes received from its customers 
 is one having some significance. If the 
 actual amount of these customers' notes is 
 obscured with miscellaneous obligations, it 
 is more difficult to picture the business in its 
 own entirety. 
 
 Notes Receivable given by subsidiary, con- 
 trolled, or allied interests for merchandise 
 should be stated separately from those re- 
 ceived from outside customers. 
 
 Where one corporation owns or controls a 
 number of other smaller corporations whose 
 business forms part of the whole, the main 
 company is sometimes referred to as the 
 "parent" company and the other smaller 
 companies as "subsidiaries." 
 
 Materials and finished manufactured 
 articles may be transported from one to an- 
 other of these subsidiary concerns, or from 
 the "parent" to one or more, or from the sub- 
 sidiaries to the parent corporation. Again,
 
 Notes Receivable 43 
 
 advances of money are frequently obtained 
 from the parent company by the subsidiary 
 concerns. On the books of the parent com- 
 pany such debts of the subsidiary companies 
 are sometimes clearly shown to be just what 
 they are, but more often the notes given to 
 the parent company are included as part of 
 the Notes Receivable balance. 
 
 In some cases these notes represent cash 
 advanced for construction purposes; in 
 others, cash for current operating expenses ; 
 in others, the notes may represent goods or 
 materials shipped which are either still on 
 hand or which have been sold. There are 
 as many different things for which these 
 notes may have been given as there are ways 
 of spending money. This uncertainty in 
 itself renders the statement more difficult of 
 understanding than it would be if all notes 
 given by one allied or controlled concern to 
 another operating under the same ownership 
 were stated separately from its ordinary 
 Notes Receivable. 
 
 So much for the clearness of understand- 
 ing. There is another reason for separating
 
 44 Net Worth and the Balance Sheet 
 
 these notes, of more importance in any con- 
 sideration of the real net worth of a business. 
 It may happen that many of these notes rep- 
 resent investments in enterprises which have 
 turned out to be unsuccessful, and while the 
 notes are being carried at full value, they are 
 not represented by full value in the assets of 
 the subsidiary concern. 
 
 In one concern whose statement was re- 
 cently examined it was found that the 
 Notes Receivable of one of the manufactur- 
 ing plants were held and carried among the 
 other ordinary promissory notes by the main 
 organization to the extent of $1,000,000, 
 while the total capital stock of the subsidiary 
 concern, all owned by the parent company, 
 amounted to only $100,000. The capital 
 needed by the small concern, not only for con- 
 struction purposes, but also for materials 
 and labor, had been supplied by the parent 
 company. Since the subsidiary company, at 
 the time, was doing very badly, it was a grave 
 question whether the assets of the parent 
 company represented by these notes were of 
 any material value.
 
 Notes Receivable 45 
 
 There was no doubt whatever that the 
 statement of Notes Receivable was mislead- 
 ing, containing as it did this large amount 
 of notes representing anything but ordinary 
 Notes Receivable from customers. It was 
 misleading to the extent that without inquiry 
 it would have appeared that the parent cor- 
 poration possessed a much larger amount of 
 what is known as "quick" assets than was 
 actually the case. 
 
 Notes Assigned or Pledged 
 
 Any notes assigned or pledged as collateral 
 for loans should be stated and the liability for 
 the borrowed money shown as a liability. 
 
 Ordinarily business concerns having a 
 credit standing are able to borrow such funds 
 as are needed for temporary purposes upon 
 their own promissory notes, which they dis- 
 count at bank. But when they are compelled 
 to offer security additional to that of their 
 own established credit standing, they may 
 take to the bank or banks, as collateral for 
 these loans, such promissory notes as they 
 have received from their customers.
 
 46 Net Worth and the Balance Sheet 
 
 If such promissory notes have been re- 
 ceived in the ordinary course of business 
 from responsible concerns, and the date of 
 maturity and places of payment are not far 
 distant, it is quite within the ordinary for the 
 holders to discount them at the bank, 
 although it is generally regarded as better 
 financing for business houses, wherever pos- 
 sible, to hold such notes until maturity, in the 
 meantime borrowing for their requirements 
 on their own notes. 
 
 But in many lines of business custom re- 
 quires that settlements be accepted for goods 
 sold, in long-term notes. In other lines the 
 business is such that the sellers have to take 
 many very small notes. In such cases the 
 notes received from customers do not in 
 themselves constitute very desirable loans 
 from a banker's standpoint, and, as already 
 suggested, money needed is obtained of the 
 bank upon the concern's own notes, with 
 these long-term or numerous small notes as 
 collateral. When so taken, it is usual for the 
 bank or banker to collect these collateral 
 notes when due and credit the amount col-
 
 Notes Receivable 47 
 
 lected to the Bills Payable of the concern 
 borrowing the money. 
 
 For the sake of clearness, as has been said, 
 the Notes Receivable taken from customers 
 and pledged as collateral should remain as 
 Notes Receivable on the books of the concern 
 owning them, the amounts of payment being 
 credited as reported by the bank. 
 
 For example: 
 
 Notes Payable $1,000 
 
 To Notes Receivable $1,000 
 
 Note J. Watkins, due December 3ist, paid and 
 applied to our loan at First National Bank. 
 
 In the balance sheet the amount of the 
 Notes Receivable pledged should be set out in 
 a separate item and designated as pledged, 
 and the amount borrowed should appear as 
 Bills Payable in the liabilities. 
 
 In the case of the Scarborough Manufac- 
 turing Company no such expedient was 
 necessary. The aggregate of the Notes Re- 
 ceivable is small and the working capital 
 owned and borrowed sufficiently large for its 
 needs.
 
 CHAPTER VI 
 ACCOUNTS RECEIVABLE 
 
 ACCOUNTS RECEIVABLE means the 
 sum total of unsettled charges against 
 debtors, usually for merchandise sold and de- 
 livered. 
 
 When used in a general sense, this term 
 may include any legal demand or claim aris- 
 ing out of verbal or written contract not evi- 
 denced by draft, promissory note, judgment, 
 or mortgage of record. 
 
 In other words, an open book debit against 
 any person may consist in part or in whole of 
 claims against him which do not represent 
 charges for delivery of the goods forming 
 the main object or purpose of the business. 
 
 Examples may be given, such as the sale 
 by a dry goods merchant of his horses and 
 wagons, or by a manufacturer, of cutlery, 
 of old machinery, etc., which, though proper 
 enough charges, are not charges for goods 
 manufactured or traded in. 
 
 48
 
 Accounts Receivable 49 
 
 When used in a more restricted sense, the 
 term "Accounts Receivable" is usually un- 
 derstood to include only unsettled charges to 
 customers for merchandise or manufactured 
 product sold on ordinary trade terms, the 
 right to collect which has not been trans- 
 ferred or assigned. 
 
 This restricted sense is that which is given 
 to the usual customers' debit balances. In 
 some retail lines the open book accounts are 
 styled "Charge Accounts" as distinguished 
 from cash sales. 
 
 In gas, water, and electric light and power 
 company accounting the unpaid charges are 
 usually styled "Consumers' Accounts" or 
 "Due from Consumers." 
 
 Referring to the suggestion that Accounts 
 Receivable should not include those accounts 
 which have been transferred or assigned, 
 perhaps it will be well to explain that some- 
 times merchants and manufacturers, finding 
 it difficult to obtain sufficient accommodation 
 for their financial needs at their banks, 
 arrange with trust companies or bankers for 
 loans on their bills for goods sold,
 
 50 Net Worth and the Balance Sheet 
 
 When this is done the bills, instead of 
 being at once mailed to the customers, are 
 first taken in lots to the trust company or 
 to the banker, and about 75, or even 80, per 
 cent, of the amount of such bills is advanced 
 to the merchant or manufacturer. The trust 
 company or banker then takes possession of 
 the bills and forwards them to the customers, 
 first stamping them with a direction to the 
 customer to remit, not to the merchant or 
 manufacturer from whom the goods were 
 purchased, but instead to the trust company 
 or banker whose name appears in the 
 stamped direction. 
 
 The business man obtaining money in this 
 way should keep a careful record of the bills 
 upon which his loans are obtained. The 
 money received as an advance should of 
 course be entered in his cash book as a charge 
 to cash, with the necessary interest and com- 
 mission adjustment, and the liability be cred- 
 ited in the proper book of record to "Loans 
 on Assigned Accounts." 
 
 In preparing his statement of net worth 
 when such loans are made, the amount of un-
 
 Accounts Receivable 51 
 
 assigned Accounts Receivable should be 
 stated first, followed by the total face value 
 of the "Accounts Receivable Assigned," each 
 and all of which should be plainly designated 
 on the ledger as assigned. As the accounts 
 are paid to the trust company or banker and 
 reported to the merchant or manufacturer, 
 he should enter in his journal credits to his 
 customers for the amounts collected, and at 
 the same time enter debits or charges of 
 corresponding amounts to the account called 
 "Loans on Assigned Accounts." Thus at 
 any given time the balance of the account 
 will show the actual amount of the money 
 owed to the bank, and the total of the "Ac- 
 counts Receivable Assigned" will show the 
 face value of those accounts assigned and 
 not paid by the customers. 
 
 As used in the restricted sense, Accounts 
 Receivable should not include money loaned 
 or advanced to any person for any purpose. 
 
 In order that a business man may intelli- 
 gently inspect his true financial position in 
 business, he should not fall into the habit of 
 carrying records of outside transactions upon
 
 52 Net Worth and the Balance Sheet 
 
 his business books of account. Investments, 
 loans, contributions to syndicates, or ac- 
 counts with individuals for any one or more 
 of a multitude of transactions which may 
 give rise to charges on open book accounts, 
 ought not to be mixed in with the accounts 
 relating solely to the business of which the 
 books purport to constitute a record. 
 
 If such outside transactions are recorded 
 on his books he should set out such accounts 
 separately from those representing the main 
 business. 
 
 Good Accounts Receivable 
 
 When Accounts Receivable are described 
 or appraised as "good," it is understood that 
 the amounts included in the total so desig- 
 nated are (a) not yet due according to the 
 terms of the sale and no information has been 
 received creating doubt of the customers' re- 
 sponsibility and readiness to pay when due, 
 or (b) are overdue, but experience with such 
 customers in the past has been such as to 
 warrant the reasonable belief that they will 
 pay within a reasonable time.
 
 Merchandise 53 
 
 The total of overdue accounts, especially 
 after request or demand for payment, should 
 not, as a rule, be considered worth face value 
 in a carefully prepared statement of financial 
 condition, but a deduction should be made 
 for possible losses on collection. 
 
 In a conscientious effort to prepare an ac- 
 curate statement of net worth, the debit bal- 
 ances or open book accounts with customers 
 should be carefully analyzed. Of course no 
 one can forecast the future action of any cus- 
 tomer with absolute accuracy. Furthermore, 
 customers who in ordinary times pay their 
 bills regularly may be entirely upset in 
 periods of business depression. Under such 
 conditions, men believed to be absolutely re- 
 liable do such strange things that their prob- 
 able course in any given transaction cannot 
 be foreseen. At the same time, a thorough 
 analysis of the open balances will throw 
 much light upon accounts the value of which, 
 considered as an aggregate without analysis, 
 may be difficult to estimate. 
 
 Overdue Accounts 
 Taking the general terms of the trade, as
 
 54 Net Worth and the Balance Sheet 
 
 well as any specific terms to certain custom- 
 ers into consideration, an analysis should be 
 made of each account and the average date 
 of the charges for unpaid merchandise ascer- 
 tained. These accounts should then be 
 classified according to age, as follows: 
 
 Analysis of Overdue Accounts 
 Under 30 days overdue 
 Over 30 days, but less than 60 days 
 Over 60 days, but less than 90 days 
 Over 90 days, but less than 6 months 
 Over 6 months, but less than 9 months 
 Over 9 months, but less than I year 
 Over i year overdue 
 
 Careful examination should be made of 
 those accounts appearing under the "over- 
 due" headings, taking the terms of sale into 
 consideration. No matter how much confi- 
 dence a merchant or manufacturer may have 
 in his customers, he cannot consistently claim 
 as absolutely good, assets accounts found in 
 the "over 90 days" column, which, by the 
 terms, were due in 30 days from date of sale. 
 
 While in many individual cases he may be 
 very sure that the customers will pay in time, 
 yet on the whole the chances are unfavorable
 
 Accounts Receivable 55 
 
 that all of those falling within the delinquent 
 90-day class will pay the full amount of their 
 debts. And so on, until he finds accounts 
 over a year old, though due in 60 days from 
 date of sale. He could not reasonably count 
 on realizing the full value of all of such ac- 
 counts unless he holds some security or pos- 
 sesses some special information regarding all 
 the individuals in this excessively delinquent 
 class, which would take them out of the gen- 
 eral rule. 
 
 Many credit men are very suspicious of all 
 accounts not paid for after 60 days from the 
 promised day of payment. To throw out 
 of asset valuation each and every such ac- 
 count would be just as unreasonable as to 
 include all old accounts at their face value. 
 
 Careful inquiry of his clerks regarding the 
 steps taken to collect overdue accounts will 
 often lead the merchant or manufacturer to 
 a definite conclusion, not perhaps that any 
 account apparently good is absolutely worth- 
 less, but that, considered as an asset, he 
 ought not to take it in his statement at full 
 value.
 
 A 
 
 CHAPTER VII 
 
 ACCOUNTS RECEIVABLE (continued) 
 CCOUNTS subject to discount, allow- 
 
 ance, rebate, claims for damaged or 
 imperfect goods, or known to be doubtful for 
 any reason, should be deducted to the extent 
 of the known or estimated shrinkage to occur 
 in final settlement. 
 
 Of course, all known bad debts should be 
 closed out and charged to the Profit and Loss 
 account. Those accounts not known to be 
 bad or even doubtful, which on their face are 
 delinquent, and thus, according to general 
 credit knowledge, not worth face value, 
 should be partially offset by means of a re- 
 serve set aside from the profits for bad or 
 'doubtful debts. 
 
 It is customary to charge off bad debts, 
 and close the accounts of those from whom 
 it appears impossible to collect the amounts 
 due. It sometimes happens, however, that 
 changes in circumstances make it possible to 
 
 56
 
 Accounts Receivable 57 
 
 collect accounts subsequently which appeared 
 worthless at the time they were charged off. 
 A separate book or ledger should be kept con- 
 taining records of all bad debts. This book 
 should be frequently scrutinized that known 
 changes for the better in any of the old 
 debtors may not be overlooked. 
 
 Unsettled Charges 
 
 No unsettled charges against any individ- 
 ual connected zvith the business, either as 
 a proprietor, stockholder, officer, or clerk, 
 whether for overdrawn salary accounts, ex- 
 pense accounts, unpaid stock subscriptions, 
 or for any other reason, should be included in 
 Accounts Receivable, but should be stated 
 separately. 
 
 It is frequently observed that overdrawn 
 salary accounts are carried in the Accounts 
 Receivable as balances due from the officers 
 or clerks who have overdrawn ; and in some 
 cases partners maintain open drawing ac- 
 counts indefinitely, including the debit bal- 
 ances in the same class as balances due from 
 customers.
 
 58 Net Worth and the Balance Sheet 
 
 Again, large advances of cash are some- 
 times made to agents or salesmen either on 
 account of salaries or commission, or for 
 expense funds. It would seem needless to 
 say that such accounts are not Accounts Re- 
 ceivable in the understood sense of the term, 
 if it were not for the fact that some business 
 men and bookkeepers include all open debit 
 balances against individuals in this one class. 
 
 Collecting Accounts Receivable 
 
 The elimination from Accounts Receivable 
 of every kind of debit charge other than for 
 goods sold, is useful in more than one way. 
 Besides the assistance rendered in determin- 
 ing the net worth of a business, the amount 
 of outstanding debit accounts for merchan- 
 dise sold, taken into connection with the vol- 
 ume of sales, throws light on the financial 
 ability of the management a light which 
 should be of help to the management in cor- 
 recting the weaknesses disclosed. 
 
 After learning the terms of credit on 
 which goods have been sold, a simple compu- 
 tation based on the terms of credit, volume
 
 Accounts Receivable 59 
 
 of sales, and the amount of Accounts Receiv- 
 able, will show whether or not the collections 
 have been made promptly. For example, the 
 Scarborough Manufacturing Company sold 
 during the year 1911 an aggregate of 
 $680,000 on various terms of credit, the aver- 
 age of which would be about 45 days. The 
 amount outstanding was approximately the 
 same at the beginning as at the end of the 
 year, i.e., $111,172.08; whereas the Accounts 
 Receivable, if collected according to the 
 terms of credit, would amount at any one 
 time to not over, approximately, one-eighth 
 of the total sales, or about $85,000. 
 
 The actual amount of the Accounts Re- 
 ceivable is therefore about $25,000 greater 
 than the average term of credit would indi- 
 cate as necessary. 
 
 Of course this rule must not be taken as a 
 basis for final judgment without further in- 
 quiry, but on its face the Scarborough Manu- 
 facturing Company's collection department 
 has been too easy with its customers for its 
 own good. 
 
 Not long since, the annual sales of each of
 
 60 Net Worth and the Balance Sheet 
 
 two concerns in the same line of business 
 aggregated about $1,000,000. One con- 
 cern carried $400,000 of Accounts Receiv- 
 able, while the other succeeded in keeping its 
 customers' accounts down to only $200,000, 
 or 100 per cent, less than the more easy-going 
 concern. As a result the first was obliged to 
 borrow heavily and pay interest on the 
 amount borrowed a tax on the business 
 which would not have been needed if it had 
 collected the accounts due to it. Besides this, 
 the danger of loss through accounts grows 
 with the length of time the accounts are al- 
 lowed to remain uncollected. 
 
 Accounts Receivable from Allied Interests 
 
 Accounts Receivable representing un- 
 settled charges against subsidiary, controll- 
 ing, or allied interests should be stated 
 separately. 
 
 Many interconnected companies buy of 
 and sell to each other, piling up large Ac- 
 counts Receivable and Payable, which are 
 not of such character as to be properly in- 
 cluded in the same class as accounts due from
 
 Accounts Receivable 61 
 
 outside parties. In some cases, of course, the 
 concerns, though controlled, are sufficiently 
 distinct to permit transactions between them 
 to be regarded as similar to those of entirely 
 separate concerns. But in many instances 
 the charges for goods delivered by one of 
 the subsidiary concerns of a large corpora- 
 tion to another of the concerns amounts to 
 nothing more than a transfer of materials or 
 merchandise from one plant to another. 
 
 Where commission merchants having mer- 
 chandise in their possession owned by manu- 
 facturers, advance funds to the owners of the 
 merchandise in anticipation of sales, the 
 amount advanced should not be included in 
 Accounts Receivable. Such advances should 
 be separately stated and described as "Ad- 
 vances of Cash Against Merchandise in Our 
 Possession for Sale on Commission."
 
 CHAPTER VIII 
 MERCHANDISE 
 
 HP HIS account in a balance sheet is in- 
 tended to mean unsold marketable 
 goods and wares owned by a merchant and 
 bought for sale, these goods being of any 
 kind falling within the general purpose of his 
 business. 
 
 Reference is made here to the merchan- 
 dise of a merchant or trader. The finished 
 product of a manufacturer is described in a 
 later chapter. 
 
 Valuation of Merchandise 
 
 With certain exceptions, the inventory 
 value of merchandise should be based upon 
 purchase price plus freight charges, and, in 
 some cases, expenses incident to carrying the 
 stock. 
 
 Some merchants and manufacturers cal- 
 culate the inventory at full selling price, or at 
 selling price less certain discounts, but ex- 
 
 62
 
 Merchandise 63 
 
 cept in a few particular cases this method is 
 not in accordance with the best business 
 principles. 
 
 According to the views of such merchants 
 and manufacturers, the moment goods are 
 bought or manufactured and ready for sale, a 
 value attaches to them corresponding to the 
 demand of the consumers. The price which 
 the purchaser is willing to pay for the goods 
 constitutes that value, they argue, and that 
 price is the amount at which the merchant 
 should be allowed to appraise his goods in 
 stock. 
 
 On the other hand, until the goods are ac- 
 tually sold and accepted by the purchaser, 
 the goods actually belong to the merchant or 
 manufacturer, although it is true that cases 
 exist in which the legal phases of the con- 
 tract between the vendor and vendee produce 
 conditions whereby it would be perfectly 
 justifiable for the merchant or manufacturer 
 to value his goods at full price. 
 
 Again, there are lines of business in which 
 the articles dealt in are constantly fluctuating 
 in price, due more or less to the speculative
 
 64 Net Worth and the Balance Sheet 
 
 value of the article, as, for example, flour and 
 cotton. 
 
 Such cases may form exceptions to the 
 general rule and must be considered carefully, 
 but if a valuation on merchandise is fixed 
 above cost, the result, according to the ordi- 
 nary methods of bookkeeping, will be a show- 
 ing on the books of a profit not yet earned. 
 
 By "not yet earned" is meant that the 
 goods have not yet been actually sold and 
 accepted. Up to that point the goods belong 
 to the merchant. When the goods have been 
 sold and accepted, the asset is changed from 
 the asset "Stock on Hand" to an asset con- 
 sisting of a claim against a supposedly re- 
 sponsible party. That change in the legal 
 status seems to form the most appropriate 
 marking point for the taking on the books of 
 a profit. 
 
 In some lines goods are ordered by the 
 purchaser six months in advance of delivery. 
 In such cases it would seem that at inven- 
 tory time such goods as are on hand, having 
 been manufactured on order, should be val- 
 ued at selling price less expenses of carrying
 
 Merchandise 65 
 
 in stock and delivery to the point agreed 
 upon. This method seems to be correct on 
 the principle that the goods actually belong 
 to the purchaser, and since he is bound to 
 take and pay for them, the profit to the man- 
 ufacturer has already been earned. 
 
 In the exceptional cases referred to, such 
 would be the fact, and such a method of 
 treatment would be correct, but the cases are 
 comparatively rare in which the goods, 
 though still in the manufacturer's actual 
 possession, have in law been delivered to the 
 customer and are simply held, subject to his 
 order and at his own risk. 
 
 A fairly accurate test of the matter in 
 each case may be applied in the form of this 
 question: ''In the event of destruction of the 
 goods by fire, on whom would fall the loss?" 
 
 If the answer is clear to the effect that the 
 customer would be the loser, the manufac- 
 turer is justified in considering the goods as 
 sold. If, on the other hand, under the terms 
 of the contract of sale, the goods, though 
 ordered and manufactured, are still the prop- 
 erty of the manufacturer to the extent that
 
 66 Net Worth and the Balance Sheet 
 
 their loss or damage by fire would fall on 
 him, he is not justified in considering them 
 sold. Cancellations may come in before de- 
 livery and after delivery the goods may not 
 be accepted. 
 
 By whatever means effected, delivery, 
 either actual or constructive in law, must be 
 made to the customer and the goods be ac- 
 cepted by him as to price, quantity, and qual- 
 ity before their ownership passes. 
 
 When, however, the cost of the merchan- 
 dise at inventory time for any reason exceeds 
 the market value, the latter should form the 
 basis of the valuation ; the reason being that 
 the inventory at cost compared with market 
 value shows a known loss, which should be 
 deducted from the value of the merchandise 
 at once. 
 
 A frequent instance of overvaluation is 
 found in merchandise which was once sal- 
 able, but which has become worn, or out of 
 style. Such articles are sometimes carried 
 in stock under the heading of "discontinued 
 numbers." Whatever the reason for their 
 depreciation in value, articles of merchandise
 
 Merchandise 67 
 
 not worth what they cost should not be car- 
 ried at more than their real value. 
 
 The exceptional cases in which the general 
 rule as to valuation does not hold are those 
 wherein the nature of the business is such 
 that the market or selling price furnishes 
 the most practical basis for the true ascer- 
 tainment of the financial position of the mer- 
 chant. 
 
 Manufacturers of paint and linoleum seem 
 to furnish instances of this kind. The con- 
 trolling ingredient in the manufacturing of 
 these articles is linseed oil, the price of which 
 varies considerably, according to numerous 
 factors which affect the market price. At 
 the end of the year 1911 the price of this oil 
 was about seventy-one cents per gallon, while 
 during the year the average cost was eighty- 
 five cents per gallon. This condition in the 
 linseed oil market during the year produced 
 a cost above market price at the end of the 
 year for such articles manufactured from 
 the higher priced oil as were then on hand. 
 In many cases at the end of the year paint 
 and linoleum concerns reduced the inventory
 
 68 Net Worth and the Balance Sheet 
 
 valuation of finished goods to a basis of the 
 price of oil at the time the inventory was 
 taken. 
 
 But suppose the price of linseed oil was 
 considerably higher at the close of the year 
 than it had been during the year. Would 
 the manufacturers be justified in increasing 
 the inventory valuation of finished stock to 
 agree with the higher priced oil ? The justi- 
 fying argument advanced by some in support 
 of this course is that if the sales for the next 
 year are based upon the actual cost price of 
 oil during the preceding year, a loss would 
 occur which would not be incurred if the in- 
 ventory of manufactured goods at the close 
 of the year was based upon the cost of oil at 
 the end of the year. 
 
 This argument is used by those who think 
 of the cost of an article as having a necessary 
 relation to the selling price, and that the cost 
 once found may be used for a year in ad- 
 vance. This idea confuses the actual cost 
 of manufacturing in the past with estimates 
 on which prices are fixed in advance for 
 future sales.
 
 Merchandise 69 
 
 While actual cost records should be con- 
 sulted very carefully in making up schedules 
 of present or future prices, it must be remem- 
 bered that the cost figures are obtained from 
 past happenings and may not be safely relied 
 upon as the sole guide for future costs or 
 prices. 
 
 When the price of an article is made and 
 the cost price must enter into the considera- 
 tion, each item of the latest cost record of that 
 article should be examined in the light of 
 later knowledge of market and labor con- 
 ditions and probable future conditions, so 
 that the future cost may be estimated as 
 nearly as possible in accordance with antici- 
 pated future happenings. 
 
 Looking at costs and prices from this point 
 of view, it will be seen that the inventoried 
 cost of an article at the end of the year may 
 be taken at actual cost, or market price if 
 that is lower than cost, and the estimates on 
 which prices for the following year are based 
 may, without inconsistency, be taken at en- 
 tirely different or even purely supposititious 
 figures.
 
 70 Net Worth and the Balance Sheet 
 
 Therefore, even in the case of oil, higher 
 priced at the end of the year than the aver- 
 age price during the year, the rule of taking 
 actual cost when lower than market value 
 would not only be sound, but would at the 
 same time be in accordance with conserva- 
 tive management, and, as has been seen, it 
 need not conflict with subsequent price- 
 making. 
 
 Merchandise on Hand 
 
 Merchandise on Hand should include all 
 merchandise actually in the merchant's store 
 or warehouse, or out on approval, and all 
 merchandise purchased by him, not yet de- 
 livered, but which he must receive and pay 
 for; but it should not include merchandise 
 ordered but not received or accepted, which 
 by the terms of the purchase he may cancel 
 before delivery, or refuse to accept upon de- 
 livery. 
 
 Any merchandise pledged for loans should 
 be stated separately from the amount of mer- 
 chandise unpledged, and the liability for the 
 borrowed money should be shown as a lia-
 
 Merchandise 71 
 
 bility. Frequently concerns handling mer- 
 chandise of considerable value are able to 
 obtain loans upon the pledge of that material 
 as collateral. Sometimes the merchandise is 
 placed in the actual possession of the bank 
 loaning the money, but more often the evi- 
 dence of its existence is in the form of ware- 
 house certificates or bills of lading. 
 
 Any merchandise held for sale on consign- 
 ment, or in trust for any purpose, not abso- 
 lutely owned by the merchant, should not be 
 included in the inventory, which is intended 
 to show only such materials or merchandise 
 as is owned.
 
 CHAPTER ix 
 
 FINISHED PRODUCT 
 
 IN I SHED PRODUCT means unsold 
 completely manufactured marketable 
 articles made and owned by a manufacturer 
 and in his possession at his factory or mill, 
 or at warehouses or branches or agencies. 
 
 In other words, this means the ordinary 
 goods produced by the manufacturer and 
 ready for sale. 
 
 It will be noted that a distinction is made 
 between the merchandise of a merchant and 
 the product of a manufacturer. This is a 
 distinction which indicates that merchandise 
 is bought and sold by merchants, while the 
 finished product represents materials bought 
 and labor expended in producing the articles 
 manufactured. The finished product of a 
 factory may consist of merchandise ready 
 for the final consumer, who purchases it 
 from the manufacturer direct or from mer- 
 chants. 
 
 72
 
 Finished Product 73 
 
 Some manufacturers accommodate their 
 customers by supplying articles not man- 
 ufactured by them, but which are traded 
 in or used by customers buying the main 
 articles manufactured. An example is found 
 in a paint company which manufactures 
 nothing besides paints, but which carries a 
 small stock of brushes, sand paper, glass and 
 similar articles for the accommodation of its 
 customers. In such cases the inventory 
 should be classified so as to show the total 
 of the raw material, the partly finished and 
 finished product, and also the merchandise 
 purchased from others for use in supplying 
 customers. 
 
 Manufacturing Cost 
 
 The valuation of finished product should 
 be based upon cost, including a proper pro- 
 portion of the expenses of manufacturing 
 and caring for the stock to the time of in- 
 ventorying. 
 
 Just what expenses may properly be added 
 to the manufactured product of a factory 
 to determine its cost cannot be enumerated
 
 74 Net Worth and the Balance Sheet 
 
 and described in detail in such manner as to 
 establish an exact rule for the guidance of 
 all manufacturers. In general it may be said 
 that the manufacturing cost of a finished 
 article is intended to include all items enter- 
 ing into the cost of production, such as ma- 
 terials, labor and overhead factory expense. 
 Manufacturing cost does not include any 
 part of the cost of advertising and selling. 
 It should include the cost of that portion of 
 the general administration devoted to pro- 
 ducing, but no portion not strictly chargeable 
 to manufacturing. 
 
 Perhaps the distinction between what may 
 be included in manufacturing cost and what 
 may not will be clearly marked in the item 
 of Bad Debts, which represents loss due to 
 error in judgment of the salesman or credit 
 man or both, or to unfortunate turns of 
 events which could not have been foreseen at 
 the time the credit was granted. 
 
 Whatever the cause for the loss on Ac- 
 counts Receivable for goods sold, delivered, 
 and accepted, the manufacturing branch of 
 the business cannot be charged with fault.
 
 Finished Product 75 
 
 If it cannot be charged to the factory, by the 
 same reasoning such items do not constitute 
 part of the manufacturing cost, and thus 
 cannot be added as a manufacturing expense 
 to the valuation of the inventory. 
 
 Briefly, the manufacturing cost attaches 
 to the product up to the time the goods are 
 ready for delivery and have been sold. A 
 distinction might be drawn between the 
 actual cost of manufacture and the expense 
 of storage up to the time the goods leave the 
 factory, but while the cost of carrying might 
 seem at first blush to constitute storage cost 
 as distinguished from manufacturing cost, 
 an argument on the other side to the effect 
 that in many lines goods cannot be sold un- 
 less made up and kept ready for sale, would 
 narrow the storage idea to a line too fine for 
 practical purposes. 
 
 In some lines of business goods are manu- 
 factured upon orders considerably in ad- 
 vance of the time set for delivery. At in- 
 ventory time many business men, consider- 
 ing that the ordered goods have been sold, 
 put the entire selling price on such of these
 
 76 Net Worth an'd the Balance Sheet 
 
 goods as have not been delivered. Unless the 
 buyer has actually inspected and accepted 
 the goods, they have not really been sold, and 
 until they are really sold the manufacturing 
 cost only should be used as a basis for valu- 
 ation. 
 
 Consigned Goods 
 
 Finished Product should include all articles 
 shipped on consignment for sale and account- 
 ing to the owner. Some manufacturers in- 
 clude the charges for such consigned goods 
 in the Accounts Receivable, but these charges 
 do not consist of actual sales, and the state- 
 ment should show what in reality is a fact, 
 that certain articles of product owned by 
 the manufacturer have been shipped to con- 
 signees for sale and accounting for the pro- 
 ceeds of the sale. 
 
 There are certain contracting enterprises 
 which do not fall under the head of manu- 
 facturing, where deviations may or must be 
 made from this general rule. An explana- 
 tion of the special accounting terms used by 
 such concerns is not included in the present
 
 Finished Product 77 
 
 consideration, which is restricted almost en- 
 tirely to the terms used by merchants and 
 manufacturers engaged in the ordinary lines 
 of business.
 
 CHAPTER X 
 PARTLY FINISHED PRODUCT 
 
 pARTLY finished product consists of 
 articles in process of manufacture at 
 the time the inventory is taken, which are 
 intended to be completed and become finished 
 and salable stock in the ordinary course of 
 the business. 
 
 Such partly completed articles should be 
 valued at cost of labor and material, plus a 
 proper proportion of the expenses of the 
 business to the time of inventorying, as ex- 
 plained under the description of finished 
 stock. 
 
 In some lines of manufacture it is com- 
 paratively easy to estimate the cost of goods 
 partly finished at the time the inventory is 
 taken. In other lines it is exceedingly diffi- 
 cult to estimate the amount of labor, ma- 
 terial, and general manufacturing expenses 
 which have been absorbed in the course of 
 manufacturing the articles not yet fully fin- 
 
 78
 
 Partly Finished Product 79 
 
 ished. Where the total of such articles 
 would, if correctly inventoried, form an im- 
 portant bearing upon the net worth, manu- 
 facturing plants cannot well do without some 
 form of cost accounting which will show 
 the cost of the manufactured product in 
 every stage of its progress through the fac- 
 tory, from raw material to its finished state. 
 It may be simple to estimate the amount 
 of material and direct labor, and even direct 
 expense, consumed in a partly finished article, 
 but the distribution of indirect or overhead 
 expense i.e., such expenses as cannot be 
 easily identified with any particular object 
 of the many produced presents a much 
 more difficult problem. Some adequate plan 
 must be provided for this, or otherwise the 
 application of such expenses at the time of 
 inventorying is likely to lead to misrepre- 
 sentation in the accounts. 
 
 The Perpetual Inventory 
 
 Contrasted with 'the difficulty which every 
 manager who does not have a cost system ex- 
 periences in placing the proper valuation on
 
 80 Net Worth and the Balance Sheet 
 
 partly finished articles is the comparatively 
 simple problem presented to the manufac- 
 turer whose cost records are carefully 
 planned and can be safely used in obtaining 
 inventory values. In some concerns the 
 amount and cost of every article in stock, 
 whether fully or partly manufactured, can 
 be readily ascertained at any time. Some, 
 indeed, maintain a perpetual inventory of 
 all supplies, materials, goods in process of 
 manufacture, and finished product. In such 
 cases the actual inventory of unfinished 
 product consists merely of the verification of 
 its existence. 
 
 For this purpose a list of the unfinished 
 articles shown by the records to be in exist- 
 ence in various stages of manufacture in the 
 different departments of the factory is pre- 
 pared, and the actual weighing and counting 
 is undertaken merely as a proof of accuracy, 
 in much the same way that a cashier counts 
 his cash in confirmation of the cash balance 
 shown in his cash book. 
 
 Ordinarily, when information is wanted as 
 to the amount of cash on hand, it is not
 
 Partly Finished Product 81 
 
 necessary for the cashier to go to his cash 
 box and by actual count assure himself of 
 the contents. An actual count is undertaken, 
 of course, with sufficient frequency to pre- 
 vent mistakes in his actual cash, but for gen- 
 eral purposes he may safely rely upon the 
 balance supposed to be on hand as shown by 
 his cash book. 
 
 In the same manner, properly planned and 
 maintained cost accounts should at any time 
 produce the most satisfactory information 
 as to the quantity and cost of not only the 
 raw materials and finished stock, but of the 
 amount and cost of the goods which have not 
 yet reached the completed state. 
 
 Parts of articles made up in advance of 
 actual assembling into the finished product 
 should be inventoried at cost, plus in some 
 cases a proper proportion of general ex- 
 penses to time of inventorying as explained 
 under Finished Product. 
 
 In some lines of manufacture the product 
 consists of complicated machinery or other 
 articles, the completion of which calls for 
 the assembling of more or less numerous
 
 82 Net Worth and the Balance Sheet 
 
 parts, which have previously been manufac- 
 tured and placed in the store-room awaiting 
 an order for the assembling. 
 
 A proper system of accounts will produce 
 the cost of each one of these parts so that 
 when assembled the total cost of the com- 
 pleted article may be determined, and in the 
 meantime the cost of each and every part 
 may be readily ascertained.
 
 CHAPTER XI 
 RAW MATERIALS AND SUPPLIES 
 
 term Raiv Materials means uncon- 
 sumed materials purchased and owned, 
 to be used in the manufacture of the finished 
 product of the manufacturer. 
 
 Raw materials in the elementary sense 
 mean nothing more nor less than earth prod- 
 ucts, such as clay, ore of various kinds, and 
 timber. But as used in the ordinary sense 
 all materials are raw materials, whether in 
 the raw state or partly finished, bought for 
 conversion through labor into another state. 
 For example, brass pipe already manufac- 
 tured is raw material for metal bed manu- 
 facturers, and sheet paper is raw material in 
 the manufacture of books. 
 
 The valuation of raw materials should be 
 based on the cost, plus freight, and a proper 
 portion of expense of carrying in stock until 
 used. 
 
 Materials not adapted to the present 
 
 83
 
 84 Net Worth and the Balance Sheet 
 
 shapes, styles, or quality of the product 
 should not be included at higher than scrap 
 value, 
 
 Inevitably in any manufacture, as the 
 shape and style change from year to year, 
 the stock of raw materials will contain more 
 or less out-of-date material, worth no more 
 than scrap value. Careful scrutiny of this 
 stock should be made by the business man 
 who does not wish to deceive himself re- 
 garding his real net worth. 
 
 Much of this loss on materials may be 
 prevented if current watchful vigilance is 
 exercised by the manager. An unnecessarily 
 large stock should not be carried. Old ma- 
 terial should be used up as far as may safely 
 be done before new is purchased. This rule is 
 not always observed. It not infrequently 
 happens that requisitions are made by fore- 
 men for certain sizes and shapes of material 
 which do not happen to be on hand, and such 
 stock is ordered immediately by those hav- 
 ing charge of the purchasing of material, 
 when the needs of the foremen might be 
 accommodated to the stock in hand, and by
 
 Raw Materials and Supplies 85 
 
 this means its volume be kept down to actual 
 needs. 
 
 Supplies on Hand 
 
 The item Supplies on Hand means uncon- 
 sumed articles in stock, to be used in the 
 operation of a factory or mill, not entering 
 directly into or forming part of the finished 
 product itself; fuel, oils, repair parts or ma- 
 terials, and packing are examples of supplies. 
 
 Supplies, as the term is ordinarily used, 
 means certain kinds of materials which must 
 be used by every factory in keeping the plant 
 in running order. This sort of material does 
 not become a part of the manufactured 
 goods, and in carefully planned accounting 
 systems, records of such supplies are kept 
 separately from material consumed in the 
 manufacture of the product. The amount 
 should be kept down to the minimum actually 
 needed. The same caution is required to 
 prevent overloading of supplies as is needed 
 to prevent too much stocking-up of raw ma- 
 terials. 
 
 The valuation of supplies should be made
 
 86 Net Worth and the Balance Sheet 
 
 on the basis of cost plus freight, unless, of 
 course, the prices of the supplies have dropped 
 below the original cost, when the same rule 
 applies as to merchandise. To the cost may 
 be added a proportion of the expense of 
 handling and storing. 
 
 Any worn-out or obsolete article should 
 be included in the inventory at no higher 
 than scrap value.
 
 CHAPTER XII 
 REAL ESTATE 
 
 JN general, the term Real Estate includes 
 any interest in lands. A more restricted 
 use excludes all other interest than actual 
 'ownership in fee of such land and buildings 
 as are used in the operation of the business. 
 
 Real Estate should be valued at cost, less 
 depreciation. There are cases in which the 
 value of the land increases to an extent suffi- 
 cient to offset the depreciation of the build- 
 ings, and there are certain cases in which 
 the merchant or manufacturer would be 
 warranted in increasing the amount at which 
 the real estate is carried on his books, but 
 in business circles it is a general rule that 
 such increase should not be placed on the 
 books. 
 
 Logically, there is no reason why the book 
 accounts representing assets should not be 
 "written up" where book values are below 
 actual values. If a manufacturer "writes 
 
 87
 
 88 Net Worth and the Balance Sheet 
 
 down" the book value to provide against 
 possible depreciation, he ought from every 
 consideration of pure reason be allowed to 
 write up his assets when their value exceeds 
 the book value. In other words, if an ad- 
 justment of book values to correspond with 
 facts is to be commended, the rule requiring 
 such adjustment ought to work both ways, 
 up as well as down. 
 
 As a matter of practice, while many cases 
 of "writing up" are not founded on facts 
 sufficiently established to warrant it, there 
 are cases in which the writing up is not ob- 
 jectionable. If the method of bookkeeping 
 employed calls for adjustments up and down 
 in definitely expressed accounts, the "appre- 
 ciation" of value would not constitute an 
 addition to the asset account itself, but would 
 call for the opening of another asset account, 
 called "Appreciation of Real Estate," with 
 a corresponding surplus account, probably 
 called "Real Estate Appreciation Surplus." 
 
 This suggestion is in accordance with the 
 opposite principle of depreciation by which 
 all plant accounts should be kept in such a
 
 Real Estate 89 
 
 way as to show actual cost, with any esti- 
 mated depreciation shown separately as a 
 reserve account. 
 
 If the merchant or manufacturer occupies 
 his premises as lessee, he should not include 
 the lease in real estate, but should state the 
 amount or value of the lease, if of a long 
 term and valuable, separately. 
 
 If the building is leased under terms by 
 which the tenant is obliged to pay for all 
 improvements, any large outlay may be 
 stated in the balance sheet under the head- 
 ing "Improvements," care being taken to 
 write off enough annually to reduce the 
 amount to the minimum at the end of the 
 lease. 
 
 On the balance sheet of the Scarborough 
 Manufacturing Company the real estate is 
 separated into two accounts "Land" and 
 "Buildings." It is of advantage to those 
 who examine statements to have these items 
 shown separately. When this is done, a 
 better idea of the equipment as a whole and 
 as to its separate parts can be obtained and 
 a better estimate of the amount of deprecia-
 
 90 Net Worth and the Balance Sheet 
 
 tion can be calculated; the depreciation on 
 buildings from a manufacturing standpoint 
 having little relation to the rise and fall in 
 the value of land. 
 
 If land and building can be stated sepa- 
 rately, the cost of each should be shown, 
 together with the amount of depreciation to 
 the date of making the statement. The 
 amount of depreciation should be shown as a 
 reserve. The assessed value of the real 
 estate and the market value should also be 
 stated in a footnote.
 
 CHAPTER XIII 
 MACHINERY FIXTURES 
 
 7l/fACHlNERY as applied to a manufac- 
 turing plant means all plant equipment 
 owned, other than buildings and land; 
 engines, boilers, shafting, belting, genera- 
 tors, machine tools, small tools, appliances, 
 and instruments; such machinery or me- 
 chanical devices as are used in the operation 
 of the mill or factory. 
 
 Many manufacturing concerns do not in- 
 clude in the plant inventory small tools such 
 as hammers, files, saws, chisels, shovels, and 
 wheel-barrows. Such tools, if subject to con- 
 stant use, usually wear out rapidly and fre- 
 quent purchase of other tools is required, the 
 cost of which is charged to the expenses of 
 operation and not to the plant account. 
 
 There is no objection to this plan, nor, on 
 the other hand, is it objectionable to include 
 in the plant inventory and carry on the books 
 all small tools at a lump sum fairly repre- 
 
 91
 
 92 Net Worth and the Balance Sheet 
 
 senting the value of such tools as are re- 
 quired to be on hand at all times. The 
 amount of the ledger account need not 
 change unless the number and value of the 
 small tools change materially. Under such 
 circumstances all renewals of worn-out tools 
 may properly be charged to maintenance of 
 the plant as an operating expense. 
 
 Valuation of Machinery 
 
 The valuation of machinery shotdd be 
 based upon cost, with the proper deductions 
 for depreciation, and, if buildings are not 
 owned, with due regard for the terms of 
 lease. 
 
 Appraisal companies, when asked to ap- 
 praise machinery, usually attempt to fix a 
 valuation thereon which they describe as the 
 "reproduction" value at the time the ap- 
 praisal is made. For example, if a machine 
 was purchased many years ago at a cost of 
 $1,000, and at the time the appraisal was 
 made could not be duplicated as a new ma- 
 chine for less than $1,200, the latter amount 
 would be used, to which would be added an
 
 Machinery Fixtures 93 
 
 estimated amount to represent cost of freight 
 and installation. 
 
 From the "reproduction" value is deducted 
 the estimated amount of depreciation on the 
 old machine as it stands at the time the ap- 
 praisal is made. If carefully estimated, the 
 total of the inventory and appraisement thus 
 produced represents the estimated amount 
 which would be required to reproduce the 
 machinery in the condition found at the time 
 the appraisal was made. 
 
 If the amount so found is kept in a sep- 
 arate book and used only for fire insurance 
 purposes, the method is, if carefully exe- 
 cuted, reliable enough for that purpose. If, 
 however, the amount so found is placed upon 
 the books, it sometimes causes a "writing up'' 
 of the machinery accounts and produces a 
 surplus not justified, on the mere assump- 
 tion that new machinery would cost more 
 to-day than formerly. 
 
 Wherever possible, it is safer for the man- 
 agement of any business to maintain the 
 machinery account at cost, providing for de- 
 preciation by proper charges to the operating
 
 94 Net Worth and the Balance Sheet 
 
 expenses and corresponding credits to a Re- 
 serve for Depreciation account. 
 
 There can, of course, be no argument 
 against the conservative adjustment of book 
 values according to established facts, but if 
 machinery values are adjusted and read- 
 justed according to the opinion of successive 
 appraisers, an unreliable balance in the ma- 
 chinery account is likely to result. Further- 
 more, such ups and downs of the machinery 
 account may produce deceiving effects upon 
 the surplus account. 
 
 If, on the other hand, the original cost of 
 machinery is adhered to, with deductions for 
 worn-out machinery and additions for new 
 machinery, the balance of the account always 
 means something definite. It means that 
 every article of machinery in use at any 
 given time is represented in the machinery 
 account at its original cost. The offsetting 
 account where the wear and tear of the ma- 
 chinery is provided for is, of course, the re- 
 serve account, which will be more fully de- 
 scribed in its own chapter. 
 
 Machinery Inventory should not include
 
 Machinery Fixtures 95 
 
 obsolete, dismantled, or worn-out tools or 
 appliances at higher than scrap value. 
 
 Sometimes machinery of special kinds is 
 purchased to be paid for in instalments. If 
 the full value of the machine is stated as an 
 asset, the amount of the unpaid instalments 
 should appear in the liabilities. 
 
 Where buildings are not owned, a careful 
 inventory of machinery actually owned by 
 the manufacturer should be made, and a defi- 
 nite understanding between the owner and 
 tenant should be reached as to just what may 
 be removed by the tenant as his property at 
 the expiration of the lease.
 
 CHAPTER XIV 
 FURNITURE AND FIXTURES 
 
 pfURNITURE and Fixtures, as usually 
 understood, means articles of ordinary 
 or special use needed by a merchant or manu- 
 facturer to display his stock of goods or 
 samples, afford conveniences to his custom- 
 ers and clerks, and record his business trans- 
 actions. 
 
 Ordinarily the term includes many articles, 
 such as, for example, show-cases, desks, 
 racks, shelves, chairs, typewriters, and some- 
 times electric lighting systems, sprinkler sys- 
 tems, partitions, and all improvements not 
 forming part of the building as a building. 
 
 The furniture and fixtures should be val- 
 ued at cost price, less a proper deduction for 
 depreciation. 
 
 If the building is owned by the merchant or 
 manufacturer, Furniture and Fixtures may 
 include all the various articles usually so 
 designated, whether separate from or at- 
 
 96
 
 Furniture and Fixtures 97 
 
 tached to the floors, walls or ceilings, such as 
 elevators, and sprinkling, heating and light- 
 ing systems; but if the building is not owned 
 by the merchant, in inventorying and valuing 
 the furniture and fixtures due regard should 
 be given to the terms of the lease.
 
 CHAPTER XV 
 OTHER ASSETS 
 
 r "PHE ordinary statement forms provided 
 by banks for the preparation of state- 
 ments by their customers are usually very 
 much condensed and provide no special 
 spaces for assets, save those which have been 
 described. Where other assets are to be 
 listed, the term "Other Assets" is frequently 
 used with a blank space or two for the sep- 
 arate listing of important items. 
 
 In a business of ordinary character, the 
 items which cannot be properly placed under 
 any of the more specific accounts will not be 
 numerous or important, but there are excep- 
 tions to this general rule. In such excep- 
 tional cases all the important assets of the 
 business should be listed and described sep- 
 arately. 
 
 Horses, wagons, and harness may be of 
 sufficient importance to list separately, in 
 which case the amount should be shown at 
 
 98
 
 Other Assets 99 
 
 cost with proper deductions for depreciation, 
 or at an appraised value. 
 
 Funds in the hands of foreign banks and 
 investments of surplus capital in stocks and 
 bonds may be shown under this general head- 
 ing, as well as investments of sinking, in- 
 surance, or other special funds. 
 
 If large, each of these separate assets 
 should be described and the amount shown. 
 
 Investments in the stocks and bonds of 
 subsidiary or affiliated enterprises, advances 
 for cash to such enterprises, or charges for 
 goods delivered to them, should be listed 
 here. 
 
 Treasury Stock 
 
 Frequently in corporation statements an 
 item called "Treasury Stock" appears as an 
 asset. In some cases the amount represents 
 an asset of the corporation. This is so when 
 the corporation, having issued its capital 
 stock, acquires portions of it for resale. In 
 other cases the so-called Treasury Stock rep- 
 resents merely that portion of the authorized 
 capital stock which has not been issued. In
 
 100 Net Worth and the Balance Sheet 
 
 the latter class of cases the amount of such 
 unissued stock is erroneously entered at par 
 as an asset and the total authorized capital is 
 entered among the liabilities. A corporation 
 is liable to account to the shareholders for 
 only such capital as has been contributed by 
 them, and therefore the real capital liability 
 can only be the amount of shares actually 
 issued and for which payment has been made. 
 There are, as stated, cases in which its 
 own stock may be acquired by the corpora- 
 tion and become real Treasury Stock. As 
 a rule, capital stock may be issued only for 
 money, property, or services rendered, and it 
 can only be issued at par value for the assets 
 acquired or services rendered. After it is 
 once issued to shareholders and afterward 
 lawfully reacquired by the corporation by 
 purchase or by donation, it becomes the prop- 
 erty of the company and may be sold for any 
 price above or below par. This stock is 
 Treasury Stock in the proper sense. 
 
 Business Investments 
 
 Merchants interested in producing com-
 
 Other Assets 101 
 
 panics will frequently hold stock, bonds, or 
 other assets of various kinds in the concerns 
 for which they act as distributors. As an 
 illustration, many wholesale lumber firms 
 own lumber mills at points distant from their 
 own yards or offices ; also timber tracts for the 
 purpose of acquiring lumber for sale. Care 
 should be taken to describe these holdings, 
 so that it may be seen just what interest the 
 firms have in the mills, and whether the 
 tracts are actually owned or whether the 
 ownership includes merely the stumpage 
 rights. All such items should be so described 
 that the exact nature of the right or title 
 may be clearly seen. 
 
 Valuation of Patterns 
 
 Under the head of "Other Assets" also 
 fall the items of patterns, patents, trade- 
 marks, good-will, copyrights, cost of secret 
 processes, formulae, and stereotypes, the val- 
 uation of all of which requires special 
 thought and skill. 
 
 The first of these assets, patterns, is one 
 the valuation of which has caused much dis-
 
 cussion, not only where special castings are 
 made in foundries belonging to the concern, 
 the castings forming one stage only of the 
 process of manufacture, but as well in foun- 
 dries where no other business is carried on 
 besides the manufacture of general castings 
 for other manufacturers. 
 
 In one case it was found that a concern 
 had been carrying a very large number of pat- 
 terns at full cost value for years, although 
 orders for but few of the castings had been 
 received during that time. In an effort to 
 ascertain the probable value the books were 
 examined for sales. One gear wheel pattern 
 was found to have been unused for over two 
 years, while six of the wheel castings had 
 remained unsold in stock during all of that 
 time. 
 
 When the expense of making patterns has 
 to be borne by the foundryman, it is hard 
 for him to make up his mind that the value 
 of patterns is very little if the customers do 
 not repeat their orders within a reasonable 
 length of time. What is a reasonable time 
 depends, of course, upon the circumstances
 
 Other Assets 103 
 
 in each case, but it is much the safer policy 
 to write off the cost of the patterns rapidly 
 until the asset value of such of them as are 
 not in actual use is reduced to a nominal 
 amount. 
 
 In some lines of manufacture where large 
 varieties of castings are required to produce 
 the articles manufactured, the patterns are 
 valued under general rules more or less 
 rigidly followed by manufacturers in such 
 lines. A rule observed by some manufac- 
 turers is that patterns shall not be carried on 
 the books at a greater value than an amount 
 equal to 10 per cent, of the average yearly 
 sales for the three years preceding the date 
 of valuation. 
 
 Another rule calls for the writing down 
 of patterns 50 per cent, the first year and 
 25 per cent, the second year, at which time 
 an appraisement is made and the pattern val- 
 uation adjusted on the books. 
 
 Another more general rule calls for the 
 establishment of an arbitrary lump sum at 
 which patterns are carried on the books, all 
 expense for patterns during the year in ex-
 
 104 Net Worth and the Balance Sheet 
 
 cess of that amount being charged off at 
 the close of the year. 
 
 No general rule adopted by others may be 
 safely followed by any manufacturer. The 
 manager of each foundry and each factory 
 of every kind in which patterns of one de- 
 scription or another are used should study 
 the problem for himself, not leaning too 
 strongly in favor of the thought that some 
 day little-used patterns may be valuable ; nor, 
 on the other hand, leaning too much the 
 other way in favor of reducing the value to 
 a merely nominal sum. Good patterns in a 
 going business possess considerable value, 
 not only because of the reduced cost of re- 
 peat orders but, in addition, because the time 
 saved in reproduction will in itself attract 
 customers, who, in the case of a general 
 foundry, may be in urgent need of castings 
 made from the patterns, or in the case of a 
 factory, may be in need of the manufactured 
 articles of which the castings form a part. 
 
 There is perhaps no better way to arrive 
 at the value of patterns than by a careful 
 inventory at the end of each year, and an ap-
 
 Other Assets 105 
 
 praisement. This should be made by those 
 of the management who may be relied upon 
 to be conservative, and take into considera- 
 tion all of the conditions of the business, the 
 part which each pattern plays in the sales, 
 and the prospects of future orders. 
 
 Valuation of Trade-Marks 
 
 Trade-marks and brands should not be 
 placed upon the books as assets unless pur- 
 chased from another concern. The actual 
 cost of obtaining original protection of such 
 things is too small to become an expressed 
 asset of the business. Where the business 
 has been incorporated and the trade-marks 
 or brands have been acquired by the com- 
 pany from the former owners, it is perfectly 
 proper for the new owner to enter these 
 items as assets on the books at the purchase 
 prices. Afterwards, serious consideration 
 should be given at each closing period to the 
 book valuation as compared with the actual 
 value. 
 
 A steel specialty manufacturer has spent 
 considerably over $1,000,000 in advertising 
 his trade-name and trade-mark, and there-
 
 106 Net Worth and the Balance Sheet 
 
 fore carries the trade-mark on his books at 
 this valuation. He has been successful and 
 could well afford to diminish this amount by 
 writing off freely from it each year for sev- 
 eral years without materially reducing his 
 book profits. But his view is that the trade- 
 mark is worth $1,000,000 and should so 
 show on the books. In this case, being the 
 principal owner of a wealthy concern and 
 the party principally interested, no one can 
 seriously question his judgment. If, how- 
 ever, the amount of the trade-mark asset was 
 essential in his statement in order to produce 
 a surplus or net worth, the actual value would 
 be brought into serious question by an exam- 
 iner for credit purposes, or by any one veri- 
 fying the net worth of the business. 
 
 In the case referred to the proprietor is 
 mistaking the value of his trade-mark for 
 the value of his good-will, taking everything 
 connected with it into consideration. It is 
 very doubtful whether any one would pay 
 $1,000,000 for the trade-mark separate from 
 the business, its organization, plant, and 
 management.
 
 CHAPTER XVI 
 OTHER ASSETS (continued) 
 
 "New Business" Cost 
 
 EQUENTLY when manufacturing 
 concerns first begin their operations a 
 large amount of expense must be undertaken 
 in introducing their products before the 
 annual profits on the sales amount to enough 
 to bear the expense of this work. Again, 
 even after the business is established, new 
 policies of expansion may be adopted and 
 large amounts of money be expended in ad- 
 vertising, and for samples, salaries, and ex- 
 penses of special salesmen and representa- 
 tives, before any adequate returns are se- 
 cured. 
 
 It is quite a common practice among man- 
 ufacturers to carry such expenses along in 
 some form of asset account until the de- 
 veloped or expanded business reaches a point 
 where the expense of obtaining new business 
 can be paid out of the profits. 
 
 107
 
 This outlay is sometimes called "Mission- 
 ary Work" or "Introducing Expense," and 
 an account under some such designation may 
 be found on numerous balance sheets. 
 
 The real asset value of such expenditures 
 is difficult to appraise. The utmost con- 
 servatism is needed if they are to be consid- 
 ered as assets at all. At most, such expenses 
 amount to deferred charges to the regular 
 expense account, since all money expended 
 in obtaining business, whether new or old, 
 must be charged as an expense of the busi- 
 ness sooner or later. 
 
 In certain cases the extraordinary amounts 
 over and above ordinary selling expense 
 spent in one year may be considered as the 
 cost of obtaining future business and may be 
 spread over a short subsequent period in- 
 stead of being charged in total to the ex- 
 pense of the year in which the money is ac- 
 tually disbursed. 
 
 Valuation of Good- Will 
 
 This discussion leads us directly to the 
 subject of good-will, concerning the value of 
 which opinions differ widely.
 
 Other Assets 109 
 
 An intangible asset, good-will, if admitted 
 to be an asset in any given case, may be of 
 more value than any other item in the entire 
 statement, or, on the other hand, it may be 
 worthless. For this reason it has been sug- 
 gested that it should not appear as an asset 
 at all. 
 
 In a recent case the question of the value 
 of good-will arose. The owner proposed the 
 sum of $50,000 as the amount which he 
 would accept for the good-will of the busi- 
 ness into which he was about to admit a 
 partner. The business had been running 
 steadily behind ever since it was started, five 
 years before. The proprietor, instead of 
 having built up a profitable business, had, in 
 reality, been able to hold his head above 
 water only by means of the capital ad- 
 vanced to him by friendly banks and indi- 
 viduals. 
 
 Now in law we say that good-will is the 
 probability that old customers will return to 
 the new proprietors, the assumption being 
 that profits on business brought by these cus- 
 tomers will continue without the exertion
 
 110 Net Worth and the Balance Sheet 
 
 originally necessary to build up an estab- 
 lished profitable business. 
 
 What good-will can there be in a losing 
 business? Either the customers are in- 
 herently unprofitable, or the articles do not 
 possess salable merit to a profitable extent, 
 or perhaps the business, while possessing in- 
 herent merit, has been conducted so care- 
 lessly that no real profit can exist until the 
 management is changed. If this last con- 
 dition be found to exist in any given plant, 
 what amount can the proprietor claim for 
 his good-will? 
 
 He may have many friends who have that 
 good will toward him which impels them to 
 go to him for goods, but will they continue 
 if the prices are raised to a profitable point 
 or if the management is changed? 
 
 It would seem that when a man claims pay- 
 ment for the good-will of his business he 
 should be able to point to the net worth as 
 shown by his books, and also to the profit he 
 has made in the conduct of his business 
 through increasing numbers of satisfied cus- 
 tomers. He should be able to say, "Here is
 
 Other Assets 111 
 
 my business. My books do not show all of 
 my assets. I have built up a successful busi- 
 ness, which now has a momentum sufficient 
 to insure profits to you right from the start. 
 That, gentlemen, is my good-will." 
 
 Good-will, when purchased with the other 
 assets of the business, ought, according to 
 general custom, to be written down each 
 year until it has entirely disappeared from 
 the books. Good-will is an asset of great 
 value when a successful business is being 
 sold, but as a part of a business man's net 
 worth or surplus expressed in the figures on 
 the books it is not so attractive to him or 
 to any one else. When the time arrives for 
 selling the business the buyer will hardly pay 
 any attention to the amount of good-will as 
 expressed in the assets. His judgment will 
 be based upon a thorough examination of the 
 nature and character of the business, its vol- 
 ume, its customers, and its profits, and he 
 will also want to determine from every point 
 of view the effect the staying in or going out 
 of the old proprietors will have on the busi- 
 ness.
 
 1 12 Net Worth and the Balance Sheet 
 
 Deferred Assets 
 
 Under the general heading of "Other 
 Assets" on a balance sheet will appear also 
 prepaid items of expense, such as insurance, 
 taxes, interest, rent, and sundry expenses, 
 which, in a finely calculated system of ac- 
 counting, constitute items of expense actually 
 paid in the period immediately prior to the 
 inventorying, but a part of which expense, 
 ascertained by calculation, justly belongs to 
 the following period. These items are some- 
 times classed as "Deferred Assets" or "De- 
 ferred Charges to Operation," the meaning 
 of the term being that the items, while not 
 assets in the ordinary sense, are expenses 
 paid in advance and not expenses of the 
 period closed. They form items of expense 
 which have been deferred until the later 
 period of accounting. 
 
 Reserve Fund Investments 
 
 In the specimen balance sheet of the Scar- 
 borough Manufacturing Company are two 
 accounts indicating that the company holds 
 securities of other corporations as invest-
 
 Other Assets 113 
 
 ments. Just what the nature of these invest- 
 ments is does not appear, but the name of 
 one of the accounts, Reserve Fund Invest- 
 ments, is an indication that whatever the 
 securities may be, they have been purchased 
 in pursuance of the idea of actually setting 
 aside and investing a portion at least of the 
 reserved profits. 
 
 Among the liabilities will be found Re- 
 serves, $108,417, consolidating several ac- 
 counts on the books, to which have been 
 credited the periodical instalments of reserve 
 taken out of the regular profit and loss ac- 
 counts by means of charges. 
 
 An analysis of the Reserve accounts is 
 given in the chapter on Reserves, where it 
 will be seen that a part of the amount con- 
 sists of a Sinking Fund Reserve. Under 
 the terms of the mortgage given as collateral 
 for the loan shown in Bonded Debt, instal- 
 ments of $5,000 each year must be set aside 
 so that in twenty years from the date of the 
 loan, when it is due, there will be on hand 
 money to the full amount of the loan ready 
 to pay it off.
 
 114 Net Worth and the Balance Sheet 
 
 The Scarborough Manufacturing Com- 
 pany set aside the instalments for five years, 
 and invested the amount in first mortgage 
 bonds of several railroad companies. The 
 amount paid for securities, with premium, 
 was, on December 31st, $22,626.79. The 
 treasurer of the company is awaiting a 
 favorable opportunity to invest the unin- 
 vested portion of the reserve. 
 
 Other Investments 
 
 The "Other Investments" on the balance 
 sheet represents an investment of $10,000 in 
 some small tenements rented to its em- 
 ployees, on which mortgages had been placed 
 prior to the time the company acquired the 
 property, and also several lots of stocks of 
 corporations which the Scarborough Manu- 
 facturing Company has been obliged to take 
 in part satisfaction of accounts due them 
 from customers, and which are carried at 
 $7,428.72. These stocks have no market 
 value and their actual value could not be de- 
 termined without a special examination of 
 the affairs of the corporations by which they
 
 Other Assets 115 
 
 are issued. No dividends have been paid on 
 these stocks for a number of years, and the 
 probability is that they are not worth 
 much.
 
 CHAPTER XVII 
 NOTES PAYABLE 
 
 TN THE Scarborough Manufacturing 
 * Company statement provision is not made 
 for a separation of promissory notes given 
 for merchandise purchased, from notes given 
 for money borrowed. 
 
 In many balance sheets these two different 
 classes of liabilities are shown separately. 
 We will first discuss Notes Payable for Mer- 
 chandise Purchased, which mean unpaid 
 promissory notes or drafts not due, given in 
 the ordinary course of business for mer- 
 chandise, materials, supplies, or other articles 
 used in the business. The term should in- 
 clude all similar notes payable negotiated by 
 branches, or agents acting for the merchant 
 or manufacturer. 
 
 The term Bills Payable is the one most 
 commonly used to designate this class of 
 commercial paper, and as so used it has a 
 more definite meaning to the courts and to 
 
 116
 
 Notes Payable 117 
 
 lawyers than the term Notes Payable. It 
 will, however, be found in practical experi- 
 ence that there is frequently considerable 
 confusion in statements of condition between 
 notes given to merchandise creditors and 
 bills received from merchandise creditors, 
 the term Bills Payable being applied to both. 
 Some merchants, manufacturers, and bank- 
 ers too, think of a Bill Payable as being 
 either a promissory note or an invoice for 
 merchandise. While no lawyer or court 
 would misunderstand the use of the term 
 Notes Payable, many merchants and manu- 
 facturers would misunderstand the use of 
 the term Bills Payable, so that it seems best 
 to use the one term which will be best under- 
 stood by all. 
 
 Banks sometimes scrutinize any large vol- 
 ume of notes given for merchandise, under 
 the belief that the better practice for business 
 houses to pursue is to borrow money from 
 bank and pay for their purchases in cash, 
 taking advantage of cash discounts offered. 
 Banks having this view are inclined to think 
 that notes given for merchandise purchased
 
 1 18 Net Worth and the Balance Sheet 
 
 indicate inability to properly finance the 
 business. 
 
 Notes Payable for Money Borrowed 
 
 Notes Payable for Money Borrowed are 
 unpaid promissory notes or drafts not due, 
 given for money borrowed from banks, bank- 
 ers, or other persons, firms or corporations, 
 for use in the business. 
 
 Notes payable to commercial note brokers, 
 or to banks through them, should be stated 
 separately. In some cases the relative pro- 
 portion between the loans effected through 
 brokers and those obtained directly from 
 banks indicates conditions which would not 
 be clear if the two accounts were consoli- 
 dated under the general head "Notes Pay- 
 able for Money Borrowed." 
 
 Some large concerns can best finance their 
 operations through the services of note brok- 
 ers in conjunction with their own banks, 
 while others can be accommodated suffi- 
 ciently through their own banks without out- 
 side assistance. 
 
 But some smaller concerns mistake the
 
 Notes Payable 119 
 
 position in which note brokers are most use- 
 ful and go to them to the neglect of their 
 banks. It is usually much wiser for all busi- 
 ness men who desire to secure the valuable 
 services of note brokers to do so with the 
 knowledge and acquiescence of their banks.
 
 CHAPTER XVIII 
 ACCOUNTS PAYABLE 
 
 TN THE general sense, the term Accounts 
 Payable means all unsettled credits to 
 parties for goods purchased, received, and 
 accepted; also credits for unpaid salaries or 
 wages, temporary loans and other unpaid 
 obligations to creditors; amounts owed by a 
 business concern to others as shown by the 
 books, but not represented by promissory 
 notes, drafts, bonds, or judgment of mort- 
 gage. 
 
 In the more restricted sense, the term Ac- 
 counts Payable is intended to represent only 
 unpaid invoices for merchandise purchased. 
 It includes only the aggregate of unsettled 
 credits for merchandise, materials, supplies, 
 or other articles purchased for sale, either 
 in its present form or to be manufactured, or 
 for use in the business. 
 
 In the ordinary course of bookkeeping, 
 credits of invoices for goods received and 
 
 120
 
 Accounts Payable 121 
 
 accepted are entered at once in an account 
 with the creditor, regardless of the date of 
 payment called for by the terms of the pur- 
 chase. Thus any general total of Accounts 
 Payable will not disclose whether the credits 
 are under- or overdue, according to the terms 
 of purchase. In order that a more intelli- 
 gent understanding of the business may be 
 obtained, it is desirable that the accounts 
 with such creditors be divided into "not due" 
 and "overdue." 
 
 Business men want to know what portion 
 of the Accounts Payable is falling due dur- 
 ing the next week and month, and they will 
 want to know at the same time what part of 
 their Accounts Receivable may be expected 
 to be collected in time to take care of those 
 payments as they mature. 
 
 In the mind of the careful executive it is 
 not enough for him to know that the cash 
 balance is large enough to meet the payments 
 falling due during the next few days. Be- 
 yond this, and regardless of the cash balance 
 at any time, he will plan, if possible, to have 
 the collections of debts due his concern pro-
 
 122 Net Worth and the Balance Sheet 
 
 duce the funds with which to pay all concur- 
 rent obligations. 
 
 For that reason it is clearer to him if a 
 statement is prepared showing amounts "not 
 due" and "overdue" on both sides of the bal- 
 ance sheet. Of course he will want much 
 more detailed information regarding Ac- 
 counts Receivable and Accounts Payable 
 than can be incorporated in a condensed 
 statement, but even if they are only classified 
 into "not due" and "overdue," the informa- 
 tion is valuable and enables him to make 
 searching inquiries should "overdue" appear 
 in connection with either one of the accounts. 
 Explanations may satisfy him, but he will 
 want to know why the Accounts Receivable 
 are not collected more promptly and why the 
 overdue merchandise bills for purchases by 
 the concern have not been settled and cash 
 discounts obtained. 
 
 Care should be taken to ascertain that all 
 invoices for purchases received are entered 
 on the books and included in Accounts Pay- 
 able. If, according to the method of book- 
 keeping employed by a business establish-
 
 Accounts Payable 123 
 
 ment, any such invoices are omitted from 
 the books during the year, the amounts 
 thereof should be carefully gathered and 
 stated in the balance sheet. For example, 
 some bookkeepers file bills for such things as 
 office supplies, freight, cartage, and other 
 petty expenses without making any entries 
 concerning them on the books until paid, 
 when the amounts thereof are charged to the 
 expense accounts. At the time a balance 
 sheet is prepared, many such bills may be 
 found on the file, but not among the liabilities 
 on the books. Their amount should, of 
 course, be brought into the balance sheet.
 
 CHAPTER XIX 
 DEPOSITS 
 
 " [DEPOSITS" in the sense used here 
 mean credits for money deposited for 
 safe-keeping or in trust for special purposes, 
 such as deposits of employees' beneficial or 
 savings funds. 
 
 Among large manufacturing corporations 
 a custom is growing whereby the manage- 
 ment encourages the employees to save a 
 small proportion at least of their wages. 
 Those of the employees who accept the plan 
 consent to the withholding of certain agreed- 
 upon amounts from the pay envelopes, which 
 amounts the company's officers credit on the 
 general books to some such account as "De- 
 posits of Money by Employees," or "Em- 
 ployees' Savings Fund," as a controlling ac- 
 count, the detailed account with each em- 
 ployee being recorded in separate or sub- 
 sidiary books. 
 
 There are several varieties of these de- 
 
 124
 
 Deposits 125 
 
 posit arrangements, in some of which inter- 
 est is allowed by the company, and to which 
 the company contributes regular amounts, 
 either voluntarily each time the contribu- 
 tion is made, or according to a stipulated 
 agreement with the employees, the object 
 being to encourage them to accumulate their 
 savings. 
 
 Another phase of "Deposits" is found 
 when deposits are made by customers of a 
 mercantile concern in expectation of pur- 
 chases at its stores, the amounts of any such 
 purchases being charged to these deposit ac- 
 counts. Interest is allowed on the average 
 balance of such deposits, and, in addition, an 
 amount is credited to the account of the indi- 
 vidual in the form of a certain percentage 
 calculated upon the aggregate of his pur- 
 chases during the year. 
 
 Deposits as used here should not include 
 any loans of a nature calling for entry in 
 other loan liability accounts, nor should it in- 
 clude deferred dividends to stockholders or 
 salaries allowed to remain in the business, or 
 loans from officers, partners, special friends,
 
 126 Net Worth and the Balance Sheet 
 
 or relatives, intended to be withdrawn on de- 
 mand. 
 
 In order to give a clear conception of the 
 liabilities of the merchant or manufacturer, 
 such loans as may or must be paid prior to 
 the other creditors on open account should 
 be listed separately and fully described.
 
 CHAPTER XX 
 BONDED DEBT 
 
 "DONDED DEBT" as used in financial 
 statements means the amount of money 
 borrozved upon a promise to pay at a definite 
 future time, with real or personal property 
 mortgaged as collateral security. 
 
 Usually the mortgage is executed in favor 
 of a trustee for the bondholders, and bonds 
 in convenient denominations are issued, each 
 one of which describes the nature and 
 amount of the debt in general terms, refer- 
 ring to the mortgage agreement for further 
 information, if desired. 
 
 Where serial bonds are issued, secured by 
 a mortgage on the plant, the total amount of 
 the bonded indebtedness should be stated "in 
 short," with a deduction of the amount not 
 issued, so that the amount extended in the 
 liability column will represent the net lia- 
 bility. 
 
 Ordinarily bonded indebtedness is secured 
 
 127
 
 128 Net Worth and the Balance Sheet 
 
 by a mortgage covering all of the real estate 
 used in the business. If more than one mort- 
 gage or lien exists on the whole or any part 
 of the real estate, it would form a clearer 
 statement of the actual condition of the mer- 
 chant or manufacturer if these mortgages 
 or liens were separately listed and described 
 and the property on which they form a lien 
 briefly designated. 
 
 Where unsold bonds of a corporation are 
 delivered as collateral for loans obtained, a 
 notation of the amount thereof should be 
 made in short under this heading, or in a foot- 
 note at the bottom of the statement. 
 
 There are various kinds of bonds denot- 
 ing the lien on the property bonded, such as 
 First Mortgage, Second Mortgage, General 
 Mortgage, Refunding, etc. 
 
 There are also Income Bonds, issued b v y a 
 corporation, the interest on which is payable 
 only out of the income of the corporation. 
 
 Bonds may be registered with the income 
 payable to the registered holder, or they may 
 be registered as to principal only with cou- 
 pons payable to bearer, or they may be pay-
 
 Bonded Debt 129 
 
 able to bearer both as to principal and in- 
 terest. 
 
 Another term applied to a form of securi- 
 ties is "Debentures," which is an English 
 term meaning bond. While a debenture may 
 be secured by a mortgage, it does not neces- 
 sarily include the idea of a mortgage. The 
 security may rest in a charge on definite or 
 indefinite property, while a regular bond and 
 mortgage always constitutes a transfer of 
 the real estate covered, the transfer to be de- 
 feated only upon payment of the principal 
 and interest. 
 
 A form of debenture sometimes arises 
 after a mortgage has been placed on a manu- 
 facturing plant and the bonds secured by 
 the mortgage do not sell as readily as ex- 
 pected. Banks may be willing to loan tem- 
 porary funds on the promissory note or de- 
 benture of the company, with the bonds de- 
 posited with a trustee as collateral security, 
 when they would not purchase the bonds out- 
 right.
 
 CHAPTER XXI 
 MORTGAGES 
 
 TITE HAVE just discussed Bonded In- 
 debtedness. In the case of most large 
 industrial corporations the bonds issued for 
 capital obtained consist of serial denomina- 
 tional bonds secured by one mortgage placed 
 upon the corporation's property for the se- 
 curity of all bondholders. In other cases, 
 particularly of the smaller concerns, the reg- 
 ular serial bond does not appear, but instead 
 the loan is obtained by the owners on the con- 
 cern's single bond with a mortgage on the 
 real estate as collateral, the mortgage being 
 executed in favor of the individual firm or 
 corporation loaning the money. In this class 
 of loans it is usual to describe the form as 
 that of a loan on mortgage, a term which in 
 this sense, as a liability, means 
 
 Mortgages or other Hens on real estate; 
 money borrowed with the real estate of the 
 business described in the mortgage pledged 
 as security for payment. 
 
 130
 
 Mortgages 131 
 
 In many statements the real estate and 
 machinery forming the plant, if mortgaged, 
 are carried at an amount equalling the differ- 
 ence between the full value and the amount 
 of mortgage. This difference is usually 
 styled the "equity" in the property. But this 
 does not give a just presentation, for besides 
 the lien given on the property, the mortgagor 
 assumes personal responsibility to pay the 
 full amount borrowed in case the debt is not 
 paid when due and the mortgaged property 
 does not produce enough money to satisfy 
 the debt. If the sale of the real estate does 
 not satisfy the amount of the mortgage, the 
 mortgagee can collect his debt out of other 
 assets of the business. For this reason, if 
 for no other, the liability to pay the debt 
 should appear on the books as a liability and 
 the full amount of the real estate and ma- 
 chinery as an asset. 
 
 The amount of the mortgages on the bal- 
 ance sheet should also include any mortgage 
 liability, subject to which the property was 
 acquired by the present owner. When prop- 
 erty is thus taken over by the merchant or
 
 132 Net Worth and the Balance Sheet 
 
 manufacturer subject to a mortgage pre- 
 viously placed on it, the purchaser does not 
 under ordinary circumstances assume any 
 personal liability to pay the mortgage. 
 
 In such case the rule stated above, that 
 every mortgage should show on the books as 
 a liability, might not seem to apply, but the 
 desire to present a complete statement would 
 still impel one preparing it to set out the 
 full mortgage liability of the concern. 
 
 In making up an ordinary statement the 
 question of priority of liens does not arise. 
 It is only necessary to show the full amount 
 of the real estate as an asset and the amount 
 of liability in the form of liens against it. 
 It would be very difficult to prepare the ordi- 
 nary balance sheet of a merchant or a manu- 
 facturer so that it would exactly express the 
 relation between the various classes of his 
 secured and unsecured creditors so that his 
 full and complete legal relation to each and 
 all would be indicated. 
 
 If real estate other than that used in the 
 immediate operation of his business is owned 
 by the merchant or manufacturer, the
 
 Mortgages 133 
 
 amount of such real estate should be stated 
 as an asset separately from the amounts of 
 real estate used in the business. Likewise, 
 where mortgages or other liens exist against 
 this separate property, such mortgages or 
 liens should be stated in the liabilities sep- 
 arately from the mortgages or liens on the 
 real estate used in the business. 
 For example, there might appear 
 
 In the Assets 
 
 Land and Building in Plant. . . $200,000 
 Property, I5th Street 10,000 
 
 And in the Liabilities 
 
 Mortgage on Plant 50,000 
 
 Mortgage on I5th St. Property 2,000 
 
 In order to carry out the idea of fully ex- 
 pressing assets and liabilities on the balance 
 sheet, it is desirable that the full value of 
 land owned subject to an annual ground rent 
 be carried as an asset and the capitalized lien 
 of the ground rent be entered as a liability. 
 
 In short, the balance sheet should include 
 the amount of all instruments recorded or 
 unrecorded, which are or which may become 
 when recorded a lien on the real estate.
 
 CHAPTER XXII 
 OTHER LIABILITIES 
 
 IN THE usual balance sheet form provided 
 by banks for the use of customers there 
 rarely appear separately listed liabilities 
 other than those which have been described. 
 In ordinary cases all liabilities of the mer- 
 chant or manufacturer are shown in these 
 accounts, except such small incidental ex- 
 penses as are commonly omitted from even 
 carefully calculated statements of condition. 
 Sometimes, however and frequently in 
 some lines of business items not found in 
 the accounts described in the foregoing chap- 
 ters must be entered in the balance sheet. To 
 provide for such items the term "Other Lia- 
 bilities" is frequently printed at the bottom 
 of the statement, with a blank space or two 
 for separate classes of items. 
 
 Sometimes under this heading appear ac- 
 counts showing the amount of dividends de- 
 clared but not yet paid, unpaid legal fees, 
 
 134
 
 Other Liabilities 135 
 
 insurance, rent, taxes, interest on ordinary 
 loans and on bonded debt, royalties, and 
 commissions, which items may or may not 
 show under the heading of Accounts Pay- 
 able, according to the method of bookkeeping 
 employed. 
 
 In many cases when an analysis is made 
 of the lumped accounts described as "Other 
 Liabilities," items are found which materi- 
 ally alter the impression produced by an in- 
 spection of the statement before such anal- 
 ysis is made. 
 
 Accrued Liabilities 
 
 In addition to the unpaid items due at the 
 time of the preparation of a statement, and 
 any items which though not due have been 
 passed through the books into Accounts Pay- 
 able, there may be other items for salaries 
 and wages, insurance, rent, taxes, or interest, 
 which, though constituting liabilities to the 
 amount accrued to the time the statement is 
 made, may not be actually due for payment 
 until some time later. In order that the full 
 liability of the concern may be shown, a care-
 
 136 Net Worth and the Balance Sheet 
 
 ful calculation should be made of the pro- 
 portion or part of the liability accrued on 
 each of these items to the date of the state- 
 ment. 
 
 For example: If the pay-roll week ends on 
 Thursday, the 28th of the month, and the 
 fiscal year ends on the 30th of that month, 
 there will be the wages of the plant for two 
 days to take into consideration, although the 
 next pay day will not arrive for four working 
 days after the end of the fiscal year. The 
 product on which the men were engaged is 
 taken as an asset, so the unpaid wages for 
 the two days should be stated as a liability. 
 Thus, assuming the total weekly wage roll to 
 be $60,000, the accrued wages will be 
 $20,000. 
 
 In the ordinary business concern, if the 
 bookkeeping is well managed, the amount of 
 accrued items should not be large enough to 
 materially affect the net worth in most cases, 
 the accrued assets omitted from the state- 
 ment practically offsetting the omitted ac- 
 crued liabilities. 
 
 But in many cases the addition of these
 
 Other Liabilities 137 
 
 accrued items will throw quite a different 
 light on the business, especially where such 
 items are large and are paid at infrequent 
 intervals. If, for example, the taxes of all 
 kinds amount to a considerable sum, and are 
 paid but once each year at about the same 
 time, the amount of accrued taxes just prior 
 to the payment would be a material item. 
 But under a good system of bookkeeping the 
 amount of these taxes is spread over the 
 expenses of the year in monthly instalments, 
 which appear on the books as a liability be- 
 fore the actual payment, or, if taxes are paid 
 in advance, their amount is distributed in the 
 same manner, so that the actual cash pay- 
 ment, while depleting the cash balance to that 
 extent, does not disturb the net worth of the 
 concern.
 
 CHAPTER XXIII 
 CAPITAL AND CAPITAL STOCK 
 
 npHE excess of assets over liabilities con- 
 * stitutes the net worth or capital of an 
 individual, firm, or corporation for whose 
 statement of financial condition the balance 
 sheet is prepared. In the economic sense of 
 the word, capital means wealth, and in that 
 sense all of the assets to which the possessor 
 has legal title constitute his wealth or capital, 
 regardless of his unpaid debts, even though 
 these may have been incurred in the purchase 
 of some or all of those assets. 
 
 In the business sense, however, capital 
 means the amount of one's own capital or in- 
 terest in the business as distinguished from 
 capital borrowed from others, either directly 
 as a loan or indirectly by means of purchases 
 of equipment, material, or supplies for which 
 payment has not been made. Thus, in order 
 to find the net capital of any concern, the 
 liabilities must be deducted from the assets, 
 
 138
 
 Capital and Capital Stock 139 
 
 the remainder constituting the capital or net 
 worth of the business. 
 
 When the net profits of an individual sole 
 owner of a business are ascertained, the 
 amount is usually transferred directly to his 
 capital account, which should at the end of 
 every closing period form the exact balance 
 between his assets and his liabilities, and ex- 
 hibit his net worth. 
 
 In the case of a partnership, the net profits 
 are usually divided at the end of stated 
 periods according to the terms of the part- 
 nership agreement, and the amounts so de- 
 termined are credited to the several partners' 
 accounts, the sum of these accounts forming 
 the capital or net worth ; provided, both as to 
 individuals and partnerships, that care has 
 been taken in adjusting the book value of 
 the assets to agree with the actual value as 
 nearly as possible ; and provided also that all 
 of the assets and liabilities are placed upon 
 the books. 
 
 In an individual's or firm's statement the 
 capital will be shown by the credit balance of 
 the individual's or partners' capital accounts,
 
 140 Net Worth and the Balance Sheet 
 
 a capital account being kept in the name of 
 the individual owner, or, in case of a firm, 
 in the name of each and all of the partners. 
 
 ^fc*. 
 
 Capital Stock 
 
 In a corporation, if only one kind of stock 
 is issued, the capital will be shown in the sum 
 of the Capital Stock account on the ledger, 
 or, if more than one kind of stock is issued, 
 then in accounts for all classes of issues. The 
 capital stock should be entered at the par 
 value of the shares issued, unless these are 
 issued when only part of their par value is 
 paid, in which case the amount paid in only 
 should be credited to the capital account./fhe 
 holdings of each individual are shown in a 
 subsidiary book called the "Shareholders' 
 Ledger," the aggregate of the shares credited 
 to the individuals agreeing at par with the 
 amount of capital stock issued, as shown in 
 the one account of each class of stock on the 
 general ledger. 
 
 The capital stock of a corporation may be 
 divided into several classes, such as common, 
 first preferred, second preferred, etc. 
 
 There are other kinds of stock that may be
 
 Capital and Capital Stock 141 
 
 issued, but these are the most frequent. In 
 fact, it is not usual for manufacturing or 
 trading corporations to issue other than 
 "common stock" and "preferred stock." 
 
 Until comparatively recent years the entire 
 capital stock of a corporation consisted of 
 what is now known as "common stock," and 
 it was issued for cash or for property ac- 
 quired for use in the business. Originally 
 the use of preferred stock was generally lim- 
 ited to cases in which the common stock had 
 all been issued and additional capital was 
 needed. The special stock was then issued to 
 those who would furnish the capital. 
 
 The use of this stock is not now limited to 
 special purposes. Such stock is known as 
 "preferred" stock because the individuals to 
 whom it is issued possess special privileges 
 or "preferences" not possessed by the com- 
 mon or ordinary shareholders. 
 
 In some cases the special privileges of pre- 
 ferred stock consist in the right to dividends 
 at a stipulated rate before the common share- 
 holders can receive any of the profits of the 
 business.
 
 142 Net Worth and the Balance Sheet 
 
 An additional privilege is given to some 
 of the issues of preferred stock described as 
 "cumulative preferred," consisting in the 
 right to receive "back" or unpaid dividends 
 before the common shareholders can receive 
 dividends in case the corporation fails in any 
 one or more years to earn profits to a suffi- 
 cient extent to pay the current stipulated 
 dividend on the preferred stock. 
 
 In other cases the preferred stockholders 
 are not only preferred as to dividends, but in 
 addition they are preferred as to distribution 
 of assets upon dissolution of the corporation 
 after liabilities are paid. Some of the pre- 
 ferred stock issues possess one or more of 
 these special privileges and some possess all ; 
 the special preferences over ordinary share- 
 holders being granted to make the preferred 
 stock more attractive to purchasers. 
 
 Formerly when preferred stock was issued, 
 it was intended, as a rule, to call it in and pay 
 the shareholders its par value within a short 
 time, the common shareholders being left in 
 possession of their full rights to profits and 
 property. This idea is still retained in some
 
 Capital and Capital Stock 143 
 
 issues of preferred stock, but it is not so com- 
 mon as formerly. 
 
 In later years a great many corporations 
 have been formed to take over existing prop- 
 erties and have issued preferred stock or 
 bonds for the cash and property acquired, 
 while the common stock has either been given 
 along with the preferred stocks or bonds as 
 a bonus, or has been issued for the supposed 
 good-will of the acquired properties. As a 
 result, the common stock has degenerated 
 into a condition in which in many corpora- 
 tions it represents very little, if anything 
 at all, when first issued. 
 
 Capital Stock and the Property Account 
 
 In inspecting the balance sheet of a cor- 
 poration it is very important to determine 
 whether all of the stock has been issued for 
 actual property or whether some of the 
 amount outstanding represents nothing of 
 any tangible value. Frequently we find in 
 balance sheets a condition similar to the fol- 
 lowing:
 
 144 Net Worth and the Balance Sheet 
 
 NATIONAL IRON COMPANY 
 Assets : 
 
 Property Account $4,552,339.00 
 
 Investments 115,714.15 
 
 Inventories 53> I 95-35 
 
 Bills and Accounts Receivable. . 235,555.00 
 
 Cash 64,430.35 
 
 Prepaid Expense Items 5>54-75 
 
 Total $5,503,738.60 
 
 Liabilities : 
 
 Preferred Stock $2,500,000.00 
 
 Common Stock 2,500,000.00 
 
 Bonds and Mortgages 20,000.00 
 
 Accounts and Bills Payable. . . . 164,282.25 
 
 Accrued Items 3,657.60 
 
 Surplus 3 I 5.798-75 
 
 Total $5.503-738.60 
 
 In this statement it will be seen that equal 
 amounts of common and preferred stock have 
 been issued. According to present methods, 
 the natural presumption is that both were 
 issued in acquiring the plant assets which 
 are included in the foregoing statement
 
 Capital and Capital Stock 145 
 
 under the one heading "Property Account" ; 
 but whether the actual property acquired is 
 worth the amount at which it is carried is 
 not disclosed in the statement. Property ac- 
 count in this case may represent the actual 
 value of the assets, without regard to the 
 earning power or good-will of the business. 
 But, on the other hand, the account may rep- 
 resent, besides the actual value of the plant, 
 the par value of stock, both preferred and 
 common, given in excess of the actual value 
 to cover the good-will. It may also in this 
 case contain discount on preferred stock and 
 other items, which the use of such a general 
 term as "Property Account" properly or im- 
 properly permits. 
 
 It may be that the bulk of the preferred 
 stock was issued for the property, the re- 
 mainder of the preferred stock being issued 
 for cash capital, in which case the Property 
 account may include the value of the good- 
 will, represented by the amount of the com- 
 mon stock. It is evident that a large part 
 of both classes of stock must be represented 
 by the Property account, because there are
 
 146 Net Worth and the Balance Sheet 
 
 no other assets large enough to explain their 
 issuance. 
 
 The capital stock issued amounts to 
 $5,000,000, while the Property account 
 amounts to $4,552,339, showing that the bal- 
 ance of the stock, amounting to $447,661, 
 was probably issued for other assets. It may 
 be, of course, that the entire issues of both 
 classes of stock were given in payment of the 
 property, which was then valued at $5,- 
 000,000. In this case, since the Property ac- 
 count balance is less than the par value of 
 the stock, the company has presumably ap- 
 plied its earnings to the reduction of the 
 Property account. 
 
 Enough has been suggested as to the possi- 
 bilities in this case to show that the use of 
 the bulk account "Property Account" pre- 
 vents the observer from accurately ascertain- 
 ing the true condition of a corporation in 
 whose balance sheet the item is found.
 
 CHAPTER XXIV 
 SURPLUS PROFITS 
 
 TN THE restricted sense, surplus means 
 accumulated undivided profits arising 
 from the operation of a business. 
 
 When used in a less restricted sense, par- 
 ticularly in a corporation statement, it means 
 the excess of assets over liabilities and cap- 
 ital. In this sense surplus may include, be- 
 sides the profits of the business, gains arising 
 from acquisition of assets other than those 
 that form the purpose for which the corpora- 
 tion was organised. 
 
 An example of surplus under the less re- 
 stricted use of the term is furnished when 
 stock in a corporation is sold to subscribers at 
 a fixed amount per share over and above the 
 par value, the excess providing a surplus at 
 the beginning of existence of the corporation. 
 This method of establishing a surplus is not 
 often used by other than financial or insur- 
 ance institutions. 
 
 147
 
 148 Net Worth and the Balance Sheet 
 
 Surplus Not from Earnings 
 
 An example, sometimes found in ordinary 
 manufacturing corporations, of an increase 
 of surplus not due to earnings is furnished 
 when subscribers donate to the corporation 
 for its own benefit shares of capital stock 
 previously purchased by them. When treas- 
 ury stock thus acquired without cost to the 
 company is placed on the books in money 
 value, some bookkeepers credit a correspond- 
 ing amount to the Surplus account. To the 
 ordinary observer this gives the false im- 
 pression that the Surplus account shown on 
 the balance sheet has been earned by the com- 
 pany from the operation of the business. 
 
 Some accountants place the amount so ob- 
 tained to the credit of an account called 
 "Working Capital" or "Capital Surplus," in 
 order to distinguish the book surplus so ac- 
 quired from the earned surplus. 
 
 Another case of increased surplus not due 
 to earnings is sometimes found when a busi- 
 ness owned by an individual or partnership 
 is sold to a corporation, the payment being 
 made in capital stock of the company. If the
 
 Surplus Profits 149 
 
 amount of stock issued at par is less than the 
 book value of the net assets taken over and 
 the amounts of the assets are transferred to 
 the books of the corporation without deduc- 
 tions, a surplus of book assets over liabili- 
 ties will be created which the bookkeeper will 
 probably credit to Surplus account. 
 
 If the net assets are worth the amount at 
 which they were entered on the new books, 
 of course the surplus so constituted is a real 
 surplus, although not earned by the new com- 
 pany ; and nothing further need be said, save 
 that, when subsequent balance sheets of the 
 new corporation are prepared, a clearer state- 
 ment of condition is presented if the surplus 
 acquired from the old business is shown sep- 
 arately from the surplus or accumulated 
 profits earned by the new corporation. 
 
 But in some cases the assets of the old con- 
 cern are not worth their book value, and the 
 apparent surplus is no real surplus at all. 
 In such cases the Surplus account may be 
 misleading to any one inspecting statements 
 of the corporation, because the natural pre- 
 sumption is that the Surplus account repre-
 
 150 Net Worth and the Balance Sheet 
 
 sents profits earned, and indicates the ability 
 of the company to build up not only a success- 
 ful dividend-paying business, but as well to 
 provide a reserve against future needs. In- 
 quiry should always be made concerning the 
 Surplus account in order that it may be made 
 clear just what part of it has been earned 
 and what part has been built up by other 
 means. 
 
 Accounts in Which Surplus May Appear 
 
 If the excess of assets of a corporation 
 over liabilities equals the capital, there is no 
 surplus, in the general sense, the capital just 
 balancing the excess or net worth of the busi- 
 ness, but if there is an excess of assets over 
 liabilities and capital, there is a surplus, 
 and while it may not be shown under that 
 name, it is there. It may appear in a busi- 
 ness statement as Profit and Loss, Earnings, 
 or Undivided Profits, or be shown in part 
 by a surplus account representing accumu- 
 lated profits earned prior to the current 
 year and in part by a profit and loss account 
 representing only the balance of profits of
 
 Surplus Profits 151 
 
 the current year after all expenses are paid 
 and dividends disbursed. 
 
 When any classification of the surplus is 
 shown in the statement, a good arrangement 
 is as follows: 
 
 (a) Surplus representing accumulated 
 undivided profit to the beginning of the cur- 
 rent fiscal year. 
 
 (b) Profit and Loss representing the 
 net profits for the current fiscal year. 
 
 (c) Special Surplus book surplus de- 
 rived from sources other than actual earn- 
 ings. 
 
 The surplus account is not commonly 
 found on the books of individuals and firms, 
 the profits being accumulated in the owners' 
 capital accounts in the manner already de- 
 scribed. 
 
 In one sense, the surplus of a business 
 means the excess of assets over liabilities, 
 and it is sometimes called "Surplus Assets." 
 In the case of individuals and firms, surplus 
 means the same thing as capital or net 
 worth.
 
 152 Net Worth and the Balance Sheet 
 
 The Corporate Surplus 
 
 In corporation accounting more formality 
 is required than in that of firms or individ- 
 ual owners, and the usual procedure when a 
 balance sheet is taken calls for the finding of 
 the net profits for the year and then for the 
 determination of how those profits shall be 
 appropriated, including the amount to be dis- 
 tributed in the form of dividends to the 
 shareholders. After the deductions for ex- 
 traordinary expenses, investments, etc., are 
 all made, the net amount is usually trans- 
 ferred to the Surplus account, where it re- 
 mains as a fund which may be drawn upon 
 to meet extraordinary occurrences or for 
 payment of dividends in years when the net 
 profits are not sufficient in themselves to 
 pay the customary or desired dividends to 
 stockholders. 
 
 As will be seen, the term "Surplus," when 
 used in corporation accounting, does not 
 merely indicate the excess of assets over lia- 
 bilities, but is used to show the excess of 
 assets over both liabilities and the contrib- 
 uted capital as represented by the shares of
 
 Surplus Profits 153 
 
 stock issued. This is shown in the following: 
 
 o 
 
 illustration : 
 
 Assets $500,000 
 
 Liabilities 250,000 
 
 Net Worth $250,000 
 
 Capital Stock 200,000 
 
 Surplus $50,000 
 
 or put in the ordinary balance sheet form: 
 Total Assets. .$500,000 Total Liabilities$25O,ooo 
 
 Surplus 50,000 
 
 Capital Stock.. . 200,000 
 
 $500,000 $500,000 
 
 This use of the term surplus does not 
 at all affect the idea of net worth, which 
 means, in each and every case, the excess of 
 the actual value of the assets over the total 
 of all the liabilities at the time the calcula- 
 tion is made, regardless of the capital con- 
 tributed originally or the amount of the cap- 
 ital stock issued and outstanding. 
 
 Thus in the foregoing example the net 
 worth is $250,000, divided into 
 
 Capital Stock $200,000 
 
 Surplus 50,000
 
 154 Net Worth and the Balance Sheet 
 
 Corporate Liability for Surplus 
 
 The corporation, as a separate entity from 
 the shareholders as individual contributors, 
 is certainly answerable to the shareholders 
 not only for the money contributed, but as 
 well for the amount of surplus or accumu- 
 lated profits not previously distributed to 
 them in the form of dividends. 
 
 This liability of the corporation to its 
 shareholders is, however, of a different na- 
 ture from that of its liability to its outside 
 creditors, for while it must ultimately ac- 
 count to the shareholders for the amounts 
 of their contributions and profits, its accounts 
 with creditors must first be settled. If the 
 corporation is liquidated, and after settle- 
 ment with all creditors a balance of assets is 
 found to be in hand, the shareholders are 
 entitled to a distribution of those assets pro 
 rata according to the number of shares held 
 by each, taking into account, of course, the 
 prior rights of the preferred shareholders, if 
 any. If the balance of assets so distributed 
 equals or more than equals the amount of 
 the shareholders' contributions, well and
 
 Surplus Profits 155 
 
 goo'd; but if the settlement with creditors 
 leaves a balance of assets too small to repay 
 the shareholders, they must suffer whatever 
 loss they sustain without complaining, unless, 
 indeed, some action may be taken by the 
 shareholders against the officers and direct- 
 ors for the mismanagement that has pro- 
 duced the unfortunate or criminal condition. 
 But, except in cases where the mismanage- 
 ment is such that the law will compel those 
 in charge of the affairs of the corporation 
 to reimburse the shareholders, they have no 
 redress for their losses. Hence the state- 
 ment that the liability of a corporation to ac- 
 count to the shareholders is not a liability in 
 the usual meaning of the term. 
 
 Corporate Deficit 
 
 Sometimes we find in balance sheets this 
 condition : 
 
 Assets $450,000 Liabilities $300,000 
 
 Deficit 50,000 Capital 200,000 
 
 Total .$500,000 Total .$500,000 
 
 which means that while the net worth of the
 
 
 156 Net Worth and the Balance Sheet 
 
 concern is $150,000, its capital has been im- 
 paired to the extent of $50,000. The surplus 
 not only does not exist, but in its stead there 
 is a deficit, or shrinkage in the actual book 
 value of the capital stock. 
 
 Stated in another way, the condition 
 would be : 
 
 Assets $450,000 
 
 Liabilities 300,000 
 
 Net Worth $150,000 
 
 Capital Stock $200,000 
 
 Less Impairment 50,000 
 
 $150,000 
 
 In whatever form the surplus appears on 
 a balance sheet, inquiry should be made as 
 to its source, and an analysis of this account 
 for a period of not less than five years imme- 
 diately preceding the date of the balance 
 sheet will throw much light upon the condi- 
 tion of the concern whose net forward or 
 backward movement it represents.
 
 CHAPTER XXV 
 RESERVES 
 
 T3ESERVE accounts consist of charges 
 **' against the earnings of the business 
 transferred to these accounts as credits, for 
 the purpose of offsetting shrinkages in asset 
 values. The most common of these reserve 
 accounts are ordinarily designated as "Re- 
 serve for Bad and Doubtful Debts," and 
 "Reserve for Depreciation of Plant." In 
 some cases an account representing the same 
 thing appears as "Contingencies Account" 
 or "Reserve for Contingencies." 
 
 In the ordinary form of balance sheet the 
 total of the debit balances, or assets, is shown 
 at the foot of one column and the total of 
 the credit balances including capital, sur- 
 plus, and reserves is shown at the foot of 
 the other column. Of course such items as 
 reserves are not liabilities, but they are 
 placed in the liability column to offset the 
 book values of the assets. In other words, 
 
 157
 
 158 Net Worth and the Balance Sheet 
 
 when the assets are listed in the statement at 
 the full cost value, reserve accounts should 
 be shown under the head of liabilities. 
 
 Reserve for Bad and Doubtful Debts 
 
 Reference has been made to the care which 
 must be exercised in valuing open accounts 
 due from customers. After all accounts 
 known to be worthless are eliminated and 
 the remainder seem perfectly good, there is 
 still some probability that the actual cash 
 to be realized in the collection of the accounts 
 will fall short of the full face value thereof. 
 It is rarely that accounts representing several 
 thousands of customers and aggregating 
 hundreds of thousands of dollars will each 
 and every one be settled without loss or ex- 
 pense for collection. 
 
 For this reason an amount calculated as a 
 certain percentage of the total of sales, based 
 upon past experience, should be set aside out 
 of the profit as a reserve to provide against 
 shrinkages of this kind which would other- 
 wise render the statement of the concern's 
 net worth misleading.
 
 Reserves 159 
 
 The amount so set aside becomes an esti- 
 mated loss for bad and doubtful debts, 
 though these debts are not known to be bad 
 or doubtful at the time the statement is made. 
 The amount set aside is placed to the credit 
 of the reserve account. Sometimes the cor- 
 responding debit is charged direct to Profit 
 and Loss account, but more often, and partic- 
 ularly in bookkeeping systems where it is 
 desired to show the full operating expenses, 
 the amount is charged to some one of the 
 operating expense accounts, the credit of 
 course being, as before, to "Reserve for Bad 
 and Doubtful Debts." 
 
 During the year, if the amounts of all cus- 
 tomers' balances actually found to be worth- 
 less are charged off i.e., credited to the cus- 
 tomers' accounts and entered as debits to the 
 Reserve for Bad and Doubtful Debts and 
 all the other accounts open at the beginning 
 of the year have been collected, the balance 
 of the reserve account will show how closely 
 the real shrinkage has been approximated. 
 If the account shows a credit balance re- 
 maining over and above the total amount
 
 160 Net Worth and the Balance Sheet 
 
 charged against it, the excess of credit will 
 indicate the amount by which the bad debts 
 were overestimated. If, on the other hand, 
 the charges or debits for bad debts exceed 
 the amount credited as a reserve, this indi- 
 cates that the amount of the bad debts was 
 greater than anticipated, and a larger amount 
 should be reserved for the next year. 
 
 Reserve for Depreciation of Plant 
 
 Sometimes, on books of large manufactur- 
 ing corporations, there are several accounts 
 showing reserved profits set aside to guard 
 against overvaluation of assets, but more 
 often one general account is used to include 
 all depreciation credits for the buildings, ma- 
 chinery, and miscellaneous articles of equip- 
 ment constituting the plant. 
 
 In some cases the amount of depreciation 
 is roughly estimated, while in other cases the 
 amount is carefully calculated after consid- 
 erable investigation and consultation with 
 the superintendent and foremen of the vari- 
 ous departments, or with outside experts. 
 
 In some systems of bookkeeping, besides
 
 
 Reserves 161 
 
 the general ledger showing the plant assets 
 in two or three general accounts, a separate 
 plant ledger is regularly kept, in which de- 
 tailed accounts for every important building 
 and machine are entered, showing the orig- 
 inal cost, the repairs expended thereon since 
 the asset was acquired and also during the 
 year, and the estimated annual depreciation. 
 The total sum of the annual depreciation 
 against each item forms the aggregate 
 amount of the depreciation charge for the 
 year as shown on the general books. 
 
 Any calculation of net worth must take 
 into consideration the amount of deprecia- 
 tion and the expenses of keeping the plant in 
 good condition. 
 
 Many manufacturers think that a certain 
 definitely stated percentage of depreciation 
 used by one manufacturer may be safely 
 used by all manufacturers, regardless of the 
 character, location, and condition of the man- 
 ufacturing plant, and also regardless of the 
 varied personal skill exercised in the opera- 
 tion of the machinery. 
 
 For example, a pamphlet prepared by a
 
 162 Net Worth and the Balance Sheet 
 
 "committee of accounts" was sent to all the 
 manufacturers belonging to a certain associ- 
 ation, and in this pamphlet it was stated to 
 be well settled that buildings depreciate 
 5 per cent, and machinery 10 per cent, per 
 annum. There is no such settled fact or prin- 
 ciple. Buildings and machinery of exactly 
 the same materials and make will not de- 
 preciate at the same rate in Colorado as upon 
 the Atlantic coast. Nor will two managers 
 in the same kind of business direct the opera- 
 tion of the machinery of their different 
 plants in the same way and with the same 
 percentage of depreciation, even though the 
 volume of business is exactly the same. 
 
 If two plants exactly alike at the start do 
 not depreciate in the same proportion, how 
 can any arbitrary figure be applied to build- 
 ings and machinery generally? Each plant 
 must be carefully studied and depreciation 
 reserves fixed with regard to the circum- 
 stances affecting the plant.
 
 S 
 
 CHAPTER XXVI 
 RESERVES (continued) 
 
 OMETIMES in balance sheets the re- 
 serve for bad debts or for depreciation 
 is stated as a "Reserve Fund," and the ques- 
 tion is raised as to the meaning of the word 
 "Fund" used in that connection. In the ordi- 
 nary use of the term, "Fund" indicates an 
 asset such as cash or its equivalent. Those 
 who regard this as the proper and only mean- 
 ing of the word wonder why it appears on 
 the liability side of a balance sheet. Those 
 who use the term to designate a reserve of 
 profits explain that a reserve is, in effect, a 
 setting aside of profits of a business to obtain 
 funds for replacement of worn-out build- 
 ings and machinery and that the reserve ac- 
 count shows the amount of such fund. In 
 other words, it is an account of the profits 
 reserved to provide a fund a Reserve Fund 
 account. 
 
 With some concerns it is the practice not 
 
 163
 
 164 Net Worth and the Balance Sheet 
 
 only to set the profits aside, but to go one 
 step further and invest cash in securities of 
 other corporations to the amount of the re- 
 serve. Thus the invested cash becomes the 
 real reserve fund, and the amount which may 
 be invested is shown by the Reserve Fund ac- 
 count. Since the word "account" on a bal- 
 ance sheet is unnecessary, as all of the items 
 found there constitute balances of accounts 
 on the ledger, or of accounts which would be 
 there if the method of bookkeeping were 
 complete, the word "account" is dropped, 
 leaving "Reserve Fund," a somewhat cloudy 
 term when used as a liability. But the term 
 does not present any difficulty to one familiar 
 with the examination of balance sheets, 
 although the title "Reserve for Deprecia- 
 tion" or "Reserve for Replacements" is 
 clearer. 
 
 Another important account appearing on 
 some balance sheets as a liability consists of 
 the "Sinking Fund," which appears when, 
 under the terms of a mortgage, certain defi- 
 nite amounts must be set aside periodically 
 for thepurpose of extinguishing the mortgage
 
 Reserves 165 
 
 liability when it matures. In some of these 
 cases the fund must be created out of profits 
 earned, while in other cases it is immaterial 
 how it is created, the only requirement being 
 that instalments be actually set aside and in- 
 vested each year. 
 
 If, under the terms of the mortgage, or 
 according to the adopted policy of the com- 
 pany, the actual money must be set aside and 
 invested, the asset side of the balance sheet 
 should show the account of the investment 
 of such funds. If the mortgage contract 
 does not provide for the actual investment 
 of the fund, it may be left in the business 
 as part of the assets of the business, the ac- 
 count thereof being kept as a liability, or 
 Sinking Fund Reserve, increased by periodi- 
 cal transfers from the Profit and Loss or 
 Surplus account. 
 
 The form of statement shown in Chapter I 
 provides for a grouping of the "Reserves" 
 in one amount, which, in the case of the Scar- 
 borough Manufacturing Company, consists 
 of the following :
 
 166 Net Worth and the Balance Sheet 
 
 Sinking Fund $25,000 
 
 Bad and Doubtful Debts 3> OI 7 
 
 Depreciation on Buildings 32,000 
 
 Depreciation of Machinery and Fixtures . . 48,400 
 
 Total $108,417 
 
 The Sinking Fund Reserve consists of five 
 credits of $5,000 each. The Reserve for Bad 
 and Doubtful Debts amounts to about 3 per 
 cent, on the total of the outstanding accounts, 
 which in this case, based on past experience 
 with the company's customers, is a sufficient 
 provision. 
 
 The Depreciation on Buildings consists of 
 an accumulation of lump sum charges ex- 
 tending over a period of ten years, and while 
 not based upon any special plan, seems to be 
 more than sufficient for depreciation. The 
 same comment may be made on the Reserve 
 for Depreciation of Machinery and Fixtures. 
 In fact, this company has accumulated re- 
 serve credits to a larger amount than is ordi- 
 narily found in manufacturing plants of its 
 size.
 
 Reserves 16/ 
 
 Hidden Reserves 
 
 Some merchants and manufacturers ir 
 preparing balance sheets are so conservative 
 in their valuations of assets that the balance 
 sheets do not represent the full net worth of 
 the business. While it is commendable for 
 the proprietor of a business to understate 
 rather than overstate his net worth, except, 
 of course, under conditions wherein the 
 understatement would be of advantage to 
 him as, for example, in preparing tax re- 
 ports or returns it is a much better prac- 
 tice for a manufacturer or merchant to cal- 
 culate his net worth as accurately as may 
 be without either over- or understating. 
 
 Since the accumulated profits of a concern, 
 set aside in reserve accounts for the purpose 
 of guarding against embarrassment from 
 unexpected shrinkages of the assets, consti- 
 tute reserves built up to protect those assets, 
 the excess of the actual value of assets over 
 the amount shown on the books is considered 
 in the nature of another reserve. For want 
 of a better name the term "Hidden Reserve" 
 or "Secret Reserve" is used to indicate that
 
 168 Net Worth and the Balance Sheet 
 
 a concern possesses secret or hidden reserves 
 not disclosed on its balance sheet, these secret 
 or hidden reserves consisting of resources 
 not claimed in the process of striking a bal- 
 ance and producing the amount of net worth. 
 The practice is one of doubtful propriety. 
 Of course, an individual sole owner of a busi- 
 ness who is under no obligation to state the 
 full value of his business may follow his own 
 inclinations in this matter without question. 
 An example of the extent to which it may 
 be carried is given in the case of a wealthy 
 manufacturer, among whose assets is listed 
 a large wharf or pier, on which are erected 
 numerous buildings for shipping purposes 
 and from which a large income is derived. 
 While this pier is easily worth $750,000, the 
 owner carries its value on his balance sheet 
 at $1 only, its real value having been reduced 
 from time to time out of the earnings derived 
 therefrom. This manufacturer's actual net 
 worth, as compared with the statement of his 
 balance sheet, would thus contain a secret or 
 hidden reserve of almost the entire value of 
 this pier, taking, of course, into account
 
 Reserves 169 
 
 reasonable provision for ultimate replace- 
 ment. 
 
 In the case of a small firm the condition 
 might be such that the inclination of the 
 members to build up secret reserves could be 
 safely followed, but even in such cases less 
 difficulty would arise upon dissolution of the 
 firm by death or otherwise if the assets were 
 shown within a reasonable degree of value 
 accuracy. 
 
 But when we come to the accounting of a 
 corporation, particularly one whose shares 
 are more or less widely held, the propriety 
 of materially understating the assets may be 
 questioned, because the rights of sharehold- 
 ers, past, present, and future, may be seri- 
 ously affected by their lack of knowledge of 
 the actual conditions. 
 
 Methods of Building Up Secret Reserves 
 
 One of the most common methods of cre- 
 ating the so-called hidden or secret reserve 
 consists in an excessive charge to profit and 
 loss for depreciation of plant assets; the 
 amounts being charged direct to the Profit
 
 Net Worth and the Balance Sheet 
 
 and Loss account, and the credits being made 
 direct to the plant asset account, the effect 
 being to reduce the book value of the plant 
 asset account below its real value. 
 
 Another method of hidden reserve build- 
 ing consists in the charging of enlargements 
 of a plant to current operating expenses. One 
 large concern whose published statement has 
 been issued for years has made from time to 
 time extensive additions to its plant, and 
 without any effort whatever to conceal the 
 practice, charged the cost of these additions 
 to operating expenses. The result is that the 
 property accounts as shown on the books are 
 to-day carried at a value far below their real 
 worth. 
 
 In this case, while there is no attempt at 
 deception, the practice being known to all 
 concerned, there is no way by which the total 
 amount of such improvements and additions 
 can be readily obtained, and for this reason 
 the plan is not to be recommended. 
 
 In another case an entire new plant was 
 erected without any increase in the book 
 value of the plant accounts of the company,
 
 Reserves 
 
 the instalments due to the contractor as the 
 building progressed being paid out of the 
 current earnings of the company, so that to- 
 day this large building, worth over a million 
 dollars, does not appear on the books of the 
 company at all.
 
 CHAPTER XXVII 
 CONTINGENT LIABILITIES 
 
 /CONTINGENT LIABILITIES are those 
 ^ amounts not directly owed by the mer- 
 chant or manufacturer, but zvhich may be- 
 come direct liabilities upon the happening of 
 certain contingencies. 
 
 Since the balance sheet is intended to in- 
 clude only direct liabilities, such contingent 
 liabilities should not be included in the reg- 
 ular statement of financial condition, but 
 should be stated as footnotes. 
 
 Notes Discounted 
 
 An example of a contingent liability is 
 found in Notes Receivable which have been 
 received from customers, endorsed by the 
 merchant or manufacturer and discounted at 
 bank. Having been received from customers 
 for goods sold, the makers are expected, of 
 course, to pay them at maturity. Should, 
 however, the maker of any such note fail 
 
 172
 
 Contingent Liabilities 173 
 
 to meet his obligation, the merchant or man- 
 ufacturer receiving and discounting the note 
 may become primarily responsible and be 
 obliged to pay. If he keeps a proper notes 
 receivable record, he will at all times be able 
 to ascertain the amount of the Notes Receiv- 
 able not yet due on which he may become 
 liable in the event that the maker does not 
 pay. The Notes Receivable Book referred 
 to is a useful record, showing details of notes 
 received, such as date, amount, maker, in- 
 dorsee, maturity, etc. It is sometimes in- 
 corporated in the bookkeeping system, but is 
 more frequently used only as a memorandum 
 book. 
 
 It will be remembered that under the dis- 
 cussion of Notes Receivable it was said that 
 some concerns show the contingent liability 
 for Notes Discounted in the body of the bal- 
 ance sheet. This is done by crediting on their 
 books in a Bills Receivable Discounted ac- 
 count all of the notes discounted, against 
 which they charge all notes as they are paid 
 by the makers, so that the balance of this ac- 
 count shows the amount of unpaid notes
 
 174 Net Worth and the Balance Sheet 
 
 which have been discounted but which have 
 not yet been paid. 
 
 Where such a system is in use, of course, 
 no footnote showing the contingent liability 
 for notes discounted is required. 
 
 Accommodation Paper 
 
 Another form of contingent liability con- 
 sists of that arising from accommodation 
 indorsements. 
 
 Any accommodation paper made by the 
 merchant or manufacturer or indorsed by 
 him for the benefit of other parties, the pro- 
 ceeds of which are not received by him and 
 entered on his books, should be stated as a 
 Contingent Liability. 
 
 Any liability for exchanged notes, drafts, 
 or checks, and any liability for guaranty or 
 suretyship should also be stated. 
 
 Ordinary business concerns are usually 
 very chary about lending the use of their 
 names on promissory notes for the accommo- 
 dation of the makers. In fact, in some cor- 
 porations this favor is prohibited under the 
 charter and by-laws, and in some partner-
 
 Contingent Liabilities 175 
 
 ship agreements no one member of the firm is 
 allowed to indorse promissory notes, either 
 in his own name or the name of the firm, for 
 any outside parties or for any outside pur- 
 pose. So many business failures have been 
 brought about through friendly but unwise 
 indorsement of promissory notes that such 
 provisions must be regarded as measures of 
 mere ordinary business procedure. 
 
 Unfortunately, concerns whose credit and 
 capital are limited do sometimes exchange 
 such accommodations with each other. In 
 one case, a small manufacturing corporation, 
 through the aid of certain loose-principled 
 note brokers, managed to exchange notes 
 with thirteen other manufacturing concerns 
 in similarly crippled financial condition. Of 
 course the inevitable collapse took place after 
 a short period of easy financing, and the one 
 concern having least need for such irregular 
 methods had to bear the brunt of the total 
 failure of all of the other concerns on whose 
 paper it had indorsed its name. Besides its 
 own direct liability on promissory notes given 
 to the others for their accommodation, this
 
 176 
 
 concern had, in addition, its contingent lia- 
 bilities for its indorsements on the notes of 
 all of the others a condition which even- 
 tually brought it into the bankruptcy court. 
 
 Liabilities Not Shown by Books 
 
 In examining his own balance sheet or 
 that of others the business man or investor 
 should satisfy himself by inquiry that there 
 are no liabilities, contingent or direct, other 
 than are shown on the statement. 
 
 Merchants or manufacturers may and fre- 
 quently do enter into contracts for purchase 
 or sale of goods, and sometimes participate 
 in syndicates or subscribe for corporation 
 securities, thereby incurring liabilities which 
 by their nature may not be entered on the 
 books in any ordinary bookkeeping. These 
 may, however, have a material effect on the 
 financial condition of the individual or con- 
 cern at the time the balance sheet is made, 
 according to the favorable or unfavorable 
 happening or turn of events. At the time 
 the balance sheet is prepared, any knowledge 
 of events which may forecast loss or disaster
 
 Contingent Liabilities 177 
 
 should be faced squarely by the merchant or 
 manufacturer if he wishes to avoid self- 
 deception, even though such knowledge 
 comes to him before the time for the per- 
 formance of the disastrous contract or en- 
 gagement.
 
 CHAPTER XXVIII 
 ANALYSIS OF BALANCE SHEET 
 
 1-J AVING considered the nature of the ac- 
 counts forming the balance sheet shown 
 in Chapter II, let us see whether we can de- 
 rive any information from the grouped 
 accounts of this same balance sheet, express- 
 ing as they do the net worth of the business. 
 The balance sheet of the Scarborough Man- 
 ufacturing Company presents a typical case 
 of a corporation statement reshaped to con- 
 form to the requirements of the American 
 Bankers' Association. 
 
 One of the first things to consider in the 
 analysis of a balance sheet is the "liquid" 
 condition of the assets as compared with its 
 immediate liabilities. The statement of the 
 Scarborough Manufacturing Company pre- 
 sents a very favorable condition from a 
 banker's point of view. Cash, Bills Receiv- 
 able, Accounts Receivable, and Merchandise, 
 representing what are usually called "quick" 
 
 178
 
 Analysis of Balance Sheet 179 
 
 or "liquid" assets, amount to about $370,000, 
 while the "quick" liabilities Notes Payable, 
 Accounts Payable, and Deposits amount to 
 but $88,000 in round numbers. This con- 
 dition presents a desirable one, in that the 
 "quick" assets exceed the "quick" liabilities 
 in the ratio of about 4J4 of assets to 1 of 
 liabilities. 
 
 Of course the nature of the business is 
 taken into consideration, but banks as a rule 
 do not look with favor upon a statement 
 unless it shows at least $2 of "quick" assets 
 for every $1 of "quick" liabilities. 
 
 Readings from the Balance Sheet 
 
 That the Scarborough Manufacturing 
 Company is somewhat easy-going is evi- 
 denced by the large cash balance as compared 
 with the amount of accounts payable out- 
 standing. It is probable that active efforts 
 directed toward reducing that liability might 
 result in material savings in the way of cash 
 discounts. 
 
 Again, the credit terms of this concern to 
 its customers average 45 days, but through
 
 180 Net Worth and the Balance Sheet 
 
 easy collection methods it has allowed about 
 $25,000 of overdue outstanding accounts to 
 remain uncollected. 
 
 Another evidence of slack methods is 
 shown in the large amount of merchandise 
 on hand, which equals about one-third of the 
 total volume of sales for the year, while, as 
 we have seen, the natural "turn-over," ac- 
 cording to the accounts receivable, occurs 
 about nine times each year. In other words, 
 with a volume of sales of $680,000, and with 
 a credit period averaging 45 days, the amount 
 of stock on hand in excess of $80,000 could 
 only be justified by a process of manufacture 
 requiring an unusually long period as com- 
 pared with the credit terms upon which this 
 stock is sold a condition which does not 
 exist in the case under consideration. 
 
 Another evidence of an easy-going man- 
 agement, not pressed by necessity or keen 
 watchfulness, is shown in the mortgage of 
 $5,000 on certain property owned by the 
 company, on which it is paying 6 per cent, 
 interest. Its bank balance is producing no 
 interest whatever. Keen financial men abhor
 
 Analysis of Balance Sheet 181 
 
 conditions under which they unnecessarily 
 pay more interest than is earned. 
 
 It is very evident from the statement that 
 the company has enjoyed rather more than 
 average prosperity since it has been able to 
 accumulate a large surplus, besides setting 
 aside ample reserve provisions, in spite of its 
 easy-going propensities. 
 
 Those in charge probably know very much 
 about what is called the practical end of the 
 business, and in that are evidently sufficiently 
 successful to be able to ignore phases of the 
 business which in other concerns receive the 
 utmost care. Of course, the net result would 
 be better if the loose ends could be gathered 
 in without sacrifice elsewhere.
 
 CHAPTER XXIX 
 
 COMPARISON OF SUCCESSIVE BALANCE 
 SHEETS 
 
 TF a single balance sheet will convey solid 
 * information regarding the concern whose 
 condition it represents, how much more is 
 gained by a comparison of the balance sheets 
 of the same concern for two or more con- 
 secutive years? 
 
 Let us take the balance sheets of a large 
 public service corporation for the years 1910 
 and 1911 and set the figures side by side for 
 comparison. 
 
 THE INTERNATIONAL SERVICE 
 
 COMPANY 
 
 Assets 1910 1911 
 
 Cost of Property $557,417,146 $610,999,964 
 
 Contracts in Process .. 7,212,781 2,943,381 
 
 Inventories 17,048,196 20,987,551 
 
 Accounts Receivable. . 49,744,919 26,077,802 
 
 Cash 32,055,866 27,548,933 
 
 Investments 38,166,284 64,766,089 
 
 Total... $701,645,192 $753.323.720 
 
 182
 
 Comparison of Balance Sheets 183 
 
 Liabilities I9IO I9II 
 
 Capital Stock $352,904,063 $344,645,430 
 
 Surplus and Reserves. 95,700,385 119,598,526 
 
 Bonded Debt 187,685,339 224,791,696 
 
 Bills Payable 40,721,625 42,566,943 
 
 Accounts Payable 24,633,780 21,721,125 
 
 Total $701,645,192 $753,323-720 
 
 Cost of Property Account 
 
 It will be observed that in the foregoing 
 form of balance sheet the accounts are ar- 
 ranged somewhat differently from those of 
 the two other balance sheets which have 
 already been shown. 
 
 The property account of one of the prior 
 examples appears here in a more definitely 
 named "Cost of Property" account. While 
 an analysis of the account might perhaps 
 show the assets to be worth less than the 
 amount at which they are carried on the 
 books, the balance sheet is evidently intended 
 to convey the impression that whatever the 
 value of the property, its cost is here stated. 
 
 Xow we naturally turn to the record of 
 depreciation to learn the amount charged off
 
 184 Net Worth and the Balance Sheet 
 
 as a provision against the shrinkage of prop- 
 erty values, but here we are met with an 
 obscurity. The surplus and the reserve ac- 
 counts, instead of being stated separately, 
 are thrown together in one lumped account, 
 so that we cannot tell just how much the com- 
 pany has thought necessary to set aside as 
 a reserve against the depreciation of its 
 costly plant. 
 
 We may observe, however, that the cost 
 of the property exceeds the entire amount 
 of capital stock issued. In fact, it exceeds 
 that amount in addition to the entire bonded 
 debt. This is as far as we can go in this 
 direction without asking the management 
 questions. 
 
 Results of Operation 
 
 Now let us see the result of the operations 
 of this company as disclosed in these two 
 statements. We notice that no two of the 
 amounts, either of the assets or liabilities, re- 
 main the same for both years. What funds 
 did this company handle during the year and 
 what did it do with them ?
 
 Comparison of Balance Sheets 185 
 
 Take the assets first. Which of them were 
 decreased ? We ask this question because we 
 know that if an asset was decreased during 
 the year, it is probable in the natural course 
 of events that the amount of the decrease 
 represents cash realized. Assets may be, of 
 course, writen down or taken off from the 
 books altogether without producing anything 
 but loss, but where reserve accounts are kept 
 and property is carried at cost, it is not prob- 
 able that the asset values were reduced ex- 
 cepting for cash realized. 
 
 The Accounts Receivable, 
 
 On December 31, 1910, amounted to. .$49,744,919 
 While on December 31, 1911, the 
 
 amount was 26,077,802 
 
 A decrease of $23,667,117 
 
 which means that an amount equal to the 
 entire current accounts for the year was col- 
 lected, and additional collections were made 
 to the extent of $23,667,117, thus increasing 
 the company's working capital by this 
 amount.
 
 186 Net Worth and the Balance Sheet 
 
 On the other hand 
 
 Cost of Property in 1911 was $610,999,964 
 
 While in 1910 the amount was 557,417,146 
 
 An increase of $53,582,818 
 
 which shows that an increase of property 
 took place during the year, consuming funds 
 to the extent of $53,582,818. That this did 
 not all come from capital, either in the form 
 of share capital or increase in bonded in- 
 debtedness, is clear when we observe that the 
 outstanding capital stock actually decreased. 
 While the bonded debt increased $37, 106,357, 
 the amount is still about $16,000,000 less 
 than the additions to plant. 
 
 Comparison of Asset and Liability Variations 
 
 Where did the company obtain the funds 
 to purchase this additional property? We 
 know that the increase of liabilities, repre- 
 sented by accounts or notes payable, or by 
 bonded debt or share capital, should produce 
 a corresponding increase of assets in some 
 form, and that the reduction of such liabili- 
 ties calls for the parting with assets.
 
 Comparison of Balance Sheets 187 
 
 Combining the decrease of assets and the 
 increase of liabilities, we get the following 
 results : 
 
 DECREASES OF ASSETS AND INCREASES 
 OF LIABILITIES: 
 
 Contracts (decrease) $4,269,400 
 
 Accounts Receivable (decrease) 23,667,117 
 
 Cash (decrease) 4,506,933 
 
 Bonded Debt (increase) 37,106,357 
 
 Bills Payable (increase) 1,845,318 
 
 Surplus and Reserves (increase) 23,898,141 
 
 Total $95,293,266 
 
 This represents the total amount which 
 during the year became available for expen- 
 diture on any one of the items in the balance 
 sheet. Of course this calculation does not 
 furnish us with the gross earnings or the 
 operating expenses. We do not have the 
 profit and loss statement before us. That 
 has all been boiled down to the remaining 
 "Surplus and Reserves," the increase of 
 which is all we have to serve as a guide. Fur- 
 ther along the line of detailed operation we 
 cannot go, but we do know that after cur-
 
 188 Net Worth and the Balance Sheet 
 
 rent operating revenues and expenditures 
 have been accounted for, there is a decrease 
 of assets and an increase of liabilities aggre- 
 gating $95,000,000, which was spent some- 
 where. Where did the money go ? 
 
 Our answer will be found if we take all of 
 the items of 
 
 INCREASES OF ASSETS AND DECREASES 
 OF LIABILITIES: 
 
 Cost of Property (increase) $53,582,818 
 
 Inventories (increase) 3.939,355 
 
 Investments (increase) 26,599,805 
 
 Capital Stock (decrease) 8,258,633 
 
 Accounts Payable (decrease) 2,912,655 
 
 Total $95,293,266 
 
 We have thus fully accounted for the ex- 
 penditure of the funds. That part of the 
 funds expended which was not derived from 
 an increase in the bonded debt, less retire- 
 ment of share capital with the small increase 
 in Bills Payable, came from the earnings of 
 the company and collections of accounts. 
 A Study of Earnings 
 
 We have one more fact, obtained from the
 
 Comparison of Balance Sheets 189 
 
 public records, showing that this company 
 paid 7 per cent, dividends during 1911 on its 
 entire capital stock; an aggregate of over 
 $24,000,000 being so disbursed. Taking this 
 fact into consideration with the balance 
 sheet, where we see an increase in the surplus 
 and reserve accounts of nearly $24,000,000, 
 it will be seen that this company earned about 
 14 per cent, on its capital stock. 
 
 When we know something about the earn- 
 ings of a corporation we can go still further 
 in a dissection of its balance sheet. In one 
 case it was claimed by parties interested that 
 a certain corporation was charging off for 
 depreciation entirely too large an amount. 
 Upon analysis it was found that the depre- 
 ciation charge for the year was $270,000. 
 The amount of this depreciation charge was 
 stated as a Reserve for Replacement, the 
 annual amount being charged to the Profit 
 and Loss account and credited to the account 
 as described. Condensed statements of as- 
 sets and liabilities and earnings only were 
 submitted. The increase in the amount of 
 the plant during the last year aggregated
 
 190 Net Worth and the Balance Sheet 
 
 $407,375.12, while the capital account was 
 not increased at all. 
 
 An analysis was made as follows: 
 
 Net earnings from operations $485,330.33 
 
 Add increase in current liabilities. . . . 27,648.65 
 
 $512,978.98 
 Deduct increase in current assets. . . . 42,392.64 
 
 $470,586.34 
 
 Reserve account at the beginning of 
 
 the year $60,133.63 
 
 Add appropriation for the year 270,000.00 
 
 Amount available for replacements 
 
 during the year 
 Amount of Reserve account at end of 
 
 year 266,922.41 
 
 Amount expended in replacements... $63,211.22 
 
 Now if we bring down the amount of 
 available funds as shown in the foregoing 
 statement, $470,586.34, and deduct the 
 amount expended for replacements of worn- 
 out equipment, $63,211.22, we have a re-
 
 Comparison of Balance Sheets 191 
 
 mainder of $407,375.12, which represents 
 the amount taken out of earnings to provide 
 new capital items, agreeing with the differ- 
 ence between the plant account at beginning 
 and ending of the year. 
 
 Two things are observed here. First, the 
 management, instead of paying dividends, 
 used the earnings to buy additional plant; 
 and, second, the depreciation charge to Profit 
 and Loss for the purpose of providing a re- 
 serve for the replacement of worn-out equip- 
 ment was larger than was actually neces- 
 sary. 
 
 The cash earnings of the company were 
 thus consumed and no dividends declared 
 a matter in which the stockholders would nat- 
 urally be interested. 
 
 Tracing Increases of Assets 
 
 Another interesting phase of increased 
 assets is shown in the following comparison 
 of two balance sheets of the Rodman Pro- 
 duction Company, taken at the close of two 
 successive years:
 
 192 Net Worth and the Balance Sheet 
 
 Assets 
 
 1908 1909 
 
 Cash .................. $27,37077 $17,909-97 
 
 Accounts Receivable. ...165,659.31 146,293.18 
 
 Stock ................. 97,049-75 496,439-8o 
 
 Real Estate ............ 223,329.30 251,572.52 
 
 Good-Will ............ 150,000.00 150,000.00 
 
 Deficit ................. 50,123.99 
 
 $7I3,533-I2 $1,062,215.47 
 
 Liabilities 
 
 Notes Payable ........ $133,565-96 $165,989.59 
 
 Accounts Payable ..... 79,967.16 230,026.21 
 
 Surplus .............. 166,199.67 
 
 Capital Stock ......... 500,000.00 500,000.00 
 
 $1,062,215.47 
 
 It will be noticed that on the face of the 
 statements this company did remarkably well 
 during the last year, changing a deficit or 
 impairment of its capital in the amount of 
 $50,123.99 to a surplus of $166,199.67. If 
 we had access to the books we would probably 
 find that these two amounts added together 
 represent the credit to the Profit and Loss 
 account as its earnings for the year.
 
 Comparison of Balance Sheets 193 
 
 But note carefully the increase and de- 
 crease of assets and see whether anything 
 exists there to warn us against a too quick 
 conclusion that the company has actually 
 made all of the money that the improved con- 
 dition of its Surplus account would seem to 
 indicate. 
 
 The cash and accounts receivable among 
 the assets decreased about $28,000, and the 
 notes and accounts payable increased about 
 $180,000. But notice the increase in the 
 stock of manufactured goods, the amount in 
 excess of that of the previous year being 
 nearly $400,000. 
 
 The first thought which comes to mind is 
 that the stock has been piling up. Then one 
 is inevitably moved to ask at what price the 
 goods were valued in the inventory. If taken 
 at actual cost, the profit on the goods actually 
 sold during the year is remarkable. But if the 
 inventory was taken at selling price, the large 
 increase of stock is seen to be less than it 
 appears to be, and the large profit apparently 
 made in the one year is partly explained as 
 a book profit, not of course actually earned.
 
 194 Net Worth and the Balance Sheet 
 
 It is obvious that if finished goods are in- 
 ventoried by the manufacturer at any value 
 above cost, it will be possible for him to man- 
 ufacture a large stock of goods, and show a 
 profit, without selling a dollar's worth. 
 
 This concern borrowed about $180,000 
 additional capital, and probably put it all into 
 the increased stock, which if carried at cost 
 might show an increase of approximately 
 the amount borrowed; this in addition, of 
 course, to the increase made possible by the 
 expenditure of funds arising out of the 
 profits on the business which was actually 
 transacted. 
 
 Since the stock increased to an amount 
 over twice the amount of additional capital 
 obtained, it may be quite necessary for an 
 examination of the inventory values to be 
 made, in order to determine whether the ap- 
 parent profit was real and to eliminate any 
 profit taken in advance of the actual sale of 
 the goods. 
 
 In the case of a large tool manufacturing 
 company, this method of inventorying was 
 carried so far that in one year, when its sales
 
 Comparison of Balance Sheets 195 
 
 had decreased to about one-half of normal, 
 it was not only able to pay the usual dividend, 
 but to show in addition an increase in its 
 Surplus account. 
 
 If this process could go on indefinitely the 
 bed of a business man might easily be con- 
 structed of roses ; but the practice of realiz- 
 ing on anticipated profits leads sooner or 
 later to serious trouble. 
 
 There is no safe course for a merchant or 
 manufacturer to pursue other than that based 
 upon a complete understanding of his affairs. 
 Such a statement, if prepared according to 
 the outline which we have discussed in this 
 little book, ought to furnish him with at least 
 the foundation of that understanding.
 
 INDEX 
 
 Accommodation Notes, 39-41, 174-176. 
 Account, Cost of Property, 183, 184. 
 Accounts, Changes in, 17, 18. 
 Accounts Payable, 120-123. 
 
 Not Due, 121, 122. 
 
 Overdue, 121, 122. 
 Accounts Receivable, 17, 18, 48-61. 
 
 Advances, 61. 
 
 as Collateral, 49-51. 
 
 Bad and Doubtful, 56, 57, 74. 
 
 Collecting, 58-60. 
 
 from Allied Interests, 60, 61. 
 
 "Good," 52, 53. 
 
 in which Surplus May Appear, 150, 151. 
 
 Overdue, 53-55. 
 
 Restricted Meaning of, 49, 51, 52. 
 
 Unsettled Charges, 57, 58. 
 Accrued Liabilities, 135-137. 
 Advances of Cash, 61. 
 Analysis of Balance Sheet, 178-181. 
 
 of Earnings, 190, 191. 
 Arrangement of Balance Sheet, 19-22. 
 Assigned or Pledged Notes Receivable, 45-47. 
 
 Entry of, 47. 
 Assets, 
 
 Deferred, 112. 
 
 Increases of, Tracing, 191-195. 
 
 Other, 28-29, 98-115. (See also Other Assets.) 
 197
 
 198 Index 
 
 Assets (Continued) 
 Valuation of, 15, 16. 
 Variations in, 186-188, 191-195. 
 
 B 
 Bad and Doubtful Accounts, 56, 57, 74. 
 
 Reserve for, 158-160. 
 Balance, Cash, 23, 24. 
 Balance Sheets, 17-22, 178-195. 
 Analysis of, 178-181. 
 Arrangement of, 19-22. 
 Comparison of Successive, 182-195. 
 A Study in Earnings, 188-191. 
 Cost of Property Account, 183, 184. 
 Results of Operation, 184-186. 
 Tracing Increases of Assets, 191-195. 
 Form of, 18-22, 144. 
 
 English, 19, 20. 
 Readings from, 179-195. 
 Bank, Cash in, 24-28. 
 Bills Payable, 116, 117. 
 Bills Receivable, 31. 
 Bonded Debt, 127-129. 
 Bonds, Kinds of, 128, 129. 
 Books, Notes Receivable, 173. 
 Building Up Secret Reserves, 169-171. 
 Buildings, 89, 90. 
 
 Depreciation of, 162, 166. 
 Business Investments, 100, 101. 
 
 C 
 
 Capital or Net Worth, 138-140. 
 Capital Stock, 140-146. 
 
 Common, 140, 141, 143. 
 
 Entry of, 140. 
 
 Issued for Property, 143-146.
 
 Index 199 
 
 Capital Stock (Continued) 
 
 Preferred, 140-143, 145. 
 Cash, 23-30. 
 
 Balance, 23, 24. 
 
 in Bank, 24-28. 
 Deposits, 25-27. 
 
 on Hand, 28, 29. 
 
 Petty, 29, 30. 
 
 Changes in Accounts, 17, 18. 
 Classification of Surplus, 151. 
 Collateral, Accounts Receivable as, 49-51. 
 
 Merchandise as, 70, 71. 
 
 Notes Payable as, 118, 119. 
 
 Notes Receivable as, 45-47. 
 Collecting Accounts Receivable, 58-60. 
 Collections, 27, 28. 
 Common Stock, 140, 141, 143. 
 Comparison of Asset and Liability Variations, 186-188, 191- 
 
 195. 
 Comparison of Successive Balance Sheets, 182-195. 
 
 A Study in Earnings, 188-191. 
 
 Cost of Property Account, 183, 184. 
 
 Results of Operation, 184-186. 
 
 Tracing Increases of Assets, 191-195. 
 Consignments, 76, 77. 
 Contingent Liabilities, 172-177. 
 
 Accommodation Paper, 174-176. 
 
 Not Shown by Books, 176, 177. 
 
 Notes Discounted, 172-174. 
 Corporate Deficit, 155, 156. 
 Corporate Surplus, 152-156. 
 
 Liability for, 154, 155. 
 Cost, Manufacturing, 69, 73-76. 
 
 of New Business, 107, 108. 
 
 Records and Prices, 68-70. 
 Cost of Property Account, 183, 184.
 
 200 Index 
 
 D 
 
 Debentures, 129. 
 
 Debt, Bonded, 127-129. 
 
 Debts, Bad and Doubtful, 56, 57, 74. 
 
 Reserve for, 158-160. 
 
 Decreases of Assets and Liabilities, 186-188. 
 Deferred Assets, 112. 
 Deficit, Corporate, 155, 156. 
 Deposits, 25-27, 124-126. 
 Depreciation of Machinery and Fixtures, 166. 
 
 of Plant, 160-164. 
 
 Reserve for, 160-164, 166. 
 Discounting Notes Receivable, 32-37, 172-174. 
 
 Entry of, 33-36. 
 
 Earnings, A Study in, 188-191. 
 
 Surplus Not from, 148-150. 
 Employes' Savings Fund, 124, 125. 
 Entry of Capital Stock, 140. 
 
 of Mortgages, 131-133. 
 
 of Notes Receivable, 33-36. 
 
 F 
 
 Finished Product, 72-77. 
 
 Consignments, 76, 77. 
 
 Manufacturing Cost of, 73-76. 
 
 Valuation of, 73-76. 
 Fixtures, Furniture and, 96, 97. 
 
 Machinery and, 91-95. 
 
 Depreciation of, 166. 
 Form of Balance Sheet, 18-22, 144. 
 
 English Form, 19, 20. 
 Fund, Employes' Savings, 124, 125. 
 
 Imprest, 29, 30.
 
 Index 201 
 
 Fund ( Continued ) 
 
 Reserve, 163-166. 
 
 Sinking, 164-166. 
 Furniture and Fixtures, 96, 97. 
 
 "Good" Accounts Receivable, 52, S3. 
 "Good" Notes Receivable, 37, 38. 
 Goods. (See Merchandise.) 
 Good-Will, Valuation of, 108-111. 
 
 H 
 
 Hidden Resents, 167-171. 
 
 I 
 
 Imprest Fund, 29, 30. 
 Increases of Assets, Tracing, 191-195. 
 
 of Assets and Liabilities, 186-188, 191-195. 
 Inventory, Machinery, 94, 95. 
 
 Perpetual, 79-82. 
 Investments, Business, 100, 101. 
 
 Reserve Fund, 112-114. 
 
 Land and Buildings, 89, 90. 
 
 Leaseholds, 89. 
 
 Liability of Corporation for Surplus, 154, 155. 
 
 of Mortgagor, 131, 132. 
 Liabilities, 
 
 Accrued, 135-137. 
 
 Contingent, 172-177. (See also Contingent Liabilities.) 
 
 for Taxes, 137. 
 
 Other, 134-137. 
 
 Pay Roll, 136. 
 
 Variations in, 186-188, 191-195.
 
 202 Index 
 
 M 
 
 Machinery Fixtures, 91-95. 
 
 Depreciation of, 166. 
 
 Inventory, 94, 95. 
 
 Partly Paid, 95. 
 
 Valuation of, 92-95. 
 Manufacturing Cost, 69, 73-76. 
 Materials, 
 
 Finished, 72-77. 
 
 Partly Finished, 78-82. 
 
 Raw, 83-85. 
 Merchandise, 62-71. 
 
 as Collateral. 70, 71. 
 
 on Hand, 70, 71. 
 
 Valuation of, 62-70. 
 Missionary Work, 107, 108. 
 Mortgages, 127-129, 130-133. 
 
 Entry of, 131-133. 
 
 Securing Bonds, 127-129. 
 Mortgagor, Liability of, 131, 132. 
 
 N 
 
 Net Worth, 13-16, 138-140, 153, 167, 168. 
 
 Definition of, 13. 
 
 Indicates Business Progress, 16. 
 
 Theory of, 13-15. 
 
 What Constitutes, 14, 15. 
 "New Business" Cost, 107, 108. 
 Non-Negotiable Notes, 39. 
 Notes, Accommodation, 39-41, 174-176. 
 Notes Payable, 116-119. 
 
 for Money Borrowed, 118, 119. 
 Notes Receivable, 31-47. 
 
 Accommodation, 39-41, 174-176.
 
 Index 203 
 
 Notes Receivable (Continued) 
 as Collateral, 45-47. 
 Assigned or Pledged, 45-47. 
 
 Entry of, 47. 
 Book, 173. 
 Discounting, 32-37, 172-174. 
 
 Entry of, 33-36. 
 "Good," 37-38. 
 Non-Negotiable, 39. 
 Not in Ordinary Course, 41-45. 
 Pledged as Collateral, 47. 
 
 Operation, Results of : 184-186. 
 Other Assets, 28, 29, 98-115. 
 
 Business Investments, 100, 101. 
 
 Cost of "New Business," 107, 108. 
 
 Deferred Assets, 112. 
 
 Other Investments, 114, 115. 
 
 Reserve Fund Investments, 112-114. 
 
 Treasury Stock, 99, 100. 
 
 Valuation of Good-Will, 108-111. 
 
 Valuation of Patterns, 101-105. 
 
 Valuation of Trade-Marks, 105, 106. 
 Other Liabilities, 134-137. 
 Overdue Accounts Payable, 121, 122. 
 Overdue Accounts Receivable, 53-55. 
 
 Analysis of, 54, 55. 
 
 Paper, Accommodation, 39-41, 174-176. 
 Partly Finished Product, 78-82. 
 
 Cost of, 78-82. 
 
 Perpetual Inventory, 79-82.
 
 204 Index 
 
 Partly Finished Product (Continued) 
 
 Patterns, Valuation of, 101-105. 
 
 Pay Roll Liability, 136. 
 
 Perpetual Inventory, 79-82. 
 
 Petty Cash and Imprest Fund, 29, 30. 
 
 Plant, Depreciation of, 160-164, 166. 
 
 Pledged Notes Receivable, 45-47. 
 
 Entry of, 47. 
 
 Preferred Stock, 140-143, 145. 
 Prices, Fixing, 68-70. 
 Product, 
 
 Finished, 72-77. 
 
 Partly Finished, 78-82. 
 Fronts, 147-156. (See also Surplus.) 
 
 Taking, 63, 64, 68, 69. 
 Property Account, 183, 184. 
 
 Stock Issued for, 143-146. 
 
 R 
 
 Raw Material, 83-85. 
 
 Valuation of, 83, 84. 
 Real Estate, 87-90. 
 
 Leaseholds, 89. 
 
 Mortgages on, 127-133. 
 
 Valuation of, 87, 88. 
 Reserve Fund Investments, 112-114. 
 Reserves, 157-171. 
 
 for Bad and Doubtful Debts, 158-16U 
 
 for Depreciation of Machinery and Fixtures, 166. 
 
 for Depreciation of Plant, 160-164, 166. 
 
 Fund, 163-166. 
 
 Hidden or Secret, 167-171. 
 Building Up, 169-171.
 
 Index 206 
 
 Reserves ( Continued ) 
 
 Sinking Fund, 164-166. 
 Rights of Stockholders, 155. 
 
 Secret Reserves, 167-171. 
 
 Building Up, 169-171. 
 Sinking Fund, 164-166. 
 Stock, 
 
 Capital, 140-146. 
 
 Common, 140, 141, 143. 
 
 Issued for Property, 143-146. 
 
 Preferred, 140-143, 145. 
 
 Treasury, 99, 100. 
 Stockholders, Rights of, 155. 
 Supplies on Hand, 85, 86. 
 Surplus, 147-156. 
 
 Accounts in Which It May Appear, 150, 151. 
 
 Classification of, 151. 
 
 Corporate, 152-156. 
 Liability for, 154, 155. 
 
 Meaning of, 147. 
 
 Not from Earnings, 148-150. 
 
 Where Entered, 150, 151. 
 
 Taxes, Liability for, 137. 
 Theory of Net Worth, 13-15. 
 Trade-Marks, Valuation of, 105, 106. 
 Treasury Stock, 99, 100. 
 
 Valuation of Assets, 15, 16. 
 of Finished Product, 73-76,
 
 206 Index 
 
 Valuation (Continued) 
 
 of Good- Will, 108-111. 
 
 of Machinery, 92-95. 
 
 of Merchandise, 62-70. 
 
 of Patterns, 101-105. 
 
 of Raw Material, 83, 84. 
 
 of Real Estate, 87, 88. 
 
 of Trade-Marks, 105, 106. 
 Variations in Assets and Liabilities, 186-188, 191-195.
 
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