THE ARTHUR YOUNG ACCOUNTING COLLECTION Graduate School of Business Administration Library of the University of California Los Angeles - 23 ACCOUNTING PRINCIPLES THE MACMILLAN COMPANY NEW YORK BOSTON CHICAGO DALLAS ATLANTA SAN FRANCISCO MACMILLAN & CO.. LIMITED LONDON BOMBAY CALCUTTA MELBOURNE THE MACMILLAN CO. OP CANADA, LTD. TORONTO ACCOUNTING PRINCIPLES THEIR USE IN BUSINESS MANAGEMENT BY SPURGEON BELL, M.B.A. PROFESSOR OF BUSINESS ADMINISTRATION IN THE UNIVERSITY OF TEXAS THE MACMILLAN COMPANY 1921 All rights reserved 46044 PRINTED IN THE UNITED STATES OF AMERICA COPYRIGHT, 1919, BY SPURGEON BELL COPYRIGHT, 1921, BY THE MACMILLAX COMPANY Set up and electrotyped. Published December. I9JI. Bus. Admin. Library TO MY FORMER TEACHER AND COLLEAGUE PROFESSOR H. J. DAVENPORT THIS BOOK IS AFFECTIONATELY DEDICATED PREFACE IT has been the aim in the preparation of this book to pre- sent the principles of accounting in their relation to business management. An effort has been made to aid the reader in a ready grasp of the principles by the free use of illustrative solutions of problems and exercises. These illustrative solu- tions also serve a useful purpose in the teaching of good form in accounting work. ." The business man, who lacks the time to work through ^ tedious routine, will find that the illustrative forms and solu- 0* tions which are presented in connection with the discussion of the principles will facilitate an understanding of the sub- Qj'ects discussed. He will also find that the text has many ^ accounting forms and statement forms which will make it a j useful reference volume. The text is supplied both with special problems and exer- . cises illustrating the principles of the separate chapters and d with a set of business transactions designed to form the basis f' for a continuous set of books illustrative of accounting prin- ** ciples for a small individual business, a partnership, and a cor- poration. In the continuous set the student will have good discipline in opening the books, in transferring a business, and in arranging for a continuous routine such as may be involved in carrying forward a regular set of books. A more hasty reading of the book by one already trained in routine need not involve the more tedious work of the continuous set. The exercise and problem material of the text have been developed during eight years of teaching of the Principles of Accounting. During five of these eight years the late Major J. E. Treleven was associated with the author in accounting instruction, and contributed much of the special problem vm PREFACE material found in the text. He also criticised the exercise material and assisted in its preparation. The author wishes also to acknowledge his obligation to his colleague, Mr. F. W. Graff, for criticism and improvement in the English of the manuscript. The author wishes to call special attention to the sets of ruled note paper furnished by the publisher to be used with this text. TABLE OF CONTENTS CHAPTER PAGE I THE BALANCE SHEET . . . . . .' . i II INCOMES AND EXPENSES . .' 12 III THE> ACCOUNTS AND THEIR RELATION TO THE STATEMENT 21 IV THE JOURNAL AND LEDGER . . . ... . 43 V THE FORM AND USE OF COMMERCIAL PAPERS . . 56 VI .THE DIVIDED JOURNAL AND THE TRADING ACCOUNT . 71 VII JANUARY TRANSACTIONS OF THE VALLEY FURNITURE STORE 92 VIII PETTY CASH . .106 IX APPORTIONMENT OF EXPENSES TO APPROPRIATE PERIOD DEPRECIATION AND REPAIRS 112 X CLOSING AND OPENING ENTRIES INVOLVED IN THE TRANSFER OF A BUSINESS 130 XI APPORTIONMENT OF INCOME AND EXPENSE . . .135 XII INTERPRETATION AND MANAGERIAL USE OF THE REVENUE STATEMENT 146 XIII THE FORM AND MANAGERIAL USE OF THE BALANCE SHEET 162 XIV INTERNAL ANALYSIS OP BALANCE SHEET AND REVENUE STATEMENT 182 XV CONTROLLING ACCOUNTS AND COLUMNAR BOOKS . . 187 XVI THE BILL BOOK ' 214 XVII TRANSACTIONS FOR FEBRUARY 222 XVIII CLOSING THE BOOKS FOR PERIODICAL REPORTS . . 239 XIX CONSIGNMENTS 245 XX TRANSACTIONS FOR MARCH 285 XXI THE INCOMING AND WITHDRAWAL OF PARTNERS . . 294 XXII DISTRIBUTION OF THE PARTNERSHIP PROFITS . . . 305 XXIII LIQUIDATION OF A SOLVENT PARTNERSHIP . . .313 XXIV CORPORATE ORGANIZATION AND ACCOUNTING . . .328 XXV CAPITAL STOCK ACCOUNTS AND THE ISSUE OF CORPORATE SHARES .......... 342 ix TABLE OF CONTENTS XXVII XXVHI XXIX XXX XXXI XXXII xxxm PAGE CHANGING TO THE CORPORATE FORM OF ORGANIZATION- . 352 BOND ACCOUNT 364 CHANGES IN THE VALUE op THE PROPRIETARY INTEREST OF THE CORPORATION . . . . . . 375 CORPORATION RECORDS 399 COST ACCOUNTS AND TYPES OF COST ACCOUNTING . . 410 THE MANUFACTURING PROFIT AND Loss STATEMENT . 433 THE VOUCHER RECORD AND THE ESTIMATING COST SYSTEM 447 OPENING THE CORPORATION BOOKS FOR APRIL TRANSAC- TIONS 458 APPENDIX: The Working Sheet 475 INDEX ........ . . . 4.79 LIST OF ILLUSTRATIONS PACK 1. An Account with a Customer 22 2. Cash Account 25 3. An Account with a Creditor 27 4. Merchandise Account 31 5. Set of Accounts 37 6. Journal Entries . -49 7. Purchase Invoice ' 57 8. Promissory Note 59 9. Bill of Exchange 62 10. Check 64 11. Bank Draft 64 12. The Divided Journal 78 13. Petty Cash Book 108 I3A. Petty Cash Book 109 14. Condensed Statement of Departmental Profits . . -151 15. Merchandise Stock Ledger 153 16. Pro Forma Revenue Statement . 157 17. Comparative Revenue Statements . . . . . -159 18. Form of General Balance Sheet Statement as Prescribed by the Interstate Commerce Commission for Steam Roads . . 169 19. Estimated Receipts and Disbursements 174 20. Valley Furn. Co. Comparative Balance Sheet, December 31 175 21. Account Form of Balance Sheet 176 22. Columnar Journal and Controlling Accounts .... 200 23. Notes Receivable Journal 216 23A. Notes Payable Journal 218 24. Sales Register, Including Provision for Consignment Sales . 246 25. Account Sales 250 26. The Book of the Consignor 262 27. Valley Furn. Co. Comparative Balance Sheet . . . 339 xii LIST OF ILLUSTRATIONS PAGE 28. Subscription Blank 399 29. Subscription Installment No. i 400 30. Subscription Ledger 401 31. Stock Transfer 403 32. Stock Ledger 405 33. Bond Register . . V V v< ' . . . . . . 406 34. Coupon Bond Register 408 35. Form for Revenue Statement Manufacturing and Merchandising Business Combined . . . . -. ... 434 36. Valley Furn. Co. Manufacturing Statement (Comparative) . 440 37. Voucher Register . 450 38. Voucher (Front) 452 39. Voucher Check 454 40. Profit and Loss (Sectionalized) 474 ACCOUNTING PRINCIPLES ACCOUNTING PRINCIPLES CHAPTER I THE BALANCE SHEET 1. Property. The word property signifies things that are owned by an individual, a firm, or a corporation. These things may consist of houses, lands, stocks, bonds, mortgages, evi- dences of debt (such as open accounts and notes), franchises, goodwill, and other valuable rights in short, of anything, either tangible or intangible, with which the owner would not ordinarily part without a consideration. Property is also fre- quently spoken of as assets. The assets of an individual, a firm, or a corporation, therefore, are all the property that each may own. 2. The Business Unit. Much confusion will be saved if the student will from the beginning think of the ownership of property and of the conduct of a business in terms of the busi- ness itself, rather than in terms of the individuals who may de- rive certain benefits therefrom. The business, whether con- trolled by an individual, a firm, or a corporation, owns all the assets of the concern, and holds them subject to the claims of the proprietors and creditors. In fact, a business is frequently thought of as owing some one for all the assets that it may hold. 3. The Individual Business Unit. The assets of a business controlled by an individual are not necessarily all owned by the particular individual, though they are, of course, all owned by the business itself. The individual may contribute all the assets of the business, in which case the business owes no one except the owner. His interest is ordinarily called the propri- etary interest or proprietorship. Frequently, however, a busi- ness buys merchandise on credit from outside parties without giving to them any power of control over the business except 2 ACCOUNTING PRINCIPLES such as might accrue through nonpayment of the obligations due. Where such purchases are made, the business is indebted to the owner for his contribution of assets and to the outside parties for the merchandise bought. An individual may, there- fore, be the owner of a controlling interest though not of all the assets of a business. A business is sometimes spoken of as an enterprise, and the owner of the controlling interest as the enterpriser. The debts or liabilities of a business controlled by an indi- vidual are ordinarily paid, when due, by the business itself. Should the business be unable to meet its obligations at matur- ity, the owner must pay them out of other property or assets he may own, even though the business is indebted to him for the assets he has contributed to it. In other words, the debts of the business become the debts of the owner or enterpriser whenever the business is unable to pay them. Whenever all the assets are sold the cash proceeds must be applied first to pay all liability interests. The balance is then distributed to the proprietors on the basis of their proprietary interests. 4. The Firm or Partnership. Whenever two or more indi- viduals combine to secure the controlling interest hi an enter- prise under the terms of what may be called a general partner- ship, they each assume the same responsibility for the debts of the business that the single individual assumes for the debts of the individual business. The firm itself is initially responsible for its debts; but, if the business cannot pay them, the mem- bers of the firm or partnership are jointly and severally re- sponsible and must meet the claims from other property or assets owned by them. 5. The Limited Partnership. Many of the states have passed laws providing for the organization of limited partner- ships, where the members are not responsible for all of the debts created by the firm. The rules and regulations under which such firms are organized vary, of course, hi the several states. 6. The Corporation. The corporation is the most con- venient form of organization for securing a large amount of THE BALANCE SHEET 3 assets under the control of a single business unit. A corpora- tion ordinarily has shares of stock of a given par value, the ownership of more than half the shares giving control of the corporation. Although the stockholders have the power to con- trol the business, they ordinarily vest this power in a board of directors. The board of directors in turn selects officers to con- duct the business. The corporation, like other forms of business units, borrows money and buys assets on time. It is therefore indebted, not only to the stockholders for the funds they have invested, but frequently to outside parties for goods bought on credit and for money borrowed. The stockholders, however, do not become personally responsible for the debts of the corpora- tion, except to the extent of their interest in its assets. The business itself is solely responsible for debts, and only its assets can be drawn on to pay the debts of the business in case they are not paid in the regular course of operation. 7. Liabilities and Proprietorship. The foregoing is a brief statement of the nature of business units, made for the purpose of throwing light on the meaning of assets and liabilities. The assets of a business unit, as indicated in the beginning, are the things owned. The claims against assets are, then, divided into two classes or equities: (a) liabilities, and (b) proprietorship. The owners of these claims are the parties interested in the business unit. The owners of the proprietary interest control the property and supervise its operation so long as the business is able to comply with its contracts with the owners of liability claims. It is, however, frequently provided in the contract between the business and the holders of liability claims that the latter take control of the business if it fails to comply with its contract obligations to the owners of these liability interests. It is common in accounting literature to see a general equa- tion or general foundation principle laid down in the form of the statement that "the assets less liabilities equal proprietor- ship." Of course it is just as true that assets less proprietor- ship equal the liabilities. The reason that both of these gener- alities are true lies in the more fundamental fact that the total 4 ACCOUNTING PRINCIPLES of ownership in assets is equal to the total of assets, since both the ownership and the assets are expressed hi terms of dollars. No assets are contributed to business under a system of private enterprise unless the contributor receives in exchange a claim against the assets equal to the valuation or price placed on the asset received by the business unit which receives it. Of course a business unit may receive certain assets and exchange there- for some other asset of equal value, but there arises no increase in assets by such an exchange. All increases in the total assets of a business are accompanied by a like increase hi the out- standing claims against the assets, the increase taking the form of an increase in either the liability claims or hi the proprietor- ship claims. 8. Proprietorship. In the case of the individual business the proprietorship claim is ordinarily spoken of as the capital of the proprietor. In the case of the partnership the propri- etary interest consists of the ownership claims of the partners which are called their capitals. When an entirely new corpora- tion is organized it begins ordinarily with a proprietary interest represented by the capital stock or capital shares of the own- ers. The par value of these shares is generally held to repre- sent the hi vestments of the proprietors hi the business. If these shareholders turn over property to the corporation in payment for their interests, this property is frequently, in fact, worth less than may be indicated by the par value of the shares received by the proprietors in question. The laws of the various states generally require that only paid-up shares may be issued, but at the same time these states do not so interpret and administer these laws that one can feel assured that the par value of the shares issued always signifies the value of the investments originally made by the proprietors. Increases in the proprietary interest arising from ordinary business opera- tions are added directly to capital hi the case of the individual business and in the case of the partnership. The corporation does not increase the issue of capital shares except by special authorization of the directors. The ordinary increases in pro- prietorship of the corporation are recorded under the caption of THE BALANCE SHEET 5 surplus, so that the entire interest of the proprietor is repre- sented by the capital stock plus the surplus. 9. Balance Sheet. A balance sheet is a statement of the assets and liabilities of a business. It may be illustrated for the several types of business units as follows: 10. The Balance Sheet of the Individual Business. Assets Liabilities Cash $5,400 . oo Notes Payable Bank $2,000 . oo Notes Receivable 4,500.00 Accounts Payable Accounts Receivable Valley Furn. Co. 2,500.00 John Jones 500.00 Rocky Mountain Ralph Reynor 300.00 Univ. 500.00 C. R. Kenedy 275.00 Desk and Chair Co. 1,500.00 Merchandise Inventory 10,000 . oo Mortgage Payable 10,000.00 Buildings 7,500.00 John Smith, Capital 21,975.00 Land 10,000 .00 M - L = */_5. {*) $38,475.00 $38,475.00 ii. The Balance Sheet of the Partnership and the Corpora- tion. If, in the foregoing statement, we should substitute for the item John Smith, Capital, $21,975.00, the following items John Smith, Capital .... $10,975.00 John Randolph, Capital . . . 11,000.00 we should have the balance sheet of the partnership firm of Smith and Randolph. If, for the same item, we should substitute the following items ., , c,. , Capital btock $20,000.00 Surplus 1,975.00 we should have the balance sheet of the corporation. It is evident, therefore, that there is no difference in the bal- ance sheets of the various types of business organizations ex- cept in the form of the statement of the liability to the owners, or, if there is objection to calling the capital account a liability account, in the form of the statement of the net worth or pro- prietorship interest. ACCOUNTING PRINCIPLES 12. The Financial Statement. Many accounting texts, in order to bring out clearly that the net worth or proprietorship interest of a business unit is always found by subtracting the outside liabilities from the total assets, adopt the financial statement form of setting forth the assets and liabilities. This form may be illustrated as follows: JOHN SMITH FINANCIAL STATEMENT, DECEMBER 31, 1918 Assets, or Resources Cash $5,400.00 Notes Receivable 4, 500 . oo Accounts Receivable John Jones $500.00 Ralph Reynor 300.00 C. R. Kenedy 275.00 1,075.00 Merchandise 10,000.00 Buildings 7 , 500 . oo Land lo.ooo.oo Total Assets $38,475.00 Liabilities Notes Payable Bank Accounts Payable Valley Furniture Co. Rocky Mountain Univ. Desk and Chair Co. Mortgage Payable Total Liabilities Net Worth (John Smith, Capital) 2,000.00 $4,500.00 10,000.00 16,500.00 $21,975.00 From this illustration, it is evident that, so far as the finan- cial statement is employed, it serves mainly to emphasize that the net worth or proprietorship interest is the balance resulting from the subtraction of the outside liabilities from the total assets. The use of the balance sheet, however, for this purpose may be entirely defended on the ground that the balance of an account is usually set down as the last item, without any actual subtraction. Indeed, the balance sheet, and not the THE BALANCE SHEET 7 financial statement, is the form commonly used in published financial exhibits. 13. The Order of the Statement of Assets and Liabilities in the Balance Sheet. For a merchandise concern, the usual order of assets and liabilities is that found in the balance sheet given above. This order is essentially for the benefit of the creditors, who are most interested, on the one hand, in the cash items and the items currently turned into cash, and, on the other, in the items that must be met from month to month out of the proceeds of current operations. The capital item is usually placed last, being regarded as the balance of the in- vestment of the owners in the enterprise. This question of the order of items will recur as other state- ments are made from time to time. 14. Grouping of Assets and Liabilities. It is not sufficient for all purposes to know simply the totals of assets, liabilities, and proprietorship. If John Smith had no liabilities and asked a bank loan of $20,000.00, the bank would wish to know not merely the total assets but the character of the assets. How much of these assets could be readily turned into cash? How much of the assets will be sold in the next sixty to ninety days in the ordinary course of business? If the bank loan is to mature in ninety days, there must be in sight some source from which the funds are to be secured to liquidate the bank loan. If the borrowed funds themselves are to be used to purchase goods which will be sold within ninety days, the sale of the goods will furnish the funds to pay the loan. If the business had in addition other goods which will be sold, the security of the loan is further improved. The bank would consequently ask John Smith to present a balance sheet showing the assets which are to be turned into cash in the ordinary course of busi- ness. These assets are called the current assets. The assets which are to be used regularly in connection with the business and were not purchased for sale are the fixed assets. They are not looked to as the source of the funds which may be used to pay current loans to banks and other creditors. They would be of particular significance in connec- 8 ACCOUNTING PRINCIPLES tion with long-time loans and are of some significance even in connection with short-time loans. There is another type of asset which is of the nature of a supply to be used up in current operation but not sold. These supplies are sometimes called deferred expense because they will become an expense as they are used up in regular operations. Other expenses paid in advance are likewise put in the same class of items. These items are not expected to be sold for cash, but their cost will generally be covered by the sale price of merchandise. 15. Grouping of the Liabilities. If loans are to be made to a business which already has liabilities outstanding, these become at once an important consideration. It is dangerous to lend to a business which may be unable to meet any of its liabilities. Moreover, the ability of a business to pay a par- ticular liability at maturity depends to some extent on the other liabilities which may be outstanding, and on the date of the maturity of these liabilities. It is, therefore, customary to classify the liabilities on the basis of the date of payment. If liabilities are to be paid out of the proceeds of sale and during the current fiscal period they are generally classified as current liabilities. Accounts payable and notes payable are current liabilities. The mortgage liabilities, the bond liabilities, and the notes having a long period to run are classified as fixed lia- bilities. It is also true of these liabilities that their ultimate payment is generally provided for either by provisions for grad- ual accumulation of an amount sufficient to pay the debt at maturity or by the issue of new notes, bonds, or liabilities, which will furnish the funds for the retirement of the old lia- bilities. These fixed liabilities are also frequently called funded liabilities. There are other classes of liabilities and also sub- divisions of the proprietary interest which will be discussed in later chapters. 1 6. Balance Sheet with Items Grouped. The following balance sheet of John Smith shows the items grouped so that the statement would serve the purpose of showing the credit position of the business: THE BALANCE SHEET 8 8 8 8 8 10 10 pT Tp O" * $ 8 8 8 <0 8 8 8 i 10 ^^o *o (N H i J4 .S2 rt 0^ ' w 1 J 1 j & 5^^1 H KJ i^ ~ Cd 3 &5 H .& <& J& w Sou a 5a Wo o n o 1C 8 CO ^. % o o W 10 ^- H" o" M i 8 8 8 pq 8 8 K tn **3 ^ qj Cy p -< d, CH Ci. O 3 CX u co s s w g W Tl S M3 2 Eo .2 I s-s u s IO ACCOUNTING PRINCIPLES 17. Financial Statement The balance sheet above is stated in the form of an account with assets appearing as debits, the liabilities as credits and the proprietorship as a balance of the account. This form of statement is easily read and interpreted by one who knows accounting, but the same facts can be indi- cated more plainly to a general reader by the financial state- ment form as follows: Current Assets Cash Notes Receivable Accounts Receivable John Jones Ralph Reynor C. R. Kenedy Merchandise Deferred Expense Office Supplies Fuel Supplies Insur. paid in adv. Fixed Assets Buildings Land Total Assets Current Liabilities Notes Payable Bank Accounts Payable Valley Furn. Co. Rocky Mt. Univ. Desk and Chair Co. $500.00 300.00 275.00 500.00 900.00 IOO.OO 6,000.00 10,000.00 Liabilities 2,500.00 500.00 1,500.00 Fixed Liabilities Mortgage Payable Total Liabilities Net Worth (John Smith, Capital) $5,400.00 4,500.00 1,075.00 10,000.00 1,500.00 16.000. oo 2,000.00 4,500.00 $38,475.00 IO.OOO.OO 16.500.00 $21,975.00 THE BALANCE SHEET n PROBLEMS AND QUESTIONS 1. On the books of D. F. Payne, the owner of a general merchandise business, there appear the following items: notes payable, $1500.0x2; accounts payable, $200.00; buildings, $4000.00; land, $1600.00; horse and wagon, $250.00; cash, $3286.00; accounts receivable, $1100.00. (a) What is the capital account of D. F. Payne? (b) Arrange the items into a balance sheet as of December 31, 1919. (c) Arrange the items into a financial statement as of December 31, 1919. 2. In the balance sheet of John Smith as given in the text, cash was set down first; notes receivable, second; accounts receivable, third; merchan- dise, fourth, etc. Give the reason for this order. 3. Give the reason for the arrangement of the liabilities in the order found in the same balance sheet. 4. In the balance sheet of John Smith, which liabilities represent the probable source (a) of the merchandise inventory; (b) of the cash; (c) of the land and buildings? 5. In case of the dissolution of a business controlled by an individual or a partnership, as illustrated in the balance sheets of John Smith and of Smith and Randolph, under what condition would the owner or owners (a) get their investment of $21,975.00 out of the business; (b) lose more than $21,975.00? 6. In case of the liquidation or dissolution of the corporation illustrated in the text, with a capital stock of $20,000.00 and a surplus of $1975.00, what is the maximum amount that the shareholders stand to lose? 7. Make a balance sheet with items grouped from the data of question No. i above. CHAPTER II INCOMES AND EXPENSES i. Income Items. No income items are found in the bal- ance sheet given in Chapter I. They represent increases in capital or proprietorship claims which have taken place in a period prior to the date of the balance sheet. Instead of sim- ply adding all these increases in capital directly to the capital item, they are analyzed according to the sources from which the incomes are received. They arise mainly from the sale of merchandise. Merchandise consists of those goods which are bought to sell. At any particular time the total of these goods is called the merchandise inventory. The business is carried on mainly for the purpose of selling the merchandise at a price hi excess of what it cost with a view to increasing the capital or the proprietorship interest. The student frequently confuses the property or asset received with the name of the source from which the asset is received. Cash may be received from the sale of merchandise, but the name of the revenue item involved is merchandise sales. No asset or property item should be designated as an income item. * If a transaction takes place which increases one asset item and decreases another by the same amount, no income item is affected. For example, accounts receivable are paid from time to time by customers without affecting the total assets which a business owns. Cash is increased by exactly the same amount that accounts receivable are decreased. Income may arise also from other sources such as rent of office space and perhaps from some business side line such as a repair shop. The income from such sources, however, is com- monly small as compared with the income from sales. All of these incomes are alike in that they represent increases hi what the business owns. They are increases hi capital or proprietor- ship. They are not the actual assets in which these increases in ownership are embodied. These assets may be cash, ac- 12 INCOMES AND EXPENSES 13 counts receivable, etc., but the revenue item is the name of the source from which the increase in assets was received. These income items are, of course, temporary items, since they are from time to time added in total to the capital and simply serve as an explanation of the sources from which the increase in capital was derived. 2. Expenses. These incomes, however, are subject to cer- tain deductions before the net is added to capital. The ex- penses are the cost which a business incurs in connection with getting its income. The purchase price of the goods sold rep- resents a cost which must be deducted from sales before any net income could be added to capital. There are other deduc- tions such as salaries of the sales force, the salaries of the ad- ministrative force, the expense of advertising, the expense of stationery and printing, etc. When all of the expenses thus incurred have been deducted from the incomes received, the balance is added to capital as an increase in capital or in the proprietorship interest. It is to be noted that the expenses are simply the classified names of the causes of expense. They are not the names of the property items which the business may sacrifice in getting the net profit which is added to capital. The business may part with cash when it pays for goods purchased, but merchandise purchases represents the expense item which must be deducted from the merchandise sales by reason of this sacrifice of cash. Expenses are deductions from capital or proprietorship. In- stead, however, of adding incomes to capital and deducting ex- penses from capital, the expenses are commonly deducted from the income so as to get a net profit, which is added to capital. If the expenses were greater than the income, the business would be operating at a loss, and the loss would be deducted from capital or the proprietorship interest. Instead of deducting all expenses in a lump sum from the total of income in the calculation of net profit, a number of sub-totals are derived showing what is left of the income after certain classes of expenses have been deducted. The state- ment formulated in connection with the calculation of these 14 ACCOUNTING PRINCIPLES sub-totals is called a Revenue Statement, or a Profit and Loss Statement. 3. Merchandising Differentials. The purchase price of the goods plus the freight and other charges incurred in transport- ing them to the place of sale is called the cost of the goods. The difference between the total proceeds of the sale of the goods and the cost of the goods sold is called the gross profits. If from the gross profits are subtracted the operating expenses, there remains a balance ordinarily called the profits from operation. The operating expenses of a business include every loss and expense in connection with the sale of its goods and the con- duct of the business organization. The money paid for rent, the salaries of those engaged in buying and selling, the salaries of those who keep the records, and the salaries of those who manage the business are all parts of the operating expenses. In other words, these payments are not made for assets which remain with the business, but are absorbed in disposing of goods which have been bought for sale. In buying and selling goods, therefore, the manager always strives to make the profits from operation as large as he can. He keeps a close record of operat- ing expenses, in order to make such expenses as small as possible. Operating expenses are sometimes classified into selling expenses, administrative expenses, general expenses, etc. The larger the business, the more numerous the classes of operating expense. Interest on funds borrowed to carry on a business is not or- dinarily classed with operating expenses, but is carried in a special section of the revenue statement. Interest represents an earning or income to at least a part of those who hold defi- nite liability claims against the assets, whereas operating ex- penses proper do not represent any part of the earnings of a business that can be distributed to holders of claims against the assets. In other words, operating expenses are not pay- ments for the use of the funds which the business owns. Moneys received from subsidiary enterprises are also treated in a separate section of the revenue statement, designated as Other Income. Profits from operation plus other income constitute the total income, which represents the entire earnings of the business INCOMES AND EXPENSES on the total assets invested. The difference between the total income and the interest charges represents the earnings of the proprietors or stockholders, or the net profits of the business. 4. Deriving the Revenue Statement and the Balance Sheet from a List of Items. The balance sheet shows the property items which a business owns at the end of a period, and the liability and proprietorship items for which the business is indebted at the same time. The revenue statement shows in an orderly way the incomes and expenses for the period with the net profits which were added to the capital of the begin- ning of the period in arriving at the capital shown in the balance sheet for the end of the period. Let us take the following list of items and derive therefrom a revenue statement and balance sheet for John Smith for the year ending December 31, 1918. LIST OF ASSETS AND EXPENSES, INCOME AND LIABILI- TIES, FOR JOHN SMITH YEAR ENDING DECEMBER 31, 1918 ASSET AND EXPENSE ITEMS LIABILITY AND INCOME ITEMS Cash 5,OOO.OO Accounts Receivable 4,500.00 Office Furniture 1,200.00 Notes Payable 2,500.00 Accounts Payable 6,500.00 John Smith, Capital 14,550.00 Gross Sales 2O,OOO.OO Returns and Allowances on Sales . 5OO.OO Interest Received on Securities Held . 250.00 Rent Received from Tenant of Store . IOO.OO Discounts on Purchases 125.00 Merchandise Inventory, ist of Period . 5,OOO.OO Merchandise Purchases . . . ' . 22,OOO.OO Returns and Allowances on Purchases . 400.00 Salaries 5,OOO.OO Advertising . . . ... 2OO.OO Rent 500.00 Taxes . 150.00 General Expense 2OO.OO Interest Paid 75-00 Discounts on Sales 150.00 44,475.00 44,475.00 l6 ACCOUNTING PRINCIPLES Merchandise Inventory, End of Period, $18,600.00. JOHN SMITH REVENUE STATEMENT FOR YEAR ENDING DECEMBER 31, 1918 Gross Sales $20,000 . oo Less Returns and Allowances on Sales 500.00 $19, 500.00 Merchandise Inventory, ist of Period $5,000 . oo Merchandise Purchases $22,000 . oo Less Returns and Al- lowances on Pur. 400.00 21,600.00 26.600.00 Deduct Merchandise Inventory, End of Period 18,600 . oo Cost of Goods Sold 8,000 . oo Gross Profits 11,500.00 Operating Expenses Salaries 5,000.00 Advertising 200 . oo Rent 500.00 Taxes 150.00 General Expense 200.00 6,050 oo Net Profits from Operation 5,450.00 Other Income Interest on Securities Held 250.00 Rent from Tenant of Store Building 1 50 . oo Discount on Purchases 125.00. 525.00 Total Income 5,975.00 Deductions from Income Interest 75 Discount on Sales 150.00 225.00 Net Profits $5,750.00 INCOMES AND EXPENSES JOHN SMITH BALANCE SHEET, DECEMBER 31, 1918 Assets Cash Accounts Receivable $5,000.00 4,500.00 Liabilities and Proprietorship Notes Payable $2,500.00 Accounts Payable 6,500.00 Merchandise Inven- tory 18,600.00 Office Furniture i , 200 . oo Proprietorship John Smith, Capital 20,300 . oo ), 300.00 $29,300.00 If John Smith's capital of $20,300.00 at the end of the period be compared with the capital of $14,550.00 as found in the Trial Balance it will be observed that the $5750.00 of net profits are added to the original capital item to produce the final capital of $20,300.00. One of the purposes of the revenue statement is to show the calculation of the net profit item to be added to capital before the balance sheet is made. It is to be noted that the gross sales item is not an asset al- though $20,000.00 in assets come into the business in connection with the $20,000.00 of sales. The item of gross sales bears a rela- tion to these assets similar to that which the capital item bears to cash when the owner of the business invests $10,000.00 of cash. The gross sales are the source from which the assets are re- ceived. The items which follow gross sales show the deduc- tions which must be made before the net profit can be "derived and added to the capital of John Smith at the beginning of the period. The net profit of $5750.00 represents an earning of 39/^% on tne capital of John Smith at the beginning of the period. It represents an earning of 19^% on the total assets as they stood at the end of the period. 5. The Use of the Revenue Statement. Business is car- ried on by the owners mainly for the net profits to be made, these net profits representing the net results of business opera- tions so far as the owners are concerned. These net profits may be added to the investment of the owners, or withdrawn from the business for other uses. If left in the business, the 1 8 ACCOUNTING PRINCIPLES net profits produce an increase of capital in the individual or partnership business and an increase of surplus in the corpo- rate form. The revenue statement serves to show to the owners the profits that have been made during a particular period and the character of the operations that have produced these results. The data in regard to expenses furnish information that is ex- tremely useful to the manager in making future plans. He knows what services have been secured through the expense outlays, and will strive to secure the same service at a lower cost or better service for the same cost. An analysis of ex- penses, therefore, provides a basis for the formulation of a busi- ness program for the succeeding period. Similarly, an analysis of the gross profits is useful to the manager in the determination of his future selling policy. Dur- ing the last period, the gross profits have been a certain per cent of sales, and the total income a certain per cent of the total assets. If this return on the total investment is unsatis- factory, the manager will strive to secure a larger gross profit from sales, so as to increase the total income. The owners of a business, of course, are mainly interested in making the net profits as large a percentage as possible of their own capital investment. If this return is unsatisfactory, the owners will either endeavor to increase the net earnings or transfer their investment to some other enterprise in which larger financial returns may be secured. 6. Complications and Omissions. From the foregoing state- ment, there have been purposely omitted the many complica- tions arising in connection with its construction. These will be considered in their due order. Likewise, there has been post- poned a consideration of many of the uses of the revenue state- ment in connection with the balance sheet. The statement as presented will suffice for an introductory treatment of the prin- ciples of double-entry bookkeeping and accounting INCOMES AND EXPENSES PROBLEMS AND QUESTIONS i. In the following statement, the items in the first column are either expenses or assets; the items in the second column are income, liabilities, and proprietorship. From these items, make out a revenue statement and a balance sheet. In solving this problem, make out the revenue statement first, add the net profits to the capital, and then make out the balance sheet. To find the cost of the goods sold, to be deducted from sales to ascertain the gross profits, deduct the merchandise on hand from the purchases. JUNE 30, 1919 ASSETS AND EXPENSES LIABILITIES, INCOME AND PROPRIETORSHIP Cash Notes Receivable Accounts Receivable Furniture and Fixtures Notes Payable $12,257.35 588.00 800 . oo 1,175.00 $7 2^0 oo Accounts Payable J. C. Kenedy, Capital Sales Discount on Purchases . . . . ' . Purchases Expenses Discount on Sales 17,000.00 1,641 .00 112 OO 3,150.00 11,000.00 12,025.50 228.20 Interest 60 1 ? $33-653 70 $33,653-7o Merchandise on hand June 30, $9074 . 50. 2. What does the revenue statement in Problem i show to have been earned (a) on total assets at the beginning of the period; (b) on capital at the beginning of the period? 3. What per cent of sales are the gross profits of Problem i? Of what value is this information to the manager or the owner of the business? 4. Explain .the difference between balance sheet and revenue items. 5. From the following statement, make out a revenue statement and a balance sheet, as in Problem i. Make out the revenue statement first, add half of the net profits to the capital item of William Henderson and half to the capital item of John Perry, and then make out the balance sheet, showing the assets, liabilities and proprietorship. 20 ACCOUNTING PRINCIPLES APRIL i, iQia-MARCH 30, 1913 ASSETS AND EXPENSES LIABILITIES, INCOME AND PROPRIETORSHIP Cash $4,^76 ?o Notes Receivable Accounts Receivable Office Furniture Notes Payable Accounts Payable William Henderson, Capital .... John Perry, Capital Sales 4,000.00 7,000.00 1,350.00 2,500.00 3,800.00 4,800.00 5,000.00 31,181 . so Sales Returns Discount on Purchases 400.00 180.00 Mdse. Inv., First of Period .... Purchases Returned Purchases Rent 2,500.00 18,000.00 1,200.00 325-00 Selling Expenses Office General Expense Salesmen's Salaries Salaries Office Interest Discount on Notes. . . . 2,000.00 3,600.00 2,000.00 1,300.00 60.00 $47,786.50 $47,786.50 Merchandise on hand March 30, 1913, $6,280.00. 6. Suppose that instead of the two items of William Henderson, Capital, and John Perry, Capital, there was one item of Capital Stock, $9,800.00; how would the proprietorship item appear in the balance sheet? CHAPTER III THE ACCOUNTS AND THEIR RELATION TO THE STATEMENT 1. Relation of Accounts to Statements. The balance sheet and the revenue statement given in Chapter II contain the items most frequently used as the names of accounts in double- entry bookkeeping. The amount of property represented at any time by an asset item or asset account is called the balance of the account. Likewise, the amount of liability represented at any time by a liability item or liability account is called the balance of the account. The same definition holds true for the income and the expense items. Their amounts at a particular time represent the balances of the accounts by the same names as the names of the items. 2. Periods Covered by Accounts. Whenever it becomes de- sirable to make a revenue statement or a balance sheet, it is necessary to calculate new balances for the accounts. These new balances, in the case of asset and liability accounts, show what the business unit owns and owes at the time the balances are taken. In the case of the revenue accounts, they show what the income and the expenses have been during the period covered by the accounts. Af cer a balance sheet and a revenue statement have been made, the accounts are reopened, and a new period of operation is begun. The time elapsing between the opening and closing of the accounts represents the period covered by the revenue statement, as well as the period cov- ered by the various accounts. 3. Transactions and Balance Changes. In double-entry bookkeeping, each transaction changes the balance of at least two accounts. In describing an account, however, it is simpler to point out how a particular transaction affects it, without noting how some other account is affected at the same time. Let us, therefore, take some of the simpler accounts. 22 ACCOUNTING PRINCIPLES 4. Customer Accounts, or Accounts Receivable. The cus- tomer accounts arise from the sale of goods to customers on time. When an article is sold to a customer on credit, he be- comes indebted to the business, and his account is debited. When the customer pays any or all of the debt, his account is credited with the amount of the debt thus canceled. In other words, the account is debited when a transaction arises to in- crease the net amount of the debt, and is credited when a transaction arises to decrease the net amount of this indebted- ness. The debit balance, therefore, is the balance of the debt still unpaid, and may be found by subtracting the total cred- its from the total debits, as indicated in Illustration No. i, below. All debit items are placed on the left side of the account and all credit items are placed on the right. All asset balances are debit balances by definition and all liability and proprietorship balances are credit balances by definition. ILLUSTRATION NO. i AN ACCOUNT WITH A CUSTOMER JOHN* SMITH 1918 Jan. i 350 oo 1918 Jan. ; a 38 X l 75 oo 35o DO , ; 28 75 - a 34 IS Jan. 1918 Jan. i 4 1 1 < 103-75 2/10, n/jo Balance k>ld to Jol a/2 25 10 ': Balance 1 4*3 103 -- 75 5*6 526 oo oo 526 526 - 00 " in S 103 75 Jan. 103 mith merchandise amounting to $350.00. 2 Sold on account merchandise amounting to $75.00. 3 Sold on account merchandise amounting to $28.75. 4 Sold on 30 days' time, 2% 10 days, merchandise amounting to $72.25. 1 The whole line is written in red ink. Throughout the book black-face type in ac- counts represents red ink. ACCOUNTS, THEIR RELATION TO STATEMENT 23 Memoranda of cash discounts should be inserted in the memorandum space, as in Illustration No. i. Jan. 5 Received on account of bill of Jan., $38.00. The fact that the receipt of Jan. 5 is to be applied to the sale of Jan. 4 is indicated by inserting the same small letter before both items, as in Illustration No. i. 6 Received on account, $350.00. 7 Received on account the balance of the bill of Jan. 4, $34.25. 8 Bill is sent to the customer for $103.75. No entry is made of this action, but the debit balance is entered in small pencil figures to the left of the last debit item. 5 Received $102.30 in full settlement of the account, $1.25 being allowed as a discount. A single red line is drawn under the debits and credits after the transaction is entered, thus indicating that the account was settled on Jan. 15. The name of the customer is written at the head of the ac- count, and becomes the name of the account. The total of the debits is set down in small pencil figures below the last debit, and the total of the credits in like manner below the last credit. Since the debits are usually greater than the credits, the bal- ance of the account is ordinarily a debit balance, and is written in small pencil figures to the left of the last debit item. If the customer should overpay his account, the credits would be greater than the debits, and the balance of the account, which in such an instance would be a credit balance, would be ini- tially entered in the same manner as the debit balance to the left of the last credit item. EXERCISE NO. i JOHN KING On a sheet of ledger paper, prepare an account for John King similar to that prepared for John Smith in Illustration No. i. Ledger paper has a ruling like the ruling in Illustration No. i. 1918 Feb. i Balance due from John King, $85.25. The balance of a debt used in opening an account is entered on the debit side, just as the amount of each transaction increasing the debt. 2 Sold on account merchandise amounting to $45.30. 24 ACCOUNTING PRINCIPLES Feb. 3 Allowed a credit of $2.00 for damaged goods. 4 Received $85.25 in payment of the balance due at the be- ginning of the month. 5 Sold on account merchandise amounting to $35.75. 6 Received a note for $79.05 in settlement of balance of account. A note is treated as cash in making credits to a customer's account. It is true that the customer still owes the amount of the note, but the record of the debt is made in the account Notes Receivable, to be explained later. When an account is settled prior to the date of closing the books, a red line is drawn underneath the last debit and the last credit item, thus indicating that the account was balanced on the particular date. 7 Sold on 30 days' time, 2% 10 days, goods amounting to $75.50, and charged $1.25 for drayage. 8 Sold on account merchandise amounting to $20.00, and received on account poultry valued at $2.50. 9 Received payment for the goods sold on the 7th, less the discount. 10 Calculated the balance due, sent out bill, and closed the account. 15 Received the amount of the bill rendered. SUMMARY OF ACCOUNTS WITH CUSTOMERS Debit Customers Credit Customers 1. For the amount due at the 4. For all cash paid on ac- time of opening the account. count. 2. For the price of all goods 5. For all notes given to ap- sold on time. ply on account. 3. For all sundry charges, 6. For all allowances made such as freight, drayage, etc. for damages, shortages, defective goods, etc. 7. For all cash discounts al- lowed. 8. For the balance of the ac- count when it is decided to be un- collectible or the account is closed. The detailed description of the customer accounts is in- tended to show the form in which the record of the changes in the balances is kept. The principle involved, however, may be stated very simply. The customer accounts are property or asset accounts. Consequently, the balances are debit balances ACCOUNTS, THEIR RELATION TO STATEMENT 25 until they begin to show, not the amount of this form of prop- erty that the business owns, but the amount that the business owes. If a transaction with a customer increases his debt or the original debit balance, his account is debited with the amount of this increase. If the transaction decreases his debt, his account is credited with the amount of the decrease. Thus, the account becomes a record of the changes in the initial bal- ance of the account, the first transaction or the opening entry representing this initial balance. 5. Cash Accounts. The meaning of debits and credits in the cash account is essentially the same as the meaning of these terms in the customer accounts described above, although the idea of debt does not enter into the cash account. Cash is, of course, an asset account. When cash is received, the amount of this asset is increased, and the account is debited. When cash is paid out, this particular asset is decreased, and the ac- count is credited. In other words, cash sales increase, whereas cash outlays decrease, the cash asset. Since the cash account is an asset account, the balance is a debit balance, and shows the amount of cash on hand. In com- mon with other asset balances, the cash balance is required if a balance sheet is to be made showing the condition of the busi- ness. ILLUSTRATION NO. 2 THE CASH ACCOUNT CASH 1918 Jan. i $000 oo 1918 Jan. I 50 00 4 4454-50 225 5225 oo oo 3 5 350 85 00 oo 6 250 00 7 35 50 770 JO Jan. Balance Balance 4454 50 5225 oo 5225 00 9 4454 50 26 ACCOUNTING PRINCIPLES 1918 Jan. i J. R. Wall invests in business $5,000.00. 2 The business paid $50.00 for rent. 3 Paid $350.00 for merchandise. 4 Received $225.00 for merchandise cash sales. 5 Purchased coal for $85.00 cash. 6 Paid $250.00 to J. R. Smith. 7 Paid sundry expenses amounting to $35.50, EXERCISE NO. 2 1918 Feb. i C. H. Johnson invested $3500.00 in business. 2 Paid for rent, $75.00; for salaries, $65.00. 3 Received on a note, $2500.00. 4 Purchased goods for $750.00 cash. 5 Received $3500.00 for cash sales. 6 Paid C. R. Rendles check for $250.00. 7 Balanced and closed the account. 6. Other Asset Accounts. If the principle of debits and credits for property or asset accounts is fully understood from the customer and cash accounts, it is hardly worth while to dis- cuss in detail the other property accounts. It is clear, for ex- ample, that a purchase of furniture and fixtures would increase the amount of this form of property, and should consequently be debited to the account. If an item of furniture and fixtures is removed or destroyed, however, the balance of the account would be decreased by the cost of the item, and the account should be credited by that amount. The various complications that frequently arise in connection with property accounts need not concern us for the present. 7. Creditor Accounts, or Accounts Payable. Creditor ac- counts are kept by a business with those from whom purchases are made. The buying of goods on time from an outside party results in a credit to the one from whom the goods are received, just as in the case of the payment by an individual of cash on his account. The payment, on the other hand, by the business to the creditor of all or part of the obligation incurred results in a debit to the account. In other words, the creditor is credited for the price of the goods turned over to the business, and is debited for all payments by the business for the goods received. ACCOUNTS, THEIR RELATION TO STATEMENT 27 The balance of a creditor account is generally a credit bal- ance, and is therefore initially entered in small pencil figures to the left of the last credit item. ILLUSTRATION NO. 3 AN ACCOUNT WITH A CREDITOR HAYWOOD BROS. 1918 Jan. 3 300 oo 1918 Jan. I 425 00 A 5 7 Note $125 30 days Balance 225 125 oo oo 6 2/IO 365.00 225 00 650 350 15 OO 00 00 650 365 oo oo 1015 oo 1015 00 1918 Jan. i Bought of Haywood Bros, goods amounting to $425.00. Bought merchandise amounting to $225.00, 2% 10 days. 3 Paid on invoice of Jan. i, $300.00. 4 Paid invoice of Jan. 2, taking the discount. 5 Settled balance of bill of Jan. i by note for $125, 30 days. 6 Bought merchandise to the amount of $350.00, Haywood Bros, agreeing to advance the freight. Bill rendered for freight charges, $15.00. 7 Calculated balance due to verify bill received, and closed the account. EXERCISE NO. 3 KIDDER & MORSE On a sheet of ledger paper, prepare an account for Kidder & Morse similar to that prepared for Haywood Bros, in Illustration No. 3. 1918 Mar. i Balance due Kidder & Morse, $455.20. 2 Bought on 30 days' time goods amounting to $225.00. 3 Bought on 30 days' time, 3% 10 days, goods amounting to $130.00. 4 Paid invoice of $235.00 and freight of $40.50, the latter being charged to their account. 28 ACCOUNTING PRINCIPLES Mar. 5 Paid invoice of Mar. 3, less the discount. 6 Gave a 3 00 3625 oo oo 3625 CO 27 1125 NOTES RECEIVABLE 1918 July II 300 oo 1918 July 26 300 X July 25 27 300.00 Balance - 300. oo = = ' Balance 300 00 600 oo oo 600 3O 300 BEN RASTALL 1918 July 4 500 oo 1918 July II 300 zz July 10 500.00 Balance == 300 00 26 Balance 500 00 800 oo oo 800 00 27 500 ACCOUNTS, THEIR RELATION TO STATEMENT 39 JOHN COMMONS 1918 July c. 700 00 1918 July 12 400 CO 19 400.00 400 00 25 300 00 . Balance 26 Balance 400 00 IIOO oo IIOO 00 July 27 400 00 MERCHANDISE 1918 July 2 800 oo 1918 July 4 500 00 3 500 oo 125 00 6 600 oo 9 700 00 13 700 oo 1C 300 00 22 900 oo 15 300 CO 26 Gross Profits 3500 650 00 oo 19 400 00 23 650.00 500 CO Mdse.Inv. 26 Inventory = 2825 1325 OO 00 00 4150 00 4150 July 27 1325 oo 1 NOTES PAYABLE 1918 July ^5 Balance SOD oo 1918 July c Balance 500 CO July 27 SGO CO ACCOUNTING PRINCIPLES ANDREW JOHNSON & Co. 1918 July 16 500 OO 1918 July 3 500 00 26 Balance 1600 00 13 700 30 OO 22 27 idoo.OO Balance 900 2IOO 00 M 2IOO 2IOO 00 00 July I6OO RENT 1918 July 17 IOO OO 1918 July 26 Profit and Loss IOO 00 MISCELLANEOUS EXPENSE 1918 July 20 250 OO 1918 July. 26 Profit and Loss 250 00 WAGES AND SALARIES 1918 July 24 _ IOO OO 1918 July 26 Profit and Loss IOO 00 SIMON YOUNG, PERSONAL 1918 July 18 150 OO 1018 July 26 Capital 150 00 ACCOUNTS, THEIR RELATION TO STATEMENT 41 PROFIT AND Loss 1918 1918 July 26 Rent 100 00 July 26 Gross Profit 650 00 Expense 250 00 Wages & Salaries 100 00 Net Profits 2OO oo = 650 oo = = = 650 00 SIMON YOUNG, CAPITAL 1918 1918 July 26 Personal 150 00 July i 1500 00 1550.00 26 Balance 1550 oo 26 Net Profits 200 00 1700 oo 1700 00 July 27 Bal.Capital iS5o 00 SIMON YOUNG Trial Balance, July 26, 1920 Cash 1125 oo Notes Receivable 300 oo Ben Rastall .... 500 oo John Commons . 400 oo Merchandise .... 3Soo oo Notes Payable . 500 oo Andrew Johnson & Co. . 1600 oo Rent IOO oo Miscellaneous Expense . 250 oo Wages and Salaries . IOO oo Simon Young, Personal . 150 oo Simon Young, Capital . 1500 oo 6425 oo 6425 oo ACCOUNTING PRINCIPLES SIMON YOUNG Balance Sheet, July 26, 1920 Assets Current Assets Cash $1125 Notes Rec. 300 John Commons 400 Ben Rastall 500 Mdse. Inv. 1325 DC DC DC DC DC DC DC 365C 22OC OC :: Liabilities and Pro- prietorship Current Liabilities Xotes Payable $500 Andrew Johnson & Co. 1600 DC :c 2IOC IOOC 275 : 2 X 90 Fixed Liabilities Mtg. Payable Proprietorship Simon Young, Cap. Fixed Assets Buildings 1 200 Land 1000 $5850 :: (5850 90 PROBLEMS AND QUESTIONS 1. Check the entries in Illustration No. 5 and note the account debited and the account credited for each transaction. 2. On a sheet of ledger paper, open the following accounts: Henry Lovell (proprietor); personal; cash; merchandise. Balance the cash ac- count, and then take a trial balance of the three accounts. June i Henry Lovell begins a cash grocery business, investing $1000.00 in cash. 2 He buys groceries for $500.00 cash. 3 He sells groceries for $25.00 cash. 4 His cash sales for the day amount to $22.00. 5 He returns groceries bought on June 2, receiving a refund of $10.00 cash. 6 His cash sales for two days amount to $47.00. 7 A customer returns groceries which proved unsatisfactory, and receives a refund of $1.25 cash. 8 He takes for his own use groceries amounting to $12.50. 9 Cash sales for three days amount to $62.40. 10 He buys groceries for $250.00 cash. 11 Cash sales for two days amount to $46.25. 3. What are the two fundamental assumptions of double-entry book- keeping? 4. What is the purpose of an account? 5. Give the rule for debiting and crediting asset accounts. 6. Give the rule for debiting and crediting liability accounts. 7. Why does the rule for debiting and crediting liability accounts serve also as the rule for debiting and crediting profit and loss and the revenue accounts? 8. In analyzing a transaction to determine what account should be deb- ited and what amount should be credited, what questions should be asked and answered before making the entries? 9. Why is the merchandise account called a mixed account? CHAPTER IV THE JOURNAL AND LEDGER i. Ledgers. The form of accounts has already been indi- cated by examples in the preceding chapter. The rulings shown in these accounts are those ordinarily used in the stand- ard ledger, each page of which has space for the following: Debit Side Credit Side Date Explanation Folio Amount Date Explanation Folio Amount (See rulings for ledger accounts at the end of Chapter III.) For accounts requiring daily or frequent balancing, a balance' ledger is provided, with separate balance columns, ruled as fol- lows: Date Balance Folio Debits Credits Debit Balance Credit Balance Banks and public service companies frequently use still an- other form of ledger, known as the Progressive or Boston Ledger, for keeping their customers' accounts. In this type, each line carries a separate account, and, through a shortening of the sheets following the one on which the names are written, ordinarily extends over several pages. The ruling of such a ledger is as follows: Month Month Name Balance Debit Credit Balance Debit Credit Balance Etc. If the balances are monthly balances, the names of the months appear above the successive Debit - Credit - Balance groups. If the balances are daily balances, the days of the week are used instead. Whether monthly or daily, however, only one column for the balances is provided. In the case of a bank, the depositor's balance is ordinarily a credit balance. Consequently, if the account is overdrawn, the 43 44 ACCOUNTING PRINCIPLES debit balance is entered in red to distinguish it from the pre- vailing credit balances. In the case of a public service com- pany, on the other hand, the customer's balance is usually a debit balance, and a credit balance, arising from an overpay- ment of the account, is entered in red to distinguish it from the debit balances commonly found. The ledger itself may be either a bound book, a loose-leaf book, or a card index ledger. The loose-leaf form is very com- monly employed, on account of the possibility of removing the sheets that contain inactive accounts. The card ledger is even more readily adjustable than the loose-leaf ledger. In fact, the readiness with which an account can be removed from the card ledger frequently results in the loss or misplacement of ac- counts. 2. The Journal. The transactions recorded in the ledger are all grouped under the particular accounts to which they refer. Moreover, no explanations are placed in a ledger ac- count, except such as may be necessary in connection with rou- tine transactions with the individual or firm concerned. There is needed, therefore, a chronological record of all transactions, with a full explanation of each. The old Day Book contained such a diary and explanation. In connection with it, however, a second book was necessary to indicate the accounts debited and credited for the various transactions described. Two books of original entry were thus required. Later, the functions of these two books were com- bined in the Journal, which was devised to contain both the diary and explanatory data and the entries showing the ac- counts debited and credited. This process of entering the items of a transaction in the Journal is spoken of as journalizing. From the Journal, the debits and credits are carried, respec- tively, to the debit and credit sides of the appropriate ledger ac- counts. This transfer is commonly called posting. The rulings of the journal usually provide for the following headings: Folio Account Debit Credit (See rulings for journal entries in Illustration No. 6 at end of this Chapter.) 45 Sometimes, in addition to the columns just indicated, there is a small column to the left of the debit column, to be used for the folio reference. Where such additional column is provided, the first column, instead of being used for the folio, is fre- quently used as a date column. In the exercise material of the text, the date is inserted on a blank line above the debit and credit entries to which it pertains. The form of the journal entries and the method of entering the explanatory data are indicated below in Illustration No. 6, which shows the journalizing of the transactions contained in Illustration No. 5. 3. Checking the Posting. At definite intervals, such as once a week or once a month, the postings from the journal to the ledger are checked, the work being done according to the folio wing plan: (i) The diary of transactions is compared with the journal entries for each item. If the diary and the entries agree, they are both checked, to indicate that the transaction has been properly journalized. (2) The journal entries for each transaction are then compared with the corresponding ledger posting. If the entries and the postings agree, the ledger item is also checked to indicate that the journal entries have been properly posted. (3) The additions of the debits and credits of the various ledger accounts, as well as the calculations of the various balances, are then verified, and the balances entered on the trial balance sheet. (4) If the sum of the debit balances of the trial balance does not equal the sum of the credit balances, the debit entries and the credit entries are totaled on each page of the journal and carried forward to the succeeding page until the complete total of all journal debits and the complete total of all journal credits have been found. If these totals agree, the difference in the trial balance footings is clearly due to an error in the ledger postings. (5) The difference between the sum of the debit balances and the sum of the credit balances of the trial balance is then taken. If this difference is divisible by 2, the indication is that a debit has been posted as a credit, or vice versa. If the difference is divisible by 9, the possibility is that there has been a transposition (such as entering 36 as 63) 46 ACCOUNTING PRINCIPLES or a slide (such as entering $125.00 as $12.50) in connection with entering some particular item, the difference in such cases, owing to the nature of the decimal system, always being divis- ible by 9. If the sum of the debit balances differs from the sum of the credit balances by i, or 10, or some power of 10, the likelihood is that an error has been made in addition. This is not necessarily, though very commonly, the case. Thus, these tests in connection with the difference between the total debits and the total credits of the trial balance afford an indication of the character of the error likely to be discovered in a recheck of the accounts, and frequently effect a shortening of the work. Although a difference between the total debits and the total credits of a trial balance definitely indicates that an error in posting or journalizing has been made, an agreement between the two totals does not conclusively prove that the work has been accurately done. For instance, some item in the diary of transactions resulting in an equal debit and credit may have been omitted entirely from the journal, and consequently also from the ledger. Neither omission would prevent an equality of debit and credit balances, although the work as a whole would be incorrect. In other words, an equality of totals in the trial balance merely indicates a probability that the work has been correctly done. Only a complete recheck, such as outlined above, can be regarded as positive proof. 4. Closing Accounts through the Journal. In closing the accounts which go into the balance sheet, the word balance is entered in red along with the amount of the balance. All ac- counts not closed into the balance sheet are generally closed through the journal, the closing entries in such cases being in black. In closing through the journal, the closing entry of the ac- count is journalized before being entered in the ledger. For example, if the debit balance of the wages account is $500.00, the account is closed into profit and loss through the following journal entries: Profit and Loss Wages 500 . oo Wages Profit and Loss 500 oo THE JOURNAL AND LEDGER 47 These journal entries indicate that the debit balance of the ac- count is to be carried to the debit side of the profit and loss account, and that at the same time the wages account is to be closed by the proper ledger entry. Other accounts closed into profit and loss would be similarly journalized before being finally closed. The balance of the profit and loss account is also journalized before being closed into the capital account. For instance, if the credit balance of profit and loss is $250.00, the proper jour- nal entries are as follows: Profit and Loss Net Profits 250.00 Capital Net Profits 250.00 In closing accounts into profit and loss and into capital, it is customary to enter along with the debit and credit balances the names of the accounts from which they come. The necessary information is entered, therefore, in the journal, the journal entries indicating not only the accounts to which the items are to be posted, but also the accounts from which the items are transferred. As each item is posted from the journal to the ledger, there is inserted in the journal folio the page of the ledger to which the item is carried, and in the ledger folio the page of the journal from which the transfer is made. 5. Journal Closing of the Merchandise Account. Since the merchandise inventory is not an item arising out of the regular transactions of a business, it is frequently entered in red to the credit of the merchandise account in connection with the calculation of the gain on merchandise. This gain is entered through the journal, the inventory being brought down as the debit balance of the merchandise account for the succeeding period. If the gain on merchandise for the period under con- sideration is, say, $300.00, the amount is closed into profit and loss through the following journal entries: Merchandise Gross Profits 300 . oo Profit and Loss Gross Profits 300.00 48 ACCOUNTING PRINCIPLES The merchandise inventory is sometimes also entered through the journal. When this is done, however, it is necessary to open a merchandise inventory account simply for the purpose of accommodating the journal entry. The loss in time does not result in any gain in clearness, and is at variance with the common practice of entering asset balances in red when asset accounts are closed. The method indicated, therefore, in the preceding paragraph will be followed in the exercise material of the text, unless the student is otherwise directed. 6. Opening Journal Entries. In the illustrations thus far given, the opening journal entry has been an investment of cash, and the item has been journalized like any other cash transaction. Frequently, however, the owner invests not merely cash but also other forms of property. The form of asset con- tributed is immaterial so far as concerns the credit of the owner on the books of the business. For instance, instead of invest- ing $10,000.00 in cash, John Smith might invest in business $5000.00 in cash, $3000.00 in land, and $2000.00 in buildings. The journal entries would then be: Cash 5.000.00 Land 3,000.00 Buildings 2 ,000 . oo John Smith, Capital 10,000.00 Investment of John Smith If against the land and buildings there should be outstanding a mortgage payable of $2,500.00, the investment of John Smith would be the difference between the total assets and the mort- gage liability. The journal entries in this case would there- fore be: Cash 5.000.00 Land 3,000.00 Buildings 2,000.00 Mortgage Payable 2,500.00 John Smith, Capital 7,500.00 Investment of the assets of John Smith, the outstanding mortgage being assumed by the business THE JOURNAL AND LEDGER 49 Accounting texts generally prefer the following form of entry: Cash 5,000.00 Land 3,000.00 Buildings 2 ,000 . oo John Smith, Capital 10,000.00 Investment of the assets of John Smith John Smith, Capital 2,500.00 Mortgage Payable 2,500.00 Assumption of mortgage against John Smith's assets The net result is the same as in the preceding form. In support of the use of the latter form, it is argued that this form of entry gives a fuller analysis of the steps taken and is more easily understood by the student or the user of the ac- counting record. If the student is taught, however, that an asset represents something which a business owns, and that the corresponding credit entry always represents the source of the asset received, he will more readily grasp the condensed form of entry first presented above. Experience in teaching both forms of entry has convinced the author that much time is saved and nothing is lost by the use of the shorter form. ILLUSTRATION NO. 6 JOURNAL ENTRIES, JULY, 1918 I 26 26 Cash Simon Young, Capital Investment in general merchandise business 1500 oo 1500 00 2 27 26 Merchandise Cash 800 oo 800 00 Purchase of merchandise for cash 3 27 28 Merchandise Andrew Johnson & Co. Purchase of merchandise on time 500 oo 500 00 ACCOUNTING PRINCIPLES 4 2Q Ben Rastall 500 oo 27 Merchandise 500 oo Sale of merchandise on time 5 26 Cash 500 oo 27 Notes Payable 500 oo Loan on note . 6 27 Merchandise 600 oo 26 Cash 600 00 Purchase of merchandise for cash 8 26 Cash 125 oo 27 Merchandise 125 oo Sale of merchandise for cash 9 29 John Commons 700 oo 27 Merchandise 700 00 Sale of merchandise on time 10 2 9 Ben Rastall 300 oo 27 Merchandise 300 00 Sale of merchandise on time ii 27 Notes Receivable 300 oo 29 Ben Rastall 300 00 Settlement of bill of July 10 12 27 Cash 400 oo 29 John Commons 400 oc Payment on account 13 27 Merchandise 700 oo 28 Andrew Johnson & Co. 700 oo Purchase of merchandise on time THE JOURNAL AND LEDGER is 26 Cash 300 oo 27 Merchandise 300 oo Sales for cash 16 28 Andrew Johnson & Co. 500 oo 26 Cash 500 oo Payment on account 17 28 Rent IOO oo 26 Cash IOO oo Payment of rent 18 26 Simon Young, Personal 150 00 26 Cash 150 00 Withdrawal of cash for personal use 29 John Commons 400 oo 27 Merchandise 400 oo Sale of merchandise on time 20 28 Expense 250 oo 26 Cash 250 oo Payment of office expense . 22 27 Merchandise 900 oo 28 Andrew Johnson & Co. 900 oo Purchase of merchandise on time 23 26 Cash 500 oo 27 Merchandise 500 oo Sale of merchandise for cash 24 28 Wages and Salaries IOO oo 26 Cash IOO CO Payment of wages ACCOUNTING PRINCIPLES 25 27 29 Notes Receivable John Commons Payment of note on account 300 oo 300 00 26 26 27 Cash Notes Receivable Payment of Ben Rastall note 30 00 300 00 CLOSING ENTRIES 27 29 Merchandise Gross Profits Profit and Loss Gross Profits Close of merchandise account into 650 oo 650 00 profit and loss 29 28 Profit and Loss Rent Rent Profit and Loss 100 00 IOO oo Close of rent account into profit and loss 29 28 Profit and Loss Office Expense Expense Profit and Loss Close of expense account into profit and loss 250 00 250 oo 29 28 Profit and Loss Wages and Salaries . Wages and Salaries Profit and Loss IOO oo IOO oo Close of wages and salaries account into profit and loss 29 Profit and Loss Net Profits Simon Young, Capital Net Profits 20O oo 200 00 Close of profit and loss account into capital : 26 Simon Young, Capital Personal Simon Young, Personal Close of personal account into capital ISO oo 150 00 THE JOURNAL AND LEDGER 53 Instead of making a separate set of journal entries for each account closed into profit and loss, a compound entry is some- times made to cover related items, as follows: CLOSING ENTRIES Profit and Loss 450 . oo Rent loo . oo Expense 250.00 Wages and Salaries 100 . oo Close of expense accounts into profit and loss The additional closing entries affecting the profit and loss and trading accounts would be the same as those given above in connection with the more detailed journalization of the closing. PROBLEMS AND QUESTIONS i. With the use of journal and ledger paper, journalize and post the following transactions. Take a trial balance of the accounts, and close the merchandise and profit and loss accounts through the journal. The accounts to be used are Ernest Nason, Capital; Ernest Nason, Personal; Cash; Merchandise; Real Estate; Store Fixtures; Expense; Notes Receivable; Notes Payable; Discount on Purchases; and such personal ac- counts as may be necessary. 1918 Jan. i Ernest Nason invests $4000.00 in cash and $2200.00 in merchan- dise in business. 2 Buys store building and lot for $3400.00 cash. 3 Buys fixtures for store for $450.00 cash. 4 Buys 2/10, n/3o, from Leonard Nelson & Co. on account merchan- dise to the amount of $1000.00. Pays freight in cash, $40.00. 5 Sells to Oliver Goldthorpe on account merchandise amounting to $120.00. 6 Cash sales, $385.00. 7 Sells to Oliver Goldthorpe on account merchandise amounting to $295.00, and to Lynn Knorr on account goods to the value of $434.00. 8 Takes Lynn Knorr's note at 30 days in payment of account. 9 Buys from Quincy Quigley & Co. on account merchandise amount- ing to $894.00. 10 Pays out $65.00 cash for sundry expenses. t ii Pays freight in cash $52.00. 12 Cash sales, $231.00. 54 ACCOUNTING PRINCIPLES Jan. 13 Pays the account of Leonard Nelson & Co., due tomorrow, less the discount. Nelson & Co. are debited for the full amount of the account, since the account is fully settled; cash is credited for the amount of cash actually remitted; and discount on purchases is credited for the amount of the discount earned. 14 Sells Lynn Knorr on account goods amounting to $276.00. 15 Borrows from the City Bank $1000.00, giving his note for that amount. 1 6 Pays sundry expenses in cash $23.00. 17 Cash sales, $314.00. 1 8 Withdraws $50.00 in cash for personal expenses. 19 Buys merchandise on account from Leonard Nelson & Co. amount- ing to $725.00, 2/io, n/30. Merchandise inventory, January 20, 1918, $3624.00. 2. From the trial balance of Problem i make the journal entries necessary to dose the revenue accounts into profit and loss and profit and loss into capital. 3. Explain the ruling and use of a balance ledger and of the Boston Ledger. \Vhat are the advantages and disadvantages for a card ledger, a loose-leaf ledger, and of a bound ledger? 4. Describe the process of completely checking a set of entries. 5. How is merchandise on hand at the end of a period entered? Why? 6. What is the general rule for the use of red ink in closing entries? 7. The following transactions do not constitute a connected series, but are intended to furnish drill in analysis. Make the opening entries in each case: (a) Harry Snyder begins business by investing cash, $3000.00; merchan- dise, $2500.00; store building and lot, $3500.00; fixtures, $700.00. (b) William Woodhead begins business with the following assets and liabilities: Cash, $2000.00; merchandise, $2500.00; deliver}- equipment, $500.00; open account against L. W. Soles, $600.00; notes due him, $8oo.cc: and note due by him to the Citizens Bank, $750.00. (c) At the time Thomas Morrison begins business, he has the following assets and liabilities: Cash, $4000.00; real estate, $10,000.00, encumbered with a mortgage payable of $4000.00; merchandise on hand, $3500.00; accounts due from the following trade debtors Roy Black, $250.00; William Hopkins, $175.00; Fred Root, $206.00; notes receivable, $975.00; furniture and fixtures, $425.00; prepaid insurance, $56.00; debts due to the following trade creditors: The National Wholesale Co., $500.00; J. B. Wells Co., $450.00; taxes unpaid, $175.00. 8. Journalize the following, omitting explanations, i.e., use the skeleton method of journal entries: (a) Henry Jones buys merchandise from J. F. Newman & Co. to the amount of $600.00, one-half cash, the balance on account. (b) Henry Jones sells merchandise to Jarnes Chochems for $320.00, re- ceiving $100.00 in cash and a note at 30 days for the balance. (c) Henry Jones gives Sam Heyman & Co. his note for $400.00 to settle his account. THE JOURNAL AND LEDGER 55 (d) Henry Jones sells merchandise to Fred Myers for $308.00, receiving in payment $100.00 cash, a note of Nathaniel Green's for $150.00, indorsed by Myers to you, the balance being charged on account. 9. A trial balance of the ledger of the insurance agency of Sidney Webb as of December jist follows. On sheets of ledger paper open the accounts, showing their condition as of December 3ist at the time of closing. Also open an account with profit and loss. Prepare the journal entries to close the revenue accounts into profit and loss. Post the entries and close the accounts. Make and post the entries to close profit and loss and personal into capital. Cash 1,620.00 Notes Receivable 590.00 Accounts Receivable 1 1,450.00 Furniture and Fixtures 1,400.00 Real Estate 5,000.00 Accounts Payable 1 525.00 Mortgage Payable 3,000.00 Sidney Webb, Personal 1,200.00 Sidney Webb, Capital 6,000.00 Premiums Earned 3,150.00 Notary Fees Earned 420.00 Interest Earned 370.00 Salaries 900 . oo Office Expense 2 75 . oo Heat and Light 3 1 5 . oo Miscellaneous Expense 180.00 Taxes and Insurance 295 . oo Interest on Mortgage 240.00 ^13,465.00 13,465:00 1 These amounts are the sums of all accounts owing from debtors and owing to creditors respectively. CHAPTER V THE FORM AND USE OF COMMERCIAL PAPERS 1. Design of Commercial Papers. In connection with the installation of a system of accounts for a business, it is always necessary to design the commercial papers to be used in fur- nishing the data required for the books of record and for the information of the parties with whom business is transacted. Before any paper of this kind is designed, however, there should be a definite plan for its use, as such a plan will determine both the character of information to be furnished and the form in which it is to be supplied. There are, of course, standard forms for such widely used papers as the check, the promissory note, and the draft. The form of other papers, such as the purchase order, the invoice, and the credit memorandum, varies according to the requirements of the particular business. 2. Sales Invoice. When an order for goods is received by a merchant, the articles are prepared for shipment and a bill for them is sent to the purchaser. This bill is commonly known as a sales invoice, and should contain all the informa- tion needed by the bookkeeper in journalizing the transaction and by the buyer in checking the goods received with the order sent. Since the buyer may not receive the goods promptly, the invoice should show the route of shipment, if the goods are sent by freight, or the name of the express company, if they are forwarded by express. Frequently, the purchaser requests that his order number be given in the invoice; and the invoice, in consequence, should provide for such a request. The follow- ing form will meet the needs of the ordinary mercantile busi- ness: THE FORM AND USE OF COMMERCIAL PAPERS 57 ILLUSTRATION NO 7 PURCHASE AND SALES INVOICE No. VALLEY FURNITURE COMPANY Valley, 111. 19. Sold to Address Shipped Via Date Shipped Buyer's Order No. Classification Article Quantity Rate Charges Credits A classification column, such as indicated above, Is needed where separate sales accounts are kept for different classes of commodities. The charges and credits columns, of course, fur- nish the necessary information with regard to the amounts to be charged and credited to the customer. For over-counter sales, a record or memorandum is designed on the basis of the information necessary for the accounting records and for rendering to the purchaser the regular sales in- voice. Usually, the record or memorandum is made in dupli- cate, one copy being given to the purchaser at the time of the sale, the other being retained by the seller as the original rec- ord of the transaction. 58 ACCOUNTING PRINCIPLES 3. Purchase Invoice. The sales invoice of the seller be- comes, of course, the purchase invoice of the buyer. When it is received by the purchaser in advance of the goods, care should be taken to file it so that a delay in the arrival of the goods will not be overlooked. A tickler file, with a guide for each day of the month, is extremely useful in this connection, per- mitting the invoice to be filed either in the tickler under the date on which the goods should ordinarily be received, or in the invoice file under the name of the seller with a cross-refer- ence in the tickler under the date on which inquiry regarding the shipment should be made. The precise method will de- pend, of course, upon the volume of purchases and the delays experienced in the arrival of goods. The method of checking goods received varies also with the size of the business. In a small concern, the goods may be checked with the invoice itself, which is then compared with the original purchase order. In a large business, a copy of the purchase order is sent to the clerk who is to receive them. When the goods are received, they are checked with this dupli- cate order, which is then returned to the bookkeeper to serve as a memorandum of goods received in checking the purchase invoice. Where only part of an order is received, the receiving clerk sends to the bookkeeper a list of the items, together with the order number, retaining the duplicate order until the re- mainder of the shipment arrives. The department store and other concerns may pay the invoice before the goods arrive in order to take discounts, the wholesaler agreeing to make necessary adjustments if goods are not as ordered. The in- voice would be entered on receipt of goods or at time of pay- ment if this date is before receipt of goods. After being completely verified, the invoice is entered to the credit of the seller. If the invoice has a discount date, it is filed in a tickler file under the date when payment must be made. If approved invoices are all paid at the same time each month, they should be filed together for future payment. When paid, the invoices should be filed under the name of the creditors in an appropriate place. The canceled checks sent in payment THE FORM AND USE OF COMMERCIAL PAPERS 59 might properly be attached to the corresponding invoices as soon as these checks are returned by the bank. In any event, a notation should be made on each invoice of the date on which it is paid. The foregoing observations on the matter of invoice filing are not intended as definite rules, but rather as pointers on the necessity of a definite program for the handling of commercial papers which are related to accounting procedure. 4. Promissory Note. A promissory note is an uncondi- tional promise in writing by one person to another, signed by the maker, engaging to pay. on demand or at a fixed or deter- minable future time a certain sum of money to order or to bearer. The promise is usually made to the order of the payee, who must indorse the note to render it transferable or nego- tiable. The general form of the instrument is shown below. ILLUSTRATION NO. 8 PROMISSORY NOTE $500.00 VALLEY, ILL., July i, 1918. . Six months after date, for value received I promise to pay to the order of John Smith Five Hundred and o/ooo Dollars at the Valley National Bank, Valley, 111 , with interest at the rate of eight per cent per annum from date until paid. And, if this note is not paid in full at maturity, and it is placed in the hands of an attorney for collection, or suit is instituted to enforce collection, then I agree to pay an additional sum of ten per cent of the amount of principal and interest of this note as attorney's fees, which said ten per cent shall be included in the judgment which may be rendered on this note. A ddress, Joshua Jones No Due 7/31/18 If the foregoing note were given by Joshua Jones to John Smith in payment for merchandise, the transaction would be journalized as follows: 60 ACCOUNTING PRINCIPLES (a) On the books of Joshua Jones: Merchandise 500 . oo . Notes Payable 500 . oo Purchase of merchandise with note payable (b) On the books of John Smith: Notes Receivable 500.00 Merchandise 500 . oo Sale of merchandise for note receivable 5. Interest on Notes. A promissory note usually bears in- terest, but the interest forms no part of the account either of notes payable or of notes receivable. Neither is it entered on the books until paid, is due and unpaid, or the accounts are closed and credit is taken for accrued items, in accordance with principles to be explained in a later chapter. When the interest is paid on the foregoing note, the transaction is journalized as follows on the books of Joshua Jones: Interest Expense 20 . oo Cash 20 . oo Payment on account of interest On the books of John Smith, to whom the interest is paid, the item is entered as follows: Cash 20.00 Interest Income 20 . oo Receipt on account of interest When business discounts its own notes before maturity, the bank discount, in accordance with the general practice, is treated as interest. Thus, if John Smith discounts his own go- day note of $500.00 at the bank at 8% his journal entries would be as follows: Cash 490 . oo Interest Expense K> . oo Notes Payable 500 . oo Discount of note at Valley National Bank, due three months from date THE FORM AND USE OF COMMERCIAL PAPERS 6 1 6. Discount of Note Receivable. In order to obtain im- mediate cash, a business frequently discounts its notes receiv- able before maturity, the proceeds usually being deposited to its credit by the bank discounting the paper. When such dis- counts are made, the amount of the note at maturity repre- sents the sum upon which the discount is based. Thus, if John Smith discounts at 6% three months before it is due the $500.00 note received from Joshua Jones, the amount to be discounted is $520.00, and the discount amounts to $7.80. In discounting a note receivable, however, the business, through its endorsement of the paper, assumes a contingent liability for the payment of the obligation at maturity; for, if the maker defaults, the endorser becomes liable for both prin- cipal and interest. Instead of crediting notes receivable, there- fore, an entirely new account is formed, commonly known as Notes Receivable Discounted. In consequence, the discount in- dicated in the preceding paragraph is debited and credited by John Smith as follows: Cash 512.20 Interest Expense 7 . 80 Notes Receivable Discounted 500.00 Interest Income 20.00 Discount of note receivable at Val- ley National Bank If a note is not paid at maturity, the endorser must be noti- fied at once; otherwise his liability ceases. If John Smith, therefore, as endorser of the note receivable discounted, re- ceives no notice of dishonor within a few days after the matur- ity of the paper, the discharge of his contingent liability is in- dicated by the following journal entry: Notes Receivable Discounted 500 . oo Notes Receivable 500.00 Credit to notes receivable for amount of discounted note paid by maker at maturity Should the note, however, be dishonored when it becomes due, Smith, as endorser, is obliged to pay it. Such payment 62 ACCOUNTING PRINCIPLES would result, not only in a discharge of his contingent liability but in a claim against the maker of the note for the principal and interest. To cover the payment of Jones' defaulted note, Smith therefore makes the following entries: Notes Receivable Discounted 500 . oo Notes Receivable 500.00 Credit to notes receivable for amount of discounted note de- faulted by maker at maturity Joshua Jones 5 20 . oo Cash 520 . oo Charge to Jones of principal and in- terest of his defaulted note If Jones has meantime become insolvent, the charge to him represents, of course, a loss or an expense. 7. Bill of Exchange. A bill of exchange, or a draft, as it is more commonly called, is an unconditional order in writing by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay to a third person named therein on demand or at a fixed or determinable future tune a certain sum of money to order or to bearer. The draft is usually made to order, and becomes negotiable only through endorsement. A three-party draft is shown below. ILLUSTRATION NO. 9 THREE-PARTY DRAFT (ACCEPTED) \J> ^^ THE FORM AND USE OF COMMERCIAL PAPERS 63 Frequently the maker and the payee or the maker and the drawee are the same party. Where this is the case, the draft is known as a two-party draft. Whether two or three party, however, the drawer usually does not make a draft without some definite understanding regarding its acceptance by the drawee. 8. Time Draft. Where a draft is due on a specified date or on a certain number of days after date or presentation, it is known as a time draft, and is presented to the drawee for his acceptance. If the drawee accepts, he endorses his acceptance across the face of the instrument, converting it into a promis- sory note. (See Illustration No. 9.) The accepted draft or acceptance shown in the preceding paragraph is therefore journalized as follows: (a) On the books of William Hayes when the draft is sent: John Smith 500.00 Joshua Jones 500 . oo Draft on Jones in favor of Smith (b) On the books of John Smith when the draft is accepted by Joshua Jones: Notes Receivable 500 . oo William Hayes 500 . oo Payment of Hayes' account with time draft, accepted by Joshua Jones (c) On the books of Joshua Jones when the draft is accepted by him: William Hayes 500 . oo Notes Payable 500.00 Acceptance of 30-day draft drawn by Hayes, due July 31, 1918 Frequently the drawee is a bank or other financial institu- tion. The principle of journalizing, however, remains the same. 9. Sight Draft. Where a draft is made payable at sight, it is known as a sight draft. Unless abrogated by law, three days of grace are allowed the drawee in which to pay it. Present- 64 ACCOUNTING PRINCIPLES merit must, therefore, first be made to fix maturity, and then for payment. In the matter of journalizing, the sight draft is treated like a check or like cash. 10. Check. A check is a draft on a bank payable on de- mand. Like other forms of drafts, it is usually made to the order of the payee, and becomes negotiable only through en- dorsement. As the paid checks are returned by the bank when the depositor's account is balanced, the endorsement serves as a receipt. The ordinary form of check is shown below. ILLUSTRATION NO. 10. CHECK VALLEY, ILL., January i , 1919 No. 89 THE VALLEY NATIONAL BANK OF VALLEY, ILLINOIS Pay to the order of John Smith $520.00 Five Hundred twenty and 00/100 Dollars Joshua Jones A bank draft is simply the check of one bank on another bank, and is payable on demand. Because of the financial standing of the institution issuing it, a bank draft is generally preferred to a personal check. The form of the ordinary bank draft is given below. ILLUSTRATION NO. n. BANK DRAFT VALLEY, ILL., January i , 1919 No. 3 THE VALLEY NATIONAL BANK OF VALLEY, ILLINOIS Pay to the order of John Smith $520.00 Five hundred twenty and 00/100 Dollars STATE NATIONAL BANK James Brown New York City Cashier The personal check and the bank draft are both treated as cash, and journalized accordingly. ii. Discount. The word discount, as ordinarily used, means the amount deducted by a bank from the face of a note which it buys before maturity. In accounting, this deduction is en- THE FORM AND USE OF COMMERCIAL PAPERS 65 tered as interest. The word, however, has other business ap- plications. Allowances are generally made by a business for the early payment of its sales invoices. These allowances, known as cash discounts, though somewhat similar to interest or bank discount, are entered as discounts on sales. Thus, if the Cen- tral Book Company sells to John Smith on January i books to the amount of $250.00, terms 2% discount for cash in 10 days, net 30 days, and Smith pays the bill on January 5, the pay- ment is journalized as follows: (a) On the books of the Central Book Company: Cash 245 . oo Discount on Sales 5 . oo John Smith 250.00 Receipt of payment on account (b) On the books of John Smith: Central Book Company $250.00 Cash $245.00 Discount on Purchases 5 . oo Payment of account Frequently trade allowances on the quoted price of a com- modity are made by a business to its customers. This allow- ance, known as commercial or trade discount, is usually not entered on the books of record. Instead of a single discount, the allowance may consist of a series of discounts. Thus, a merchant might offer to his customer a discount of 20%, 10%, and 5%, or 20, 10, and 5, on a bill of $500.00. Such a quota- tion means that the actual purchase price is to be found by taking 20% from the face of the bill, 10% from the balance, and 5% from the amount then remaining. The series may, of course, be converted into a single discount by the following process: $200 X .80 X .90 X .95 = $200 X .684 = $136.80 In fact, the conversion of the various percentages into one equivalent percentage is the usual form of calculation. 66 ACCOUNTING PRINCIPLES 12. Time Calculations. There are various methods in vogue for the reckoning of time in interest calculations. The units of tune involved are the day, the month, the quarter, the half year, and the year. In all cases involving days the day from which should be excluded. If a loan is made on the first day of the month and paid on the tenth day of the month and the unit of time is the day, then interest is paid for nine days. But this does not fully settle the case. The next question is as to the number of days in a year. The interest tables are gener- ally based on a 30-day month and a 36o-day year. On such a basis the interest for nine days would be 9/30 or 3/10 of the interest for one month or 1/40 of the interest for one year. In this case the calculation would get the same result with a month unit as the basis as it would with the year unit. In general a certain rate of interest not qualified is understood to mean a rate per year. The rate then for a half year is regarded as one half the rate for the year although technically, instead of multiplying the amount by 1.03 for a half year of interest when the rate is 6 per cent per annum, the exact method would involve the multiplication of the principal by 1.02956. The interest paid at the half-year period would itself draw interest so that the lender actually gets a rate better than 6 per cent if he gets 3 per cent of the principal twice each year. Likewise the interest for one quarter of the year is ordinarily taken as one fourth of the interest for the year. If the interest contract makes the month the time unit, one would begin with the date of the first day of the interest period and exclude that day. Then the day in the next month having the same number as the initial day of the period will be the last day of the first month. If, however, the first day of such a period is January 31, February 28 in a common year or Febru- ary 29 in a leap year will be the last day of the first month. In a common year the last day of the first month would be February 28 if the initial day were January 28, 29, 30, or 31. 13. Treasury Method of Calculating Time. The interest method adopted by the United States Treasury is as follows: Only one of the two days of the date and due date of an THE FORM AND USE OF COMMERCIAL PAPERS 67 obligation is taken into account in stating the time for which interest is to be calculated. A month is to be regarded as one twelfth of a year re- gardless of the number of days it contains. Likewise, a quar- ter is one fourth of a year and six months one half of a year, regardless of the number of days they contain. When an interest rate is referred to as 6 per cent or other rate, a rate per annum is understood to be implied. "In calculating interest for a fractional period, the time is the true fraction of that period. For an annual rate, the time is the exact number of days for which the interest runs, divided by the number of days in the year, 365 or 366; for a semi-an- nual or quarterly period, it is the number of days for which the interest runs, divided by the number of days in the particular half year or quarter year. "Unless the unit period is a month, the month does not enter into interest computations, only days and the full unit period being considered." According to this method an interest period of a year would involve in the case of calculating interest for a part of a year the multiplication of 1/365 of the annual interest for a com- mon year and 1/366 of the annual interest for a leap year by the number of days for the part year. The month would not be considered. It will also be noted that if the quarter is the time basis and the time in the quarter is 75 days, the interest fraction would be 75/120 of the interest for the quarter if the year were a common year, or 75/121 if the year were a leap year. In the case of the second quarter of the year the fraction would be 75/123 of the interest for the quarter. The half year basis would be treated in the same way as the quarter basis. If a month were taken as the basis a month would be denned as indicated in paragraph 12 above. A fraction of a month would be the number of days already elapsed divided by the number of days in the month in question. 14. The New York and Massachusetts Method. In the states of New York and Massaqhusetts a year is denned by law as consisting of 365 days. 68 ACCOUNTING PRINCIPLES 15. Method Recommended for Students. In making cal- culations of accruals it is recommended that the 3o-day month and the 36o-day year be adopted for periodic closings in which no transfer of property is involved. The net profits cannot be an exact figure since depreciation and other similar items must be an approximation. The interest tables could then be used in the periodic closings and much time saved. When transfers of property are involved or interest payments must be made it seems preferable to adopt the method pre- scribed by law of the state in which the contract is made. The calculations of interest for any fraction of a year would then be made according to the method adopted by the treasury de- partment in common year calculations. The interest due on 60 and 90 day notes' at maturity would be 60/365 or 90/365 of the interest for a year if 365 days were defined as the year. In those states where the Law Merchant is adopted and not modified by special statute, such as the state of Texas and many other states, the 3o-day month and the 36o-day year is adopted as the basis of the calculations. Interest calculations in Texas both for accruals and for actual interest payments should be made on the basis of the 30-day month and the 360- day year. 16. Corrections of Table Calculations. If interest has been calculated on a 36o-day basis a change may be made to a 365- day basis by subtracting 1/73 of the interest calculated on the former basis. If the interest has been calculated on a 365-day basis, it may be changed to a 36o-day basis by adding 1/72 of the interest calculated on the former basis. PROBLEMS AND QUESTIONS 1. Why is it customary to make arrangements in advance for drawing a three-party draft? 2. Why do some business men very much dislike to have drafts drawn on them? 3. What is the most frequent use to which the two-party draft is now put? 4. You ship merchandise amounting to $260.00 to Cotter & Hines, of Centerview, and draw a sight draft on them, which is attached to the bill of lading and deposited in your bank for collection. Give the entries on your books and on those of Cotter & Hines. THE FORM AND USE OF COMMERCIAL PAPERS 69 5. You draw on the Young Mercantile Co. at sight for $300.00 and place the draft in your bank for collection, receiving credit for that amount. The draft is not honored upon presentation. What entries on your books are then necessary? 6. You receive an invoice of $263.00 from the Newman Cloak Co. of Chicago, and at the bank pay this amount on a sight draft, to which the bill of lading is attached. Give the entries. 7. You discount at the Valley National Bank at 8% a $600.00 note receivable payable without interest, three months from the date on which the discount is made. Journalize the transaction. The maker of the note defaults when the note becomes due, and you are called on to pay it. Make the necessary journal entries. You discount at the Valley National Bank at 5% three months before maturity a $500.00 note receivable due six months after date, with interest at 6%. Journalize the transaction. The note is paid at maturity, no notice of dishonor being received. Make the proper entry. 8. You draw at 10 days' sight on Peters & White, of Chicago, for $500.00 in favor of the Chicago House Furnishing Co. What are the entries of each party concerned if the draft is accepted two days later; if the draft is dishonored; if the draft is paid at maturity; if because of lack of funds the draft is not paid at maturity? 9. Draw on the Emmons Hardware Co. at 30 days' sight for $500.00. Give the entries of both parties if the draft is accepted; if it is paid at maturity. What would be done if the Hardware Company refuses to accept the draft? 10. On January i, you purchase a bill of goods amounting to $300.00, terms 2/10, n/3o. On January 3 you return $50.00 worth for credit. What amount of cash will settle the bill on January u? 11. From what date does the discount period begin to run the date of the invoice, the date of the shipment of the goods, or the date of the re- ceipt of the goods? 12. Is it the practice to mail checks out on the last day of discount or to mail them in time so that they will reach their destination on the last day of discount? 13. What is the purpose of the custom of dating invoices ahead, i.e., post-dating? For example, a bill of millinery bought in July and shipped from the factory on August i may be accompanied by an invoice dated September i. 14. You buy a bill of goods on July i amounting to $500.00, terms 2/10, n/3o. Not having the necessary cash on July 1 1 to pay the bill, you borrow money at 6% to take advantage of the discount. How much do you gam or lose by the transaction? 15. You purchase a bill of goods from John Smith on October i, terms 2/10, n/3o. On October n you are unable to pay the entire bill, but by arrangement with Smith you are to be allowed the discount on whatever portion of the bill you can meet. If you send Smith a check for $245.00, how much credit will you receive? 70 ACCOUNTING PRINCIPLES 16. On September i, you purchase goods amounting to $2,000.00, terms 2/10, n/30. You have $2000.00 in the savings bank with which to meet the bill. This money is drawing 4%, but must remain in the bank until Oc- tober i, or else all interest since the last interest computation day, July i, will be forfeited. You have your choice, therefore, of the following ways of paying your bill: (a) You may let the bill run until October i, forfeiting the discount but retaining the interest on your savings account; (b) you may withdraw your savings and pay the bill on the discount date; (c) you may borrow the money on your note for 20 days at 6% and pay the bill on the discount date. Which plan is the best, and by what amount? 17. Why do wholesale firms use a series of discounts, such as 25%, 20%, and 5%, instead of a single discount, such as 50%? 18. Which is the better and how much a series of 25%, 20%, and 10%, or a single discount of 50%? 19. One firm offers a piano for $400.00, subject to discounts of 20% and 20%, and another offers the same make of piano with 25% and 15% off list. Which is the better offer, and by how much? 20. Find a single rate of discount equal to a discount series of 50%, 25%, 20%, and 10%. 21. Find the net selling price of an oak sideboard listed at $125.00, less 25%. 33^%. and 10%. CHAPTER VI THE DIVIDED JOURNAL AND THE TRADING ACCOUNT i. Character of Entries in a Merchandise Business. A re- view of the problems and exercises contained in the preceding chapter will show that nearly fifty per cent of the items have been posted to the cash account, the merchandise account, and the sales account. Moreover, for each transaction involving any of these accounts, there have been two postings one to cash, merchandise, or sales, and one to the other account in- volved in each case. Manifestly, economy of time and effort would result if the number of postings could be reduced. This could be accomplished to a degree by collecting the various debits and credits to these accounts and recording them as a compound entry in the general journal, thus: Cash 500 . oo Sales 200 . oo John Smith 200. oo Notes Receivable 50.00 Interest Income 50.00 Merchandise 400 . oo Wages 150.00 Office Expense 50.00 Interest Expense 100.00 Notes Payable 300.00 Cash 1,000.00 The first compound journal entry above indicates how ac- counts having the same debit may be grouped together so that there will be only one debit posting whereas there would be four without the grouping accomplished by the compound entry. Likewise the second compound entry by grouping the accounts having a common credit account will require only one credit posting instead of five which would be required without the grouping. If a journal were selected which would contain 72 ACCOUNTING PRINCIPLES only cash items and all credit accounts having cash as a corre- sponding debit were placed on one page and all debit accounts having cash as the offsetting credit were placed on the right page, the charge and credit to cash could themselves be omitted. (See Illustration Xo. 12 below.) The appearance of accounts to be credited on the debit page (left page) of such a cash jour- nal would be a sufficient indication that cash was to be debited for the total of amounts credited to these accounts. Likewise the appearance of accounts on the credit (right) page of such a journal would be a sufficient indication that cash was to be credited for an amount equal to the total of the amounts set opposite these accounts. 2. Cash Journal. The cash journal may consist of paper with the ordinary journal ruling, the debits being entered on the even pages (left pages) and the credits on the odd pages (right pages). For a particular period, therefore, the debit entries are on the left and the credits on the opposite page or the right. (See Illustration No. 12.) As the sum of the debit entries less the sum of the credit en- tries is equal to the amount of cash on hand, provided the bal- ance at the beginning is entered as the first debit, the cash journal can be used to show the cash balance at any time, and nothing is gained by retaining a cash account in the ledger. The cash journal becomes, therefore, not only a book of orig- inal entry, but a ledger account as well. 3. Purchase Journal. It might seem logical to use a simi- lar journal for the merchandise account, with purchases as debits on the left and sales as credits on the right, and with the merchandise inventory at the beginning as the first debit to the account. The sum of the debit entries less the sum of the credit entries does not, however, give the balance of merchan- dise. Consequently, there is no particular advantage in enter- ing purchases and sales in the same journal. On the other hand, as in a large business the recording of purchases is the work of one clerk and the recording of sales is the work of an- other, there is a distinct gain in having separate books of orig- inal entry for purchases and for sales. DIVIDED JOURNAL AND TRADING ACCOUNT 73 In the purchase journal are entered all purchases of mer- chandise as made, together with the account to be credited in each particular case. As cash purchases are entered in both the purchase journal and the cash journal, as a debit in one and a credit in the other, no record of the account to be cred- ited in the first journal or debited in the second journal need be made. After cash purchases have been entered in each jour- nal, however, the entries in both should be checked in the folio columns to indicate that no necessary posting has been omitted. The unchecked items in the purchase journal are then posted to the proper accounts, and a periodic closing is made, the total purchases being entered as a debit to the merchandise purchases account, which is explained in a later paragraph on the trading account. Purchases of property other than merchandise are not en- tered in the purchase journal, but in the old, or, as it may now be called, the general journal. Such a differentiation is, of course, necessary. The total of purchases is used in the calculation of the gross profits arising from operation, and would fail of its pur- pose if purchases of items not intended for sale were included. 4. Sales Journal. The ruling of the sales journal is similar to that of the cash and purchase journals. In the sales journal are entered all sales of merchandise as made, together with the account to be debited in each transaction. This debit account is, however, unnecessary in cash sales, which, like cash pur- chases, are entered in both the sales journal and the cash jour- nal, the debit entries of the latter constituting the credit en- tries of the former. After checking the corresponding items in the two journals to indicate that th'e proper cross-entries in the cash journal and the sales journal have been made, the un- checked entries in the sales journal are posted to the proper accounts. As in the case of the purchase journal, a closing is periodically made, the total of the sales being carried to the credit of the merchandise sales account in the ledger. 5. General Ledger. Although relieved of more than sev- enty-five per cent of the original entries by means of the special journals indicated, the general journal still serves a useful pur- 74 ACCOUNTING PRINCIPLES pose. In it are recorded the opening entries of a business for assets and liabilities contributed to it or taken over by it, these assets and liabilities being listed as the debits and credits of a compound journal entry. Where cash forms all of the as- sets, the opening entry is made simply in the cash journal; but, where cash is only one of a number of assets, the cash item is entered in both the cash journal and the general journal, the two entries being checked to indicate that the proper cross- entry has been made. In the general journal, also, are recorded the closing entries of the revenue accounts in connection with the formation of the profit and loss account, and the closing entry of the latter in connection with the transfer of its balance to the capital ac- count, as well as adjustment entries, credit purchases of expense items, credit purchases of property items, and all other entries not belonging to any of the special journals already described. 6. Trading Account. The trading account is practically a reconstruction of the old merchandise account, which was de- stroyed, of course, through the formation of the merchandise purchases and the merchandise sales accounts. Unlike the old merchandise account, however, the trading account consists of totals rather than of individual items. To the trading account are debited the merchandise inventory at the beginning of the period and the balance of the merchandise purchases account for the period under consideration; while to it are credited the balance of the merchandise sales account for the interval and the merchandise inventory at the close of the period. The bal- ance of the account, as in the old merchandise account, repre- sents the gross profits, which are closed into profit and loss. The trading account, therefore, may be said to bear the same relation to the merchandise purchases and merchandise sales accounts that profit and loss bears to the revenue accounts. 7. Return Purchases and Allowances. Where merchandise is returned by a business on account, or allowances are made on merchandise purchases, entries are made in the general jour- nal to the debit of the seller and to the credit of the merchan- dise purchases account. Consequently, the balance of the mer- DIVIDED JOURNAL AND TRADING ACCOUNT 75 chandise purchases account represents the net purchases, and is the amount to be debited to the trading account. If the number of items of return purchases and allowances is large a separate account may be set up and closed into mer- chandise purchases or trading when the books are closed. 8. Return Sales and Allowances. The return of goods to a business, or allowances made by it on merchandise sales, are also entered in the general journal, the transactions being deb- ited to the merchandise sales account and credited to the cus- tomers involved. The balance of the merchandise sales ac- count, therefore, represents the net sales, and is entered as a credit to the trading account. If the number of items of return sales and allowances is large, a separate account may be carried and closed into merchandise sales or trading at the time of closing the books. 9. Invoices as Original Entries. Purchase invoices are fre- quently bound, or pasted in a bound book, and used as a pur- chase journal. The sellers are then credited by postings direct to the ledger, the total of the invoices for a given period con- stituting the debit to the merchandise purchases account. Sales invoices are also frequently used as a sales journal. Where this is the case, the invoices are printed, bound, and numbered in duplicate, the originals being sent to the buyers and the duplicates constituting a bound book of original entry, from which the individual debits are posted and the total credit to merchandise sales is taken. 10. Treatment of Discount n Special Journals. When an invoice is sent or received, the gross amount of the invoice is entered in the sales journal or in the purchase journal, as the case may be, the amount being later debited or credited to the proper account. When paid, the gross amount of the invoice is entered on the proper side of the cash journal, together with the name of the customer from whom payment is received or the name of the creditor to whom remittance is made. The discount is entered on the opposite side of the ledger, becoming a discount on sales in the case of a sales invoice and a discount on purchases in the case of a purchase invoice. Thus, the full 76 ACCOUNTING PRINCIPLES amount of a sales invoice is entered as a debit to cash, the dis- count becoming a credit to cash under the designation of dis- counts on sales. Conversely, the gross amount of a purchase invoice is entered on the credit side of the cash journal, the discount in this case becoming a debit to cash under the head- ing of discounts on purchases. The result is a correct cash bal- ance and a correct debit or credit of the full amount of the in- voice to the proper personal account. This style of entering discounts is not used in the columnar journals to be treated in a succeeding chapter. ii. Illustration. The illustration below will show in detail the method of recording merchandise transactions by means of the divided journals described above. The transactions in- volved precede the illustrated account entries. TRANSACTIONS FOR ILLUSTRATION No. 12 1918 Mar. i Russell Scott opens business with the following assets: cash, $1600.00; merchandise, $2000.00; store fix- tures, $500.00. 2 Buys merchandise to the amount of $600.00 from the Emporium on account, terms 2/10, n/3O. 3 Pays freight charges in cash amounting to $14.00 Sells merchandise to Henry Waddell on account to the amount of $240.00. 4 Buys two horses and a wagon from the City Sales Co. for $300.00, giving a 6o-day note in payment. 5 Cash sales, $150.00. Sells Edward Lange on account mer- chandise to the amount of $250.00. 6 Buys a lot and small store building from the Reuter Realty Co. for $2000.00. paying $800.00 cash and giving a one-year note for the balance. 8 Cash sales, $i 20.00. Buys on account from the Emporium merchandise amounting to $750.00, terms 2/10, n/3o. 9 Sells Henry Waddell on account merchandise to the amount of $325.00. Pays insurance on store build- ing, fixtures, and stock, amounting to $26.00. 10 Cash sales, $135.00. Pays the Emporium bill of March 2 in full by remitting $588.00 in cash. 1 1 Buys a cash register from the National Cash Register Co. for $200.00, giving a 1 5-day note, bearing 6% interest in payment. Sells Edward Lange on account mer- chandise to the amount of $150.00. DIVIDED JOURNAL AND TRADING ACCOUNT 77 Mar. 12 Buys hay and other stable supplies for $75.00 cash. 13 Pays for postage, stationery, and other store expenses $32.00 in cash. Pays store salaries for two weeks, amounting to $50.00. 15 Cash sales, $126.00. 16 Henry Waddell pays $200.00 cash on account and gives a 6o-day note for $300.00. Credit of $10.00 allowed Waddell on account for merchandise returned. 17 Pays the Emporium bill of March 8, taking the discount. 1 8 Sells Henry Waddell on account merchandise amounting to $225.00. 19 Buys from the Emporium, 2/15, n/3o, merchandise to the amount of $950.00. 20 Sells Edward Lange on account merchandise amounting to $175.00. Returns $18.00 worth of damaged goods to the Emporium for credit. 22 Pays cash for sundry store expenses amounting to $15.00. 23 Cash sales, $260.00. 24 Edward Lange pays $200.00 on account, and is allowed $50.00 additional credit in exchange for harness for delivery team. 25 The Emporium allows credit of $25.00 for damage to mer- chandise bought on March 19. 26 Pays note to National Cash Register Co., due today, with $.50 interest. 27 Pays store salaries for two weeks, $50.00. and sundry store expenses amounting to $32.00. 28 Sells Henry Waddell on account merchandise amounting to $185.00. 30 Pays the wages of the driver of the delivery truck amount- ing to $37.50. Returns $25.00 worth of merchandise to the Emporium for credit. Allows credit of $15.00 to Henry Waddell for goods returned. 30 Merchandise inventory, $2,785.00. Accounts to be kept: Russell Scott, capital; Russell Scott, per- sonal; merchandise purchases; merchandise sales; merchandise in- ventory; store fixtures; delivery equipment; freight in; notes receivable; notes payable; real estate; insurance; discount on sales; discount on purchases; delivery expense; store expense; in- terest; personal accounts as needed. Make the original entries, post, and take a trial balance. Close the revenue accounts into profit and loss, and profit and loss and Russell Scott, personal, into capital. Close the books, and take another trial balance after closing. ACCOUNTING PRINCIPLES Dr. ILLUSTRATION NO. 12 THE DIVIDED JOURNAL CASH 1918 Mar. i Original Investment V 1600 90 5 Cash Sales V 150 00 8 Cash Sales V I2O 00 10 Cash Sales V 135 0-0 Discount on Purchases 88 12 00 15 Cash Sales V 126 DO 16 Henry Waddell Paid on account 84 200 CO i? Discount on Purchases 88 IS 00 23 Cash Sales V 260 CO 24 Edward Lange Paid on account 84 200 DC \ \ 28lS 00 Mar. 3i Balance 136 CO CASH Cr. IQlS Mar. 3 Freight In 88 14 cc 6 Real Estate Part Pay. Lot and Bldg. 85 800 CO 9 Insurance Bldg., Fix. and Stock 87 26 00 10 Emporium Invoice Mar. 2 a 600 00 12 Delivery Expense Hay and Other Stable Sups. > s 75 cc 13 Store Expense Postage, Stationery, etc. >- 32 CO Store Expense Store Salaries s? 50 CO 17 Emporium Invoice Mar. 8 86 750 CO 22 Store Expense Sundries 87 IS cc 26 Notes Payable Nat'l Cash Reg. Note 86 200 CO Interest Nat'l Cash Reg. Note S< So 27 Store Expense Store Salaries >: 50 CO Store Expense Sundries 87 32 CO 30 Delivery Expense Wages Truck Driver ss 37 $o Balance 136 00 2818 90 == J 79 igi8 Mar. 2 Emporium Inv. 540,2/10,11/30 86 600 00 8 Emporium Inv. 690,2/10,11/30 86 750 00 = 19 J Emporium Inv. 972,2/15^/60 Merchandise Purchases Total Purchases 86 87 95 00 2300 oo SALES F 1918 Mar. i Henrj Waddell Inv. 10 84 240 00 5 Cash Sales V 150 00 Edward Lange Inv. 114 84 250 00 8 Cash Sales V I2O 00 9 Henry Waddell Inv. 260 84 325 00 Cash Sales V 135 00 ii Edward Lange Inv. 319 84 150 00 15 Cash Sales V 126 00 18 Henry Waddell Inv. 629 84 225 00 20 Edward Lange Inv. 635 84 175 00 23 Cash Sales V 260 00 28 30 Henry Waddell Merchandise Sales Inv. 1059 Total Sales 84 87 185 00 2341 00 8o ACCOUNTING PRINCIPLES GENERAL JOURNAL MARCH, 1918 i V Cash 1600 oc 85 Merchandise Inventory 2000 oc 85 Store Fixtures 5o DO 85 Russell Scott, Capital 4100 X Original investment 4 85 Delivery Equipment 300 00 86 Notes Payable 300 OC Sixty-day note for horse and wagon 6 85 Real Estate 1 200 oc 86 Notes Payable I2OO 0-0 One-year note for balance lot and bldg. ii 85 Store Fixtures 200 oc 86 Notes Payable 2OO 00 Fifteen-day note to Nat'l Cash Register Co. for cash register 16 84 Notes Receivable 300 oc 84 Henry Waddell 300 00 Sixty-day note on account 17 8? Merchandise Sales 10 00 84 Henry Waddell IO 00 Credit for merchandise returned 20 86 Emporium 18 0-0 8? Merchandise Purchases 18 ^0 Allowance for damaged goods returned Carried Forward 6128 oc 6128 30 DIVIDED JOURNAL AND TRADING ACCOUNT 8l Brought Forward 6128 oo 6128 00 24 85 84 Delivery Equipment Edward Lange Allowance on account for harness So oo 5 00 86 8? 25 Emporium Merchandise Purchases Allowance for damaged goods returned 25 00 25 00 86 87 3 Emporium Merchandise Purchases Merchandise returned 25 00 25 00 87 84 Merchandise Sales Henry Waddell Credit for merchandise returned CLOSING ENTRIES 15 00 15 00 6243 00 6243 00 March 30 88 85 Trading Mdse. Inv. Beginning of period Mdse. Inv. Trading Closing of Mdse. Inv. beginning of period into trading 2OOO oo 2OOO 00 88 88 Trading Net Purchases Merchandise Purchases Net Pur. Closing of merchandise purchases into trading 2232 oc 2232 00 88 88 Trading Freight In Freight In Trading Closing of freight in into trading 14 00 14 00 ACCOUNTING PRINCIPLES 87 Merchandise Sales Net Sales 88 Trading Net Sales Closing of merchandise sales into trading 85 Mdse. Inv. End of Period Trading 88 Trading Mdse. Inv. End of Period Entry of merchandise inventory end of the period 88 Trading Gross Profits Profit and Loss Gross Profits Closing of trading into profit and loss 89 Profit and Loss Store Expense 87 Store Expense Profit and Loss Closing of store expense into profit and loss 89 Profit and Loss Delivery Expense 88 Delivery Expense Profit and Loss Closing of delivery expense into profit and loss 89 Profit and Loss Interest 88 Interest Profit and Loss Closing of interest into profit and loss 89 Profit and Loss Insurance 87 Insurance Profit and Loss Closing of insurance into profit and loss 88 Discount on Purchases Profit and Loss 89 Profit and Loss Disc, on Pur. Closing of discount on purchases into profit and loss 89 Profit and Loss Net Profits 86 Russell Scott, Capital Net Profits Closing of profit and loss into capital 2785 855 17900 5 26000 27 56400 2316 2785 855 17900 11250 26 27 564 DIVIDED JOURNAL AND TRADING ACCOUNT 83 The closing entries are made in detail above. The related entries may be combined into compound journal entries, and the closing entries abbreviated as follows: GENERAL JOURNAL MARCH, 1918 CLOSING ENTRIES March 30 Trading 4245 oo Mdse. Inv. Beginning of Period 2OOO oo Merchandise Purchases 2232 oo Freight In 14 oo Closing of the merchandise accounts into trading Sales 2316 oo Mdse. Inv. End of Period 2785 00 Trading 5101 oo Trading Gross Profits 855 oo Profit and Loss Gross Profits 855 oo Closing of trading into profit and loss Profit and Loss 3i8 oo Store Expense 179 00 Delivery Expense 112 50 Interest Paid 50 Insurance 26 00 Closing the expense accounts into profit and loss Discount on Purchases Profit and Loss 27 oo Profit and Loss Discount on Pur. 27 oo Closing of discount on purchases into profit and loss Profit and Loss Net Profits 564 oo Russell Scott, Capital Net Profits 564 oo Closing of profit and loss into capital ACCOUNTING PRINCIPLES LEDGER OF RUSSELL SCOTT NOTES RECEIVABLE 1918 Mar. 16 Balance J8o 300 oo 1918 Mar. J Balance = 300 00 Mar. 31 300 00 HENRY WADDELL 1918 Mar. i 879 -4 00 1918 Mar. 16 J8o 300 00 9 879 325 oo 78 200 DO 18 879 225 00 i/ J8o IO CO 28 879 l8 S oo 30 JSi 15 00 Mar. 3i Balance = 975 45 00 oo Balance = 450 975 00 00 EDWARD LANGE 1918 Mar. 5 879 250 oo 1918 Mar. 24 C?8 200 CO ii 879 15 00 J8i 5 90 Mar. 20 31 Balance S79 175 J75 325 oo oo 00 30 Balance 325 575 00 CD DIVIDED JOURNAL AND TRADING ACCOUNT MERCHANDISE INVENTORY F F 1918 Mar. i Inventory Inventory J8o 2OOO OO 1918 Mar. 30 Trading J82 2OOO 00 3i J82 2785 OO DELIVERY EQUIPMENT 1918 Mar. 4 J8o 300 OO 1918 Mar. 30 Balance 350 00 24 J8i 50 00 Balance 350 OO = = 35 00 Mar. 3i 35 OO STORE FIXTURES 1918 Mar. I J8o 500 OO 1918 Mar. 30 Balance 700 00 Mar. ii 31 Balance J8o 200 700 OO OO OO = = 700 00 700 REAL ESTATE 1918 Mar. 6 J8o 1 200 00' 1918 Mar. 30 Balance 2000 00 Mar. Balance C?8 800 OO = = 2000 2OOO OO 2OOO 00 3i OO 86 ACCOUNTING PRINCIPLES NOTES PAYABLE 1918 Mar. 26 C?8 2OO oo 1918 Mar. 4 J8o 300 DC 30 Balance 1500 oo 6 J8o 1 200 00 ii J8o 200 >o 1700 00 1700 00 Mar. 3i Balance 1500 Z'J EMPORIUM 1918 Mar. 10 17 C78 C?8 600 oo oo 1918 Mar. 2 8 P 79 P79 600 75Q 00 CO 750 20 J8o 18 oo iQ P 79 950 00 25 J8i 25 oo 3 J8i 25 oo = Balance ! ^=-_ 882 2300 oo oo 3i Balance 2300 00 00 Mar. 882 RUSSELL SCOTT, CAPITAL 1918 Mar. 30 Balance 4664 00 1918 Mar. i J8o 4100 00 30 Net Profits Balance J82 564 00 4664 oo 4664 70 00 Mar. 3i 4664 DIVIDED JOURNAL AND TRADING ACCOUNT INSURANCE - I9i8 Mar. 9 M] 26 oo 1918 Mar. 3 Profit & Loss J82 26 00 :RCH AND ISE SA LES 1918 Mar. I? J8o 10 oo 1918 Mar. 3 879 2341 00 3 J8i 15 oo Net Sales IV J82 2316 oo 2341 oo 2341 00 IERCHANDISE PURCHASES 1918 Mar. 3 P7P 2300 oo 1918 Mar. 2O J8i 18 00 25 J8i 25 00 3 J8i 25 00 NetPurchases J8i 2232 00 2300 00 2300 00 STORE EXPENSE 1918 Mar. 13 C?8 32 oo 1918 Mar. 3 Profit & Loss J82 179 00 C 7 8 50 oo 22 C 7 8 15 oo 27 C 7 8 5 00 C 7 8 32 179 oo oo 179 00 88 ACCOUNTING PRINCIPLES DELIVERY EXPENSE 1918 Mar. 12 Cy8 75 oo 1918 Mar. 3 Profit & Loss J82 112 50 30 ] C?8 37 50 112 5o 112 SO DISCOUNT ON PURCHASES 1918 Mar. 3 Profit & Loss 27 oo 1918 Mar. 10 C78 12 00 1 17 C78 15 00 00 27 oo 27 FREK 3HT IN 1918 Mar. 3 Cj4 I: 14 \ T TER 00 1918 Mar. 3 Trading J8i 14 00 EST EXPE: ^SE 1918 Mar. 26 C/8 50 1918 Mar. 3 Profit & Loss 282 = 50 PRA DING 1918 Mar. i Mdse. Inv. J8i 2OOO oo 1918 Mar. 30 Net Sales J82 2316 00 30 NetPurchases J8i 2232 00 Mdse. Inv. J82 2785 00 Freight In J8i 14 oo Gross Profits J82 Jss ^101 oo oo 5IOI 00 DIVIDED JOURNAL AND TRADING ACCOUNT 89 PROFIT AND Loss 1918 Mar. 30 Store Exp. J82 179 oo 1918 Mar. 30 Gross Profits J82 855 00 Deliv. Exp. J82 112 So Disc, on Pur. J82 27 00 InterestExp. 5 Insurance J82 26 oo Net Profits J82 564 oo _ 882 00 = = 882 00 PROBLEMS AND QUESTIONS i. Make a cash journal, general journal, purchase journal, and sales journal from ordinary journal paper. Enter the transactions listed below, post them to the ledger, take a trial balance, and close the accounts. 1918 Mar. John Smith begins a coal business by turning over the following: Building, $1500.00; land, $1200.00; cash, $250.00; furniture and fixtures, $300.00. The land and building have a mort- gage payable outstanding against them to the amount of $750.00. Buys from the Central Coal Co., 7 tons of nut coal at $8.00 a ton and 10 tons of lump coal at $7.00 a ton, 2/10, n/3o. Sells to J. T. Sanders on account 3 tons of nut coal at $11.00 a ton; to M. H. Borders on account 5 tons of lump coal at $10.00 a ton; and to Walter Love for cash 2 tons of nut coal at $10.50 a ton. Receives invoice from the Valley Coal Co. for the following items: 5 Tons Mine Run Coal, at $6.00 a ton (2000 Ibs.) $30 . oo 6 Tons Lump Coal, at $7.00 a ton 42 .00 4 Tons Nut Coal, at $8.00 a ton 32.00 $104.00 Upon weighing, there are found the following shortages: 200 Ibs. Mine Run Coal, 100 Ibs. Lump Coal, and 200 Ibs. Nut Coal. Sales as follows : M. H. Borders, 4 tons Nut, at $11.00 a ton, 2/10, n/3o. R. N. Johnson, 3 tons Lump, at $10.00 a ton, cash. Valley Hotel, 3 tons Mine Run, at $8.00 a ton, 2/10, n/3o. 90 ACCOUNTING PRINCIPLES Purchases as follows: Valley Coal Co., 2/10, 11/30: 10 Tons Nut, at $9.00. 4 Tons Lump, at $7.00. 6 Tons Mine Run, at $7.00. On receipt of the coal, it is discovered from samples to be of in- ferior quality, and an allowance of $7.75 is made by the Valley Coal Co. Mar. 6 John Smith decides to invest $1000.00 additional in the business, and spends $900.00 of this for the construction of coal bins and loading facilities. He then hires day laborers to shovel coal into the bins, paying them $25.00 for their services. He spends $10.00 additional in repairs to the building. The following amounts are paid on account: Invoice of March 2 of Central Coal Co., less discount. Invoice of March 5 of Valley Coal Co., less discount. 7 Collections as follows: J. T. Sanders, $33.00. M. H. Borders, $50.00. Valley Hotel, $23.52, amount of bill of March, less the discount. 8 Sales as follows' Valley Hotel, 6 tons Mine Run, at $8.00 a ton on account. Central Hotel, 5 tons Nut, at $10.50, cash. Capital Boarding Club, 4 tons Lump, at $10.00 on account. 9 Purchases as follows: Central Coal Co. on account: 20 Tons Nut, at $7.75. 30 Tons Lump, at $7.00. 25 Tons Mine Run, at $7.00. 10 Sales as follows: Central Manufacturing Co., 10 tons Mine Run, at $8.00 on account. Central Hotel, 5 tons Nut, at $10.50, cash. Valley Lumber Mills, 8 tons Lump, at $10.00, on account. 11 The Valley Lumber Mills reject one ton of coal on account of inferior quality, and return it for credit. 12 The Central Manufacturing Co. makes a note for $80.00 for 3 months at 8% in settlement of its account. 13 John Smith discounts the note at 7% at the Valley National Bank. 14 Pays the Valley Coal Co. in full for purchases of March 4. Receives payments as follows on account : Valley Hotel, $48.00. Capital Boarding Club, $40.00. Makes the following payments: Office Salaries, $175.00. Stationer)' and other office expenses, $25.00. 15 Calculate the balances of the accounts and check the entries, then take a trial balance. The business has $400.00 worth of coal on hand. Close the accounts through the journal. DIVIDED JOURNAL AND TRADING ACCOUNT 91 2. What per cent of the postings required by the regular journal is saved for items entered in (a) the cash journal; (b) the purchase journal; (c) the sales journal? About what per cent of the total transactions are entered in these special journals? 3. What economy other than that in posting results from the use of the special journals? 4. Compare the trading account with the merchandise account. 5. Make a trading account from the following items: Merchandise at the beginning of the Period $1,500.00 Merchandise Purchases 10,500.00 Merchandise Sales 15,000.00 Return Purchases 250.00 Return Sales 150. oo Freight In 35 .00 Office Expense 50 . oo Merchandise on Hand at Close of Period 1,400.00 6. The balance of each account on the books of Samuel J. Smith, hard- ware merchant, on September 30 follows: (a) Construct the trial balance. (b) The merchandise inventory on September 3oth was $8700.00. Construct a statement of Losses and Gains and a Financial Statement. (c) Give the journal entries to close the books : 1 Accounts Payable $2,500 . oo 1 Accounts Receivable 5,200.00 Cash 5,075.00 Commission Earned 500.00 Delivery Equipment 2,000 . oo Delivery Expense 3 7 5 - oo Expense 700 . oo Heat and Light 500.00 Interest Earned 250.00 Merchandise Purchases 30,800.00 Merchandise Sales 29,700.00 Mortgage Payable 4,000.00 Notes Payable 3,000.00 Notes Receivable 2,000.00 Real Estate 8,000.00 Salaries 2,800.00 Samuel Smith, Capital 18,000.00 Samuel Smith, Personal 300.00 Taxes 200 . oo 1 These items are the sums of amounts owing by debtors and owing to creditors. CHAPTER VII JANUARY TRANSACTIONS OF THE VALLEY FURNITURE STORE ILLUSTRATING THE USE OF SPECIAL JOURNALS i. Taking Over the Urban Furniture Co. On January i, 1914, Frank Williams starts into the furniture business under the firm name of Valley Furniture Store. He takes over the assets and assumes the liabilities of the Urban Furniture Co. on the basis of the following statement, prepared by Erwin Beckman & Co., Certified Public Accountants, paying out of his own personal assets $23,275.00 to John Smith, the owner of the Urban Furniture Co. BALANCE SHEET OF URBAN FURNITURE Co., DECEMBER 31, 1913 Assets Cash 500.00 Accounts Receivable: 5,000.00 St. Luke's Hospital $1,000.00 Bagdad University 2,000.00 Rice Mfg. Co. 500 . oo Smith Institute 600.00 J. H. Brigham 400.00 K. C. Riley 500.00 Merchandise Inventory 22,275.00 Fixtures 1,000.00 Delivery Equipment 3,000.00 $31,775.00 Liabilities and Proprietorship Notes Payable $1,000.00 (Note in favor of the Grand Rapids Furn. Co., dated Jan. 9, 1913, for i yr.) Accounts Payable 7,500.00 Sheboygan Chair Co. $2,400.00 Michigan Bed Co. 1,000.00 Wilson Carpet Works 2 , i oo . oo Hay wood Furn. Co. 2,000.00 John Smith, Capital 23,275.00 $31,775.00 92 TRANSACTIONS OF VALLEY FURNITURE STORE 93 It was also provided that the building of the Urban Furni- ture Co. should be leased from Chester Allen, the owner, for the year at $100.00 per month. (No entry is made in the jour- nal in regard to this lease.) 2. Order of Accounts in the Ledger. After the opening en- tries are made in the general journal, these opening entries are posted to the ledger. Before this posting is made, however, it is necessary to determine the accounts which are to be kept in the operation of the books of the Va'ley Furniture Store. The accounts to be kept are classified below, mainly with reference to the order which they are to take in the ledger. The ledger order is dictated mainly by the order in which the several accounts appear in the balance sheet and revenue statement which are to be made at the end of the month of January. If the accounts in the trial balance have the same order as that given the accounts in the ledger, the trial balance can show the accounts in the same order as they are shown in the ledger and they can be taken off in regular order in connection with the preparation of the balance sheet and the revenue statement. The classification, however, is not the order in which the accounts would appear in a ledger index which shows the accounts listed alphabetically. There should appear as the first page of every ledger, an index to the ledger accounts. The following classification of accounts will be used for the Valley Furniture Store during the month of January. A. Assets 1. Cash (as per Cash Book) 2. Accounts Receivable Page (a) Bagdad University i (b) J. H. Brigham i (c) H. R. Caldwell i (d) J. Collins 2 (e) Foster Hall 2 (f) Rice Mfg. Co 2 (g) K. C.Riley 3 (h) St. Luke's Hospital 3 (i) Smith Institute 3 (j) Square's (H. P.) Business College .... 4 94 ACCOUNTING PRINCIPLES Page (k) H. P. Henderson 4 (1) H. R. Scott 4 (m) R. H. Thompson 5 (n) Wm. Ward 5 (o) Wm. Day 5 (p) Hotel Bismarck 6 3. Merchandise Inventory 6 4. Scrap 6 5. Supply Invs 7 6. Deferred Exp 7 7. Store and Office Fixts 7 8. Deprec. Res. for Fixts 8 9. Delivery Equipment 8 10. Depreciation Reserve for Equipment 8 11. Land 9 12. Buildings 9 13. Depreciation Reserve for Buildings 9 B. Liabilities and Proprietorship 1. Notes Payable 10 2. Accounts Payable (a) Cross Farming Co 10 (b) Hay wood Furniture Co ' . . .10 (c) Michigan Bed Co u (d) Wilson Carpet Co n (e) Sheboygan Chair Co 1 1 (f) Loey Lock and Safe Co 12 (g) Sample Fur Co 12 (h) Underwood Typewriter 12 3. Proprietorship (a) Frank Williams, Capital 13 C. Revenue Accounts 1. Income Accounts (not a Ledger Account) (a) Merchandise Sales 13 (b) Sales Returns and Allowances . . . . . .13 (c) Financial (not a Ledger Account) (1) Discount on Purchases 13 (2) Interest Income 14 2. Expense (a) Merchandise Purchases 14 (b) Purchase Rets, and Allow 14 TRANSACTIONS OF VALLEY FURNITURE STORE 95 (c) Administrative (not a Ledger Account) Page (1) Salaries 15 (2) Miscellaneous Admin 15 (d) Selling Expense (not a Ledger Account) (1) Advertising 16 (2) Salaries 16 (3) Miscellaneous Selling Expense . . . .16 (e) Delivery Expense 17 (f) Financial (not a Ledger Account) (1) Interest Expense 17 (2) Discount on Sales 17 (g) General Expense (not a Ledger Account) (1) Depreciation .18 (2) Miscellaneous 18 (3) Over and Short 18 D. Closing Accounts 1. Trading 19 2. Profit and Loss 19 3. Groups of Accounts. It will be noticed in the classifi- cation given above, that a certain number of captions represent the title of accounting groups, instead of ledger accounts. Considering the use made of the balance sheet, it is advan- tageous to have all the customer accounts in one total under the caption of accounts receivable, as well as to have a list of the detail customer accounts. There is, therefore, found a group caption to the customer accounts when they appear in a balance sheet. The same explanation can be made with the caption for the group of accounts payable. The heading of proprietorship, under which is listed the account of Frank Wil- liams, marks this account off from the group of definite liabil- ities, so that it will be understood to be a type of obligation of the business, different from that which is represented by promises to pay definite sums of money at specific times, or obligations to pay certain accounts at stated times. The pro- prietorship claim against the assets of a business is a claim in perpetuity and is never paid in full unless the business itself is liquidated. It will also be noted that certain groups of accounts appear 96 ACCOUNTING PRINCIPLES under the heading of revenue accounts. The financial group of income accounts represents earnings due to efficient financial services, and from investments incidental to the main busi- ness. The expense accounts are grouped according to the serv- ices rendered and follow in general the lines of division of labor in the business itself. There will ordinarily be one or more employees whose attention is devoted to administration; some employees whose attention is given to selling; others who are charged with the delivery service. Then, there will be the general financial expenses such as interest and discount on sales. The general expense account is meant to contain all those items not otherwise classified. If at any time the amount of a sundry item not otherwise classified, becomes large, the general expense account would become the name of a group of accounts and would be split up into the cost of services ren- dered, under the caption of general expense. For example, rent, janitor services, cost of heat and light, might become the names of separate accounts instead of being charged to gen- eral expense, if the total expenditure under these captions were large in amount. The reason for the grouping of expense accounts is found in the explanation of why the accounts should be set up in the first place. There will, in general, be a standard expense under the caption of the cost of the several services which are recog- nized as distinct. This standard expense may grow out of the experience of the manager of the business, or it may grow out of the experience of others who have been engaged in the same business. It will in general be recognized that administrative expense should not be more than a certain per cent of total sales; that selling expense should not be more than a certain per cent of gross sales, and likewise for other expenses. It will, likewise, be recognized that there should be some proportion between advertising and the total of selling expense. After all, then, the record of costs is to be used by the manager in check- ing up to discover the points at which his business may be in- efficient, and the points at which it is regarded as particularly efficient. Moreover, since the groups of expenses follow along TRANSACTIONS OF VALLEY FURNITURE STORE 97 the lines of division of labor, they serve to enable the manager to hold certain individuals responsible for efficient service and also place him in position to reward them for efficient service. 4. Closing Accounts. The closing accounts serve the pur- pose of collecting the incomes and expenses with a view to cal- culating the net increase in proprietorship, which is carried to the credit of the capital account of the owner. 5. Payroll. The weekly payroll of the Valley Furniture Store from January i, was as follows: Frank Williams, Manager $100.00 H. P. McCulloch, Salesman 25.00 J. R. James, Bookkeeper 30.00 R. P. Ranger, Driver 10.00 John Moulton, Office Boy 7.00 Total $172.00 All of the employes are directly responsible to the manager, who can employ or dismiss the working force at his discretion. 6. Erasures. There are to be no erasures in this set of books. If an error has been made in journalizing, it can be corrected by a journal entry. For example, suppose that by mistake, a sale of $5.00 of merchandise on time were charged to the account of John Smith, when it should have been charged to William Jones. The correcting entry will be: William Jones 5 . oo John Smith 5.00 Correcting an error on July 5 in charging a sale to Smith instead of Jones In the memorandum space of the original entry, there should be a reference to the correcting entry as follows: "Corrected by entry July 5." 7. Journal Memoranda for the Books of the Valley Furni- ture Store. In the various journals for the transactions in January, the student will not be required to copy the detail either from the purchase invoices or from the sales slips. The Valley Furniture Store will be assumed to keep a set of pur- chase invoices numbered serially to which it can refer by num- 98 ACCOUNTING PRINCIPLES her in the purchase journal and on the credit side of the cash journal. The sales slips are also filed serially and referred to for detail in the sales journal. This reference to the original basis of the entry will serve for memoranda in entering the January transactions. There should always appear on the credit side of the cash journal the name of the payee and the check number for each payment. If the name of the payee is the account also, it need not be entered in the memorandum space. In any case, the check number should appear to the right of the center line dividing the account space from the memorandum space. The sales slip number and the invoice number would appear in the same place in the sales journal and in the purchase journal, respectively. 8. Ledger Memoranda. Discount terms should always be entered in the memorandum space of the ledger account. As indicated in Chapter VI, the special journals for sales and pur- chases are frequently so combined with the invoices, that a page reference is also a reference to the original invoice. When a note payable is made or a note receivable is received, there should be entered in the memorandum space of the general journal, the rate of interest, the due date, the name of the maker, the name of the indorsers, and the date of the note. When a special bill book for notes receivable and notes pay- able is used a reference to this book may displace the detailed memoranda. The general principle is that the journals should either have in them full information about each transaction or should refer to original records which are readily accessible for full information. If it is feasible to make the original records serve as journals, this is desirable. The ledger, on the other hand, should have a reference to the journal and such infor- mation as the business will require in connection with settling and receipting for accounts. The summary accounts made for the purpose of showing profits and the condition of the business, have full memoranda in the ledger and also refer to the journal. When these ac- counts are referred to by the manager or others who may be interested, the name of each account appearing on the debit or TRANSACTIONS OF VALLEY FURNITURE STORE 99 credit side of the trading account, the profit and loss, or the balance sheet is needed to convey the meaning of the sum- mary. 9. Transactions for January. January i, 1914. To provide working capital, Mr. Frank Williams invests $5,000.00 cash in addition to the assets taken over from the Urban Furniture Co. January 2. It is assumed in the January transactions that all money received is deposited in bank. The cash journal, conse- quently, takes the place of an account with the bank. Goods are ordered from the Haywood Furniture Co. to the amount of $i 1 50.00, and a duplicate of the order is duly filed. (No entry is made at this point.) Bills are paid as follows: Check # i. John Smith for 2 tons Oklahoma coal $14.00 Check # 2. Chester Allen, rent of store 100.00 Check # 3. Corner Book Store, for stationery 20.00 January 3. Pay the following bill with Check # 4: J. P. Johnson for shoeing horses and repairs to wagon $i 2 . oo The goods ordered from the Haywood Furniture Co. on the 2nd arrive together with the invoice. Terms, 2% 10 days, net 30 days, invoice #i. (The goods as received are checked up with the invoice in order to detect any discrepancies. The purchase of the goods is then recorded in the Purchase Journal. The terms quoted mean that the account is payable in 30 days, but that a dis- count of 2% from the face of the invoice will be allowed for payment within 10 days from the date of the invoice. Since there is no assurance that the discount will be taken, the pur- chases are entered at the face of the invoice.) January 4. The store is opened for business and the following sales are made: To H. R. Caldwell, sales slip #i $45.00 Terms: 3% 10 days, net 30 days. To H. P. Square Business College, sales slip #2, $125.00. Terms: Net 30 days, 8% interest after 30 days. January 5. Cash sales for the day are $130.00 Sales slips #3-6. (One entry for the daily cash sales is sufficient.) Allowance is made for damage on the H. P. Square Business College order, $20.00. Mr. Williams withdraws Cash, $50.00 (check #11). (Charge to Frank Williams, Personal.) TOO ACCOUNTING PRINCIPLES ^ (Full details of each sale may be placed in the journal, but the better business practice is to make out the sales slips in dupli-' cate, filing one copy. The explanation in the journal may then be merely a reference to the number of the sales slip and a statement of the terms of the sale.) January 5. Pay the Hay wood Furniture Co., check #5. their bill of January 3, taking the discount. (The check is made out for $1127.00. By the payment of this amount a debit of $1150.00 is canceled. An analysis of the transaction shows that a liability to pay a creditor $1150.00 has been canceled; that the asset Cash has been reduced $1127.00; that for prompt payment a reward of $23.00 has been earned. In the form of a journal entry the analysis becomes: The Haywood Furniture Co. $1,150.00 Cash $1,127.00 Discount on Purchases 23 . oo Since the transaction involves the payment of cash, it is not logical to make the entry in the journal. If the cash element of the transaction is entered in the Cash Journal and the discount in the General Journal, the debit to the Haywood Furn. Co. is split into two parts. If the transaction is considered as a pay- ment of the face of the bill to the creditor, and a refund of the amount of the discount from him, the journalization becomes: The Haywood Furniture Co. $i , 1 50 . oo Cash $1,150.00 Cash 23 . oo Discount on Purchases 23 . oo In this form the transaction can be entered in full in the Cash Journal. It is evident that the difference between the cash credit and the cash debit is $1127.00, the amount of the check. For convenience in auditing the books, the amount of the check should be stated hi the explanation space hi the credit entry, and reference made to the debit entry. In the later months this somewhat cumbersome arrangement will be avoided by the use of special columns.) TRANSACTIONS OF VALLEY FURNITURE STORE IOI Pay the weekly payroll with checks No. 6010. Charge part of payroll to administrative salaries and part to selling salaries. January 6. The St. Luke Hospital pays on account, $500.00. They also purchase, sales slip #7, beds amounting to $100.00. H. R. Caldwell pays his bill of Jan. 4, taking the discount of 3%, amount- ing to $1.35. (Read the explanation on Jan. 5 again, and make a similar analysis of this transaction. Notice that in this case the discount is a Discount on Sales and is, therefore, a loss to the business.) Purchase on account from the Sample Furniture Co. for office use the following: 2 high chairs at $5.00 $10.00 2 high desks at $20.00 40.00 i high stool 2 . oo Terms: 2% 10 days, net 30 days. $52.00 January 8. Purchase on account from the Cross Farming Co. a pair of mules for delivery service, $400.00. Sales for the day: Cash sales (one entry) Sales Slips #8, #9, #10 $125.00. Credit Sales: Foster Hall, Sales Slip #11, Dining room set $40.00 Miscellaneous rugs 3 5 . oo $75.00 January 9. A rug sold to Foster Hall on the 8th is returned for credit, $20.00. Frank Williams purchased at cost for his personal use rugs costing $50.00. (Charge to Frank Williams, Sales Slip #12.) Personal and credit to Mdse. Purchases. Paid interest due on notes payable, $80.00. Also paid the note of $1,000.00. Check #12 covers both transactions. (Although one check covers both transac- tions, separate entries are required in the Cash Journal.) Buy hay for $20.00, paying cash. (Check #13.) Mr. Williams increases the capital invested in the business by $500.00, cash. January 10. Cash Sales: Sales slip #13 $15.00 Sales slip #14 10.00 Sales slip #15 12.50 Sales slip #16 8.00 $45-50 102 ACCOUNTING PRINCIPLES January 10 Credit Sales: Sales slip #17 Bagdad University $40.00 Sales slip #18 J. H. Brigham 30.00 Sales slip #19 H. R. Caldwell 20.00 $90.00 Receipts on account : Bagdad University, account of Jan. 10, 1913, $2,000.00. This ac- count had run for one year after it was due and bore interest after maturity at the rate of 6^' c per annum. The interest, amounting to $120.00, is paid as well as the amount of the account. January n. Make payments on account as follows: Sheboygan Chair Co.. Check #14 $2,400.00 Michigan Bed Co., Check #15 1,000.00 Cash Sales: Sales slip #20 32.00 Sales slip #21 26.00 Sales slip #22 35- Goods on sales slip #20 are damaged in delivery to the amount of $25.00. Refund for this amount is made in cash (check #16). Credit Sales: Sales slip #23, H. R. Scott $33 .00 Sales slip #24, J. Collins 18.00 Sales slip #25, William Wood 55 oo Terms in all cases, 2% 10 days, net 30 days. (Since the terms quoted above are the usual terms of sale in this business, they will be called regular terms hereafter.) January 12. Make an agreement with the Stechert Advertising Agency to have five insertions in the Valley News at $50.00 per page. Pay for a half page insertion, $25.00. (Check #17.) Frank Williams draws for personal use, $50.00. (Check #18.) Pay taxes, $275.00. (Check #19.) Pay the personal taxes of Frank Williams, $125.00. (Check #20.) The St. Luke Hospital sends a check for $98.00 in settlement of their bill of Jan. 6. As the terms of sale did not provide for a cash discount on this bill, the check is returned. (No entry required.) Cash Sales: Sales slip #26 $34 . oo Sales slip #27 19.00 Credit Sales: Sales slip #28, William Day 4500 Sales slip #29, R. H. Thompson 15.00 Sales slip #30, R. P. Henderson Terms: Regular in each case (2% 10 days, 30 net). The St. Luke Hospital sends a check for $100.00, which is accepted. TRANSACTIONS OF VALLEY FURNITURE STORE 103 January 13. The Sample Furniture Co. is closing out business. Take advantage of the low prices offered on their stock to order the following goods, terms: settlement on delivery. Order merchandise to the amount of $1,850.00. (No entry required at this time.) January 13. Cash Sales: Sales slip #31 $25.00 Sales slip #32 17-5 Sales slip #33 22.00 Sales slip #34 38 . oo $IC2.50 Credit Sales: Sales slip #35, J. Collins $25.00 Terms, 3% 10 days. Sales slip #36, H. R.-Caldwell 30.00 Sales slip #37, J. H. Brigham 30.00 Terms, regular in both cases. Pay the weekly payroll (checks #21-25). January 15. The goods ordered from the Sample Furniture Co. arrive (invoice #2). The order for the five dining room sets costing $200.00 could not be filled and this portion of the order is canceled. The delivery of the 30 fumed oak chairs for $300.00 is delayed. Credit the Sample Furniture Co. for goods delivered. Arrange for the payment of this account as follows: cash, $1,000.00 (check #26), balance note without interest at 30 days. Receipts on account as follows: J. H. Brigham $400.00 H. R. Caldwell, bill of Jan. 10 20.00 J. Collins, bill of Jan. u (less $.36 discount) 18.00 Note: From this date the sales are listed and entered at the end of each week for the purpose of abbreviating the number of entries. It must not be forgotten that in actual business sales would be made and entered daily. The freight bill for the first two weeks in January, amounting to $125.00, is presented by the Valley Central Railroad. Pay by check #27. (Freight-in is part of the cost of merchandise pur- chased.) After the payment is receipted and entered, an error of $10.00 is discovered in the bill and a cash refund of this amount is secured. Receive on account from K. C. Riley, $200.00. January 16. The following bill, dated Jan. 10, is paid with check #28: To A. B. Kirk, Dr. Painting of sign (advertising) $10 . oo Painting of Store 7 5 oo 104 ACCOUNTING PRINCIPLES January 17. Frank Williams draws $25.00 as an advance on salary due at the end of the week. (Check #29.) January 18. The Clerk discovers that the $200.00 credited to K. C. Riley on the 1 5th should have been credited to the Rice Mfg. Co. Buy an Underwood typewriter from the Underwood Company, price $102.50. Buy from the Corner Book Store for cash (check #30) 50 carbons for $1.50 and 1000 letter heads for $5.00. January 20. Cash sales for the week are $870.00. Credit sales as follows: #43, Hotel Bismarck $150.00 #44, H. P. Square Business College oo . oo #45. Bagdad University 325.00 Terms: net 30 days hi each case. #46, J. H. Brigham 25.00 Terms: 3% 10 days, net 30 days. Pay the weekly payroll, checks #31-35. (Remember the advance payment made to Frank Williams.) The chairs on the Sample Furniture Co. order of January i3th arrive to-day, invoice #3. Pay by check #36. (Enter in Purchase Journal and Cash Journal. Check in both so that no posting will be required.) Receive from H. R. Scott check for bill of January n, less discount. January 22. Pay the Stechert Advertising Agency for four ad- ditional half page insertions in the Valley News according to the agreement of January i2th. (Check #37.) J. R. James is dismissed from service. Pay him $5.00 (check #38) for the day's service. Engaged Floyd Jones as clerk at $30.00 per week beginning January 24th. Pay the Rapid Repair Co. $15.00 for repairs on the furniture bought from the Sample Furniture Co., and charge the amount to the Sample Furniture Co. (check #39). Pay the Rapid Repair Co. $25.00 (check #40) for repairs to the store fixtures. Receive on account checks as follows: R. H. Thompson, bill of Jan 12, less discount. R. P. Henderson, bill of Jan. 12, less discount. (These checks are accepted since they were mailed within the discount period.) January 24. Receive payment on account as follows: Bagdad University $180.00 J. Collins, bill of Jan. 13, less discount. H. R. Caldwell, bill of Jan. 13, less discount. TRANSACTIONS OF VALLEY FURNITURE STORE 105 January 25. In counting the cash for the day there was found an excess of $1.00 above the amount shown by the record of receipts and sales. (It is usual to open an account Over and Short to care for cash discrepancies. Amounts in excess of the recorded receipts are credited to this account; amounts under the recorded receipts are debited to Over and Short. At the end of the month the account is closed into Profit and Loss.) January. 26. Frank Williams invests $1000.00 in the business. January 27. Frank Williams' personal grocery bill of $35.00 is paid by check #41. Buy the lot and building in which the business is conducted for $6000.00, paying $3000.00 in cash (land, $2000.00, building, $4000.00) (check #42), and making a five-year 8% note, payable to R. H. Jones, for the balance. Interest on the note is to begin on Feb. i, 1914, and is to be paid semi-annually, May i and Nov. i. A cash allowance of $10.00 is received for rent paid this month. January 27. Cash sales for the week, $483.00. Credit Sales: #51, Bagdad University $65.00 #52, J. H. Brigham 235.00 #53, H. R. Scott 428.00 #54, St. Luke Hospital 160.00 #55, J. Collins 120.00 Terms: Regular in each case, except the Bagdad University bill is 30 days net. Pay the weekly payroll. (Checks #43-47.) (Floyd Jones is paid for the actual time employed.) January 30. Buy a burglar-proof safe from the Lacy Lock & Safe Co. for $150.00; terms: 2% 10 days, net 30 days. PETTY CASH 1. Petty Cash Book. The cash transactions of a business are more readily checked if all money received is deposited in a bank and all money expended is paid out by check. The can- celed check is better evidence of the amount paid out than even a signed receipt, the check automatically becoming a re- ceipt through the endorsement of the payee when the cash is secured. It is more convenient, however, to pay small amounts for express, telegrams, and other sundry expenses over the counter in cash. As these small amounts are expended, a receipt for them should be taken and deposited in the cash drawer or in a lockable money box. When the fund set aside for these petty expenses is exhausted, it is renewed, the process being repeated as often as may be necessary. If the fund is created and re- plenished by check, even the petty expenses of the business may be made to pass through the bank. If the petty expenditures are small in amount and volume, no book at all need be used to record them. The receipts themselves serve as evidence of payment and as vouchers showing what accounts should be charged. If the payments are frequent, however, and large in the aggregate, they should be entered in a special book known as the Petty Cash Book. 2. Imprest System and Associated Journal Entry. In the imprest system, this book is used simply as a memorandum cash journal to place in permanent form a record of the receipts and disbursements of petty cash. The creation of the fund is accomplished by the following journal entry: Petty Cash 100.00 Cash 100 . oo Setting aside of $100.00 for petty cash. 106 PETTY CASH 107 Let us assume that this fund is replenished on the first of each month, and that the expenditures for January are as fol- lows: cartage, $35.00; postage, $40.00; general expense. $20.00. On February i, a check would be drawn to cover these items, and the latter entered on the credit side of the cash journal. From the cash journal, the items would then be posted to the debit side of the proper accounts. After the first charge, therefore, there is no debit or credit to petty cash. When petty cash is handled in this way, the clerk in charge should at all times have in his fund either the cash charged to him or the receipts which, added to the balance on hand will equal the amount originally charged. To guard against possible shortages the fund should be audited at least once each month. 3. Petty Cash Journal. The petty cash book is sometimes used as a book of original entry, thus becoming one of the journals of the business. This method involves successive deb- its and credits to the petty cash account. The account is charged on the cash journal, not only with the original check creating the fund, but with all subsequent checks to renew it when depleted. The expenditures, on the other hand, are charged directly from the petty cash journal to the proper expense accounts and credited to petty cash. This division of the cash record into two books of original entry might result in serious inconvenience, especially when the keeper of the petty cash is not located in the same building with the keeper of the regular cash journal, and accounts for the common use of the imprest system. The form of the petty cash book or journal and the method of entry are illustrated on pages 108-109. TRANSACTIONS FOR ILLUSTRATION No. 13 1 Received check No. 45 for $100.00 to be used for petty cash. 2 Paid on a collect telegram $1.25. 3 Paid out for postage $5.00. 4 Spent for sundry office supplies $7.50. 5 Paid for drayage $2.50. 6 Donated to charity $5.00. 7 Paid for carriage hire on official business $1.50. 8 Paid out for express charges $1.35. io8 ACCOUNTING PRINCIPLES z M to O O O to D NO O >O l^ U H z U O 8 M U 10 10 II S & *- _ a. in H o fi M O VO II rt> < M (N 1 B a Q S ^ S II 3 M H * *-*J E M at X IH NH In O 3 O =3 M H CO ^ W -3 U to *> S 01 >o O O O O O ^ d O *^ ^^ O ^^ r ^ 2gl8l! M lOC^CI W M M c* t* O M H u -S g ^ g"S w H *n CO H M d i PU g in | NOI1VNV w 1 w ll,ll^lli 1 1 2 3 1 . J 3 1 -3 1 b nerj-*lO<5^-OO O 1 ( Q 1^ t H. H- > I, g 8 Isl &2 8 8 t> c u M H -1 O M H < Q >. w 1 > 1 PETTY CASH 109 ILLUSTRATION ijA PETTY CASH JOURNAL (Form same as above except for closing as below.) PETTY CASH GENERAL EXPENSE ir> O O O 1/5 t^. O M VO \O M hH OFFICE SUPPLIES O >o "-; r^ t* DRAYAGE O to ll Oil M CN EXPRESS >o r<5 >o|| POll M M (H HI * * o *N O IO to O to CO O II 10 O O to O 1 O O II wll PO to to r>- M|_M_O Oil l-l >O t^ M IO IH M * N HMt-^d -<3- 1 -3- m Q H | ill 1 i|.b|.tll sS 1 ^^ ^i filllal a^|S^ s| 0)23 > - l -c!^3 X- RECEIVED 8 8ll 8 8 85 "> * O t>- (N H M 9 Q 2 M It SI HO ACCOUNTING PRINCIPLES Under the imprest system, after entering the transactions in the petty cash book, as shown, the petty cash clerk forwards to the cashier the receipts for the amounts expended, together with a memorandum or voucher attached giving a summary of the expenditures, as follows: Express $1.35 Dray age 2 . 50 Office Supplies 7 . 50 General Expense 12.75 $24. 10 Upon receipt of the charges, the cashier ente-s them on the credit side of the cash journal, and sends to the petty cash clerk a check for the full amount. When entered on the petty cash book, the check restores the petty cash to its original amount. If the petty cash book were used as a journal, the items of expense would be brought down in the explanation column with the amounts in the paid column to the right. The charges would then be posted to the different accounts, and the ledger page entered in the folio column, as hi the case of other journal postings. The folio column would, of course, be useless if the book were used merely as a memorandum under the imprest system, already described. When the petty cash book is used as a journal the original charge to petty cash appears hi the cash journal. If the petty cash clerk repo ts the journal entries aris ng out of the petty cash journal for the purpose of closing or furnishes these journal entries to the keeper of the general ledger, the petty cash account in the general ledger would be credited with the total of the amount charged to the several expense accounts. The petty cash account would then have a balance differing from the original charge to the account. In any case, the credit to petty cash shou'd be posted from the petty cash jour- nal at the same time the several expense accounts are charged. When the cashier issues a check to reimburse the petty cash clerk the petty cash account would be charged again in the gen- eral cash journal at the same time the cash account is credited PETTY CASH ill for the amount of the check issued. It is more usual and also the preferable usage to make the petty cash book a memoran- dum book and the only charge to the petty cash account under such usage is the original charge made when the fund is cre- ated. The charges to the expense accounts covered by the ex- penditures of the petty cash clerk are then entered in the gen- eral cash journal at the same time that the check is issued to reimburse petty cash. That is, the cash account is credited and the expense accounts charged so that the petty cash account stands as it was at the beginning of the fund. PROBLEMS AND QUESTIONS For the following problems, the student should rule a letter size page for petty cash. i. Enter the following data in the Petty Cash Book, using it as a petty cash memorandum book. Enter the expenditure under the following ac- count headings: express, cartage, delivery expense, general expense. June i Received from the cashier Sioo.oo to be used as petty cash, the petty cash journal to be turned over to the ledger clerk at regular intervals for posting to the ledger. 2 Paid for repairs to office fixtures, $2.50. 3 Purchased stamps for cash, $5.00. 4 Paid charges on collect telegram, $1.25. 5 Paid for drayage, $3.50. 6 Paid for express charges, $4.50. 7 Paid for repairs to fixtures, $5.00. Settled with the Valley Blacksmith for the following: Shoeing of horses, $2.50; welding of tires, $5.50; other repairs to wagon, $4.75. 8 Purchased hay for delivery team, $5.00. 9 Purchased fuel for use in store, $5.25. 10 Make up a statement for the cashier, covering receipts for ex- penses to date, and close the petty cash journal. 12 The cashier reimburses petty cash for the total expenditures reported. Journalize the items showing the debits and credits for items going into the regular Cash Journal. 2. Journalize the items of the Petty Cash Book as of June 12 as they would be journalized if the Petty Cash Book were used as a journal. In- dicate how those journal entries should be made in the Petty Cash Journal. CHAPTER EX APPORTIONMENT OF EXPENSES TO APPROPRIATE PERIOD -DEPRECIATION AND REPAIRS i. Definition of Expense. Expense accounts have already been referred to as the debit balance group of the revenue ac- counts. They tend to decrease proprietorship or capital, while the income accounts, the other group of revenue accounts, have precisely the opposite effect. It frequently becomes necessary to determine whether a cer- tain outlay is an asset or property expenditure or an expense. This can be done only by considering it in connection with the particular period in hand. Thus, if $500.00 is spent for fuel, the purchaser secures an asset worth $500.00. If the fuel so purchased is used in heating the store building for the month of January, a summary of the expenses for that month must in- clude the $500.00. If, however, only one fourth of the fuel is used for the month of January, then only $125.00 of the fuel outlay can be regarded as expense for the month of January, the balance constituting an asset expenditure at the close of the month. Expenditures for merchandise are treated in precisely the same way. A business purchases, we will say, $10,000.00 worth of goods during the month of January. During the month, however, only half of the goods are sold. Consequently, only $5,000.00 of the outlay can be counted as an expense, to be charged against the sales in the calculation of the profits for the month of January. The remaining $5,000.00 worth of mer- chandise is an asset, and is scheduled as such in the balance sheet at the close of the month. If the question is asked, therefore, whether a certain expen- diture is an asset or expense, it must be determined whether the outlay is a part of the cost of securing the income for the APPORTIONMENT OF EXPENSES 113 definite period under consideration. If entirely used up in se- curing this income, the whole outlay becomes an expense. If only partly used up, the part so expended becomes an expense, the remainder constituting an asset at the close of the period. 2. Supply Inventories. The merchandise on hand at the close of a period has been scheduled as the merchandise inven- tory. Supplies such as fuel, stationery, stamps, etc., are simply inventories of another kind, and may be styled supply inven- tories. Just as credit is taken in the merchandise and trading accounts for the merchandise on hand at the close of a period, so credit must be taken for the final supply inventories in clos- ing the expense accounts. Thus, if the $500.00 outlay for fuel referred to above has been charged to expense, credit for the $375.00 unexpended on January 31 must be taken by journal entry, as follows: Supply Inventories Fuel 3 7 5 . oo Expense 375-oo Credit for supply inventories The remainder of the expense account is, of course, a pure expense, and is closed into profit and loss by the following journal entry: Profit and Loss Expense 125.00 Expense Profit and Loss 125.00 Closing of Expense into Profit and Loss By these two journal entries, therefore, there has been a cor- rect apportionment of the $500 fuel outlay between assets and expense for the period ending January 31. Although there can never be a correct statement of net prof- its without an apportionment of expenditures between assets and expense, a business may neglect to take credit for supplies on hand if the total supplies purchased have been practically used up for the period under consideration. In some instances, the total supplies on hand never constitute any considerable item at any time throughout the period. This might be true of stationery and stamps. In such instances, also, a business may legitimately fail to take credit for a small unused balance. 114 ACCOUNTING PRINCIPLES In many accounting texts, the apportionment between assets and expense is referred to as an apportionment between capital expenditures and expense. It is fair, however, to question the appropriateness of this terminology, since an asset expenditure may leave capital unaffected, whereas an expense outlay always tends to decrease capital. True, the word capital is frequently used in economics as synonymous with assets, but in accounting there should be a consistent use of terms and a precise definition of them. In the interest of clearness, therefore, business outlays should be referred to as asset expenditures or as expense. 3. Definition of Depreciation. Certain assets, frequently called fixed assets, such as houses, land, office equipment, fac- tory machinery, etc., are secured to furnish the necessary fa- cilities for the conduct of the business. One is accustomed to think of these as durable assets as assets not used up in the ordinary conduct of the business and to think of expendi- tures for them as asset expenditures. While these particular assets are not used up so rapidly as supplies, still they are used up over a longer or shorter period of time, thus becoming an expense of operation for the period over which they are used. Thus, if a typewriter costing $100.00 lasts ten years, the $100.00 outlay becomes a charge to expense. If the business is calculating profits for a one-year period only, manifestly only one tenth of the amount, or $10.00, should be charged to this account; for, if the loss of the asset, which is equal to the cost of the asset, were charged entirely to any one year, the other nine years would fail to bear their proportion- ate cost of the profit arising from the use of the typewriter in question. The cost of the typewriter should, consequently, be equitably distributed over the ten-year period in charging; the loss of the asset to expense. This process of charging a fixed asset to expense over the period of the life of the asset is called depreciating the asset, or the depreciation of the asset. 4. Causes of Depreciation. The causes of depreciation of a fixed asset are as numerous as the factors affecting the life of the asset itself. The causes generally considered are wear and tear, obsolescence, inadequacy, and accident. APPORTIONMENT OF EXPENSES 115 If the type of machinery and tools used in a factory did not change from year to year, the life of these assets would be marked by the period of their usefulness as determined by or- dinary wear and tear. This period of usefulness is frequently shortened, however, by the appearance of improved machines and tools. If such later types reduce the expense of produc- tion by an amount in excess of an adequate return on the in- vestment involved in their purchase and installation, the earlier types are discarded as obsolete. A tool or machine may also become worthless for purposes of operation because of inadequacy long before its usefulness is de- stroyed through wear and tear. Thus, a certain switchboard may provide satisfactorily for all of the telephones that can be attached, but the growth of the community may have been such that the old switchboard must be discarded for a new one equipped for a larger service. In other words, the old switch- board has become inadequate, and its life has been shortened materially by reason of this inadequacy. The life of an asset is also frequently shortened by fire or flood, or by some other accidental, providential, or fortuitous circumstance. There are doubtless other possible causes, but those mentioned will suffice to show the nature of depreciation. 5. Depreciation and Price Reductions. Frequently the value of an asset is reduced through a lowering of the cost price. For instance, after a machine has been in operation for a year, the price of the machine may be so reduced that a new one could be installed for half the original cost. The question therefore arises as to whether there should be set up a deprecia- tion charge of half the cost of the old machine. If the defini- tion already given of depreciation is the correct one, it is clear that there has been no depreciation. The old cost must be properly distributed over the useful life of the asset, regardless of what the cost of the new asset may be. In other words, the amount of expense that is to be occasioned by the purchase of an asset is determined at the time of the purchase. A lower price at a later date has nothing to do with the original expense or with its proper distribution. The reduction in the price of Il6 ACCOUNTING PRINCIPLES assets is a question to be considered in connection with the valuation of assets, to be treated in a subsequent chapter. 6. Methods of Charging Depreciation. An asset may be entirely worthless at the expiration of its useful life in a busi- ness, or it may have a value as scrap. The scrap value of an asset is its value for purposes other than those of the business by which it is owned, or its value on the market apart from the going concern for which it was purchased. As this scrap value cannot be definitely fixed until the asset is sold, the depre- ciated asset is carried on the books of the concern at an esti- mated market price. The original cost of the asset less the scrap value may be designated as the use value of the asset. There are several well-known methods of charging this use value to expense. Chief among these are the straight-line charge, the charge of a constant per cent of the diminishing value, and the sinking-fund method. 7. Straight-line Depreciation. This method involves a charge for depreciation each time the books are closed in con- nection with the calculation of profits. As the books are usually closed at regular intervals monthly, quarterly, semiannu- ally, or annually the use value of the asset is divided by the number of such periods which mark its useful life, the quotient representing the amount to be charged as depreciation at the close of each succeeding period. Thus, if the use value of a machine is $400.00 and the period of useful service is ten years, an annual depreciation charge of $40.00 must be made at each successive yearly closing. This is the method most commonly used. 8. Constant Percentage of Diminishing Value. The straight- line method is sometimes criticized because it does not accom- plish what at first thought it seems to accomplish. It seems to distribute the cost of the asset equally over the periods of its use. This purpose, however, is defeated by reason of the fact that repairs to the asset cost more each year as the end of its useful life is approached. In other words, this constant increase in the cost of repairs results in a gradually increasing charge in connection with the service furnished by a given asset. APPORTIONMENT OF EXPENSES 117 To meet this defect, it has been suggested that a charge of a certain constant percentage of the diminishing value of the as- set should be made at the close of each period until the entire use value of the asset has been charged off for depreciation. For example, if a machine costing $500.00 has a residual or scrap value at the end of six years of $131.08, an annual depre- ciation charge of 20% of the diminishing value of the machine is made. The yearly charges are as follows: Value Depreciation Residual Value $500.00 $100.00 $400.00 400 .00 80 . oo 3 20 . oo 320.00 64.00 256.00 256.00 51.20 204.80 204.80 40.96 163.84 163.84 32.76 131 08 This method of depreciation accomplishes the desired pur- pose only when the annual increase in the cost of repairs is equal to the annual decrease in the depreciation charge. It is not to be expected, of course, that there will be an exact equality; but, unless the two quantities are approxi- mately equal, this method is not far superior to straight-line depreciation. The percentage of diminishing value to be applied in the method under consideration may be derived as follows: Let V = the original cost of the asset R = the residual value d = the rate of depreciation which will reduce V to R in n years n = the number of years of useful life of the asset Then V dV = residual value at the end of the first year V dV d(V d V} = residual value at the end of the second year V(i d) 2 = residual value at the end of the second year V(i d) n = residual value at the end of the nth year V(i -d) = R (i - <*)" = R/V_ i -d = \/R/V d = i - Il8 ACCOUNTING PRINCIPLES Thus the rate of depreciation to be applied to the residual value of an asset each year to charge off the use value of the asset in n years is one minus the nth root of the final residual or scrap value divided by the original value or cost. This equation is easily solved in a given case by the use of logarithms. Substituting in this equation the figures from the example given above, we have d = i -^131.08/500.00 = 20% 9. Repairs and Depreciation. Depreciation is sometimes defined as the wear that cannot be repaired. Regular and skillful repairs frequently lengthen the period of usefulness of an asset, and the failure to make such repairs often results in a more rapid depreciation of the asset. This close relation be- tween depreciation and repairs suggests the possibility of charg- ing each year for depreciation and repairs an amount sufficient to provide for both these items. The balance not spent for re- pairs may then be charged to depreciation. This method of providing for depreciation can be used to make constant dur- ing the life of the asset the cost of the services rendered by it, without at the same time obscuring the actual expenditures for repairs. Let us suppose that the residual or scrap value of a machine costing $600.00 is $100.00 at the end of five years, and that a fair estimate of the average annual cost of repairing the ma- chine is $30.00. Then the total cost of securing efficient service from the machine for the five-year period is $650.00, or an aver- age cost of $130.00 a year. During the first year, the repair bill would of course be small, possibly not more than $20.00, while the charge for depreciation would be relatively large, or $110.00. During the fourth year, the repair bill would prob- ably be about $40.00, whereas the depreciation charge would be reduced to $90.00 Thus the total annual charge for both depreciation and repairs remains unchanged. 10. Depreciation Reserve --The first method of journaliz- ing depreciation that suggests itself is to debit depreciation and to credit the account of the depreciating asset. Thus, if delivery APPORTIONMENT OF EXPENSES 1 19 equipment were the asset in question, and the amount of the depreciation charge were $40.00, the journal entry would be: Depreciation 40 . oo Delivery Equipment 40.00 Record of depreciation of delivery equipment The chief objection to this method of entering the deprecia- tion charge is that it destroys the record of the original cost of the asset as contained in the asset account. In practice, there- fore, the charge is credited to an entirely new account, known as the depreciation reserve, which must be considered in con- nection with the asset account to obtain the correct current value of the asset. For this reason, the depreciation reserve is commonly called an offset or valuation account, its balance in- dicating the amount by which the current book value of the corresponding asset is overstated. The effect of the deprecia- tion reserve is simply to hold the offset in suspense until the preparation of the balance sheet, when the current value of the asset is shown as the difference between the original cost and the depreciation reserve. The better method of journalizing the depreciation of the de- livery equipment, therefore, is to debit depreciation and to credit the depreciation reserve of the particular asset, as follows: Depreciation 40 . oo Depreciation Reserve for De- livery Equipment 40 . oo Record of depreciation of delivery equipment If the original cost of the equipment was $250.00, the current value of the asset is entered in the balance sheet in the follow- ing manner: JOHN SMITH BALANCE SHEET, DECEMBER 31, 1918 Assets Liabilities Sundry Assets $7250.00 Sundry Liabilities $460.00 Delivery Equip- John Smith, Capital 7000 . oo ment $250.00 Less Depreci- ation Reserve 40 . oo 210.00 $7460.00 $7460.00 120 ACCOUNTING PRINCIPLES This method of handling the depreciation charge is applicable to straight-line depreciation as well as to the fixed percentage of diminishing value. If depreciation and repairs are provided for hi one reserve and by the same estimated charge, the charge is journalized as follows: Depreciation lio.oo Depreciation Reserve 110.00 Charge of depreciation and re- pairs for one year At the tune this entry is made, there would already exist on the books the cost of repairs for the period under consideration. If these repairs amount to $40.00, they would be closed out by the following journal entry: Depreciation Reserve 40.00 Repairs 40 . oo Closing of repairs into depreci- ation reserve After this journal entry is posted, the balance of the depre- ciation reserve represents the total depreciation charge against the cost value of the asset in question. If it is considered desirable for the profit and loss account to show separately the charges for repairs and for depreciation, this result can be accomplished by closing the original repairs account into profit and loss and at the same time making a corresponding offset to the depreciation reserve and the depre- ciation charge, as follows: Profit and Loss Repairs 40 . oo Repairs Profit and Loss 40 . oo Closing of repairs into profit and loss Depreciation Reserve 40.00 Depreciation 40 . oo Allowance for repairs in the de- preciation charge and de- preciation reserve APPORTIONMENT OF EXPENSES 121 After the depreciation account is closed into profit and loss, the latter account would show separate entries for depreciation and for repairs. Obviously, these separate items might be com- bined into a single item, the separate entries becoming merely memorandum side entries, as follows: Depreciation and Repairs no.oo Depreciation 70 . oo Repairs 40 . oo This method of providing for both depreciation and repairs through a reserve is not commonly recommended in, accounting texts, nor will it be found to be the common practice. It pro- vides, however, a most satisfactory means of showing that de- preciation is ordinarily greatest when repairs are lowest, and an unfailing method of equitably distributing the charge for the depreciation and maintenance of an asset over the period of its usefulness. ii. Sinking-fund Method of Depreciation. It is question- able whether there is any method of depreciation that can properly be styled the sinking-fund method. A sinking-fund is usually set aside for purposes of replacement. The ordinary depreciation charge and the creation of a depreciation reserve result in a lessening, by the amount of the charge, of the prof- its to be added to capital or to be withdrawn from the business, the funds thus reserved from distribution being commonly used for the general purposes of the business rather than set aside as a special fund for the replacement of the depreciating assets. If the depreciation charge is to be set aside and allowed to ac- cumulate, then the problem arises as to how much must be set aside each year and placed at compound interest in order to equal the original cost of the asset by the time its useful life is ended. As the interest on the fund is a part of the depreciation charge, the actual charge is composed of the annual install- ment plus the interest for the year on the amounts set aside in the past. Thus, if the charge for the year is $250.0x5 and the interest on the funds already set aside is $50.00, these items are placed on the books by the following journal entry: 122 ACCOUNTING PRINCIPLES Depreciation 300 . oo Depreciation Reserve 300.00 Charge of depreciation for the year The following additional entries must be made in connection with the fund itself: Depreciation Fund Cash 250.00 Cash 250.00 Setting aside of annual install- ment to depreciation fund Depreciation Fund Cash 50.00 Interest 50.00 Credit to interest of income from depreciation fund Instead of being charged directly to the depreciation fund, the interest might be charged first to cash, and then credited to cash and charged to the depreciation fund. It is simpler, how- ever, to treat the depreciation fund cash as a separate ac- count and charge the interest directly to this account. The discussion of a depreciation fund belongs to the chapter on funds and is inserted here to avoid any confusion that might result from the use of the phrase sinking-fund method of depreciation. The purpose is to call attention to the fact that a special fund for depreciation is sometimes created in place of a depreciation reserve from profits to be used for the general purposes of the business. 12. Scrapping an Asset A depreciation reserve being set up to show the extent to which the value of an asset is over- stated on the books, the asset is kept on the books at its orig- inal value until its useful life is over. When it wears out or is discarded for any reason, the asset account is credited for the original cost of the asset, and the depreciation reserve and the scrap account are charged, respectively, with the use value and scrap value. Since the purpose of the depreciation reserve is to denote an excessive book value, it follows that the depre- ciation reserve should be marked out at the same time this ex- cessive value is marked off. APPORTIONMENT OF EXPENSES 123 Let us suppose that a machine costing originally $600.00 is worth only $100.00 as scrap at the end of its useful life. Mani- festly, scrap should be charged for $100.00 and the deprecia- tion reserve for $500.00, and the asset account credited for $600.00. In the journal, these operations would be entered as follows: Depreciation Reserve for Ma- chinery 500 . oo Scrap 100 . oo Machinery 600 . oo Marking off the use-value of discarded machinery If a new machine were now purchased for $750.00 from the Central Electric Company, the transaction would be recorded by the following journal entry: Machinery 750.00 Central Electric Company 750.00 Purchase of machinery The fact that the machine is a replacement does not make the entry of its purchase differ from that of the ordinary pur- chase of machinery. When no depreciation account is kept, a business frequently charges replacements to expense, just as it does outlays for re- pairs. While it is bad practice to neglect to keep a deprecia- tion account, it is not bad practice to charge replacements to expense in amounts equal to the cost of the machines replaced when no depreciation account is kept. 13. Extraordinary Repairs. The question may be fairly raised as to whether expenditures for repairs are an expense, since they do not entirely disappear in connection with the sale of merchandise. In fact, if all the depreciation in assets were charged off as expense, it would not necessarily be erroneous to charge repair expenditures to the corresponding assets. These small expenditures from year to year, however, amount to a smaller sum than the depreciation on the property, and charging them to expense merely decreases the amount 124 ACCOUNTING PRINCIPLES to be charged to depreciation. The total value of the property is, therefore, still less than it was when the asset was new. If the repair items were large In some years, however, and small in others, there would be an unfair distribution of the expense of maintenance. This unfairness would be especially evident if some unusually large expenditure were required in any one year. For instance, in a boiler room the boilers need to be relined about once even' five years. Since the expense of relining would be a large percentage of the total boiler-room expense, the cost of operations would be unfairly stated for the year to which such repairs are charged. This would, of course, not be the case if depreciation and repairs were provided for in one reserve, as indicated above. But, if only the depreciation not made good by repairs is provided for in the depreciation charge, then it becomes necessary to devote special attention to extraordinary expenditures for repairs, and to distribute them over several years, in order that the profits of a particular year may not be unreasonably small. In other words, the amount of the expenditure not charged to expense must be carried as an asset in what is known as a deferred expense account, an asset of this character being scheduled as a deferred expense. The account should contain a complete explanation of each item closed into it. To illustrate, suppose that the extraordinary repair account debit balance is $800.00, and that it is desired to defer $600.00 of this amount. The journal entry would then be: Deferred Expense Extraordinary Repairs 600 . oo Extraordinary Repairs Def erred Expense 600 . oo Charge of $600.00 of extraordinary repairs to deferred expense The remaining $200.00 of the extraordinary repairs account would, of course, be closed into profit and loss by the usual closing entry. As the deferred expense account is opened only for the pur- pose of closing the books, the deferred expense charge is re- APPORTIONMENT OF EXPENSES 125 Versed when the books are opened again for the entry of the transactions of a subsequent period; thus: Extraordinary Repairs Deferred Expense 600 . oo Deferred Expense Extraordinary Repairs 600 . oo Reversal of deferred expense entry made in closing By means of these entries, $200.00 of the extraordinary re- pairs account has been charged to expense for the period af- fected by the closing. The remaining $600.00 has been deferred for the purpose of distributing it over the succeeding years at the rate of $200.00 a year. The reversing entry item may, however, be avoided by re- garding the account of extraordinary repairs as an asset account instead of an expense item, but as an asset the cost of which accrues as expense from year to year just as the cost of a ma- chine gradually becomes expense through the depreciation charge as the machine wears out. If the $200.00 referred to above were regarded as the part of extraordinary repairs which, at the end of the year, had become expense, this could be indi- cated by the following journal entry: Repairs 200 . oo Extraordinary Repairs 200.00 Crediting the extraordinary repairs account with the amount chargeable to repairs for the period The balance of the extraordinary repairs account could then be carried down to the balance sheet and grouped with other similar items under the caption of deferred expense, but no re- versing entry would be required. The same entry could be made at the end of successive periods until the whole of the orig- inal $800.00 of extraordinary repairs had been charged to ex- pense. There are various other deferred expense items, such as in- surance paid in advance, rent paid in advance, etc. All these items in closing follow the same treatment as expenditures for extraordinary repairs. 126 ACCOUNTING PRINCIPLES 14. Other Adjustment Items. There are other adjustment items at closing that ordinarily require attention. These are postponed to a later chapter. 15. Replacing Parts of an Asset. Let us suppose that all the machinery of a boiler and engine room be considered as a unit in determining the depreciation charge and the credits to the depreciation reserve. The boiler in such a group of ma- chinery may wear out at the end of five years and the engine at the end of ten years. The prevailing practice would require that the cost of the boiler be charged to the depreciation re- serve and credited to the machinery account at the time it might be scrapped. The cost of the new boiler would also be charged to the machinery account and credited to the seller or cash according to the manner of purchase. Under such a pro- gram of purchasing separate units of machinery it is clear that at no time after the initial installation would the machinery all be new at the same time. It is also clear that there would constantly be to the credit of the depreciation reserve the esti- mated amount of depreciation, which had accrued on such ma- chines as had been used for a period but had not v/orn out. This balance serves for valuation purposes to indicate the ex- tent to which the cost of all these old machines exceeds what may be regarded as their fair going value. A little consideration will also show that if an amount of cash were always set aside in a special fund equal to the charge for depreciation, there would always be an amount of cash on hand in this fund approximately equal to the credit balance of the depreciation reserve. If the depreciation estimate had been correct there would always be a large balance in the de- preciation fund not required for replacement purposes unless all of the machinery should wear out at the same time. In some instances one plant item, in its relation to deprecia- tion, is like the boiler and engine group of machines. A dis- tinct part of the item may be replaced without replacing the item as a whole. Railroad tracks are an illustration in point. If sixty feet of the track became worn while the rest were in good repair a special section might be replaced. Would the APPORTIONMENT OF EXPENSES 127 cost of the special section be charged to a repair account under the heading maintenance of way or would it be charged to the depreciation reserve for railroad tracks? Since the practice would sanction a charge to maintenance of way the question arises as to the value of the reserve for depreciation since no charge would be made against it. If such a reserve were cre- ated it is clear that there would be soon accumulated an amount which would be sufficient to indicate the prevailing difference between the value of the railroad track after years of use as compared with the initial cost. Where such a situation should obtain there would cease to be any occasion for further charges to depreciation of track or of credits to the correspond- ing depreciation reserve. On the other hand, there is always the possibility of making the charge for depreciation large enough to cover all repairs and partial replacements. This pol- icy would require that the cost of the repairs and replacements be charged against the depreciation reserve at the time of clos- ing the books. In planning a system of accounts for any busi- ness there should be a consistent policy adopted in regard to repairs and depreciation so that the balance of the deprecia- tion reserve may be relied upon as a reasonable statement of the amount of depreciation which has accrued on the assets still in use. If an item is not replaced in total at any time and its partial replacement from time to time is charged to repairs or maintenance, the question frequently arises as to whether it is worth while to make any depreciation charge against such an item, particularly if its condition is kept as good as new. If, in fact, the asset were kept as good as new, no depreciation would be necessary. If, on the other hand, it were maintained indefinitely by expense charged to repairs or maintenance, but at the same time after five years or more of use were worth only three fourths of the original value (assuming a stable price situation) then it would seem to be fair to spread the deprecia- tion charge of one fourth the original cost over the years re- quired for the depreciation in question to accrue. 128 ACCOUNTING PRINCIPLES PROBLEMS AND QUESTIONS 1. Directions for the January closing: (a) Close the cash account with red ink closing and bring down the balance. (6) Take a trial balance. (c) Before closing any account into profit and loss, make journal entries and post to show the following items: (1) A depreciation reserve of 2% on delivery equipment, i% on furniture and fixtures and % of i% on building. (2) The loss through depreciation of a delivery wagon costing originally $200.00 and having a scrap value of $25.00. (3) A fuel inventory of one ton of coal costing $7.00. (4) A stationery inventory of half the amount purchased during the month. (5) A deferred charge of half the advertising expenditures for the month. (d) Close through the journal all accounts which are dosed into the trading account, and enter the merchandise inventory at the end of the period, amounting to $22,631.40. () Close the trading account into profit and loss through the journal. (/) Close the revenue accounts by journal entry into the profit and loss account. (g ) Close the balance of profit and loss by journal entry into the capital account. (h) Post all closing entries to the ledger accounts involved. (*") Make a balance sheet from the accounts left open on the books. (/) The personal accounts, the asset accounts, and the liability accounts not affected by the journal dosing need not be closed, except in the case of an annual dosing or in case of a transfer of the business, and the opening of a new set of books. The debit balances of these accounts should be written in penal to the left of the last debit entry before the trial balance is made. The credit balance of any of these accounts should be placed to the left of the last credit entry before the trial balance is made. (k) All ruling of accounts should be done in red ink. (/) The capital account should be closed with a red ink closing. 2. Explain what is meant by the depredation of a fixed asset. 3. On January 31, 1918, the Valley Grocery deddes to set up a depre- dation reserve of $500.00 to cover depreciation of equipment and fixtures, and to set up a depredation fund of the same amount. On July 31, 1918, there was scrapped a cold drink fountain costing $250.00 and another pur- chased for $300.00. On January 31, 1919, there had accumulated $25.00 of interest to be turned into the sinking fund. Journalize all of these items so that they will be properly placed on the books. APPORTIONMENT OF EXPENSES 129 During the course of the year extraordinary repairs to the amount of $150.00 became necessary, but half of this expense is deferred to the follow- ing year. Make the proper closing entries and the required opening entry for the extraordinary repairs account on February i. 4. A machinery asset cost originally $500.00. It is estimated that the machine will last four years and have a scrap value at the end of that tune of $100.00. If a constant rate of depreciation is applied to the diminishing value of the asset from year to year, what rate must be charged? 5. Suppose that the machinery asset just mentioned is to be depreci- ated by a constant charge each year for both repairs and depreciation, and that the total amount to be charged is $600.00. For the first year the outlay for repairs is $20.00; for the second year, $25.00. Make the journal entries required at the close of each of the two years in connection with the depre- ciation and repair accounts. CHAPTER X CLOSING AND OPENING ENTRIES INVOLVED IN THE TRANSFER OF A BUSINESS 1. Formal Closings. At stated intervals, such as once a year, along with an audit of the books, there is a formal closing of all the accounts kept by the business. For the purpose of calculating profits from time to time, there are frequently clos- ings at shorter intervals. If an inventory is taken at these shorter intervals, all the accounts closing into profit and loss are closed through the general journal, and the cash account and the capital account in. the usual way. The other accounts are ordinarily left open, with the balances in the memorandum spaces, as indicated in previous closings. If the business is transferred to a new concern and a new set of books opened, the accounts on the old books are closed by a general journal entry. 2. Example of Closing. Let us assume that John Smith , owner of the Urban Furniture Store, is to become a partner in the Valley Furniture Company through the transfer to the company of his individual business assets and liabilities, as follows: URBAX FURNITURE STORE BALANCE SHEET, DECEMBER 31, 1919 Assets Liabilities Cash $500.00 Notes Payable $1,000.00 St. Luke Hospital i.ooo.oo Sheboygan Chair Co. 2400.00 Bagdad University 2,000.00 Michigan Bed Co. i.ooo.oo Rice Manufacturing Co. 500 . oo Wilson Carpet Works 2 , i oo . oo Smith Institute 600.00 Haywood Furn. Co. 2,000.00 J. H. Brigham 400.00 John Smith, Capital 23,275.00 J. C. Riley 500.00 Merchandise 22,275.00 Fixtures i ,000 . oo Delivery Equipment 3.000.00 $31.775.00 $31.775.00 130 CLOSING AND OPENING ENTRIES 131 On the books of the Urban Furniture Store, the transfer of the assets is effected by the following journal entry: Valley Furniture Company 3 1 , 7 7 5 . oo Cash 500 . oo St. Luke Hospital i ,000 . oo Bagdad University 2,000.00 Rice Manufacturing Co. 500.00 Smith Institute 600.00 J. H. Brigham 400.00 J. C. Riley 500.00 Merchandise 22,275.00 Fixtures i ,000 . oo Delivery Equipment 3,000.00 Transfer of assets to Valley Furniture Company If a separate cash book has been maintained for the cash transactions, the closing item is entered in both the cash book and the general journal, and checked in each of these books of original entry to indicate that no detail posting is required. Similarly, the liabilities of the Urban Furniture Store are transferred by the following compound entry: Notes Payable 1,000.00 Sheboygan Chair Co. 2,400.00 Michigan Chair Co. 1,000.00 Wilson Carpet Works 2,100.00 Haywood Furniture Co. 2,000.00 John Smith, Capital 23,275.00 Valley Furniture Company 3 1 , 7 7 5 . oo Transfer of liabilities, including capital, to Valley Furniture Company The account with the Valley Furniture Company is, of course, opened merely for the purpose of showing that the busi- ness has been transferred to this new concern. 3. Entry of Transfer on Books of Valley Furniture Company. - There are several methods of entering the assets and liabil- ities taken over from John Smith in the formation of the new partnership relation. The simplest way is obviously to enter the assets as debits and the liabilities, including the capital, as credits to the Valley Furniture Company. This compound 132 ACCOUNTING PRINCIPLES entry is not only the simplest, but also the most reasonable entry, in view of the usual relation of debits and credits. When an asset comes into a business, the general rule requires that the asset account in question be debited and the account repre- senting the source of the asset be credited, the liabilities repre- senting the sources from which the assets are secured. The setting down of the assets, therefore, as debits and of the lia- bilities and proprietorship as offsetting credits for the journal opening is defensible, not only as the simplest method, but also as the most accurate representation of the important relation of assets and liabilities. Accordingly, the transfer, of the assets, liabilities, and pro- prietorship of the Urban Furniture Store is set up on the books of the Valley Furniture Company by the following journal entry: Cash as per Cash Book 500.00 St. Luke Hospital i ,000.00 Bagdad University 2,000.00 Rice Manufacturing Co. 500.00 Smith Institute 600.00 J. H. Brigham 400.00 J. C. Riley 500.00 Merchandise 22,275.00 Fixtures 1,000.00 Delivery Equipment 3,000.00 Notes Payable 1,000.00 Sheboygan Chair Co. 2,400 . oo Michigan Bed Co. 1,000.00 Wilson Carpet Works 2,100.00 Haywood Furniture Co. 2,000 . oo John Smith, Capital 23,275.00 Taking over of assets and liabilities of Urban Furniture Store with John Smith as partner A question may be raised in regard to the cash entry in the general journal. The assembly of all the opening entries in one book of original entry, however, has distinct value, and the entry may be defended on this basis. It seems sound also on theoretical grounds, because the cash book represents not only CLOSING AND OPENING ENTRIES 133 a book of original entry, but in addition a cash account similar to the ledger account of the same name. Another form of opening entry is frequently advocated by text writers. The purpose of this form is to stress the fact that the Valley Furniture Company has taken over the assets and assumed the definite liabilities of the Urban Furniture Store, and that the new partner's actual investment is the dif- ference between the two. Consequently, the transfer of the assets and liabilities is under the second method journalized as follows: Cash as per Cash Book 500.00 St. Luke Hospital 1,000.00 Bagdad University 2,000.00 Rice Manufacturing Co. 500 . oo Smith Institute 600.00 J. H. Brigham 400.00 J. C. Riley 500.00 Merchandise 22,275.00 Fixtures i ,000 . oo Delivery Equipment 3,000.00 John Smith, Capital 3i>775-oo Transfer of the assets of the Urban Furniture Store John Smith, Capital 8,500.00 Notes Payable 1,000.00 Sheboygan Chair Co. 2,400.00 Michigan Bed Co. 1,000.00 Wilson Carpet Works 2 , i oo . oo Haywood Furniture Co. 2,000.00 Assumption of the liabilities of the Urban Furniture Store If the charge and credit to John Smith, Capital, are posted, the balance of the capital account will be $23,275.00 or the same as in the other form of entry. 4. Opening Entries for Consolidation of Two Individual Businesses. In the example used 'above, it is assumed that the business of the Urban Furniture Store is transferred to the Valley Furniture Company and entered on the books of the latter concern. The Valley Furniture Company is thus 134 ACCOUNTING PRINCIPLES changed from an individual business to a partnership, though continuing to operate under the original firm name. If two in- dividual concerns are consolidated and taken over by a new general partnership, each of the individual businesses is under the necessity of closing its books and making a formal transfer. On the books of the new firm, the transfer of the assets and lia- bilities of the old concerns is set up in the manner indicated in the preceding section. The assets and liabilities of each of the old firms are, of course, treated as separate entries, there being no consolidation of accounts of the same name until after a journal record of each transfer has been made. 5. Capital Accounts of Partners. The books of a partner- ship are similar to those of an individual business, except that there are two or more capital accounts instead of simply one, and that the net profit item must be divided between or among the partners before being closed into the capital ac- counts. The closing entry of the profit and loss account, in the case of a credit balance, has in the case of an individual busi- ness been a debit of net profit to profit and loss and a credit to the individual capital account. In a partnership, the debit is the same, but the credit is in fixed ratios to the capital ac- counts of the several partners. As the profits and losses of a general partnership are divided equally, unless otherwise speci- fied in the partnership agreement, a credit balance of $300.00 hi the profit and loss account is closed into the capital ac- counts of John Smith and John Doc by the following entry: Profit and Loss Net Profits 300 . oo John Smith, Capital 150.00 John Doe, Capital 150.00 Closing of profit and loss into capital accounts Withdrawals by the partners of cash or goods are charged to their separate personal accounts, which are later closed into their individual capital accounts, just as the personal account of the single owner is closed into the one capital account. CHAPTER XI APPORTIONMENT OF INCOME AND EXPENSE 1. Definition of Accrued Income. Whenever an asset is re- ceived without the equal sacrifice of another asset, an income results. Although expense is generally incurred in connection with the receipt of such income items, the latter are closed as credits into profit and loss, the expense being also closed into profit and loss, but on the debit side. The credit balance of the account represents the net profits or the net income earned. In other words, income items are received subject to such ex- pense deductions as may arise in the conduct of the business. Certain items are treated as income for a reason similar to that involved in depreciation charges, which are made for the purpose of bringing about an equitable distribution of expense over the successive periods covered by statements of profit and loss. For instance, it may take a year to earn a certain in- come, the receipt of it at the end of that time being contractu- ally assured. If two statements of profit and loss are made during the year and all of the income is credited to the second period, the profits of the two periods cannot be fairly com- pared. If the income is an annual interest payment on notes receivable, and is due on December 31, a closing on June 30 should have credit for half of the amount; for clearly half of the interest has been earned, even though it is not due until the end of the second half of the year. Items thus earned but not due are scheduled as accrued income, and must be taken account of in closing, so that the profits of one period may be comparable with those of earlier or later periods. 2. Treatment of Accrued Income. Accrued income is en- tered as an asset in the balance sheet by means of an accrued income account, which is opened only in connection with the closing of the books. If the accrued interest receivable on De- 135 136 ACCOUNTING PRINCIPLES cember 31 is $1,000.00, then the interest earned on June 30 is $500.00, and on closing is entered as follows: Accrued Income Not Due Interest 500.00 Interest 500 . oo Placing of accrued interest on the books When the whole amount of the interest is paid on Decem- ber 31, the following journal entry is made: Cash 1,000.00 Interest 1,000.00 Receipt of interest on notes receivable This entry alone would result in an excessive credit to inter- est for the second period. To obviate this difficulty, the pre- vious closing entry is reversed after the closing of the books on June 30 by the following opening entry: Interest 500 . oo Accrued Income Not Due Interest 500 . oo Reversal of accrued interest entry to reopen the interest account. With this reversing entry and the final credit of $1,000.00, there results a credit balance of $500.00 for the second half of the year, which is the same amount credited to the interest account for the preceding period. In other words, these entries make a fair apportionment of the interest earnings between the first and the second period of the year. As rents, royalties, and other incomes due at stated periods are treated "n the same way, the journal memoranda showing the nature of the accrued items are entered both in the ledger and in the balance sheet For example, f in addition to the accrued interest there should be accrued rents of $300.00 and accrued royalties of $150.00, the several items are entered on the asset side of the balance sheet as follows: Accrued Income Not Due Interest 500 . oo Rents 300 . oo Royalties 150.00 950.00 APPORTIONMENT OF INCOME AND EXPENSE 137 3. Accrued Expense and Accrued Accounts Payable. The problem of accrued expense is similar to that of accrued in- come. Payment for a loan or facility may be made at the close of the year. As a result, the profits of the first half of the year cannot be properly compared with the profits of the second half unless the expense incurred for the whole year's operation is correctly apportioned between the two periods. If interest to the amount of $400.00 is paid December 31 on a note pay- able, half of the interest has accrued on June 30, and is entered on the books at the mid-year closing by means of the following journal entry: Interest 200 . oo Accrued Accounts Payable Interest 200 . oo Placing of accrued interest payable on the books As the accrued accounts payable account is opened only for the purpose of facilitating the closing of the books, the follow- ing reversing entry must be made to reopen the books for the succeeding period: Accrued Accounts Payable Interest 200 . oo Interest 200 . oo Reversal of accrued interest entry to reopen interest account After this entry has been posted, the accrued accounts payable account is closed and the interest account reopened with a credit balance of $200.00 for the second half year. When the payment of the interest is finally made on Decem- ber 31, the outlay is journalized as follows: Interest 400 . oo Cash 400.00 Payment of interest on notes payable The posting of this interest charge results in an interest debit balance of $200.00, which is an amount equal to that charged to the preceding period. By means of these entries, therefore, the annual interest payment has been equitably distributed be- tween the two half vears. 138 ACCOUNTING PRINCIPLES Accrued accounts payable represent, of course, a liability. As this liability may consist of accrued interest, accrued taxes, accrued wages, accrued rent, or any other accrued expense which is payable at stated tunes and apportionable over a num- ber of periods, the journal memoranda showing the nature of the items should be entered in the ledger memorandum space, so that a proper analysis of the accrued accounts payable ac- count may be made in the balance sheet. 4. Deferred Expense. The matter of deferred expense was referred to in Chapter IX in the discussion of the treatment of extraordinary repairs. There are many expenses which are paid in one period but properly chargeable over a much longer tune. For instance, an insurance premium may be paid in ad- vance for three or five years. It is clear that such an expense should be apportioned in equal amounts to the three or five years for which the policy is secured. If the premium payment is $60.00 for three years, the expenditure is journalized as follows: Insurance 60 . oo Cash 60 . oo Premium for three years on fire insur- ance policy As only $20.00 of the outlay is chargeable to expense at the close of the first year, the remainder must be deferred to the succeeding period by means of the following journal entry: Deferred Expense Insurance 40 . oo Insurance 40 . oo Deferment of part of the insurance ex- pense After the balance of the insurance charge has been c'osed into profit and loss, another journal entry must be made for the purpose of reopening the insurance account and closing the deferred expense account, which is opened mere'y to facilitate the closing of the account. The proper reversing entry is, of course, the following: Insurance 40.00 Deferred Expense Insurance 4 Reversal of the deferred expense entry to reopen the insurance account APPORTIONMENT OF INCOME AND EXPENSE 139 At the end of the second year, another $20.00 is charged as expense to profit and loss, the remaining $20.00 being deferred to the last year by means of a deferring and reversing entry similar to those employed at the close of the previous year. At the end of the third year the balance of the original expendi- ture is closed into profit and ]oss. A more abbreviated way of treating the entries is to set up both an expense and asset account. The expense account may be called insurance and the asset item unexpired insurance, or insurance paid in advance. The entry of the original $60.00 for the three-year policy would be as follows: Unexpired Insurance 60 . oo Cash 60 . oo Purchase of three-year insurance policy At the end of the year when it would be necessary to charge $20.00 of the amount to the expenses for the year the following entry could be made: Insurance 20 . oo Unexpired Insurance 20.00 Charging $20.00 to insurance expense The advantage of this treatment is that it requires no reversing entry. All of the other items of deferred expense may be treated in the same way. If several of these items are treated without the use of the deferred expense account, it is still ad- vantageous to group the several items on the asset side of the balance sheet under the heading of deferred expense as follows: Deferred Expense: Unexpired Insurance 40 . oo Rent Paid in Advance 75 oo Advertising 1 2 5 . oo 240 . oo Interest, rent, and other expense items that are paid in ad- vance to cover a period longer than that covered by the first closing after the expense has been incurred are treated in a similar manner. If the expenditure for advertising for a given year is unusually large, that too should be deferred in part for 140 ACCOUNTING PRINCIPLES the purpose of making the amount of this expense approxi- mately the same from year to year, unless the larger expendi- ture clearly affects only the income of the year in which it is made. Large advertising expense frequently affects the income of the business for many years, and tends to create a permanent goodwill that may be sustained by annual expenditures much lower than those made in the earlier periods of the business. It is commonly regarded as conservative accounting practice to include organization expense as a deferred expense to be ap- portioned over a period of years, perhaps five or more. There is, however, no sound theoretical basis for such a treatment. The expenses of organization provide an asset which is owned as long as the business exists as a going concern and upon which the business may earn in competition with other con- cerns, which must incur a similar investment before entering the field. In other words, only those assets should be depre- ciated which last but a term of years. Conversely, no asset should be depreciated unless it wears out, becomes obsolete, or for some other reason ceases to serve the purpose for which it was originally purchased. 5. Deferred Income. An expense paid hi advance by one firm may be an income received in advance by another. An in- surance company receiving premiums three years hi advance does not apportion all of this income to the year in which it is received, nor would a newspaper receiving subscriptions for a year in advance credit all of this income to the first half of the year if the books are closed twice during the annual period. If the annual advance subscriptions received by the newspaper on January i total $10,000.00 the receipt is journalized as follows: Cash 10.000.00 Subscriptions 10,000 . oo Subscriptions received in advance In closing the books on June 30, credit is taken by means of the following entry for only half of the total amount: Subscriptions 5,000.00 Deferred Income Subscriptions 5,000.00 Deferment of part of subscription receipts APPORTIONMENT OF INCOME AND EXPENSE 141 The remaining $5,000.00 of the subscription account is, of course, credited to profit and loss in the usual way. As the deferred income account is opened only for the purpose of apportioning income properly at the time of closing, the defer- ring entry must be reversed to reopen the subscription account for the subsequent period. This is effected by means of the fol- lowing journal entry: Deferred Income Subscriptions 5,000.00 Subscriptions 5 ,000 . oo Reversal of deferred income entry for purpose of reopening subscription account At the close of the second period, the deferred income of $5,000.00 is, of course, closed into profit and loss. The deferred income account obviously appears on the liabil- ity side of the balance sheet, its treatment in this respect being precisely the opposite of the deferred expense account. De- ferred expense may be thought of as a receivable from a subse- quent period. If this is done, deferred income clearly becomes a payable to a subsequent time. It is possible to treat deferred income without the use of a de- ferred income account and without the reversing entry at the time of reopening the books. The income deferred can be treated as a reserve account and the amount charged against it in closing the books is the amount credited to income for the period. In the subscription illustration there would be an unearned sub- scription account and a subscriptions earned account. The sub- scriptions received in advance would be credited to the un- earned subscription account. The following journal entry would be made in recording the $10,000.00 of subscription referred to above: Cash 10,000.00 Unearned subscriptions 10,000 . oo Subscriptions received in advance At the end of the six months period half of the total could be either credited directly to profit and loss as subscriptions earned or the credit could be made to a subscriptions earned ac- 142 ACCOUNTING PRINCIPLES count which would be closed into profit and loss. If the closing entry were the only credit to the subscriptions earned account the closing entry would be made to profit and loss as follows: Unearned subscriptions 5,000.00 Profit and Loss Subscriptions earned 5,000 . oo Crediting profit and loss with the period's share of the subscriptions earned The balance of the unearned subscription account would then be carried to the liability side of the balance sheet as deferred income or income reserved for credit to later periods. It might be true, however, that some of the subscriptions would be received at the expiration of the year for which the papers were received so that credits would be made from tune to time during the period to the subscriptions earned account. Under such circumstances the part of unearned subscriptions credited to profit and loss would go first to the subscriptions earned account, which would then be closed into profit and loss by the following entries: Unearned Subscriptions 5,000.00 Subscriptions Earned 5>ooo . oo Crediting the period with its share of subscriptions earned Assuming the subscriptions earned account had already to 'ts credit $7,500.00, then it would be closed to profit and loss by the following journal entry: Subscriptions earned 7,500.00 Profit and Loss Subscriptions Earned 7,500.00 Closing subscriptions earned into profit and loss The fact that the form of entry involving the deferred income account is frequently used makes it necessary to understand the procedure. It is, however, more involved and less satisfac- tory than the usage involved in the two accounts of unearned subscriptions and earned subscriptions APPORTIONMENT OF INCOME AND EXPENSE 143 6. Reserve for Bad Debts. It has been found by experi- ence that a certain percentage of accounts receivable prove to be bad or uncollectible, and failure to take account of such losses results in an overstatement of the net profits from year to year. If the losses from this source were the same each year, they could be charged to expense as they arise, and there would be no need of providing for an even distribution of them over the good and the bad years. Inasmuch, however, as the large losses of bad years may be due entirely to circumstances beyond the control of the management, such exceptional losses must clearly be treated as a deferred expense or must be pro- vided for in advance. The latter method is the one commonly employed, a valuation reserve being set up against accounts re- ceivable or notes receivable, or against both of these accounts. At the end of each period, a certain per cent of the credit sales, as determined by experience, is charged to the account of losses from bad debts and at the same time credited to the bad debt reserve. If the bad debts are estimated at two per cent of the credit sales and the latter amount to $100,000.00, the journal entry providing for losses under this head is as follows: Losses from Bad Debts 2,000.00 Reserve for Bad Debts 2,000 . oo Setting up of a reserve for bad debts The debit element of this entry is, of course, closed into profit and !oss in the usual way. After the creation of the bad debt reserve, losses arising from the default or insolvency of debtors are charged directly to this account. For instance, if the loss hi the account of John Smith is $250 oo, the mount is marked off by the following journal entry: Reserve for Bad Debts 250 . oo John Smith 250.00 Charging off the account of John Smith on account of insolvency If the average annual losses fall far below the amount set aside each year to the bad debt reserve, the latter becomes in 144 ACCOUNTING PRINCIPLES effect an addition to capital. Whenever such a condition arises, the excess in the reserve should be credited to the capital ac- count, and the annual charge to losses from bad debts should be decreased so as to bring the bad debt reserve within an amount safely necessary to cover probable losses. As the reserve for bad debts is a valuation account, similar to the reserves for depreciation, it is entered in the balance sheet as a deduction from the assets against which it is accu- mulated. Assuming that the accounts receivable were Sioo,- ooo.oo and that the reserve for bad debts at the date of closing was 87,500.00, the items on the asset side of the balance sheet would appear as follows: Accounts Receivable Sioo.ooo.oo Less Reserve for Bad Debts 7.500.00 $92,500. oo QUESTIONS AND PROBLEMS 1. What is an income? 2. What is meant by expense? 3. The Valley News received subscriptions a year in advance as follows: January i $5000.00 February i 6000.00 March i 4000.00 April i 4500.00 May i 3000.00 June i 2000.00 On June 30 the bookkeeper closes his books. What entries would he make to properly close the subscription account into profit and loss? What journal entry affecting subscriptions should be made in reopening the books on July i? 4. On January i the Valley Book Store discounted its $600.00 note at the bank at 8*^ for six months, getting credit at the bank for the face of the note less the discount. On March 31 the books are closed. Make the entry required to properly apportion the interest expense involved in the discount of the note. What entry should be made in reopening the interest account April i so far as this item is concerned? 5. The Valley National Bank dosed its books June 30. Of the total interest received $3,000.00 was deferred. It found also that $2,500.00 of interest had accrued on bonds owned. It also had $500.00 in wages and $200.00 in rent which were accrued and unpaid. Make appropriate closing entries for these items. Make also the entries to reopen the accounts July i. APPORTIONMENT OF INCOME AND EXPENSE 145 6. The Rational Biscuit Co. closed its books June 30. The Valley Grocery Co., one of its customers, having an account of $750.00, went into bankruptcy and was fully liquidated in June. General creditors received fifty cents on the dollar. The Rational Biscuit Co. received its check on June 20. In closing on June 30 the Company made its usual credit of $1,000.00 to Reserve for Bad Debts. It had spent during the six months $20,000.00 in advertising and decided to defer one half of this. Enter all the above items into the journal. Make the opening entry July i for the advertising account. CHAPTER XH INTERPRETATION AND MANAGERIAL USE OF THE REVENUE STATEMENT i. Basis of the Grouping of Accounts in the Revenue State- ment. The general purpose of the revenue statement was ex- plained in Chapter II, the outline there given being for a small merchandise business. The number of accounts entering into the revenue statement is determined partly by the number of commodities and services involved in the business and partly by the amount of the expenditures for each. If the total outlay for a given commodity is large, the expenditures for the com- modity are brought together in a separate account, so that the management 'may plan economhs in its purchase and guard against waste hi its use. For instance, if a large amount of fuel is purchased annually, a fuel account is ordinarily entered on the books. The various commodity accounts, in turn, are classi- fied under the cost of the services of which the accounts form a part. This grouping of accounts according to the service into which they enter may be called a functional classification. The various functional classifications are further grouped according to the administrative head or the administrative unit responsi- ble for the different functions or services entering into the life of the business. This underlying basis of the creation and grouping of ac- counts is of great importance, and becomes increasingly so with a growth in the size and complexity of the business. The sundry and miscellane us accounts should be used only to include small items that are not otherwise provided for in the accounting classification. As these particular accounts are of very ittle managerial use, care should be taken to see that their totals do not become large. When they do, the accounts should be further analyzed as to the c~mmodities o services secured for the outlays. In other words, the accounts showing 146 MANAGERIAL USE OF REVENUE STATEMENT 147 the commodities and services purchased should include all but a small fraction of the total expenditures. No classification of accounts should be made for any busi- ness until an analysis has been made of the organization of the business under consideration. The grouping of accounts ac- cording to the administrative units has the advantage of fur- nishing information, not only to the head of each division as to the operating results of a particular unit, but to the general manager as to the operating results of the business as a whole. There is a growing tendency in commercial enterprises to de- partmentalize business activity, and to hold some one individ- ual responsible for the results achieved in a department As a result, the accounts created and their grouping in the revenue statement should be such that the administrative officers of the different units and the general manager of the business will have a proper basis for considering the problems of the various units or the efficiency of their personnel. 2. Frequency of Closing the Accounts. The growing ten- dency to make larger administrative use of accounting data is bringing about more frequent closings of the books. Without such closings, it is of course impossible to ascertain the results of operation or the condition of the business from time to time. Monthly closings are becoming quite frequent, while much statistical data are taken from the books daily and weekly for the purpose of keeping check on the efficiency of operation. Some concerns go so far as to show a daily tabulation with es- t'mated profits. 3. Fixed Costs. An examination of published revenue statements and the writings of well-known accounting authors will show that considerable attention has been given to gather- ing together a group of items designated as fixed charges. Lit- tle has been done, however, toward pointing out their use and business significance. These have either been presumed to be commonly understood, or have been left by common consent to each business executive for his own determination. Perhaps the first impression to be formed regarding fixed charges is that no great amount of attention need be paid to 148 ACCOUNTING PRINCIPLES them in the management of the business, because so little can be done toward changing the amount when once contractually determined. They have, however, played a larger role hi busi- ness policy than such casual consideration might seem to indi- cate. Fixed costs must be met regardless of the volume of sales. A certain outlay or investment is made to provide the organization and facilities to carry on a certain volume of busi- ness, but a failure to realize this anticipated volume does not oroduce a corresponding reduction in the fixed charges, those having been determined in connection with the original set-up. A business thus operating below its capacity suffers of course a disadvantage in competition with concerns more favorably sit- uated, and, under freely competitive conditions, provided the fixed investment is large, must sell its goods at a price insuffi- cient to produce the usual return on the investment and also to pay the fixed charges. Under such conditions, the price is fre- quently lowered to cover no more than the costs other than the fixed charges until a larger volume of business is secured. An alternative and sometimes better course is to maintain prices and incur exceptional expenses in the way of advertising until the business is brought to its proper volume, even though meantime the net profits may not be such as to cover the fixed charges and at the same time yield a return on the investment that would be satisfactory in the long run. If the business se- cured by this extraordinary expense affords a return hi excess of the additional expense involved, it reduces to that extent the loss from the fixed charges. While considerations of business policy seem to call for a dis- tinct classification of fixed charges, the administrative or func- tional classification is the predominant basis for account group- ing in the revenue statement, a schedule of the fixed charges being usually submitted as a separate exhibit. Thus, in Dlus- tration No. 16, below, there is a group of accounts under the caption, Maintenance, Operation, and Upkeep of Building. These expenses, though ordinarily falling under the supervision of one of the executives of the business, are hi the nature of fixed charges. In order to make a complete summary of these MANAGERIAL USE OF REVENUE STATEMENT 149 charges, account must be taken also of items in other groups which vary little with the volume of business after provision has once been made for organization and the installation of equipment. Telephone charges, delivery expenses, and inter- est do not vary much from month to month and cannot be ig- nored in considering fixed costs. In other words, a separate schedule of items from various captions must be made if it is desired to make an accurate estimate of fixed charges. 4. Selling Expenses. The selling organization of a busi- ness is ordinarily under the supervision of a separate executive if the business is large enough to justify such specialization. With the appointment of a separate sales manager, it is logical, of course, to group under the general caption of Selling Ex- penses the accounts showing the cost of the several services and functions for which he is directly responsible. Such grouping provides the basis of valuable information to the executive of the sales department and to the general manager of the busi- ness as well. In a smaller establishment, in the absence of a special sales executive, the grouping of the sales functions under a separate head becomes less important, though the grouping may be em- ployed if there are a sufficient number of employees to set up a division of labor under this head. Where the manager is at once salesman, office manager, and caretaker of the establish- ment, an attempt to maintain a departmental grouping of ac- counts and to apportion his salary among the various general captions is hardly worth while, since the results derived are of practically no significance from the managerial point of view. Consequently, the general heads of the more elaborate organi- zation disappear and become combined under the caption of Store Management. But, while there is no further need of the general caption of Selling Expenses, subsidiary captions show- ing the cost of items easily segregated, such as advertising, rent, water and light, are still maintained. 5. Delivery Expenses. This group of accounts appears in the statement of any establishment which renders this particu- lar service. If the total of the expenditures is small, the group 150 ACCOUNTING PRINCIPLES may become a single account. Under any circumstance, there is ordinarily a division of labor such that some particular indi- vidual is charged with rendering this service, and therefore to some extent responsible for its cost. 6. Classification of Income. In a mercantile establish- ment, as a large percentage of the income arises from sales, it is desirable to know the amount of the gross profits received from the various commodities and the net income derived from each. Information of this kind is useful in the determination of ad- vertising policy, in the choice of brands to be carried, and in the adjustment of purchases to the trade demand. Conse- quently, in the revenue statement of the departmentalized business, the total of sales for each department is shown. If the business is conducted as a single unit, the statement would show the amount of sales for only the chief articles of merchan- dise. Frequently, hi order to have a full line with which to at- tract trade, it is necessary to carry certain commodities for which the per annum volume of sales is small. These items are generally grouped together and the amount of the sales given in a single item. But, even hi such cases, the accounting and statistical data showing the amount of purchases and sales for each item should be available in such form that an analysis can be made of the rapidity of the turnover of each of the vari- ous classes of commodities carried. The basis for the classification of incomes is obviously similar to that for the classification of expense. The commodities sold represent the services rendered by the business, and the income depends upon the volume of sales of the various commodities sold at a profit. In short, the classification is primarily a com- modity classification, allied commodities being grouped into separate departments each under the supervision of a responsi- ble head. By means of such a classification, it is possible to ar- rive at not only the gross profits made by each department but also the net profits from operation for each of the several units of which the business may be composed. These separate de- partmental revenue statements have a distinct value, and may be in the form illustrated on the following page. MANAGERIAL USE OF REVENUE STATEMENT 151 o H * & JZJ Q O H i I H CO U gs HQ 152 ACCOUNTING PRINCIPLES Where condensed, as in the foregoing illustration, the depart- mental revenue statements should be accompanied by special exhibits setting forth the essential details for each department, including a classification of expenses after the manner of Illus- tration Xo. 1 6. The more important items of expense, or for that matter each item of expense, may be shown as a certain percentage of the sales. An analytical statement of the gross profits is advantageous even if the business is not organized on the departmental basis. With a knowledge of the joint expenses required to sell certain commodities, it is possible from the gross profit statement to ascertain whether the mark-up is sufficiently high for the vari- ous commodities to allow for the expenses estimated to be chargeable to them. 7. Purchases and Inventory. Since an inventory is neces- sary for closing the books of a mercantile business, there has" arisen a tendency to keep a record of purchases at cost, to- gether with, in a parallel column, a record of the sale price of the goods bought. Under such an arrangement, the purchase register shows not only the total of merchandise purchases, but also the selling price which is placed on the goods. If a record is further kept of the mark-down as well as of the mark-up, it is possible to approximate the merchandise inventory by the use of an average percentage of the mark-up, the individual percentages being of course certain ratios of the selling price. A weekly departmental stock summary may be kept in a stock ledger in something like the form illustrated on the following page. The data thus summarized hi the stock ledger must necessa- rily be entered in detail in the purchase register; otherwise the weekly totals for the merchandise stock register cannot be ob- tained. The requirement is easily provided for by an increase hi the number of columns in the purchase register to include a column for purchases, sales, mark-up percentage, and reduc- tions. This information must, of course, be given for each commodity or group of commodities for which accounts are kept. The inventory at the end of a period may then be cal- MANAGERIAL USE OF REVENUE STATEMENT 153 10 W M O Q h-1 I I W d 8 8 ^ wi CJ \ to | w 1 v ^- m to 8 O to _B s 6 00 O2 f. jj O to O to s o o M M H ON ON 5 CN | O to O to 8 to to M NO o o w 'O to O to o o CN CN to en a O O to to 8 o < C/} Tt- 't oo ft O O ON o ON rt&x Tf co CO *. CO 1 W o < z 8 8 8 8 8 6 do d d as U o o o O OO OO to to to EH t^ t^ 00 3 8 8 8 8 8 w o d o o d o J2 i^. c2 rt H- > * c" (5 S J3 CJ I PH to .a 154 ACCOUNTING PRINCIPLES ciliated by means of the following formula, which is derived in the manner indicated: S = Sales during the period. R = Average percentage of the mark-up. D = Deductions from sales through price reductions. C = Deductions from sales through discounts. L = Sales value of inventory at the beginning of the period plus purchases at sales price. N = Inventory at the end of the period at cost. Then A T = (L-S-D-Q (ioo-R)%. If the total reductions from the sales inventory at the begin- ning of the period plus purchases at sales price are represented byT, Then T = S + D + C And AT = (L - T) (loo-R). The calculations involved in the application of this formula are made in the illustration given above. There should be a test of the calculated inventory not less than once a year. If the calculated inventory is used as indi- cated above, the inventory count should show both the pur- chase and the sales price of the goods on hand. In some cases, the inventory is taken at the sales price, and the mark-up per- centage used to calculate an inventory at cost, but this method does not provide a satisfactory cost-price inventory' to be used in the calculation of the annual profits. 8. Revenue Item Comparisons and Percentages. It does not mean much to a busy executive to tell him that the selling expenses of the past year were $1,500.00. If, however, you say that the selling expenses were $1,500.00, or an increase of $500.00 over the selling expenses of last year, while the profits from sales were $500.00 less this year than the year before, he gets an idea of the course of affairs. He at once raises the question whether the increase in selling expenses does not rep- resent a bad investment, resulting in a reduction of profits. To answer this question correctly, the selling expenses must be ex- pressed as a percentage of the total sales. If it is found that, MANAGERIAL USE OF REVENUE STATEMENT 155 although the selling expenses for the past year were $500.00 larger than they were the year before, they were at the same time only 5 per cent of the total sales, whereas in the preceding year they constituted 7 per cent of the total sales, the executive must look elsewhere than to the selling expenses for the source of the reduction in the profits. In other words, a comparison of one year with another, or of one month with another, can- not be advantageously made unless the expenses are stated both absolutely and relatively, or in percentages of income. Expenses are justified only because they produce income. If increased expenses add to income a smaller amount than the expense increase, the surface indications are that the addi- tional expense is not justified from the business point of view. If along with an increase in expenses there develops a reduction in the ratio of expenses to income, the increased expenses seem amply justified. The condensed departmental comparative statement shown above in Illustration No. 14 will serve as a condensed compara- tive statement for two years of operation if there is substituted for the column Department A a column covering the business operations for the past year, and for the column Department B a column covering the operations of the year preceding that for which the statement is primarily made. If the statement is to be made for the year ending December 31, 1919, the caption of the column headed Department A becomes Year Ending Decem- ber 31, 1919, while the caption of the column headed Depart- ment B is changed to read Year Ending December 37, 1918. The form of statement given below in Illustration No. 16 is designed to show in detail an analysis of the data as found in the annual closing of the accounts, and is used where the busi- ness has some plan for cumulative comparisons, such as charts, and wishes a full statement from which needed data may be se- lected. The statement shown in Illustration No. 17 is the one which would prove of most service to an executive. While there are no percentages except the percentages of increase of each item as compared with the same item for the previous year, these percentages are very useful as a basis for compari- 156 ACCOUNTING PRINCIPLES sons. If, for example, there is a 20 per cent increase in income from sales and a 15 per cent increase in operating expenses, the manager is able to draw his conclusions much more quickly from this statement than from Illustration No. 14 above, in which the percentages are given in parallel columns and must be subtracted. In the form of comparative statement shown below, de- creases are entered in red in the increase column. 9. Budgets and Statements. The statement that salaries and wages in the month of January were $15,000.00 does not mean a great deal to a manager unless his business program has been carefully analyzed in advance and it has been deter- mined that a reasonable allowance for salaries and wages is, say, $12,000.00. The statement showing a larger outlay than was anticipated leads to analysis for the purpose of finding the causes of the unexpectedly large total of expense. The fact that expenditures are larger than they were for the correspond- ing month last year would lead to some inquiry, but it should be possible on January i to use the previous experience and to forecast the current situation, so that a close estimate could be made of the expenditures to be anticipated. This estimate serves as a standard accomplishment which the officers and em- ployees should strive to attain. It is becoming more customary in business to estimate for each succeeding month what the ex- pense and incomes are to be for the month. These estimated incomes and expenses may be combined into an estimated reve- nue statement with which the actual revenue statement may be compared when the statement for the month is made. Illus- tration No. 17 shows such a comparative revenue statement. The estimated expenditures of a business are sometimes re- ferred to as a budget. The word budget has been more gener- ally used to refer to classified estimates of expenditures for a period made by a municipality as a guide to the discovery of appropriations required. A business is in a position similar to that of the municipality or governmental body. Its budget of expenses must be related to its present resources and its ex- pected incomes. The budgetary expenses are thus related to MANAGERIAL USE OF REVENUE STATEMENT 157 the incomes in the estimated or anticipated revenue statement for the month shown in Illustration No. 17. In large business concerns the expense estimate may be set up on the journal and ledger as they are in the municipal ac- counts. On the other hand, these estimates may be set up as comparative statistical data, as they are set forth in Illustra- tion No. 21. ILLUSTRATION NO. 16 Pro Forma Revenue Statement REVENUE STATEMENT FOR PERIOD BEGINNING ENDED (All Expense Per Cents are per cents of Net Sales; Net Profit per cent is per cent of Total Capital.) Gross Sales Less Returns and Allowances . Net Sales Cost of Goods Sold: Purchases Mdse. Inv. ist of Period Freight-In Total Less: Purchase Returns and Allow- ances Mdse. Inv. End of Period . . Total deductions Net Cost of Goods Sold .... Gross Profits (%s) Expenses: Selling Expenses: Salaries and Wages of Sales Force Commissions to Sales Force Traveling Expenses for Sales Force House Entertainment Advertising ^^^^ Total (%s) Delivery Expense: Operation of Auto Truck Operation of Wagon Truck Depreciation of Del. Equipment Sundry Delivery Expense Total (%s), 158 ACCOUNTING PRINCIPLES ILLUSTRATION NO. 16 Continued REVENUE STATEMENT FOR PERIOD BEGINNING ENDED Continued Management and Office: Stationery . Salaries of Office Force Office Supplies Telephone and Telegraph Sundry Office Expenses Total (%s)...- Maintenance, Operation and Upkeep Bldg.: Rent Heat, Light and Power Taxes Insurance Repairs of Bldg. and Equipment Depreciation of Building Depreciation of Equipment Sundry Expenses of Bldg Total Losses from Bad Debts .... Miscellaneous Expense .... Total Expense (...%&) Profits from Operation ( . . . %s) Other Income: Discount on Purchases .... Interest Total other income Total Income Deductions: Interest Discount on Sales Total Net Profits (...%s) MANAGERIAL USE OF REVENUE STATEMENT 159 ILLUSTRATION NO. 17 COMPARATIVE REVENUE STATEMENT Month Month Estimated ended ended Increase Increase for Dec. 31, Dec. 31, percent Dec., 1918 1918 1917 r. Net Sales Furniture 2. Cost of Fur. Sales 3. Gross Profit 4. Net Sales Carpets 5. Cost of Car. Sales 6. Gross Pro. (Carpets) __ 7. Total Gross Profits ^_^_L 8. Selling Expenses a. Salaries & Wages b. Commissions c. Traveling Exp d. House Entertain- ment e. Advertising Total Selling Exp. 9. Delivery Expense a. Operation Auto Truck b. O p e r . Wagon Truck c. Sundry Total Del. Exp. 10. Management and Office Exp. a. Stationery b. Salaries c. Office Supplies d. Tel. and Teleg e. Sundry Total M. & O. Exp. 160 ACCOUNTING PRINCIPLES ILLUSTRATION NO. 17 Continued COMPARATIVE REVENUE STATEMENT Continued Month Month Estimated ended ended Increase Increase for Dec. 31, Dec. 31, per cent -, . . Dec., 1918 1918 1917 n. Maintenance, Opera- tion and Upkeep of. Bldg. a. Rent b. Heat, Light and Power c. Taxes d. Insurance e. Repairs f. Depreciation g. Sundry Total M. O.&U. of ~ Bldg. Exp. 12. Losses from Bad Debts 13. Misc. Expenses 14. Total 9, 10, ii, 12, 13 ....... 15. Profit from Operation (7 minus 14) 16. Other Income 17. Total Income 18. Deductions 19. Net Profit QUESTIONS AND PROBLEMS 1. What is the managerial use of an account payable? An account receivable? A delivery expense account? A fuel account? 2. What is the purpose of the accounts other than financial accounts (accounts receivable, accounts payable, etc.)? 3. What is the test as to whether any particular accounts should be kept? 4. When would a commodity be the subject of an account? 5. On what basis are accounts grouped in a revenue statement? 6. What has the organization of a business to do with the grouping of accounts? 7. Of what managerial advantage has the group of fixed costs? 8. What makes it difficult to segregate the group of fixed cost accounts? 9. On what basis are incomes grouped in the revenue statement? Why? 10. On January i, 1919, the merchandise inventory was $5,000.00. The purchases for the month of January were $4,000.00. The sales were $5,500.00. The average mark-up was 40% of the sale price. The total price re- ductions for the month were $125.00. What was the inventory at the end of the month? MANAGERIAL USE OF REVENUE STATEMENT 161 11. What are the advantages of percentages in the totals of accounts or groups of accounts? 12. Discuss the uses of the comparative revenue statement. Trial Balance of King Mdse. Co. for Year Ended Dec. 31, 1919 Cash Accounts Receivable Mdse. Inventory Delivery Equipment Furniture and Fixtures Land Buildings Notes Payable Accounts Payable Mortgage Payable John King, Capital Mdse. Sales Return Sales and Allowances Discount on Purchases Interest Received Mdse. Purchases Return Purchases Administrative Salaries Administrative Expense-general Advertising Salaries of Salesmen Misc. Selling Expense Operation of Delivery Service Repairs on Delivery Equipment Interest Paid Discount on Sales 2,500.00 4,500.00 21,000.00 7,500.00 2,000.00 10,000.00 25,000.00 150.00 40,000 . oo 12,000.00 3,000.00 1,500.00 3.550.00 850.00 1,750.00 250.00 350.00 375-00 136,275.00 8,900.00 5,000.00 25,000.00 21,025.00 75,000.00 400.00 750.00 Adjustments, Dec. 31, 1919. Mdse. Inventory 25,000.00 Salaries of Salesmen accrued 200 . oo Interest accrued on Notes Payable 75 .00 Depreciation 4% on bldgs., 7% on Del. Equip., 5% on Fur. and Fixts. Reserve for Bad Debts 125.00 Deferrred Expense Advertising 250.00 Deferred Expense Repairs on Delivery Equipment 75 .00 (a) Journalize the adjusting entries and close through the journal, open- ing all accounts on the ledger which are involved in the adjusting and closing entries. (b) Make out a Revenue Statement and Balance Sheet in due form CHAPTER XIII THE FORM AND MANAGERIAL USE OF THE BALANCE SHEET 1. Use of the Balance Sheet. The balance sheet is highly essential to the manager in arriving at the standing of the busi- ness at the close of the fiscal period and in determining changes in the financial policy of the concern rendered necessary by a comparison of the condition of the business at the particular time with its condition at the close of previous years. While the revenue statement provides a summary of operations for the years and of their result in net profits, the balance sheet is needed to show the final effect of these operations on the form and amount of the assets and liabilities. Such information the manager should have, and the creditors of the concern will usu- ally require, before arranging for material additions to the in- ventory or to the working capital. The form of the balance sheet and the order of the items which it contains become, therefore, matters deserving of consideration. 2. Kinds of Assets. The classes of assets usually found in balance sheets are as follows: (a) Current assets; (b) working assets; (c) investments in reserves; (d) permanent investments; (e) fixed assets. Current assets and working assets are tem- porary in character. The first class (current assets) consists of cash and of other items which are turned into cash from month to month as the business proceeds; the second (working assets) of supplies on hand, expenses paid in advance, advances to agents, etc. While it is true that some of the working assets may be converted into cash, they are not ordinarily thus changed in the regular course of business. Permanent invest- ments consist usually of interest in outside ventures maintained for reasons of business strategy, and may be composed of the securities of corporations over which it is desired to exercise control or of long-time loans to allied concerns for the purpose 162 MANAGERIAL USE OF BALANCE SHEET 163 of gaining a degree of control over their operations. Fixed as- sets are the investments of the business in plant and other per- manent property essential to its operation, and include such items as land, buildings, furniture and fixtures, machinery and equipment, goodwill, patents, and franchises. In considering the stability of a business, attention must be paid to the readiness with which the various assets can be turned into cash. To be able to pay obligations from funds ac- cumulated from the regular turnover of current assets is not only desirable from the point of view of the business itself, but is particularly desirable from the standpoint of the creditors of the concern. The latter do not ordinarily wish to collect their bills through foreclosure or bankruptcy proceedings. The in- terests of both the business and its creditors require, therefore, that all accounts and notes currently falling due shall be met from current assets through the regular turnover accumulation of cash receipts. The working assets may be partly converted into cash, and are valuable to this extent in case liquidation becomes neces- sary. They are not currently turned into cash, however, with the regular turnover of the merchandise inventory. The permanent investments may or may not be readily sala- ble, but a business can ill afford to sell them to liquidate liabil- ities which are currently falling due. On the other hand, they may be very desirable property in connection with a liquida- tion of all the assets, frequently bringing an amount greatly in excess of the value at which they were carried on the books. The fixed assets of a business suffer most in case of liquida- tion. They are primarily valuable as part of a going concern, and cannot be sold to advantage when separated therefrom. They frequently form the basis for a long-time first mortgage, the holder being ordinarily given the ranking claim against the proceeds arising from a liquidation of the mortgaged assets. 3. Kinds of Liabilities and Proprietorship. Liabilities are classified according to the time ordinarily elapsing before they must be met. The classes most commonly found in liability and proprietorship statements are as follows: (a) Current 1 64 ACCOUNTING PRINCIPLES liabilities; (b) deferred credits; (c) fixed liabilities; (d) capital; (e) appropriated surplus; (f) surplus. Current liabilities are obligations which mature from month to month as the regular turnover of the merchandise stock proceeds. They are in effect short-time loans to the business, and include such items as notes payable, accounts payable, and accrued accounts payable. The last-named item is sometimes given a special heading, such as accrued liabilities not due. Deferred credits are the claims of a succeeding period against the income received by the business during the period covered by the balance sheet. They are not liabilities, however, in the sense of claims that must be paid. They represent merely profits received in advance and therefore deferred to a later period. Fixed liabilities are those which are not being paid from month to month out of the current proceeds of sales, such as bonds, five-year notes, etc. Appropriated surplus is a group of accounts belonging to the corporation balance sheet, and represents surplus reserves which have been set aside for special purposes. The surplus invested in fixed assets is sometimes also classed as an appropriated surplus, because it is presumed not to be s'ubject to distribution in the form of dividends. As any surplus, however, unless specially set aside, is subject to dividend declarations, regardless of the business asset in which it may be invested, the better practice is to limit the application of the term appropriated surplus to surplus funds which have been created and are being held for designated purposes. The final caption of the liability side is, of course, the capital group of accounts. In the partnership, this group consists of the capital accounts of all the partners; hi the cor- poration, of the various classes of capital and of the regular as well as the appropriated surplus. 4. Relation of Liabilities to Assets. The assets of a busi- ness arise only through the creation of liabilities and pro- prietorship. If two or more partners invest a certain amount of cash each in a business venture, the firm acquires a cash asset of the total amount and at the same time assumes an equal proprietary obligation to the owners for the money thus con- MANAGERIAL USE OF BALANCE SHEET 165 tributed. If goods are later bought on credit, a liability of accounts payable arises to compensate for the asset of mer- chandise received. Loans from a bank provide an asset of cash through the creation of notes payable, while a mortgage of the equities of the owners may secure still other assets through the setting up of a long-term liability. In acquiring assets through the creation of liabilities, a busi- ness usually relies upon the former through sale or operation to provide the funds with which the latter may be paid. When accounts payable are incurred, it is expected that the business will be able to pay these accounts from the proceeds of the sale of the goods purchased and still have in excess of the purchase price a gross profit sufficient to yield a net profit after expenses have been deducted. For the fixed or service assets, which or- dinarily remain for years in approximately the form in which they are installed and which are commonly acquired through the creation of a long-term or fixed liability or through the is- suance of capital stock, provision must be made for retiring any liabilities outstanding against them at the termination of their useful life, or a reserve must be built up from year to year to equal the value of the assets by the time they are used up and scrapped. As the total of fixed assets is ordinarily maintained through reserves which equal or exceed the depreciation of these assets, it is unimportant for the general commercial busi- ness to undertake to make the fixed liabilities expire with the disappearance of the original assets against which they were is- sued, because new assets regularly take the place of those which are discarded and the total of these assets is thus main- tained. The term for which long-time liabilities are issued, therefore, becomes more a question of the demands of the in- vestors to whom such securities may be sold. A business, how- ever, whether public or private, which does not provide for the depreciation of assets through the creation of a reserve should make the term of the liabilities incurred no longer than the use- ful life of the assets concerned; otherwise, the business will be under the necessity of paying a return for the use of assets which it no longer owns in addition to a return for the use of 1 66 ACCOUNTING PRINCIPLES assets still in operation. Frequently, where the business is a prosperous one, instead of providing a fund for the retirement of the fixed liabilities as they fall due, the owners refund the original obligation through the issuance of a second liability. Since deferred credits are essentially an apportionment of revenues to a future period, no provision is necessary for their payment. The capital of the owners of a business represents an excess in assets over the amount required to meet the definite liabili- ties, and an increase in capital an increase in the safety of these outside claims. Increases in capital thus have a tendency to reassure the firm's creditors and to secure for the business a more extensive credit than would otherwise be the case. The holders of current liabilities obviously cannot feel safe if the total of their claims almost equals the value of the current as- sets which are relied upon for payment. Consequently, where increases of capital are available for increasing the current as- sets or reducing the current liabilities, the credit standing of the business is materially improved. The psychological effect of such increases is no less important than the strictly financial, for in the case of a thriving business the total current assets reach much further as a basis for credit than in the case of a business in which the net profits and the capital balances are on the decline. An increase in the surplus of a corporation has, of course, the same significance with reference to its credit standing that an increase in capital has with respect to the credit standing of an individual business or a partnership. Funds derived from net profits may be used to increase the current assets, the working assets, or the fixed assets, and should be placed where they will best serve as an effective means of still further increasing the net profits, except in so far as they may be required for distri- bution to the owners of the business. There is a special significance in the ratio of the net profits of the business to the investment of the owners. This ratio rep- resents the percentage earned on the capital, and according as it is large or small marks the success or failure, of the business MANAGERIAL USE OF BALANCE SHEET 167 so far as the interest of the owners is concerned. If the earn- ings are greater than in other possible lines, the owners will re- gard their interest as a profitable investment and extend the business as favorable opportunities present themselves. If, on the other hand, the earnings are comparatively low, the own- ers will tend to contract the business or place their returns in other enterprises. 5. Comparative Balance Sheets. A comparison of balance sheets furnishes valuable information in addition to that of- fered by an analysis of the individual balance sheets under con- sideration. The effect of a certain line of business policy on the financial status of a concern cannot be fully foreseen nor can it be fully measured except by comparing the balance sheet items as they existed before the policy was inaugurated with the same items after sufficient time has elapsed for the policies in question to accomplish their results. If, for example, a busi- ness decides to discount its receivables and borrow money to be in a position to take advantage of its own purchase dis- counts, this policy will increase notes receivable discounted and decrease accounts payable, or, in other words, lessen the total investment in current assets and at the same time reduce the current liabilities. Whether the results of such .a policy are a financial advantage is best determined by a comparison of the balance sheet after the adoption of the policy with the balance sheet before it was initiated. Certain tendencies, moreover, of a favorable or unfavorable nature may develop in connection with a business, growing largely out of the personal characteristics of subordinate execu- tives, changes in the personnel of the working force, or circum- stances outside the business itself, and not in accord with the general business program. If these tendencies are to be quickly discovered, there must be frequent comparisons of the financial condition of the business with its condition at previous clos- ings. Otherwise, encroachments on current assets through their investment in fixed assets may gradually result, without a full realization of what is actually taking place. If a comprehensive view of the changes occurring in a given 1 68 ACCOUNTING PRINCIPLES period is desired, this can be had by first determining the total increase on the liability side and then analyzing the asset changes to ascertain the assets in which the additional funds have been invested. If no asset has been decreased in the in- terval, the increase in the liabilities must be offset by a corre- sponding increase in one or more of the various asset items. If some asset has been decreased, manifestly there results another source from which the increases in the other assets may have been derived. .Conversely, in a similar manner, the total in- crease on the asset side may be compared with the increases in the several liability items for discovering the sources from which the increase in the assets has been secured. Business concerns, like other institutions, are creatures of growth, and the measure and character of this growth during a given interval are best studied by a comparative analysis of the balance sheets at the beginning and at the end of the period. If the growth is to be considered as a cumulative mat- ter, it is necessary to go even further than this, and to extend the comparison over a series of previous balance sheets. Such studies from time to time yield valuable information bearing on managerial policy which cannot otherwise be secured. 6. Comparison of Balance Sheets with Estimates. In Chap- ter XII, it was pointed out that a well-managed concern usu- ally has a general business program for the year and perhaps a special program for a shorter period of time. Such general and special programs involve the setting up, not only of an esti- mated revenue statement for the period covered, but also of an estimated balance sheet at its close. In order to determine the particulars in which there has been a failure to accomplish what was planned, this estimated balance sheet is compared with the actual balance sheet drawn up at the end of the period under consideration. It is probably not often that a business program is worked out in sufficient detail to include a complete estimated balance sheet, being more frequently limited to esti- mated sales, estimated purchases, estimated expenses, and esti- mated net profits. The effect, however, of the business opera- tions proposed on the financial status of the concern at the end MANAGERIAL USE OF BALANCE SHEET 169 of the period for which the program is formulated should be con- sidered in order to control properly questions of business policy. 7. Selection of the Form of Balance Sheet. As already ex- plained, the current assets and current liabilities are particu- larly important in the determination of the financial problems of a mercantile business. They are of importance also in the case of a railroad or of a manufacturing concern. The greater part of railroad financing, however, is not accomplished through the creation of current liabilities, generally taking the form of long-term loans or of funded debts. The long-term loans are in most instances mortgages on the fixed assets. As these mort- gages are brought on the market, the prospective purchasers of the securities, in order to arrive at the safety of the loan, in- variably compare the total assets subject to the mortgages with the total long-term liabilities having a claim against the assets in question. The order of setting up the assets in the case of a railroad is, therefore, ordinarily opposite to that commonly recommended for a mercantile concern. The fixed assets are listed first, the other assets following in inverse order. Simi- larly, the liabilities are set up with capital stock first, funded debt second, and current liabilities third. In order that the difference between the assets and the liabilities may appear in the form of a balance, the surplus is frequently entered last on the liability side of the corporation balance sheet. As an illus- tration of a typical balance sheet of this kind, there is given be- low the balance sheet recommended by the Interstate Com- merce Commission for the railroads of the country. ILLUSTRATION NO. 18 FORM OF GENERAL BALANCE SHEET STATEMENT AS PRESCRIBED BY THE INTERSTATE COMMERCE COMMISSION FOR STEAM ROADS Assets Property Investment: Road and Equipment: Investment to June 30, 1907 Investment since June 30, 1907 Reserve for Accrued Depreciation Cr. 170 ACCOUNTING PRINCIPLES Securities: Securities of Proprietary, Affiliated, and Controlled Companies Pledged Securities Issued or Assumed Pledged Securities of Proprietary, Affiliated, and Controlled Companies Unpledged Other Investments: Advances to Proprietary, Affiliated, and Controlled Companies for Construction, Equipment, and Betterments. Miscellaneous Investments: Physical Property Securities Pledged Securities Unpledged Working Assets: Cash Securities Issued or Assumed Held in Treasury Marketable Securities Loans and Bills Receivable Traffic and Car-Service Balances Due from Other Companies Net Balance Due from Agents and Conductors Miscellaneous Accounts Receivable Materials and Supplies Other Working Assets Accrued Income Not Due: Unmatured Interest, Dividends, and Rents Receivable Deferred Debit Items: Advances: Temporary Advances to Proprietary, Affiliated, and Controlled Companies Working Funds Other Advances Rents and Insurance Paid in Advance Taxes Paid in Advance Unextinguished Discount on Securities: On Capital Stock On Funded Debt Property Abandoned. Chargeable to Operating Expense Special Deposits Cash and Securities in Sinking and Redemption Funds Cash and Securities in Insurance and Other Reserve Funds Cash and Securities in Provident Funds Other Deferred Debit Items Profit and Loss: Balance (if a debit) MANAGERIAL USE OF BALANCE SHEET 171 Liabilities Stock: Capital Stock: Common Held by Company Not Held by Company Preferred Held by Company Not Held by Company Debenture Held by Company Not Held by Company Receipts Outstanding for Installments Paid Stock Liability for Conversion of Outstanding Securities of Con- stituent Companies Premiums Realized on Capital Stock Mortgage, Bonded, and Secured Debt: Mortgage Bonds Held by Company Not Held by Company Collateral Trust Bonds Held by Company Not Held by Company Plain Bonds, Debentures, and Notes Held by Company Not Held by Company Income Bonds Held by Company Not Held by Company Equipment Trust Obligations Held by Company Not Held by Company Miscellaneous Funded Obligations Held by Company Not Held by Company Receipts Outstanding for Funded Debt Receivers' Certificates Obligations for Advances Received for Construction, Equipment, and Betterments Working Liabilities: Loans and Bills Payable Traffic and Car-service Balances Due to Other Companies Audited Vouchers and Wages Unpaid Miscellaneous Accounts Payable 172 ACCOUNTING PRINCIPLES Matured Interest, Dividends, and Rents Unpaid Matured Mortgage, Bonded, and Secured Debt Unpaid Working Advances Due to Other Companies Other Working Liabilities Accrued Liabilities Not Due: Unmatured Interest, Dividends, and Rents Payable Taxes Accrued Deferred Credit Items: Unextinguished Premiums on Outstanding Funded Debt Operating Reserves Liability on Account of Provident Funds Other Deferred Credit Items Appropriated Surplus: Additions to Property through Income Reserves from Income or Surplus: Invested in Sinking and Redemption Funds Invested in Other Reserve Funds Not Specifically Invested Profit and Loss: Balance (if a credit) 8. Relation of Form of Presentation to Problem to be Solved. The comparative balance sheet has been especially recom- mended for managerial use. In determining the form of it, however, the special problem to be solved should always be considered. If the manager desires to compare the balance sheet with an estimated balance sheet, or with the balance sheet of a preceding period, the form shown in Illustration Xo. 20 below should be used. On the other hand, a banker is ordi- narily satisfied by a revenue statement and a balance sheet without detailed comparisons, the single statement indicating the strength or weakness of the business. For the banker's purpose, therefore, the forms shown in Illustration Xo. 21 and Illustration Xo. 16 are sufficient. An accountant ordinarily makes out a combined revenue statement and balance sheet for the period under consideration before throwing the infor- mation into the form of a comparative revenue statement and comparative balance sheet. 9. Importance of Revenue Statement and Balance Sheet. The accounting information found in the regular books of rec- MANAGERIAL USE OF BALANCE SHEET 173 ord is largely a sealed book for many business executives, the facts being couched in a language unintelligible to those who do not understand the form and interpretation of accounts. A trial balance conveys an interesting story to an accountant, but may be entirely without value to an executive. As a large part of the information upon which business policies are based is contained in the accounting records, it is of the greatest impor- tance that this information should be so formulated as to con- vey to the manager the data which he needs in the solution of the problems that confront him. The accountant must conse- quently be informed in regard to these problems, so that he may be guided thereby in determining the form in which re- ports shall be made. Frequently, in addition to comparative data properly arranged, a full discussion of the figures by the accountant is extremely desirable, in order to give to the execu- tive a more complete idea of the significance of the information conveyed in the report. 10. The Cash Estimate and the Budget. Expenses, pur- chases, and short-time liabilities are generally liquidated in cash. A liability is sometimes met by the issue of another lia- bility. This serves to postpone the day when the outlay of cash is to be made in an amount equal to the liability. A company with ample assets may become insolvent because of its inability to sell these assets for cash in time to pay certain liabilities falling due. The assets are worth the amount of the liability provided it was not necessary to sell quickly. At a sacrifice sale they may not be sufficient to meet the liabilities. If the holder of liability claims becomes insistent, the business may become insolvent and the proprietors may lose their entire claims in the sacrifice sale. It is, therefore, important to esti- mate the cash requirements of a business and also the sources from which the cash may be received, in order to be in a posi- tion to make provision for financing the business operations. Such a financing program for a period of six months would in- volve listing the amounts of cash receipts expected from various sources by months and listing opposite the cash requirements. Such a schedule might be made in the following form : 174 ACCOUNTING PRINCIPLES *& 0, < s. & en us P. a ^ -1 C> _ rf\ V _ - M W -Q . C e8 V > s Sf 1 a P o | *o o = -33 2 5 Sj3 c S So s 3 ?2 c - "5 ^IllS 8 "S -? S S | = O o: _ U) u rt il il X U W y: 13 PQ MANAGERIAL USE OF BALANCE SHEET 175 The preparation of a form of expected cash receipts and dis- bursements would require a careful analysis of both the bal- ance sheet and revenue statement. ILLUSTRATION NO. 20 VALLEY FURNITURE COMPANY COMPARATIVE BALANCE SHEET, DECEMBER 31 (The per cents other than increase per cents are of total assets or total liabilities) Assets 1918 Current Assets: Cash Notes Receivable Accounts Receivable Mdse. Inventory Accrued Inc. Not Due: Interest Rent Total (-%) (-%). Working Assets: Supplies Inventory Deferred Expense: Insurance Ext. Repairs Advances to Agents Total (-%) (-^%). Investment of Reserves: Bond Sinking Fund Replacement Fund Total (-%) (-^%T Permanent Investments: Securities in A. B. C. Co Advances to G. H. Co. . . .... Total .(-%) (-~%)^ Fixed Assets: Land Buildings Furniture and Fixtures Plant Equipment Goodwill Totals ( %) (-^). Grand Total Assets 1917 Increases Inc. % 1 76 ACCOUNTING PRINCIPLES Liabilities and Proprietorship Current Liabilities: 1918 1917 Increases Inc. % Notes Payable Accounts Payable Accrued Accounts Payable: Interest Rent Taxes . Totals (-%) (-%) Deferred Income: Royalties Rent Total ( %) (To). Fixed Liabilities: Bonds Mortgages Notes (Long-term) Totals ( %) ( %) *Capitals: A's Capital B's Capital C's Capital Total (-%) (-%) Grand Total Liabilities . . ( %) ( %) ILLUSTRATION NO. 21 Account Form of Balance Sheet VALLEY FURNITURE COMPANY BALANCE SHEET, DECEMBER 31, 1918 (The per cents are of total assets or total liabilities) Assets Liabilities and Proprietorship Current: Current Liabilities: Cash Notes Payable Notes Receivable Accounts Payable Accounts Receivable Accrued Accounts Pay.: Mdse. Inventory Interest Accrued Income Not Due: Rent Interest Taxes Rent . . . . 111 Total (%)... Total ( %) * For a corporation this section would be as follows: Capital: igi8 1917 Inc. Inc. Capital Stock Common Capital Stock Preferred Appropriated Surplus Surplus Total ( %) ( %) MANAGERIAL USE OF BALANCE SHEET 177 Working Assets: Supplies Inventory Deferred Expense: Insurance Ext. Repairs Advertising Advances to Agents Total . . Investment of Reserves: Bond Sinking Fund . Replacement Fund . Total ( Permanent Investments: Securities in A. B. C. Co. . Advances to G. H. Co. . Total . .( Fixed Assets: Land Buildings .... Furniture and Fixtures Plant Equipment Good will .... Total (- Grand Total . Deferred Income: Royalties . Rent . . . Total . Fixed Liabilities: Bonds Mortgages Notes (Long-term) Total *Capital: A's Capital B's Capital C's Capital Total . Grand Total QUESTIONS AND PROBLEMS 1. What are the purposes of the balance sheet? 2. Why does a creditor wish to see the balance sheet? 3. What are the classes of assets ordinarily found in the balance sheet? 4. Define each of the classes of assets and discuss the difference between the several classes. 5. What are the different kinds of liabilities?- 1 6. Define each class of liabilities and discuss the basis of the classification. 7. Indicate the various ways in which assets are secured through the creation of liabilities or proprietorship. * For a corporation this section would be as follows: Capital: Capital Stock Common Capital Stock Preferred Appropriated Surplus Surplus Total : ( %) i 7 8 ACCOUXTIXG PRINCIPLES 8. Upon what assets does a business ordinarily rely for funds to meet the several classes of liabilities as they fall due? 9. To what other class of liabilities are deferred credits similar in their nature? To what class of creditors would the property or funds reserved by the creation of deferred credits finally be apportioned in the case of a successful dividend producing property? 10. How would the balance sheet be used by a prospective creditor for the purpose of determining the advisability of an additional extension of credit for the purchase of more merchandise? 11. How would the balance sheet be used by a bank in determining whether it should extend short-time loans to be invested in current assets and working assets? 12. What are net current assets, and what is their significance to creditors in determining the advisability of granting a request for additional loans? 13. What useful information may a manager secure from the comparative balance sheet in the determination of financial policy? 14. How often should the manager require a balance sheet? Why? 15. What factors have a bearing on the question of the order in which the respective groups of assets should be placed in the balance sheet? 16. Why might it be more desirable to have a railroad balance sheet with the fixed property investments and permanent liabilities listed first? 17. What factors have a bearing on the determination of the order in which items should be listed in the balance sheet? 18. Make the necessary arrangements and corrections to place the fol- lowing comparative revenue statement and balance sheet in the best form: THE NATIONAL FARM MACHINERY COMPANY REVENUE STATEMENT Harvesting machinery, tillage instruments and twine: United States Foreign Countries Total Wagons, manure spreaders, gasoline engines, cream separators, auto wagons, tractors: United States Foreign Countries Total Stool Products, fibre sales, etc.: Total Sales Miscellaneous Earnings and Charges Total Income 1918 34,616,559 22,894,797 15,480,607 5.239,578 1919 37,730,448 25,202,914 57,511,356 62,933,362 i8.772.535 8,993,142 20,720,185 27,765,677 8,383.068 10,467,320 86,614,549 101,166,359 869,767 828,529 87,484,316 101,994,888 MANAGERIAL USE OF BALANCE SHEET 179 Deductions: Cost of Manufacturing and Distributing Ordinary Repairs and Maintenance Experimental, Development and Patent Expenses Administrative and General Expenses Interest on Loans Appropriations for Fire Insurance Fund Appropriations for renewals and minor improve- ments Reserve for Pension Fund Reserve for Industrial Accident Fund Reserve for plant depreciation and ore extinguish- ment Reserve for contingent losses and collection ex- penses on receipts Total Deductions Net Profit Preferred Dividends Common Dividends Balance of undivided profits 1918 1919 64,950,314 76,641,370 2,244,404 2,911,945 474.515 567,933 589.753 610,883 558,056 1,003,981 250,000 250,000 567,152 575,00 250,000 250,000 250,000 1,827,382 1,848,957 880,000 1,000,000 72,591,576 85,910,069 14,892,740 16,084,819 4,200,000 4,200,000 10,692,740 4,200,000 3,200,000 7,400,000 8,684,819 NATIONAL FARM MACHINERY COMPANY COMBINED STATEMENT OF PROFITS 1909-1910 Balance Sheet, December 30 1909 1910 Current Assets: Raw Materials and Products Notes Receivable Cash Current Liabilities: Bills Payable Accrued Payables Purchase Money Obligations Dividends Payable Net Current Assets Fixed Assets: Real Estate, Plant, etc. Insurance Fund Assets Advance Payments on Royalties 53-399,926 46,212,036 5,426,600 105,038,652 61,646,435 55.506,547 4,561,171 121,714,153 23,866,157 5,824,750 5,090,531 2,250,000 1,050,000 14,215,128 13,778,045 7.9I3," 2 1,125,000 1,050,000 90,823,371 66,532,609 1,070,862 153,419 67,766,890 71,887,402 1,514,313 190,215 97,847,996 73,591,930 i8o ACCOUNTING PRINCIPLES Fixed Assets plus Net Current Assets: Capital Stock: Prfd. Stock Preferred Stock Common Misc. Reserves Surplus 1009 158,580,261 1910 171,439,926 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000 80,000,000 11,195,531 131,195,531 14,540,377 154,540,377 27.384.73 19. TRIAL BALANCE OF KING MDSE. Co. FOR YEAR ENDED DECEMBER 31, 1920 $2,000.00 18,250.00 15,000.00 7,500.00 16,899,549 $125.00 525-00 100.00 Cash Accounts Receivable Reserve for Bad Debts Mdse. Inventory Delivery Equipment Delivery Equipment Depreciation Reserve Furniture and Fixtures Depreciation Reserve Furniture and Fixtures Land Building Building Depreciation Reserve Notes Payable Accounts Payable lortgage Payable John King, Capital Merchandise Sales Return Sales and Allowances Interest Received Merchandise Purchases Return Purchases Administration Salaries Administration Expense general Advertising Salaries of Salesmen Miscellaneous Selling Expenses Operation of Delivery Service Repairs on Delivery Equipment Interest Paid Discount on Sales $170.950.00 $170,950.00 ADJUSTING ENTRIES, DECEMBER 31, 1920 Merchandise Inventory 1 8 , 500 . oo Bonus to Salesmen allowed on year's service 475.00 Deferred Expense Items: Operation of Delivery Service 125.00 Repairs on Delivery Equipment 350.00 2,500.00 10,000.00 25,000.00 1,000.00 9,000.00 7,500.00 25,000.00 26,800.00 100,000.00 300.00 63,000.00 475 oo 425.0 12,700.00 3,500.00 2,500.00 4,750.00 750.00 1,950.00 350.00 400.00 500.00 MANAGERIAL USE OF BALANCE SHEET l8l Accrued Accounts Payable: . Interest 135 . oo Salesmen's Salaries 525.00 Depreciation Allowed: 4% on Buildings, 7% on Delivery Equipment, 5% on Furniture and Fixtures Deferred Expense Items: Advertising 400 . oo Repairs on Delivery Equipment 85 . oo (a) Journalize the adjusting and closing entries as at the close of 1919. (b) Make comparative revenue statement, taking the figures from the pre- ceding chapter for 1919. (c) Comment on the explanation of the increases in revenue items in so far as any inference can be drawn. CHAPTER XIV INTERNAL ANALYSIS OF BALANCE SHEET AND REVENUE STATEMENT i. Method of Internal Analysis. In the preceding chapter conclusions were, in general, drawn from a comparison of cer- tain items of the revenue statement as shown in the report of a given year with the similar items shown in a report of a corre- sponding preceding year. This method of comparison is of value in determining to what extent a business is making im- provement from period to period over its results as shown by preceding periods. It is possible, however, to construct certain ratios and certain comparisons in the case of a balance sheet that are significant from a credit point of view and from a point of view of the condition of the business, by comparison of certain items of the periodical report with certain other items for the same period. For example, if the net worth of a business as shown by the balance sheet has a ratio to the total of fixed assets equal to one, this indicates that the proprietors have themselves in- vested an amount in the business equal to the total investment in fixed assets. Of course, further analysis could be made by deducting from fixed assets the net worth for the purpose of showing the amount of proprietary investment in current as- sets. This amount could likewise be reduced to percentage, showing the per cent of current assets provided for by the in- vestment of the proprietors. Likewise, the ratio of the net sales of a business to the accounts receivable at a particular date would have a distinct value in indicating the readiness of collection of the proceeds of sales. If the ratio is very high, say 500%, this would indicate that one fifth of the sales for the period were not collected at the end of the period. If the period were a year and the sales were credit sales, one would judge that accounts on an average ran something over sixty days. 182 INTERNAL ANALYSIS OF BALANCE SHEET 183 If the percentage of sales were over 1000, as is the case in the packing industry, and sales were, in general, made on time, this would indicate that accounts receivable on an average run between thirty and sixty days. If the ratio of sales for a year to the average merchandise in- ventory at sale price be high, this would indicate that there is a rapid turnover of goods, and that consequently a business man could afford to lend money for the purchase of such mer- chandise, because of its ready conversion into cash. At the same time, however, a low ratio of sales to receivables would indicate slow collections and would tend to make a given amount of merchandise stand for a smaller amount of credit. If in any particular business the ratio of sales to net worth were high, this would indicate a low investment on the part of the proprietors, considering the volume of sales, and in case the ratio of net worth to fixed assets is at the same time low, a sat- isfactory profit could be made by a small differential on each unit of goods sold. The business would also tend to be satis- factory from the standpoint of commercial credit advances. The ratio of total liabilities to net worth in terms of per cent in- dicates the comparative amount of investment by the propri- etors in contrast to that of outside parties. 2. A Comparison of Ratios for Various Industries. A list of industries will be found in the table below ranked according to the ratio of current assets to current liabilities. This ratio is sometimes spoken of as the current ratio. It is high in the case of farm implements. It is not safe in such an industry where collections are comparatively slow that current liabilities shall be so high as compared with current assets as they are in other industries more favorably situated in this respect. It is found that the current ratio is low in the case of the packing industry. Current liabilities can be very high as compared with current assets in the packing industry because there is a rapid turnover and also ready collections. This rapid turnover will also be found to exist in the case of the packing industry as compared with other industries by reference to the sales- merchandise inventory column in the table below. On the 1 84 ACCOUNTING PRINCIPLES other hand, this ratio is very low in the case of the farm imple- ment business. In the table below it is generally true that if the current ratio is low the turnover or sales-merchandise in- ventory ratio will be high. It would further tend to be true that the ratio of sales to receivables in such cases will also be high. The table below showing these various ratios was con- structed from data furnished by Alexander Wall and published in the Federal Reserve Bulletin for March i, 1919, page 243. See Table A on opposite page. 3. Ratios and Comparison of Periods. While the percent- ages described hi Table A have particular value for the purpose of determining the credit standing of a business, they also have value from a managerial point of view. If a banker or creditor has apprehension concerning the prosperity and financial sta- bility of a business, the managers themselves should take pre- cautions so to improve the affairs of the business that it will command confidence and show a more prosperous condition. Table A illustrates one of the methods of setting standards for the relative status of various items in the periodic reports of a business. If it is found that the average status of items for widely distributed prosperous concerns show certain percent- ages and relations, one is justified in raising questions in regard to the advisability of a set of ratios for his own business vary- ing widely from those commonly found. It may not be feasible to change the status of various items sud- denly. The comparative report shows the progress being made from period to period hi improving the standing of a business. 4. Ratios Representing Prosperity. One of the ratios com- monly used to indicate the degree of the prosperity of a busi- ness is not found in Table A. The ratio of net profits to net worth indicates the percentage of earnings which the business yields to the proprietors. If this percentage is increasing from year to year it is the best possible proof of successful manage- ment. But one of the chief methods of running up this ratio is to increase the column of ratio of sales to merchandise. The manager should see to it that the business does not carry a su- perfluous stock of any item of merchandise considering such INTERNAL ANALYSIS OF BALANCE SHEET .1 vOHVO^^OOtooOto vO cs to M OO lOroO't O 8S, p* PO>oO ^O -iMC*M , w tOO t-^>o<5 t^oo f) f) O rj-lo IB c/2 a (N ro ^> OO M *O t^ to O VO O H M COtOM t^ ts OoO t^ior^^o w M 2 oS t^O^tOOtOtH M T^-M 101000 rooOCXD ^-Ov<3\ roolwtooiMMtotH RECEIVABLE MDSE. w -3-ioO r r^.M OO o ts >OuOcE3'-S j-0rt'srf3'r=2oi PpqpHOHH-jQKnv, a S o '3 o> 'g 3 : i .> - -3 . S % fi H a - s AM 8 5 Of e a ,a ! S V * a .a" o-'g ' tfl aji^ <3 ja _, i; K Seo-g s g M & *e .a ^^ 5 II s S ^ ^3 (Li-a g J " S S 73 a c." 12 fe 1 a %2 1 33 s 61I.S ^C-G ?i_ J Q "> C^ ||| 1 5||a| 5 111 -4-> O > "^ C fcj % SeS'-a.. JJ'"J"S 1 |'is < 2 sT-gj 5 Hlltl 2 ^ e E gb " 1 l-gl^-s | ial gl -JS^ < h g^S % Ijfljl r~* o, t ^ tfl 5 fc^ Q, tn a 3 grs 3$ c-g 2 ." 3 J t/j g ] ^ O T3 Q o S'i i "8 aS-iQ HH C 5? _ VH C S t o rt '-3 ^ * *^ < 1 'fl o 225'o'o-g ^ g o G g S 1 " 1 w -i " "^ L^ilfel '5 .2 |J3 ^ ^ c p & p 3 ' ' 01 ^BcsBxoS ^^ *-* > fe Crt C^j* J ^J3 J.S W H fe"S e' rt 2i " 3- 5 2i o'5'.H s 35 s 3^ c*" a " S M .5 C 4> c 3a , o >/ Statements. The ted areas of the Uni lalio Per Cent. Tt 'urrenl Ratio. This ss Merchandise. E 2 wi,, L. S 'S 3-5.g s^ IHiPi! 55 1 s _^ ^ MCI % **M_a H* LJ SHE'S 8%> "W _C | ^^ W ^ll '. 1 .2 !! Ill jlllflll M| *4 I " . .1 . .a g 10 t/r vo t~ -g oo o 3 1 86 ACCOUNTING PRINCIPLES factors as time required to replenish stock and economy of quarterly orders. An attempt to increase the ratio of sales to merchandise inventory will require some standardized program of maximum and minimum of stock to be carried in the various lines of merchandise and supplies. An improvement in the collection program might decrease the ratio of receivables to merchandise and thus improve the credit position of a company and decrease the losses from bad debts. One of the reasons for receiverships and bankruptcies lies in the fact that the ratio of debt or liabilities to net worth is un- reasonably high. The remedy lies in a larger proprietary in- vestment. When a receivership occurs for this reason, a reor- ganization should set up a balance sheet showing a smaller ratio of liabilities to net worth. In Mr. Wall's studies these ratios were also compiled by sec- tions of the country as well as by industries. The value of the whole study, however, lies more in the method than in the re- sults, although the results themselves might be taken subject to corrections and further modification to be made on the basis of a study of the particular problems of the given business. 5. Limitations of Statistical Analysis. Accounting statis- tics never tell the whole story in regard to the credit position or even the future prospects of a business concern. The experi- ence, character, and intelligence of the manager are always of great importance. Moreover, the character of employees, local competition, and the general business situation are all matters of consequence in gauging the future prospects of an enter- prise. QUESTIONS AND PROBLEMS 1. What is the use of the ratio of net profits to proprietary investment, expressed in per cent? 2. Define and discuss the use of each of the eight ratios discussed in the text. 3. What facts outside statistical analysis are important in gauging the credit and future prosperity of a business? 4. Presuming the John Smith business referred to in the Questions and Problems at the end of the two preceding chapters to be a dry goods busi- ness, discuss its peculiarities and analyze the credit position and prospects of the enterprise. CHAPTER XV CONTROLLING ACCOUNTS AND COLUMNAR BOOKS i. The Nature of a Controlling Account. If all customer accounts and all creditor accounts were kept in the general ledger, it would become a very large and unwieldy book in the case of a large business. It is customary, therefore, to elimi- nate from the general ledger all detail customer accounts and all detail creditor accounts, and to insert in their stead a gen- eral controlling account for customers and a general controlling account for creditors. The detail customer accounts are then kept in what is called the sales ledger and the detail creditor accounts are kept in what is called the purchase ledger or creditors' ledger. These customer accounts are then represented in the general ledger only in totals. The controlling account for the customers' ledger would be called accounts receivable and the controlling account for the purchase ledger would be called ac- counts payable. There would be charged to the accounts re- ceivable controlling account in total all of the charges which are made in detail to the individual customer accounts. Like- wise, there would be credited to the accounts receivable account the total of all credits which are made in detail to the individ- ual customer accounts. It is clear then that the balance of the accounts receivable controlling account would be equal to the sum of the balances of the individual customer accounts in the sales ledger. In the same way, the total of the credits posted to the individual creditor accounts is posted in total to the credit of the accounts payable controlling account. Likewise the total of debits which are posted in detail to the debit of the particular creditor accounts is posted to the debit of the ac- counts payable controlling account. It would then be true of course that the balance of the accounts payable controlling ac- count would be equal to the sum of the balances of the indi- 187 1 88 ACCOUNTING PRINCIPLES vidual creditor accounts which would be found in the purchase ledger. In taking the trial balance the details in the purchase ledger and in the sales ledger can be omitted, since the accounts receivable controlling account represents a summary of the in- dividual accounts in the sales ledger and the accounts payable controlling account represents a summary of the individual ac- counts in the purchase ledger. If these controlling accounts and all of the other general ledger accounts make a balancing trial balance when taken from the general ledger, the general ledger accounts are probably correct. If then the sum of the balances of the individual accounts in the sales ledger are not equal to the balance of the accounts receivable controlling ac- count, some of the individual accounts are probably in error. The clerk who keeps the customers' ledger would then be ad- vised to check the entries in his ledger for the purpose of dis- covering the error. It would similarly be true that some of the accounts in the purchase ledger would likely be in error if the sum of the balances of these individual accounts should not be equal to the balance of the accounts payable controlling account. The clerk who keeps the purchase ledger would be directed, in such a case, to check the entries in the purchase ledger for the purpose of discovering the error. The control ledgers would be regarded as correct when the sum of the bal- ances of the individual accounts in the customers' ledger were equal to the balance of the accounts receivable controlling ac- count, and the sum of the balances in the purchase ledger were equal to the balance of the accounts payable controlling ac- count in the general ledger. 2. Columnar Journals. In a business of considerable size it is customary to provide the journals of original entry with columns which will serve to collect all of the charges to the controlling accounts receivable account and likewise the cred- its to this account, and similarly it is customary in such a busi- ness to create columns in the books of original entry which will provide for the collection in columns of the debits and credits to accounts payable. For example, the total of credit sales as recorded in a sales journal or a sales ledger can be collected CONTROLLING ACCOUNTS AND COLUMNAR BOOKS 189 into one column headed accounts receivable. The total of this column for a given month would be the total of debits to the controlling account of accounts receivable which arise from credit sales to customers. Now the credits to the controlling account would arise in connection with receiving cash on ac- count from individual customers. It would therefore be neces- sary to have on the debit side of the cash journal a column designated accounts receivable, in order that all of these pay- ments on account might be collected in a column and added for a period such as a month, so that the total might be carried to the credit of the accounts receivable controlling account in the general ledger. Likewise in the general journal certain adjust- ments in the customer accounts might arise which would occa- sion debits to the accounts receivable controlling account and also credits to the same account. Consequently, a debit col- umn for accounts receivable and a credit column for accounts receivable would be required in the general journal. A glance at the columnar books of original entry shown in Illustration No. 22 will show how the books 'of original entry are designed to provide columns for all debits to accounts receivable and all credits to that account which might arise from day to day in the entry of transactions. A reference to Illustration No. 22 will further show the provision in the form of columns which it is necessary to make in the columnar books of original entry in order to pro- vide for the accounts payable controlling account. Since these accounts payable arise in connection with purchases, the large volume of the credits to accounts payable may be collected by providing a special column with an accounts payable heading in the purchase journal or purchase register. The most of the debits to accounts payable arise in connection with payments on account which would be entered on the credit side of the cash journal. It is, consequently, necessary to have an ac- counts payable column on the credit side of the cash journal so that all of these debits may be collected and carried as one total to the debit of the accounts payable controlling account. The opening entry of a credit to accounts payable would ordinarily 190 ACCOUNTING PRINCIPLES appear in the general journal, and there may be adjusting en- tries which would likewise appear in the general journal, either as debits to the accounts payable controlling account or as credits to it. It will be desirable, therefore, to have in the gen- eral journal a debit column for accounts payable and also a credit column for accounts payable. If the student will stop at this point and review the illustration at the end of the chap- ter, it will readily appear just what columns have been pro- vided in order to collect the information which is required for the two controlling accounts above described. 3. Discount Columns. In the special journal which had only one column, a cash discount was ordinarily carried as a credit to cash, while the total of the balance of the customer ac- counts was represented as being received on the debit side of the cash journal. It will readily appear that each of such dis- counts on customers' accounts required a posting to the debit of discount an sales. Of course the credit to cash was automat- ically made by the entry of the item on the credit side of the cash journal. Now all of this detail posting and also the repe- tition of the description of the original entry may be saved by the creation of a column of discounts on sales on the debit side of the cash journal. The total of the amount of the balance of the customer's account may then be entered in the accounts receivable column on the debit side of the cash journal when the customer pays his account, and the amount of the discount which the customer receives may be entered in. the parallel col- umn, so that the net balance of cash received is carried over into the cash deposits column. It would be clear that no de- scription is necessary, except the description at the head of the column. It would further be clear that no posting is required then except the posting of the total of the column of the dis- counts on sales when the books are closed. See illustration of cash journal in Illustration Xo. 22, page 204. In the same way, the discounts on purchases are provided for by a column on the credit side of the cash journal, so that when the total of a bill is entered in the accounts payable column on the credit side of the cash journal, the discount appears in a CONTROLLING ACCOUNTS AND COLUMNAR BOOKS IQI parallel column and the cash withdrawals in a third column shows the net amount of cash paid in settlement of the invoice. This column requires the detail entry of the account named at the head of the column only and one posting each time the books are closed. The use of the column eliminates the account entry for each of the discount items collected in the column. See cash journal, credit page, Illustration No. 22, page 205. 4. Classification Columns. In the purchase and sales jour- nals heretofore used, it was impossible to classify purchases or sales into groups of items. If the separation were made, it was necessary to post each sales item to a separate account and there was set up the sales classification into as many groups of items as might seem desirable. It is possible, however, by the use of columns to provide for a classification of sales and a classification of purchases in the books of original entry. It is necessary to provide as many columns in the sales register, or sales journal, as there are classes of sales. It is evident that the same classes of items would appear in the purchase journal as would appear in the sales journal, since the chief reason for classifying sales into groups is to secure a figure for gross prof- its on each class of items. See purchase register and sales reg- ister in Illustration No. 22. When sales and purchases are thus classified, it is necessary to post only the totals of the several columns to the purchase and sales accounts at the time the books are closed. Since freight-in is ordinarily regarded as a part of the cost of goods purchased, it becomes necessary to apportion freight~in between the classes of purchases set up in the purchase register if only one freight-in account is kept. It is sometimes feasible to distribute freight-in between the classes of purchases on the basis of the total purchases that are shown at the time of closing the books in the several classes provided for. In case this does not prove to approximate fairly the ac- tual amount of freight incurred in connection with the purchases in question, the apportionment must be made on the basis of an estimate of the actual amount of freight incurred, and all the facts of the given case must be duly considered in making this estimate. 1 92 ACCOUNTING PRINCIPLES 5. Columnar Books. As we have seen, the introduction of separate books of original entry saves approximately fifty per cent of the postings to accounts in which the number of entries for any fiscal period is large. The use of columnar books not only extends this saving, but provides the basis for what are known as controlling accounts. 6. Columnar Cash Journal. In the ordinary cash book containing but a single debit and a single credit column, it is necessary to write the cash discount on the side opposite the entry of the purchase or sale and to post each individual dis- count to the ledger. By adding, however, a column for dis- counts on purchases next to the credit column, it is possible merely to enter the amount of the discount in the proper col- umn, and to post the total of each as a single item to the ap- propriate ledger account. Thus, by adding to the ordinary cash journal a number of columns and by putting as the head- ings of these columns the names of the accounts to which deb- its and credits are most frequently made, we save not only in the number of ledger postings but also in the number of ac- count entries in the cash book, the entry of the amounts in the proper columns obviating the insertion of the account names. The ruling of the ordinary columnar cash book is shown in Illustration No. 22 below. When cash is received on account, the amount of the invoice is entered in the Accounts Receivable column, and, in the absence of a cash discount, also in the De- posit column. When a cash discount is allowed, the amount of the invoice is entered, as before, in the Accounts Receivable col- umn, the amount of the discount in the Discount on Sales col- umn, and the net cash received, or the amount of the invoice less the cash discount, in the Deposit column. Similarly, pay- ments on account, when no cash discount is taken, are entered in the Accounts Payable and Withdrawal columns. The De- posit and Withdrawal columns thus represent the debits and credits to cash. 7. Columnar Purchase Journal. In the ordinary purchase book or register, there is frequently only one money column CONTROLLING ACCOUNTS AND COLUMNAR BOOKS 193 showing the amount of merchandise purchases. When such is the case, the total of this column is debited to the merchandise purchases account, the offsetting credits being posted in detail to the accounts of the concerns from which the purchases are made. Quite often it is desirable to classify the various pur- chases, in order to determine the profits arising from each sep- arate class. To do this with the ordinary purchase book, it is necessary to have as many purchase registers as there are items in the classification, with the result that a single invoice may involve a number of separate entries. Obviously, the same in- formation is more readily supplied by means of additional col- umns in the purchase journal, whereby the total of the invoice may be entered in one column, and the amounts chargeable to the various classes in parallel columns to the right. The classi- fication adopted will, of course, determine the number of col- umns to be used and the character of the purchase accounts to be kept on the ledger. A form of columnar purchase journal, ruled to fit the trans- actions of the particular example, is shown in Illustration No. 22, below. The total of the Accounts Payable column repre- sents the aggregate of the detailed ppstings to the credit of the individual accounts payable, while the totals of the Furniture column and the Mattresses column show the amounts to be deb- ited to the corresponding ledger accounts, these two accounts replacing the single account of merchandise purchases. 8. Columnar Sales Journal. A columnar sales journal ordi- narily follows the classification of the columnar purchase regis- ter, or vice versa. Thus, in the form of the sales journal illus- trated below, the sales are divided into furniture sales and mattress sales to correspond with the purchase classification es- tablished in the purchase journal. The total of the Accounts Re- ceivable column represents the aggregate of the detailed post- ings to the debit of the various individual accounts receivable, while the totals of the columns representing furniture and mat- tress sales denote the amount to be credited to the correspond- ing ledger accounts, which together replace the merchandise sales account. 194 ACCOUNTING PRINCIPLES 9. Columnar General Journal. With the use of the various columnar books, the number of entries in the general journal becomes comparatively small. It contains, as explained before, merely the opening, closing, adjustment entries, purchases in- volving expense, and such other entries as are not provided for in the separate columnar journals. A form of general jour- nal meeting the requirements of the transactions involved is shown in Illustration No. 22, page 200. It will be noticed that the columnar headings for the journal are similar to the headings found in the columnar cash book, the columnar purchase register, and the columnar sales register. The Accounts Payable column provides for transactions affect- ing creditors other than merchandise creditors and for entries affecting the accounts of the latter arising out of adjustments rather than from purchases or payments on account. Thus, purchases of machinery and equipment and of other fixed as- sets are entered in the general journal. The Accounts Re- ceivable column, on the other hand, provides for credit sales of fixed assets and for adjustment in accounts receivable. 10. Return Purchases and Sales. Where the volume of return purchases and sales is large, it is of advantage to the manager to have the data entered in separate accounts under the headings Returns and Allowances on Purchases and Returns and Allowances on Sales. For convenience, these accounts may be kept, respectively, in the back of the regular purchase and sales journals, the rulings of which are adapted to the purpose. n. Controlling Account Entries. A controlling account is a summary of a group of accounts of the same kind. Take, for example, the customer accounts, of which there may be a large number. If, along with these accounts, there is kept a separate account containing on the debit side the sum of all the debits to the customer accounts, and on the credit side the total of all the credits to the latter accounts, there results a controlling ac- count or summary for accounts receivable. Obviously, the bal- ance of the summary or controlling account is equal to the sum of the balances of the individual customer accounts of which the former is composed. CONTROLLING ACCOUNTS AND COLUMNAR BOOKS 195 The creditor accounts may, of course, be summarized in pre- cisely the same way. On the credit side of the controlling ac- count in this case are entered in total the various credits to the individual creditor accounts, while on the debit side are entered in a lump the different debits to the latter accounts. The bal- ance of the controlling account, therefore, is equal to the sum of the balances of the several individual accounts payable. A special word of explanation is necessary in connection with the postings from the pages of the purchase and sales reg- isters devoted to returns and allowances on purchases and sales. Manifestly, the commodity classifications and controlling ac- count columns are identical in these special sections with those of the purchase and sales journals proper. The posting to the ledger of the totals of the controlling account columns is, how- ever, radically different. In the purchase register, all accounts payable items are credits to the individual creditor accounts, and the total of these items a credit to the controlling creditor account. Goods purchased but returned, on the other hand, become a debit to accounts payable; and hence the accounts payable column of the purchase returns and allowances journal is posted as a debit to the account controlling accounts pay- able. Similarly, the accounts receivable column of the sales returns and allowances journal represents a credit to the con- trolling customer account, and not a debit, as does the ac- counts receivable column of the sales register. 12. Purchase Ledger. To derive the full advantage of a controlling account, all accounts covered by it should be grouped in a separate ledger. If all the purchase accounts are thus segregated, this subsidiary ledger becomes known as the purchase ledger, and the book heretofore called the ledger de- velops into what is termed the general ledger. In order that the general ledger may contain all the data needed for a trial balance, there is inserted in it, in place of the individual ac- counts which have been transferred to the purchase ledger, a summary or controlling account covering the various accounts payable. Consequently, the individual accounts payable no longer appear in the trial balance or in the balance sheet, but 196 ACCOUNTING PRINCIPLES are submitted as a separate schedule to show that the subsidi- ary ledger is in accord with the controlling account of the gen- eral ledger. As the sum of the balances of the individual accounts must equal the balance of the controlling account, it is clear that a difference in these amounts indicates that an error has been made either in the controlling account or in the purchase ledger. In case the trial balance proves correct, it is equally clear that the error must be sought in the individual accounts payable. 13. Sales Ledger. The sales ledger is created as another subsidiary ledger to be governed by the accounts receivable controlling account in the general ledger. If a trial balance taken from the general ledger shows an equality of assets and liabilities, any discrepancy between the sum of the balances of the sales ledger and the balance of the controlling account clearly indicates an error in the individual accounts receivable. 14. Value of Controlling Accounts. Because postings could be made in totals, much saving of time and effort was effected through the introduction of the merchandise purchases and merchandise sales accounts. They are in no sense, however, controlling accounts, there being no group of subsidiary ac- counts fully represented in total by either of them. Controlling accounts present a means of condensing into summary form in the general ledger a large number of accounts which are kept in detail in one or more subsidiary ledgers. Thus the general ledger remains a small book that can be easily used at any time for the purpose of taking a trial balance and cal- culating profits, without even attempting a balance of the vari- ous subsidiary ledger accounts. Should an error develop, it can be easily limited either to the general ledger or to one of the subsidiary ledgers. Without a controlling account, it would be necessary to check all of the accounts in order to locate the discrepancy. Moreover, as the subsidiary ledgers are usually placed in the hands of special clerks, only the general ledger clerk need know the general condition of the business, or whether it is succeeding or failing. The larger the business, CONTROLLING ACCOUNTS AND COLUMNAR BOOKS 197 therefore, the more important becomes the use of controlling accounts. 15. Interest in the Columnar Cash Journal. In the ordi- nary cash journal with only one column for debits and another for credits, the most feasible plan is to enter the discount of a note payable on the credit side and the face of the note on the debit side. There are objections, however, to this procedure, as it increases the total of deposits as indicated by the cash journal to an amount larger than the total as shown by the bank pass book, although the balances of these two books should be the same when all checks issued have been cashed by the bank. Usually, however, a number of checks issued toward the end of the month remain outstanding when the bank book is balanced and returned, making a reconciliation between the pass book and the cash book necessary. This reconciliation is obviously greatly facilitated when the total deposits and the total withdrawals are the same in both the cash and the bank account. The desired result is easily accomplished in the columnar cash journal by entering the face of the note in the general col- umn opposite the entry of notes payable as the account to be credited. The bank discount is then entered in red directly under the entry of the face of the note in the general column opposite the entry of interest as the account to be credited, the net amount of the note being entered in the deposit column. As the interest account is debited with the amount of the discount, this particular entry -must be differentiated from the prevailing credits on the debit side of the journal by being written in red ink. Entries involving notes receivable discounted are, of course, made in the same way. An example will be found in Illustration No. 22, page 204. 1 6. Illustration. The illustration given below is intended to show how items are entered in the different columnar books, how the books are used, how the postings to the controlling ac- counts are made, and how the books are closed at the time of taking a trial balance. Although the purchase and sales ledg- ers, showing the individual accounts of creditors and custom- 198 ACCOUNTING PRINCIPLES ers, are omitted to economize space, there is inserted below the balance sheet a list of the balances from these ledgers as supporting schedules for the balances of the controlling ac- counts. TRANSACTIONS FOR ILLUSTRATION No. 22 John Smith and John Doe on January i, 1919, begin conducting a general partnership under the firm name of the Central Furniture Store. John Smith invests $10.000.00 and John Doe $30,000.00, but they agree that three fourths of the profits and losses shall go to Doe and one fourth to Smith, and allow themselves salaries of $40.00 per week each. They deal in furniture and mattresses, and keep their purchases and sales accounts with these two classes of goods. Their transactions are as follows: Jan. i Purchases on credit: Sample Furniture Co., 2/10, n/3o, furniture, $5,000.00; mattresses, $2,000.00 Haywood Furniture Co., 2/10, n/3o, furniture, $500.00; mat- tresses, $250.00. Purchased office equipment for $350.00 cash. Took out of stock additional office furnishings costing $150.00. Purchased stationery for $25.00 cash. Credit sales: Valley Hospital, 2/10, n/3o, furniture, $750.00; mattresses, $200.00 W. H. Meyer, furniture, $28.50; mattresses, $7.50 J. J. Hewitt, 2/10, 0/30, furniture, $400.00; mattresses, $150.00. 2 Cash sales, furniture, $800.00. 2 Purchased delivery truck for $1.500.00 cash. 6 Transactions for remainder of week entered under this date. Paid on account: Sample Furniture Co., invoice of Jan. i, less discount; Haywood Furniture Co., invoice of Jan. i, less discount. Credit purchases: T. & G. Morgan, furniture, $6,000.00; mattresses, $2.560.00 H. E. Duncan, furniture, $5,860.00; mattresses, $1,850.00 W. T. Hamer, fur- niture, $7,280.00; mattresses, $3,260.00. Received on account: Valley Hospital, invoice of Jan. i, less discount J. J. Hewitt, invoice of Jan. i, less discount. Purchased lot and building for $10,000.00 from K. C. Jones Realty Co., of which $3,500.00 was for the lot and $6,500.00 for the building. The firm paid $7.500.00 in cash and gave a five-year 8% mortgage for the balance. CONTROLLING ACCOUNTS AND COLUMNAR BOOKS 199 Purchased three tons of coal from the City Coal Co. for office use, paying $18.00 cash. Paid for salaries: Managers, $80.00; R. L. Kaid, $30.00; J. P. Johns, $35.00; H. R. Salder, $35.00. Sales on credit, 2/10, n/3cr: J. Collins, furniture, $250.00 H. P. Henderson, furniture, $160.00; mattresses, $80.00 J. H. Brigham, furniture, $250.00; mat- tresses, $90.00 St. Luke Hospital, furniture, $2,- 750.00; mattresses, $750.00. National University, fur- niture, $5,600.00; mattresses, $1,750.00. Cash sales: Furniture, $8,500.00; mattresses, $3,260.00. 13 Transactions for the week ending on this date. Paid on account: T. & G. Morgan, $6,000.00; H. E. Duncan, invoice less discount; W. T. Hamer, invoice less dis- count. By agreement, the firm drew a 3o-day draft on the St. Luke Hospital for $3,430.00, to cover account less discount, the hospital accepting the draft. Discounted at 5.808% at the Central Trust Co. the 30-day draft of the St. Luke Hospital. 2OO ACCOUNTING PRINCIPLES a, 06 8 8 8 8 at a 8 8 8 >0 8 10 8E 1-1 >O >O M O ** c hJ < * o\ ~_ oo o < o n d w ^ ' I g 5s t> "H ||25 i o - f, v & o tn ti-' *' H-> j-Q - cn'- |V T 3 5 ! g I^I^JB .a.s 1| jj ciis "4j"cg-U-C ^^ W >."g -rt"^^^ C P O iN^lJ || Y|1 Ililfi sByll 1 ^ 'si -11^1 *fi39l^ ^^.S^^.3 ^fa ^ U ^(S llo^H 8 oo 1^.1^ r^* O\ O O O O O (N O* 10 O 00 M t^ ^J- O M M M IO 10 ^ O^ ^ H M 5; o > o" O H S O O O ON O M M O O\ O O M m ._. o Bi; CO o "* l~~ > a i i p Purchas ^ H d 2 o i l! 8 ^.-S | SrttcS^ S o9^ a" PH -g .5 -3 Jjj o^^ 3 1 M all^ 2 OJ *" a i i B a iT ^ Gt 5r> t^. o o M o> o> o o O O M 1-1 M O (S N !N CN 8 8 8 O O O O c o o o OO t^ vO O* H 00 M 00 OO Tf CO *o IO ^t "^ "t "t. "^ 1 M Ht CO M cr 202 ACCOUNTING PRINCIPLES E | M ENERAL O O O O ro 8 i/j BO M jt G i 3 c 1 O *o w i/l rf ON - b o o ; | X I a * ^^ O "O rought Forward Office Expense Office Salaries .osing Expense Account -z ~. 8 c = iscount on Purchases i I 9 1 i- 5 .7 t/. 1 chase into Profit and Lo ofit and Loss Net Pro ~ '5. - O . a in a ~ . John Doe, Capital (Ji) osing Profit and Loss int the Capital Accounts M U Q b O (x. 1 O t 2 lJ 1 ' 3 a M M o O <> ** - r a c CONTROLLING ACCOUNTS AND COLUMNAR BOOKS 203 | 8 8 8 8 8 8l a 0000 o i to *O to *O w W to OO . O a dodo 0^3 T3 T3 T3 W H 2 "oT w u S II d^ u a I ? r/1 i s S 8 5 -i a ^ S g g H fc ) J2 Jl e r 3 g rt S = ^^ 3 ^ fl S ew ^2 ^I^QM S JJ T3 P . * II a w tj -| Jo W H W ^ f S s 8 5 J Oj < s ^ 9. 1 0> fi . O cd M t ' , 204 ACCOUNTING PRINCIPLES - = to if 80 o o o o o i 01 O O O O O *! 1-1 gf. 2 ? = O O * O - p \c O 8 - : "5 Q ii 8 8 si sslsl o o 8 as g j: s. - ; GENERAL 888 8 88, 8 2-5:8 8.5- ^:5- o o o o o >o O* O" <-T w ro O <*5 O O v -- ' __ <-" O_ J C C " u^ in is: M h 0030 -* * f^ O* O 1 f^ oo^--r:;>o~> > o o > o M W t/J */J d W W N Z 1 5 11 s = = s ip IP S * jr^^J j- > > 3 || S | "3 ^ ^s -s r= S U r i Uc 03 ! ^j *-* 'Is S .I -1 ^ 1 ? 5 'i - - ^ -3 ^ II "1 *J3 GM t 8 >-H_. w c Q J - C o a i , CONTROLLING ACCOUNTS AND COLUMNAR BOOKS 205 jjjw 8OOOQOQOQOQOOOO OOOOOOOOOOOOOOM 811 > < OioOOioOoOOOOioioOtoo> 211 "** < co, to OQ t^ to O to co O 1 z x M \o ""- *O l~* O M o co 1 ^o O coil co o ^ u IOC4Q OH'^"'^" r C f O^O r> t^ Q **** ^^ O^ ^" 8 co ^o 10 10 o O 10 O i/> ^O O M t^- ^ 1 O\ CN M 11 M ^Q* t-*. CO ^" ^ M ly ^ WOcgjj^OOOOOOjj.jj 00 C4 O g o H W CO^tOO t^OO O^O M CS CO^J-IO U^ 6 . . to *s M o n " y 9 ^^ ac I-.^ w T2 c^^-g-g i ^H cO o 0,2,0 65^0^ o g g SS^od . O ^ > ' _ i . o 11111^11^^111 2 O 3 c 6 w 1 1 9 i i i S r M " g Si 3 *2 . y || | 8 gaa-grS^-c.g Su| V *J "S 52 r^ W ^ Cd ^ erf , C C J9 i LH ^^ ' t'n " ^ Fi M "73 c5 ^ ^ g s .ts !l iiJils g 'S^S llli Si ^ f5 1^-3 ^ ^4 ^^ , f rt ^ ^^ ^ feOQc^KcoOO HW^ o <: u PQ M W \O CO M Q oo . ON cd 206 ACCOUNTING PRINCIPLES O W cr: CO I 8O 10 O 8 8 8888 IO 8t- o o o o o o i^ to 00 O^ 1 O IO V O OO p Pt t > W * 3 CO O u M 8 Q 10 O 8 8 8 8888 sJ voll O OO O IO PI O O O O O O Q to vo O O 00 00 M t-- OO Tf M l-l PI * *O VO 3 PI VO 00 <> h | 8 8 8 D Q|| o 10 O II O! -J NO O \ I 00 i>- X ** r~-\ < "f "? C" < l_l M pT i >vO to U M "| -1 p si 8 8 8 8 8 8 8 8 Sl8 8 8l 3 > 10 co O O 10 >o -3- O O O r}* O t o NO *O O M M \O t- is to PI PI c-o 10 co C< CS I s -*. o* CO *""* PO PO W o 3 MM M N fa. C/5 V3 "^ C/D c/2 in J J ^3^. C/) yO C/3 ^ o" > '< ts i ft? i PI M co t^ CO O 1 O M M M o CO O O O o o o ro ro ^O as a c 3 C C C C C B-S a 2 u o o o 2 2 2u P< PI C) PI M pi in U 1 g- Jj 13 c< 2 *pj C/) C t/> Valley Hospital W. H. Meyer a -8 i !> H >O s'i-i rt C J3 hH >-, 6C W "> a 1 . ^ _o . -w ^ > >O3 21 11^ ^ U 2 ^ -1 8 3 : < U U Mattress Sale M CO M I 2^42, CONTROLLING ACCOUNTS AND COLUMNAR BOOKS 207 GENERAL LEDGER NOTES RECEIVABLE 1919 Jan. 13 1 J 2 3430 oo 1919 1 NOTES RECEIVABLE DISCOUNTED 1919 Jan. 13 C204 3430 00 1919 Jan. 13 8216 8206 I32I6 OO 1919 Jan. 13 13 C204 J2OI 1500 350 OO oo 500O 00 MDSE. INVENTORY 1919 Jan. 13 J2OI IS580 00 LAND 1919 Jan. 6 J2OO 350 oo BUILDINGS 1919 Jan. 6 J2OO 6500 00 208 ACCOUNTING PRINCIPLES FURNITURE AND FIXTURES 1919 Jan. 13 i 500 J2OO C20 S I5C 350 00 00 1919 DELIVERY EQUIPMENT 1919 Jan. 2 C205 1500 oo ACCOUNTS PAYABLE 1919 Jan. 13 13 C20S C20S 26000 6000 oo oo 1919 Jan. 13 2560 P203 3456o 3D MORTGAGE (NOTES) PAYABLE 1919 Jan. 6 J200J 2500 JOHN* SMITH, CAPITAL 1919 Jan. 13 Balance 11831 60 1919 Jan. Jan. i 13 14 XetProfit(i) Bal. Cap. J202 IOOOO 1831 00 60 11831 60 11831 ? - 11831 JOHN DOE, CAPITAL 1919 Jan. 13 Balance 35494 80 1919 Jan. Jan. i 13 14 XetProfit(f) Balance J 20 : 30000 5494 ro Bo 35404 80 35494 - Bo 35494 CONTROLLING ACCOUNTS AND COLUMNAR BOOKS 209 FURNITURE PURCHASES 1919 Jan. 13 P203 it 24640 oo 1919 Jan. i 13 Trading J200 J20I 150 24490 OD 00 24640 00 25640 oo WAITRESS PURCHASES 1919 Jan. 13 P20 3 9920 oo 1919 Jan. 13 Trading J20I 9920 oo FURNITURE SALES 1919 Jan. 13 Trading J2OI 19488 50 1919 Jan. 13 8206 19488 50 MATTRESS SALES * 1919 Jan. 13 Trading J2OI 6487 DlSCOL 5Q_ NT 1915 Jan. 13 S2O6 6487 50 ON SALES 1919 Jan. 13 13 J200 C20 5 70 30 oo 00 1919 Jan. . X 3 Profit &L. Jaoi IOO 00 IOO 00 IOO 00 INTEREST 1919 Jan. ( C205 16 60 1919 Jan. 13 Profit & L. J2OI 16 (.0 210 ACCOUNTING PRINCIPLES DISCOUNT ON PURCHASES F 1919 Jan. y Profit & L. J200 < 520 GiENE] 00 o Ol 1* - . ,| | E 8 8 8 8f8i 88l8 s o >0 C >0 "-.H Q - Tt o >o c- r : %* i-> fO C30 X ~ H 8 Sis Is B 9 " I o B J rt rt cj rt oj "> rt 2 ACCOUNT CREDITED S -o 3 -/-. 8 Q c i > il I U Co/2 * - x 6 8 JS "1, S |j O S 3 rt la -* 'rt "S 1*1 < ^i C " C ^ C ^ C s > w c3 x a x oj x oj ^ < ej P5 Ji pQ jo pg ^o pq 13 3 "e3 rt > ^ > > - i 8 'e |1 P< V2 2" si o H 9 3 3 3 M flj cj lij c) < X >, >> >> a. V5^i C/3 ^ CA3 ^ CO c] 3 > > gg 2 o 8 tx e c oE l= s 1 tt) B O Q o i > 2 c o 1 A a M f^ * sP <- ? C as I- 1 1 M cc * .9 fl g _= a 5 S s~ THE BILL BOOK 217 i I I 0* W H S P> d AMOUNT OF Disc. AMOUN COLLECT 530 aunf I d V oo oo 2l8 *> ACCOUNTING PRINCIPLES 8 8 8181 1 V ft, ^ i = 8 8 & a u 888 858 ^ o o o .c. c a a 4) 1 88 81 8 8 18 H O OON Ol OO |O oo>-i OB voo 1*0 IO C 00 O I rf I h 1 > rt rt d rt ^> c3 S jfl ACCOUNT DEBITED jili! "1 U j < *J ct O fc JOURNAL WHERK PAYABLE ^ *j " *j ^ "c ^^ M Lj rf .M !* ,*^ , ~J f " 1 J8 5TRATION zs PAYABLE FOR WHAT GIVEN C C Q u -1 ?& 1 H O fc INDORSES OR DRAWER 1 K I- 25 ! 2 6.a u H e* A !i!i t | II MAKER OR DRAWEE ? y || |||B II 2 00 o , S'lA E 3 o" 1 fc IM M ro 1 THE BILL BOOK 2IQ 220 ACCOUNTING PRINCIPLES The foregoing transactions having been entered in the note journal, accounts receivable should be credited for $895.00, in- terest with $5.00, and the individual accounts listed under Ac- counts Credited, credited with the amount set opposite each, the ledger reference being entered in the folio column as the vari- ous postings are made. The notes should be numbered consecu- tively as entered on the record, and designated by number on the cash book entries when paid, so that reference to the record in the bill book may be quickly and easily made. If used merely as a memorandum record, the bill book need have no folio column for the ledger posting. The notes in this case are entered in detail in the general journal, and are iden- tified by their bill book number, so that the complete data con- cerning them may, if necessary, be obtained. In that case the money column would be Notes Receivable or Notes Payable, as the case might be, instead of the three money columns found above. Obviously, if a large number of notes is received, the bill book should be made an auxiliary journal rather than a memorandum record of notes given and received. 2. The Note Payable Journal and Cash. If a note payable is made for cash, no account need be entered on the debit side of the cash journal opposite the entry of the amount of cash received. The memorandum and folio space should, however, refer to the original entry in the Note Payable Journal. The folio of the Note Payable Journal should refer to the cash jour- nal page where the amount of cash is entered. 3. Note Accounts as Controlling Accounts. If a business used notes and expected that many installments should be paid on a note without renewing it, a notes receivable or payable ac- count would not be sufficient. It would be desirable to carry a subsidiary account with each of such notes just as the debt would be treated in an open account. QUESTIONS AND PROBLEMS i. Make the following entries in the bill book, which is to be used as a journal both for notes receivable and for notes payable. Accounts payable and accounts receivable are to be provided for as controlling accounts. THE BILL BOOK 221 1919 July i The Valley Furniture Store draws a 30-day draft on John Smith for $250.00 covering a shipment of goods. Smith accepts the draft as payable at the Valley National Bank. The draft draws interest from maturity at 8%. The note is discounted at once at the bank at 6%. 2 The firm gives to Fielding Co. for merchandise purchases on ac- count a note of $500.00 payable 60 days after date at the Valley National Bank, with interest at 8%. 3 John Smith pays his account of $300.00 with a go-day note en- dorsed by John Doe, and payable at the Central National Bank, Centre, 111., with interest at 8%. 4 The firm accepts in settlement of its account a 6o-day draft of the Sample Furniture Co., dated July i, making it payable at the Valley National Bank. 5 The firm discounts at 6% at the Valley National Bank its go-day note for $400.00, endorsed by John Smith. 6 The firm settles with the Grand Rapids Furniture Co. for its overdue account by giving its note for $300.00, due in 60 days at the Valley National Bank, with interest at 6%. 7 The firm receives from John Ray in settlement of his account a note for $125.00 dated July 5, endorsed by Wilh'am Kaid, and payable at the Valley Grove National Bank, Valley Grove, Mass., with interest at 8%. 8 John Weaver buys merchandise to the amount of $500.00, giving his personal note for 60 days at 8%, payable at the Valley National Bank. The firm, immediately discounts the note at the bank at 6%. 9 The firm receives of J. C. Jackson his 3o-day note for $300.00, dated July 5, payable at the Johnson City State Bank, Johnson City, Pa., with interest at 6%, in full settlement of his account. 10 Post the entries to date, and close the bill journal. 2. State how the transactions in Problem i would have been treated both in the original entries and in the ledger if the bill book had been used simply as a memorandum book and not as a subsidiary journal. CHAPTER XVII TRANSACTIONS FOR FEBRUARY 1. Materials Required for the February Transactions. The following kinds of paper will be required for the February transactions: a. About eight sheets of columnar journal paper, pp. 1-16. b. About six sheets of columnar journal paper, pp. 1-12. c. One sheet of register paper for purchase register, pp. 1-2. d. A second sheet of register paper for returns and allowances on purchases, pp. 1-2. e. One sheet of register paper for a sales register, pp. 1-2. f. A second sheet of register paper for returns and allowances on sales, pp. 1-2. 2. Ledger for New Set. The ledger will be divided into the following ledgers: general ledger, purchase ledger, and sales ledger. The accounts and pages for the general ledger (February accounts) are as follows: A. Assets Ledger page 1. Current Assets a. Cash (see Cash Journal) Petty Cash i b. Notes Receivable * (i) Notes Receivable Disc, (deduction) 2 c. Accounts Receivable 2 (i) Reserve for Bad Debts 3 d. Merchandise Inventory Carpets 3 e. Merchandise Inventory Furniture 4 f. Scrap 4 g. Accrued Accounts Receivable 5 2. Working Assets a. Insurance Unexpired 5 b. Supplies Inventory 6 3. Fixed Assets a. Land 6 b. Buildings 8 (i) Depreciation Reserve for Buildings 8 c. Delivery Equipment 9 (i) Depreciation Reserve for Del. Equipment 9 TRANSACTIONS FOR FEBRUARY 223 A . Assets Continued d. Furniture and Fixtures Administration 10 (i) Depreciation Reserve for Furniture and Fixtures Administration 10 e. Furniture and Fixtures Selling 1 1 (i) Depreciation Reserve for Furniture and Fixtures Selling 1 1 B. Liabilities Current Liabilities a. Notes Payable 12 b. Accounts Payable 12 c. Accrued Accounts Payable 13 Deferred Income 13 Proprietorship a. Frank Williams, Capital 13 b. Frank Williams, Personal 14 c. Walter Day, Capital 14 d. Walter Day, Personal 15 C. Revenue Accounts Income Accounts a. Furniture Sales 17 (i) Returns and Allowances on Furniture Sales 1 8 b. Carpet Sales 18 (i) Returns and Allowances on Carpet Sales 19 c. Other Income (1) Discount on Purchases 19 (2) Interest Earned 20 Expense Accounts a. Furniture Purchases 21 (i) Returns and Allowances Furniture Pur. 21 b. Carpet Purchases 22 (i) Returns and Allowances Carpet Pur. 22 c. Freight In 23 d. Administrative Expenses (1) Administrative Salaries 23 (2) Depreciation of Furniture and Fixtures Administration 24 (3) Administrative Miscellaneous 24 e. Selling Expense (1) Freight Out 25 (2) Advertising 25 (3) Sales Salaries 26 224 ACCOUNTING PRINCIPLES C. Revenue Accounts Continued (4) Depreciation of Furniture and Fixtures Selling 26 (5) Miscellaneous Selling Expense 27 1 (6) Losses from Bad Debts 27 (7) Collections and Exchange 27 f. Delivery Expense (1) Operation of Auto Truck 28 (2) Operation of Wagon Truck 28 (3) Depreciation on Delivery Equipment 29 (4) Miscellaneous Delivery Expense 29 g. Building Expense (1) Depreciation of Building 30 (2) Repairs of Building 30 (3) Heat and Light 31 h. Deductions from Income (1) Interest Expense 31 (2) Discount on Sales 32 g. General Expense (1) Expired Insurance 33 (2) Losses from Sale of Fixed Assets 33 (3) Miscellaneous 33 D. Closing Accounts 1. Trading 2. Profit and Loss An index should be inserted at the beginning of the general ledger and all accounts should be indexed as they are entered. The purchase ledger, which follows the general ledger, should contain all the accounts payable arising out of pur- chases. An index sheet should be inserted at the beginning and three account pages should be inserted and paged consecutively as they are needed. The sales ledger should be constructed in the same way as the purchase ledger. 3. New Finn Organized. A new firm, Williams and Day, is constituted to take over the business of the Valley Furniture Store owned by Frank Williams. It is agreed that profits and losses are to be shared equally by the partners. 4. Transfer to the New Firm the Business of the Valley Fur- 1 Losses from Bad Debts would be charged against a credit and collection department if there existed such an administrative division. TRANSACTIONS FOR FEBRUARY 225 niture Store. From the Balance Sheet of the Valley Furni- ture Store as shown by the closing entries for January, or by a post-closing trial balance, make journal entries transferring the business to Williams and Day and make the final closing en- tries in the ledger of the January books. 5. Make Opening Entries Taking Over Business of Valley Furniture Store. Now make the opening entries in the Feb- ruary books required to place on the books the assets and lia- bilities taken over from the Valley Furniture Store owned for- merly by Frank Williams, who is given a capital interest in the new firm equal to the capital shown on the books of the Valley Furniture Store at the close of business January 31. 6. Taking Over the Business of Walter Day. The business of Walter Day is taken over on the basis of the Balance Sheet of January 31 as follows: WALTER DAY BALANCE SHEET, JANUARY 31, 1914 Assets Current Assets: Cash 1,500.00 Notes Receivable (dated Jan. 500.00 i, 1914, due Sept. i, 1915, interest 7%) Accounts Receivable: George Carey J. Collins Fulton Furniture Co. Martindale Furniture Co. A. W. Martin Randolph Furniture Co. K. C. Riley 4,685.00 Merchandise Inventory 2 5 ,000 . oo Accrued Accounts Receivable Interest 2.92 31,687.92 Deferred Expense : Insurance (expiring Jan. i, 1917) 200.00 Fixed Assets: Delivery Equipment 2,000.00 Total Assets 33 ,887 . 92 226 ACCOUNTING PRINCIPLES Liabilities Current Liabilities: Notes Payable: Page Furniture Co. (Note dated Dec. i, 1913, due May 30, 1914, interest 8% payable at maturity.) 2,500.00 John Smith (dated Nov. i, 1913, due April 30, 1914, interest at 8% payable at maturity.) 3,500.00 Accounts Payable: Lambert & Gray Furniture Co. 1,800.00 Tobey Furniture & Carpet Co. 1,650.00 Lacy Lock & Safe Co. 200 . oo Haywood Furniture Co. 235.00 3,88S-oo Accrued Accounts Payable: Interest 104 . 67 9,989.67 Proprietorship: Walter Day, Capital 23^98.20 Total Liabilities 33.887.92 7. Readjusting the Inventories. In the February books, the following accounts are to be substituted for the merchan- dise purchases, the merchandise sales, and the merchandise inventory: furniture purchases, carpet purchases, furniture sales, carpet sales, merchandise inventory carpets, merchan- dise inventory furniture. Of the merchandise turned over by the Valley Furniture Store, $4,500 is carpets and the remainder is furniture. Of the merchandise turned over by Walter Day, $10,000.00 worth is carpets and $15,000.00 furniture. 8. Petty Cash Book. Petty cash is to be entered in a memorandum Petty Cash Book ruled as indicated in Illustra- tion No. 13. 9. Note Journal. The book for notes payable and notes receivable will be kept as a journal. The student will rule paper to be used for the journal in accordance with Illustration No. 23 and 23 A. TRANSACTIONS FOR FEBRUARY 227 Feb. i. Williams and Day borrow by discounting the firm's note of $5,000.00 at 8% for 90 days, at the Valley National Bank. Ac- counts are paid as follows: Check #i, Wilson Carpet Co. 2,100.00 Check #2, Hay wood Furniture Co. 2,000.00 Check #3, Lacy Lock & Safe Co. 150.00 Check #4, Sample Furniture Co. 37. oo Check #5, Underwood Typewriter Co. 102 . 50 4,789-5o Discounts were taken as follows: Lacy Lock & Safe Co., 2%. Enter the total of each bill in the Accounts Payable column of the cash book, any discounts in Discounts on Purchases, and the net payments in Bank Withdrawals. The partnership also settles with the contractors, who have built additional storage capacity in anticipation of the partnership, paying $500.00 cash (check #6) and making a $500.00 one-year 8% note to A. J. Hamburg, contractor, the entire cost of the addition being $1,00000. (Charge to buildings.) The firm also receives bills for additional stock orders in anticipation of the expansion in business. One of those bills, bearing the date of January 25, 1914, was for $1,500.00 of rugs and carpets from the Wilson Carpet Co. and pro- vided for a 2% discount for ten days, 30 days net. The bill was checked and paid (check #7). Enter the purchase in the purchase register as invoice No. i, and in the cash book also referring to purchase register. Feb. 2. The firm decides to dispose of some surplus delivery equipment, and buy one automobile truck instead. One team and two trucks costing $1,800.00 are sold for $1,650.00, and an automobile truck is purchased for $2,000.00 (check #8.) l Bank deposits are made once a day. This is the only receipt recorded on February 2. Enter the amount in the General and in the Bank Deposits columns. In order to enforce a plan of making all payments by check and properly checking the cash balance, it was decided to create a petty ' A new account, losses from sale of fixed assets, might be opened for this item. 228 ACCOUNTING PRINCIPLES cash fund of $100.00, and check #9 was issued to the cashier for this amount. One team is kept and it is decided to carry separate accounts, showing the cost of horse food and repairs and upkeep of the auto- mobile track, naming the accounts "operation of automobile truck" and "operation of wagon truck." The firm buys 10 gallons of gasoline for $1.50 (petty cash) and corn and hay costing $20.00 (petty cash). The wagon truck is repaired at a cost of $15.00 (petty cash). The firm also buys two tons of fuel for $12.50 (petty cash). The firm carries no separate fuel account, preferring to charge such items to "general expense." Feb. 3. The firm receives cash in payment of accounts as follows: St. Luke Hospital 660.00 (2% discount being taken on $160.00 of the amount.) Bagdad University 250.00 Rice Mfg. Co. 300.00 Smith Institute 600 . oo J. H. Brigham 290.00 [disc, on K. C. Riley 500.00 $235.00] H. P. Square Business College 195 . oo Foster Hall 55 .00 Randolph Furniture Co. 1,075.00 George Carey 700.00 K. C. Riley 150.00 A. W. Martin 375 -oo Enter the amount of each bill in Accounts Receivable and the discounts allowed in Discounts on Sales. One entry for the total of the net receipts is made in the Bank Deposits column, since all money received on February 3 is deposited at one time. The student is expected to refer to the ledger account to see if discounts are allowed, and may assume that all discounts are taken, unless otherwise stated. In actual operation, the firm would refer to those accounts in making out its monthly state- ment to customers, but since statements are not made out here, we shall assume the firm to receive the cash over the counter or in each case to figure the allowable discounts from its ledger accounts. For these transactions the student may further as- sume that the customer gets a discount on such amounts as TRANSACTIONS FOR FEBRUARY 229 may be applied on accounts subject to discount even if the payment does not cover all of such an account. Feb. 3. W. M. Day fails in business and his account of $45.00 is marked off as an absolute loss. The student should charge this to reserve for bad debts. The account is debited for all losses on bad debts. Be sure that the debit and credit items are carried into the proper columns. The cash sales for the last three days of the week were as follows: Carpets 180.00 Furniture 225.00 Less frequent records are made in this business to shorten the routine work. The evidence of receipts from cash sales is supplied in the business by cash register slips, which are filed. The credit sales are evidenced by duplicate sales slips as usual. The credit sales were as follows: Carpets: # i , Foster Hall 50 . oo #2, Smith Institute 85 . oo #3, K. C. Riley 30.00 #4, Randolph Furniture Co. 125.00 (2% 10 days, net 30) Furniture: #i , Foster Hall $30 . oo #2, Randolph Furniture Co. 150.00 (2% 10 days, net 30) #5, Martindale Furniture Co. 75 .00 (2% 10 days, net 30) Credit sales are entered in the sales register. The total of each sale is placed in the amount column and the amount of carpets and furniture in their respective columns. Notice that in two sales both carpets and furniture are involved. The payroll is made out for a week, the accrued wages for three days of January being, by consent of the partners, charged to the February account. The two partners agree that, since they are to share profits equally, they will draw out equal amounts of $30.00 230 ACCOUNTING PRINCIPLES per week each as salaries and charge these amounts to the salary account. The new partner, Walter Day, takes a salary for only three days, or $15.00, so that the salary payment for the week is as follows (check #10): Frank Williams, Partner $30 . oo Walter Day, Partner 15.00 H. P. McCullough, Salesman 25.00 Floyd Jones, Clerk 12.00 R. P. Ranger, Driver 10.00 J. E. Smith, Chauffeur 10.00 $102.00 The above payroll is the regular weekly payroll except that Walter Day's regular salary is $30.00 per week. February 5. Bills for goods ordered were approved as follows: Invoice #2, Wilson Carpet Co. for rugs and carpets 500.00 Invoice #3, Sample Furniture Co. for furniture 2,500.00 (Each bill was 2% 10 days, net 30) February 8. H. R. Scott makes a 6o-day note bearing 8% for $428.00 in settlement of his account. The firm makes a sixty-day 8% note in settlement of its account of $1,800.00, with the Limbert & Gray Furniture Co. The firm pays a bill of $50.00 to the Tribune for advertising (check #11). It also pays a bill from the Capital Garage for $10.00 for repairs on the automobile (check #12). K. C. Riley returns a $30.00 rug delivered to him Feb. 4th. The Randolph Furniture Co. ; s allowed a rebate of $10.00 for damages of its shipment of furniture purchased Feb. 4th. (A sales returns and allowances book is opened on a sheet of the sales register paper. Entries in this book are made just like entries in the sales register. The postings will, of course, be reversed. To distinguish the book from the sales register, the headings are written in red.) February 9. On account of an increase in stock and additions to building, the firm took out additional fire insurance to the amount of $25,000.00 for three years, paying a premium of $360.00 (check #13). The Capital Garage rent for February was paid in advance, the amount being $10.00. A new extra tire of the same type as the original tires was bought for the automobile from the Capital Garage, the cost being $18.00. Additional gasoline to the amount of 10 gal- lons at 15 cents per gallon was purchased from the Capital Garage (check #14 pays all items). TRANSACTIONS FOR FEBRUARY 231 February 10. In order to strengthen the firm's credit w th the bank in anticipation of loan requirements, it was decided to borrow $1,000.00, thus preventing any decrease of deposits at this time, and at the same time preparing to meet the larger total of bills at the end of the month. A $1,000.00 note for 60 days at 8% was made and the firm was credited with the amount less bank discount of 8%. (This discount is interest, and not to be confused with discounts on pur- chases or sales.) The face of the note is entered in the general column. On the line next below the interest is entered. The journalization of the interest is interest Dr. and cash Cr. This entry is ex- actly the opposite of all other entries on the debit side of the cash book. To prevent confusion in posting, the entry is made in red ink. The net cash proceeds of the note the face less the interest are entered in the Bank Deposits column. An order of goods was received from the Hay wood Furniture Co., totaling as follows: Invoice #4, Rugs and Carpets 1,000.00 Invoice #4, Furniture 3,500.00 Returns were made as follows: Rugs and Carpets 50.00 Furniture 25.00 There was also an allowance of $30.00 for damages 1.0 furniture in transit. Returns and allowances are kept both for purchases and sales, one account for returns and allowances on purchases, and one for returns and allowances on sales. Open a purchase re- turns and allowances book similar to the sales returns and allowances. The Sales for the week were as follows: Cash sales: Carpets 250.00 Furniture 400 . oo Credit sales: #6, Fulton Furniture Co. Carpets and rugs 125.00 Furniture 175.00 (2 / 10 days, net / 30) #7, J.Collins Rugs 45 .00 #8, K. C. Riley Furniture 35.00 #9, A. W. Martin Furniture 65.00 232 ACCOUNTING PRINCIPLES The firm paid its bilk approved February 5 for $500.00 and $2,500.00, taking advantage of the discounts (checks 15 and 16). The weekly payroll was also paid (check #17). Frank Williams cashed his personal check for $25.00 from the re- ceipts from sales. A customer, K. C. Riley, also secures $30.00 in currency from the receipts from sales in exchange for his personal check for the same amount. February 12. The cashier paid an express bill of $5.00 from petty cash. There was also paid from the petty cash fund $2.00 for typewriter repairs, and $5.00 for resetting of shoes on the horses. February 13. The Randolph Furniture Company settles its ac- count of $265.00, taking the discount. February 14. The note in favor of the Sample Furniture Co. due on February 14, is paid today by check #18. Freight on goods received on invoices 1-4 is paid by check #19 to the Valley Central Railroad, $190.00. (Freight-In.) Walter Day takes from stock a rug costing $38.00 (Record this transaction in the journal. Walter Day's account is in the general ledger, hence the entry is made in the General column.) Check #20 for $25.00, payable to Mrs. Frank W'illiams, is charged as an advance of salary to Frank Williams. February 15. A contract is made with the Oakley Elevator Co. for the installation of a freight elevator in the building to cost $350.00. Payment of $100.00 is made by check #21 at this time; the balance is to be paid on completion of the work. During the night a thief rifled the safe and secured the amount of the petty cash fund on hand, $39.00. A check, #22, is made to replace the stolen money in the petty cash fund. This theft is an unusual, unforeseen loss and should be charged to general expense miscellaneous. February 16. Repairs on the safe (General Expense) costing $25.00 are made by the Lacy Lock and Safe Co. on account. To prevent a recurrence of the theft a burglar alarm system costing $150.00 is purchased from the Lacy Lock and Safe Co. on account. (Since this is not a purchase of merchandise, it is recorded in the Journal and not in the Purchase Register. Be sure that the items appear in the proper columns.) The firm joins the Merchants' Mutual Protective Association, pay- ing $10.00 in advance for watchman's service (check #23). February 17. A check, #24, for $25.00, is drawn payable to the Valley Commercial Club as a contribution toward bringing a conven- tion to the city. TRANSACTIONS FOR FEBRUARY 233 Checks in payment of account are received as follows: J. Collins, $75.00. Fulton Furniture Co., $200.00 to apply on old account. The weekly payroll is paid with check #25. (Remember the ad- vance made on the i4th.) Cash sales for the week: Furniture $350.00 Carpets 285.00 Credit sales: Customer Furniture Carpets Terms Rice Mfg. Co. 74. 60 2/10, n/3o Smith Institute 51.20 '20.00 J. H. Brigham 34. oo 26.00 H. P. Square Business College 95-00 30 . oo H.R.Scott 73.40 Wm. Wood 60.00 A. W. Martin 23 .20 60 . 60 Randolph Furniture Co. 103 .00 20 . oo K. C. Riley 37.10 " Purchases: Creditor: Wilson Carpet Co. 60.00 75 .00 Limbert & Gray Furni- ture Co. 60.00 " " Tobey Furniture & Car- pet Co. 40.00 50.00 February 19. The check of J. Collins deposited on the seven- teenth is returned dishonored because of insufficient funds. Check #26 is drawn in favor of the National Bank to make good the amount and notice of the failure to collect the check is sent to J. Collins. A dishonored check is charged back to the account of the person from whom it is received. An order is received from J. H. Hotchkiss of Ft. Green for carpets, $150.00. Since the firm has no information regarding his credit standing, Mr. Hotchkiss agrees to have the goods shipped to him C. O. D. (Collect on Delivery). When a C. O. D. sale is made, the transportation company collects for the goods on delivery and remits the amount. A 234 ACCOUNTING PRINCIPLES collection charge is made for this service. C. O. D. sales are not charged to the persons buying the goods, but to a C. O. D. account, the name of the customer being written in the expla- nation space. When the remittance is received, C. O. D. is credited. The balance in C. O. D. at any time shows the amount outstanding on C. O. D. account. Several items in the account of the Martindale Furniture Co. are long overdue. They are pressed for payment, but cannot pay cash. As a compromise, three notes for $500.00, $500.00, and $350.00 at 30, 60, and oo days, respectively, without interest are accepted in pay- ment for the overdue items. February 20. A C. O. D. sale of furniture is made, $76.40, to Henry Perkins of Newton Corners. J. H. Brigham sends word that in his bill of the 1 7th, he was over- charged $4.25 on furniture. Investigation shows that he is correct and a credit memorandum for the amount is sent him. This is neither a return sale nor an allowance. It is merely the correction of an error. In what book should it be entered? February 2 1 . Feed amounting to $20.85 is bought from the Central Produce Company (check #26). Stationery and office supplies amounting to $34.68 are purchased from the Corner Book Store on account. J. Collins, whose check of the i7th was returned dishonored, sends a second check with assurance that it will be honored. February 23. The Fulton Furniture Co. sends a check in payment of their account of $300.00. The Newsome Furniture Co. of Hixton offers to buy a bill of goods providing transportation charges to Hix- ton are paid. As the account seems to be a profitable one, arrangements are made to sell them furniture $125.00 and carpets $68.00 f. o. b. Hixton. (Free on Board that is, the vender pays all charges to Hixton.) The terms of the sale are regular. A check is made out to the Valley Central Railroad for $11.50 freight charges (Freight-Out.) (Check #28.) The remittance for the C. O. D. sale of the igth is received. Collection charges of $0.85 are paid in cash from the petty cash fund. February 24. A storm damages the store building to the extent of $150.00 and the stock of furniture to the extent of $100.00. A con- tract for repairs to the building is let to J. R. Gross for $150.00. (No TRANSACTIONS FOR FEBRUARY 235 entry at this time. Why not?) The damages to the stock cannot be repaired. (This stock damage is an expected loss. The value of the mer- chandise inventory of furniture has been decreased by the amount of damage.) The remittance for the C. O. D. sale of the 2oth is received. The 3O-day note of the Martindale Furniture Co. dated the igth is discounted at the bank at 6% (six per cent) and the proceeds placed to the credit of Williams and Day. To show the contingent liability on a discounted note the face of the note is credited to notes receivable discounted in- stead of to notes receivable. Interest is debited for the amount of the discount and the bank for the net proceeds. For convenience in auditing, the debt to interest is made in red ink in the General column on the debit side of the cash book. The weekly payroll is paid with check #29. No deductions are made on account of the holiday. Cash sales: Carpets $225.00 Furniture 375- Carpets Terms $125.00 40.00 2/10, n/3o 66.00 80.00 65 . oo 2/10, n/3o 75.00 160.00 2/10, n/3o 70.00 The Western Union collects a bill of $15.50, which is paid from petty cash. February 26. The bookkeeper discovers that the sale charged to A. W. Martin on the i7th should have been charged to A. M. Mastin. Credit sales: Customer Furniture St. Luke Hospital $175.00 Randolph Furniture Co. 225.00 George Carey 34.00 A. W. Martin 70.00 A. M. Mastin 80.00 K. C. Riley 85.00 Hotel Bismarck 125.00 Purchases: Creditor Tobey Furniture & Carpet Co. 225.00 Wilson Carpet Co. Haywood Furniture Co. 125.00 236 ACCOUNTING PRINCIPLES Interest on a note, the personal property of Frank Williams, is collected and deposited with the funds of the firm. Amount $25.00. A bill of the Central Garage for $36.00 is paid with check #30. $16.00 of this amount is for supplies for the truck and $20.00 for repairs to Walter Day's car. The elevator installation is completed. A check (#31) is sent the Oakley Elevator Co. for the amount due them. The 6o-day note of the Martindale Furniture Co. is discounted at the bank at 6%. A bill of carpets, $70.00, and furniture, $123.50, is sold to the Newsome Furniture Co., f. o. b. Hixton, the terms regular. February 27. Customers pay their accounts as follows: Randolph Furniture Co. $123.00 (Discount taken whenever possible) Rice Mfg. Co. 74 . 60 W. Wood 1 1 5 . oo (Discount on $60.00) K. C. Riley 72.10 (Discount on $37.10) February 28. The repairs on the store building are completed and a check (#32) is given J. R. Gross in payment for the contract price. A check (#33) is given the Valley Central Railroad in payment of freight bills. $9.60 is for freight on the Newsome Furniture Co. shipment of the 25th and $24.68 for freight on goods received. Walter Day takes from stock a table costing $17. 50.* Apply payments on earliest bills unless otherwise directed. A C. O. D. sale of carpets, $42.35, is made to Peter Wilson of Pine Grove. The bookkeeper reports petty cash expenditures as follows: Express (Freight-In) $5.00 Collection and Exchange .85 General Expense 30.00 Operation of Horse Truck 40 . oo Operation of Auto Truck i . 50 $77-35 He is given a check (#34) to reimburse the fund for these payments. Payments on account as follows: (Take discount whenever possible) Tobey Furniture Co. $90.00 (#35) Limbert & Gray Furniture Co. 60.00 (#36) Wilson Carpet Co. 75 .00 (#37) Haywood Furniture Co. 2,000.00 (#38) Lacy Lock & Safe Co. 225.00 (#39) 1 Charge Walter Day, personal, and credit furniture purchases. TRANSACTIONS FOR FEBRUARY 237 A cash customer is refunded $3.30 (check #40) for a rug returned (enter in cash book). A carpet is returned to the Tobey Furniture & Carpet Co. for credit $32.50. Claim against the Hay wood Furniture Co. for damages of $8.75 in recent furniture shipment is allowed and credit memo- randum received. K. C. Riley is allowed $6.00 for imperfections in furniture delivered. George Carey returns a rug for credit, $24.00. POST TRIAL BALANCE CLOSINGS 1. Directions for closing the February Books: a. Defer the interest paid in advance, and insurance. b. Depreciate the delivery equipment by allowing 2 per cent for the month. c. Other depreciation charges for the month are: Building, 3/ of i per cent; store and office fixtures, 2 per cent. d. Make the necessary entries to place on the books in- terest accrued on both notes receivable and notes payable as shown by the notes in the note journal. e. The bill for $150.00 for building repairs paid to J. R. Gross on Feb. 28 should be distributed over 12 months, beginning with February. An account of repairs on building is opened. Make neces- sary entries. f. In order to allow for the accrued wages, it is necessary to allow $58.50 ($5.00 operation of auto truck; $5.00 wagon; $48.50 salary) for this item. 2. Close the returned sales and allowances and the purchase returns and allowances and other appropriate accounts in the trading account. 3. Close the trading into the profit and loss. 4. Close all accounts going to profit and loss into this account and close this account into the capital accounts. 5. Close any personal accounts into the appropriate capital ac- counts. 6. Make a balance sheet according to Illustration No. 21. 238 ACCOUNTING PRINCIPLES 7. Make a Revenue Statement in the form indicated in Illus- tration No. 1 6. Inventories at end of period : Furniture Inventory $37,422.10 Carpets Inventory 16,286.07 CHAPTER XVIII CLOSING THE BOOKS FOR PERIODICAL REPORTS i. The Use and Limitations of the Trading Account. Pur- chases, sales, sales returns and allowances, purchase returns and allowances, freight-in, merchandise inventory at the be- ginning of the period and merchandise inventory at the end of the period can all be closed into the trading account by means of two compound journal entries. The current textbooks are giving preference to a style of closing which avoids the use of the trading account. It seems worth while to make an analy- sis of the comparative efficiency of the trading account method and that more commonly recommended both as an example of accounting analysis and for the practical results to be had from the analysis. Let us make the closing journal entries for the trial balance on the next page as they affect the trading account and see what the substitute would be in case the gener- ally preferred method were employed: 2.39 240 ACCOUNTING PRINCIPLES A. P. LINDSEY TRIAL BALANCE, DECEMBER 31, 1920 Cash 590.21 Notes Receivable 569.75 Accounts Receivable 8,275.46 Merchandise Inventory, January i, 1920 . 4,975.20 Furniture and Fixtures 3,215.80 Buildings 9,000.00 Land 3,000.00 Notes Payable 2,192.67 Accounts Payable 5,460.75 A. P. Lindsey, Capital 20,000.00 A. P. Lindsey, Personal 1,701.09 Sales 45,102.75 Sales Returns and Allowances . . . . 2,193.60 Purchases 30,190.40 Purchases Returns and Allowances . . 2,970.80 Inward Freight and Drayage . . . . 3,841.39 Salaries 3?59O.67 Advertising 1,140.75 Insurance 316.00 Light and Fuel 750.00 Office Supplies 250.30 General Expenses 1,590.55 Royalties 100.00 Discounts on Purchases 830.00 Interest Expense 225.80 Discounts on Sales 1,240.00 76,656.07 76.656.97 ADJUSTMENT DATA, DECEMBER 31, 1920 Merchandise Inventory 5,190.34 Office Supplies Inventory 50 . 30 Salaries Accrued and Unpaid 100.00 Advertising Paid in Advance 215.25 Unexpired Insurance 75. 40 Interest Accrued on Notes Receivable 40 . 59 Royalties Received in Advance .* 25.00 Bad Debts, 2% of Accounts Receivable Depreciation: Buildings, i% Furniture and Fixtures, 10% CLOSING THE BOOKS FOR PERIODICAL REPORTS 241 2. Directions. Set up the accounts on ledger paper, making provision for valuation accounts. Next, make on a sheet of journal paper the necessary adjusting and closing entries, and post to the ledger accounts. Finally, make up in proper form a balance sheet and profit and loss statement. JOURNAL CLOSINGS FOR THE TRADING ACCOUNT 1. Trading 60,500.00 Merchandise Inventory Jan. i, 1920 9,000.00 Sales Returns and Allowances . . 2,500.00 Purchases 48,000.00 Inward Freight and Drayage . . 1,000.00 2. Merchandise Inventory end of period 16,211 . 50 Sales 63,100.00 Purchase Returns and Allowances . 3,000.00 Trading 82,311.50 3. Trading Gross profit 21,811.50 Profit and Loss Gross profit . . 21,811 . 50 The form of closing which is more generally recommended for the accounts concerned would require the following journal entries: 1. Purchases 10,000.00 Merchandise Inventory First of period 9,000.00 Inward Freight and Drayage . . 1,000.00 2. Merchandise Inventory End of Period 16,211.50 Purchase Returns and Allowances . 3,000.00 Purchases 19,211.50 3. Sales 41,288.50 Purchases Cost of Sales . . . 38,788.50 Sales Returns and Allowances . . 2,500.00 4. Sales Gross Profits 21,811.50 Profit and Loss Gross Profits . 21,811 . 50 In the journal entries above a compound entry was made when it was feasible to do so. In all cases where a compound entry was made and the total of the items was debited or cred- 242 ACCOUNTING PRINCIPLES ited to one of the closing accounts, the posting to the closing account is made in detail instead of in total, as might be sup- posed from the appearance of the journal entry. There is one more journal entry pair involved when the sales account is substituted for the trading account, but the substitution is generally preferred mainly on the ground that the balances of the accounts would be ready for use in making the revenue statement. The cost of sales represents the item which the sales account method of closing furnishes that must be separately calculated when the closing is made through the trading ac- count. Of course the regular form of the revenue statement requires the use of the items involved in calculating the cost of sales so that no more work is involved in the added calculations made in the purchases account when it is closed into sales. In fact the trading account serves the purpose of grouping more items which are taken from the accounts in making the revenue statement. In making the revenue statement all the items above the gross profit item can be taken from the trading ac- count. Otherwise it is necessary to refer to the purchases and the sales accounts for these items. There is possibly a slight economy involved here in the use of the trading account al- though the number of journal items is the same in each of the two methods, and one more account must be ruled when the trading account is employed. There is doubtless a feeling on the part of some that the analysis involved in closing through the sales account is more readily grasped by a beginning student than the analysis which is necessary in explanation of the trading account. This may be true for an accounting program which eliminates the mer- chandise account, but it is not true in the case of students who have already learned the merchandise account. At any rate the trading account analysis is not difficult for a college student and its frequent use would justify teaching it even if it were not as serviceable as the sales account in the computation of gross profits. 3. The Closing Accounts. When the closing is made through the trading account, the closing account will be as follows: CLOSING THE BOOKS FOR PERIODICAL REPORTS 243 TRADING Mdse. Inv. Jan. i, 1920 Purchases Sales Ret. and Allow. Inw. Frt. and Drayage Gross Profits 9,000 . oo 48,000.00 2,500.00 I ,OOO . OO 21,811 . 50 82,311.50 Sales 63,100.00 Purchases Ret. and Allow. 3,000.00 Mdse. Inv. Dec. 31, 1920 16,211.50 82,311.50 When the closing is made through purchases and sales ac- counts, the two closing accounts will appear as follows: PURCHASES Purchases Mdse. Inv. Jan. i, 1920 Inward Frt. and Dray. 0,ooo.oo 9,000.00 1,000.00 58,000.00 Purchase Returns and Allowances Mdse. Inv. Dec. 31, 1920 Cost of sales 3,000.00 16,211.50 38,788.50 58,000.00 SALES Cost of sales 38,788. 50 Sales Ret. and Allow. 2,500.00 Gross profits 2 1 ,8 1 1 . 50 63,100.00 Sales 63,100.00 63,100.00 The frequency of the use of the sales account in closing as a substitute for the trading account makes it necessary for the student to become acquainted with the procedure involved in such cases. There is not a great deal of difference in the time required in the use of the sales and trading accounts for closing purposes, and little can be said in favor of one of these plans as against the other. QUESTIONS AND PROBLEMS i. Explain the procedure involved when purchases and sales accounts are used instead of trading. 244 ACCOUNTING PRINCIPLES 2. Make the journal entries for closing through purchases and sales for the trial balances at the end of Chapter XV. 3. (a) How many additional original entries are required over those needed in the case of the use of the trading account? (b) How many additional postings? (c) How much additional ruling? 4. State the comparative advantages and disadvantages in the two methods of closing. 5. Make the adjusting entries, a profit and loss account, and a revenue statement and balance sheet from the trial balance given in this chapter, making use of the sales account instead of the trading account. CHAPTER XIX CONSIGNMENTS 1. Business of a Consignee. Instead of purchasing all, or sometimes even part, of his stock in trade, a merchant fre- quently acts as the agent of another in the sale of certain goods, charging a commission for his services. Where such an arrangement obtains, the goods are said to be sold on consign- ment, the owner being spoken of as the consignor and the mer- chant as the consignee. As owner, the consignor is responsible, not only for the transportation charges, but for such other ex- penses as may be incurred in connection with the sale of the goods consigned. As agent, the consignee must dispose of the ship- ment in accordance with the terms laid down by the consignor. 2. Consignee Records. Since neither the assets nor the liabilities of the consignee are affected by the mere arrival of a consignment, no journal entry is made at the time the goods are received. A memorandum record is necessary, however, to show the nature and amount of the consignment and the terms on which it is to be sold. This memorandum record may be conveniently entered on the stub of an account sales blank, as indicated in Illustration No. 25 below. To facilitate the jour- nal entries to be later made on the books of original record, each consignment should be given a specific number at the time it is received. In recording sales of consignment goods, two possible meth- ods present themselves. Under the first method both the cash and the credit sales may be entered in the regular sales journal or register, which is provided with a special column for the purpose, or only the credit sales may be recorded in the sales journal, the cash sales being entered in the cash book and posted to the credit of the respective consignment accounts. The regular account space of the sales register 245 246 ACCOUNTING PRINCIPLES J H Z , 4 - 5 en W z i_) H a 11 g z o H E O >< M O u H Qj t/3 ^ O Cl ft i ISION M pq s O H & i ;LUDINC 3i H u jo j __ e? > M H o w en "^as M en J t/: C/3 V2 g a 1 CONSIGNMENTS 247 serves for the entry of the accounts to be debited in connection with the various consignment sales, the consignments to be credited being indicated in a column to the right of the column for consignment sales. In other words, there is no posting of the total of the consignment sales column. The debits for the various items of the column are cash and individual accounts receivable, the corresponding credits being the respective con- signment accounts. The illustration on the opposite page gives the correct form of the sales register above described. There is an alternative which would eliminate the consign- ment sales from the sales journal, the time sales being entered in the general journal and the cash sales in the cash journal. This method is used in Illustration No. 26. Expenses incurred by the consignee in connection with con- signment goods are credited to cash or accounts payable and debited to the consignment accounts to which they pertain. The consignee's commission is, of course, also charged to each consignment account and credited to an income account of commission earned, which, when the books are closed at the end of a particular period, is closed into profit and loss along with the other revenue items. The balance of the consignment account manifestly represents the amount due to the consignor, and is ordinarily paid in cash at the tune the accounting to the consignor is made. Since the commission account represents the total income of the consignee on consignment goods and the sundry expenses are charged to the consignor, there is little occasion for creating controlling accounts in connection with recording consignment data on the books of the consignee. There would be practi- cally no managerial significance to the collection in one total of all the charges made in connection with consignment accounts, inasmuch as these charges affect the income of no one but the consignor. The purpose of the consignment accounts is simply to furnish a record from which there may be made to the con- signor a statement of the gross receipts from consignment sales, the charges incurred in connection therewith, the agent's com- mission, and the balance due to the consignor by the consignee. 248 ACCOUNTING PRINCIPLES As an illustration, let us suppose that John King on January i, 1919, consigns to H. P. Woodrow, of Center, 111., fifty bar- rels of apples to be sold at $5.00 a barrel, Woodrow to receive ten per cent commission for his services. The following ex- penses are incurred by Woodrow in connection with the con- signment: freight, $20.00; drayage, $5.00. On January 15, 1919, Woodrow renders to King on account sales with check for forty-nine barrels of apples, one barrel having spoiled after being received. The journal entries required to record on Wood- row's books the various transactions involved are as follows: JANUARY i Consignment No. i (J. R. King) Freight 20 . oo Consignment No. i (J. R. King) Drayage 5 . oo Cash 25.00 Charges incurred in receipt of 50 barrels of apples from John King to be sold on consignment. Cash 245 . oo Consignment # i Sales 245.00 Goods sold on consignment JANUARY 15 Consignment No. i Commission 24 . 50 Commissions Consignment #i 24 . 50 Commission earned on Consignment #i Consignment #i Balance Due Consignor 195.50 Cash 195-50 Payment of balance due on consignment After these journal entries are posted to the general ledger, the consignment account will appear as follows: CONSIGNMENT NO. i J. R. KING, CONSIGNOR Sales 245 . oo 1919 1919 Jan. i Freight 20.00 Jan. 15 Drayage S-oo 15 Commission 24-50 Balance Due Consignor IQ5-50 245.00 245 . oo CONSIGNMENTS 249 Instead of sending a check with the account sales for the bal- ance due to the consignor, Woodrow might have credited King with the amount due. The consignment account would then have been closed with the following journal entry: Consignment #i Balance Due Consignor 195 . 50 Account Payable (John King) 195-5 Credit to King of balance due on consignment An account sales is simply a summarized statement of a par- ticular consignment account, showing the consignment sales, the expenses incurred, the commission earned, and the balance due to the consignor. As the account sales is usually made from the ledger record, the consignment account should show in the memorandum space the data set forth above. 3. Information Required by the Consignor. Although there is no change of ownership when the consignor ships goods to the consignee to be disposed of on a commission basis, it is de- sirable for the consignor to know the results of his consign- ment business not only as regards individual consignees but also as regards the consignment business as a whole. He must be in position to determine whether the business should be ex- panded or contracted, and which of a number of consignees should be encouraged or eliminated. The records commonly kept show the results so far as individual consignees are con- cerned, but are deficient in supplying information with refer- ence to the business as a whole. This latter information may be gained through controlling accounts, with a reduction rather than an increase in the labor ordinarily involved. 4. Consignee Record of Shipments. When goods are sent to a consignee, an account is set up by the consignor with the consignment in question, which for purposes of convenience is designated by number. The account is debited with the cost of the goods shipped, the purchases account being credited for a like amount. Thus the initial step is taken for setting up a separate profit and loss account, which is later closed into the regular profit and loss. By means of controlling accounts, these 250 ACCOUNTING PRINCIPLES ILLUSTRATION NO. 25 ACCOUNT SALES No. Account Sales for Consignment No. i from J. R. King Address Valley, 111. 50 barrels of apples $5.00 per barrel 10% Mdse. Received Terms of Sale Commission Account Sales Rendered January 15, 1919 Amount Sold 49 barrels Deductions i barrel spoiled on arrival Balance Unsold Carried Forward to Account Sales No._ See also Account Sales H. P. WOODROW, Center, 111., Jan. 15, 1919 Account Sales for Consignment No._i_from J. R. King Address Valley, 111. Date Description 1919 Jan. 15 Sales for half month Freight .... Dray age Commission 20.00 5-00 24 . 50 245.00 49-5 I95-50 The stub of each Account Sales should contain a reference to all preceding account sales affecting a given consignment number, as well as a reference to the account sale number to which the balance of any unsold portion of a consignment may be carried. CONSIGNMENTS 251 individual shipment profits and losses may be combined into a single shipment profit and loss account, the balance of which would, of course, represent the total of the balances of the vari- ous subsidiary shipment accounts. To illustrate the use by the consignor of controlling accounts in connection with consignment shipments, let us consider again the fifty barrels of apples consigned to Woodrow by King, sup- posing this time that the apples cost $150.00 and that the freight and drayage are paid by the owner. The cost of the shipment and the expenses incurred are set up on King's books by the following journal entries, which contain a debit first to the con- trolling account and second to the subsidiary account, written in parentheses underneath: JANUARY i, 1921 Sh. P. and L. Cost of Goods Shipped 150.00 (Shipment No. i, H. P. Woodrow, Center, 111.) l Purchases 150.00 Shipment of 50 bbls. of apples to H. P. Woodrow to be sold at $5.00 a barrel on 10% commission Sh. P. and L. Shipment Charges Freight, $20.00; drayage, $5 25 . oo (Shipment No. i) Cash 25.00 Payment of shipment charges ad- vanced by Valley Warehouse If the shipment charges had been credit transactions, the second entry would have been as follows: Sh. P. and L. Shipment Charges Freight, $20.00; drayage, $5.00 25.00 (Shipment No. i) Accounts Payable 2 5 . oo (Valley Warehouse) Credit to warehouse of shipment charges advanced 1 The parenthesis memorandum indicates in each case the subsidiary account debited or credited- 252 ACCOUNTING PRINCIPLES The journal entries connected with consignment shipments are most advantageously handled through a shipment journal, such as is shown in Illustration No. 26, below. Such a journal provides for all the data involved, except shipment charges which are paid in cash. These must be entered on the credit side of the cash journal, a special controlling account column being added for these items, as indicated in the cash journal illustrated below. 5. Recording the Data from the Account Sales. Upon re- ceipt of an account sales from the consignee, the consignor en- ters on his journal or cash record the amount of the proceeds of the shipment, the account sales constituting the only record kept by the consignor of the consignee's commission and ex- penses. A controlling account may thus be opened with ship- ment profit and loss. If shipment proceeds are always received in cash as each account sales is made, a column on the debit side of the cash journal headed Shipment Profit and Loss Shipment Proceeds will fully provide for the entry of the data received from the consignee. In the case of the shipment used for illustration, the receipt of Woodrow's check is recorded on King's books by the following journal entry: JANUARY 15, 1921 Cash 195 . 50 Sh. P. and L. Shipment Proceeds 195 . 50 (Shipment No. i) Proceeds of sale of 50 bbls. apples con- signed to H. P. Woodrow, Center, 111. The entry in this instance would be made on the debit side of the cash journal, in the column headed Shipment Profit and Loss Shipment Proceeds, opposite the subsidiary account of Shipment No. i, and extended into the Bank Deposit column, following the illustration given below. Frequently, periodic settlements are made by the consignee covering a number of shipments, the shipment proceeds being during the interim credited to the consignor by the consignee. Cases of this kind can be readily provided for by placing a Ship- CONSIGNMENTS 253 ment Profit and Loss Shipment Proceeds column in the gen- eral journal, as shown below. For example, had the account sales covering our apple shipment not been accompanied by cash, the shipment proceeds would have been entered by King in his general journal in the following manner: Accounts Receivable 195 . 50 (H. P. Woodrow) Sh. P. and L. Shipment Proceeds 195 . 50 (Shipment No. i) Proceeds of Shipment No. i due from Woodrow, consignee. The exact form in which the entry is made is indicated in the illustration given below. If shipment No. 2 to H. P. Woodrow by King be 100 barrels of apples costing $3.50 per barrel to be sold at $5.00 per barrel on a 10% commission, the entries on King's books would be as follows: Sh. P. and L. Cost of Goods Shipped 350 . oo (Shipment No. 2) Purchases 350.00 If there were charges paid on the shipment for freight-out amounting to $4.50 the entry would be: Sh. P. and L. Charges (freight) 4. 50 (Shipment No. 2) Cash 4 . 50 Let us suppose further that Woodrow sends his account sales as follows: JANUARY 20, 1921 too bbls. of apples at $5.00 per bbl. $500 . oo Dray age 2.75 Commission 50.00 52.75 Balance due (cash inclosed) $447 . 25 King would make the following entry: JANUARY 20, 1921 Cash 447- 2 5 Sh. P. and L. Sh. Proceeds 447-25 (Shipment No. 2) 254 ACCOUNTING PRINCIPLES 6. Closing of the Consignment Books. In the closing of the consignment books, the subsidiary accounts are provided for through the posting of the detailed entries in the various journals. The controlling accounts, however, are debited and credited by means of closing entries of a character similar to those of the following illustration. A final general journal entry closes the shipment profit and loss into the regular profit and loss for the period under view. The controlling account for the two shipments would be as follows: SHIPMENT PROFIT AND Loss Cost of Goods Shipped Shipment Charges Net Profits 500.00 29.50 529-50 113-25 Shipment Proceeds 642 . 75 642-75 642.75 The two subsidiary accounts would appear in the subsidiary shipment ledger as follows: SHIPMENT No. i H. P. WOODROW, Center, 111. Jan. i i 15 Net Profit 150.00 25.00 175-00 20.50 195.50 Jan. 15 I95-50 195-50 SHIPMENT No. 2 H. P. WOODROW, Center, 111. Jan. 5 5 20 Net profit 350.00 4-50 354 50 92-75 447-25 Jan. 20 447-25 447-25 The shipment profit and loss controlling account serves the purpose of showing to King, the consignor, what the total prof- its on his shipment business are and the detail shipment ac- CONSIGNMENTS 255 counts serve the purpose of showing to King the amount of the net profits on each consignment. It will be noted that the sum of the net profit balances shown by the subsidiary accounts equals the net profit balance shown by the controlling account. There is an inventory to be entered in those cases where the account sale is rendered before all the goods shipped have been sold. The ledger accounts of Illustration No. 26 show how the inventory is entered. 7. Inventory of Goods Shipped. At the periodic closings, along with the regular merchandise inventory, account must be taken of the consignment goods still unsold by the consignees. As it is not always convenient to wait for a statement from them of the goods on hand, the consignment goods inventory is usually calculated by means of the accounts sales. To make this calculation possible, there is entered in red, in both the cash journal and the general journal in the column to the right of the column for shipment proceeds, along with the entry of the account sales data, the cost of the goods sold, the red-ink entries simply indicating that these figures are not to be added with the black-ink entries to be found in the same column. The total of these red-ink entries represents the cost of the goods sold during the period under consideration, and, when sub- tracted from the cost of the total goods shipped, discloses the cost of the goods still on hand, or the inventory of consignment goods. This inventory is then credited to the shipment profit and loss before the latter account is closed into the general profit and loss, and debited to a new account of in- ventory of goods shipped or simply brought down as the debit balance of the cost of goods shipped account for the succeeding period, the necessary memorandum entry being made to show the nature of the beginning charge. It would also be advan- tageous to carry in the memorandum columns of the shipment ledger the cost figures of goods sold when the credit for ship- ment sales is made from the account sales to the subsidiary shipment account. The account would then show data for calculating the merchandise inventory credit to be used in the subsidiary account. 256 ACCOUNTING PRINCIPLES 8. Illustration. The illustration given below gives in defi- nite form the treatment of consignment transactions in accord- ance with the principles discussed above. CONSIGNMENT TRANSACTION FOR ILLUSTRATION NO. 26 I. Organization of the Valley Book Store. The Valley Book Store is organized to do a wholesale business in books. It plans to sell books on consignment and also to sell goods consigned to it. It organizes with a capital of $50,000.00 and takes over the business of K. C. Johns on the following statement of assets and liabilities: BALANCE SHEET OF K. C. JOHNS JUNE 30, 1919 Assets Liabilities Cash 1,000.00 Accounts Payable 5,000.00 Books 10,000.00 Capital 13,000.00 Stationery 5,000 . oo Furniture and Fixtures 2,000.00 18,000.00 18,000.00 The Valley Book Store allows $3,000.00 to K. C. Johns for good- will, and takes over his business, assuming his liabilities. Randolph Jones contributes $30,000.00 of the capital and K.C.Johns, $20,000.00. Profits and losses are to be shared according to capital. II. Keeping the Laboratory Books. No detail customer and creditor accounts will be kept except in connection with consignment transactions. The consignment business will be confined to books. III. Transactions for Juiy, 1919. July i (M.). The business buys on credit goods as follows: Books . . $5,000.00 Stationery . . $2,000.00 July 2 (T.). It receives $3,125.00 of books on consignment from McClure s New Book Store, Chicago, 111., as follows: 300 Jones' Laws of Contracts to be sold at $5.00 $2,500.00 250 Hortcut's Business Law to be sold at $2.50 625 .00 $.3.125.00 The books are to be sold on a commission of 10 per cent and settle- ment is to be made at the end of each week. The freight and cartage- in were $50.00; telephone and telegraph, $1.50, CONSIGNMENTS 257 July 3 (W.) . The Company ships 3 50 copies of Willis on Sales which cost $5.00 per copy to the Wisconsin Corporation Book Store, Cedar Grove, Wis., to be sold at $7.50 per copy, commission 10 per cent. July 4 (T.)- The Company pays $2.00 for cartage and receives a bill from the Valley Central Railroad for freight on this shipment, $30.00. July 6 (F.). The Company pays its weekly payroll as follows: R. C. Criswell, Manager $ 50.00 T. J. Caft, Salesman 30.00 R. M. Paine, Bookkeeper 35 .00 G. M. Ross, Shipping Clerk 25.00 K. R. Kenedy, Stenographer 20.00 R. B. Klette, Traveling Salesman 35 .00 B. C. Kohler, Traveling Salesman 35 .00 L. R. Trailer, Traveling Salesman 30.00 $260.00 The credit sales for the week were: Books $2,000.00 Stationery 1,500.00 The Company received the following account sales from the Wis- consin Book Store, Cedar Grove, Wis.: Sales $375.00 Cartage 3 . oo Damage Discounts 10.00 Commission 37.50 50 . 50 Balance Due Consignor $324.50 (Check inclosed) It sends to the McClure's Book Co., Chicago, 111., the following account sales: 75 Jones' Laws of Contracts, at 5.00 $375.00 50 Hortcut's Business Law, at 2.50 125.00 Total Sales 500.00 Freight and Cartage-In 50.00 Telephone and Telegraph i . 50 Commission 3 7 . 50 89 . oo Balance Due Consignor $411.00 (Check inclosed) July 6. Cash Sales for week: Book Sales $ 500 . oo Stationery Sales 225 . oo Paid on accounts payable ; ,500 . oo 258 ACCOUNTING PRINCIPLES July 8. The Company takes out a $16,000.00 fire insurance three-year policy and pays a premium of $60.00 to the Renox Fire Insurance Co July 9. It purchases on time additional stock as follows: books, $2,000.00; stationery, $1,000.00. The Company decides to buy the building in which it does business from the Valley Trust Co. at $10,000.00. It plans a 6% ten-year mortgage on the building with the Trust Co. for S8.ooo.co; paj r s $1.000.00 in cash and makes a two- year 8% note to the Valley Trust Co. for the balance. July 10. The Company ships to the Macon Book Co., Macon, Minn., 300 copies of Johnson on Agency, which cost $4.00 per copy, to be sold at $6.50 per copy. The goods are shipped over the National Railway, which sends a bill for $35.00 freight. The cartage was $2.50, which was paid in cash to the Valley Express Co. Commission 10%. July n. The Company lost in a fire stock as follows: Books $5,000.00 Stationery 3 ,000 . oo The Insurance Company in this case according to the policy re- quired the insured to bear 25 per cent of the loss. The Insurance Company paid in cash the amount due and the book company marked down accordingly the book value of its insurance. July 12. Instead of charging the fire loss to profit and loss the stockholders decided to reduce the capital by the amount of the loss falling on the company, each stockholder bearing the loss in proportion to his capital. July 13. The Company received from the Wisconsin Corporation Book Store the following account sales: loo Williston on Sales, at $7.50 $750.00 Commission on Sales 75 .00 Due Consignor (check not inclosed) $675.00 (If this report were frequently without a check enclosure, how would the journal be ruled?) The payroll was disbursed as in the preceding week. The Company sends the Mi Clure's Book Co. the following account sales: 125 Jones' Law of Contracts, at 5.00 $625.00 100 Hortcut's Business Law, at 2.50 250.00 Total 875.00 Commission 87.50 Due Consignor (check inclosed) $787 . 50 CONSIGNMENTS 259 Credit sales for the week: Books $1,800.00 Stationery 900 . oo Credit purchases: Books 5,000.00 Stationery 2, 7 50 . oo Cash sales: Books 750.00 Stationery 500 . oo Received on account 3,500.00 Paid on accounts 10,000 . oo Discount on sales 50.00 Discount on purchases 125.00 July 20. (Week of July 15-20.) (For the remainder of .the month the sales and purchases will be given as a total and the details of the consignment sales and the shipments will be given for the week as a whole.) At the end of the week the Company received from the Wisconsin Corporation Book Store the following account sales: loo Williston on Sales, at $7.50 $750.00 Refund on Defective Copy 5.00 Commission 75 .00 80.00 Due Consignor (check inclosed) $670.00 It sent the following account sales to the McClure's Book Co.: 150 Jones' Laws of Contracts, at $5.00 50 Hortcut's Business Law, at $2.50 Total Commission on Sales Due Consignor (check inclosed) $7^7 . 50 The regular payroll was disbursed. Purchases on credit for the week: Books $3,000.00 Stationery i , 7 50 . oo Credit Sales: *4,75<>.oo Books $3,500.00 Stationery 2 ,000 . oo $5,500.00 Paid on account 4,500.00 (Includes disc, of $75.00) Received on account 5,000.00 (Includes disc, of $87.50) 2<5o ACCOUNTING PRINCIPLES Cash sales: Books $8,000 . oo Stationery 550 oo July 27. (Week ending July 27.) The Company sent to the McClure's Book Co. its weekly account sales as follows: loo Jones' Laws of Contracts, at $5.00 $500.00 50 Hortcut's Business Law, at $2.50 125.00 Total 625 . oo Commission 62 . 50 Due Consignor (check inclosed) $562.50 There remained of this consignment only 50 Jones' Law of Con- tracts. The Macon Book Co. sends the following account sales: 250 Johnson on Agency, at $6.50 $1,625 . oo Telephone and telegraph 2 . 50 Cartage 3 . 25 Commission 162.50 174.75 Due Consignor (check inclosed) $1,450.25 Its purchases for the week were: Books $4,000.00 Stationery 1,800.00 $5,800.00 Its credit sales were: Books $5,000 . oo Stationery 2.250.00 $7,250.00 Cash Sales: Books $780.00 Stationery 480 . oo Received on account Less discounts Paid on account Less discounts $950-00 CONSIGNMENTS 261 It was decided to make the payroll monthly for the future and pay it on Saturday of the first week of the month. The store was closed for inventory on July 31. Regular payroll was disbursed. 262 ACCOUNTING PRINCIPLES 1 p< O Q g iJ 525 5 | & u & 2 B ^ H m H) < o < B a i C/3 O W D o o 3 M $1 8 jjl 2 gl.S ! ! J'-l p x i S M ^ 8 8l H hH I 5 c j M M 'S-g.a'S^S - .a-3QrtD.gC $-G I "S o 8 S -5 a 3 iS Si *^ r^ -^ *"^ ' "~ "^ O 0^ ^ >,' - O -^o o N O N M 1 l a -o^^ll -"g c'rf- Q o 3 S -TJT35 I * ! 2 *? 1 ! | b 1 1 a M S &'S g 3 - 2 SrtjS'g j* JB " J . * ;"> c rtOox g^^^^^i ^o > ^is m r;~2%"x Ifl *S ^ S 0-5 xu-|-^2c2> b 1 S - o *- - rt^'ig8o_8c i c3-i c : Sorj"c'? >^ coovoHs2-sS-.2-5H 'CjsS ... >>o <*5f M 5 3 F'^-'S-J X ^ L J & o_c _g^^^^j 5 grt <^o h ^- Carried Forward H fa PQ UcO H U. CO r~- oo O> MM MM j 88888 8 M O M ejj l| p O ^ CONSIGNMENTS 263 < -s-3 8 :;: ! ! lo-S 1 SH. P. & L PROCEEDS OF SHIPMENTS - 8 O O Q ol O *f> i M 00 ^ o H J o o o v'3 o S> p > Brought Forward 6 onsignment # i McC Commissions Earned o bring commission books 9 uildings Notes Payable Mortgage Payable year 8% note; 6%, 10- gage on buildings to V Co. Carried Forward H PQ M ^ O 00 oO f. H a 8 o IT) 8 a! 2 g u CO Q O O M M O ii ii Ii o ^* 264 ACCOUNTING PRINCIPLES !i! 8 o o ;:gJ o 8 o * O ... f V) O^ \f, | w to to ^.Sg 8 8 ci a to to . a * >o vO~ r - a? :/:~ ri O O Q Q to 5 5 5 8 O to 5 f- O O O f> 5 O *5 o o 5 t^ to 00 to O to to PO cj to (1 f) h J^oo_ ^ ro oo oo s MM N M N c S -Q O "rt OT 0) - -^ S* O CO 1 O 6 D M ~> M S > ^^ 3 * 1 x|^ 1 ^ 1 >"2- - 1 s-f 1 8 | ^MC^I fa S^S S 1 o* 5 S-o -3 2ls c l-Sjl^ 6|3 . 8 3 S g-o ' s. s. O H * K. C. Johns, Capital Randolph Jones, Capital Fire Loss Proprietors reduce their article of Fire Loss 13 1 Wisconsin Corporation Shipment jff i W. B Con. * i McClure's Commission Earned To record commission ea Carried Forward hi M t5 O ON o 00 00 00 i^ 00 1-1 d w M M rf to o O 8 8 O to 5 1 ? n t^ to 00 to O O 00 HI o" si 9 8 5fe 1C to g H vO vO -~ _ 5 a 5 < o > b < M C CONSIGNMENTS 265 8 8 8 O oo > 00 l^ 00 OO OO 00 O "O -y^> * Pti fl A > >>ab3 tn 1 ^ ,o> Cin Ctn C!r!!r!e S g > bCi i ^ >% bO I .14 I I^MH^.S 3b b ^Iffj iffl |l|ii al 8^2 ' d Sg'C' 6 ^S^o"^- 2 ^-2d MgH-^o gH^ rtpq^PQ^o gS H Harried Forward WH c^H H HWtAi jj . 00 N O O t> t^ OO OO OO J N t^ 06 RN OO oo oo oo 00 OO >-) M CM ot w n 4 I $ ^ 1 2 B ^ <3 t& A ^j co n O ~~ P O P< T3 ^ GENERAL ^.2^2^ JpS."3 8 1^ 1 83 M I| J -S 11*5 - -c - s^ w|^jg; prT-'O vc 3 y-C3* 7^S2 2 "3 28J!5o gl^oo * 1 -3 H o, 8 w | c -2 .2a,^2fe - T- - '- prt B 5 9 fl ' - - . S,ccl 2S 23^&S SSS^ |l3s 831 lsS |j|3|3 H H C3 H H UQ H h 00 OO OO 00 00 J ci O M O O >o O ^ i O M OO O* r^. 10 r^ i 10 O* M t^ (> oo l ACCOUNTS PAYABLE CONSIGNMENTS 269 NO CO 10 Tj- 11 CO O O 270 ACCOUNTING PRINCIPLES 8O Q Q O *r> if) O O >o o I/) 1 1 M G o\ O "5 r^. o fN as 00 Sw^.oOW^.^0007^00^.^^00^ H- d MPP MPI MPI PI P M O V 3 1 " *?L 8 fi " " 9* " o co -^ r e ? c c *5 ^ * J< *j o 5g^? 1 i* J 2tJaij4 !n 3UO in ai" b a "^ 1 ^ 8""i g"5 c ~ 8 " "2 c B "rt "g c | w ^^"S6-=^-Sa w ^6-S^a-l C a u='lcj|^up:s'iallcji CJ '1-3 - * ' -i M ^DiM^j ^jM^jPt^j 1 "o 2 c | 8 | | c lac | g u| 1^ ll| II| II > ' H- t O. j- enCS* Cai< Cm 2 o.Ss 3OJ3 o^Sja oa g M O M PO O J> MM PI Cl Q l| M H- CONSIGNMENTS 271 8 Kgl ^ \o * o * -^- vo od" eJ" vcT fO O_ PO \O" w" eed it es Bank D Disc, on Sa General Sh. P. &L. Pr of Shipments Accounts Receiva 1 H 272 ACCOUNTING PRINCIPLES , 3 O l/- 8 8 8 8 8 QOOOOOOO M 8 8 P, Q H M] -; y M MOO M O \C Tf VO O ct r^ oo t^. M Tf -I P in M . 8 8 8 8 M S If] is 8 8 8 8 8 8 Q o *f) T? 8 S . 0_ 8 8 8 00 00 O O **} *^ O C "-. 8 8 i H O LC 2 rj 5. * o *^* t*** o O GO CO O -i | 8 *6 M " Tfr VO\O r-00 0> M M co -* U-. o ^ uz; j d -2 X OO "> OO M M M M M M MM --T. Ct -s. ' "s. EXPLANATION McClure's ctg. 1C M 1 0_ g c v: 1 v; 1 X ri X S McClure's settle On acct. . Renox Fire Ins. O jj y ' \ ?r, O . . 4> ^/ t/J o w McClure's 1 to ,_c 1 >, 4 Paid on acct. M M M M M j Consignment * Shipment # i Salaries 1 Consignment # Creditors . Insurance . iLliLi i 11 11 ii i Consignment * Salaries Creditors . B Q ' It M I, ^ X3 00 M M M M M M M t. CN r^ M u l-f i a CONSIGNMENTS 273 O O O 8 8 i 6 ufc "I 1: I > * !> H M ^JS si od m PQ H 274 ACCOUNTING PRINCIPLES > 88888 g ' 1 0000 o l o *o O O t>- r^* OQ 8 -^ & W IH Cl M M r 88888 s 8 8 1 8 8 *-. -*-. pq O irj PO T(- c- od od M M 5a 88888 s 88 8! l< OOOO O 10 *J^ O O f** t** oo 5 3 8 8 8 1 ' o ^ ^ < r*. ro r- ^- *o y. -i c> o ocB . ,| h J M M A 00 00 S M t. (I PARTICULARS 11111 u u u u u c c c c c o o o o o _ _ _ _ _ j= j: j= j= J3 SC SC M SX SC 33333 O O G> ^O ' 5!^ rS 1 J u w 2 2 3 S 3 2 ill J fa U ^ i-t z ^ *! 11111 CJUUUU ill en 5 o - *J O *- M Cl fl It M t t M fJ 1 1 CONSIGNMENTS 275 i 88888888 8 810 O O O O O O c* O O *o 10 oo o 1 t p M N W 'JZ ^ C/5 88888888 8 H 0000000 IJ ~> O O O oo w> oo 1*- 10 co O t^- M cs M ro l o to H | 8888 8 8 8 si t/3 u-> o O O -r O >o 10 co O co M X-* C) f} M H4 ^- VO S M M ^ looo co u M o iO| 1O OO CO 5 10 r^ vo cs c> ON IO *O o CO - oo 00 oi C/3 M N COTj-lOO t^OO CJ CJ O CJ S C/D 5 c/) s c/2 5 oo .... C/3 O C/5 O C/3 C^ C/3 O ACCOUNT 1 i 1 I J|J| 2 2 2 2 ^cAj'g's j tn tn en OJ3Of2 p 3 3 s StattSn u o u u ^^ w II H M M M ro H II Q. II |t 276 ACCOUNTING PRINCIPLES C V II ^r* "3 ' - ~ ** "^ J|^ j U 8 8 81 8 8131 *} o o 1^5 *Oj! O *^ l/- (x? a ro co O 1O *O O BJU (i ' ; Q 8 8 818 8 8 O 80 O o t/- LT. ~ 5 ~ *^ O* O 1-T C? cT 1 j*. U ^ ro ,J. <*5 "-" co O> OO OO 00 OO OO t^ _: M * N r< r M s xp >o o O U M M r O O to II l^ O i- V -3 o> ? iH 09 J3 2 o o g J U< Q a J3 d* "S | ^ ^~fc O O o tc * 8< 1 u a g = I M O 1 | o O C > tn 1 Q ^ S iS 1 C > ACCOUNT AN hipment # Book Store, Wisconsin is "|i^ SI i^ 1 c & oc ^ o^ 5 *it o JM sis< 8 CO C/3 CO CO co O 23-343 46 23.343 22,543 46 4" Bo OKS Aug. SALE i B 1919 July E Trading 6267 15.130 oo 1919 July Jl ES 8275 15.130 00 STAT ION] ERY S AL 1919 July Trading ONSIGNME 6267 "JT N 8,405 00 Me 1919 July . NEW BOO] 8275 i STC 8,405 00 C 0. I :CLUR K.'e )RK 1919 July ' t 6 M :o -7 -7 0263 C2 C2 6264 C2 6265 C2 6265 { 37 411 87 787 87 562 62 50 50 oo 50 50 50 50 50 1919 July 6 13 20 C270 C270 Ci 500 875 875 625 00 00 00 00 2,875 oo 2,875 DO COMMISSIONS EARNED 1909 July 3' Gen.P.&L. 6269 275 oo 1919 July 13 JC 27 Gi 6264 6265 6265 37 87 87 62 50 So 50 00 275 oo 275 DO CONSIGNMENTS BOOKS PURCHASES 281 1919 1919 July 31 P 27 4 19,000 oo July 31 Sh.P.&L. SJ 27 6 2,95 00 31 Trading 0267 16,050 00 = 19,000 oo = 19,000 00 1919 July ill Gen.P.&L. 6269 350 oo 1919 July 31 C2 7 3 350 00 STATIONERY PURCHASES 1919 July 31 P 274 9,30 00 1919 July 3i Trading G 2 6 7 9-300 oo FIRE Loss 1919 1919 July ii 264 8,000 oo July II 270 6,000 00 12 6264 2,000 00 - 8,000 oo 8,000 00 SALARIES 1919 1919 July 6 C272 26O OO July 3i Gen.P.&L! 6268 780 00 *3 C272 26O oo 3 1 Gen.P.&L. 6269 260 00 20 C272 26O oo 3? C2?2 26O oo I,O4O oo 1,040 00 282 ACCOUNTING PRINCIPLES INSURANCE 1919 1919 Tulv 8 C2 60 00 July ii Gen. P & L. 6264 30 00 ,?i G266 29 17 31 Gen. P.&L. GS S3 60 oo - 60 30 DISCOUNT ON SALES i 1919 1919 July ii C27i L337 50 July 3J Gen. P.&L. G 5 L337 ; DEPRECIATION 1919 1919 July 31 Buildings G266 40 oo July 31 Gen. P. & L. GS 55 33 31 Fur. & Fix. G266 IS oo 20 = - 55 oo 55 OO TRADING 1919 1919 July Jl Books Inv. July 31 Books Inv., ist per. G S 5,000 oo End period G267 11,972 00 31 Stat. Inv. 31 Stat.Inv.end ist per. GS 2,000 oo pr. G26? 6,257 03 3> Books Pur. G S 16,050 oo SI Books Sales 6267 15.130 00 Ji Stat. Pur. GS 9.300 oo 31 Stat. Sales 6267 8,405 00 31 Gross P. G268 9.4M oo 41,764 00 - 41,764 : : CONSIGNMENTS SHIPMENT PROFIT AND Loss July 31 Cost of goods July 31 Pro. of Ship- shipped SJ 2.95 oo ments C27i 2,444 75 Charges C273 4 SO Pro. of Shp. G 2 6 S 675 00 Charges SJ 65 oo Charges (de- Net profits 6266 815 64 ferred) 6265 IS 39 Ship. Inv. G 2 6 5 500 00 Ship. Inv. G 2 6 S 200 00 3,835 14 3.835 ii GENERAL PROFIT AND Loss 1919 1919 July LI Insurance 6264 3 oo July 31 P.&L.Shipts. 6266 815 64 31 Insurance G 2 68 83 31 Trading G 2 68 9,4i4 00 31 Salaries G268 780 oo 3i Commissions 6269 275 00 31 Disc, on 3' Disc, on Pur. 6269 350 00 Sales G268 1,337 So 31 Interest G266 32 67' 31 Depreciat. G268 SS oo 31 Salaries G26g 260 oo 31 K. C. Johns, Cap. G6 3-343 46 31 R. Jones, Capital G6 S-oiS 18 === 10,854 6^ 10,854
  • 4 284 ACCOUNTING PRINCIPLES SHIPMENT No. 2 MACON BOOK Co. 1919 1919 July 10 SJ 27 6 1,200 oo July 37 C27o i,4S ^ 10 C272 2 So 31 0284 200 00 10 SJ 27 6 35 oo 31 0265 6 25 3 6266 419 oo = - 1,656 50 - 1,656 g> CHAPTER XX TRANSACTIONS FOR MARCH In the month of March the business of Williams and Day is continued on the same salary basis as in the preceding month. March i. The following accounts are paid in full: Haywood Furniture Co. $2,746.25 Tobey Furniture Co. 2,002.50 disc. $7.05 March 2. A check for $42.35 is received from Peter Wilson for a C. O. D. sale made on February 28th. The Company also receives on consignment 100 automatic window fasteners from Beecher Sash & Door Co. to be sold at $5.00 per set on a commission of 10%. A settlement is to be made each week on fasteners sold. The Company paid cartage of 50 cents on these fasteners to the Transfer Co. March 3. The following bills are paid in cash: City Garage $64.00 for two new tires to replace truck tires discarded City Garage 5.00 for 100 gallons gasoline Jno. Cox 3.00 for shoeing horses Jay Leather Co. 25.00 for additional set of harness. Receives on consignment 200 Adjustable shades from Mueller Shade Co. to be sold at $3.00 each, commission 10%. Pays $1.25 express and cartage. Account is to be rendered each week provided a dozen or more shades are sold during the week. A C. O. D. sale of furniture is made to the Smith Institute for $250.00. The weekly payroll is paid. March 2. A check for $42.35 is received from Peter Wilson for a C. O. D. sale made on February 28th. The Company also receives on consignment 100 automatic window fasteners from Beecher Sash & Door Co. to be sold at $5.00 per set on a commission of 10%. A settlement is to be made each week on fasteners sold. The company paid cartage of 50 cents on these fasteners to the Transfer Co. 285 286 ACCOUNTING PRINCIPLES March 3. The following bills are paid in cash: City Garage $64.00 for two new tires to replace truck tires discarded City Garage 5.00 for 100 gallons gasoline Jno. Cox 3.00 for shoeing horses Jay Leather Co. 25.00 for additional set of harness. Receives on consignment 200 Adjustable shades from Mueller Shade Co. to be sold at $3.00 each, commission 10%. Pays $1.25 express and cartage. Account is to be rendered each week provided a dozen or more shades are sold during the week. A C. O. D. sale of furniture is made to the Smith Institute for $250.00. March 5. The Smith Institute refuses to receive $50.00 worth of the furniture sold on the 4th on the ground that the pieces are de- fective, and gives a check for $200.00 covering the balance of the purchase. Collections on account have been as follows: Name Amount Discount St. Luke Hospital $300.00 Smith Institute 156.00 J. H. Brigham 85.75 K. C. Riley 144.00 $2.88 H. P. Square Business College 125.00 Foster Hall 80.00 Randoph Furniture Co. 265 .00 5 . 30 George Carey 76.00 A. W. Martin 215.00 J. Collins 475-QO Fulton Furniture Co. 450.00 Newsome Furniture Co. 386 .50 3 . 87 $2,758.45 March 6. George Carey's check for $76.00 is dishonored by the bank because of no funds. (Remember that accounts receivable must be charged with this amount as well as George Carey's personal account.) March 7. Consignment cash sales for the past week were as follows: 50 automatic fasteners $ 2 50 . oo 30 adjustable shades 90.00 Render account sales and make all necessary entries. Inclose in cash the amounts due consignors. TRANSACTIONS FOR MARCH 287 March 8. The following invoice is received from the Tobey Fur- niture Co.: Terms 2/10, 11/30. Carpets $1,150.00 Furniture 2 , 500 . oo $3,650.00 The firm ships to be sold on consignment the following goods: (a) To the Swanson Furniture Co., Carson, Mo., 10 Oriental rugs costing $6,000.00, to be sold 40% over cost. Ten per cent of the sale price is to be paid as commission. Freight bill covering shipment ($4) was received from Valley Railroad and paid. An account sales is to be rendered at the end of each week covering sales made. (b) To Smithson Hardware Co., Smithville, 111., 50 O. K. churns costing $4.00 each to be sold at $6.00 with a commission of 75 cents for each churn sold. Freight of $3.00 was paid to the Valley Railroad Co. and the drayage of 50 cents paid to the Valley Transfer Co. (c) To Mason Furniture Co., Mason, Kansas, 50 Universal Filing Cabinets costing $30.00 each to be sold at $50.00 with commission of $5.00 on each sale. Valley Storage Co. crated and delivered to the depot the cabinets making a charge of 50 cents each. The freight charge by the Valley Railroad was $15.00. March 9. On arrival of the goods listed in the Tobey invoice of March 8th, goods worth $150.00 are returned as unsuitable. Of the amount $100.00 was for furniture and $50.00 for carpets. Regular payroll is disbursed. Furniture was purchased from the Haywood Furniture Co. on account, $50.00. March 12. Payments are made from cash as follows: Coal, $6.00; office supplies, $7.50. Both items are charged to general expense. Make out account sales covering the following consignment sales: 50 automatic window fasteners (sold on credit to K. C. Riley) 60 adjustable shades (sold on credit to St. Luke Hospital) Credit consignor for proceeds instead of inclosing check. Received for record the following account sales: (a) From Swanson Furniture Co., Carson, Mo.: Sales of Oriental rugs $2,800 . oo Cartage Q-75 Telegram . 50 Commission ( i o%) 280.00 281.25 Proceeds (check inclosed) $2,518.75 288 ACCOUNTING PRINCIPLES (b) From Smithson Hardware Co., Smithville, 111.: 25 O. K. Churns, at $6.00 $150.00 Repairs on imperfect churns 2 . 50 Cartage . 50 Commission (75 cents) 18.75 2I -75 Proceeds (charge) $128.25 (c) From the Mason Furniture Co., Mason, Kansas: 20 Universal Filing Cabinets, at $50.00 Cartage Commission ($5.00) Proceeds (check inclosed) March 14. The Tobey invoice of March 8 is paid, the discount being $70.00. (Remember the $150.00 returns.) March 15. The firm decides to borrow on demand from Frank Williams $5,000.00 at 6%, giving a note of the firm for this amount. (Since a loan from a partner is on a different basis from liabilities to persons outside the business, an account, loans from partners, should be opened to which such items should be credited.) The note of the Fulton Furniture Co. for $500.00 at 7% dated January i and due September i is discounted at the bank at 8%. (At the time of maturity this note will be worth its face, $500.00, plus interest at 7% for 20 months, $58.33, or $558.33. The bank discounts this amount, $558.33, for the time the note has still to run, 17^ months, at 8%. The discount is $65.14, leaving the net proceeds of the note $493.19. The entry could be made debiting cash $493.19 and interest $6.81, and crediting notes receivable discounted $500.00. Since, however, it is desirable to show in the statement of profit the earnings from interest and also the cost of interest, it is better to make the entry in this form: debit cash $493.19 and interest $65.14, and credit notes receivable discounted $500.00 and interest $58.33. This entry can be made in the cash book in this form by writing the debit to interest in red ink in the General column and posting the item to the debit of interest at the end of the month.) March 16. Stock is increased by the following purchase from the Wilson Carpet Co., terms 2/10, n/3o: Furniture $4 ,000 . oo Carpets 2,000.00 $6,000.00 March 17. Day is allowed to withdraw $500.00 indefinitely. The regular payroll for the week is disbursed. March 19. The Rapid Repair Co. reports work done for cash as follows: TRANSACTIONS FOR MARCH 289 H. P. Square Business College $50 . oo J. Collins 75-oo H. R. Scott 25.00 The customers are charged for the work. March 19. Purchased furniture from the Tobey Furniture Co. on account for $50.00, and from the Lacy Lock & Safe Co. on account for $35.00. March 20. Account sales sent to consignor covering sales as follows: To Muller Shade Co. : 100 Adjustable Shades at $3.00 (check inclosed) 300.00 Make out the account sales and make the necessary entries. Account sales received from the Swanson Furniture Co. : Oriental rugs $4,200.00 Commission (10%) 420.00 Proceeds (check inclosed) $3,780.00 Received account sales from the Smithson Hardware Co. as follows: 25 O. K. Churns at $6.00 $150.00 Commission (75 cents) 18.75 Proceeds (check inclosed) $131 . 25 Received account sales from the Mason Furniture Co. as follows: 15 Universal Filing Cabinets at $50.00 $750.00 Commission 75.00 Proceeds (check inclosed) $675.00 Martindale Furniture Co. dishonor their 3o-day $500.00 note. March 22. Payments are made from cash for coal for the store, $12.00 (general expense) and for hay, $15.00. The firm authorizes the Swanson Furniture Co. to sell the re- mainder of rugs at a reduction of 20% on the sale price. A sale is advertised at a cost of $5.00 to the Swanson Furniture Co. which is charged against the shipment. The remaining rugs are sold and an account sales received. Make the appropriate entries. (Check also received.) (a) Received to be sold on consignment: 100 Universal Dictionary holders from the Central Furniture Co., Reedville, Mich., to be sold at $5.00 on commission of 10%. The freight bill from Michigan Valley Railroad Co. for $5.00 was duly approved and entered. The drayage of $1.00 was paid to the Valley Transfer Co. 290 ACCOUNTING PRINCIPLES (b) Received from the same company another consignment con- sisting of 50 No. 3 Jewel Fireless Cookers to be sold at $15.00 on a commission of 12^%. (c) Shipped to the Mason Furniture Co. 100 additional Universal filing cabinets costing $30.00 each, to be sold for $50.00 each on a commission of 10%. The freight bill from the Valley Central Rail- road was $7.50 and the crating was $25.00. Credit Valley Storage Co. for this amount. (d) Shipped to the Smithson Hardware Co. 60 O. K. Churns cost- ing $4.00 each to be sold at $6.00 on a commission of 75 cents each. The freight of $4.00 was paid to the Valley Central Railroad Co. and the crating bill of $2.50 was paid to the Valley Storage Co. March 23. The policy of paying the railroad fare of customers from surrounding towns is adopted and a check of $25.00 is given to the Valley Commercial Association for this purpose. (Advertising.) A check for $60.00 is also given to the Stoddard Poster Co. to pay for advertising in surrounding towns. March 24. A check is given the Valley Central Railroad for $55.34 to pay the freight bills not charged to the Company. The payroll for the week was disbursed. March 26. Furniture in stock was repaired by the Rapid Repair Co. at a charge of $30.00. $25.00 is charged to General Expense and $5.00 is charged to the Haywood Furniture Co. because of their carelessness in packing. Wilson invoice March 16 is paid, discount taken being $120.00. March 28. Office supplies are purchased from the Corner Book Store for cash, $25.00. A desk costing $35.00 is taken for office use. (Credit furniture inventory or purchases.) March 29. In counting the cash for the day, it is found that there is a shortage of $1.50. Sold the following and rendered account sales inclosing cash due consignor: 50 Universal dictionary holders at $5.00 $250.00 25 No. 3 Jewel Fireless Cookers at $15.00 375 -oo Received account sales from Mason Furniture Co. as follows: 50 Universal Filing Cabinets at $50.00 $2,500.00 Cartage 2 . 50 Commission 250.00 252.50 Balance due consignor (check inclosed) $2,247.50 Received account sales from Smithson Hardware Co. as follows: TRANSACTIONS FOR MARCH 291 50 0. K. Churns at $6.00 $300 . oo Warehouse charge o . 50 Drayage i . 50 Commission 37 . 50 39 . 50 Balance due consignor (check inclosed) $260.00 March 30. The People's Electric Co. is paid $26.00, covering light for the store for the month. March 31. The sales for the month have been as follows: (Sales are listed all at one time to shorten the routine of entering them. In actual business, of course, they would have been entered as they were made.) Cash sales: furniture, $1,500.00; carpets, $1,400.00. Credit sales: Name Furniture Carpets St. Luke Hospital $7 50 . oo $300 . oo Foster Hall 500 . oo 300 . oo Randolph Furniture Co. 800 . oo 400 . oo Smith Institute 200 . oo 800 . oo J. H. Brigham 150.00 7S-oo A.W.Martin 225.00 55 .00 Fulton Furniture Co. 500 .00 3 50 . oo Rice Mfg. Co. 200 .00 50 . oo Newsome Furniture Co. 1,000.00 1,500.00 George Gary, whose check was dishonored on the 7th, has gone into bankruptcy, and a settlement of claim is made at 50%. The Martindale Co. pays one half the amount of their dishonored note, with promise of payment of the remainder shortly. The payroll is disbursed. ADJUSTING AND CLOSING ENTRIES FOR MARCH i. Adjustments: (a) For depreciation. The allowance for depreciation is the same as for February, 2% on the cost of delivery equipment, and 2% of the cost of store and office furniture, and ^ of i% on buildings. (b) For unexpired insurance. The insurance cost for the month is the same as for February. (c) For interest on partners' loans and withdrawals. The in- terest to date on the loan from Frank Williams ($12.50) should 292 ACCOUNTING PRINCIPLES be charged to interest and credited to Frank Williams, per- sonal. (d) For accrued interest on notes receivable. At the begin- ning of the month the amount of accrued interest on notes re- ceivable was carried as an asset. This accrued interest now on the books corresponds exactly to an inventory of merchandise. In closing the books for March, this "inventory" of March i must be deducted from the interest received during the month. This deduction is made by closing accrued interest into in- terest by an entry debiting interest and crediting accrued in- terest. It is then necessary to place the new inventory of accrued interest on the books. This is done by an entry debiting accrued interest and crediting interest. (e) For interest accrued on notes payable. At the begin- ning of March there was a liability inventory for interest ac- crued. This liability inventory must be closed into interest and the new inventory of interest accrued on March 31 placed on the books. (Note that the entries to adjust the books for interest accrued on notes payable are, as one might naturally expect, the reverse of the entries to adjust the books for ac- crued interest on notes receivable.) 2. Determining Gross Profit on Sales : In previous work the gross profit has been shown in trading. This month gross profit is shown in sales rather than in trad- ing, (i) Gross profit is shown in sales rather than in trading so frequently that it is desirable that one become familiar with both plans; (2) when gross profit is shown in sales it is possible to determine the profit on each class of goods sold, easily. The steps in closing the merchandise accounts when gross profit is shown in sales are these: (1) Purchase returns and sales returns are closed into pur- chases and sales. (2) Freight-in is closed into purchases. Since freight on both carpets and furniture has been charged to one account, it is necessary now to divide the cost of freight between carpet and furniture purchases on some equitable basis. An exami- nation of the freight bills shows that for this month an ap- TRANSACTIONS FOR MARCH 293 proximate division of freight charges on the basis of 4/5 to furniture and 1/5 to carpets is equitable. (3) The inventories of March i are closed into purchases. (4) The new inventories of March 31 are: furniture, $35,- 265.70; carpets, $10,256.47. (5) The purchase accounts now show the cost of the goods sold. The sales accounts show the net sales. When purchases are closed into sales, the balance of each sales account shows the gross profit on the sale of the goods. QUESTIONS AND PROBLEMS 1. What are generally the liabilities of the consignee and the consignor in the sale of goods through a consignee? 2. What record should a consignee make when goods are received to be sold on consignment? 3. If cash and credit sales of consignment goods are entered in the sales journal and posted therefrom to the respective ledger accounts, indicate the necessary form of sales journal. 4. What are the debits and credits to the consignment account, and from what books are they commonly posted? 5. Describe the content of an account sales. 6. What information is needed by the consignor in regard to the opera- tions of the consignee? 7. Give the debits and credits to the shipment profit and loss. 8. What provision is made for the maintenance of a control over the consignment inventories in the hands of consignees? CHAPTER XXI THE INCOMING AND WITHDRAWAL OF PARTNERS 1. Articles of Partnership. If two or more individuals carry on a business together and hold themselves out as partners, a partnership exists, even though there are no formal articles set- ting forth the rights and duties of the partners. The act of carrying on the business together and of sharing in the man- agement and profits is sufficient in itself to establish the part- nership relation. In short, articles of partnership are not es- sential to the existence of a general partnership. It is advisable, however, in most instances, to have a definite partnership agreement, in order to place proper limits on the rights and duties of the partners in the conduct of the business. For an accountant, such an agreement has particular interest, because its provisions usually affect the nature of the business to be done, the character of the accounts to be kept, the divi- sion of the profits and the losses, the compensation of the part- ners, the interest to be allowed on the investments of the part- ners, the distribution of the managerial functions between or among the partners, the period between closings and audits, and the dissolution of the partnership. The articles of partner- ship should be read, therefore, before any accounting records are opened, or before any audit is made of the books. It need hardly be said that a lawyer rather than an accountant is the logical person to draft the partnership agreement. 2. Books of the Partnership. The capital accounts of the partners and their relation to the other accounts constitute the chief problems of partnership accounting. The capital accounts of a partnership are, of course, similar to the capital account of an individually owned business. They are credited with the respective shares of the partners in the profits of the business, 294 THE INCOMING AND WITHDRAWAL OF PARTNERS 295 and are charged with the debit balances of the respective per- sonal accounts at the time of closing. The other accounts to be set up and the general books of record to be kept are iden- tical with those of an individual concern of similar size. 3. Admission of Partner without Goodwill Allowance. A partnership is frequently formed by the owner of an individual concern to increase the investment in the business and at the same time to bring into the concern a man competent to assist in its management. Before a partner is thus admitted, it is necessary to close the accounts of the existing firm and to de- termine the conditions of the partnership arrangement. One of the most important questions to be decided is the basis upon which profits and losses are to be shared. If no agreement is made covering this point, the profits and losses are shared equally. Of similar importance is the question of the capital interest the incoming partner acquires through his investment in the business. 4. Capital Interest Acquired. (a) The simplest arrange- ment is obviously to give to the original owner a capital equal to the amount at which his capital stood at the time of the closing of his individual books, and to give to the incoming partner an interest equal to the cash or property value which he contributes to the new concern. If we assume that this amount is $5,000.00 and that the old books are continued, the admission of the new partner is recorded by the following jour- nal entry: Cash 5>ooo . oo John Smith, Capital 5,000.00 Investment of John Smith as a part- ner in the business (6) The case is not different in principle if the incoming partner contributes other forms of property in addition to cash and the business of the new concern is carried on under the old firm name. If his assets, liabilities, and capital are accepted by the new concern at the figures shown on his own books of record, the journal entry marking his engagement in the part- nership relation becomes the following: 296 ACCOUNTING PRINCIPLES Sundry Assets (Detailed) 1 0,000. oo Sundry Liabilities (Detailed) 5,000.00 John Smith, Capital 5,000.00 Assumption of the assets and liabili- ties of John Smith as a partner in in the business This entry on the books of the partnership is clearly identical in form with the opening entry on the books of an individual business where the assets and liabilities of another concern are taken over. (c) Frequently, when a partner is taken into a business, his assets are revalued by the firm of which he is to become a member. Where such is the case, the books of the incoming partner must be readjusted so as to bring his record of asset balances to the amount agreed upon as their transfer value. If a series of readjustments must be made, it is advisable to open an adjustment account. Any reductions in asset valuations are then charged to this account and credited to the assets affected. After the necessary readjustments have been made, the account is closed into capital. Let us suppose, for example, that the furniture and fixtures account is to be reduced by $75.00, the inventory account by $150.00 and accounts receivable by $100.00. All three read- justments may be placed on the books by the following journal entry: Adjustments 325.00 Furniture and Fixtures 75 oo Inventory 150.00 Accounts Receivable 100 oo Adjustment of asset balances After the necessary postings have been made, the adjustment account is dosed into the capital account, as follows: John Smith, Capital 325.00 Adjustments 3 2 5 . oo Closing of adjustments into capital Where the members of a partnership are taken in as partners in another concern, the adjustment account must be appor- THE INCOMING AND WITHDRAWAL OF PARTNERS 297 tioned to their respective capital accounts in the old firm. In such cases, the adjustment account represents a material sav- ing; for, if each reduction in assets were to be distributed as a loss to the several partnership accounts, the number of such distributions would be limited only by the number of items to be readjusted. After the required adjustments and closings have been made, a new balance sheet is drawn up to serve as the basis for the transfer of the assets and liabilities at the agreed valuation. The items are actually entered on the books of the new firm in the manner set forth in (b) above. An incoming partner not infrequently demands that adjust- ments be made in the valuation of the assets and liabilities of the business of which he is to become a member. If the new firm created by his admission uses the same books of record employed by the old concern, the readjusting entries are placed on the books of the old firm in a manner similar to that illus- trated in (c) above. The revised balance sheet is then recorded on the books of the new business, and in conjunction with the balance sheet of the business taken over serves as the basis for the opening entry of the new concern in connection with the admission of the additional partner. 5. Admission of Partner with Goodwill Allowance. Good- will is not recorded on the books of a partnership unless its value is definitely determined through some transaction con- nected with the admission or withdrawal of a partner. During the early period of its existence, a business is usually regarded as fortunate if an ordinary return is received on the actual invest- ment of the owners. After the business has been in operation for a period of years, it not infrequently earns a larger return than that commonly made on the amount invested. This larger return is due, of course, to an increased volume of business which the firm has secured through the good management of the enterprisers. Since these larger profits are usually secured only after a more or less extended period of operation, goodwill is sometimes calculated as worth four or five times the average annual net profits of the business, on the assumption that this 298 ACCOUNTING PRINCIPLES length of time is required to place the business on a good earn- ing basis. A more common basis of calculating goodwill is to capitalize the excess of the average annual net profits for a short period of years beyond what is regarded as a reasonable return on the actual business investment. These considera- tions, however, have largely to do with the basis upon which the partners proceed in the determination of goodwill. Let us assume that John Smith has a capital of $5,000.00, and that he sells a half interest to John Doe for $3,000.00, the money being paid to Smith personally and not to the business in which Doe becomes a partner. If the business of John Smith is worth $5,000.00, manifestly a half interest should sell for $2,500.00. The $500.00 excess may be regarded as a payment for goodwill. A conservative rule, much advocated, requires that goodwill be placed on the books only when it has been purchased by the business. In this transaction there has been no purchase of goodwill, but its market value may be regarded as established at $1,000.00 through the payment of $500.00 for a half interest therein. If this reasoning is adopted, the trans- action is journalized as follows: Goodwill 1,000.00 John Smith, Capital 2,000.00 John Doe, Capital 3.000.00 Purchase of half interest in the busi- ness by John Doe through pay- ment to John Smith of $3,000.00 cash If the more conservative practice is followed of avoiding an entry to the debit of goodwill unless actually purchased, the journal entry becomes the following: John Smith, Capital 2,500.00 John Doe, Capital 2,500.00 Purchase of half interest in the busi- ness by John Doe through pay- ment to John Smith of $3,000.00 cash Let us suppose that, instead of paving $3,000.00 to John Smith personally for a half interest in his business, John Doe THE INCOMING AND WITHDRAWAL OF PARTNERS 299 contributes $6,000.00 to the business itself for a half interest therein. This transaction may be assumed to establish a $i,- ooo.oo value for the goodwill of the business, and, if the good- will entry is allowed, is journalized as follows: Cash 6,000 . oo John Doe, Capital 6,000.00 Purchase of half interest in the busi- ness of John Doe Goodwill i ,000 . oo John Smith, Capital 1,000.00 Credit for goodwill established in con- nection with admission of John Doe as partner with a half inter- est allowance of $6,000.00 Under more conservative treatment, the transaction is recorded by means of the following entry: Cash 6,000 . oo John Doe, Capital 5,500.00 John Smith, Capital 500.00 Purchase of half interest in the busi- ness by John Doe for $6,000.00 If instead of merely cash John Doe brings into the new con- cern a business of his own, it is entirely possible for him to re- ceive an allowance for goodwill instead of consenting to such an allowance to the firm with which he becomes connected. If he is given a $5,000.00 interest for an asset contribution of $4,- 000.00,' the new concern is making a goodwill purchase of $1,000.00 and crediting the amount to the capital account of the incoming partner. Such a procedure represents the con- servative practice of placing goodwill on the books at the actual cost price. Let us now suppose that John Doe becomes a half- interest partner by the simple payment of $4,000.00 cash. If no compensating allowance is to be made, the admis- sion of the new partner is recorded by the following journal entry: 300 ACCOUNTING PRINCIPLES Cash 4,000.00 John Smith, Capital 500.00 John Doe, Capital 4,500.00 Purchase of half interest in the busi- ness by John Doe for $4,000.00 Such an entry, however, in view of the goodwill entries made above, is easily open to criticism for not still further reducing the capital account of John Smith. If a partner buys a half interest for $4,000.00, on what ground can it be urged that the whole business is worth more than double this sum? Does not the sale demonstrate that the market value of the assets of the old business has decreased by $1,000.00? In other words, if the payment of $6,000.00 for a half interest established a goodwill asset of $1,000.00, why does not the payment of $4,000.00 for a half interest give rise to a shrinkage charge of $1,000.00 against the value of the business assets? Such a shrinkage can, of course, be set up by a journal entry, as follows: Shrinkage in Value of Total Assets i ,000 . oo Goodwill Depreciation Reserve 1,000.00 Creation of depreciation reserve to re- cord decrease n value of business as a whole The amount of the shrinkage is then charged to John Smith by the following additional entry: John Smith, Capital 1,000.00 Shrinkage in Value of Total Assets 1,000.00 Charge to capital of decrease in busi- ness goodwill The result of these two entries is to produce the following modification of the partnership record: Cash 4,000 . oo John Doe, Capital 4,000.00 Purchase of a half interest in the busi- ness by John Doe through the contribution of $4,000.00 cash Some question may well be raised, however, concerning the conclusion that the payment of an amount less or greater than THE INCOMING AND WITHDRAWAL OF PARTNERS 301 the total assets establishes a goodwill item as definitely as the entries seem to indicate. On the one hand, the incoming part- ner may be undesirable as a counselor, because of his short ex- perience or lack of training. In such a case, the extra charge may not be wholly a question of goodwill. On the other hand, a payment of less than half the value of the total assets for an equal interest in the business may be an indication of a high estimation of the ability and experience of the incoming part- ner. It is questionable, therefore, whether the tendency to de- part from conservative practice and to place goodwill on the books when it has not been purchased, is justified as a general rule. Such deviations may be proper as exceptions if the facts clearly demonstrate that a fairer valuation would result from their use. In any event, they should be allowed only after very careful analysis of each particular case. 6. Purchase of Interest of Retiring Partner. A goodwill item may well arise through the purchase of the interest of a retiring partner. If partner A, having an interest of $5,000.00, is allowed this amount by the remaining firm member out of the funds of the business, the retirement of A from the concern is recorded by means of the following journal entry: A, Capital 5,000.00 Cash 5,000.00 Allowance to A of the book value of his interest upon his retirement from the firm If, however, A is allowed $5,500.00 for his interest upon retire- ment, the transaction may be journalized as follows: A, Capital 5,000.00 Goodwill 500 . oo Cash 5,500.00 Allowance to A of $500.00 in excess of the book value of his interest upon his retirement from the firm If it is assumed that B's interest in the firm is also $5,000.00, it becomes fair to argue that the purchase of an equal partner's interest at $500.00 in excess of its book value must establish 302 ACCOUNTING PRINCIPLES $1,000.00 as the worth of the entire goodwill of the business. If this interpretation is accepted, the transfer of A 's interest to B may be recorded by the following entry : A, Capital 5,000.00 Goodwill i ,000 . oo B, Capital 500.00 Cash 5,500.00 Allowance to A of $500.00 in excess of the book value of his interest upon his retirement from the firm In the foregoing argument, it has been assumed that goodwill is attached to the business and not to the individual. It is probably true, however, that goodwill is to some extent a per- sonal matter, and that hi going away from the firm A does not transfer ah 1 of his goodwill to the concern. This fact is ordi- narily taken into consideration by the remaining members of the firm hi the negotiations for the interest of the retiring part- ner. Moreover, the personality and reputation of an incom- ing partner would have a bearing on whether he would be al- lowed a half interest at a price hi excess of the capital interest already existing or at a lower figure. Strictly speaking, of course, there has been no purchase of goodwill by the business in the transaction assumed above, the goodwill of the firm after A's retirement being no greater than it was before. Consequently, ultra-conservative practice re- quires the elimination of the goodwill item in the journal entry, thereby forcing it to assume the following form: A, Capital 5,000.00 B, Capital 500.00 Cash 5,500.00 Allowance to A of $500.00 in excess of the book value of his interest upon his retirement from the firm Let us suppose now that A received only $4,500.00 for his $5,000.00 interest hi the business. If no consideration is given to the matter of goodwill, the transaction is journalized as fol- lows: THE INCOMING AND WITHDRAWAL OF PARTNERS 303 A, Capital 5,000.00 Cash 4,500.00 B, Capital 500.00 Purchase of A's $5,000.00 interest by B for $4,500.00 cash As a result of this entry, B's capital would be increased to $5,500.00. In all probability, however, the sale of A's inter- est for $4,500.00 indicated that this particular half interest was worth less than its recorded book value. It would seem to fol- low that .6's half interest is also worth less than its book value in a corresponding ratio. To establish the actual market valu- ation of the proprietorship interest in the concern, the follow- ing entry may be made: Shrinkage in Value of Total Assets 1,000 . oo Goodwill Depreciation Reserve i ,000 . oo Creation of depreciation reserve to record decrease in value of the business as a whole This shrinkage should, of course, be borne by the partners alike as follows: A's Capital 500.00 B's Capital 500.00 Shrinkage in Value of Total Assets 1,000.00 Charge to capital accounts of decrease in business goodwill The entry recording A's, retirement from the concern then be- comes: .4's Capital 4,500.00 Cash 4,500.00 Purchase of A's half interest for 4,500.00 ash This latter treatment does not represent established account- ing practice. It is given merely for the purpose of carrying out a logical program of setting up book values for partnership as- sets on the basis of the price established for these assets through the sale of an interest in the concern. The sale of an interest cannot, of course, be relied upon with assurance to define the 304 ACCOUNTING PRINCIPLES market price of the entire proprietorship interest. There are frequently factors affecting the market price of a part interest which would not necessarily apply to the interest as a whole. A consideration of the various possibilities in the sale of a part interest in a business throws doubt on the propriety of the whole series of entries in which a goodwill value is regarded as established by the sale of an interest either to the concern it- self or to an incoming partner The old rule of not allowing an entry of goodwill on the books unless actually purchased by the business should be strictly adhered to, except where the particular circumstances clearly indicate that a different entry would more fairly represent the facts. QUESTIONS AND PROBLEMS 1. What are the tests in regard to the existence of a general partnership? 2. What subjects should articles of partnership cover? 3. With what particular accounts are the chief problems of partnership accounting connected? 4. If a partner comes into the business without provision as to how the profits and losses will be divided, how are profits and losses shared? 5. What is the use of an adjustment account? What items are debited to it and what items are credited? 6. How is goodwill created? 7. On what basis is goodwill calculated? 8. What is the conservative rule in relation to the price at which good- will should be placed on the books? 9. On what other basis than purchase price is goodwill frequently entered on partnership books? 10. A and B are equal partners with an investment of $20,000 each. They desire to secure additional capital with which to extend the business and agree to admit C as an equal partner on the payment of $14,000 into the firm. Give the entries to record the admission of C, (i) keeping an account with goodwill, and (2) eliminating goodwill from the accounts. n. X and Y are partners with an investment of $20,000 each. The business is highly prosperous. Z is admitted as an equal partner on the payment of $25,000 into the firm. Give the entries to record the admission of Z, (i) keeping an account with goodwill, and (2) eliminating goodwill from the accounts. 12. D has invested $15,000 in a business. He agrees to sell to E a one- half interest in the business as it stands for $8,000. Give the entries to admit E to the partnership, assuming the keeping of an account with good- will. CHAPTER XXII DISTRIBUTION OF THE PARTNERSHIP PROFITS i. Basis of Distribution. Although the partners are in a certain sense creditors of the firm in which they hold a control ling interest, one of the primary characteristics of a partner- ship is that the claims of outside creditors outrank those of the partners themselves. The partners may create priorities affect- ing the funds which they themselves contribute, but they can- not create claims for themselves against the assets or income of the business superior to those of outside creditors. For instance, the partners may agree that each shall be entitled to a definite wage, to be charged as a part of the operating expenses, before there is any distribution of the profits. This agreement holds so far as the claims of the partners are concerned, but does not affect the priority of outside claims if the gross income is insufficient to meet all of the operating expenses of the business. As owners of the business, the partners may set up a series of mortgages or priorities affecting the rank of the liabilities as well as a similar series of priorities with respect to their own claims. They cannot, however, make their partnership claims superior to those of outside parties. In other words, the in- come of a general partnership must be used first to meet the outside liabilities, and then to satisfy the claims of the part- ners themselves. In fact, the claims of outside creditors go be- yond the income and assets of the business, and become a charge against the personal assets of the partners, individually as well as collectively. 2. Interest Claims of Partners. A partner may lend money to the business and receive the firm's note payable, or the capi- tal of each partner may be fixed at a definite figure, with the understanding that contributions in excess of these amounts shall be treated as loans upon which the business is to pay in- 3S 306 ACCOUNTING PRINCIPLES terest. Conversely, it may be agreed that the partners shall pay interest on drawings which bring their investments below the amounts fixed as their respective capital shares. While these interest claims of the partners against the business may be made to rank ahead of their profit-sharing claims, as ex- plained above, they must always be subject to the rights of outside creditors. The note payable and interest claims of the partners against the business are of an entirely different character from the profit-sharing rights they may hold. The partner who is the owner of one of the firm's notes may legally compel an account- ing and, if necessary, a sale of the assets to meet his claim. As against the other partners, the particular partner's claim car- ries with it all the rights ordinarily pertaining to such an in- vestment. It is frequently stipulated in the partnership agreement that each partner shall receive annually a certain percentage on his capital investment before there is any distribution of the prof- its for the year. Such a provision is generally regarded as a supplementary device for dividing profits rather than as a de- vice for creating interest claims against the income of the busi- ness. Such claims are, therefore, treated as deductions from the net profits and not as expenses chargeable to income before the net profits are ascertained. The agreement not infre- quently further specifies whether these claims are to be met only in so far as the annual net profits may suffice, or whether any deficit created thereby is to be charged to the capital accounts of the partnership in the loss and gain sharing ratio. These various considerations lead to the following classifica- tions of the partnership interest claims: (a) Interest to out- side creditors; (b) in terest on partners' loans; (c) interest on partners' capitals. As the latter two classes, as well as the matter of interest on withdrawals, are based on the under- standing of the partners themselves, it is of the greatest impor- tance that the partnership agreement should clearly define the rights of the partners in the matter of the payment and receipt DISTRIBUTION OF THE PARTNERSHIP PROFITS 307 of interest as well as in the matter of the distribution of losses and gains. 3. Distribution of Profits. In the absence of a definite un- derstanding to the contrary, the profits of a partnership are divided equally between or among the partners. Some of the forms of distribution by agreement are as follows: a. Distribution of Profits on Basis of Capitals at Beginning of Period. If the profits are to be shared on a basis of the capi- tals at the beginning of the period, the partners should have an understanding with reference to drawings and to contributions in excess of capital. Salaries for services and interest on draw- ings serve as protective measures in this regard. Let us sup- pose that, under such an arrangement, the net profits for the year of the firm of A and B are $6,000.00, 4's capital at the beginning of the period being $12,000.00 and B's $18,000.00. If the interest on .4's drawings during the year amounts to $150.00, and the interest on -B's drawings amounts to $75.00, the following capital charges must be made before the annual profits are distributed: A's Capital 150.00 B's Capital 75 .00 Interest on Drawings 2 2 5 . oo Interest on year's drawings The interest on drawings account is then closed into profit and loss, though not into the section in which the net profits are calculated. This done, the total profits of $6,225.00 are divided in the proportion of 2/5 to A and of 3/5 to B, the distribution being journalized as follows: Profit and Loss Balance 6,225.00 .4's Capital 2,490.00 B's Capital 3 ,73 5- Distribution of year's profits The closing of the principal section of the profit and loss ac- count and the opening of the distribution section is effected by the following journal entry: 3 o8 ACCOUNTING PRINCIPLES Profit and Loss Net Profits 6,000 . oo Profit and Loss Net Profits (down) Bringing down of net profits to distri- bution section of account 6,000.00 With this entry posted, the profit and loss account will appear as follows: PROFIT AND Loss 1919 IQIQ Dec. 31 Sundry Ex. 15,000.00 Dec. 31 Net Profits 6,000.00 21.000.00 Dec. 31 Balance for Dec. 31 Distribution 6, 2 2 5 . oo Gross Profits (down) Net Profits (down) Interest on Drawings 6.225.00 21,000.00 21.000.00 6,000.00 225 oo 6,225.00 If the two partners had paid to the business in cash the amount of the interest on their drawings, the payments would have constituted an actual income of the business. The inter- est charges made above, however, merely serve to readjust the profit distributions, and do not affect the total amount to be divided. Though the amount to be distributed is apparently increased by $225.00, a like amount has been deducted from the capitals of the partners. The really significant factor is that, while the deductions were in the ratio of 2 to i, the addi- tions are in the ratio of 2 to 3. In other words, although A and B together gain nothing by the readjustment, B suffers less than .4 in the deductions and acquires more than A in the distribution. b. Distribution of Profits on Basis of Average Capital In- vested. Let us suppose that, instead of following the previous plan, the partners agree to divide the profits of the firm on the basis of the average amount each has contributed during the year, the record of their investments and withdrawals being as follows: DISTRIBUTION OF THE PARTNERSHIP PROFITS 309 Partner A 1919 Investments Withdrawals January i $10,000.00 February i 1,000.00 March i $500.00 April i 200.00 May i 400.00 Partner B 1919 Investments Withdrawals January i $15,000.00 February i $500.00 March i 300.00 April i 750.00 July i 200.00 September i 1,000.00 A simple method of averaging the investments and withdraw- als is to reduce them to a month equivalent, as follows: .4's Investments: $10,000.00 X 12 $120,000.00 1,000.00 X ii 11,000.00 400.00 X 8 3,200.00 Month Equivalent $134,200.00 ^4's Withdrawals: $500.00 X 10 $5,000.00 200.00 X 9 1,800.00 Month Equivalent 6,800.00 Average Investment, Month Equivalent $127,400.00 B's Investments: $I5,OOO.OO X 12 $l8o,OOO.OO 750.00 X 9 6,750.00 1,000.00 X 4 4,000.00 Month Equivalent $190,750.00 B's Withdrawals: $500.00 X ii $5,500.00 300.00 X 10 3,000.00 200.00 X 6 1,200.00 Montii Equivalent 9,700.00 Average Investment, Month Equivalent $181,050.00 310 ACCOUNTING PRINCIPLES The average investment of each partner for a single month having thus been determined, the net profits are divided in the ratio of 127400.00 to 181,050.00. In other words, A's share will be $6,000.00x127,400/308^50, or $2478.46; while B's share will be $6,000.00 x 181,050/308450, or $3,521.54. Another method of calculating the average investment in- volves a consideration of the time for which the investment re- mains unchanged, thus: A 's Investment Time Unchanged Month Equivalent $10,000.00 i Month $10,000.00 11,000.00 i Month 11,000.00 10,500 oo i Month 10,500.00 10,300.00 i Month 10,300.00 10,700.00 8 Months 85,600.00 12 Months $127400.00 B's Investment Time Unchanged Month Equivalent $15,000.00 i Month $15,000.00 14,500.00 i Month 14,500.00 14,200.00 i Month 14,200.00 14,950.00 3 Months 44,850.00 14,750.00 2 Months 29,500.00 15,750.00 4 Months 63,000.00 12 Months $181,050.00 The result of this method is obviously the same as that of the preceding one. As in the second method, however, the sum of the months for which the various amounts remain un- changed should equal the number of months for which the average investment is computed, a safeguard against error is provided not to be found in the method first discussed. c. Distribution of Profits on Basis of Capitals at End of Period. It is inadvisable to distribute profits on the basis of the investments at the end of a period, unless it is strictly un- derstood that no partner can add to his capital without the consent of the other members of the firm. Otherwise, a part- ner can affect favorably his own share in the distribution by a large addition to his capital toward the close of the period. DISTRIBUTION OF THE PARTNERSHIP PROFITS 311 The basis is, in fact, not commonly used, and is of importance mainly in connection with liquidating dividends. d . Distribution of Profits Partly on Basis of Capitals at Be- ginning of Period and Partly on Basis of Agreed Ratio. It is sometimes stipulated that a certain percentage on capitals shall be paid to the partners before the balance to be distributed is divided upon an agreed ratio. As was pointed out above, this percentage on capitals is not regarded as interest, in the ordi- nary sense of the term, and is not, therefore, charged to the regular interest account. Interest on partners' capitals is the name generally given to the account covering these charges. While the account is closed into profit and loss, it is placed in the distribution section, along with interest on withdrawals. There might also be an interest credit on contributions in ex- cess of the capitals at the beginning of the period. This inter- est on excess capital would be a charge against net profits in the distribution section of the profit and loss account, and a credit to the respective capitals. There are several forms in which this method of distribution may be made. It may be agreed, for instance, that interest on partners' capitals shall be allowed only to the extent to which it is earned. Unless a limitation of this kind is set up, the in- terest claims may create a deficit in the balance of profit and loss, to be charged to the capital accounts on the profit and loss sharing ratio. Again, the agreement may provide that half of the profits or losses shall go to the partners on the basis of their investments at the beginning of the period or on the basis of their average investments for the time, the other half to be divided according to fixed proportions. It is, therefore, of im- portance to consider the various possibilities, and to let the ar- ticles of partnership definitely express the wishes of the mem- bers of the concern. QUESTIONS AND PROBLEMS i. A and B are general partners without an agreement as to the division of profits and losses. A has a capital of $10,000.00 and B a capital of $12,- ooo.oo. They have profits of $5,000.00 and decide to allow 5% on their 312 ACCOUNTING PRINCIPLES respective capitals before division. Journalize the distribution of profits and set up a ledger record of it. 2. M, N, and O are partners, sharing equally in the profits, but with unequal investments on which interest is allowed bef6re the remaining profits are distributed. At the end of a year there is due M for interest $250.00, N $125.00, and O $225.00. The profits for the year before interest charges are taken into account are $3,600.00. (i) Make the entries to adjust interest and profits, using the nominal accounts of interest on partners' investments for the interest charges. 3. A, B, and C are partners having capitals as follows: A, $10,000.00; B, $15,000.00; and C, $20,000.00. A has loaned $4,000.00 to the business at 6%; B has loaned $4,000.00 at 6%; and C has loaned $6,000.00 at 6%. There is an understanding that interest will be allowed on capitals at 5% and that the balance of net profits will be divided equally. The net profits of the year are $1,500.00. Give the journal entries involved in its distri- bution. CHAPTER XXIII LIQUIDATION OF A SOLVENT PARTNERSHIP 1. Sources of Partnership Funds. Where the partners themselves have furnished all the funds necessary to the pur- chase of the assets of the partnership, the distribution of the funds arising from the liquidation of the business is not a com- plex problem. The assets or the proceeds of their sale are sim- ply distributed to the partners on the basis of their capital balances or on whatever basis may be stipulated in the part- nership agreement. There are usually, however, a number of outside creditors, some of whom not infrequently hold a mort- gage against specific assets to secure the loan of money or the sale of goods on credit. Furthermore, the wage earners at the time of liquidation may not have been paid in full, and thus have a preferential claim against the assets of the business. Not infrequently, too, the partnership is indebted to the indi- vidual partners for funds advanced by them in addition to their capital investments. As a final complication, the proceeds of liquidation may be distributed at intervals rather than at one time after all the assets have been sold. 2. Causes of Liquidation. A partnership may be liquidated for one or more of the following reasons: (a) One of the part- ners may die, in which case the estate of the decedent can de- mand a settlement for his interest. This settlement involves either a purchase of this interest by one of the surviving part- ners or by an outsider whom the surviving partners are willing to take into the firm, or a sale of all the assets and a distribu- tion of the proceeds. (6) The obligations to outside creditors may not be paid at maturity, and liquidation may be forced for the satisfaction of their claims, (c) The partners may vol- untarily agree to discontinue the business, or the term or pur- pose for which the partnership was established may be fulfilled. 313 314 ACCOUNTING PRINCIPLES (d) One of the partners may force a liquidation for the satis- faction of a credit claim arising out of a loan to the firm. The accounting problems occasioned by the taking in of a new partner and by the purchase of the interest of a retiring partner have already been discussed in a preceding chapter. We shall now take up the more complicated cases, which re- quire a sale of all the assets and a distribution of the proceeds among a variety of claimants on the basis of the priority of their claims. 3. Liquidating Dividends. The proceeds of liquidation of a partnership are applied (i) to the payment of claims of out- side creditors, (2) to the payment of loans by the partners to the business, and (3) to the payment of the partners' capital investments. Before any liquidating dividends can be made on account of the partners' capitals, however, the losses from liquidation must first be distributed as charges to the partners' capital accounts on the basis of the profit and loss sharing ratio. These losses are, of course, the excess of the book value of the assets over the price at which they are sold. For example, if land and buildings, furniture and fixtures, and delivery equip- ment are carried on the books at $25,000.00, $5,000.00, and $2,500.00, and are sold for $20,000.00, $4,000.00, and $2,- ooo.oo, respectively, the losses from liquidation are $6,500.00. The transaction would, therefore, be journalized as follows: Cash 26,000 . oo Losses from Liquidation 6,500.00 Land and Buildings 25,000.00 Furniture and Fixtures 5,000.00 Delivery Equipment 2 , 500 . oo On the assumption that A and B are partners sharing profits and losses equally, the foregoing losses, at the tune of closing the books, would be charged to their capital accounts in equal amounts, as follows: A's Capital 3,250.00 B's Capital 3,250.00 Losses from Liquidation 6,500.00 LIQUIDATION OF A SOLVENT PARTNERSHIP 315 4. Liquidating Dividends to Creditors. The claims of out- side creditors are paid in the order of their priority. If there are preferential claims, as for wages, taxes, court costs, etc., these in Texas must first be met in full. Next in rank are the creditors whose claims are wholly or partially secured, the pro- ceeds arising from the sale of the mortgaged or hypothecated assets being first applied to the satisfaction of the obligations they were pledged to secure. If there is a surplus over the amount required to meet these claims, this surplus is available to meet the claims of unsecured or general creditors. If there is a deficit, the deficiency ranks as an unsecured or general claim against the free assets of the business. Thus, if the pro- ceeds of liquidation are sufficient to pay the preferential and secured claims and in addition 25 per cen^ of the unsecured claims of general creditors, the preferential and secured credit- ors will be paid in full, while the unsecured or general creditors will receive a liquidating dividend of 25 per cent, distributed ratably on the basis of the amounts of their respective claims. 5. Payment of Loans from Partners. Loans from partners should never be paid until losses from liquidation have been distributed, for it may well happen that the aggregate of the losses chargeable to one of the partners may exceed his capital investment. If his loan has not been paid, the capital defi- ciency may be charged to the partner's loan account; whereas, if the loan has been paid and the partner becomes insolvent, the capital deficiency becomes a loss to the other partners. For example, suppose that A and B have capital investments of $5,000.00 and $15,000.00, respectively, and share profits and losses equally. Let us suppose, further, that they have loaned the business $4,000.00 and $6,000.00, respectively. In the process of liquidation, the assets are sold for $14,000.00, in- volving a loss of $16,000.00. ^4's portion ($8,000.00) would exceed his capital investment by $3,000.00. If A were in- solvent and his loan account had already been paid, his capital deficiency would become an additional loss to B. If the losses from liquidation had been charged to the partners' capital accounts before any liquidating dividend had been made on 316 ACCOUNTING PRINCIPLES account of the partners' loans, the capital deficiency could have been remedied as follows: A's Capital 5,000.00 A 's Loan 3,000.00 B's Capital 8,000.00 Losses from Liquidation 1 6,000 . oo The $14,000.00 of cash received for all the assets would then be distributed as follows: .4 's Loan i ,000 . oo B's Loan 6,000.00 B 's Capital 7 ,000 . oo Cash 14,000.00 With these journal entries, the accounts of the partnership would be closed and the business liquidated. 6. Problems of Liquidation in Periodical Dividends. When the process of liquidation extends over a long period, the cred- itors may desire partial payments from time to time as the as- sets are sold. Where this plan of liquidation is adopted, there will ordinarily be expenses of liquidation. These expenses may be closed into the account of Losses from Liquidation, or may be charged to this account in the first instance if the transac- tions are small in number. Before a liquidating dividend is de- clared, these losses and expenses are charged to the partners' capital accounts on the profit and loss sharing ratio. Let us suppose that A, B, and C are partners sharing profits and losses equally. On December 31, 1919, they have assets and liabilities as shown on the following page. LIQUIDATION OF A SOLVENT PARTNERSHIP 317 A. B. C. COMPANY BALANCE SHEET, DECEMBER 31, 1919 Assets Liabilities Real Estate $25,000.00 Mortgage on Real Es- Other Assets 132,500.00 tate $15,000.00 Notes Payable (se- cured) 40,000.00 Accounts Payable 25,000.00 yl's Loan 10,000.00 B's Loan 15,000.00 C's Loan 7,500.00 * A's Capital 15,000.00 B's Capital 20,000 oo C's Capital 10,000.00 5157,500.00 $157,500.00 Early in January, 1920, it is decided to liquidate the business, and during the month the following sales are made: Cost Sale Price Real Estate $25,000.00 $20,000.00 Other Assets 30,000.00 22,000.00 $55,000.00 $42,000.00 The expenses of liquidation for January are $2,000.00. The foregoing transactions may be journalized as follows: Cash 42,000.00 Losses and Expense from Liqui- dation 13,000.00 Real Estate 25,000.00 Other Assets 30,000 . oo Losses and Expense from Liqui- dation 2,000.00 Cash 2,000.00 A's Capital 5,000.00 .B's Capital 5,000.00 C's Capital 5,000.00 Losses and Expense from Liquidation 1 5,000 . oo ACCOUNTING PRINCIPLES From the balance of cash ($40,000.0x3), it is possible to pay the mortgage in full and $25,000.00 on the notes payable, which are secured. The distribution would be journalized as follows: Mortgage on Real Estate Notes Payable (secured) Cash 15,000.00 25,000.00 40,000 . oo A statement of the transactions for the month would involve a summary statement of the January liquidations together with a balance sheet showing the conditions of the business after these liquidations had taken place. The summary of liquida- tion might be made as follows: Cash Received during Month: Sale of Real Estate Sale of Other Assets Total Cash Received Expenses of Liquidation Balance of Cash Cash Distribution: Mortgage on Real Estate 15,000.00 Notes Payable 25000.00 Total Losses in Liquidation Losses Charged as Follows: A's Capital 5,000.00 B's Capital 5,ooo . oo C's Capital 5,000.00 Sale Price $20,000 . oo 22,000.00 42,000.00 2,000.00 40,000 . oo Liquidation Losses $5,000.00 8,000.00 2,000.00 40,000 . oo 15,000.00 15,000.00 A. B. C. COMPANY BALANCE SHEET, JANUARY 31, 1920 Assets Other Assets $102,500.00 Liabilities Notes Payable (se- cured) Accounts Payable A's Loan B's Loan C's Loan A's Capital B's Capital C's Capital $102,500.00 $15,000.00 25,000.00 10,000.00 15,000.00 7,500.00 10,000.00 15,000.00 5,000.00 $102,500.00 LIQUIDATION OF A SOLVENT PARTNERSHIP 319 During the month of February, the remaining assets are sold for $70,000.00 at an expense of $3,500.00. The journal entries recording the sale and distribution of the liquidation losses would be as follows: Cash 70,000 . oo Losses from Liquidation 3 2 , 500 . oo Other Assets 102,500.00 Losses and Expense from Liquidation 3,500.00 Cash 3,500.00 ,4's Capital 10,000.00 A 's Loan 2,000.00 B's Capital 12,000.00 C's Capital 5,000.00 C's Loan 7,000 . oo Losses and Expense from Liquidation 36,000.00 The cash balance of $66,500.00 would then be distributed by means of the following entry: Notes Payable (secured) 15,000.00 Accounts Payable 2 5 ,000 . oo A's Loan 8,000.00 B's Loan 15,000.00 C's Loan 500 . oo B's Capital 3,000.00 Cash 66,500.00 A summary of the liquidation operations should again be made for the month of January, though this time there would be no balance sheet, inasmuch as all the assets have been sold and all the liabilities liquidated. Let us now suppose that at the end of January the balance of each of the capital accounts was hi excess of the chargeable losses, and that at the same time funds were available to pay in full the claims of outside creditors and 50 per cent of the partners' loan accounts. The question then arises as to whether there should be a ratable distribution to the partners according to their loan account balances. Such a course would be proper were it not for the fact that one cannot foresee how great 320 ACCOUNTING PRINCIPLES future losses from liquidation may be. A future loss chargeable to one of the partners may well exceed the balance of his capi- tal account and the remaining 50 per cent of his loan account. If this should happen in the case of an insolvent partner, it would vitiate the distribution of losses on the profit and loss sharing ratio and result in the final charge of the insolvent partner's share to his solvent copartners. To avoid such an occurrence, it is sometimes urged that any periodic dividend on loans to partners should be made so as to reduce the loan bal- ances to the profit and loss sharing ratio. Such a procedure will not, however, insure the final apportionment of losses on the profit and loss sharing ratio, unless the balance of the capi- tal accounts are brought to the same ratio; for, where the capi- tal balances are not in the profit and loss sharing ratio, a loss chargeable to one of the partners may at a subsequent date exceed his capital balance and fall on his loan, thus disturbing the profit and loss sharing ratio which had been set up. There are, however, possibilities of a periodic settlement in- volving loans and capitals without endangering the distribu- tion of losses on the profit and loss sharing ratio. If liquidation has at any tune proceeded to the point where the cash balance exceeds the loans from partners by an amount sufficient to re- duce the capitals to the profit and loss sharing ratio, a distribu- tion that will retire the partners' loans and reduce the capitals to the profit and loss sharing ratio may safely be made. The prior claim for distribution of losses on the profit and loss sharing ratio destroys the priority of partners' loans over their capital hi the case of the liquidation of a solvent partner- ship. If the rule for charging losses on the profit and loss shar- ing ratio is held to be binding so that losses can be charged against partners' loans instead of then* capital when the losses for any partner exceed loans, then no valuable right is sacri- ficed by the partners if they add their loans to their capitals for purposes of liquidation and create an account of loan and capital for each partner which represents his personal claim against the assets. Distribution of liquidating dividends should then be made so that the totals of the partnership claims of the LIQUIDATION OF A SOLVENT PARTNERSHIP 321 several partners will be reduced to the profit and loss sharing ratio. For illustration let us suppose that A , B, and C are partners with the following balance sheet: Sundry Assets . . $85,500.00 Notes Payable . . $10,000.00 Accounts Payable . 15,000.00 A 's Loans . . . 7,500.00. B's Loans . . . 4,000 . oo C's Loans . . . 6,000 . oo A's Capital . . . 10,000.00 B's Capital .- . . 15,000.00 C's Capital . . . 18,000.00 $85,500.00 $85,500.00 Let us now suppose that assets are sold in January for $44,- ooo.oo that cost $65,000.00. Of this amount $25,000.00 would be used to pay the notes and accounts payable, journal entries being made as indicated in paragraph 6, leaving $19,000.00 to be used as a liquidating dividend. Since the losses reduced the total claims of partners to $39,500.00, the $19,000.00 dividend would reduce the balance of these claims to $20,500.00. The $19,000.00 must be so distributed that the balance of each clainTwould be equal or in the profit and loss sharing ratio, or $6,833.33. Subtracting the desired balance from each of the partners' balances after liquidating losses are charged would give their respective shares in the distribution as shown in the table below. If we now suppose the $20,500.00 balance of assets to be sold in February for $8,500.00, the $12,000.00 of loss would be first charged to the partner claims equally. The balance of $8,- 500.00 cash would then be distributed equally to the partners as shown in the table on the following page. 322 ACCOUNTING PRINCIPLES ABC Total claims of partners Loan $ 7,500.00$ 4,000. 00$ 6,000. oo $17. 500. oo Capital 10,000.00 15,000.00 18.000. oo 43,000.00 Total $17, 500. 00$ 19.000.00 $24,000.00 $60,500.00 Liquidating Losses . 7,000.00 7,000.00 7.000.00 21.000.00 Balance . . . . $10,500. oo$i2,ooo.oo$i7.ooo.oo$39,5oo.oo Liquidating dividends . 3.666.66 5,166.67 10.166.67 19,000.00 Balance .... $6,833.34 $6,833.33 $6.833. 33 $20, 500.00 Liquidating Losses . 4,000.00 4,000.00 4,000.00 12,000.00 Balance .... $2,833.34 $2.833.33 $2,833.33 $8.500.00 Liquidating dividends . 2,833 34 2,833.33 2 - 8 33-33 8,500.00 If the loan and capital claims had not been consolidated it would not have been safe to have distributed the $19,000.00 liquidating dividend in January because future losses might more than cover the capitals of some of the partners. The $19,000.00 would have paid all partners' loans and left $1,500.00 for a dividend on capitals. This dividend, however, would not have sufficed to have reduced the balance of capitals to an equality. The January losses would have reduced A's capital to $3,000.00 and C would have been entitled to the $1,500.00 dividend if it had been distributed. The February loss of $4,000.00 would have more than wiped out A's capital. Since the loan would have been paid B and C might not have been able to collect from A his share of the losses unless he were personally solvent. It would have, therefore, been improper to allow the January distribution. By the consolidation of the capital and loan interests the partners both protect then- right and secure liquidating dividends at an earlier date. 7. Reduction of the Capitals to the Profit and Loss Sharing Ratio. Pro rata liquidating dividends on capitals render dif- ficult the distribution of losses on the profit and loss sharing ratio unless the capitals are themselves reduced to this particu- lar ratio. Where there are periodic liquidating dividends on capitals, therefore, it is generally urged that the first dividend should be distributed so as to reduce the capitals to the profit and loss sharing ratio in so far as this may be possible. For LIQUIDATION OF A SOLVENT PARTNERSHIP 323 example, let us suppose that A and B are partners, with capi- tals of $25,000.00 and $35,000.00, respectively, and that they share profits and losses equally. Let us suppose, further, that they dispose of assets with a book value of $30,000.00 for $20,000.00, the proceeds to be applied first to the liquidation of accounts payable amounting to $10,000.00. To record the transactions, the following journal entries would be made : Cash 20,000 . oo Losses from Liquidation 10,000.00 Sundry Assets $30,000.00 ^4's Ccpital 5,000.00 B's Capital 5,000.00 Losses from Liquidation 10,000 . oo Accounts Payable 10,000.00 Cash 10,000.00 By these entries the total capital has been reduced to $50,- ooo.oo, while the total cash has been reduced to $10,000.00. The distribution of this cash balance to the partners will reduce the total capital to the still lower figure of $40,000.00. The distribution should be made, however, so as to bring the capi- tal balances to the profit and loss sharing ratio. Since ^4's capital is $20,000.00, the remaining cash available for distribu- tion must be applied to the reduction of B's capital to the same amount. This is effected by the following journal entry: B's Capital 10,000.00 Cash 10, oo.oo By these entries, the liquidated assets have been fully distrib- uted and the capital balances so adjusted that future liquidat- ing dividends can be made on a pro rata basis without pre- venting a distribution of losses on the profit and loss sharing ratio, the two ratios being now one and the same. 8. Overdraft of Capital. At any time that the losses in liquidation apportioned to a given partner exceed his loan, the amount of such overdraft is charged against his loan to the business if any. If there were no loan, or the overdraft ex- ceeded the loan, the amount of the overdraft would be charged 324 ACCOUNTING PRINCIPLES to his personal account if he were solvent, and to the other partners in accordance with their profit and loss sharing ratio, if he were insolvent. When the capital and loans are com- bined for the purpose of liquidation, the loss apportioned to a particular partner might exceed the total of his interest, in which case the amount would be charged against his personal account if he were solvent and to the other partners if he were insolvent. For example, suppose A, B, and C are equal partners with capitals of $2,000.00, $3,000.00, and $5,000.00 respectively and loans of $4,000.00, $2,000.00, and $3,000.00. The liabilities are $25,000.00. Suppose the losses in liquidation are $18,000.00; that is, the assets are sold for $26,000.00. The following jour- nal entry would show the facts: 1. Cash 26,000.00 Losses in Liquidation .... 18,000.00 Sundry Assets 44,ooo . oo 2. A 's Interest 6,000.00 B's Interest 6,000 . oo C's Interest 6,000 . oo Losses in Liquidation .... 18,000.00 But the total interests of the partners would be as follows: ABC Total Loan .... 4,000.00 2,000.00 3.000.00 9,000.00 Capital .... 2.000.00 3,000.00 5,000.00 10,000.00 Total Interest . . 6.000.00 5,000.00 8,000.00 19,000.00 - Since the total of B's interest is $1,000.00 less than the loss chargeable to him, it will be necessary to increase his interest by the following entry: Cash 1,000.00 B's Interest .... 1,000.00 This entry is made in case he is solvent and can furnish funds to meet the claim against him. The total interests would then be as follows: LIQUIDATION OF A SOLVENT PARTNERSHIP 325 ABC Total Total Interest . . 6,000.00 5,000.00 8,000.00 19,000.00 Added Interest of B 1,000.00 1,000.00 Total Interest . . 6,000.00 6,000.00 8,000.00 20,000.00 Losses in Liquidation 6,000.00 6,000.00 6,000.00 18,000.00 o.oo o.oo 2,000.00 2,000.00 The total cash will now be $27,000.00. The first distribution would be journalized as follows: 1. Liabilities 25,000.00 Cash 25,000.00 2. C's Interest 2,000.00 Cash 2,000.00 These two entries put into the table would show the closing out of the interests as follows: A B C Total Interests . . $ $ 2,000.00 Liquidating Dividends 2,000.00 Of course the last entry in the table belongs with the other items. It was separated for the purpose of analysis. In the illustrations above the table is simply an abbreviated substitution for ledger accounts. In case the student under- stands the procedure better when the accounts are employed he may substitute these for the table. The table is a report form and not the ledger form of entering the data. It was used for brevity in the illustration on the assumption that the stu- dent would at the same time readily visualize the accounts to be set up in the ledger. 9. Justice of Distributing Liquidation Losses on the Profit and Loss Sharing Ratio. The question may fairly be raised as to whether liquidation losses should be placed on the same basis as operating expenses and losses. It might be urged that since the capital balances represent the ownership interest of the partners in the assets, the losses from liquidation, which are essentially losses, in these assets, should be borne on the basis of the relative ownership claims. While this view would have materially simplified the problems of liquidation, and 326 ACCOUNTING PRINCIPLES might have been more equitable than the view already set forth, it is not the view adopted by the common law. The profit and loss sharing ratio has been the dominant principle in the liquidation of partners' claims against the assets of the partnership, pro rata distribution on partners' loans and part- ners' capitals being made only to the extent to which this type of distribution does not prevent the charging of liquidation losses on the profit and loss sharing basis. PROBLEMS AND QUESTIONS 1. To what accounts are losses in liquidation charged? 2. Can you legally declare a liquidating dividend on capitals before paying all liabilities? 3. What is the order of priority among the liabilities? 4. Why is it impossible to give the loans from partners the priority over their capital claims to which the obligation is apparently entitled? 5. Is it possible to enforce the rule of charging losses in liquidation on the profit and loss sharing ratio, making the partners' loans chargeable for a deficit in capital, and at the same time give priority to the loans over the capital of the partners? 6. If the partners' loans are combined with their capitals for the purpose of liquidation, do the shares received by the partners differ in total from what the partners would receive if the loans and capitals were kept separate and at the same time liquidation were carried forward so that all losses would be chargeable to the partners' capital or to their loans in case of a capital deficit? Explain your answer fully. 7. A, B, and C are equal partners with capitals and loans as follows: ABC Loans .... $6,000.00 $7,500.00 $10,000.00 Capitals .... 12,500.00 15,000.00 20,000.00 The partnership owes $10,000.00 to fully secured creditors and $15,000.00 to unsecured creditors. Partner A is made the liquidator and is allowed 5 per cent of the proceeds of liquidation with the understanding that he is to be paid this commission by the other two partners. (In such cases the settlement is a private settlement and is not entered on the books.) In the month of January assets costing $45,000.00 were liquidated at $30,000.00 cash. Make the proper distribution and the proper charges for January. In February the balance of assets are sold at 50 cents on the dollar. Make the entries involved in winding up the partnership in February. 8. (a) X, Y, and Z are equal partners with the following interests: X Z Loans .... $2,000.00 $4,000.00 $6,000.00 Capital .... 6,000.00 8,000.00 10,000.00 LIQUIDATION OF A SOLVENT PARTNERSHIP 327 They owe outside creditors $30,000.00. They sell the total assets for 50 per cent of their book value. X is solvent and can therefore be charged with any deficit for which his interest does not provide. Make entries to wind up the partnership. (b) Solve the same problem on the assumption that X is insolvent and could not meet any deficit in his interest. CHAPTER XXIV CORPORATE ORGANIZATION AND ACCOUNTING 1. The Original Proprietary Interest. It has been set forth in preceding chapters that in the corporation the proprietary interest instead of being expressed in the dollar unit only, as in the partnership and individual business, is expressed in terms of share units of so many dollars per share. A stock- holder will say that he owns ten shares of stock in the corpora- tion, each share having a certain par or face value, such as $100.00 or $150.00. This original par value is intended by the various states which have authorized the organization of cor- porations to represent the number of dollars invested by the shareholder for each share owned. It does represent facts of this sort in some cases. But property is frequently transferred to the corporation for shares of stock and the states have not in many cases created efficient administrative machinery for carrying out the intent of the law. Hence the face value of the shares frequently does not signify even approximately the actual investment of the shareholder in the corporate assets. The journal entry, however, is generally made to give a "book value" to assets exchanged for corporate shares equal to the face value of the shares so issued. That is, the assets are gen- erally entered as having a money value equal to the par value or face value of the shares for which they are exchanged. 2. Shares without Par Value. Since it has been found that the par or face value of shares is so often in excess of the sale value of the assets which have been exchanged for the shares, the original proprietary interest has been represented in some cases by shares without par value. If these shares were sold for cash by the corporation, the shareholders' capital would be credited for the amount paid instead of the nominal value appearing on the face of the shares. Another advantage 328 CORPORATE ORGANIZATION AND ACCOUNTING 329 to be realized by the use of shares without par value is found in the escape from the statutes requiring that the money or property exchanged for shares of a corporation shall be at least equal in value to the par of the shares issued. When the shares have no par value it is clear that the shares may be ex- changed for such money or property as the corporation may see fit to accept in exchange. The credit to capital and to the shareholders would be determined, however, by the valuation placed on the property exchanged for such shares. 3. Surplus. The earnings of a corporation may be dis- tributed to the stockholders or they may be accumulated into what is called a surplus reserve. When earnings are distrib- uted they are always distributed pro rata; a dividend of a cer- tain number of dollars for each share is declared from surplus and distributed on a certain date to the stockholders of record for the date in question. The profit and loss account is closed into a surplus account instead of being closed into a capital account as would be the case for the partnership or the indi- vidual business. Extraordinary profits or adjustments in the book value of assets are carried directly through the surplus instead of through profits and loss. The practice of the corpo- ration in this respect is the same as that found to prevail for the partnership and the individual business. 4. Liabilities of the Stockholders. The ordinary private corporation is liable to its creditors, who have a first claim against the total assets of the corporation. In case of insol- vency, the proceeds of the sale of assets would be subject first to the claims of creditors. Any balance remaining after all creditors are fully paid is distributed pro rata to the sharehold- ers, but the shareholders are not liable for the debts of the corporation except to the extent of their ownership interest in the corporation. If the corporation itself cannot pay its lia- bilities out of the assets turned over to it in exchange for the shares of the stockholders, the creditors have no other remedy, and must accept in settlement of their claim a pro rata dis- tribution of the proceeds of liquidation of such assets as the corporation may own. In the case of the national banks 330 ACCOUNTING PRINCIPLES the stockholders are liable for an additional levy equal to the par value of the shares which they may hold, in case this amount is required to pay the outstanding liabilities of a bank. The immunity of the shareholders in the ordinary private corporation from additional levy to meet the liabilities of the corporation in case of insolvency is one of the chief char- acteristics of the corporation commonly relied upon to popu- larize subscriptions for corporate shares. Large amounts of money can be raised more readily by the corporation than by the partnership on this account. 5. Classes of Stock. The corporation may have only one class of stock or it may have several classes. The most com- mon types of capital stock are common and preferred stocks. There are, however, several varieties of preferred shares, such as the ordinary preferred and the cumulative preferred. In the case of any type of preferred there may be a first preferred, a second preferred, etc. When there is only one class of stock, no stockholder has a claim which is to be preferred over that of any other stockholder. The preferred stockholders, how- ever, ordinarily have a claim which is preferred to that of the common stockholder in the distribution of profits and in the distribution of the proceeds of the liquidation of assets. The provision under which the preferred stock is issued might set up, for example, the right to a dividend of 7 per cent on the par value of the shares from the earnings of any year, before the common stockholders would have any right to participate in the profits of the year in question. If the earnings were .suffi- cient to pay the 7 per cent on the preferred stock and a divi- dend on the common stock in addition, the common sharehold- ers might participate in the distribution of profits. Similarly, if the assets of the corporation are sold, the balance of the proceeds of the sale of the assets after paying the liabilities of the corporation would be available for distribution to the hold- ers of preferred stock in an amount equal to the par value of such stock outstanding. The balance of the proceeds of liqui- dation in excess of the par value of the outstanding preferred stock would then be available for distribution to the holders of CORPORATE ORGANIZATION AND ACCOUNTING 331 common stock or to the holders of the second preferred shares in case such a class of shares existed. There is some variety in the rights of the holders of preferred stock. They might have a preference over the common stock only as to dividends, with- out preference as to assets. The holder of cumulative preferred stock would have the same rights as the holder of the pre- ferred stock to the dividend distribution guaranteed as a prior claim over distribution to the holders of common stock, but the dividend of any particular year if unpaid would accumulate in succeeding years as a claim of the preferred shareholder which must be met prior to the distribution of any dividends to the holders of common stock. If the cumulative preferred dividends were 6 per cent and the corporation should be un- able to pay this dividend in the first and second years of its operation, the cumulative claim of the cumulative preferred stockholders would be 18 per cent for the third year of the operation of the business. The corporation is, however, under obligation to pay the dividend to preferred stockholders only when the dividend is earned. It does not become a liability of the corporation in the sense that notes payable and accounts payable are liabilities. If the student desires to make a thorough study of the varieties of corporation stock issued against the corporate property, he is referred to the texts on corporation finance which are primarily concerned with such matters. The preferred stocks themselves may be classed as follows: (a) preferred stock, second preferred, etc.; (b) cumu- lative preferred, second cumulative preferred, etc. The two types (a) and (b) may exist in the case of the same corpora- tion. Moreover, either class (a) or class (b) may be preferred as to dividends without being preferred as to assets or vice versa. Either class may have the right to vote or it may not. Preferred shares may, in some cases, be allowed to share with the common stock additional dividends after their pre- ferred claim has been met and the common shareholders have received certain specified distributions. 6. Bonds. The corporation employs another device for raising funds to carry on its operations through the sale of 332 ACCOUNTING PRINCIPLES corporate bonds. These bonds may be debenture bonds or mortgage bonds. The debenture bonds are unsecured notes maturing in a certain number of years and bearing a desig- nated rate of interest on the par value of the bonds. First mortgage bonds are based upon a first mortgage against cer- tain designated assets which must be sold to meet the claims of such bondholders for interest or principal on the corporate debt in case the corporation is not able to pay such obligations from the income derived from its operations. The amount of the bonds issued may be limited to 50 per cent or 75 per cent, or to some designated fraction of the value of the mortgaged property. The instrument under which the bonds are issued which describes the rights of the holders of the bonds and of the corporation, is called a "deed of trust." This deed of trust will ordinarily require the corporation to maintain the mortgaged property and carry out other provisions designed to protect the interests of the bondholders. The bonds are com- monly issued in denominations of $100.00, $500.00, $1000.00, $5000.00, or in amounts representing some multiple of $100.00. The face value of the bonds will be the amount which the cor- poration promises to pay the bondholder on the date of ma- turity of the bonds. If the corporation becomes insolvent at any time the proceeds of the sale of the mortgaged property must be devoted first to the payment of the bonds issued on the basis of the mortgage. Any balance which might remain would be available to meet the claims of general creditors, such as those represented by the debenture bonds or ordinary notes and accounts of the corporation. There may also be a second mortgage bond, which would be entitled to the balance of the proceeds of the liquidation or sale of mortgaged prop- erty after the liabilities to the first mortgage bondholders had been fully met. If a second mortgage exists, the general cred- itors have no claim against the proceeds of the liquidation of the mortgaged property until the holders of the second mort- gage bonds as well as those of the first mortgage bonds have been fully paid. Another type of bonds which is important in accounting procedure is the sinking fund bond. The deed of CORPORATE ORGANIZATION AND ACCOUNTING 333 trust for such bonds requires the corporation to set aside each year a designated amount of money which is relied upon to accumulate to an amount equal to the face value of the bonds prior to the date of maturity. The money so set aside is com- monly invested in securities which can be readily sold. The interest on such securities held in a sinking fund is accumulated in the fund on a compound interest basis. The deed of trust under which such bonds are issued designates not only the amount of the annual contribution which must be made to the sinking fund, but has provisions in regard to the type of assets which may be purchased with funds so accumulated. 7. Charter and By-laws of the Corporation. Corporations are commonly organized under the provisions of the laws of some state, which places limitations upon the corporation as to its operations and as to the liabilities which it may assume. Three or more individuals wishing to organize a corporation must, therefore, commonly apply to the secretary of state for authority to do so. These individuals are required to state the purposes for which they wish to organize the corporation and to comply with other formalities in connection with their ap- plication before the secretary of state will issue a charter to the parties presenting application. When a charter has been secured and the capital stock has been subscribed for and paid in in accordance with the laws of the state under which the cor- poration is organized, the stockholders are then called together for the purpose of perfecting the organization of the business which is provided for in the charter. A set of by-laws is ordi- narily adopted, which designates the offices of the corporation and the rights and duties attached to the respective offices created. The charter also commonly provides for a board of directors to whom the stockholders delegate general managerial authority. The board of directors is also entrusted with the duty of employing officers to carry on the routine operations of the corporation. The directors are then expected to meet from time to time, to pass on the proposals made by the officers of the corporation in regard to the conduct of its business. The officers of the corporation are required to carry out the instruc- 334 ACCOUNTING PRINCIPLES tions of the board of directors and to carry on the business in accordance with the by-laws of the corporation and the instruc- tions of the board of directors. The stockholders themselves generally have an annual meeting for the purpose of deciding such general questions of management as may not be dele- gated to the board of directors. Moreover, the stockholders will yearly elect additional directors to fill the places of those directors whose terms may have expired. For a fuller descrip- tion of the nature and content of the by-laws of the corporation, the student is referred to the texts on corporation finance. 8. Distribution of Profits. The stockholders commonly delegate to the directors of the corporation the determination of the amount of profits which are to be distributed from time to time to the stockholders. If it should appear that the di- rectors are withholding profits from distribution unnecessarily, the aggrieved stockholders might apply to a court of equity for an injunction which would require the directors to distribute the profits to which the stockholders might be entitled. Wide discretion is, however, commonly given to the directors in de- termining whether the interests of the corporation require the retention of profits for an expansion of the operations of the corporation. 9. Minute Book. The by-laws of the corporation would commonly require that a minute book be kept, in which a' full record is made of all the resolutions and proceedings of the board of directors. The record set forth in this minute book is the authority upon which the officers of the corporation pro- ceed in carrying forward the business of the corporation. 10. Nature of the Corporate Organization. It will appear from the previous description of the characteristics of the cor- poration that it is a highly developed type of business organi- zation designed primarily for the raising of adequate funds for carrying forward and expanding the operations of a business. The various classes of claims created against the assets of the corporation are designed to meet the requirements and preferences of the various types of investors who may have money available for business investments. If the investor CORPORATE ORGANIZATION AND ACCOUNTING 335 desires to have authority to determine the general policies of the business with which he is connected and at the same time to share in the profits of the enterprise he will invest in corpo- rate stock. If he is a holder of common stock he wil', in gen- eral, have a vote in the election of the board of directors and he will have certain rights in regard to inquiry into the opera- tions of the business with which he is associated and he will also have the right to a share in the profits of the business. If he is a holder of preferred stock, he may have a vote in the election of directors and certain rights in regard to directing the affairs of the business, or he may be deprived of this right by the articles under which the preferred stock is issued. In any case, however, his investment will be attended with less risk than that connected with the ownership of common stock. There will be less risk still connected with the ownership of bonds, and the safest bond, in general, is the first mortgage bond. The investor who desires a safe investment requiring little attention on his part will commonly select a high class first mortgage. This variety of investment opportunity created by the corporation makes it the favorite device for the financ- ing of business enterprise on a large scale. ii. The Relation of Corporate Organization to Accounting Procedure. The accountant could not intelligently proceed to set up a schedule of accounts until he had first familiarized himself with the types of securities authorized by the charter, by-laws, and directors of the corporation. Moreover, the audi- tor would need to familiarize himself with the provisions of all deeds of trust and of all instruments under which the various types of liabilities and shares are issued. He would need to know these facts both from the standpoint of determining what information should be recorded in the corporate books and also for the purpose of determining whether the officers and di- rectors of the corporation were carrying on its operations in accordance with the provisions of these instruments designed to protect the various investors interested in the property. The accountant must not only be familiar with the contents of all the instruments creating liabilities and proprietary claims, 336 ACCOUNTING PRINCIPLES but he must also be familiar with all actions taken by the board of directors as recorded in the minute book of the corporation. The proceedings of the directors may at any tune require that certain accounts be set up or that certain records be initiated which have not heretofore been found hi the accounts of the corporation. 12. Corporate Accounting. The income, expense, and asset accounts are similar to the accounts under these various head- ings in the partnership and individual business of a similar size and character. The peculiar features of corporate accounting arise hi connection with the proprietary and liability interests. These interests are complex and the officers and directors need to be fully acquainted at all times with the character and amount of liabilities to holders of securities of every class. They also need to know the obligations to the corporation which the holders of subscription claims and corporate securi- ties may have. The corporation reports of income and ex- pense and the classification of assets as found in corporation reports present no special characteristics as compared with those of the types of business which have been so far consid- ered. 13. The Corporate Balance Sheet. The balance sheet of the corporation, which is presented in outline below, shows in summarized form how the facts of corporate liabilities and pro- prietorship are presented for the purpose of an operating con- cern. The corporate balance sheet presents the financial situ- ation of the corporation. The ratios of current assets to cur- rent liabilities, net worth to fixed assets, etc., have a signifi- cance similar to that already pointed out in a preceding chap- ter. The caption of fixed liabilities has far more importance, however, in the corporate balance sheet than it has in the other forms of organization because this type of investment interest is larger as compared with proprietary investments than for the partnership and the individual business. There is present the temptation to issue a large total of fixed liabilities in the form of bonds and mortgages as compared with the total pro- prietorship investment. The holders of the fixed liabilities CORPORATE ORGANIZATION AND ACCOUNTING 337 commonly have the right to displace the proprietorship in the management of the corporation in case it does not prove to be able to pay the interest charges and also pay the liabilities when they fall due. The holders of bonds and mortgages ordi- narily get control through the appointment of a receiver, who operates the property with a view to meeting their claims, or the receiver may undertake to sell the property with the view to paying the claims of the holders of liability interests. If the court appoints the receiver on the application of the bond or mortgage holders, the receiver is required to act on instructions from the court in his operation or sale of the property. If the property is sold for no more than enough to pay the obligations of the corporation to its creditors the proprietary interest loses its entire investment. In organizing the corporation, therefore, the proprietors should be cautious not to create fixed interest charges so large in amount that the total income of the corporation may in the years of dull business be insufficient to pay them. The margin of total income over the amount required to meet these guar- anteed claims should be so large that there will be little chance for the proprietary interest to lose its investment. The ratio of fixed liabi ities to the proprietary interest should be smallest in those lines of industries in which the total income fluctuates widely from year to year. A street railway's income does not generally fluctuate so widely as the income of the industrial corporations. It is not uncommon for the street railway to be constructed mainly from the proceeds of bond sales. The in- dustrial organized on such a basis would be in an unstable position both from the standpoint of the creditors and of the proprietary interest. A similar analysis may be made from the standpoint of the relation of the appropriate amount of investment of the com- mon stockholders as compared with that of the holders of the preferred shares. If one interested in such analysis had a large number of corporate statements in each industry, some conclu- sion might be reached as to the prevailing ratio of fixed lia- bilities to proprietorship in the respective industries. 338 ACCOUNTING PRINCIPLES The sale value of the proprietary interest may be, at the time of the organization of the business, much less than its nominal or face value. The full analysis of the actual invest- ment of the proprietors as compared with the nominal value of the shares may be secured in the first instance by a fa'.r valua- tion of the assets turned over to the corporation in exchange for the shares as shown by the journal entries involved in the issue of the corporate shares. The additional funds invested from year to year would generally be shown by the corporate surplus if no further shares were issued. For a detailed analysis of the factors connected with the or- ganization and capitalization of the corporation the student is referred to the texts on corporation finance. The following balance sheet outline shows the more staple items and groups of items found in the corporate balance sheet: ILLUSTRATION NO. 27 VALLEY FURNITURE COMPANY COMPARATIVE BALANCE SHEET, DECEMBER 31, 19 (The per cents other than increase per cents are of total assets or total liabilities) Assets Current Assets: Cash 1918 1917 Increase Inc. % Notes Receivable . . . Accounts Receivable . . Merchandise Inventory . Accrued Inc. Not Due:. Interest Rent Totals Working Assets: Supplies Inventory Deferred Expense: Insurance Ext. Repairs .... Advances to Agents . Totals Investment of Reserves: Bond Sinking Fund . Replacement Fund . . Totals Permanent Investments: Securities in A. B. C. Co. Advances to G. H. Co. . Totals Fixed Assets: Land Buildings Furniture and Fixtures . Plant Equipment Goodwill Totals Grand Total Assets . . . 339 340 ACCOUNTING PRINCIPLES Current Liabilities: Notes Payable . . . . Accounts Payable . . . Accrued Accts. Payable: Interest Rent Taxes Totals ....... Deferred Income: Royalties Rent Totals Fixed Liabilities: Bonds Mortgages Notes (Long term) . . Totals Proprietorship : Capital Stock, Common . Capital Stock, Preferred . Appropriated Surplus Surplus Totals Grand Total Liabilities . Liabilities 1918 1917 Increase Inc. QUESTIONS AND PROBLEMS 1. In the corporation how is the original proprietary interest created and designated? 2. \Vhat is meant by par value? 3. What are the advantages of shares without par value? What credits to capital would arise out of then- sale? 4. What becomes of the net profits of the corporation? 5. (a) Describe the nature of corporation dividends, (b) Who gener- ally has authority to declare them? (c) From what account are they com- monly declared? CORPORATE ORGANIZATION AND ACCOUNTING 341 6. (a) What are the liabilities of the shareholders of the ordinary pri- vate corporation? (b) Of the national bank shareholders? 7. (a) What are the classes of corporate shares? (b) Describe the rights generally belonging to the various types of shares. 8. Describe the nature of the bond liabilities and the process of their issue. 9. (a) What are the classes of bonds? (b) What are the rights of the owners of these several classes? 10. What instruments determine the rights and duties of directors, offi- cers, and stockholders? 12. What is the content of the minute book? 13. What are generally the duties of the directors? 14. Compare the corporate balance sheet with that of the individual business and that of the partnership. CHAPTER XXV CAPITAL STOCK ACCOUNTS AND THE ISSUE OF CORPO RATE SHARES i. Issue of Capital Stock. The private corporations are in general organized under the laws of the several states. Each state makes certain requirements in regard to reports, in re- gard to the maximum liability of the corporation and the duties of shareholders, which must be complied with by all corporations organizing under the laws of the state in question. The general corporation laws of some states are more favorable to a corporation than those of other states. It is consequently advisable before making application to the secretary of state for articles of incorporation to become acquainted with the cor- poration laws of the state in question. After these prelimi- naries have been carried out, three or more individuals make application for the right to incorporate, stating the character of business to be done, the amount of capital which is to be au- thorized, and stating such other facts as may be required of prospective incorporators by the laws of the state under which the corporation is to be organized. When the charter has been secured, and the preliminaries in regard to the formation of the corporation have been complied with by the incorporators, a prospectus is commonly issued indicating to prospective sub- scribers for corporate shares the type of business to be carried on and the rights of shareholders in the corporation. A regu- lar blank form is generally provided on which a subscriber makes his subscription for a certain number of shares of stock and promises to make payment for the same as required by the subscription blank in question. A list of subscribers is thus developed and this list of subscribers is the basis of setting up a general ledger account with subscribers. At the same time a capital stock account is set up on the general ledger, subsidiary 342 CAPITAL STOCK ACCOUNTS 343 ledgers showing in detail the accounts with the particular sub- scribers and particular shareholders. 2. Entry of Authorized Shares. When the capital stock of the corporation is duly authorized, it is common to make a general journal entry charging unissued stock or unsubscribed stock and crediting capital stock for the amount of capital au- thorized. For example, if $500,000.00 of capital stock were authorized and no subscriptions had been taken, the journal entry representing this fact would be as follows: Unissued Stock 500,000.00 Capital Stock 500,000.00 Entry of authorized capital An alternative entry here would be: Unsubscribed Stock 500,000.00 Capital Stock 500,000.00 3. Entry of Capital Stock Subscriptions. Let us suppose in the case above cited that the following list of subscribers is made up from the subscription blanks: John Smith 2500 shares John Quade 1250 shares Henry Post 1000 shares Let us further suppose that this subscription is accompanied by a cash payment of 10 per cent on the amount subscribed. The journal entry involved in entering these subscriptions might be made according to several different methods. Per- haps the most common journal entry would be the following: Subscribers 475,000.00 John Smith 250,000.00 John Quade 125,000.00 Henry Post 100,000.00 Unissued Stock 475,000.00 An alternative entry which might be substituted along with the alternative entry in the preceding paragraph would be as follows: 344 ACCOUNTING PRINCIPLES Subscribers 475,000.00 John Smith 250,000.00 John Quade 125.000.00 Henry Post 100,000.00 Unsubscribed Stock 475,000.00 At the same time it would be necessary to make a second entry covering the cash received, as follows: Cash 47,500.00 Subscribers 47,500.00 John Smith 25,000.00 John Quade 12,500.00 Henry Post lo.ooo.oo Other payments of the subscribers under the requirements on their subscription blanks would be entered in the same fashion as the 10 per cent paid at the time of the original subscription. In case property were turned over to the corporation by cer- tain shareholders in payment for their subscriptions, the prop- erty so transferred would be charged, and the subscription ac- count in question credited. It might be true that certain sub- scribers who exchanged property for shares would receive fully paid stock covering the valuation placed on the property re- ceived. If it be supposed that John Quade were allowed $10,- ooo.oo for patent rights, he might be given paid-up shares for $10,000.00, or the valuation placed on his patent rights trans- ferred to the corporation might be credited to the subscription account as follows: Patent Rights 10,000.00 Subscribers 10,000.00 (John Quade) Crediting John Quade on his sub- scription account for patent rights transferred to the cor- poration 4. Definition of Unissued Capital and Capital Stock Ac- counts. If the entry be made as provided for in the preced- ing paragraph, the unissued stock account would be described as follows: CAPITAL STOCK ACCOUNTS UNISSUED STOCK 345 Total Authorized Stock Unissued Balance of Unsubscribed Stock Total Capital Stock Subscribed The unsubscribed stock referred to as an alternative entry would be described in the same way. The two accounts mean the same but the alternative account is more satisfactory as descriptive of the item. The capital stock account would be described as follows: CAPITAL STOCK Reductions in Capital Stock Balance Authorized Total Capital Authorized Under this plan the capital stock account in the case of the corporation above described would appear on the liability side of the balance sheet as follows: Capital Stock $500,000.00 Less Unissued Stock (Or Unsubscribed) 25,000.00 $475,000.00 Objection is sometimes made to the fact that stock is repre- sented as corporation capital before the subscriptions are fully paid. The shareholders do not commonly have even the vot- ing right until the subscriptions have been fully paid. More- over, it is contended that the capital stock account with the deductions of unissued shares should be so stated as to show the proprietary investment made in connection with the or- ganization of the corporation. On the other hand, it is con- tended that the subscriptions of the prospective shareholders represent for the time being their investment in the capital of the corporation and that the balance of the subscribers' ac- count will at all times show the balance to be paid on sub- scriptions and that hence all the facts are fully set forth that 346 ACCOUNTING PRINCIPLES would be needed by any creditor of the corporation, by refer- ence to the balance of the capital stock account after the de- duction of the unissued or unsubscribed stock. It is preferred, however, by some that a different definition shall be given to unissued capital stock and that another ac- count shall be introduced called capital stock subscriptions. If this second method of opening entry were adopted the trans- actions above described would be entered as follows: (a) Unissued Capital Stock 500,000.00 Capital Stock 500,000.00 (b) Subscribers 475,000.00 (Detail list of subscribers as above) Capital Stock Subscriptions 475,000.00 'c) Cash 47,500.00 Subscribers 47,500.00 (Detail credit to particular subscribers) Finally when all subscriptions to the $475,000.00 of capital stock have been fully paid, an entry would be made as follows: (d) Capital Stock Subscriptions 475,000.00 Unissued Capital Stock 475,000.00 This set of entries involved in entering subscriptions is more accurate in some particulars and conveys on the face of a bal- ance sheet during the period when subscriptions are being paid more information than the first method referred to above. In this case the balance of the unissued capital stock account would always show the amount of stock unissued (not out- standing). The capital stock, less unissued stock, as it would appear on the balance sheet of the corporation, would then show the capital stock actually outstanding. It is fair to raise the question, however, whether it is more desirable to show during this period the actual stock outstanding or whether it would be preferable to show the original proprietary interest as the capital stock for which subscriptions had been received. 5. Capital Stock as a Controlling Account If it is desired to make the capital stock account a controlling account over the capital stock ledger, it would be necessary to make no CAPITAL STOCK ACCOUNTS 347 credits to capital stock until shares are fully paid and issued. On the basis of a program of this character, the entries de- scribed above would be made as follows: (a) Subscribers 475,000.00 (List in detail as above) Capital Stock Subscriptions 475,000.00 (b) Cash 47,500.00 Subscribers 47,500.00 (Subscription credits in detail) When the $475,000.00 of stock has been fully paid the sub- scribers' account will be closed and all of the individual sub- scription accounts will also be closed. The entry under such circumstances would be as follows: (a) Capital Stock Subscriptions 475,000.00 Capital Stock 475,000.00 (Credit also individual accounts of each shareholder) Prior to the issue of capital stock the account of capital stock subscriptions will represent the proprietary interest of the stockholders in the enterprise. If the subscriptions are fully paid at the time of opening the books of the corporation, it is then unnecessary to open ac- counts with subscribers or to set up a subscribers' account. If the subscriptions are paid in cash at the time of opening the books the capital stock would be issued and the journal entry would be as follows: Cash 475,000.00 Capital Stock 475,000.00 (Credit also individual accounts of each shareholder) If, however, it were desired to credit capital stock with the total of the authorized issue instead of the amount issued, the journal entry would be made as follows: Unissued Stock 25,000.00 Cash 475,000.00 Capital Stock 500,000.00 With the last entry the capital stock account would not be a controlling account over the stock ledger, although reference to 348 ACCOUNTING PRINCIPLES unissued stock would readily show the amount of stock out- standing, which could be checked against the detail stock ledger accounts to see whether the capital stock account in the general ledger was in accord with the stock ledger and other entries affecting capital stock. 6. Installment Records. Even though subscription to cap- ital stock is paid in installments, it does not seem necessary to set up each installment as a separate subscription account. The payment of installment No. i can be credited to the sub- scription account as Installment No. i; likewise, the payment of installment No. 2 can be credited to the subscription ac- count as Installment No. 2. This could be readily accom- plished by columns in the cash journal headed Installment No. i and Installment No. 2, so that the total received could be carried from the cash journal as one item of credit to the sub- scribers' account with a ledger memorandum showing the amount collected on Installment No. i. Likewise the credits to the individual accounts of subscribers in the subscription ledger might show in the memorandum that the credit was for Installment i, 2, or 3. However, it is sometimes desired to set up a separate ac- count in the general ledger, for each installment and at the same time to charge the subscribers with the special install- ments so that for each subscriber there would be as many subscription accounts as there are installments and as many general subscription accounts in the general ledger as there are installments. Let us suppose that the $475,000.00 subscrip- tions referred to above were in three installments of 10 per cent, 45 per cent, and 45 per cent. In that case the subscrib- ers' account might be closed out into the respective installment accounts by the following journal entry: Installment #i 47,500.00 Installment #2 213,750.00 Installment #3 213,750.00 Subscribers 475,000.00 In connection with each charge to the Installment Accounts the detail charges to individual subscribers should be made. CAPITAL STOCK ACCOUNTS 349 The individual accounts would in each case be divided into three in the same proportion as that indicated for the total of subscriptions. If $47,500.00 of cash were received on install- ment No. i the journal entry showing the receipt would be as follows: Cash 47,500.00 Installment #i 47,500.00 Credits to the subsidiary ac- counts would be made here also Individual installment accounts would likewise be credited for the first installment. 7. Exchange of Property for Stock. It happens frequently that a corporation takes over the property of some other busi- ness, assuming its liabilities and exchanging shares to the pro- prietors of the old business for their interest. For example, the ABC Corporation might 'issue shares to D and C, who are partners in a firm with the following balance sheet: BALANCE SHEET, DECEMBER 31, 1919 Assets Current Assets: Cash $10,000.00 Notes Receivable 4,000.00 Accounts Receivable 17,500.00 Merchandise Inventory 15,000.00 Fixed Assets: Fixtures Total Assets Liabilities Current Liabilities: Notes Payable Accounts Payable Proprietorship : C's Capital * D's Capital Total Liabilities 557,500.00 12,000.00 20,000.00 12,000.00 , 500.00 5,000.00 ;i,5oo.oo $19,500.00 32,000.00 $51,500.00 350 ACCOUNTING PRINCIPLES It will be seen that the proprietary interest in the partnership amounted to $32,000.00. If it were desired by the corporation to take over the assets and liabilities at their book valuation, then $32,000.00 of the capital stock of the ABC Corporation would be issued to C and D for their proprietary interest, $20,- ooo.oo to C and $12,000.00 to D. In some instances, however, the corporation might insist on a reduction in the book value of some of the asset items; accounts receivable, merchandise inventory, or fixed assets might be reduced and the proprietary interest in the partnership would be correspondingly reduced. These adjustments would be made in the books of the old firm prior to the transfer to the corporation. The corporation would take the assets over at their readjusted value and would exchange capital shares to the partnership in amount indicated by the readjusted valuation of their partnership interest. If the capital stock were issued in exchange for the proprietary interest, the following journal entry might serve to incorporate the business in the books of the corporation: Cash 10.000.00 Notes Receivable 4.000.00 Accounts Receivable 17,500.00 Merchandise Inventory 15,000.00 Fixtures 5,000.00 Notes Payable 7,500.00 Accounts Payable 12,000.00 Capital Stock 32,000.00 C's Capital 20.000.00 D's Capital 12,000.00 If, however, the books of the corporation had been opened with subscription accounts and some of the subscribers were ex- pected to pay for their shares in installments, then the part- ners in the firm taken over would also be represented as sub- scribers by means of the following journal entry: Subscribers 3 2 ,000.00 Capital Stock Subscriptions 32,000.00 Then the taking over of the assets and liabilities would be recorded by the following journal entry: CAPITAL STOCK ACCOUNTS 351 Cash 10,000.00 Notes Receivable 4,000.00 Accounts Receivable 17,500.00 Merchandise Inventory 15,000.00 Fixtures 5,000.00 Notes Payable 7,500.00 Accounts Payable 12,000.00 Subscribers 32,000.00 C, 20,000.00 D, 12,000.00 After this entry is made and the subscriptions of C and D are fully paid the following journal entry would be made: Capital Stock Subscriptions 32,000.00 Capital Stock 32,000.00 The student will readily see how these items would appear on the books of the corporation if any one of the plans referred to hi the preceding paragraphs were adopted for the opening entries. Accountants frequently insist on a still further analysis for indicating the opening entries of the corporation, showing in separate entries the assets taken over, the liabilities assumed; and the transfer of the proprietary interest. The detail would require journal entries as follows: 1 (a) Cash 10,000.00 Notes Receivable 4,000.00 Accounts Receivable 17,500.00 Merchandise Inventory 15,000.00 Fixtures 5,000.00 C and D, vendors 51,500.00 Entries of the purchase from C and D of the assets of the partnership (b) C and D, vendors 19,500.00 Notes Receivable 7,500.00 Accounts Payable 12,000.00 Entry showing the assump- tion of the partnership liabilities by the corpora- tion (c) C and D, vendors 32,000.00 Capital Stock 32,000.00 1 Again, if it were desired to enter C and D as subscribers this entry would be made before any of the entries recorded above. CHAPTER XXVI CHANGING TO THE CORPORATE FORM OF ORGANIZATION i. Transferring Entries on the Old Books. If an individual or partnership business is changed to the corporate form and the operating records used for the old business are continued, the entries required to indicate the change will be simple. Sup- pose the partners A and B decide to incorporate with a capital stock of $10,000.00 in excess of their total capital. A's capital is $40,000.00 and B's is $50,000.00, while the authorized capital of the corporation is $100,000.00. Since the assets less the lia- bilities are $90,000.00, it is necessary either to start with a defi- cit or to introduce an item of goodwill. If profits and losses were divided equally in the old business, the $10,000.00 of goodwill would be divided equally between A and B by the following journal entry: Goodwill 10,000.00 A's Capital 5,000.00 B's Capital 5,000.00 Goodwill placed on the partner- ship books as set up in accord- ance with the purchase price placed on the assets by the corporation which took over the assets After the goodwill has been placed on the books, it is then necessary to close out the partnership accounts and open the capital stock account by the following journal entry: A's Capital 45,000.00 B's Capital 55,000.00 Capital Stock 100,000.00 (Capital Stock to A 45,000.00) (Capital Stock to B 55,000.00) The memorandum entry below the capital stock entries would serve to open the subsidiary stock ledger accounts for the indi- vidual stockholders if such a ledger were kept. 352 CHANGING TO THE CORPORATE FORM 353 2. Transferring to a New Set of Books. Let us take first the simple case when the partnership books are to be closed preparatory to forming the corporation and a new set of books is to be opened. Suppose the AB partnership has the follow- ing balance sheet: BALANCE SHEET OF AB PARTNERSHIP Assets Cash $10,000.00 Notes Receivable 4,000.00 Accounts Receivable 17,500.00 Merchandise Inventory 15,000.00 Fixtures 5,000.00 $51,500.00 Liabilities Notes Payable $7,500.00 Accounts Payable 12,000.00 Capital Stock 32,000.00 $51,500.00 The following journal entries would be sufficient to make the transfer : 10,000.00 4,000.00 17,500.00 15,000.00 5,000.00 (a) AB Corporation 51,500.00 Cash Notes Receivable Accounts Receivable Merchandise Inventory Fixtures Transfer of the assets of the partnership to the AB Corporation (b) Notes Payable 7,500.00 Accounts Payable 12,000.00 AB Corporation 19,500.00 The AB Corporation as- sumes the definite liabil- ities To represent the fact that the partners transfer their capital interests in the partnership to the corporation the following entry may be made : (c) A, Capital 20,000.00 B, Capital 12,000.00 AB Corporation 32,000.00 Partners' capitals are trans- ferred to the Corporation 354 ACCOUNTING PRINCIPLES If it is desired to show on the books what the partners re- ceived for their capital, this can be indicated as follows: (d) Corporation Stock 32,000.00 AB Corporation 32,000.00 Stock of the Corporation received for distribution to partners (e) A, Capital 20,000.00 B, Capital 10,000.00 Corporation Stock 32,000.00 Corporation stock received by partners in exchange for their capital interests If entries (d) and (e) are used, they take the place of the (c) form of entry. The two latter entries seem preferable because they make the picture more complete. If any adjusting entries were required in connection with the transfer, those would be made as in paragraph i above, before the final closing entries are made. 3. Opening the Corporation Books. All of the necessary accounts for the corporation books would be opened by the following journal entry: (a) Opening Entries of AB Corporation : Cash 10,000.00 Notes Receivable 4,000.00 Accounts Receivable 17,500.00 Merchandise Inventory 15,000.00 Fixtures 5,000.00 Notes Payable 7,500.00 Accounts Payable 12,000.00 Capital Stock 32,000.00 (A, Capital Stock 20,000.00) (B, Capital Stock 12,000.00^ The corporation purchases the ownership interest of A and B, partners, by an issue of $32,000.00 of capital stock, takes over the assets of the partner- ship, and assumes the lia- bilities CHANGING TO THE CORPORATE FORM 355 The memorandum of this journal entry refers to several steps or aspects of this transfer. The accountants generally advocate the portrayal of these steps in more detail by -dis- tinct journal entries. If this is done, the opening entries above would be accomplished on the books by the following journal entries: (b) Opening Entries of AB Corporation: Subscribers 32,000.00 (A, Subscriber 20,000.00) (B , Subscriber 1 2 ,000.00) Capital Stock 32,000.00 Cash 10,000.00 Notes Receivable 4,000.00 Accounts Receivable 17,500.00 Merchandise Inventory 15,000.00 Fixtures 5,000.00 Notes Payable 7,500.00 Accounts Payable 12,000.00 Subscribers 32,000.00 (A, Subscription 20,000.00) (B, Subscription 12,000.00) The corporation takes over the assets and assumes the definite liabilities of A and B, partners, crediting their subscrip- tion accounts with the net assets If one desired to make the capital stock account a controll- ing account over the subsidiary stock ledger the style of opening entry shown on the following page would be used: 356 ACCOUNTING PRINCIPLES (c) Opening Entries of AB Corporation: Subscribers 32,000.00 A, Subscriber 20,000.00 B, Subscriber 12,000.00 Capital Stock Subscriptions 32,000.00 Cash 10,000.00 Notes Receivable 4,000.00 Accounts Receivable 17,500.00 Merchandise Inventory 15,000.00 Fixtures 5,000.00 Notes Payable 7,500.00 Accounts Payable 12,000.00 Subscribers 32,000.00 (A, Subscription 20,000.00) (B, Subscription 12,000.00) Corporation takes over the assets and assumes the definite liabilities of A and B, partners, crediting their subscrip- tion accounts with the net assets Capital Stock Subscriptions 32,000.00 Capital Stock 32,000.00 (A, Capital Stock, 20,000.00) (B, Capital Stock, 12,000.00) Capital Stock is issued covering paid up subscriptions The steps set forth in the three entries above are: (a) sub- scription to the capital stock by the partners, (b) the transfer of their property in payment of their subscription, and (c) the issue of stock covering the paid up subscriptions. In this form of entry the subscribers' account is a general ledger account controlling the subsidiary subscriber accounts in the subscrip- tion ledger. The capital stock account is a general ledger ac- count controlling the capital accounts of the stockholders in the stock ledger. The transfers of stock, however, do not affect the balance of stock outstanding. It is not, therefore, neces- sary to provide for the postings of the total transfers to the controlling account. The general ledger account is affected only by the original issue of stock and the cancellation of stock. Neither of the forms of opening entries used above shows un- CHANGING TO THE CORPORATE FORM 357 issued stock. If it be supposed in the above case that there is $8,000.00 of unissued stock, this may be shown on the books by the following form of opening entry: (d) Opening Entries of AB Corporation: Unissued (or Unsub- scribed) Stock 40,000.00 Capital Stock 40,000.00 Entering the authorized capital stock Subscribers 3 2 ,000.00 (A, Subscriber 20,000.00) (B, Subscriber 12,000.00) Unissued (or Unsub- scribed) Stock 32,000.00 A and B subscribe for $32,000.00 of capital stock Cash 10,000.00 Notes Receivable 4,ooo.bo Accounts Receivable 17,500.00 Merchandise Inventory 15,000.00 Fixtures 5,000.00 Notes Payable 7,500.00 Accounts Payable 12,000.00 Subscribers 32,000.00 (A, Subscription 20,000.00) (B, Subscription 12,000.00) The corporation takes over the assets and assumes the definite liabilities of A and B, partners, crediting their subscrip- tion accounts with the net assets The capital item on the balance sheet -would then appear as follows: Capital Stock $40,000.00 Less Unissued (Unsubscribed) 8,000.00 $32,000.00 If it were desired to make the proprietary interest appear as the actual capital stock outstanding rather than the sub- scribed capital the form of opening entry would be as follows: 358 ACCOUNTING PRINCIPLES (e) Opening Entries of AB Corporation: Unissued Stock 40.000.00 Capital Stock 40,000.00 Entering the authorized capital stock Subscribers 32,000.00 A, Subscriber 20,000.00 B, Subscriber 12,000.00 Stock Subscriptions 32,000.00 A and B subscribe for $32,000.00 of capital stock Cash lo.ooo.oo Notes Receivable 4,000.00 Accounts Receivable 17.500.00 Merchandise Inventory 1 5 .000.00 Fixtures 5,000.00 Notes Payable 7,500.00 Accounts Payable 12.000.00 Subscribers 32.000.00 (A. Subscription 20.000.00) (B, Subscription 12,000.00) The corporation takes over the assets and assumes the definite liabilities of A and B. partners, crediting their subscrip- tion accounts with the net assets The final entry would then be as follows: Stock Subscriptions 32,000.00 Unissued Stock 32,000.00 Issue of certificates covering paid up sub- scriptions The stock subscription account would then be closed, the subscribers' account would then be closed, and the unissued stock account would have a balance of $8,000.00. An objec- tion sometimes raised to this form of entry is that the capital stock account would show a balance of the authorized capital instead of the amount of stock issued and outstanding. This difficulty may be obviated by the following form of statement of capital stock in the balance sheet: CHANGING TO THE CORPORATE FORM 359 Capital Stock $40,000.00 Less Unissued Stock 8,000.00 Capital Stock Outstanding $32,000.00 The liability to stockholders is then represented as $32,000.00 on the amount of stock issued. The form of opening entry referred to in the parenthesis after the unissued capital stock item above would be as follows: (f) Unsubscribed Stock 40,000.00 Capital Stock 40,000.00 The AB Corporation authorizes $40,000.00 capital stock Subscribers 32,000.00 (A, Subscriber 20,000.00) (B, Subscriber .12,000.00) Unsubscribed Stock 32,000.00 A and B subscribe for $32,000.00 of capital stock Cash 10,000.00 Notes Receivable 4,000.00 Accounts Receivable 17,500.00 Merchandise Inventory 15,000.00 Fixtures 5,000.00 Notes Payable 7,500.00 Accounts Payable 12,000.00 Subscribers 32,000.00 (A, Subscriber 20,000.00) (B, Subscriber 12,000.00) The corporation takes over the assets and as- sumes the outside liabilities of A and B, partners, crediting their subscription ac- counts with the net assets When this form of entry is used, the capital stock statement hi the balance sheet would be made as follows: Capital Stock $40,000.00 Less Unsubscribed Stock 8,000.00 $32,000.00 The unsubscribed stock and the unissued stock are represented above by the same totals, but this would not be the case if part 360 ACCOUNTING PRINCIPLES of the subscribed stock had not been fully paid. The total of unissued stock would exceed the total of unsubscribed stock. This form of entry is in substance the same as the first one (a) used above with the exception that the word unsubscribed is used instead of the word unissued. There are other forms of opening entries sometimes referred to in the accounting texts. The capital stock account is not strictly a controlling account in the last two forms of opening entries used above, because the item includes all capital stock authorized while only the capital stock issued would be recorded in the stock ledger. The stock ledger would then be a memo- randum ledger. Its accuracy could be readily tested, however, by a comparison in one instance with capital stock less unis- sued stock, and in the other instance by an examination of the subscribers' account and the unsubscribed stock account. No unsubscribed stock would be issued. No subscribed stock would be issued until it was fully paid. If the (b) form of opening entries were used, the record of authorized and unsubscribed stock would be found in the min- ute book. It would also be significant as a memorandum in connection with the balance sheet. This form would then be entirely satisfactory and would yield all needed information. Forms (d) and (e) insert this memorandum information in the journal entries. In opening the corporation books the opening entries should be made and posted before the entry of the regular transac- tions begins. The remainder of the accounting problems of the private corporations are substantially the same as those of any other kind of business organization. The voucher record is used frequently with the books of the corporation, but it may be used either with an individual enterprise or with a partner- ship if the size of the business justifies it. 4. Forfeited Stock. In some states a subscriber is not al- lowed to forfeit a stock after he has subscribed for it. The corporation and its creditors hold a claim against the sub- scriber for the amount of his subscription even if the total amount is not paid into the corporate treasury. CHANGING TO THE CORPORATE FORM 361 In other states the corporation may require the subscriber to forfeit his stock in case of failure to pay the subscription in- stallments. Under such circumstances the corporation would generally protect itself by requiring the subscriber to forfeit any payments already made in so far as these payments might be required in bringing to the corporation the original sub- scription price of the shares. Suppose, for example, that A subscribed for fifty shares of stock with par of $100.00 each, agreeing to pay therefor the par value of each share, and making an initial payment of 25 per cent, or $1,250.00. He later forfeits the fifty shares and they are sold to B at $90.00 per share. The settlement, which would protect the corporation against loss, would be journal- ized as follows: (a) Subscriber 5,000.00 (A's Subscription Acct.) Unsubscribed Stock 5,000.00 Entering A's subscription for 50 shares of stock (b) Cash 1,250.00 Subscribers 1,250.00 (A's Subscription Acct.) Crediting the controlling subsidiary subscrip- tion amount for A's payment on his sub- scription (c) A's Account 3,750.00 Subscribers 3,750.00 (A's Subscription Acct.) A forfeits his subscription and is charged with the balance of the account (d) Subscribers 4,500.00 (B's Subscription Acct.) A's Account 4,500.00 Crediting A with amount of B's subscription to stock forfeited by A (e) Cash 4,500.00 Subscribers 4,500.00 (B's Subscription) Payment of B's subscription to forfeited stock 362 ACCOUNTING PRINCIPLES (f) A's Account 7 50.00 Cash 750.00 Payment to A of balance due from sale of his forfeited subscription The (f) entry would close the account with A, and B's sub- scription account would be closed by the (e) entry. The addi- tional entries involved in the issue of the stock would be made in accordance with one of the plans described above. If capi- tal stock had been credited with the total of the authorized stock and no capital stock subscription had been opened, no further entry would be required. QUESTIONS AND PROBLEMS 1. How would goodwill enter into the books of a partnership if its assets were purchased by a corporation? On what basis would it be distributed to the partners? 2. If the assets of a partnership be $200,000.00; the liabilities, $50,000.00; the interests of partners Smith and Jones, $45,000.00 and $55,000.00, re- spectively; and the partners sell their interests to a corporation J for stock equal to the book value of their respective interests, make the journal en- tries showing two forms of transfer which would close the books of the partnership. 3. Make the opening entries of the corporation according to four differ- ent possible forms of entry. Which form seems preferable in this case? Why? 4. Make the transferring entry on the assumption that the corporation uses the same books of record as the partnership. 5. The partners in the firm of Smith and Jones decide to incorporate and operate their business under the name of the Star Mercantile Company. The partnership agreement provided that profits and losses should be di- vided '. to Smith and ^ to Jones. The balance sheet of the partnership on December 31 after the dosing entries for the year had been made and profits dosed into the partners' accounts was as follows: SMITH & JONES BALANCE SHEET, DECEMBER 31, 1916 Cash $1,925.00 Notes Payable $2,000.00 Notes Receivable 2,800.00 Accounts Payable 8,170.00 Accounts Receivable 14,420.00 Jones, Capital 14,825.00 Inventor}' 30.000.00 Smith, Capital 27,150.00 Furniture and Fixtures 3.000.00 $52,145.00 $52.145.00 CHANGING TO THE CORPORATE FORM 363 The agreement under which the business is to be incorporated provides for the following: (a) Capital stock, $50,000.00, divided into 500 shares, par value $100.00. (b) Jones & Smith to be paid for their interest in the old partnership with the stock in the corporation at par, th? following adjustments to be made prior to the transfer of the business: (1) 10 per cent is to be deducted from the inventory value. (2) 5 per cent is to be deducted from the value of furniture and fixtures. (3) The goodwill of the partnership is valued at $6,000.00 and placed on the books prior to the transfer. (4) No cash is to be turned over to the corporation. Smith is to take personally all cash excepting an amount sufficient to reduce Jones' investment to even hundreds of dollars, (s) Jones & Smith jointly guarantee collection of accounts receivable. (c) The stock remaining after the payment of the partners for their in- terest is subscribed for by Brown, who pays for his stock in cash. Give the entries to adjust the books of thr partnership and to close out the partnership business. Open the books of the corporation. Give the balance sheet of the corporation after the opening entries have been made. (6) Make the opening entries on the books of the Taylor Electric Com- pany, a concern which is incorporated according to the following agreement : Capital stock, $200,000.00. H. C. Taylor, the promoter of the enterprise, is to receive shares to the par value of $100,100.00 for which he is to pay $90,000.00 in cash in two equal installments. He is to receive credit toward his subscription for $10,100.00 on account of services rendered during the process of incor- poration. Stock to the par value of $40,000.00 is subscribed for by How- ard at no, payment to be made in two equal installments. Jones sub- scribes for $10,000.00 at no, payment to be made in two equal installments. The remaining $49,900.00 of stock is given to Smith in full payment for his electric lighting plant. Taylor, Howard, and Jones all pay their first installment as it comes due. Make the entries. Taylor pays his second installment in cash; Howard pays $15,000.00 in cash and gives a note due in 30 days for the remainder. Jones defaults in his payment. The stock subscribed for by Jones is sold by the directors to White at 105. White pays for the stock in cash, and the directors refund to Jones the amount of his first payment above the sum necessarily retained to protect the corporation against loss. Make the entries. An appraisal is made of the Smith plant at this point which shows the following facts: Land 10,000.00 Buildings 20,000.00 Transmission Lines 15,000.00 Accounts Receivable 1,000.00 Accounts Payable 3,000.00 49,000.00 Place the assets on the books at their appraised value. CHAPTER XXVH BOND ACCOUNT 1. Issue of Bonds. \Yhen mortgage bonds are issued, the consent of the stockholders is first secured. Then a deed of trust is created fully describing the terms under which the issue is made and a trustee is selected and charged with the duty of certifying all bonds proposed before they are actually issued by the corporation. The bonds are then prepared in due form and turned over to the trustee for certification before they are issued to subscribers who have paid in full for their bonds. 2. Bond Subscriptions. Bonds may be paid for in full at the tune of their purchase. In some instances, however, a subscriber will have the right of paying for his bonds on the installment plan. For brevity, however, the most usual entry for an authorized issue of $500,000.00 of first mortgage bonds, $400,000.00 of which had been subscribed, would be as follows: (a) Unissued Bonds 500,000.00 Bonds Payable 500,000.00 Authorization of half million of first mortgage 5 per cent bonds due December 31, 1940, dated January i, 1920, interest payable January i and July i (b) Bond Subscribers 400,000.00 (Subsidiary subscription accounts in subscrip- tion ledger.) Unissued Bonds 400,000.00 Entry of subscription for $400,000.00 of first mortgage 5 per cent bonds (c) Cash 100,000.00 Bond Subscribers 100.000.00 (Subsidiary subscription accounts credited also) A more accurate description of the accounts would require a substitution of an account of unsubscribed bonds for that of un- 364 BOND ACCOUNT 365 issued bonds. But the usage indicated in the journal entries is the more general although it makes the word "unissued" mean the same thing as the word "unsubscribed." The subsidiary ledger for bond subscribers would be of the same character as that for stock subscribers described in a preceding chapter. The best usage would require the bond item on the liability side of the balance sheet to appear as follows : Bonds Payable $500,000.00 Less Unissued 100,000.00 Bonds Issued $400,000.00 When the subscriptions had been paid the "bonds issued" would become the bonds outstanding. There is some contro- versy as to whether unissued bonds should be treated as an asset or as a deduction from the liability as shown above The mer- its of the case are more fully discussed in a paragraph below. Bonds which are simply authorized are preferably regarded as a deduction from bonds payable. 3. Bond Discount. Bonds always bear a fixed rate of in- terest which is payable at stated times, annually, semi-annually, or quarterly. If the nominal rate which the corporation prom- ises to pay on the par or face value of the bonds is lower than the acceptable rate for such loans the bonds cannot be sold for the par value but must be sold at a discount. Let us suppose that the bonds referred to above bear 4 per cent interest pay- able semi-annually, Jan. i and July i, and bring only 90 cents on the dollar or sell at a 10 per cent discount. Then the sale would be journalized as follows: Cash 360,000.00 Bond Discount 40,000.00 Bonds Payable 400,000.00 4. Treatment on Bond Discount. The interest paid for the use of money is the expense involved in securing the loan of the funds borrowed. But when the face value of the bond payable exceeds the amount of money secured the cost of the loan is the interest plus the discount on the bonds. This ex- 366 ACCOUNTING PRINCIPLES cess in the face of the bond represents interest paid in ad- vance. Bond discount, therefore, partakes of the nature of a deferred expense and should be classified with the deferred ex- penses in the balance sheet. During the life of the bonds, this interest paid in advance is treated from year to year as insur- ance paid in advance has been treated. The expired part of the payment is marked off each year. A rough calculation of expired discount for each year could be had by dividing the total discount by the life of the bonds. However, a more ac- curate computation of expired discount can be made by the use of bond tables showing the yield of the bond sold at a discount or the effective (true) interest received by the investor and paid by the corporation. Let us suppose, for example, that a $1000.00 bond with nominal rate of 4 per cent and effective rate of 5 per cent was sold at $950.00. The following table will show the expired discount each year: Norn. Cost Effective Nominal Expired Prin. Prin. Interest Interest Discount 1,000 95- 47-50 40.00 7.50 1,000 957-5 47-87 40.00 7.87 i,ooo 965.37 48.26 40.00 8.26 The entry which the corporation would make at the end of the first year for the interest on the $1000.00 bond would be as follows: Interest 47. 50 Cash 40.00 Bond Discount 7.50 The effective rate is the interest basis upon which the bonds are sold and the yield on the investment. In the case above cited the 8950.00 represents the actual investment made by the bond buyer. The corporation pays effective interest on these funds and the amount of interest at the effective rate repre- sents the interest cost to the corporation. Although the nomi- nal interest is $40.00 per year the effective interest is $47.50 for the first year, $7.50 of this amount being expired discount on the bonds. This accurate method of amortizing is referred BOND ACCOUNT 367 to as the scientific method. The division of the bond discount by the life of the bonds to get the amount of expired discount is referred to as the straight line method. If the bonds had been purchased at a discount instead of being sold, the principal would be increased each year as the bond approached maturity. The amount of increase in prin- cipal each year would be credited to interest. The entry for the first year would be as follows: Cash 40.00 Bond Investment 7.50 Interest 47 -So 5. Bond Premiums. If, on the other hand, 5 per cent bonds were sold at $1100.00 on a 4 per cent basis, i.e., to yield 4 per cent, a part of the $50.00 of interest paid each year would be a return of the bond premium. The premium is like de- ferred income or interest received in advance. The amount paid as interest each year is in part a return of the premium. The purchaser of the bond pays money in advance for the right to receive more each year than the effective rate on the par of the bonds purchased. The seller of the bond should credit his interest account each year with the amount representing a re- turn of premium and charge the bond premium with the same amount. The following table shows the nominal and effective interest and the excess of the nominal interest. This excess is the amount representing a return of a part of the premium re- ceived. Principal Nominal Invest. Price of Nominal Interest Effective Interest Excess of Nominal Bond per Year per Year Interest 1,000.00 1,000.00 1,000.00 1100.00 1,094.00 1,087.76 50.00 50.00 50.00 44.00 43-70 43-Si 6.00 6.24 6.49 The payment of the $50.00 nominal interest the first year would be journalized as follows: Interest 44.00 Premium on Bonds 6.00 Cash 50.00 368 ACCOUNTING PRINCIPLES If, however, the corporation should purchase such a bond as an investment a part of the interest received each year would be credited either to premium on bonds or to bond investments in case the premium were not carried as a separate account. The journal entry would be as follows: Cash 50.00 Interest 44.00 Bond Investment 6.00 6. Bond Investment Account. When bonds are purchased the date of purchase will not in general correspond with the interest date of the bonds. There will be accrued interest at the date of purchase. For example, $5000.00 of 6 per cent bonds, interest payable Jan. i and July i, may be purchased March 15 in New York City. Interest has accrued for a frac- tion of the half-year interest of 3 per cent. If the bonds are purchased at 102 and accrued interest the question arises as to the price paid. Since the accrual calculation here involves the payment of a money price, the accrued interest calculation might be made with accuracy at 73/181 of the 3 per cent an- nual interest payment to be made July i, or 73/181 of which is $60.49. The cost of the bonds would be $5160.49. If 360 days were taken as the year and the half year taken as the unit, since one half of the annual interest is paid July i, then the accrual fraction would be 73/180 instead of 73/181 and the accrued interest $60.84. If, however, the month be taken as the unit for accruals and be regarded as consisting of 30 days, then the accrual would be for 2-7/15 months and would amount to $61.00. This less accurate method is frequently used in ac- cruals for the purpose of closing the books. The New York Clearing House method would make the interest $60.84 since 360 days is treated as a year according to the rules of the clearing house. According to the statute law of the state of New York the accrued interest would be $60.49 because 365 days constitute the year according to the statute in question and the number of days falling in each half year is taken as you find it except that the extra day of the leap year is ig- BOND ACCOUNT 369 nored. We may, therefore, assume that the bonds are pur- chased at $5160.49. The journal entry would be as follows: 5,100.00 60.49 5,160.49 On July i the corporation would receive the $150.00 of interest for the half year. At that time the appropriate journal entry is the following: Cash 150.00 Bond Interest 150.00 Entry of payment of semi-annual interest The $60.49 f ^e $150.00 received by the corporation was in- terest income for the seller of the bond and not for the buyer. The seller of the bond held as an investment would have jour- nalized his sale as follows: Cash 5,160.49 Bond Investment 5,100.00 Bond Interest 60.49 If the issuing corporation sold the bonds at $102.00 and ac- crued interest it would journalize the sale as follows: Cash 5,160.49 Unissued Bonds 5,000.00 Bond Premium 100.00 Bond Interest 60.49 When a bond issue is placed on the market it accumulates in- terest, in case the sale materializes, from the date of the bond. In case the sale did not materialize the corporation would find no good reason for paying interest to itself on unissued bonds. If, however, a corporation invests in its own bonds with a view to accumulating a fund for some purpose by setting aside the interest, then the corporation may pay itself interest on its own bonds. If the buyer of a bond were strict in his computation he would object to paying what is described above as accrued in- terest in addition to the fair investment price of a bond. The accrued interest right figured at $60.49 is worth a little less 370 ACCOUNTING PRINCIPLES than $60.49 because about two and one half months elapse before the sum is received. This fact, however, seems to be largely ignored in the bond market and this right to receive $60.49 several months later is consequently purchased at its face value instead of at its discounted value. 7. Treasury Bonds. The term treasury bonds is not limited altogether to the meaning of bonds sold and later re- purchased by the corporation. It is also applied to unissued bonds either certified by the trustee or simply authorized under a mortgage or other written instrument. The Interstate Com- merce Commission has denned as nominally issued bonds those which have been certified by the trustee and placed with the proper officer for sale and delivery, or pledged, or placed in some fund of the corporation. If bonds which have been is- sued and outstanding are reacquired by the corporation they are designated by the Interstate Commerce Commission as nominally outstanding bands. It would seem desirable to re- tain for the treasury bond term a meaning similar to that ap- plied to treasury stock if usage had not already rendered the term ambiguous. It is not unusual in corporation accounting to include the nominally outstanding bonds in some special fund or in the investment bond account. From the standpoint of their availability for corporate uses there are the following four classes of bonds: (a) unissued bonds, or those authorized and not "nominally issued"; (b) those nominally issued; (c) those nominally outstanding; (d) those actually outstanding, or those sold to a bona fide purchaser and not reacquired. There must always exist in fact a liability for bonds actually outstanding which cannot exist for the other classes. If a cor- poration became insolvent and its assets are sold to meet the claims of the creditors none of the types of bonds except actu- ally outstanding bonds would have a claim against assets which would be considered by the owners of other claims against assets. The pledged bonds nominally issued might become actually outstanding bonds when the creditors holding them as security saw fit to foreclose. It would consequently be significant to show bonds payable in the balance sheet in the following form: BOND ACCOUNT 371 Bonds Payable Less: Unissued Bonds Nominally Issued Bonds Nominally Outstanding Bonds Bonds Payable Actually Outstanding The question arises as to how the nominally outstanding bonds should be entered when purchased. This question is in- volved in the nature of the transaction. A candid examination of the facts must require the conclusion that the purchase of a corporation's own bonds to the amount of $5000.00 decreases its liabilities by the same amount, but does not increase its as- sets. If, for example, the bond in question were a first mort- gage bond the holder of a second mortgage bond would be in error if he counted the $5000.00 of nominally outstanding bonds as a liability in the calculation of the amount of liability prior to his own. If the assets were liquidated and the corporation were dissolved, no funds would be required to meet the nomi- nally outstanding bonds which had been purchased. If the corporation purchased back at par $5000.00 of bonds sold at 102 and accrued interest the entry would be: Nominally Outstanding Bonds 5,000.03 Cash 5,000.00 Purchase of $5,000.00 of company bonds at par If they had been purchased at 101, the entry would be: Nominally Outstanding Bonds 5,000.00 Premium on Bonds 50.00 Cash 5,050.00 Purchase of $5,000.00 of company bonds at 101 By this transaction the corporation lost $50.00 of the premium secured in the original issue of the bonds. This treatment of the account of nominally outstanding bonds would result in a correct statement of the liabilities when the nominally out- standing bonds, the nominally issued bonds, and the unissued 372 ACCOUNTING PRINCIPLES bonds are subtracted from bonds authorized to show the bond liability of the corporation. The same principle would apply to the entry of bonds if purchased at a discount. The account would be charged with the par of the bonds and bond discount would be credited along with the cash credits, if the bonds had been sold at a discount. The bond premium would be debited if the bonds had been sold at a premium. The treatment of the purchase of com- pany bonds and the treatment of reissued bonds as deductions from outstanding liabilities is not in accord with more gen- eral practice, although it has some adherents. 1 It is argued by some that the purchase of company bonds for sinking fund purposes makes it desirable to treat such bonds as a sinking fund investment at their purchase price so that the sinking fund will maintain the proper proportions when com- pared with the bond liability. If, however, the purchase of company bonds be regarded as decreasing the liability of the corporation and the funds used be regarded as a credit to the sinking fund, the sinking fund would still bear the right pro- portion to the bonds outstanding. The terms of a deed of trust might make such a treatment of the case inadvisable, but there seems to be no fundamental reason why the deed of trust should be so drawn that bonds nominally outstanding would be neces- sarily treated as an asset when purchased with funds from the sinking fund. However, when company bonds are carried in the sinking fund they would be entered as any other bond investment so far as their book value and cost are concerned. They would be entered at cost and their premium or discount would be duly authorized, or spread over the life of the bond as set forth in a preceding paragraph. In case it was found desirable to use the term "bonds in the treasury" to indicate all bonds certified by the trustee and held in the treasury either as a result of the purchase of company bonds or as a result of delay in the sale of certified bonds, the liabilities of the corporation would be correctly represented in See C. S. Luddam, C. P. A. (N. Y.), Journal of Accountancy, March, 1914. BOND ACCOUNT 373 the balance sheet by showing this class of bonds along with the unissued bonds as a deduction from those authorized. The items would appear as follows: Bonds Payable Less: Unissued Bonds Bonds in the Treasury Bonds Payable Outstanding In case, however, one desires to make the bond classification fully descriptive, it will be found useful to adopt the Interstate Commerce Commission's classification. The classification, at least, serves the purpose of the most complete analysis. PROBLEMS AND QUESTIONS i. The ABC Corporation is incorporated to take over the assets and the liabilities of the AB partnership and of C's individual business. The AB partnership has assets and liabilities as follows: Plant and Property Furniture and Fixtures Merchandise Inventory Cash Assets Liabilities Notes Payable Accounts Payable A's Capital B's Capital C has assets and liabilities as follows: Assets Plant and Property Delivery Equipment Furniture and Fixtures Merchandise Inventory Cash Liabilities Notes Payable Accounts Payable C's Capital $150,000.00 20,000.00 75,000.00 10,000.00 $20,000.00 50,000.00 100,000.00 85,000.00 555,000.00 10,000.00 15,000.00 50,000.00 4,000.00 15,000.00 35,000.00 $255,000.00 70,000.00 $185,000.00 $164,000.00 50,000.00 $114,000.00 374 ACCOUNTING PRINCIPLES The AB partnership is allowed for goodwill $25,000.00, after plant and property is marked down $10,000.00. C is allowed a goodwill of $12,000.00 and the merchandise inventory is reduced by $5,000.00. The ABC Corporation authorized $400,000.00 of capital stock and $100,- ooo.oo.of first mortgage 4^2 P^r cent bonds, dated January i, 1920, and due January i, 1940, with interest payable annually January i. The bonds are sold on ^a 5 per cent basis to the Central Trust Co. at 92.77 and accrued interest, one half in cash at the time of subscription and the balance in 6c days. A, B, and C also subscribe for $20,000.00 each in capital stock, pay- ing 10 per cent down, the balance to be paid in equal installments in three and six months respectively. (a) Make journal entries to transfer the partnership to the corporation. (b) Make journal entries to transfer C's business to the corporation. (c) Make the opening on the books of the corporation. (d) Make journal entries also covering the sale of the bonds. (e) Make also the interest entries for the bonds January i, 1921, when the first annual interest is paid. 2. Define the various classes of bonds according to the Interstate Com- merce Commission classification. 3. (a) On April i the company bought for cash $5,000.00 of 5 per cent bonds on a 6 per cent basis at 90 and accrued interest. The bonds were dated January i, 1918, the interest date being January i and July i, and the purchase was made in the state of New York, where 365 days is counted as a year. Journalize the purchase, designating the bonds as treasury bonds purchased. (b) On September i the bonds are sold at 95 and accrued interest. Jour- nalize. CHAPTER XXVIII CHANGES IN THE VALUE OF THE PROPRIETARY INTEREST OF THE CORPORATION i. Definition of Profits. Much has been written by ac- countants, economists, and others about profits and the mean- ing of the term. For the purposes of this elementary treatise the term net profits may be defined as the earnings of the proprietary interest after all prior contractual payments and accruals have been duly considered. When a corporation has been first organized the proprietary interest is represented by the capital stock. The additions to the proprietary interest from year to year are credited to the surplus account so that the proprietary interest of a corporation which has been in operation for a period of time is represented by the capital stock plus the surplus. The periodic additions to surplus from year to year represent the increases in the proprietary interest or in the stockholders' interest. The increase in the proprietary interest due to the business operations for which a concern is organized is referred to as the profits from operation. There are also sources of income indi- rectly associated with regular operations such as investments in related enterprises or incidental rentals and earnings. These incomes are generally 'designated as other income. The term net profits is used to designate the balance after incidental and interest expense deductions are made from the total income re- sulting from the addition of other income to profits from oper- ation. These net profits, however, generally mean the ordinary net profits. Profits from the sale of fixed assets or any extraor- dinary profit are frequently carried directly to the surplus ac- count. The total net profits, however, would include the ex- traordinary net profits and hence comprise the total net in- crease in the proprietary interest. 375 376 ACCOUNTING PRINCIPLES 2. Book Value of Shares. When the corporation is organ- ized the shares stand on the books at the par value and there is not generally any surplus reserve, since this reserve is accumu- lated from annual profits. Let us suppose that plant and prop- erty are transferred to the ABC Corporation at $500,000.00, and that capital stock to the par value of $500,000.00 is issued to the owner of the plant and property. Let us further sup- pose that $500,000.00 additional stock is sold for cash at par. The balance sheet would then be as follows: ABC CORPORATION BALANCE SHEET, DECEMBER 31, 1920 Assets Liabilities Cash $500,000.00 Capital Stock $1,000,000.00 Plant and Property 500,000.00 $1.000.000.00 Sr.ooo.ooo.oo The book value of each share is $100.00 hi the beginning. After a year's operation the net profits of, say, $50,000.00 are carried to surplus and the balance sheet would be as follows: ABC CORPORATION BALANCE SHEET, DECEMBER 31, 1921 Assets Liabilities Cash $250.000.00 Capital Stock $1,000,000.00 Accounts Receivable 40,000.00 Surplus 50,000.00 Merchandise Inv. 200,000.00 Furniture and Fixts. 20,000.00 Plant and Property 540,000.00 $1.050.000.00 $1.050.000.00 After the $50,000.00 of profits have been added to surplus the total proprietary interest is then $1,050,000.00. If the par value of a share is $100.00 the number of shares would be 10,000 and the book value of shares on December 31, 1921, CHANGES IN VALUE OF PROPRIETARY INTEREST 377 would be $1,050,000.00 or $105.00 per share. When the sur- plus had accumulated to $500,000.00, the book value of a share would be $150.00. 3. Declaration of Dividends. Instead of adding the net profits of each year to surplus there may be a distribution from surplus of a part of the accumulated earnings. It creates a more favorable market for a stock if a dividend of a certain amount is paid each year. The initial dividend should not be placed so high that it will probably be necessary to reduce it in later years in order to preserve the surplus accumulated be- fore the initial dividend is declared. The market value of the stock is favorably affected by a stable dividend or, at least, one that is not decreased from year to year. It is common, therefore, for a corporation, in prosperous years, to declare an increased dividend as an 'extra dividend. If the regular divi- dend is 6 per cent and it seems feasible for a particular year to declare an 8 per cent dividend, the declaration may take the form of a regular dividend of 6 per cent and an extra dividend of 2 per cent. The regular dividend would not be made 8 per cent until it seemed probable that the annual dividends of the future would not fall below 8 per cent. The payment of divi- dends makes it necessary to have a list of stockholders with addresses. When stocks are sold they must, therefore, be re- corded in the books of the treasurer as transferred. A trans- fer book is frequently used for this purpose; the shareholder who sells his shares would be charged in his capital stock ac- count for the par value of the shares sold and the purchaser would be credited in the capital stock ledger for the par value of the shares purchased. The capital ledger, therefore, will fur- nish the list of stockholders which will suffice for the payment of dividends. The dividends are declared as payable to the shareholders of record as of a certain date and are also declared as payable a few days after this date of closing the transfer books for the purpose of making a list of stockholders. Suppose a 2 per cent dividend were declared as payable January 15, 1922, to stock- holders of record January i, 1922. Books might then be closed ACCOUNTING PRINCIPLES for transfer purposes from January i, 1922, to January 15, 1922. The stocks sold between January i and January 15 would be sold ex-dividend. If the dividend were 6 per cent the market value of the share on January i should decrease $6.00 per share. If a share were purchased January 2 the seller would receive the dividend of January 15, although he might not own the share at that time. The buyer takes the share ex-divi- dend, which means that he will not receive the approaching dividend. 4. Journal Entry of Dividends. If a 2. per cent dividend were declared December 15, 1921, payable January 12, 1922, on the $ i ,000,000.00 of stock the journal entry would be as fol- lows: DECEMBER 15, 1921 Surplus-Dividend 10,000.00 Dividend Payable 10,000.00 Declaration of dividend on common stock When the dividend was paid the entry would be: JANUARY 15, 1922 Dividend Payable 10,000.00 Cash 10,000.00 Payment of 2 per cent dividend 5. Dividends and Book Value. The surplus has been re- duced $10,000.00 by the dividend and the total book value of the proprietary interest has been reduced from $1,050.000.00 to $1,030,000.00, the book value per share being reduced from $105.00 to $103.00. 6. Book Value and Market Value. The book value of shares signifies what has been invested by the proprietary in- terest rather than the present sale price of this investment. The annual total net profits of a corporation divided by the num- ber of shares represents the annual earnings of each share. The market value of a share depends more on its prospective annual earnings than on the book value. An increase in book value has a significance because it is fair to presume that the in- creased investment per share will result in increased earnings CHANGES IN VALUE OF PROPRIETARY INTEREST 379 per share. If the prevailing rate of interest which investors may expect on an investment of the character of the ABC Cor- poration stock were 8 per cent and the annual earnings amount to only 5 per cent on the par of the stock or $5.00 per share, then the shares would sell for $5.001.08 or $62.50 per share. The rate of capitalization in this case is 8 per cent. There are va- rious factors affecting this rate, such as the risk involved and the policy as to dividend distribution. For good investments (those involving little risk) the rate is lower and the value of a given prospective annual earning is greater. It is clear that anything affecting the expected earnings of a corporation will also affect the market value of its shares. 7. Stock Dividends. The stock dividend accomplishes for the stockholders of the corporation substantially the same thing that the credit to capital accomplishes in the case of the part- nership. It is a device by which the surplus of the corporation is carried to the credit of the stockholders in the form of a cer- tain number of shares with a definite par value. A stock divi- dend is never declared unless there is a corporate surplus ac- cumulated to offset the stock dividend. Let us suppose that the ABC Corporation after accumulating a surplus of $500,- ooo.oo decides to issue a stock dividend of 25 per cent. This stock dividend would carry to each shareholder with four shares an additional share, making his interest to consist of five shares in the corporation instead of four. However, the aggregate proprietary interest consisting of capital stock plus surplus is not affected by the stock dividend. Part of the pro- prietary interest which was formerly classified as surplus is, after the declaration of the stock dividend, classified as capital. The journal entry for the declaration of the 25 per cent divi- dend would be as follows : Surplus-Stock Dividend 250,000.00 Dividend Payable 250,000.00 The dividend would again be declared payable on a certain date to stockholders of record on a prior date. The payment of the dividend would be accomplished by the issue of 250 380 ACCOUNTING PRINCIPLES shares which would be distributed as a 25 per cent dividend on the holdings of each shareholder hi the corporation. Some of the shareholders would receive fractional shares, since 25 per cent of their holdings would not represent an integral number of shares. When the dividend is paid the journal entry would be as follows: Dividend Payable 250,000.00 Capital Stock 250,000.00 The specific shareholders' accounts in the stock ledger would be credited with the additional shares going to each shareholder as a result of the declaration of the stock dividend. The Supreme Court has recently held that a stock dividend is not income. The only peculiarity about the question is that a stock dividend should have ever been supposed to constitute income. It is clear that the shareholders and the corporation itself own no more after the declaration of dividends than they owned before the declaration. The ownership of shares carried with it the ownership of the surplus and the distribution of additional shares did not increase the total equity or the total book value of interest in the assets of the corporation. An in- come to the shareholders from the corporation always results in a decrease in the assets of the corporation. 8. Subscription Rights. Frequently the shareholders of a corporation decide to increase the capital stock by issuing an additional number of shares to be paid for at the par yalue. If, however, the shares have a market value hi excess of par, as a result of the accumulation of the surplus, the new shares issued will ordinarily sell for more than their par value after they have been subscribed for and issued to the stockholders. As a result of this fact, the stockholders ordinarily reserve for themselves the right to purchase the new shares, each share- holder having the right to purchase an amount of the new shares in proportion to his holdings at the time of the issue. If the capital stock were increased 25 per cent, each shareholder would be entitled to subscribe for additional shares in an amount equal to 25 per cent of the number of shares already owned CHANGES IN VALUE OF PROPRIETARY INTEREST 381 by the stockholder. A stockholder owning four shares would have the right to subscribe for the additional share which he is entitled to purchase. He would, however, have the alternative of selling his right at its market value on the open market. Let us now see what the value of a right to subscribe would be. Suppose, for example, the market value of the shares of a corporation is $150.00 per share. Four of such shares would be worth $600.00. One additional share at $100.00 would mean that the assets back of the five shares including the additional one issued would be worth $700.00 and consequently the value of the assets corresponding to each share would be 700/5 or $140.00. In other words, by paying $100.00 a man with four shares acquires an additional share worth $140.00. The profit on the transaction is clearly $40.00. The subscription right, therefore, going with each one of the four shares would be worth one fourth of the $40.00, or $10.00 per share. In such an instance, rights would sell at approximately $10.00 per share held prior to the new issue. The actual market value of the rights may vary to some extent from the calculated value of the right to subscribe, on account of the particular circum- stances affecting the demand for the stock in question, but in general the market value will not fluctuate widely from the calculated value of the right as indicated above. The journal entry involved in the issue of additional stock does not differ from the entries already described in connection with opening the books of the corporation. 9. Discount on Stock. While most of the states require that all capital stock shall be issued for property worth not less than the par value of the stock issued, there is still a possibil- ity in some parts of the country and in other countries, of is- suing shares for an amount of cash less than the par value of the shares in question. If $250,000.00 of capital stock is issued at seventy-five cents on the dollar, the entry would be as fol- lows: Cash 187,500.00 Discount on Stock 62,500.00 Capital Stock 250,000.00 382 ACCOUNTING PRINCIPLES This discount of $62,500.00 represents in fact that the proprie- tary interest when stated at $250,000.00 is overstated by $62,- 500.00. This overstatement may be remedied by crediting each year a certain portion of the corporate surplus to discount on stock. Let us suppose, for example, that it was decided to mark off the $62,500.00 of discount on stock over a period of ten years. Each year $6.250.00 of the discount would be charged against the surplus, the journal entry being as follows: Surplus 6,250.00 Discount on Stock 6,250.00 Charging discount on stock to surplus At the end of ten years the discount on stock would have dis- appeared, and the capital stock liability would fairly represent the actual investment of the stockholders in the corporation. At any time prior to this, the proprietary investment would be fairly represented on the liability side of the balance sheet by the deduction of the discount on stock from the capital stock issued. For example, at the end of the first year, when $6,250.00 of the $62,500.00 had been charged against surplus, the following statement of the capital stock item would fairly represent the proprietary capital investment : Capital Stock $250.000.00 Less: Discount on Capital Stock 56.250.00 Capital Stock Investment $193,750.00 This manner of statement, however, is not one generally adopted, although it would be the most desirable statement of fact. In some instances the discount on stock may be car- ried on the asset side of the balance sheet, where it would serve to convey the idea of an amount of assets hi excess of a fair statement of the total investment in these assets. There are some who have argued that a discount on stock is a part of the cost of the property actually turned over in exchange for the stocks. This, however, seems to be a superficial view of the nature of the transaction involved. 10. Premium on Stock. It is much more common, how- ever, to have stock issued in the first instance for cash in ex- CHANGES IN VALUE OF PROPRIETARY INTEREST 383 cess of the par value of the shares than it is to receive an amount of cash less than the par value of the stocks issued. Property is frequently overvalued in connection with the issue of stock. However, when shares are issued for cash in connec- tion with an original issue they are more commonly sold at the par value of the shares. The national banks frequently sell shares in excess of par, because the law requires the bank to accumulate a certain surplus prior to the declaration of the dividends. If, however, the required surplus is contributed by the shareholders in connection with the organization of the corporation, there will be no legal prohibition against the pay- ment of dividends even during the first year of the operation of a bank. If $200,000.00 of capital stock is sold at 120, the jour- nal entry would be: Cash 120,000.00 Capital Stock 100,000.00 Premium on Stock 20,000.00 Sale of $100,000.00 of capital stock at premium of 20 per cent. The national banks, however, generally credit the $20,000.00 to surplus instead of designating the item as premium on capi- tal stock. It seems desirable, however, that the word "sur- plus" be used to describe the increases in proprietary interest from year to year arising from the operations of the business rather than from initial investment. It is of course true that the premium on stock is a part of the proprietary investment just as the surplus is a part of the proprietary investment, and should be added in with surplus in connection with the calcu- lation of book value of the shares of the corporation. There is no occasion for the 'retiring of premium on stock. It is. re- garded as appropriate that the dividends shall be declared out of surplus accumulated from the earnings of operation. The contributed surplus, such as that arising from premium on stock, is ordinarily regarded as a part of the permanent pro- prietary interest of the stockholders rather than as a part of the surplus subject to distribution from time to time. 384 ACCOUNTING PRINCIPLES ii. Available Surplus. The term available surplus is or- dinarily understood to designate that part of the surplus of a corporation which is available for dividends. There is no legal objection to the distribution of the entire accumulated surplus of a corporation. There would be no legal bar to a declaration of dividends from premium on stock, if this divi- dend did not reduce the surplus to an amount below that which might be required by law as in the case of the national banks. It is not regarded, however, as desirable business procedure to distribute to stockholders except from the surplus which has been accumulated from earnings. All of this surplus would be commonly regarded as available for the distribution of cash dividends or stock dividends. If one should define available surplus with reference to the amount of such surplus which would be available for cash dividends, it would be necessary to reduce further the amount of surplus which could be regarded as available. Cash cannot be distributed in excess of that which is on hand. If the cash on hand were less than the ac- cumulated surplus then the surplus available for cash dividends would be less than the accumulated surplus. In some instances the corporation may borrow money for the purpose of declar- ing cash dividends, provided there is an available surplus out of which dividends can be properly declared. This type of loan, however, is unusual, and is not generally regarded as con- servative business practice. If cash were temporarily tied up in current assets soon to be realized, it might be regarded as legitimate to make a temporary loan for the purpose of the payment of the dividend. The funds to be distributed to stock- holders as a dividend might be secured from bank loans or by the issuance of bonds or notes. This is a procedure which does not reflect credit on the financial management of a corpora- tion. There is in the case of some corporations a term more con- venient than surplus for indicating the accumulated earnings which are not regarded as a part of the permanent proprietary investment. This term is the undivided profits of the corpora- tion. In many bank statements the term undivided profits will CHANGES IN VALUE OF PROPRIETARY INTEREST 385 be found. Dividends or banks would, in general, be declared out of the undivided profits of the bank. When earnings are carried from the undivided profits into surplus, it is recognized that they become a part of the permanent proprietary invest- ment of the corporation and they would not, in general, be dis- tributed to stockholders unless they were later covered by a stock dividend. This stock dividend, however, is not in fact a distribution, and simply represents a different name or form for the proprietary investment. The undivided profits term would seem to be an entirely desirable form of designating the accumulated earnings which have not been so tied up in fixed assets or some other form of permanent investment that they would not be available for the declaration of cash dividends. Surplus would come to mean that part of the accumulated earnings of the property which has been used for the perma- nent enlargement of the enterprise of the stockholders, but has not been covered by issues of additional stock in the form of stock dividends. 12. Appropriated Surplus. The words appropriated surplus are commonly used to designate that part of the corporate sur- plus which has been set aside for some special use. For exam- ple, if the corporation surplus amounted to $200,000.00 and $100,000.00 of this corporate surplus were set aside for prop- erty additions or for improvements, the journal entry would be as follows: Surplus 100,000.00 Appropriated Surplus-Improvements 100,000.00 Instead of having all of the appropriated surplus items in one account it might be desirable to carry several accounts repre- senting the purposes of the appropriations. In such cases the appropriated surplus item may be designated as a reserve. The alternative entry would then be: Surplus 100,000.00 Reserve for Improvements 100,000.00 Setting aside part of surplus for improvements 386 ACCOUNTING PRINCIPLES The words appropriated surplus might then be used as the name of an item in the balance sheet under which the several special reserves would be listed. For example, if these reserves in the case of a given corporation were for improvements or for a sinking fund, they might be designated on the balance sheet as follows: Appropriated Surplus: Sinking Fund Reserve $25,000.00 Reserve for Improvements 50,000.00 75,000.00 The two accounts involved would be the sinking fund reserve and the reserve for improvements. The appropriated surplus would simply be the name of a group of accounts brought to- gether in the balance sheet because of their similarity. 13. Donated Stock. According to the laws of most of the states it is illegal to issue shares of stock with a par value in excess of the value of property transferred to the corporation in exchange for the shares. However, there is no efficient ad- ministrative provision in many of these states for the enforce- ment of the statute. Property is frequently transferred to the corporation in exchange for shares with a par value far in ex- cess of the market value of the property received by the corpo- ration. A group of individuals in organizing a corporation can transfer to the corporation a certain amount of property in ex- change for the total amount of authorized capital. The capital thus becomes paid up stock. The shareholders can, if they see fit, donate to the corporation 25 or 50 per cent of the capital stock or such other amounts as they may determine, and the corporation will then have the right to issue this paid up capi- tal to subscribers for treasury stock at such prices as the shares may bring on the open market. This procedure amounts in fact to an evasion of the law in regard to the issue of shares in exchange for property worth less than the par value of the shares issued. Let us suppose that X, Y, and Z organize a cor- poration and turn over their property to the corporation in exchange for capital stock with a par value of $500,000.00. They then decide to raise working capital by donating to the CHANGES IN VALUE OF PROPRIETARY INTEREST 387 corporation 25 per cent of their respective holdings, to be later sold for the purpose of raising working capital. The journal entry involved in donating this stock to the corporation would be: Treasury Stock 125,000.00 Donated Surplus 125,000.00 Donation of treas-ry stock by stockholders If the stock were donated with the specific provision that it should be used for working capital the account working capital might be substituted in the journal entry for the term donated surplus. It is also a general practice to regard the treasury stock as one of the assets of the corporation and donated sur- plus as one of the surplus reserves of the corporation. It is questionable whether in fact treasury stock can be fairly re- garded as an asset of the corporation because .of the fact that the corporation cannot own a proprietary claim in its own as- sets; that is, the corporation owns all of the assets and it owes the stockholders and the holders of liabilities for what it has received in the form of assets. If any claim, whether of the character of a bond or stock, is turned over to the corporation, its liabilities to the bondholders or to the stockholders would thereby be canceled. If no money were paid in exchange for the bond or stock, the surplus would be increased by the par value of the donated liability or proprietary interest. The actual proprietary investment would therefore be properly represented on the balance sheet by making treasury stock a deduction from capital stock issued, the balance being desig- nated as outstanding capital stock. In the instance above cited, let us assume that the balance sheet stood as follows prior to the donation of the stock: BALANCE SHEET, XYZ CORPORATION Assets Liabilities Plant and Capital Stock $500,000.00 Property $500,000.00 388 ACCOUNTING PRINCIPLES After the donation of $125,000.00 of stock, the balance sheet might be properly represented as follows: BALANCE SHEET, XYZ CORPORATION Assets Liabilities Plant and Capital Stock $500,000.00 Property $500,000.00 Less: Treas. Stock 125,000.00 Outstanding Capital Stock 375,000.00 Donated Surplus 125,000.00 $500,000.00 $500.000.00 This type of representation does not correspond to universal usage. Frequently treasury stock is carried in the balance sheet as an asset of the corporation. If the $125,000.00 of treasury stock were sold for $100,000.00 cash, the journal entry would be: Cash 100,000.00 Discount on Treasury Stock 25,000.00 Treasury Stock 125,000.00 Sale of the corporation's treasury stock At the time of closing the books, the discount on treasury stock account should be closed into the donated surplus account by the following journal entry: Donated Surplus 25,000.00 Discount on Treasury Stock 25,000.00 Closing discount on treasury stock into donated sur- plus 14. Purchase of Treasury Stock. While it is not generally regarded as legitimate practice for a corporation to deal hi its own capital stock, it frequently happens, nevertheless, that a corporation does purchase its own stock. This would be re- garded as entirely legitimate, if it were under obligations to re- tire the stock at a certain designated tune. The stock might then be retired by purchase in advance of the date when its re- CHANGES IN VALUE OF PROPRIETARY INTEREST 389 tirement might be required. If the XYZ Corporation should purchase $20,000.00 of its outstanding stock at $90.00 per share, the following entry might be made covering the purchase: Treasury Stock 20,000.00 Discount on Treasury Stock 2,000.00 Cash 18,000.00 Purchase of $20,000.00 of treasury stock This form of entry would be more in accord with the donated stock entry described above. However, practice is not entirely uniform in regard to the entry of donated stock. There are some who regard treasury stock as an asset, and would there- fore be inclined to enter donated stock at the estimated market value of the stock donated, and to credit donated surplus with a similar amount. Likewise, they would enter the purchase of the $20,000.00 of capital stock referred to above as follows: Treasury Stock 18,000.00 Cash 18,000.00 Purchase of $20,000.00 of stock at 90 This latter entry would require that treasury stock be carried as an asset of the corporation while the former entry would require that the $20,000.00 of treasury stock be carried as a deduction from capital stock issued, and would further require that the discount on treasury stock of $2,000.00 should be closed into the surplus account at thfe time of closing the books. The lat- ter usage seems to the writer to be more in accord with the facts and with the nature of the transaction involved. The fact is that treasury stock once purchased is canceled and ad- ditional shares are issued when a sale is made of an amount of stock equal to that which has been purchased. So far as the nature of the asset is concerned, there seems to be little differ- ence between stock duly certified and ready to issue and stock which has been purchased subject to re-issue by the corpora- tion. In both cases there is a decrease of the proprietary in- vestment in the form of capital stock as compared with the authorized capital. If $10,000.00 of the $20,000.00 of capital stock purchased 3QO ACCOUNTING PRINCIPLES above were sold at $95.00, the journal entry involved would be as follows: Cash 9,500.00 Discount on Treasury Stock 500.00 Treasury Stock 10,000.00 If, however, treasury stock were regarded as an asset at $18,- ooo.oo, then the sale of $10,000.00 of stock costing $9,000.00 at $9,500.00 would be journalized as follows: Cash 9,500.00 Treasury Stock 9,000.00 Surplus 500.00 Sale of $10,000.00 of treasury stock costing $9,000.00 for $9,500.00 A question might be raised as to whether a profit on treasury stock should be carried directly to surplus. It might be argued that the surplus should be specifically designated so as to dif- ferentiate it from the regular surplus of the corporation. In general, however, the profit would probably be carried directly to surplus. The writer does not believe that the latter entry represents the best practice because treasury stock is not be- lieved to be properly regarded as an asset of the corporation. 15. Sale of Fixed Assets. There is a distinct advantage in showing the net profits item of the corporation from year to year in such form that it will be fairly comparable with the net profits of other years. This has ordinarily been accom- plished in accounting by making the net profits revealed by the revenue statement to consist of the profits of operation plus the incidental profits derived from incidental investments of the business. Profits from the sale of fixed assets have then been generally closed directly into surplus without being shown in the regular revenue statement in the comparison of the prog- ress of a business from year to year. However, there is also something to be said in favor of bringing the surplus account into the regular statement and showing the sources of addi- tions to surplus that may arise out of extraordinary circum- stances such as the sale of fixed assets. CHANGES IN VALUE OF PROPRIETARY INTEREST 391 16. Surplus Account. At the beginning of each year the credit balance of the surplus account represents the accumu- lated earnings and profits from all sources which have not been distributed in previous years, or appropriated for the purpose of being used for certain designated purposes. At the close of the year the balance of the profit and loss account is carried to the credit of the surplus account. Dividends de- clared are debited to the surplus account. Likewise, separate surplus accounts are frequently created for such portions of surplus as may be designated as usable only for specific pur- poses. Corrections in the surplus account as at the beginning of the year, arising out of the discovery of errors in the ac- counts of a preceding year, would be carried as debits or cred- its to the surplus account at the end of the succeeding year. If several adjustments are made in the surplus account, an ad- justment account is sometimes set up, and the balance of this account is carried to the surplus account. For example, let us suppose that the valuation of furniture and fixtures is to be decreased by $750.00, the valuation of buildings to be de- creased by $3,000.00, and the reserve for bad debts is to be corrected by carrying $1500.00 of its balance to the credit of the surplus account. The following journal entries might be made to represent these changes: Adjustment Account 3,750.00 Furniture and Fixtures 750.00 Buildings 3,000.00 Reserve for Bad Debts 1,500.00 Adjustments 1,500.00 Surplus 2,250.00 Adjustments 2,250.00 This series of entries would serve to bring all of the adjusted items to the surplus account as one total instead of carrying them to the surplus account as separate items. However, the adjustment account has less use in corporation accounting than in the accounting for partnerships. Each change hi the value of assets would involve for the partnership a distribution to 392 ACCOUNTING PRINCIPLES the several capital accounts. The work is therefore very much shortened by the use of the adjustment accounts, thus avoid- ing all the distributions except the one final distribution of the net result of all the changes. In corporation accounting, how- ever, the adjustment account has little value, as the various charges and credits can be carried directly to surplus without loss in clerical speed. The surplus account as a part of the revenue statement might be attached in the following form: Net Profits for Year $ Surplus at the Beginning of Year Total Surplus Add: Portion of Bad Debt Reserve $ . Profits from Sale of Fixed Assets Extraordinary Profits from Other Sources Surplus Credit Adjustments Deduct: Reduction in Valuation of Land Loss from Sale of Fixed Assets Extraordinary Losses Balance Surplus Dividends on Stock Final Surplus, End of Year Appropriations : Reserve for Sinking Fund Reserve for Improvements Balance Unappropriated Surplus > The inclusion of a form similar to the one shown above will in- dicate as a part of the revenue statement the entire disposition of the profits for the year and of all former profits earned by the corporation. 17. Limitations to the Payment of Dividends. In many states there is a statute prohibiting the declaration of dividends except from profits and accumulated profits of the corporation. CHANGES IN VALUE OF PROPRIETARY INTEREST 393 It is intended by these laws to prevent the gradual dissipation of the original investment of the stockholders through the pay- ment of dividends, and thereby protect not only the interests of the stockholders themselves but the interests of the credit- ors of the corporation. This statute is, however, not properly enforced until it is comb ned with a requirement that deprecia- tion reserves be set up covering the value of assets which dis- appear through use and obsolescence. The courts have in some instances interpreted the statute to require the setting up of appropriate charges to depreciation, but in other states there are conflicting court decisions. In those states where neither the decision of the courts nor the statutes require depreciation charges against the fixed assets little can be accomplished by a statute prohibiting the declaration of dividends except from the profits or accumulated profits of the corporation. In the case of some corporations such as mining enterprises, oil property and mineral deposits of all kinds, it is obvious that the original investment will tend to disappear if the ownership of assets is confined to a specific deposit. As this deposit of coal, oil, or other mineral is extracted, no valuable asset remains except the scrap value of the machinery and assets used in develop- ing the enterprise. It might not even be desirable that the original capital investment should be maintained in such an enterprise. The courts have not, in general, required corpora- tions engaging in the exploitation of such natural resources to set aside reserves covering the reductions of fixed assets through mining operations. 1 8. Sinking Funds. The creation of sinking funds involves an appropriation of a part of the accumulated surplus of the corporation. The appropriation is similar to that of appropri- ating surplus for improvements. The purpose of the appro- priation from surplus in both cases is to indicate that the sur- plus so appropriated is not available for dividends. But in both cases no funds are set aside through the entries appropri- ating from surplus. The setting aside of funds involves a credit to cash and a charge to the fund thus created. When bond sinking funds are set aside they are generally turned over to 394 ACCOUNTING PRINCIPLES the trustee for the issue of bonds to be held at compound in- terest until the maturity of the bonds in question The deed of trust of sinking fund bonds will generally provide a percent- age of the face value of the outstanding bonds which shall be set aside each year for the sinking fund. The interest on the sinking fund thus set aside becomes a part of the sinking fund, although it must also be carried to the surplus reserve created to offset the fund thus set aside. If $100,000.00 of 6 per cent bonds are sold to mature 20 years from date it is not a difficult matter to determine the annuity which must be set aside each year to amount to $100,000.00 in 20 years. If we suppose that the funds with the trustee will yield 4 per cent each year we must find the sum, which, set aside at the end of each year, will amount to $100,000.00 in 20 years. If an annuity of $1.00 at 4 per cent amounts to $29.78 in 20 years the $100,000.00 will require an annuity of $100,000.00/29.78, or $3357.96. At the end of the first year after the issue of the bonds the following journal entry would be made: (a) Surplus 3,357-96 Sinking Fund Reserve 3,357-96 Contribution to sinking fund reserve for retire- ment of bonds (b) Sinking Fund Trustee 3,357-96 Cash 3,357-9 6 Charging trustee with annual sinking fund At the end of the second year the trustee would report the in- terest earned amounting to, say, $134.32. The company would also set aside the annual amount required by the deed of trust, making the following journal entries: (c) Sinking Fund Trustee 134-32 Interest on Sinking Fund 134-32 Annual interest accumulated on the sinking fund This interest would, of course, go to the credit of the regular profit and loss and be credited to surplus at the close of the year. The company would then include this interest thus ac- CHANGES IN VALUE OF PROPRIETARY INTEREST 395 cumulated in its regular annual reservation from surplus as follows: (d) Sinking Fund Trustee 3,357-96 Cash 3,357-96 Charging trustee with annual sinking fund (e) Surplus 3,492.28 Reserve for Sinking Fund 3,492.28 Charging surplus with annual sinking fund amount of $3,357.96 plus annual interest of $134-32 These entries would take care of the regular contributions to the sinking fund. However, the corporation frequently desires to show in the balance sheet how its sinking fund is invested. Let us suppose that during the second year of the life of the bonds $2000.00 were in bonds. The original entry of this in- vestment would be made by the trustee, but the corporation would receive in the annual report of the trustee a record of this investment along with the report of interest earned. The corporation, then, in many cases, divides its sinking fund ac- count into two accounts, one showing the cash and the other the investments. The sinking fund trustee account would then be designated as the sinking fund trustee-cash account. The following journal entries would set up the second account: (b) Sinking Fund Trustee Bonds 2,000.00 Sinking Fund Trustee Cash 2,000.00 Investment of trustee in bonds The corporation could then show the facts on its annual bal- ance sheet as follows: Sinking Fund Trustee: Cash $4,850.24 Bonds 2,000.00 $6,850.24 It is more common, however, to find the two accounts on the balance sheet as follows: Sinking Fund Cash 4,850.24 Sinking Fund Bonds 2,000.00 396 ACCOUNTING PRINCIPLES 19. Surplus Reserves and Valuation Reserves. Certain reservations from earnings are made from time to time for the purpose of offsetting losses in assets. These losses are really expenses of the business and should be charged against the in- come before the balance earnings could be regarded as the net profits Depreciations of fixed assets is charged as an expense, but the amount so charged is commonly carried to the credit of a reserve for depreciation, as explained in previous chapters, instead of being credited directly to the assets which have de- preciated. This depreciation reserve then represents the amount by which the asset is overstated and is called a valuation reserve. The reserve for bad debts similarly should represent the amount by which the valuation of accounts and notes receiv- able are overstated in the balance sheet and is likewise a valua- tion reserve. The reserves, however, which are made for special purposes other than to offset decreases in assets are surplus reserves. If the assets reserved are set aside in a special fund the reserve is spoken of as a covered reserve. The sinking fund reserve and the reserve for improvements are surplus reserves. On account of the fact that these surplus reserves are like the regular surplus except that they are not available for dividends it becomes appropriate to retain these surplus reserves on the liability side of the balance sheet and to represent them as follows: Surplus Reserves: Sinking Fund Reserve $ Reserve for Improvements Undivided Profits Balance Surplus Total $ However, these special surplus reserves are frequently shown as separate items on the liability side of the balance sheet, being listed as follows: Sinking Fund Reserve $ Reserve for Improvements Undivided Profits Surplus CHANGES IN VALUE OF PROPRIETARY INTEREST 397 20. Total Proprietary Interest. The total proprietary in- terest of the corporation is represented by the total capital plus the surplus reserves. While the balance sheet frequently shows the capital stock accounts first and the surplus reserves last as representing the balance difference between the assets and liabilities, the original capital being thought of as a type of liability, much is to be said in favor of grouping all the pro- prietary items together as follows: Proprietorship: Capital Stock $ Surplus Reserves: Sinking Fund Reserve Reserve for Improvements Undivided Profits Surplus Total QUESTIONS AND PROBLEMS 1. What is meant by the net profits of the corporation? 2. The XYZ Corporation has the following balance sheet: Assets Liabilities Plant and Property 750,000.00 Capital Stock 600,000.00 Furniture and Fixtures 20,000.00 First Mortgage Bonds 50,000.00 Merchandise Inventory 75,000.00 Accounts Payable 30,000.00 Cash 15,000.00 Surplus 80,000.00 860,000.00 860,000.00 (a) What is the book value of a share of its stock? (b) On February 15 the corporation declared a cash dividend of 5 per cent, payable March i, 1921. At the same time it declared a 10 per cent stock dividend payable the same date. (c) On March i the dividends are paid. Journalize the entries involved in (a), (b), and (c). (d) At the end of the period the net profits from operation were $25,- ooo.oo. There were set up the following reserves: $5,000.00 for sinking fund and $10,000.00 for improvements. Adjustments were made as fol- lows: furniture and fixtures, written down $500.00, an error of $750 in plant and property corrected by placing this amount on the books. Make out the surplus account and show how it would appear as a part of a profit and loss statement. 398 ACCOUNTING PRINCIPLES (e) The corporation decides to expand its business and consequently authorizes an increase in capital of $300,000.03, each stockholder having the right to purchase stock equal to 50 per cent of his holdings. The shares were selling for $125.00 per share, the par being $100.00. At what price should the rights sell? 3. (a) The GHK Corporation has the following balance sheet: Assets Liabilities Plant and Property 600,000.00 Capital Stock 750,000.00 Furniture and Fixtures 100,000.00 Cash 50,000.00 ^50,000.00 750,000.00 The stockholders G, H, and K donate pro rata $150,000.00 of stock to the corporation for working capital. Of this amount 1000 shares are sold at $75.00 per share, the par being $100.00. Journalize and set up the bal- ance sheet after the sale. (b) One year later the corporation sells $100,000.00 of additional stock to outsiders at $125.00 per share, the par being $100.00. Journalize the sale. (c) It also sells certain parts of plant and property costing $75,000.00 at $85,000.00. Journalize the sale and state how the profits and loss account would be dosed out at the end of the period. CHAPTER XXIX ' CORPORATION RECORDS i. Subscription to Stock. A subscription blank which would serve the purpose for a prospective subscriber might have a form as follows: ILLUSTRATION NO. 28 SUBSCRIPTION BLANK DATE or SUBSCRIPTION SIGNATURE OF SUBSCRIBER ADDRESS OF SUBSCRIBER No. OF SHARES AMOUNT The prospective subscriber would be furnished a prospectus along with the subscription blank or prior to his receipt of it. The prospectus would give the names of the incorporators, the nature of the business to be conducted, and such facts and statistics as might indicate the corporate earnings which might be anticipated so that a prospective subscriber might deter- mine for himself whether the prospect for returns on the invest- ment justified the required purchase price. When the sub- scription blanks are received they might be entered in a sub- scription book as they are received. The book would have columnar headings similar to those of the subscription blank. This book would serve as a book of original entry for subscrip- tions. The subscription blanks themselves could also be used as the original entry from which postings would be made to the subscription ledger. If an installment book were used to record the payment of each installment, it might have the following form: 399 400 ACCOUNTING PRINCIPLES fe 1 I I P.' x S I ON B - % 1 is 5 - a = < SCRIBE \AMI CORPORATION RECORDS 401 O fe in 1 1 1 1 1 1 1 1 1 I H h i o 1 1 u >H o u a BE c I . s u h 6 H *M OSJ w s* 21 ss I 5 g H b M H O U /3 CJ 2 u ^ S < 8 8 ^ W o u I 3 1 H a * F^ en a w 3 O J tt 6 H M QZ, u 1 O !s 3 A CO o fl M CJ D bo f CO ffi^ "d HH < Q ATION NO :K LEDGER FK WILLIAMS M Q HH 14 M *IH g g 3 CO ^ fe M W a U 3 fi M P CO a H O u < U H H Q 406 ACCOUNTING PRINCIPLES (Left-hand page) ILLUSTRATION NO. 33 BOND REGISTER CLASS REGISTERED IST MORTGAGE 1925 No. DATE or BOND To WHOM ISSUED TRANSFERRED AMOUNT = Nun ADDRESS NAME ADDRESS I 2 3 4 5 6 7 8 9 10 32 33 34 CORPORATION RECORDS 407 (Right-hand page) INTEREST PAYABLE JANUARY IST TO JULY IST INTEI DAI : . , . = .EST re 1916 1917 1918 1919 1924 1925 REMARKS I JAN. JULY JAN. JULY JAN. JULY JAN. JULY JAN. JULY JAN. JULY 2 3 4 5 6 7 8 9 10 1 32 33 34 408 ACCOUNTING PRINCIPLES 6. Bond Forms. Corporation bonds also require regular forms. The bonds are frequently classified from the standpoint of their entry in the books of record as registered bonds and coupon bonds. The coupon bonds are payable to bearer and have attached to them coupons easily removed from the bond form and sent in to the treasurer of the corporation for pay- ment at the respective interest dates. The coupon bond is payable to bearer and no bond register at the offices of the cor- poration or in the hands of the treasurer is required to record the names of the holders of the outstanding bonds. The regis- tered bond, on the other hand, is transferred on the books of the company just as corporation stocks are transferred. The forms on the two previous pages will indicate the type of bond register which may be used to indicate the holders of outstanding bonds. The bond register used for coupon bonds is one which shows the canceled coupons which are attached to the register. The amount of interest coupons not paid will be indicated by the spaces on the bond register not covered by canceled coupons. The coupon bond register form may be as follows: ILLUSTRATION NO. 34 COUPON BOND REGISTER UNITED STATES BOND AND MORTGAGE COMPANY BOND REGISTER $1,000.00 8% TRUST BOND Dated Jan. i, 1916 Due Jan. i, 1926 First Coupon Due July i, 1916 13 19 12 5 16 9 2 CANCELLED COUPON CORPORATION RECORDS 409 There is no indication on this register as to the name and ad- dress of the holder of the coupon bond. A combination of coupon and registered bonds is sometimes used. The principal of the bond is transferred and recorded hi a register similar to the left-hand page of the bond register il- lustrated above. No provision, however, would be needed for interest payments except that shown in the coupon bond regis ter illustrated above. In other words, the right-hand side of such a bond register page would be the coupon register, instead of an interest record. 7. Dividend Book. The dividend book of a corporation is used for the purpose of making out a list of stockholders for each dividend declaration. The spaces provided for on the dividend book page would be as follows: a. Name of stockholder. b. To whose order check should be drawn if different from that of stockholder. c. Mailing address. d. Number of shares. e. Amount of dividend paid. f. Number of check issued in payment. At the head of the list a memorandum would indicate the rate of the dividend declaration. There are other special forms and records used in connection with the corporation but those cited above will serve to indicate the character of special records re- quired for the corporation. The student will readily see the relation between the books of original entry and the ledgers described above. An acquaintance with the purpose of these records as set forth in the description of corporate accounts in a preceding chapter will carry with it sufficient directions for the use of the corporate forms. CHAPTER XXX COST ACCOUNTS AND TYPES OF COST ACCOUNTING 1. Accounting Problems of a Factory. A factory may en- gage in the business of trading and selling its own products or it may furnish its output entirely to a selling organization so that the two enterprises are distinct units from the standpoint of management. Such an organization would involve a sepa- ration of cost into factory cost and selling cost. Even where the two functions are under the control of the same manage- ment they are ordinarily under the supervision of separate de- partments and consequently the same grouping of cost data is found advisable. The selling costs and their classification for a factory do not differ materially from the classification of sell- ing costs already described in connection with the trading business. 2. Factory Costs. The cost of manufacturing is ordinarily divided into two classes of items: (a) prime costs and (b) indi- rect expense. Prime costs consist of the wages of labor de- voted directly to manufacturing operations plus the cost of materials used in manufacturing. Indirect expense includes all other expenses of manufacture. 3. Significance of Direct Labor Cost There is no factor in modern production which has given more concern to factory managers than the direct labor item. When costs of produc- tion have been greatly reduced the reduction has been gener- ally concerned mainly with the reduction in the cost of labor. The more enlightened managers have set up the program of increasing wages of individual laborers and of reducing, at the same time, the cost of labor required to perform manufacturing operations. This can only be achieved by so standardizing and supervising the work to be done that time will be saved. If several operat'ons are involved it may be desirable to set up a 410 COST ACCOUNTS, TYPES OF COST ACCOUNTING 411 direct labor account for each of two or more divisions of the factory work required to produce a given commodity. In some cases the factory work is departmentalized and an account for direct labor may be required for each department. Still an- other labor cost program requires a record of the direct labor for each job of work performed. This form of charge is used when factory production goes forward on the job order basis. In some instances, however, the direct labor record goes even to the point of showing the direct labor cost of each operation involved in factory production. Much of cost accounting work is concerned with recording and assembling data showing the cost of labor. It is one of the principal problems of any cost accounting program. 4. Material Costs. The recording of material costs is at- tended with less complexity. It is not difficult to keep a ma- terial account showing the cost of all materials going into the production process. It is frequently true that all the material is properly chargeable to the product in one account showing the total material cost of producing a commodity. If more than one material is used in production there may be more than one material account. If there are departments one or more material accounts may be required for each department. 5. Indirect Expense. In the fields of factory production where material costs are a large fraction of total costs, indirect expense is usually small and no intricate or refined system is required for properly charging indirect expense if it becomes necessary to apportion it between departments or separate divisions of work. However, the direct and indirect labor cost tend in many lines of factory production to constitute a large fraction of total cost. In such cases indirect expense is gener- ally a large fraction of total cost. A large investment in fixed assets tends to increase further the indirect expense. When in- direct expense becomes large any considerable error in its dis- tribution may render the cost data of little value. Much of modern cost accounting is concerned with a study of means by which an accurate distribution of indirect expense may be made according to the extent to which it is occasioned by the 412 ACCOUNTING PRINCIPLES several operations, processes, departments, or commodities which may be the subject of cost-finding. 6. Types of Cost Systems. The more important types of cost systems are: (a) the estimating cost system and (b) job cost systems, which include those employing the machine rate as a means of distributing indirect expense and those employing other methods for this purpose. The estimating cost system may be carried on for a plant as a whole or the classifica- tion of costs may be by departments. The subject of the cost- finding may be a commodity, or certain operations on the com- modity. The job cost system of accounting is applicable to a plant doing a miscellaneous type of foundry and machine work largely on orders coming from customers, and opens the possi- bility for accurate and dependable cost-finding. The estimat- ing cost system is commonly used when approximate costs can be secured in that way provided the less accurate results prove sufficient for the managerial needs of the factory. 7. The Estimating Cost System and the Job Order System. If a job order system prevails all factory work must be done on the basis of a job order prepared under the supervision of a superintendent of factory operations. The job orders may be prepared by a production clerk, a production engineer, or some other officer charged with the duty of arranging a production program. The use of the job order requires ordinarily the fol- lowing provisions: (a) a storeroom with a perpetual inventory of raw materials, (b) a daily record showing the job or jobs to which the labor of each workman is chargeable, (c) a daily record of the issue of all material from stock showing the job to which such material is chargeable, (d) a system of apportion- ing overhead expense to the respective jobs so that a ledger record in the form of a job order sheet may be prepared for each job showing its cost at the time of its completion. In the case of the estimating cost system, however, the situ- ation is quite different. The simplest situation would be that in which there are just three accounts: (a) direct labor; (b) di- rect material; and (c) indirect expense. All expenditures made on the manufacturing process would be charged against one of COST ACCOUNTS, TYPES OF COST ACCOUNTING 413 the three accounts named. The sum of the debit balances of these three accounts should show at all times the total expen- ditures incurred in the manufacturing process. The question arises as to whether this sum would represent an accurate cost of goods manufactured. It would represent with a fair degree of accuracy the total cost of goods in process of manufacture plus the cost of finished goods. The difficulty would arise in the separation of the expense chargeable to finished goods from that chargeable to goods in the process of manufacture but not yet finished. This separation of the cost of finished goods from that of unfinished goods takes place when an inventory is taken. This separation must take the form of an estimate. There are no records which would serve to make this estimate accurate. As the processes of manufacture become more involved this esti- mate becomes less accurate and the estimating cost system becomes less satisfactory. There would be no difficulty in mak- ing this separation for a job cost system. The cost sheet would show the cost of finished work when the work was completed. A*ll expenses charged to jobs under the several account titles would constitute subsidiary accounts under the general con- trolling caption of work in process. In the job order system the work in process account balance is the sum of the debit balances of all job order accounts or job order sheets. But in the estimat- ing cost system it is necessary to determine by estimate the amount of expenditure on uncompleted work. Since this estimate can be an approximation only, the cost of finished stock can also be only an approximation because it is arrived at by subtract- ing the work in process estimated item from the total charges to the manufacturing process in the manufacturing account. This text is concerned only with a simple case of the esti- mating cost system. The more general accounts involved in the estimating cost system are about the same as those em- ployed in all of the cost accounting programs. Moreover, the voucher register, which is generally used as a means of dis- tributing items to the several expense accounts in the esti- mating cost system, has a wide application to many other cost 414 ACCOUNTING PRINCIPLES accounting programs. A simple estimating cost system serves, therefore, as a suitable means of introducing the general sub- ject of cost accounting. 8. Cost Accounts. It was pointed out above that the prin- cipal accounts are direct labor, direct material, and indirect expense. In the job cost system the cost sheet commonly shows both the direct labor and direct material in separate col- umns. There is substantially a separate direct labor account for each job, although no formal ledger account may be opened except for the general direct labor control. Exactly the same thing may be said for the material accounts and the gecferal material control account. In the estimating cost system there might be two or more direct labor accounts corresponding to the several departments or the several divisions of the work involved in manufacturing. There might be the same number of material accounts or there might be only one material ac- count for the several divisions of the work. In the estimating cost system as well as in other cost accounting programs the indirect expense is usually the caption of a group of accounts instead of being an account title. Some of the more common indirect expense accounts are as follows: (a) shop supplies, (b) heat, light, and power used in manufacture, (c) factory re- pairs, (d) factory insurance, (e) administrative salaries, (f) ad- ministrative expense, (g) depreciation of machinery, and (h) de- preciation of building. One of the characteristics of factory accounting as contrasted with the small retail establishment lies in the large number of accounts to which charges must be made. 9. Manufacturing Account. The manufacturing account bears the same relation to the factory accounts that the trad- ing and profit and loss accounts bear to the accounts of the trading business. It is the dosing account into which the various expense items are grouped for the purpose of arriving at the total cost of manufacturing finished goods. The following skeleton of a manufacturing account indicates the detailed accounts dosed into manufacturing at the time of closing the books: COST ACCOUNTS, TYPES OF COST ACCOUNTING 415 MANUFACTURING ACCOUNT Raw Material Inv. First of Period Goods in Process First of Period Materials Purchased Direct Labor Indirect Labor Frt. on Mat. Purchased Cartage on Mat. Purchased Shop Supplies Heat and Power Used for Mfg. Misc. Fac. Expense Repairs to Mchy. and Tools Factory Insurance Depreciation: Mfg. Machinery Mfg. Building Other Mfg. Equip. Taxes on Mfg. Property Raw Material Inv. End of Period Goods in Process End of Period Shop Supplies Inv. End of Period Manufacturing Cost Car- ried Down If it were desired to get a correct figure for direct labor per unit of finished product, a direct material cost per unit of prod- uct, and an indirect expense per unit of product, it would be- come necessary to divide the process account as follows: Goods in process, direct labor. Goods in process, direct material. Goods in process, indirect expense. (This account includes as a total all accounts other than direct labor and material) In setting up the respective accounts at the beginning of a subsequent period the following journal entry should be made: Direct Labor Direct Material Indirect Expense Goods in Process Charging the goods in process to the several cost accounts. 416 ACCOUNTING PRINCIPLES It is clear, therefore, that when unit costs are employed the goods in process item would appear in the beginning of the period as the total of the charges to direct labor, material, and indirect expense. The goods in process items, even at the end of the period, should preferably be entered as credits to the direct labor, direct material, and indirect expense accounts, if unit costs are to be calculated. The entry would be as follows: Goods in Process Inv Direct Labor Material Indirect Expense The balances of the direct labor account, the direct material account, and the indirect expense account would then be the expenditures on these accounts for finished goods, and the bal- ance of the manufacturing account would be the cost of fin- ished goods. In this discussion all of the indirect expense ac- counts have been treated as a total for brevity. In practice a unit cost for each of these items would require that it be treated just as the direct labor and direct material accounts were, the respective accounts being credited at the time of closing with so much of the item as might be chargeable to the goods in process inventory. The journal entry involved in closing the several accounts into the manufacturing account are similar to those involved in closing the accounts of a trading firm into the trading and profit and loss accounts. The closing entries can be abbre- viated in the same way by compound entries. The balance of the manufacturing account is brought down to the trading account by the following journal entry: Trading Mfg. Cost Manufacturing Mfg. Cost Bringing down the balance of the manufac- turing account to trading. The journal entries involved in the trading account can be readily supplied by observation of the following skeleton of the account : COST ACCOUNTS, TYPES OF COST ACCOUNTING 417 TRADING Mfg. Cost Fin. Stock, First of Period Fin. Stock Purchases Fit. in on Fin. Stock Pur- chases Gross profit Finished Stock Sales Fin. Stock Inv. End of Period The gross profit balance is then brought down to profit and loss and the closings into profit and loss are made as set forth in preceding chapters. Paragraphs 10, n, and 12 maybe omitted for first-year stu- dents. This would also involve the omission of No. 12 in Prob- lems and Questions at the end of the chapter. The paragraphs are necessary, however, for a, complete understanding of the simplified cost systems which rely upon a voucher register for the distribution of cost expense. 10. Estimating the Goods in Process. In order to set up some standard cost data and facilitate the inventory of goods in process an estimate is frequently made showing the expected cost of a product to be manufactured. This estimate is ana- lyzed into the cost of the separate operations to be performed on the commodity so as to show direct labor, direct material, and indirect expense for each operation. Suppose, for example, the unit cost of a commodity A were estimated as follows: TABLE XXX-A ESTIMATED OPERATION UNIT COSTS TOTAL COST OPERATION No. 3 OPERATION No. 2 OPERATION No. i Material $^.00 $3.00 Direct Labor .... Indirect Expense . . I.OO 50 SO 25 .20 .IO 30 15 Totals $4..=;o to.?* .30 .ax 4i8 ACCOUNTING PRINCIPLES It would be possible by test performances of these separate operations and by comparing the result with experience records in bulk production to set up a standard unit cost estimate which would be applied to the work in process in various stages of production so that the inventory might be made. Let us suppose, further, that at the end of a month 10,000 units of commodity A have been completed, 1000 additional completed through Operation No. i, and 500 additional through Operation No. 2. The additional items are work in process. On the basis of the estimated costs the following would be the work in process inventory: TABLE XXX-B WORK IN PROCESS ON THE BASIS OF THE ESTIMATED OPERATION UNIT COSTS Direct Material Oper.#i $3 ooo.oo Oper.# 2 Total $3,000.00 Direct Labor 500.00 $100.00 600.00 Indirect Expense 250.00 "5O.OO 300.00 $3,750.00 $150.00 $3,000.00 If the estimates had all been correct, the total expenditures to date would be as shown in the table on the following page: 13 lines short COST ACCOUNTS, TYPES OF COST ACCOUNTING 419 o U I H WHH 1 OT -5 : M M I J H I 888 ill 8 8 E O ^O O 10 ^ M 8 8 8 (J : 8 8 w 8 H o ^ *r> 6 W ? M " | H H S M H o w 2; (J P. ) : O ir, *r> W S jO O 1 888 8 d o" o" o" H M H O~ H H CO - 8 8 8 U H : g _ d HO H - . M W O M CO d ^V ^= o H _, H M W M H o H * lr> ^ ^*1 ^ W CO 10 N M W 5 80 >0 IO M je 1 f5 ro < *^ ^ B o i 888 8 d H M H? M M HI M H ^ c M S S 4) O O< 9 ^ CtJ W I-H 3 ** 2 -! O H P Q ^ 420 ACCOUNTING PRINCIPLES But the voucher register may be supposed to show the fol- lowing expenditure after due elimination of materials on hand which have not been placed into factory process: TABLE XXX-D ACTUAL TOTAL MANUFACTURING COSTS INCLUDING WORK IN PROCESS TAKEN FROM FINANCIAL RECORDS Direct Material $32,500.00 Direct Labor 11,000.00 Indirect Expense 5,600.00 This would be regarded as proof that the estimates were approximately correct. Yet the material unit estimate was too high by 500/33,000 or 1.5 cents per unit of estimated cost. The labor estimate was slightly too low because the expenditure on the estimated basis was less than the actual expenditure. The same would be true of indirect expense. These facts may be verified by comparing Table XXX-D with the All Operations column of Table XXX-C. It would not be possible to get the actual cost per unit for each operation unless we assume that the direct labor, direct material, and indirect expense costs for the actual expenditures are in the same proportion as between the three operations as they are found to be in the case of the estimated expenditures. This assumption is not unreasonable, however, since 'the esti- mated costs are usually set up on the basis of job cost data taken for sample batches of items run through the factory under a job cost accounting analysis. The job cost analysis may be applied to a sufficient number of batches to satisfy the management that representative data have been secured for the estimate. Of course no accurate costs can be found by the use of the estimating cost system. But the original estimate will at least be subject to correction for a closer approximation on the basis of the total costs when it is found that the total costs on the estimated basis do not agree with the total costs as taken from the financial records which show the actual ex- COST ACCOUNTS, TYPES OF COST ACCOUNTING 421 <0 to H M m in '. tO M Tj- Bi . co to M M O v Oo ** M oq oq 00 00 M M M M |1 8 8 O OO 8 -88 8 $h 800 r*. O oo in O 8t- \o : o o to tH M M O M m .MM to s O O4 M M O 4/3- Oo ** M 8 8 O* O* M M 2% M M to 10 m m O H 8 8 8 8 8 S- 8 888 8 H O o 80 O *o 10 o^ ^t* oo o o in r- to o {** O\ 0^ to^S to CO o o o o \O O 8 8 CO VO 10 t*** O^ ir> ro M H J^ O 1-1 d M J - u" d X ... U 3 -I en 11 r i t -4-J U u H Material Estimate . Material Actual Direct Labor Estima Direct Labor Actual Indirect Expense Est Indirect Expense Act Number of Items (see Unit Costs: Material Actual . Direct Labor Actu Indirect Expense / S 3 1 422 ACCOUNTING PRINCIPLES penditures for direct labor, direct material, and indirect ex- penses. If we now divide the actual cost totals between the three operations for the three items on the same percentage basis as they are found to be divided in the estimated cost table on p. 419, we will have the table as shown on the previous page. When one has taken the inventory by the use of the esti- mated costs the question arises as to whether the estimates have any other useful purpose. It is obvious that the Unit Costs found hi Table XXVI-E could be used in closing the manufacturing account and in setting up the work-in-process inventory. The total estimated costs need not even be entered in the books of original entry. They serve their purpose in in- dicating how to distribute actual cost data between the sev- eral operations. ii. Journal Entry of Estimated Cost Data. There may be an advantage, in some cases, in entering the estimated cost data in the journal and later correcting the estimated entries before the final dosing of the books. There are two items of data which can be secured by this practice. The total direct labor, direct material, and indirect expense might be charged weekly or daily to manufacturing. If the manufacturing ac- count is credited with the cost of finished stock on the basis of the estimated unit costs, then the daily or weekly balance of the manufacturing account would show to the management the approximate cost to date of all work in process. At the same time, however, the manufacturing account would be cred- ited with the cost of finished stock under the account caption of manufacturing cost. This account would be debited with the same figure. This would show the total approximate cost of all finished stock. This cost less cost of finished stock sold would show an approximate inventory of finished stock daily or weekly, as the case might be. Assuming, therefore, that the estimated costs are entered in the financial records, let us see how the cost data referred to above would be shown. When the 10,000 items had been finished the following jour- nal entry would be made: COST ACCOUNTS, TYPES OF COST ACCOUNTING 423 (a) Manufacturing Cost 48,000.00 Direct Materials 33,000.00 Direct Labor 10,000.00 Indirect Expense 5,000.00 (See Table XXX-A above for unit costs) The debits to the direct material, direct labor, and the indirect expense accounts would be from the financial books showing the expenditures under these captions. The sum of the bal- ances of these several accounts would show the work in pro- cess total. This would produce an estimated cost of work in process. When manufacturing cost is thus entered on the estimating cost basis, then the balance of the manufacturing account be- comes the cost of work in process instead of the manufacturing cost, which was shown as the balance in the illustration of the manufacturing account given in paragraph 9 above. If it were desired at the end of the month to close the books without taking an actual inventory of work in process, a trial balance might be taken and the estimated net profits worked out through the use of the estimated cost units. If this pro- gram were adopted there would be a use of the estimated cost data in connection with sales. Let us suppose that the 10,000 units referred to represented the output for January and the sales for the same month had been 9000 items. The entry of this item can be made by ref- erence to the data in Table XXX-A as follows: (b) Trading Cost of Sales (at $4.50 per unit) 40,500.00 Manufacturing Cost 40,500.00 If we suppose the 9000 items to be sold on time at $6.00 per item, the entry would be as follows: (c) Accounts Receivable (Detailed) 54,000.00 Trading Sales 54,000.00 The indirect expense can be closed into profit and loss and show the estimated net profits after the gross profits have been calculated. 424 ACCOUNTING PRINCIPLES TRADING Manufacturing Cost Gross Profits 40,500.00 13,500.00 Sales 54,000.00 54.000.00 54.000.00 The general indirect expense other than the factory indirect would be shown by the financial records. This would include the selling expenses and general administrative expenses. These would be charged to the profit and loss, which would also be credited with the gross profits. The balance of the account would show the net profits on the basis of the estimated cost data. 12. Journal Entries to Correct Estimated Figures. It was pointed out in the preceding paragraph that, in practice, the monthly profit and loss statement might be made five months in succession without an inventory by count, the costs and in- ventory taken on the basis of the estimated unit costs being relied upon. At the end of the sixth month a statement would be made hi most cases for the entire six months and the book inventory would be checked with the actual inventory by count. At such a time the unit cost data would also be revised as indicated in the preceding paragraph. For the purpose of abbreviating the discussion let it be sup- posed that the estimated data are corrected for the month of January for which entries were made in the preceding para- graph. The final items to be corrected are the cost of sales item and the inventory of finished stock. Then a revised profit will result. Now let us compare the estimated and the actual data for the 10,000 completed items as shown on the next page: COST ACCOUNTS, TYPES OF COST ACCOUNTING 425 TABLE XXVI-F DIFFERENCES OF ACTUAL AND ESTIMATED COST ITEMS ACTUAL (SEE TABLE 26-E) ESTIMATED (SEE TABLE 26-A) EXCESS (+) OR SHORTAGE ( ) OF ESTIMATE Material $29,550.00 $3O,OOO.OO + $450-00 Direct Labor .... 10,037.00 IO,OOO.OO - 37-oo Indirect Expense 5,290.00 5,OOO.OO 290.00 The original entry for the estimated data shown above was as follows : Finished Stock Material Direct Labor Indirect Expense 48,000.00 33,000.00 10,000.00 5,000.00 But the items are in error and hence the balances. for work in process from the several accounts will be in error. How- ever, the estimated items can be brought to the actual balances by the following correcting entry in the journal. Material Finished Stock Direct Labor Indirect Expense 450.00 123.00 37-00 290.00 Entry to correct the balances of the several accounts resulting from entry of estimated data. When the original material account was credited with $30,000.00 instead of $29,550.00, the balance of this account was reduced excessively by the $450.00. Likewise direct labor account was left with a balance of $37.00 too much because of the credit of $10,000.00 when $10,037.00 should have been credited. Likewise the indirect expense balance was left with too large a balance. The correcting entry, however, brings ah 1 the estimated account balances into accord with the actual 426 ACCOUNTING PRINCIPLES figures taken from the financial record. The error in finished stock would of course be the net error of $123.00 as shown by the above table. The several accounts with all the corrections would now stand as follows: MATERIAL Jan. 31 3i 32,500.00 450.00 Jan. 31 31 Balance 30,000.00 2,950.00 32.950.00 2.950.00 Feb. i Balance 2,950.00 DIRECT LABOR Jan. 31 11,000.00 Jan. 31 31 Balance II.OOO.OO Feb. i Balance 11,000.00 10,000.00 37-00 II.OOO.OO II.OOO.OO INDIRECT EXPENSE January 31 5,600.00 January 31 5.000.00 290.00 Balance 310.00 5.600.00 5,600.00 February i Balance 310.00 The sum of the balances of the three accounts would give the corrected work in process account, the total being $4223.00 which is $323.00 in excess of the work in process on the basis of the estimated unit cost (Table XXX-B). Before giving the revised finished stock and sale accounts it will be necessary to make a journal correction for the entry of the sale of 9000 items credited to finished stock on the esti- mated basis. The revised unit cost (Table XXX-E) was $4.521, so that the revised credit for the sale of oooo items would be $40,689.00 instead of $40,500.00, the old credit show- ing a shortage of $189.00. The correcting entry would be: COST ACCOUNTS, TYPES OF COST ACCOUNTING 427 Sales Cost of Sales 189.00 Manufacturing Cost 189.00 Correcting entry for credit to finished stock on estimated basis. MANUFACTURING ACCOUNT Jan. 31. Direct Mate- rials Direct Labor Indirect Exp. 2,950.00 963.00 310.00 Jan. 31. Work in Pro- cess 4,223.00 4,223.00 4,223.00 Feb. i. Balance Work in Process 4,223.00 MANUFACTURING COST Jan. 31. Direct Mate- rials 33,00000 Direct Labor 10,000.00 Indirect Exp. 5,000.00 48,000.00 Feb. i. Balance Fin- ished Stock 7,188.00 Jan. 31. Cost of Sales 40,500.00 Correction 189.00 Correction 123.00 Balance Mfg. Cost 7,188.00 5,ooo.oo TRADING (JANUARY) Cost of Sales Error in Est. Gross Profits 40,500.00 189.00 13,311.00 Sales 54,000.00 54,000.00 54,000.00 These entries bring the estimated figures into accord with the actual financial figures of the journals and hence these latter data are not posted. They are simply used as a basis of correcting the estimated data. 13. The Distribution of Indirect Expense. If exactly the same operations or series of operations are performed on each item of factory product, the indirect expense can be appor- 428 ACCOUNTING PRINCIPLES tioned accurately by charging the same amount to each unit of product. Practically all manufacture proceeds on the basis of estimated costs with also an estimated amount of indirect expense. The voucher record with a monthly closing of the books would indicate each month the extent to which the actual indirect expenses exceeded the estimate. There are two other types of distribution of indirect expense frequently re- sorted to in the simpler types of manufacture. In the one, a percentage of direct wages is added to cover indirect expense; in the other, indirect expenses are distributed on the basis of the number of hours of direct labor involved hi the productive processes concerned. When the wages of direct labor are com- paratively uniform, and the amount of investment in machinery comparatively small, it frequently happens that the cost of supervision and the other indirect expenses may be fairly ap- portioned by either of these two methods. It is usually neces- sary, however, to classify the indirect expenses into a variety of accounts to be distributed to the departments or products by different methods. For example, the cost of heating might be fairly distributed to departments on the basis of floor space or cubical content of the rooms. Power and light costs are fre- quently distributed on the basis of the capacity of the electric fixtures in the various departments. There are other indirect expenses such as depreciation, interest, and taxes which would be distributed to the various departments on the basis of the investment involved in their operation. One must analyze for each type of indirect expense the basis upon which it may be occasioned hi various productive processes carried on in the factory. The distribution of indirect expense through a ma- chine rate is another method used in cost accounting, but its treatment is outside the scope of a general text. 14. Cost Terminology. In this chapter a selection of terms has been made and they have been used as if there were no other conflicting usage. The term productive labor is frequently used instead of direct labor. The term unproductive labor is also used instead of the term indirect labor. The terms over- head expense and burden are widely used instead of factory in- COST ACCOUNTS, TYPES OF COST ACCOUNTING 429 direct expense. Indirect expense may be used without quali- fication, as in this chapter, provided only factory cost is under discussion. But trading and selling costs are also indirect ex- pense. When the costs of the entire factory enterprise are under discussion the indirect expenses of the factory should be designated as factory indirect expense to distinguish them from the general administrative and selling expenses, which are also in- direct expenses. The latter group of indirect expenses may be designated as general indirect expenses. QUESTIONS AND PROBLEMS 1. What are the principal divisions of factory cost? 2. With what items are modern factory problems chiefly associated? 3. What divisions are sometimes found in the direct labor account? How is the number of such accounts determined? 4. What determines the number of material accounts to be kept? 5. What circumstances of factory production cause large indirect ex- pense? 6. Contrast the estimating cost system with a job order system. Dis- cuss the type of factory to which each is suited. 7. (a) How is the work in process account set up in the estimating cost system? (b) In a job order system? 8. What are the means adopted to aid in the estimate of work in process? 9. Suppose factory operations to be duly efficient and properly stand- ardized, how would erroneous estimate cost data be corrected? 10. Describe the content and use of the manufacturing account. ii. Make the journal entries necessary to close the accounts of the American Manufacturing Co. from the trial balance and adjusting entries below. Make the manufacturing account, trading account, surplus account, profit and loss account, and balance sheet. The American Manufacturing Co., a corporation, manufactures patented pump jacks. It also deals in engineers' supplies. A trial balance of the general ledger, June 30, 1908, disclosed the following conditions: Land 20,000.00 Buildings (cost, July i, 1907) 64,000.00 Reserve for Depreciation Building 1,600.00 Real Estate Mortgage 24,000.00 Machinery and Tools 52,000.00 Reserve for Depreciation Machinery and Tools 2,600.00 Horses and Wagons 3,400.00 Furniture and Fixtures 600.00 Patents 16,000.00 43 ACCOUNTING PRINCIPLES Inventories, January i, 1908: Raw Materials 25,200.00 Goods in Process 16,100.00 Pump Jacks (Finished Goods) 42,040.00 Engineers' Supplies 28,620.00 Notes Receivable 20,000.00 Accounts Receivable 96,000.00 Cash 4,440.00 Notes Payable 24,000.00 Accounts Payable 65,100.00 Capital Stock 200,000.00 Treasury Stock 30,000.00 Surplus 44,160.00 Raw Material Purchases 67,300.00 Freight Raw Material Purchases 5,240.00 Productive Labor 77,820.00 Non-productive Labor 21,800.00 Superintendence Factory 7,000.00 Heat, Light, and Power 55,220.00 Shop Supplies 2,380.00 Miscellaneous Factory Expense 1,640.00 Cartage 3,200.00 Stable Expense 1,660.00 Insurance Factory Building and Stock 1,860.00 Repairs to Buildings 820.00 Repairs to Machinery and Tools 720.00 Advertising 10,520.00 Taxes 1,000.00 Salesmen's Salaries 7,500.00 Salesmen's Traveling Expenses 6,420.00 Rent Warehouse 1,800.00 Insurance Warehouse Stock 2,280.00 Pump Jacks Sales 284,080.00 Pump Jacks Return Sales and Allowances 7,700.00 Engineers' Supplies, Sales 80,810.00 Engineers' Supplies, Return Sales and Allow- ances Engineers' Supplies, Purchases Office Salaries Stationery and Printing Postage Miscellaneous Office Expense Rent Office Building Legal Expense Bad Debts Written Off Interest Discount on Sales Discount on Purchases 2,820.00 54,100.00 9,000.00 550.00 840.00 620.00 1,200.00 500.00 66O.OO I,84O.OO 5,46o.OO 3,520.00 729,870.00 729.870.00 COST ACCOUNTS, TYPES OF COST ACCOUNTING 431 Close the books, taking into consideration the following: Unexpired Insurance Factory Building and Stock 640.00 Unexpired Insurance Warehouse Stock 940.00 Accrued Taxes Estimated 600.00 Accrued Interest on Notes Payable 560.00 Accrued Interest on Notes Receivable 300.00 Inventories, June 30, 1908: Raw Material 28,240.00 Goods in Process 17,820.00 Pump Jacks (Finished Goods) 46,640.00 Engineers' Supplies 27,320.00 The cartage and stable expense and depreciation on horses and wagons to be charged one half to Manufacturing and one half to Selling account. The taxes are to be charged three fourths to manufacturing and one fourth to profit and loss. Create, reserve for depreciation on buildings at the rate of 5 per cent per annum, on the original valuation. Create reserve for depreciation on machinery and tools at the rate of 10 per cent per annum on the diminishing value. Write off depreciation for horses and wagons at the rate of 20 per cent per annum. Write off depreciation for furniture and fixtures at the rate of 10 per cent per annum. Patents expire 10 years from January i, 1908. Create a reserve for doubtful accounts, $1500.00. The directors declared a dividend on June i, 1908, of 5 per cent on the outstanding capital stock, payable July 15, 1908, for which no entry had been made on the books. Prepare necessary journal entries giving effect to the foregoing, also en- tries closing the books through the manufacturing, the trading, and the profit and loss accounts. Make a manufacturing account, trading ac- count, profit and loss account, surplus account, and balance sheet. Make all closings through the journal. 12. A foundry produced annually a large output of cast iron lamp posts of a given dimension. The operations involved included (i) preparation of metal for molding, (2) moulding, and (3) clipping and finishing. The es- timated unit cost of the lamp posts was as follows: TOTAL OPERATION No. i OPERATION No. 2 OPERATION No. 3 Direct Labor I.7C .co I.OO 2<; Material ?.oo 4.00 I.OO Indirect Expense .... 1-25 65 .40 .20 Totals 8.00 5.15 2.40 45 432 ACCOUNTING PRINCIPLES (a) In the month of January, 1921, the foundry produced 5006 finished lamp posts and put 500 others through Operation No. i, and 300 through Operation No. 2. There were sold during the month 4000 lamp posts on 60 days' time at $12.00 each. The financial records showed the following expenditures: Direct Labor $10,000.00 Materials 28,000.00 Indirect Expense 6,500.00 Make out the following accounts on the basis of the estimated data: (i) direct labor, (2) materials, (3) indirect expense, (4) finished stock, (5) cost of goods sold, (6) sales, (7) profit and loss, assuming that sales expense is 5 per cent of factory cost. (b) In the month of February the output was 7000 lamp posts and the sales at the same price were $7,500.00. At the end of February there were on hand 500 of finished stock, 600 items finished through Operation No. i, and 400 finished through Operation No. 2. During the month of February the increases in the three financial account balances were as follows: Direct Labor $12,500.00 Material 38,000.00 Indirect Expense 9,000.00 Make out the same accounts for the two months together on the basis of the estimated cost data as those made out in (a) above. (c) Revise the unit cost data on the basis of the financial records. (d) Make a corrected journal and ledger closing for the several accounts involved in (a) and (b) and also a revised set of unit costs. CHAPTER XXXI THE MANUFACTURING PROFIT AND LOSS STATEMENT i. Comparison of Manufacturing Statement to Trading Statement. The uses of a profit and loss statement of a manufacturing business and those of a trading statement for a mercantile business are similar in character. The manufactur- ing business frequently does also a trading business in addition to the production of goods. It may not sell its products to the final consumer and consequently may have only a small trad- ing organization. The trading section of the profit and loss statement of a manufacturing business is essentially the same as the revenue statement of a trading business. The treatment of a manufacturing statement, therefore, is concerned mainly with the treatment of that section of the statement involved in the explanation of manufacturing costs. . A successful oper- ation of a factory from the standpoint of the production of a high grade product at a low cost would not, necessarily, insure a successful business. If the provision for the sale of the prod- uct were unsatisfactory, the concern might fail either by reason of manufacturing the wrong product or by reason of inefficient methods of selling the product which has been produced. Moreover, the management of a factory is frequently committed to a superintendent and his advisory staff with only a very general supervision from the financial and selling organization. It is possible, therefore, to make the statement of the results of operation so far as factory production is concerned somewhat distinct from the profit and loss aspect of the business opera- tions. Factory production is unsuccessful in carrying out the production of a product in accord with specification unless this production is carried out at a reasonable cost. It might be en- tirely successful from the standpoint of the factory manager 433 434 ACCOUNTING PRINCIPLES without the product's being sold at a profit. In the profit and loss statement of the factory, therefore, the question of unit costs of production becomes an important item of information. The manufacturing section of a profit and loss statement will possibly secure better results if it is made preliminary to the trading profit and loss statement instead of being thrown into the trading statement as a subhead. Ordinarily the first step hi the formation of a trading statement would be to make the profit and loss statement for the period under consideration. The interpretation of this statement might then require addi- tional information and comparative data. The following form of statement will serve to indicate the initial draft of a manu- facturing statement which would serve the purposes of a fac- tory relying mainly on the voucher record for cost data. ILLUSTRATION NO. 35 FORM FOR REVENUE STATEMENT MANUFACTURING AND MERCHANDISING BUSINESS COMBINED MANUFACTURING STATEMENT Prime Cost Materials: Inventory (Beginning) .... Purchases .... Deduct: Returns Net Purchases Add: Freight-In Cost Materials Purchased Materials to be Accounted for Deduct: Inventory (End) Materials Consumed Direct Labor Total Prime Cost MANUFACTURING PROFIT AND LOSS STATEMENT 435 Manufacturing Expense Indirect Labor Factory Supplies: Inventory (Beginning) Purchases Total Factory Supplies Deduct: Inventory (End) Factory Supplies Consumed Repairs Heat, Light and Power (Factory) Taxes Factory Insurance Factory Depreciation on: Factory Buildings Factory Fixtures Machinery and Tools Patents, etc. Miscellaneous Factory Expense (All other items of factory expense are treated similarly.) Total Manufacturing Expense Total Manufacturing Cost Add: Inventory Goods in Process (Beginning) Total Deduct: Inventory Goods in Process (End) Manufacturing Cost of Goods Completed l TRADING AND PROFIT AND Loss STATEMENT Trading Section Manufactured Goods: Gross Sales Deduct: Returns 1 This form can be adapted with variations to all ordinary manufacturing businesses. The items listed and the inventories to be considered will vary, but the principles to be followed in the statement form are unvarying. 436 ACCOUNTING PRINCIPLES Net Sales Inventory Completed Goods (Beginning) Cost of Goods Manufactured (Brought down) Total Manufactured Goods to be accounted for Deduct: Inventory Completed Goods (End) Cost of Manufactured Goods Sold Gross Profit on Manufactured Goods Purchased Merchandise Class one (Furniture or whatever sort of mer- chandise is sold) Gross Sales Deduct: Returns Net Sales Inventory (Beginning) Purchases Deduct: Returns Net Purchases Add Freight-In Cost of Purchases Total (Furniture) to be accounted for Deduct: Inventory (End) Cost of (Furniture) Sold Gross Profit on (Furniture) Class two (Carpets or whatever sort of merchandise is sold) Form similar to above, arriving at Gross Profit on (Carpets) Class three (Similar form for each class of merchandise sold) Total Gross Profit Deduct: MANUFACTURING PROFIT AND LOSS STATEMENT 437 Gross Profits (Forward) Selling Expenses .... Salesmen's Salaries .... Salesmen's Traveling Expenses Freight and Cartage Out Advertising .... Heat, Light and Power (Store) .... Miscellaneous Selling Expense Delivery Expenses: Operation Auto Truck .... Operation Wagon Truck Depreciation on Delivery Equipment .... Total Delivery Expenses Credits and Collections Depreciation on Store Fixtures Other Selling Costs Total Selling Expenses Profit on Selling Deduct: Administrative Expense: Office Salaries Stationery and Printing: Inventory (Beginning) Purchases Total to be accounted for Deduct: Inventory (End) Stationery and Printing Cost Miscellaneous Office Expense Heat, Light and Power (Office) Depreciation : Building Office Equipment, etc. Taxes (Office Building) Insurance (Office Building) General Administrative Expense Total Administrative Expense Profits from Operations 438 ACCOUNTING PRINCIPLES Profits from Operation (Forward) Add: Other Income Interest Earned Discount on Purchases .... (Any other income) Total Other Income .... Total Income Deductions from Income Interest Expense Discount on Sales Total Deductions from Income Net Profit for the Period l 2. Sections of the Statement. The first section of the manufacturing statement is that having to do with prune cost. This data is perhaps the most important from the standpoint of judging the efficiency of the labor force of a factory. Statis- tical information made up on the basis of the prune cost figures would show the unit cost of production for the several items of prime cost if the output consisted of a uniform product. There would ordinarily be a specification prime cost or an estimated prime cost which could be compared with the actual cost data taken from the profit and loss statement. The results for the period would indicate the degree of efficiency with which the factory had been operating so far as the direct labor engaged in manufacture is concerned and so far as economy in the pur- chase and use of material is concerned. There is ordinarily less uniformity in the indirect expenses of a factory than would be found in the direct costs of production. The indirect expenses are likely to vary less with the total output of a factory than would the direct or operating expenses. An estimated cost of factory production, however, would also involve an estimated 1 The statement may be closed at this point, or it may be followed by the surplus state- ment showing the distribution of the profit. Sometimes the unusual gains are added and the unusual losses deducted, arriving at the amount which is to be carried to surplus. The sur- plus statement then shows the distribution of the profits. MANUFACTURING PROFIT AND LOSS STATEMENT 439 indirect expense cost per unit of output, and the indirect or manufacturing expense section would serve the purpose of in- dicating the extent to which the actual cost had kept within the estimated cost. Likewise each account of manufacturing expense would be subject to estimate and it would be possible to discover by an analysis such as that shown in the statement which of the items of indirect expense had been larger than the estimate or smaller than the estimate. No statement of costs can have great value to one who does not have in mind stand- ard costs with which to compare actual costs. 3. Standard Costs. One of the important functions of fac- tory management is to set up standard costs of production for a factory under supervision. Unless these standard costs can be fairly determined, the management is not efficient. The standard costs are the basis upon which comparison is made with results of a given period. It is more usual to set up esti- mated costs as a standard of what may be expected than in any former period of industrial production. Estimated costs are after all to a large extent the basis of determining the cost ac- counts which are to be set up. The estimated costs are conse- quently becoming a more significant part of the manufacturing statement than in any previous period of factory production. The actual costs of production from period to period are of great importance in making an estimate of the probable costs of production in any future period. Moreover, a reduction in cost in a given period as compared with costs in a preceding period is a favorable indication in regard to the efficiency of a factory. There are consequently two sets of data which are important for the purpose of determining the significance of a statement of factory production. The first of these is a state- ment of costs in a preceding period and the second is the esti- mate of cost which was made at the beginning of the period in question. Of course, unit costs are important both in connec- tion with the estimated costs and the actual costs. In fact, the estimate frequently takes the form of an estimated cost per unit in the first instance. The following form, therefore, of a factory statement will be of distinct value as a means of inter- 440 ACCOUNTING PRINCIPLES preting the initial statement made in connection with closing the books for a period. ILLUSTRATION NO. 36 VALLEY FURNITURE COMPANY MANUFACTURING STATEMENT (COMPARATIVE) ACTUAL EST. ACTUAL PER ACTUAL PER INCREASE 1 INCREASE 1920 1920 UNIT 1919 UNIT 1920 OVER PER UNIT 1919 i. Prime Cost a. Materials Used $.... $ $.... $ $.... $ $ b. Direct Labor . Total 2. Manufacturing Exp.: a. Indirect Labor b. Factory Sup- plies . . . c. Repairs Fac. . d. Heat Light and Power . e. Taxes Factory f. Depreciative Factory . . g. Miscellaneous Total 3. Total Factory Cost . $.... $ $ $ $ $ $ The comparative statement of the trading results of a factory is also important for the same reasons as those referred to in connection with factory production. It would therefore be advisable to make the trading statement on the same basis as that indicated for factory production when a comparative statement is made. A form for the comparative statement might be made as follows: 1 It is only possible to incorporate the per unit data when the factory is sufficiently spe- cialized so that accounts can be set up on this basis. MANUFACTURING PROFIT AND LOSS STATEMENT 441 COMPARATIVE STATEMENT OF PROFIT AND LOSS OF VALLEY FURNITURE COMPANY SHOWING MERCHANDISE SALES EST 1920 EST. PER UNIT AC- TUAL 1920 AC- TUAL PER UNIT AC- TUAL 1919 AC- TUAL PER UNIT ACTUAL INCREASE 1920 OVER 1919 "IN- CREASE PER UNIT i Net Sales Carpets . f $.... $.... $ 2. Cost of Goods Sold Car- pets 3. Gross Profits Carpets . . 4. Net Sales Chairs . . . 5. Mfg. Cost Chairs . . . 6. Gross Profits Chairs . . 7. Net Sales Furniture . . 7. Cost of Goods Sold Fur. 9. Gross Profits Fur. . . . 10. Total Gross Profits . . . (3) (6) (9) n. Selling Expenses: a. Salesmen's Salaries b. Salesmen's Trav. Exp. c. Frt. and Cartage Out . d. Advertising .... e. Heat, Light and Power (Store) f. Del. Exp. and Frt. . . . Del. Exp. Wagon Frt. . Deprec. on Del. Eq. i. Creditors and Collect- ors j. Dep. on St. Fixtures . k. Other Selling Exp. . . Total .... 12. Profit on Selling .... 13. Adm. Exp.: a. Office Sal b. Stationery and Printing c. Heat, Light and Power Office .... d. Deprec. (Adm. As- sets) e. Taxes (Adm. Assets) f . Insurance ( Adm. As- sets) Total 14. Profits from Operation . . 15. Other Income: a. Interest Earned . . b. Discount on Purchases c. Miscellaneous . . . Total 1 6. Total Income 17. Deductions: a. Int. Exp b. Discount on Sales . . 18. Net Profits : [ I $ $ $ $. . . 1 It might not be feasible to carry the per unit columns unless the sales and expenses could be classified by commodities. 442 ACCOUNTING PRINCIPLES 4. General Administration and Cost Data. The manufac- turing profit and loss statement is of use mainly to the general administrative officers of a business. It has a significance to the subordinate operating officers, but it is more important as a means of control from the standpoint of the officers in charge of the business as a whole. The manufacturing statement is commonly made once each month. The general administrative officers devote their attention more to questions of planning and matters of method, specification costs, and similar general considerations rather than to the detail operating facts of the factory. On the basis of the profit and loss statement, together with a balance sheet, the factory manager or officer in charge of production might estimate what commodities should be produced, and could in addition set up estimated costs of pro- duction on the basis of the specifications involved in the given case. This program of production together with estimated costs would be the basis of a program of purchase of raw ma- terials and a program of employment of labor. The general officers of a business charged with the employment of labor and with the purchase of material would be guided in their program of administration by the production estimate made by the officers in charge of production. The officer in charge of financing production must likewise rely in the first instance upon the statement of the financial condition of the business at the beginning of the period and secondly upon the requirements of the program for production that may be adopted. The esti- mate of the financial requirements connected with any produc- tion program has already been discussed in a preceding chap- ter on the profit and loss statement. One cannot, however, possibly understand the significance of the profit and loss statement for a factory unless it is understood that its content must be such as to provide adequate information for the prep- aration of a general plan of production, the preparation of a general plan of financing, and a general plan of employment. The plan of production, however, must itself be based upon the sales estimate made by the selling organization of a business. The factory might produce goods in accordance with its estimate MANUFACTURING PROFIT AND LOSS STATEMENT 443 and carry out a program completely in every respect except in connection with selling the product of the factory. This one deficiency would defeat the entire aim of the business and the entire aim of factory production. The estimate as to the sales possibilities of a business must be satisfactory before the results of production can be fairly forecasted. The detail of relating the profit and loss statement to the financial requirements of a business would be substantially the same in factory production as in the case of the trading concern discussed in a previous chapter. 5. Operating Data. For operating data officers and fore- men of a factory rely rather upon a detail plan of production which is based upon the general plan referred to in the para- graph above. The superintendent of a factory or the assistant superintendent must present a plan of production for each day. This plan involves production orders going to the several de- partments of the factory and these production orders should set forth both what is to be produced, the specifications for pro- duction and the time limits within which production is expected to take place. There will consequently arise certain day to day operating reports in regard to the daily output and the ex- penditure on direct labor for certain operations, and reports must be made from day to day showing these results so that the work of a succeeding day may be planned and provision may be made for carrying out the general program. If the actual results of operation are not made known from day to day to the operating foreman and officers so that they know substantially how actual results compare with estimated re- sults, there are probably defects in the management of the business. The monthly statement will doubtless show the gen- eral results of operations with greater accuracy than they are known by the operating officials prior to the expiration of the month, but the daily and weekly reports to operating execu- tives should be sufficient to enable them to forecast with a fair degree of accuracy the results of operation for the longer period. 6. Manufacturing Budget. The manufacturing budget is a systematic statement of the financial requirements of a factory for a given period. This budget must be based upon a program 444 ACCOUNTING PRINCIPLES of production similar to that referred to in describing the uses of the comparative statement in the paragraph above. The expense accounts found in the revenue statement together with the income accounts with which they are associated, rep- resent the framework for the construction of a budget. If the sales for a period can be estimated with a degree of accuracy the production requirements can then be set up by the man- agement of a factory. The sales program and the production program together will then be the basis of determining the fi- nancial requirements for the period concerned. An estimated revenue statement for a period together with a balance sheet at the beginning of the period would serve the financial man- agement of a factory in determining the funds to be required for a given period. The detailed calculation involved would be similar to that discussed in connection with the interpretation of the revenue statement for a trading concern. 7. Budgetary Accounts. In the small business the esti- mated costs are generally treated as statistical data to be set up in comparison with actual cost data that results from a given period of operation. In the large business, however, it is frequently regarded as desirable to set up the budgetary pro- gram in the accounts of the concern. The oil refining business, for example, frequently appropriates for a given period a cer- tain sum of money for a distributing station at a certain point. A journal entry is made of this appropriation in the same way that a journal entry would be made in connection with munici- pal accounting when an appropriation is made for the opera- tion of the street department. If the distributing station were to be built from accumulated surplus an appropriation therefor might be made by the following journal entries: a. Station A Fund Cash _. Set aside funds for construction of Station A b. Surplus Station A Appropriation Charging surplrs with appropriation for construction. 445 If these entries were made the specific appropriation accounts would be subsidiary to the total of appropriations for improve- ments and additions. As funds were spent they would be charged to the appropriation account. If $1500.00 were so spent it might be entered as follows: Station A Appropriation 1,500.00 Station A Fund 1,500.00 If material for station A account were purchased on time the journal entry would be: Station A Appropriation Accounts Payable, Station A (Individual creditor) When the account is paid the payment would be charged to accounts payable, station A, and credited to the station A fund. When the job has been finished let us suppose that it cost $15,000.00 when the appropriation was $18,000.00. The following entries would be made: Plant and Property, Station A. ... 15,000.00 Appropriation, Station A 3,000.00 Surplus 18,000.00 Cash 3,000.00 Station A Fund 3,000.00 An entry of this form does little more than to set up a fund and a reserve from surplus accumulated to be used for the con- struction of a distributing station. QUESTIONS AND PROBLEMS 1 . What is the use of the statement of manufacturing costs? 2. What is the relation between factory costs and business profits? 3. (a) What are the standard costs which are significant in a manufac- turing statement? (b) What is the relation between standard costs and the usefulness of actual costs? 4. Show the relations between the following: (a) sales program, (b) pro- duction program, (c) financial program. 5. How would each of these be constructed? 446 ACCOUNTING PRINCIPLES 6. From the trial balance and accounts made in connection with exer- cise data at the end of Chapter XXX make out a manufacturing statement. 7. The GX Oil Co. appropriated $25,000.00 for the construction of Station A, January i, 1921. On January 15 $5,000.00 of brick were pur- chased for the job and payrolls for direct labor amounting to $3,000.00 were paid. January 31 the balance of invoices were paid: materials, $10,000.00; direct labor, $5,000.00; indirect expense, $2,000.00. The work was finished and all necessary entries were made. Journalize the data and show how all accounts stood at the close of the job. CHAPTER XXXII THE VOUCHER RECORD AND THE ESTIMATING COST SYSTEM 1. Record of Expenditures. The variety of indirect ex- penses is larger for a factory than for a simple mercantile con- cern. The four-column purchase journal used in previous chap- ters would be insufficient to provide for the classification of ex- penditures involved in even a comparatively small factory. A voucher register is frequently substituted for the purchase jour- nal. An example of such a book of original entry is shown in Illustration No. 37 below. The transactions illustrated are for an establishment which combines the furniture business with the manufacture of chairs, and will be found in the transactions for May of the Valley Furniture Company at the end of Chapter XXIV. When a voucher record is used, all expenditures are included in it. Even cash outlays are entered in the voucher record prior to their entry in the cash book. The expense classification is pro- vided for in the voucher record so that the detail posting of charges to expense accounts is eliminated in the cash book. The advantage of the many columns provided for in the voucher register is the economy achieved in posting. It is necessary to post only the monthly totals of items charged to the several expense accounts. There is a limit, however, to the number of columns which may be readily used in an ex- pense distribution. A sundry column is consequently provided to take care of those expense accounts which involve a com- paratively small number of postings for each account. The form for closing the voucher register and posting the totals of the columns is shown in the illustration (No. 37). 2. Vouchers. The form of a voucher suitable for the voucher register referred to in paragraph i is shown in Illustra- 447 448 ACCOUNTING PRINCIPLES tion No. 38. The front of the voucher is used for listing the separate invoices included in a given voucher and for such gen- eral descriptive material as may indicate the character of the expenditure. The back of the voucher is ordinarily used for making the distribution of the total expenditure to the sepa- rate accounts to be charged. If the factory were in the habit of paying its bills monthly, unpaid bills could be assembled in a file according to firms. At the end of the month the invoices for a given firm could then be vouchered and attached to the face of the voucher. The voucher could then be folded prop- erly and placed in the unpaid voucher file. They are num- bered serially and filed in numerical order. They are com- monly entered in the voucher register when they have been thus prepared, after having been duly approved for payment by the appropriate officers of the business. At the time pay- ment is made, the original voucher and attached bills are sent to the payee to be receipted and returned. The payment would be entered in the cash book opposite the appropriate check number, and the gross amount of the voucher carried over into the vouchers payable column. The cash discounts could then be treated as they have been in the columnar cash book for the February and March entries. The discount col- umn in the voucher register is used for statistical purposes only. The postings to discount on purchases account and discount on sales account are made from the columnar cash book. Duplicates of respective vouchers are frequently also filed by the clerk in charge of voucher payments in order to preserve the voucher memorandum for such original vouchers as the payees may fail to return. When the original voucher returns, it is filed in numerical order among the paid vouchers. If the payee does not require for his own purposes the invoices cov- ered by a given voucher, the invoices may be attached to the duplicate voucher and held for reference in the file for dupli- cate vouchers. This might serve in some instances instead of the detail copy of bills made by business houses. The management cannot, however, conveniently refer to vouchers by number unless they have an index showing the VOUCHER RECORD AND ESTIMATING COST SYSTEM 449 voucher numbers for each creditor of the business. Such an alphabetical classification of creditors with numbers of vouchers issued to each will readily take the place of an accounts pay- able ledger, and make unnecessary all the detail postings to the credit and debit of purchase ledger accounts. 3. Voucher Checks. If a firm wishes to assure the re- turn of the receipted vouchers, it can do so by the use of what is called a voucher check. A voucher check suitable for the firm referred to in Illustration No. 38 is shown in Illustration No. 39 below. The accounts to be charged are shown on the face of the voucher, and one fold of the back of the voucher serves as a check, while the other fold provides space for en- dorsements. The voucher check would be treated in the same way as the original voucher referred to above. 450 ACCOUNTING PRINCIPLES Z tt = S8P Q * UNTS ABLE B ? 8 81 3 1 ll I I i 1 go VOUCHER RECORD AND ESTIMATING COST SYSTEM 451 8 8 888^^^8^88888 1^00 O O w &s I I! 452 ACCOUNTING PRINCIPLES ILLUSTRATION NO. 38- VOUCHER (FRONT) Valley, Ill.,_ THE VALLEY FURNITURE COMPANY To Dr. DATE OF INVOICE I PARTICULARS AMOUNTS Audited: Approved for Payment: RECEIVED PAYMENT ILLUSTRATION NO. 38 (BACK) CHECK NO._ VOUCHER NO._ Date iQ AMOUNT $ Name ACCOUNTS TO CHARGED BE Purchases: Material Furniture Carpets Labor: Direct Indirect Operation of Wagon Truck Operation of Auto Truck Mfg. Expense: Repairs Heat, Light, and Power Factory Supplies . . Misc. Factory Expense Selling Expenses: Salesmen's Salaries Traveling Expenses Advertising .... Misc. Selling Expense . General Expenses: Office Salaries . . . Stationery and Printing Misc. Expense . . . Freight-In . . . . 453 454 ACCOUNTING PRINCIPLES O _f ,? ~ p^g ffi s u 8 o > g H HH z p< 5 |J < d c E- 1 rv; " 5 .: ?? -0 d ortM tC O -* ^5 r/^ r- ^ cj api"aR t> 2 -g 2 - - < Sfigt5B3i3iM< i g lllI^||llJfll-31 ^tsi-u-i-E; -- z.rJ^-i>t-.-JS -^C--XCi_^0^- i-' t ' Pk _J = = o VOUCHER RECORD AND ESTIMATING COST SYSTEM 455 ILLUSTRATION NO. 39 (BACK) r gj o" c-f Cf VOUCHER CHECK NO. MAKE ENDORSEMENTS HERE < S Q g r 1 2 O) fl > 335- f r grading the factory grounds and laying out drives and walks. (Is this an expense or an addition to assets?) April 27. Credit Sales: A. W. Martin furniture, $ 400.00; carpets, $300.00; terms, reg. H. R. Scott furniture, 1,010.00; carpets, 460.00; terms, reg. K. C. Riley furniture, 1,725.00; carpets, 760.00; terms, reg. April 28. The Valley Mills is willing to allow the discount on Voucher # 26 if payment is made by a note of the corporation. A note payable in 30 days with interest at 6 per cent is given for the net amount of the voucher. (Mark the voucher "Paid by journal entry," referring to page on which the entry is made, and make the necessary entry in the journal.) Purchased from the Borch Tannery materials amounting to $2,160.00. Terms, n/3o. (Voucher #31.) Voucher #32 is drawn and paid to James Blackwell, the cashier, for payments from petty cash as follows: Shop Supplies 22.00 Miscellaneous Factory Expense 10.00 Advertising 3.20 Miscellaneous Selling Expense 2.10 Stationery and Printing 14 75 Miscellaneous Office Expense 7.30 Operation Wagon Truck 21.70 81.05 A second shipment of chairs to the Soars-Roduck Co. is made, 680 chairs being sent, billed as before. Allowance is made for damage to the goods sold to H. R. Scott on the 27th: furniture, $16.00; carpets, $23.00. April 30. Voucher #35 to currency covers the semi-monthly pay- roll as follows: Direct Labor 1,140.00 Indirect Labor 652.00 Repairs 25.00 Salesmen's Salaries 170.00 Operation Auto Truck 35- Office Salaries 266.00 Operation Wagon Truck 27.50 2,315-50 OPENING THE CORPORATION BOOKS FOR APRIL 469 The following vouchers are drawn and paid: Donald Home, salesmen's salaries, $125.00; expenses, $87.00; (Voucher #34.) Elaine Harris, salesmen's salaries, $110.00; expenses, $82.50. (Voucher #35.) Frank Williams, salary as general manager, $200.00 (Voucher #36.) 5. The Record of April Transactions. After entering the April transactions the student should close the books of orig- inal entry first with pencil closings. Then the trial balance for the April transactions should be taken. After the transactions are checked and a correct trial balance is found the additional entries should be made from the succeeding paragraph. 6. Additional Summary Entries. To provide material upon which to base a yearly closing for the business of the Valley Furniture Co. without making necessary routine detailed en- tries for the whole period the transactions between May i, 1915, and March 31, 1916, are given below hi total. Enter these totals properly in the books of the Valley Furniture Co.; post them, and take a trial balance as of March 31, 1916. VOUCHER RECORD Material Purchased 64,243.00 Furniture Purchased 70,314.00 Carpets Purchased 48,372.00 Freight-In 4,367-45 Direct Labor 33,460.45 Indirect Labor 13,748.90 Repairs to Machinery 1,136.27 Heat, Light and Power 6,358.70 Factory Supplies 1,428.40 Misc. Factory Exp. 162.36 Operation Auto Truck 954-85 Operation Wagon Truck 746.63 Salesmen's Trav. Exp. Misc. Selling Exp. Advertising Freight Out Office Salaries Stationery and Printing Misc. Office Exp. Taxes Interest Notes Payable Advances to Salesmen Salesmen's Salaries 1,468.40 726.35 2,475.20 675.28 8,342.00 543-95 150-30 i,340.54 1,143.27 24,360.00 200.00 5,640.00 The total credit to accounts payable is $292,358.30. SALES REGISTER SALES RETURNS AND AL- LOWANCES Furniture Sales Carpet Sales Chair Sales 106,342.50 Furniture 78,221.40 Carpets 126,347.29 Chairs i, 100.60 627.30 1,225.65 470 ACCOUNTING PRINCIPLES JOURNAL Accts. Rec., $17,268.40 are paid by notes. Notes Rec. Disc., $500.00 have matured without protest. Bad Debts amounting to $251.00 are charged off. CASH BOOK DEBITS Collection of Accts. Rec. $276,543.20, less disc, on sales $2,821.43. Notes Rec. paid up, $13,436.40, and from int. $740.00. Notes Rec. Disc. $1.310.00 less int. of $35.00. Notes Pay. $25,400.00 less int. of $325.30. CASH BOOK CREDITS Accts. Pay. paid $285,362.40, less disc, on pur. of $3,204.63. 7. Data for Annual Closing. A. Adjustments prior to closing: (a) Depreciation. Allow annual depreciation on store build- ing of 5 per cent and on factory of 6 per cent. Allow annual depreciation on machinery and tools of 8 per cent. The depre- ciation on these classes of assets should be shown in the re- serve accounts which have already been provided for. Write down the value of factory fixtures, store fixtures, and office equipment 10 per cent for depreciation, and the value of the delivery equipment 20 per cent for depreciation. (b) Interest Items. Any accrued interest on notes receiv- able or accrued interest on notes payable which was found on the books at the beginning of the period should be dosed out by the usual reversing entry if it was not done at the beginning of the period. (c) Accrued interest on notes receivable at the end of the year was $174.50. Place this item on the books. Interest paid in advance on notes payable amounted to $45.00. (d) Payroll Payable. There was direct labor accrued of $795.40, indirect labor of $286.79, an< ^ engineers' and firemen's salaries of $24.00. (Open payroll payable on page 58.) B. Closing entries: OPENING THE CORPORATION BOOKS FOR APRIL 471 (i) Manufacturing costs are shown in the manufacturing ac- count. This account is debited with all costs of manufacturing and credited with all off-sets, so that when all entries have been made, the balance in the account represents the cost of manu- facturing the goods which have been made during the period. The first items to be shown in this account are the elements of prime cost, materials and direct labor. The cost of materials used in manufacturing is, of course, the inventory of materials at the beginning of the period plus the purchases, less the in- ventory at the end. The adjustments for inventory can be made either in mate- rial purchases or in manufacturing. The first entry made is that to transfer to material purchases the proportionate cost of the freight on materials purchased. Three eighths of the freight- in is to be charged to materials. The inventory of materials is $12,000. The next step is to close into manufacturing all other costs. The elements of manufacturing costs in addition to prime cost which are found in this business include indirect labor, used for factory operation, factory supplies, miscellaneous fac- tory expense, depreciation on factory and equipment, taxes and insurance on factory and equipment. Some of these items can be transferred directly to manufacturing. Others require adjustment. There is an inventory of factory sup- plies of $325.00. (Adjust the account to show the cost of fac- tory supplies consumed before closing it into manufacturing.) Three fourths of the cost of heat, light and power was for the factory. The depreciation on factory building, machinery and tools, and factory fixtures is chargeable to manufacturing. One half of the taxes was for the factory equipment and materials. The insurance expired during the year was $434.60, of which one half was insurance on the factory and contents. (The simplest method of booking this cost is by debiting manufacturing and crediting insurance with the proper amount.) Patents should be written down one tenth, as their value has decreased by at least that amount. This decrease in the value of patents is a manufacturing expense. 472 ACCOUNTING PRINCIPLES The final step is to make the adjustment in manufacturing for the goods in process so that the account will show the cost of the actual goods completed. This adjustment is made by transferring any inventory of goods in process at the begin- ning of the period to manufacturing (hi this case there was no such inventory since the factor}' began operations at the be- ginning of the period) and placing the new inventory of goods in process on the books. This inventory was $10,290.00. The Manufacturing account now shows the cost of the goods which have been manufactured. (2) To determine gross profits. The gross profits are to be determined on each class of mer- chandise sold. To determine the gross profits on chairs it is necessary to show first the cost of manufacturing the chairs. The cost of manufacturing has been determined in manufac- turing. An entry transferring this cost from manufacturing to trading is necessary. The principal credit is of course the chair sales, and this account, after adjustment for returns, is closed into trading. When the account is adjusted for the in- ventories, the gross profit on chair sales can be found. There was no inventory of chairs at the beginning of the period, but at the end there was an inventory of finished product, chairs, of $9,980.00. In order that the gross profit may be shown dearly, the trading account should be balanced at this point and the gross profit on chair sales brought down. The gross profit on furniture sales and carpet sales is to be determined in separate trading accounts. One fourth of the freight- in is to be charged to carpet pur- chases and three eighths to furniture purchases. The inventory of carpets at the end of the year was $30,000.00 and of furniture, $59,000.00. The trading account now shows the gross profit on all classes of goods sold. (3) Setting Costs. A setting account is sometimes opened either as a separate closing account or as a section of the profit and loss account. It may be opened as a separate account. The gross profits from the trading accounts would be brought down to the credit of the setting account by journal entry. All OPENING THE CORPORATION BOOKS FOR APRIL 473 the expense accounts classified under selling expenses in the schedule of accounts would then be closed into selling by jour- nal entry. In this business the selling costs are the proportionate amount of heat, light, and power used in the store, which was one eighth of the total amount, the operation of the auto truck, the oper- ation of the wagon truck, the depreciation on delivery equip- ment (remember that during the year a charge was made to depre- ciation on some delivery equipment, which must be added to the depreciation allowed at the end of the year) the deprecia- tion on store fixtures, salesmen's salaries, salesmen's travel- ing expenses, miscellaneous selling expense, freight and cart- age out, and advertising. $275.00 of the advertising expen- diture is to be treated as a deferred charge. The balance in selling now shows the profit on selling before the general ex- penses of the business are deducted. (4) Determining the Net Profit. The net profit on selling is then transferred to profit and loss, in which account the va- rious general expenses of the business are deducted. These general expenses include office salaries, stationery and print- ing (before closing this account must be adjusted for an inven- tory of $25.00 of office supplies on hand), miscellaneous office expense, depreciation on store building and on office equip- ment, one eighth of the total cost of heat, light, and power, and one half of the taxes and one half of the insurance. The balance in profit and loss at this point is the net profit from operations. The account should be balanced and the net profits from oper- ation shown. To this net profit from operations is to be added the secondary income, and the deductions from income are the dis- count accounts. A reserve for uncollectible accounts is to be set up by debiting profit and loss and crediting reserve for bad debts. Allow $750.00 for this item. Against this reserve charge the uncollectible accounts as they are marked off. The balance in profit and loss now shows the net profit for the year. The accounts are now in such condition that the final statements can easily be made. (5) Form for a Sectionalized Profit and Loss Account, The 474 ACCOUNTING PRINCIPLES student will readily see just what journal entries are made from the following form for a sectionalized profit and loss: ILLUSTRATION NO. 40 PROFIT AND Loss (Sectionalized) Operation of Auto Truck Operation of Wagon Truck Advertising Salesmen's Trav. Expense Salesmen's Salaries Depreciation on Delivery Equipment Net Profit on Selling Gross Profits (down) Office Salaries Stationery and Printing Depreciation on Stores and Fixtures Insurance Misc. General Expense Net Profit from Operation Net Profits on Selling (down) Discount on Sales Interest Expense Net Profits Net Profits from Opera- tion (down) Interest Income Discount on Purchases APPENDIX THE WORKING SHEET 1. The Purpose of the Working Sheet. When the closing is made by journal entry, the whole process involves several accounts, the balance sheet, and revenue statement. The accountant frequently wishes to bring all of these together on the same page, for the purpose of working out the data in the first instance prior to placing it on the ledger. The old elementary text furnished for this purpose what was called the six-column statement. This statement had in it the following columns: (a) Trial balance debits; (6) Trial balance credits; (c) Profit and loss debits; (d) Profit and loss credits; (e) Balance sheet assets; (/) Balance sheet liabilities. The working sheet takes all of these columns and adds two more for the purpose of taking care of such adjustments as are needed in connection with making the final entries involved in drawing off a revenue statement and balance sheet. The form below will show the headings for the working sheet. 2. Entries on the Working Sheet. The new accounts in- volved in taking off the working sheet are entered ordinarily directly under those which would be used in making the trial balance. Instead of entering these items in the trial balance columns, however, the new account entries are placed in the adjustment column. The letter placed to the left of each entry refers to the list of items involved in the adjustments. These items appear below. After the adjustment items are properly entered and carried over into the profit and loss column or the balance sheet column, as may be required, it is then possible to calculate the net profits which are entered in the left column of the profit and loss column. With this new net profit the capital account or total net profit accumulated may be changed to correspond with the final total. The two columns of the balance sheet should then balance if the work has been correct. 475 476 ACCOUNTING PRINCIPLES 3. The Working Sheet and the Statement The working sheet is not the final form in which the statements are commonly left. It is only preliminary and is merely an aid to the ac- countant in bringing the data together. When the profit and loss items and the balance sheet items have been thus assembled it is a simple matter to draw off the revenue statement and balance sheet in the form most suitable for comprehension by the ordinary manager or stockholder who may not be ac- quainted with accounting terminology. 4. Adjusting Entries. The adjusting entries used in the working sheet are as follows: a. Merchandise inventory end of the period, $10,200.00. b. Accrued taxes, $150.00. c. Reserve for bad debts, $180.00. d. Reserve for depreciation on furniture and fixtures, $100.00 e. Interest accrued on notes receivable, $50.00. /. Selling salaries accrued, $200.00. g. Administrative salaries accrued, $250.00. THE WORKING SHEET 477 3 S 3 o o o o o o INDEX Accounts: Accrued expense, 137 Accrued income, 135 Asset account, debits and credits, 26 Balances as affected by transactions, 34; 35 Capital, 33 Cash, 25 Closing of, 46 Creditor accounts, 26, 27 Customer accounts, 22 Liability accounts, debit and credit of, 28 Merchandise, 29, 31 Period covered by, 21 Personal, 34 Profit and Loss 32 Relation to statement 21 Return purchases and allowances, 74 Return sales and allowances, 75 Revenue accounts, 29 Trading, 74 Account sales, 250 252 Admission of partners, 295, 297 Appropriated surplus, 385 Assets, i order of in the balance sheet, 7 classes of, 7, 162 B Balance sheet: Comparative, 167 Corporation. 5 Form of, 169, 172, 175, 176 Individual business, 5 Methods of internal analysis, 182 Partnership, 5 Relation to estimates, 168 Showing groups of items, 9 Use of ratios for interpreting, 183, 184, 185 Uses of, 162 Bill book, 214 Bonds: Bond discount, 365 Bond investment account, 368 Bond premium, 367 . Bond register, 406 Bond subscriptions, '364 Treasury bonds, 390 Book value of shares, 376 Budgetary accounts, 444 Budget and cash estimate, 173 Budgets and statements, 156 Capital account, 33 Capital accounts of partners, 134 Cash journal, 72, 192 Cash requirements of a business, 173, 174 Checking the ledger, 45 Classification of accounts in revenue statement, 146 Classification of incomes in revenue state- ment, 150 Closing accounts, 95 Closing accounts through the journal, 46, 47 Columnar cash journal, 192 Columnar journals, 188 Columnar purchase journal, 192 Columnar sales journal, 193 Commercial papers: Acceptance, 62 Design of, 56 Draft, three-party, 62 Promissory note, 59 Purchase invoice, 57, 58 Consignee records, 245, 246, 248 Consignments, 245 Consignor records. 249 262 Consolidation of two or more individual businesses in a partnership, 133 Controlling accounts, 187, 196 Corporate organization, 328-338 Bonds, 331 Charter and by-laws, 333 Common stock, 330 Corporate organization and account- ing, 335 Dividends, 334 Liabilities of stockholders, 329 Minute book, 334 Preferred stock, 330 Shares without par value, 328 Corporation, 2 Corporation accounting, 336 Bond register, 406 479 480 ACCOUNTING PRINCIPLES Corporation accounting continued Book value of stock 376 Corporate balance sheet, 336, 330 Discount on stock, 381 Entry of exchange of property for stock, 349 Forfeited sleek, 360 Instalment records, 348 Issue of corporate shares and journal entries of, 342, 343 Opening the corporation books, 458 Premium on stcck. .380 Stock certificate, 402 Stock dividends, 379 Stock ledger, 404, 405 Stock transfer book. 405 Subscription ledger, 401, 402 Subscriptions to stock, 343, 399 Transferof business to corporation. 352 Unissued stock, 345 Corporation bonds, 364-373 Bond discount, 365 Bond investment account, 368 Bond premiums, 367 Bond subscriptions, 364 Treasury bonds, 370 Correcting estimated costs, 424 Cost terms, 428 Deferred expense, 138 Deferred income, 140 Delivery expense, 149 Depreciation : Causes of, 114 Constant percentage of diminishing value, 116 Definition, 114 Depreciation and extraordinary re- pairs, 124 Depreciation and replacements, 126 Depreciation reserve, 118 Depreciation and scrap value, 122 Methods of charging, 116 Relation of repairs to, 118, 120 Relation to price reductions, 115 Sinking-fund method of depreciation, 121 Straight-line. 116 Direct labor, 410 Direct material, 411 Discount, 64, 65 Discount in columnar journals, 190 Discount in the special journals, 75 Discount on stock, 381 Distribution of partnership profits, 305, 307 Divided journal, 71 Dividend book, 409 Dividends, declaration of, 377 Donated stock, 386 Draft: Acceptance, 62 Bill of exchange, 62 Check, 64 Sight draft, 63 Time draft, 62, 63 Enterprise, 2 Enterpriser, 2 Erasures, 97 Estimating costs, 412 Estimated cost data journalized, 422 Exchange, 62 Exchange of property for stock, 349 Executive use of cost data, 442 Expenses: Apportionment of, 112 Nature of, 13, 112 Extraordinary repairs, 124 Factory accounting, 410-432 Correcting estimated costs, 424 Cost terms, 428 Direct labor, 410 Direct material, 411 Estimated cost data journalized, 422 Estimating costs, 412 Goods in process, 415, 416, 417 Indirect expense, 411 Manufacturing account, 414 Financial statement: Form of, 6 Showing account groups, 10 Fixed costs, 147 Forfeited stock, 360 General journal, 73, 89, 83 General ledger, 73 Goods in process, 416 Goodwill in partnership, 295, 297 INDEX 481 Incomes, n Nature of, 12 Indirect expense, 411 Individual business unit, i Instalment records, 348 Interest: Calculation of, 66-68 Entry in columnar cash journal, 197 Inventories: Calculation of, 153, 154 Merchandise, 30, 31 Shipment, 255 Stock ledger, 152, 153 Supply, 113 Invoices used as journals, 75 Journal, 44: Cash journal, 72, 78, 192 Divided journal, 71 General journal, 80, 83 Memoranda in, 97 Notes payable journal, 219, 220 Notes receivable journal, 216 Purchase journal, 72, 79, 192 Sales journal, 73, 79, 193 Use of, 44 Ledgers: General ledger, 73 Kinds of, 43 Memoranda in, 98 Purchase ledger, 195 Sales ledger, 196 Stock ledger, 404, 405 Subscription ledger, 401, 402 Liabilities: Classes of, 7, 8, 9, 163 Definition and nature, 3 Order of in the balance sheet, 7 Relation to assets, 164 Liquidating dividends, 314 Loans from partners, 315 M Manufacturing account, 414 Manufacturing budget, 443 Manufacturing profit and loss statement. 433-44S Comparative, 441 Form of, 434 Sections of, 438 N Net profits: Definition, 15 Notes payable controlling account, 220 Notes payable journal, 219, 220 Notes receivable controlling account, 220 Notes receivable discounted, 61 Notes receivable journal, 216 Opening accounts- thf'ough journal, 48 Opening corporation books, 458 Opening the voucher register, 462 Partnership, 2, 294 Partnership accounting: Admission of partners, 295, 297 Articles of partnership, 294 Books of the partnership, 294 Distribution of partnership profits, 305, 307 Goodwill in partnership, 295, 297 Liquidating dividends, 314 Loans from partners, 315 Overdrafts of capital, 323 Priority of partnership claims, 305, 306 Reducing capitals to profit and loss sharing ratio, 322 Retiring partner's interest, 301 Petty cash book, 106, 108 Petty cash, impressed system of, 106 Petty cash journal, 107, 109 Posting, 45 Premium on stock, 384 Profits from operation, 14 Promissory note, 59 Proprietorship, 3, 4 Purchase journal, 72. 192 Purchase ledger, 195 Reserve for bad debts, 143 Reserve for sinking fund, 393 Retiring partner's interest, 301 Return purchases and allowances, 74 Return sales and allowances, 75 482 ACCOUNTING PRINCIPLES Revenue statement: Construction from list of items, 15 Form of, 16 Gross profits, 14 Income balances, 14 Profits from operations, 14 Relation of budgets to, 156 Uses of, 17 Saks journal, 73, 193 Saks ledger, 196 Selling expenses, 149 Shipment inventory. 255 Shipment journal, 276 Shipment profit and loss, 254 Standard costs. 439 Stock certificates, 402 Stock dividends, 379 Stock ledger, 153, 404. 405 Stock transfer book, 403 Straight-line depreciation, 116 Subscription ledger, 401 Subscription rights, value of, 380 Subscriptions to stock, 343, 399 Supply inventories, 113 Surpl u Appropriated, 385 Available, 384, 391, 392 Donated stock, 386 Sinking fund reserve, 393 Surplus reserves, 396 Trading account, 74, 239 Transferring of assets and liabilities to a new concern, 130-133 Transfer of business to a corporation, 352 Treasury bonds, 370 Trial balance, 36 Unissued stock, 345 V Valley Furniture Store: April transactions, 463-470 February transactions. 227-236 January transactions, 09-105 Ledger accounts for April, 460 Ledger accounts for February. 222 Ledger accounts of, 93-95 March transactions, 285-295 Valuation reserves, 306 Voucher check 449 454 Voucher record, 447-457 Voucher register and purchase ledger, 456 Vouchers, 447, 452, 453 UNIVERSITY OF CALIFORNIA LIBRARY Los Angeles This book is DUE on the last date stamped below. JAN 8 1962 jm8J. JUL 27 19J6 AUG 3-* 2 REMOVED FROM SN/ 2PM G SHELf Form L9-32m-8,'58(5876s4)444 UCLA-GSM Library HF5635B4133 L 005 003 502 1 SOUTHERN A 001259721