THE LIBRARY OF THE UNIVERSITY OF CALIFORNIA LOS ANGELES 3RANCH, UNIVERSHY OP CALIFORNIA, LIBRARY, 1UDS ANGELES, CALIF. Graduate Sc^'ol of Business Administration Uni'/ersity of California Los Angeles 24, California C. P. A. ACCOUNTING THEORY, QUESTIONS, AND PROBLEMS BY GEORGE HILLIS NEWLOVE, Ph.D., C.P.A. (,.,) RESIDENT AUDITOR, INCOME TAX UNIT, BUREAU OP INTERNAL REVENUE; DEAN, WASHINGTON SCHOOL OF ACCOUNTANCY; MEMBER, NATIONAL Y. M. C. A. ACCOUNTANCY STANDARDIZATION COMMITTEE; MEMBER, AMERICAN ASSOCIATION OF UNIVERSITY INSTRUCTORS OF ACCOUNTING; LIEU- TENANT (j. G.), PAY CORPS, U. S'. N. R. F. (INACTIVE). VOLUME I V/ACA ASSOCIATION PRESS NEW YORK: 347 MADISON AVENUE 1921 40064 COPYRIGHT 1921. BY THE IXTERNATIO.NAI. COMMITTEE OF Vrii-x<; MEN'S CHRISTIAN ASSOCIATIONS (Printed in the United States of America) .111 Rights Reserved Boa. Admin, Library FOREWORD The past school year .H)2lM921 closed the first decade of the study f of Accountancy in V. .M. ('. A. Schools, with an enrolment of approxi- sSinately 10,000 students, it is, therefore, quite in line with the progressive 'policy of the United V. M. ('. A. Schools to begin the second decade o!' Association Accountancy instruction by furnishing, for advanced stu- ^ dents, these two volumes on "C. P. A. ACCOUNTING THEORY, QUESTIONS, : AN- i) PROBLEMS,". by George Hillis Newlove, Ph. I)., C. P. A. For two years the standard Accountancy Commission of the United Y. .M. C. A. Schools has been carefully studying the Accountancy courses 'offered by the local Association schools, with a view to planning a f*standard four-year curriculum that would be of maximum service to the student, not only in giving him sound instruction, but in equipping Jhim to pass his state examination. / These books by Dr. Newlove are admirably planned to furnish the ^instruction and equipment referred to, for they are the outgrowth of .Jiis own experiences as instructor and Dean of the Washington, D. C., School of Accountancy. Q It will be observed that there are more problems in the books than ocan be solved within class periods. In order to relieve the instructor /Jand to aid the student, model solutions for all problems have been pro- vided, in mimeograph form. These may be secured, at slight cost, from the Educational Director of the local Association, by resident students, After they have solved the problems required by the instructor. Those Jprho arc using these books, but are not in Association classes, may secure 'sPlhe model problem solutions from Association Press, 347 Madison Avenue, JNew York City. The Accountancy Commission, to which full credit is due for its earnest and practical work in formulating curricula, consists of D. S". Sylvester, B. C. S., LL. B., Dean, School of Commerce and Finance, Northeastern College, Boston, Mass.; H. C. Dairies, A. B., B. C. S., Edu- cational Director, Chicago; Ralph B. Mayo, President of R. B. Mayo. & Co., Denver; Gr. H. Newlove, Ph. D., C. P. A., Dean, Washington School of Accountancy, Washington, D. C.; F. L. Roth, Dean, School of Business Administration, Cleveland; and C. A. Wesp, Dean, School of Commerce, Philadelphia, PREFACE This volume together with Volume II classifies all the general accounting theory and auditing questions given in 335 C.P.A. examinations. When more than one examination has used identical questions all references are given, and where questions are practically identical an asterisk has been used after the reference which used the question in a slightly different form. The lectures, which attempt to answer the questions, presuppose at least two years' study of accounting or its equivalent, in a resident school. The elimination of the elementary subject matter enables the lectures to con- tain in a comparatively brief compass, a digest of the advanced theory and auditing points. As the attempted use of at least three references for each accounting point rendered the giving of proper credit for direct quotations impossible, direct quotations have been avoided. The references practically amount to indirect quotations, however, and no special changes in phraseology have been made to conceal this fact. It is not claimed that the bibli- ography is complete, three references on undisputed points and as many references as possible on disputed points being the desired goal. The purposes of this work are (a) to show the C.P.A. candidates what will be expected of them and to offer them an opportunity for further study on the particular points on which they are weak, and (b) to incite the universities to offer post-graduate courses in accounting literature so that there will not be as much diversity of thought in the accounting books of tomorrow as is shown by the references to exist in the accounting books of today. This volume and Volume II have been arranged so that the theory and auditing questions and the practical problems on each subject will be studied concurrently with the lecture on each subject. The undersigned wishes to express his appreciation to Mr. Thos. W. Walton and Mr. Arthur L. Ward, the former and present educational sec- retaries, Young Men's Christian Association, Washington D. C., for assist- ance in developing the C.P.A. preparatory courses given by the Wash- ington School of Accountancy, from 16 two-hour class sessions with 8 students in November, 1918, to 64 two-hour class sessions with 142 stu- dents in June, 1021. This teaching experience and the opportunity for two years to spend practically my entire time on the material is responsible for whatever merit there may be in this work. The undersigned is further indebted to Professor R. B. Kester, C.P.A., Columbia University, for his valuable suggestions; to Mr. John Berg, C.P.A., Washington, D. C., for liis help on the detailed references, and to Miss Margaret E. Batson, Sec- retary, Washington School of Accountancy, for her help in editing the material. G. H. NEWLOVE. r -f, r lOOl cfl o3 a3 03 03 03 03 ro cs a: 6161 8161 9161 161 SI6I II6I 0161 6061 8061 1061 V06I 9061 1-061 J061 061 1061 00-.il (it is I StiSl 9681 VI 1 F*o,L t to General Accounting; Comparison of Cost and Non- Cost Systems; Kinds of Cost Systems; Control of Material; Control of Labor Costs ; Wage Systems ; Control of Manufacturing Expenses ; By- Products ; Inventories. CONTENTS xiii KEY TO REFERENCES PAGK A to Q 339 R to Z 340 AA to MM 340 NN to ZZ 341 AAA to GGG 341 HHH to ZZZ 342 A A AA to VVVV 343 \V\VWW to ZZZZ 344 AAAAA to HHHHH 344 REFERENCES FOR CHAPTERS REPERENCKS FOR CM AFTER I 345 REFERENCES FOR CHAPTER II 346 REFERENCES FOR CHAPTER III 347 REFERENCES FOR CHAPTER IV 349 REFERENCES FOR CHAPTER V 350 K KFERENCES FOR CHAPTER VI 351 REFERENCES FOR CHAPTER VII 351 REFERENCES FOR CHAPTER VIII 352 REFERENCES FOR CHAPTER IX 355 REFERENCES FOR CHAPTER X 357 REFERENCES FOR CHAPTER* XI 358 REFERENCES FOR CHAPTER XII , 359 REFERENCES FOR CHAPTER XIII 360 REFERENCES FOR CHAPTER XIV 363 REFERENCES FOR CHAPTER XV 364 REFERENCES FOR CHAPTER XVI . . 366 C. P. A. ACCOUNTING CHAPTER I FIELD OF ACCOUNTANCY Bookkeeping Bookkeeping may be defined as the art of keeping a systematic record of business transactions. 1 There are two systems of bookkeeping, namely: (1) Single entry (some- times called simple entry), the system wherein entries of transactions do not require equal charges and credits for every exchange, 2 and where in its simplest form, transactions are shown only in the relation they bear to persons; 3 and (2) double entry, the system wherein two equal records are made for each transaction, one a charge and the other a credit to the re- spective accounts affected. 4 Accounting Accounting may be defined as the science which treats of the systematic record, compilation, and presentation in a comprehensive manner for administrative purposes of the financial operations of a busi- ness organization. 5 While accounting includes bookkeeping, it does not stop with the mechanical recording of any given set of facts, but embraces the designing of bookkeeping forms and methods and the presentation of the data gathered by the bookkeeper in the form of statements for the information of the management." Installing Systems The work of installing a system for an industry requires first, a knowledge of mechanics of the industry; second, a knowl- edge of the financial and legal status of the industry, and third, a knowledge of the men who will operate the system. 7 The first is needed to have the data classified according to the operations of the business, the second so that the interests of the firm may be safeguarded and all legal requirements met, and the third in order that the system may be operated by the men available. This third point is so important that accountants specializing in system work usually arrange to have the clients' staff in- structed in the operation of the system. Auditing Auditing is the art of verifying the work incident to the record, compilation, and presentation of the facts concerning business transactions. 8 Large firms have "inside" auditors who regularly audit their books and documents. This excellent practice has the effect of discouraging fraudu- lent practices and of increasing the care with which the records are kept. However, even if "inside" auditors are employed, the affairs should be regularly investigated by a professional auditor, who, removed from local influences, can be relied upon to treat matters in a disinterested manner, and whose wider experience makes him capable of advising his client as 'For explanation of superior figures see page 337. 1 C. P. A. ACCOUNTING to the probable effect of practices which he condemns and those which he rccomnu nds." Professional auditors frequently are able from their experi- ence to develop a percentage table based upon net sales which shows the normal ratio of the various items in the profit and loss statement. A comparison of the actual with the theoretical percentages frequently leads to discovery of leaks and over-expenditures. Objects of Auditing The three objects of an audit usually given are the discovery of errors of principle, the elimination of mechanical errors, and the detection of fraud. 10 To these a fourth and fifth object may be added, namely, the ascertaining of ways of improving the accounting system and office organization methods, 11 and the preparation of analytical and un- biased statements showing the business conditions." The last object is the most important, as the correct statements aid (a) in the securing of short time credit, (b) in floating bonds, (c) in sale of the business, (d) in adjustments between partners, and (e) in the settlement of fire loss claims." Errors of Principle As mistakes in principle are usually more im- portant than mechanical errors or even fraud, the auditor must be con- stantly guarding against them." As errors of principle, such as capitaliz- ing revenue expenditures, 15 omitting a proper allowance for depreciation, 1 " etc., are usually caused by ignorance and because the errors usually make out the profits to be higher than they really are, it is frequently difficult to convince the management that they are wrong." Mechanical Errors It must not be assumed that mechanical errors are due to fraud, 18 frequently they are caused by the ignorance or carelessness of the bookkeeper. It is important to remember that incorrect books frequently balance as the errors offset one another. 1 " This fact shows the danger of the practice of writing off a small error in the trial balance." However, an auditor lays himself open to just criticism if he devotes a considerable part of his time searching for clerical errors. 21 Methods for locating errors in a trial balance are too numerous to mention, especially as they are largely guesswork. Auditors usually try to avoid auditing the books when they are mechanically incorrect, as they realize that their clients cannot afford to pay professional fees for such mechanical services." However, frequently auditors are compelled to audit books which are out of balance, in which cases they usually depend upon either blocking or analyzing the ledger, procedures discussed in Chapter XIII, Volume II. Detection of Fraud The business world still holds the discovery of fraud as the chief aim of an audit, 21 Although this idea is incorrect, it forces the auditor to pay special attention to this feature, for even though an auditor has left no stone unturned in his search for fraud, his practice will be hurt if fraud is later discovered, even though he is not legallv liable. 24 There is one feature about fraud, however, that aids the auditor, namely, the fact that each case of fraud is usually concealed in the same way, due, FIELD OF ACCOUNTANCY 3 no doubt, to the desire of the culprit to simplify the continuation of the defalcation and the fear of trying a new method of concealment when one has already proved so far successful." For this reason the auditor is always suspicions ut any unusual variations in the accounts. Qualifications of Auditor* The C. P. A. boards by their requirements show the legal qualifications to be a thorough knowledge in accounting and auditing theory and practical accounting and a fair knowledge of commercial law coupled with a high school education and several years of experience as a junior accountant. There are two additional qualifica- tions which the legal requirements cannot reach namely, thoroughness and imagination/" Nothing short of exact correctness can be accepted by a good auditor. The faculty for imagination comes into opei'ation when the auditor visualizes the accounting system in search for possible oppor- tunities for fraud, or when the auditor tries to work out in his imagina- tion the operation of the accounting system he is creating. Responsibility of Auditor Legally, an auditor does not insure the accuracy of the books he audits or the statements he compiles, but is merely liable for reasonable care in his investigation." For instance, an auditor is not liable for accepting as a valid voucher a document not representing value actually expended, if the true situation could not be ascertained by reasonable carefulness. Where there is nothing to arouse suspicion, a few cases at haphazard would be a reasonable check, but, when there are grounds for suspicion, a much more careful scrutiny must be given."" Legally, "reasonable" care and skill require more than an audit of the books, the auditor being held for "reasonable" care to ascertain that the books show the true status of the firm. 28 The moral responsibility of auditors greatly exceeds their legal liability." Sentiment has been growing that investigations should be so thorough that the statements will show the entire truth about the business, and it is a matter of pride to the profession that American accountants have not accepted the limited, though legal, views of their responsibility. 31 The delegation of the detailed work to junior accountants does not re- lieve the auditor from his personal responsibility. 32 This is recognized by the courts, who will permit a senior accountant to testify in regard to facts discovered by the junior accountants working under his personal supervision.'" As he cannot excuse himself by throwing the blame on his subordinates, a careful auditor keeps in close touch with the detailed work by requiring frequent reports showing the progress made in conducting the audit according to the auditing program which he has carefully de- vised. 34 j H The auditor is responsible for the reporting of all illegal acts of officers and directors, but questions of the wisdom of the action of these officials, unless they constitute a violation of accounting principles, are outside the scope of the auditor's responsibility/ Attitude of Auditor In preserving his complete independence the auditor must be careful not to offend his client by too much assertiveness. 3 " As he cannot compel ths adoption of his improvements, the auditor should 4 C. P. A. ACCOUNTING use tact, and, by avoiding arguments on trivial points not involving prin- ciple, strengthen his position for the important points which may come under consideration."' Cooperation with the client's staff may he gained by avoiding parades of authority and by showing a desire to lessen or improve the quality of the work. 38 The auditor and his assistants should treat the clerks with due courtesy, 39 but no intercourse beyond strictly business arrangements should be allowed. 40 Tact in the use of books when they are idle is advisable. 41 Auditor as Witness The auditor, as a witness, must tell the truth and nothing but the truth, but only in answer to direct questions. 42 He should not volunteer information either favorable or unfavorable to his client. 43 His impartiality on the witness stand should not deter him from assisting his client's lawyer to determine what questions should be asked and what subjects should be avoided. 44 It is therefore necessary that auditors have sufficient knowledge of the laws of evidence to know what answers are admissible. 45 Before an auditor can testify as an expert accountant it is necessary to have his qualifications established by answers to his client's attorney. The auditor, by concise, modest answers, should relate his experience and reputation as a public accountant. 4 ' Before entering the court room, it is important that all the statements and schedules not prepared by the auditor himself should be examined with the assistant who did the work and verified by reference to the books of original entry and supporting vouchers. 47 If memoranda and references in his own handwriting are made, the auditor will qualify as a wiines>. 4s In testifying, the auditor should prevent his being placed in the position of advocate for his client. 49 On the stand, the auditor is in much the position of a teacher, for he must bring his points within the reach of the jury who are untrained in accounting principles. He must, on the other hand, avoid in his effort for simplicity covering up his point in a mass of verbiage." An accountant with legal knowledge can serve his client by acting as an interpreter between his client's lawyer and the jury of business men, for lawyers, from their legal viewpoint, frequently ask questions so phrased that the ordinary juror cannot grasp the accounting point involved. An auditor must recognize the law of expert testimony which requires that the testimony must be the best available for each item. 62 He can, if given access to the records, give an opinion as to the value of goodwill based upon earning power. 63 He, however, could not as an accountant say that the plant should be valued at cost less depreciation, as the valuation of fixed assets is the work of an appraiser.* 4 Internal Check Internal check is the method by which employees check the records of one another, and the entire control does not rest in any one clerk. 65 Such a system eliminates the probability of fraud 59 and accordingly greatly lessens the amount of detailed checking which must be done. 5 ' As most fraud consists either in the misappropriation of cash FIELD OF ACCOUNTANCY 5 or merchandise, these two points are especially guarded by the system of internal check. The receipt of cash should be safeguarded by having all incoming mail opened and listed by an official other than the cashier or bookkeeper. 6 " This practice, if cash sales are made and recorded by parties without access to the cashier's department, will prevent the manipulation of cash receipts. Cash payments should be made by check 59 and supported by a duly authorized voucher. 00 Small payments should be made out of a petty cash fund set aside for the purpose.'' 1 The cashier should not have access to the personal accounts, 02 nor to bills submitted to customers/" 1 Payrolls should be changed only upon written authority" 4 and each step in their preparation should be checked by some one not directly in charge of the work." 5 Payments should be made in the presence of a witness, who, together with the paymaster, should sign the payroll. 6 " The purchase of materials should be safeguarded by careful records of receipts 07 and by filing of filled orders to pi-event passing of duplicate invoices.' 8 Invoices should be checked as to number and quality of received goods, and as to extensions, 09 and when check is drawn therefor, notation should be made on invoice to prevent duplicate payment. 70 Sales invoices should be checked like purchase invoices 71 and also against the customer's order. 72 Systematic records should be kept of all orders re- ceived and shipments made." Records of returned sales 74 and returned purchases 75 should be kept. Allowances should be granted only upon written approval of proper authority." Perpetual inventories should be maintained 77 which should be verified by physical inventories from time to time. 78 C. P. A. ACCOUNTING QUESTIOiNS FIELD OF ACCOUNTANCY BOOKKEEPING 1. Define: Bookkeeping. (N. Y., Jan., 1900; Wash., May, 1003; N. J., 1904-1909*; Mich., July, 190G; N. Y., Oct., 1907; R. I., Dec., 1907.*) 2. Define: Double-entry bookkeeping. (Pa., Nov., 1S99* ; N. Y., Jan., 1900*; Pa., May, 1905; Md., Jan., 1909; Ohio, Nov., 1913*; S. C., Sept., 1919.*) 3. State various kinds of bookkeeping with explanations. (Mich., July, 1906.) 4. State the essential principles of double-entry bookkeeping. (X. Y.. Dec., 1896; N. Y., Jan., 1897; Wash., May, 1903; N. Y., June, 1909; Va., Nov., 1910; Wash., June, 1912*; W. VaJ May, 1917.) 5. Under what conditions does double-entry bookkeeping become an exact science? (N. Y., June, 1917.) 6. Name three objects of bookkeeping. (N. Y., Oct., 1907* ; R. I., Dec., 1907*; Mich., June, 1912.) ACCOUNTING 7. Define: Accounting. (N. Y., Jan., 1900; Wash., May, 1903; N. J.. 1904-1909*; Ohio, Nov., 1913; Ohio, Nov., in 15; Ind.,' June, 1916*; N. C., Aug., 1917.*) 8. What is a certified public accountant? (Wash., May, 1911; Iowa, Dec., 1918.) 9. What is the relation of the accountant to the bookkeeper? (N. Y., Jan., 1900*; Wash., May, 1903*; Ind., June, 1916.) 10. State the fundamental objects of accounting. (Ohio. Nov., 1913*; Ohio, Nov., 1915*; N. C., Aug., 1917*; Iowa, Dec^lS.) 11. As a certified public accountant and auditor, what would be your relation with your client? (N. J., 1904-1909.) 12. Are the theory of accounting and the theory of common law based in any respect on the same principle? Which is the more reliable as to facts f (N. Y., June, 1917.) 13. (a) Why should we favor the stand jnlization of accounting terminology and forms? (b) What means would you suggest as best FIELD OF ACCOUNTANCY 7 adapted to obtain such uniformity? (c) Give two examples of ac- counting terms that are ambiguous. Suggest remedies. (N. Y., June, 1915.) 14. If you were employed by a firm or corporation to install a system of accounting, what would be your procedure? (Pa., Nov., 1899*; Ind., June, 1916; N. Y., Jan., 1917.*) 15. Enumerate the fundamental principles to be followed in devising an accounting system for a large mercantile company. (N. Y., Jan., 1904*; Ohio, March, 1910*; La., May, 1913*; Mo., Dec., 1913; S. C., Sept., 1919.*) 16. In devising a system of accounts for a business, what are the main subjects for consideration, and in what order should they have attention? (N. Y., Dec., 1896.) AUDITING 17. Define: Auditing. (N. Y., Dec., 1898*; N. Y., June, 1899*; Pa., Nov., 1899*; N. Y., Jan., 1900; Pa., Nov., 1900*; Pa., Nov., 1901*; Wash., May, 1903; Pa., May, 1903*; Md., Oct., 1903; N. J., 1904-1909*; Mich., Nov., 1907*; Mass., June, 1910*; N. Y., June, 1911.) 18. What are the objects to be attained by an audit? (N. Y v June, 1897; N. Y., Dec., 1898*; Wash., May, 1903; Mass., June, 1910*; Mich., June, 1910*; N. Y., Jan., 1911*; Cal., May, 1916*; Cal., Nov., 1916*; N. D., July, 1916*; W. Va., May, 1917*; W. Va., May, 1919*; S. C., Sept., 1919.*) 19. What are the advantages of an audit? (Cal., May, 1916; Cal., Nov., 1916; Cal., June, 1917.*) 20. Explain the value of an outside audit for a business having a regularly employed auditor. (Mich., June, 1913.) 21. State what are the advantages of the certified public accountant (C. P. A.) degree to: (a) the accountant, (6) the client. (Wash., Aug., 1908*; Wash.,' May, 1911.) 22. In large businesses internal auditors, members of the staff of the concern, are frequently the only ones employed. Where this is the case, do you think it desirable that professional certified public accountants should be engaged? If so, give reasons. (Til., Nov.. 190S; Ind., June, 1916.*) 23. What meaning attaches to the term "auditing" other than the re- view and verification of accounts of past transactions? (N. Y., Jan., 1907.) 24. State generally your idea of your duties as an auditor and the points to be covered by an audit. (Pa., Nov., 1906.) 25. Is criticism the chief duty of 'an auditor? What additional points should be covered in his report? (Minn., Oct., 1916.) 26. Wherein do the functions of accountants and auditors differ? (Cal., June, 1904*; W. Va., May, 1917; W.'Va., May; 1919.) 8 C. P. A. ACCOUNTING 27. Outline the duties of an auditor. (N. Y., Dec., 1896; N. Y., June, 1898*; N. Y., Dec., 1898*; Pa., Nov., 1900*; N. Y., June, 1901*; Pa., Nov., 1901*; Pa., May, 1902*; Cal., June, 1904*; N. Y., Jan., 1907; N. Y., June, 1909*; Mass., June, 1910*; N. Y., June, 1910*; Va., Nov., 1910*; Mich., June, 1912*; La., May, 1913*; Ga., May, 1919*; N. D., July, 1919.*) 28. What qualifications must an auditor possess? (N. Y., Dec., 1898; Pa., Nov., 1899; N. Y., June, 1900*; Pa., Nov., 1900; N. Y., June, 1901; Pa., Nov., 1901; Pa., May, 1903; Wash., May, 1903; Md., Oct., 1903; Cal., June, 1904; Mich., Nov., 1907; Wash., Aug., 1908; Md., Jan., 1909' Mich., June, 1912*; La., May, 1913*; N. D., July, 1919.*) 29. State the training necessary to fit an auditor for the discharge of his duties. (N. Y., June, 1900; Mich., June, 1912.*) 30. To what extent and for what purposes should an auditor be familiar with : (a) law; (6) algebra; (c) economics; (d) financial history? (Cal., Nov., 1916.) 31. Is it an auditor's duty to concern himself to any extent with the validity of the transactions that come under his notice? Explain. (N. Y., June, 1900; Wash., May, 1903; 111., Nov., 1903.*) 32. To whom is an auditor responsible? (S. C., Sept., 1919.) 33. What are the responsibilities of an auditor? (N. Y., Dec., 1896*; N. Y., June, 1901; Pa., May, 1902; Pa., May, 1903; N. J., 1904-1909*; N. Y., Jan., 1907*; Wash., Aug., 1908; Md., Jan., 1909; N. Y., June, 1909*; Mass.. June, 1910; Va., Nov., 1910*; Mich., June, 1912*; La., May, 1913*; Ga., May, 1919*; N. D., July, 1919.*) 34. To what extent is an auditor morally responsible for his certifi- cate? (N. Y., Dec., 1898; Wash., May, 1903.) 35. To what extent is an auditor legally responsible for his certifi- cate? (N. Y., Dec., 1898; Wash., May, 1903; Wash., March, 1909.) 36. What are the duties and responsibilities of an auditor in the following circumstances : (a) Where the system of internal check is defective? (6) Where the transactions for the year under review are correctly recorded but the auditor has reason to believe that the property accounts, Goodwill account, and Surplus account of prior years (not audited) have been manipulated or improperly handled? (c) Where restrictions are placed on an audit by one of the prin- cipal officers? (111., Dec., 1918.) 37. To what extent should an auditor be governed by instructions? (Pa., May., 1902.) 38. Give at length your views on the ethics of accountancy. (N. Y., June, 1912.) 39. Name the character of irregularities, the evidence of which your audit would disclose. (N. C., June, 1920.) FIELD OF ACCOUNTANCY 9 40. Define and illustrate: (a) Technical error; (6) error of principle; (c) compensating error. (Kan., May, 1916.) 41. What is the principal effect of errors of principle? In what part of the accounts are they most apt to be found? (Minn., Oct., 1916.) 42. The A 1 Manufacturing Company employs a staff of bookkeepers. The head bookkeeper has not studied the theory of accounting, neither has his experience been extensive. He understands double-entry bookkeeping, but he cannot be described as a well trained accountant. Previously the A 1 Manufacturing Company has been satisfied with annual accounts prepared by competent auditors. They decide to have monthly statements of accounts in future, and with this end in view instruct the head bookkeeper to prepare statements on the same lines as the last annual accounts \rere prepared. State the imaginary errors of principle that might not unreasonably be found upon an expert examination of his works. (111., May, 1916.) 43. In auditing a client's books you are requested to note any defects in the system of accounting and submit suggestions for its improvement. Make a brief report to your client accordingly. For this purpose suggest the remedying of some of the defects which you have most frequently observed in your own experience. (Wash., March, 1909; Wash., May, 1911.) 44. What is your idea of the proper and a just charge or compensation (a) to the employer and the employee, for your services as a certified public accountant; (b) to the services of a first assistant; (c) to other assistants. (N. J., 1904-1909.) INTERNAL CHECK 45. Define: Internal check. (Fla., April, 1908*; Colo., Dec., 1913; Mich., Dec., 1914; Ohio, Nov., 1918; 111., Dec., 1918; Ohio, Nov., 1919.) 46. State what you consider the best system of bookkeeping to guard against speculations and what regulations you would recommend for the conduct of the financial affairs of the concern. (La., May, 1913.) 47. What plan would you suggest to minimize the risk of fraud in the following: (1) Payrolls; (2) accounting of cash receipts; (3) invoices of purchases. (Colo., Dec., 1913; 111., Dec., 1918.*) 48. How is the position of an auditor affected if the system of the concern under audit is defective, (a) as to internal check; (&) as to cost methods? (A. I. of A., May, 1918.) 49. Trace the various operations in a well regulated wholesale mer- cantile office from the time an order is given for the purchase of material until such material is paid for, to protect the company from any possible loss in the transaction. (Colo., Dec., 1913.) 50. Name the ten matters of special importance in devising any system of internal check in the handling of office records. (Mich., June, 1910.) 10 C. P. A. ACCOUNTING 51. Outline a system of internal check for a wholesale grocery concern doing a business of $3,000,000 a year, with about 2,000 customers. The system should coordinate with an annual audit by professional account- ants. (A. I. of A., Nov., 1919.) 52. A clothing manufacturer has in an adjacent city a separate retail establishment for the sale of his goods. The whole of the clerical work and cash transactions are in the hands of one clerk. Suggest the method of bookkeeping which, in your opinion, will afford the best check from the auditor's point of view and at the same time be thoroughly practical. (Pa., Nov., 1906.) 53. You are asked to offer suggestions regarding a system of internal check for a company whose business is that of wholesale merchants. De- scribe the office methods you would introduce to safeguard the funds and merchandise of the company. (111., Dec., 1910*; \Yash., Nov., 1913.) 54. The accounting department of a jobbing house, consisting of 5 men, keeps the books, does the billing, makes city collections, handles the general and petty cash and pays the invoices of the company. On what general lines would you distribute the work of the department to secure the best internal check? (Md., Jan., 1909*; Mass., Oct., 1915; Ind., Nov., 1917.) 55. What condition of office organization, above all others, leads to fraud and defalcation by bookkeepers and cashiers? Support your opinion. (N. Y., June, 1912.) 56. Where would irregularities be most likely to be discovered in a detailed audit of a men's furnishing store which employs 10 salesmen? In your answer assume that the books are kept according to a good system of accounting and that the bookkeeper has complete charge of the office with only the occasional supervision of the owner. (111., May, 1917.) 57. Outline a system for handling the accounts of a large retail store, explaining specially how you would arrange to guard against possible dishonesty of such employees as have access to valuable jewels and plate. (111., May, 1907.) 58. Under what circumstances can a bookkeeper cover up forced foot- ings and postings during the course of an audit, so that ordinarily you would not detect the same unless certain precautions are taken? State what these precautions should be. (Colo., Dec., 1913.) 59. Give six typical examples of fraud, of Avhich only four involve the abstraction of actual money, and explain shortly what means you would suggest to reduce the risk of loss under each of these headings to a mini- mum. (111., May, 1909.) b'O. The General Ledger of a trading concern contains, in addition to the \isual Balance Sheet and Profit and Loss accounts, personal accounts of officers whose salaries are credited and drawings charged thereto. In addition to currency, drawings on signed and numbered vouchers, they are all privileged to pay private bills with company checks, and also to pur- chase company merchandise for personal use. FIKLD OF ACCOUNTANCY 11 The General Ledger and General Journal are kept by and in full charge of one of the officers. This officer handles no funds of the company. The Ledger is in balance; there are no errors in the footings of the Ledger accounts ; the cash at banks and in hand is correct ; and this officer's account shows a small credit balance. You find that periodical statements prepared by this officer are accepted without question; and that the several amounts stated thereon are in agreement with balances of the respective accounts in the General Ledger. (a) State three ways by which this officer, without collusion, might defraud the company. (b) State, briefly, the way you would adjust any differences that might be disclosed; and (c) What preparation you, as a public accountant, would make to clearly state the facts and prove the defalcation in event you are re- quired to give expert testimony in court proceedings. ' (Wis., April, 1915.) 61. Name five common methods of defalcation and explain the steps which you would suggest to detect each of them. (M ; ch., June, 1919.) 62. What system would you recommend to a factory for the proper checking of all labor employed : (a) To obtain complete record of each employee from date of applica- tion for employment to date of discharge? (b) To prove that all labor paid for was actually accounted for? (c) That no mistakes had been made in figuring the time or in the pay- ing off? (d) That the payroll had not been padded in any manner? Mention the forms, mechanical appliances, etc., required for such system and the independent internal checks necessary to prevent collusion between clerks and employees. (Mich., July, 1909.) 63. Discuss fully an effective method of controlling raw material for a mill or factory. Select any types of mill or factory you desire. Illustrate by sketches any forms not clearly described by their titles. (Pa., Nov., 1919.) 64. Whei'e embezzlement of cash by usual means is impossible, how can fraud be perpetuated by manipulation of accounts and records result- ing ultimately in a large loss? (N. Y., Jan., 1916.) 12 C. P. A. ACCOUNTING PROBLEMS FIELD OF ACCOUNTANCY 1. From the following accounts appearing on the trial balance prepare, without using figures, statements which you consider best calculated to set forth the operations of the year and the financial position at December 31, 1916, assuming that you are preparing these statements on behalf of a bank which desired paper available for rediscount with the Federal Reserve Bank: Accounts payable. Accounts receivable. Advertising. Buildings. Capital stock. Capital stock unsubscribed. Cash on deposit. Commissions paid salesmen. Depreciation, buildings, 1916. Depreciation, machinery, 1916. Discount allowed on sales. Discount received on purchases. Doubtful accounts receivable. Factory expense. Finished goods, inventory, December 31, 1915. Freight and cartage inward. Freight and cartage outward. Material purchased. Mortgage on plant. Notes payable. Notes receivable. Office expenses. Office furniture and fixtures. Office payroll. Organization expenses (to be distrib- uted over three years from Jan. 1, 1916). Payroll factory, accrued. Petty cash. Prepaid taxes, real estate. Profit and loss, 1915 surplus. Repairs, buildings. Fuel. Goodwill. Insurance, buildings and machinery. Insurance, finished goods. Insurance, unexpired, buildings and machinery. Insurance, unexpired, finished goods. Interest accrued on investments. Interest accrued on mortgage payable. Interest paid. Interest received. Investments. Labor factory payroll. Land. Machinery Material inventory, December 31, 1915. Repairs machinery. Reserve for bad and doubtful ac- counts. Reserve for depreciation, machinery. Reserve for depreciation, buildings. Returns and allowance on sales. Salaries of general officers. Sales. Salesmen 's accounts, advanced on sal- aries. Subscriptions and donations. Taxes, income, U. S. Taxes, real estate. Work in progress inventory, Decem- ber 31, 1915. The inventories December 31, 3916, not on the books were: Finished goods, ; material, work in progress, . (It is assumed that the last inventory is intended to mean both the inventory of material and that of work in process.) (A. I. of A , Nov 1917.) 2. Following is a list of the accounts appearing on the trial balance cf a manufacturing company which deals in finished merchandise pur- FIELD OF ACCOUNTANCY 13 chased, as well as in its own products. From the list, and without using figures, draw up plans of financial statements (balance sheet, manufac- turing account, profit and loss account, etc.) in the form which you think most suitable: Accounts payable. Salaries, management. Capital stock. Notes receivable. Cash. Notes payable, partly secured by deed of trust. Salaries, office and store. Real estate. Fuel. Insurance plant. Light. Freight on merchandise purchased. Machinery and tools. Freight on raw materials. Printing and stationery. Accounts receivable. Horse, wagon, and harness. Stable expense. Advertising. Purchases, raw material. Productive labor, factory. Machinery repairs. Office furniture. Reserve uncollectable accounts. Reserve for depreciation. Insurance merchandise. Uncollectable accounts. Buildings. Sales, own products. Inventory, own products. Inventory, raw materials. Inventory, partly manufactured goods. Inventory, merchandise purchased. Inventory, repair supplies. Undivided profits, end of last year. Purchases, merchandise. Sales, merchandise purchased. Rent, factory. Rent, store and office. Discount on sales, own product. Interest payable. Depreciation, building, machinery, wagons and harness. Sundry factory expenses. Sundry office expenses. Postage. Subscriptions and donations. Discount on purchases, merchandise. Rents, income. Insurance paid in advance, plant. Labor, warehouse. Insurance paid in advance, merchan- dise. Management, salary, factory. Management, salary, office. Salesmen's expenses and salaries. (Mich., Dec., 1906*; Mo., Dec., 1913; Ohio, Nov., 1915.) 3. You are given a trial balance of a wholesale jobbing corporation embodying the following accounts, and are requested to prepare a Balance Sheet and Profit and Loss statement. Prepare such statement, without the use of figures, showing the form in which you would present them. Real Estate, Capital Stock, Traveling Expense, Sinking Fund, Reserve for Depreciation, Taxes (State and City), Accounts Receivable (Cus- tomers'), Sales, 10-years debenture Insurance Policy, Insurance (all ex- pired), Purchases, Depreciation, Accrued Interest on Bonds, Notes Re- ceivable (Customers'), United States Income and Excess Profits Taxes Paid, Furniture and Fixtures, Surplus, Liberty Bonds, Overdrafts on Salary Accounts of Officers, Reserve for Bad Debts, Trade Acceptances Receivable, Bond Interest, Petty Cash Fund, Auto Trucks, General Ex- pense, Collections on Bad Debts Previously Charged Off, Notes Receivable Discounted, Merchandise Inventory (at beginning of period the amount of inventory at the date of trial balance is also given you), Returns and Allowances on Sales, Interest Received on Liberty Bonds, Discounts Re- ceived on Purchases, Dividends Paid, Trade Acceptances Payable, Dis- counts Allowed on Sales, Notes Payable Officers, and Treasury Stock. (Va., Nov., 1918.) ]4 r. P. A. Accorvnxf; 4. The Spark Plug and Auto Supply, Inc., is the manufacturer of a patented spark plug and is also dealer in automobile supplies. From the following trial balance (as of October 31, 1919) and information prepare Balance Sheet and Profit and Loss statements showing cost of manufacture of spark plugs and gross and net profit on sales : Advertising $ 26,450 Accounts Receivable 180,105 Accounts Payable Bills Receivable 35,000 Bills Payable Trade Creditors Bills Payable First National Bank Bonds 5% First mortgage Building Factory 225,000 Bad Debts written off 7,850 Capital Stock, common (authorized $250,000) Fully paid Capital Stock, 6% preferred, authorized and issued Dividend preferred stock 18,000 Delivery Expenses 7,140 Delivery Equipment and Trucks 9,250 Directors' Fees 2,500 Discount on Sales 12,200 Freight, Raw Materials 12,050 Freight, Automobile Supplies 2,345 Finished Goods 34,320 First National Bank Current Account 51,850 General Expenses 14,770 Goods in Process 13,250 Heat, Light and Power 22,200 Interest on Bonds 9,375 Insurance and Taxes, Factory 17,400 Labor, Productive 233,846 Labor, Nonproductive 99,444 Liberty Bonds 195,000 Loose Tools 15,270 Machinery and Plant 165,090 Office Furniture and Fixtures 1,200 Payroll Patent Rights 30,000 Purchases, Raw Materials 450,960 Purchases, Automobile Supplies 141,690 Repairs 14,050 Rent, Warehouse 3,875 Reserve for Depreciation, Buildings Reserve for Depreciation, Machinery Reserve for Bad Debts Real Estate, Factory Site 150,000 Shop Supplies and Expenses 15J560 Surplus Sales, Spark Plugs Sales, Automobile Supplies Salaries, Office and General 14,500 Salaries, Salesmen 34|600 Traveling Expenses 22,300 $2,288,440 $2,288,440 FIELD OF ACCOUNTANCY 15 Inventories, November 1, 1918: Raw materials, $14,500; automobile supplies, $22,450. Inventories, October 31, 1919: Raw materials, $27,300; automobile supplies, $19,200; finished goods, $50,400; goods in process, $17,205; loose tools, $10,500. Reserve for bad debts to be adjusted to 5 per cent of open accounts. Depreciation for the 12 months ended October 31, to be allowed as follows : Factory buildings, 2 per cent ; machinery, 5 per cent ; delivery equipment, 10 per cent ; furniture and fixtures, $200. Disregard fractional parts of a dollar. Patent rights expire October 31, 1925; advertising, $950, applies to next season; taxes on factory buildings accrued, $1,400. First mortgage 5 per cent gold bonds are a first charge on all the assets of the company. Interest payable quarterly on the first of February, May, August and November. [Calculate depreciation on diminishing values.] (A. I. of A., Nov., 1919.) NOTE: Model solutions of the problems presented in this book may be secured by students in Y. M. C. A. classes, on application to the instructor. Those who are not students in Association classes may secure the Model Solutions from Association Press, 347 Madison Avenue, New- York. CHAPTER II DOUBLE-ENTPxY BOOKKEEPING Double Entry Bookkeeping As the name implies, double entry book- keeping is based on the principle of two entries for each business trans- action, a debit and a credit. 1 It presupposes an initial equation at the inception of the business between the money or property furnished by the proprietor and the proprietor's interest in the business. 3 Starting with this initial equilibrium or balance of both sides of the accounts, each subsequent transaction affects the two sides of the equation alike necessi- tating for each debit entry a credit entry of equal amount, thus evidenc- ing that no matter what transactions occur, if they are recorded by a double entry, the original equilibrium will not be destroyed. 3 Accounts An account is a record under a specific heading of a single or group of either similar or dissimilar items relating to the same person or thing. 4 For convenience the account is divided into two parts or sides in which the similar items are grouped. 5 As each of the sides of the account is opposed to the other, the .rule for journalizing, or entering trans- actions into accounts, is to debit or enter on the left side of the account all increases of assets or decreases of liabilities and proprietorship, and to credit or enter on the right side of the account all decreases in assets or increases in liabilities and proprietorship." If the balance of an account, the difference between the sum of the debits and the sum of the credits, is a debit, then the account is an asset, expense, or deficit, while accounts with credit balances represent liabilities, income, or proprietor- ship.' Classes of Accounts Classification of accounts usually divides the accounts into the following classes : 1. Personal or accounts showing the effect of the transactions on the various people or corporations with whom the firm deals. 8 2. Impersonal or accounts recording profits, losses, receipts, disburse- ments, and non-personal assets and liabilities. 9 The limiting of the term "impersonal accounts" to real accounts 10 seems fallacious. 3. Real or accounts recording assets, liabilities, and vested proprietor- ship." 4. Nominal (sometimes called representative)" or accounts recording income and expenses. 13 5. Mixed or accounts containing both real and nominal elements. 14 6. Major (sometimes called primary) 15 or accounts recording all of the transactions of a particular class. 16 'For explanation of superior figures see page 337. 16 DOUBLE-ENTRY BOOKKEEPING 17 7. Subsidiary or accounts auxiliary to, though not necessarily depend- ent upon, a major account. 17 8. Summary or accounts slimming up the data contained in a number of other accounts of different classes to display some fact. 18 9. Specific or accounts containing items of only an exact, particular nature. 1 ' 10. Controlling (sometimes called collective) 20 or accounts containing the totals of the debits and credits of a number of accounts in order to show at any time the balance of the aggregate of these accounts. 21 Con- trolling accounts are sometimes called summary accounts, 2 " but summary accounts combine dissimilar accounts, and controlling accounts do not. The purpose of classification of accounts is to clarify the financial state- ments by grouping similar accounts together. Another use is to place all the subsidiary accounts in schedules and place only the major accounts in the statements. Nominal Accounts If nominal accounts were not used an entry to vested capital would be necessary with every income or expense trans- action." This is impractical, for the exact profit on each sale is seldom known, at the time of the sale, and it is further inadvisable, for the administration requires statistics showing the detailed effect of the various transactions upon the business and not just the net result. 24 Accordingly items of income and expense are classified as minutely as the administra- tion desires and then these nominal accounts are closed through the sum- mary accounts into the vested proprietorship accounts. 25 Controlling Accounts Controlling accounts are used because they enable daily or monthly financial statements to be prepared without waiting for the balancing of all the subsidiary accounts and greatly reduce the work of locating errors in posting. 2 " The subsidiary ledger can be made self-balancing by an "adjustment" account, which is an exact copy of the controlling account in the general ledger except it is reversed. 27 Special columns for the controlling accounts are made in the books of original entry from which posting is done to the subsidiary accounts. 28 The posting to the subsidiary accounts is done as usual and then the totals of such debits and credits are posted to the controlling account. 29 As the controlling accounts and not the subsidiary accounts are entered in the trial balance of the general ledger, the books will balance. 30 All posting to controlling accounts should be checked by the auditor. 31 Then the subsidiai-y ledger balance should be compared with the balance of the controlling account. 32 If these balances agree only a test check of the cases at random is necessary for the satisfactory audit of the sub- sidiary accounts. 33 Suspense Accounts An account used as a place for temporary records of items pending determination of their final allocation is a suspense account. 3 * The usual examples of suspense accounts are unlocated errors in trial balance, cash received without name of sender, and discrepancies between the bank's records and the firm's cash book. 35 It is important that 18 C. P. A. ACCOUNTING ea<-h suspense item be placed in an account under a suitable title instead of general suspense account." 1 " When it becomes apparent that the cause of the suspended items cannot be 1 discovered, such item should be closed into profit and loss. ' However, in a C. P. A. problem where the books are out of balance, the necessary adjustment cannot be investigated and the suspense account should be carried on the balance sheet instead of being closed into profit and loss. This is especially true if the balance is a credit. Some business men carry their doubtful accounts and notes receivable in a suspense ledger.* This provides a convenient way of keeping track of these items, especially if the accounts are kept in loose-leaf binders.* However, as such a transfer does not affect the book valuation of the items, it must not be used as an argument for omitting the reserve for doubtful accounts. 4 " Arrangements of Accounts The accounts should be arranged in such a manner so as to facilitate the preparation of the financial statements. 41 Such an arrangement would list the assets in the order of their liquidity, each valuation account following its related asset; and would list the liabilities likewise followed in order by the vested proprietorship accounts, the profit and loss account, and the expense and income accounts in the order in which they appear in the profit and loss statement." If eon- trolling accounts are not maintained, the customers' and creditors' accounts would be placed in the back of the ledger. 43 A trial balance from a ledger whose accounts are arranged as mentioned above is called a classified trial balance. 44 Sometimes, for reference purposes, the accounts are arranged alphabetically. 4 ' Numbered Accounts In some large businesses the accounts are so numerous that they are given numbers as well as names. This is especially important where the accounts are used for detailed statistical purposes by having the numbers of the accounts punched on the cards, together with the data. There are several good systems of numbering accounts. A good general idea of these plans can be had from the study of one of the simplest which arranges the accounts into nine fundamental groups, as follows : 4: 1. Asset Accounts. 6. Valuation Reserves. -. Investments and Treasury Securities. 7. Capital Surplus. 3. Prepaid Items. 8. Income Accounts. 4. Liability Accounts. 9. Expense Accounts. 5. Accrued Items. These general groups may be subdivided into more special groups if desired. An example of this subdivision would be : 9. Expense Accounts. 91 Manufacturing. 911 Prime. 9111 Wages. 9112 Freight. DOUBLE-ENTRY BOOKKEEPING 19 912 Overhead. 92 Selling Expenses. 93 Administrative Expense. 931 Salaries. 9311 Clerks. 9312 Stenographers. 94 Non-operating Expenses. The above system is especially good as it emphasizes the major divisions of accounts. A bookkeeper would hardly post a debit to an asset to an account beginning with 9. Another advantage is that the general correct- ness of the system could be checked by an official with only a general knowledge of the business, for a cursory survey of the books would detect the capitalization of an expense. A system very similar to the above is one that has only three grand divisions, viz., property, proprietorship, and revenue accounts, the initial numbers being respectively 1, 2, and 3, and the liabilities being differenti- ated from the assets by having the second number 2 instead of 1, as in the case of assets. 47 In some systems key letters are also used with the numbers to aid in rapid identification and to facilitate the operation of the system. 48 In others each class of accounts is given the numbers starting with a certain, hundred, viz., 100 to 290 for plant and equipment, 700 to 800 for de- ferred charges, and 1700 to 1800 for factory overhead, etc. 48 Journalizing Journalizing is the systematic classification of the debits and credits of a business transaction. 50 In double entry bookkeeping there are two axioms for journalizing, namely, that the sum of the debits equals the sum of the credits, and that all entries are journal entries. 51 Formerly the words "to" and "by" were almost universally used. 52 A few accountants still use the word "to" although they do not use the word "by." 53 However, the majority no longer advocate the use of either of the words. 64 Another recent change in journalizing is the dropping of the practice of making the entries closing the nominal accounts at the end of the fiscal period with red ink posting directly from one account to another, the practice generally followed now being to have the entries entered in the journal and posted in black ink. 55 The verification of journal entries is very important as the journal is sometimes used fraudulently by making fictitious or irregular entries to personal accounts to conceal misappropriation of cash. 51 All journal entries to personal accounts should be substantiated by vouchers approved by authorized officials. 57 If they have not been so approved, the auditor should have them initialed. 58 Verification of Footings and Postings As experience has shown that the percentage of frauds which have been concealed in false posting and incorrect footings is small, auditors should not verify every posting and every footing, but should depend on tests to locate such frauds. 59 20 C. P. A. ACCOUNTING Posting to the ledgers should be verified by working back from the ledger to the book of original entry and not rice reran, as this procedure pre- vents anyone from tampering with the auditor's check marks, and because it will enable the auditor to detect entries made in the accounts, which were not made on the books of original entry."' If there are controlling accounts, it will not be necessary to verify the detailed posting to the subsidiary accounts. 81 If there are no controlling accounts, the auditor should create them. 62 Even if it is deemed wise to verify the postings to the subsidiary accounts, all of the accounts should not be checked.' 3 In periodical audits a certain number of the subsidiary accounts should be verified each audit so that all of the accounts would be verified in a reasonable time.* 4 As to the footings, checking, in addition to the last page of each month, about every tenth page in the purchase records'" 5 and every eighth page in the sales records would be satisfactory if the firm is large."' In an audit of a small concern, the footing of every sixth page of the purchase journals 67 and every fourth page of the sales journals 68 should be verified. If all receipts are deposited in the bank and all disbursements made by check, no footing need be done in the general cash book, provided the disbursements have been vouched and the bank account reconciled.'* If the cash book footings can not be verified by the bank account, the net cash and discount columns on both sides are usually added for the entire period. Some auditors only add every third or fourth page of the cash disbursements, if checks are always used, 70 but add all receipt columns, if the cashier has access to the receipts. 71 In verifying additions special care should be taken of the amounts carried forward." Trial Balance A trial balance is a table of the balances shown on a ledger. 73 Its purpose is to prove the mathematical accuracy of the ledger, but mathematical equilibrium is not in itself sufficient proof of correct- ness, as frequently errors offset each other. 74 While a trial balance does not prove the correctness of the ledger, the failure to balance does prove incorrectness. 75 This, together with the fact that the trial balance places the accounts in a convenient form for the making of the financial state- ments, is the value of taking a trial balance. 78 Before closing, the trial balance of the general ledger contains both nominal and real accounts, but after closing, it really constitutes a non-classified balance sheet. 77 Books The desire to keep some of the facts of the business unknown to the clerks has caused the particulars relative to the capital of the business, the profit and loss accounts and other matters to be kept in a separate ledger called "private ledger," which is made self-balancing by using an "adjustment" account called general ledger account. 78 The other data is recorded in the ledger accessible to the clerks, called the "general ledger," which is also self -balancing, the "adjustment" account, which is called the private ledger account, being the reverse of general ledger ac- count in the "private ledger." 79 While bookkeeping can be done with only the standard "T" ledger accounts, many variations have been devised whose chief point of interest DOUBLE-ENTRY BOOKKEEPING 21 is the insertion of a "balance" column. Sometimes the money columns are placed in the middle of the page, the order being debit, balance, and credit. 80 Another variation is for the money columns to be all at the extreme right of the page in the order debit, credit, and balance. 81 Still another variation, called the Boston or tabulated ledger, has very wide sheets containing space for the names of the accounts (written one to a line under each other) and a group of three money columns in the order debit, credit, and balance for each day or month, as the case may be. 82 Used in a bank, the total of balance columns gives the aggregate depositors' balance, and the totals of the debit and credit columns give the aggregate of the deposits received and checks cashed, respectively. 83 Voucher System The voucher system is the treatment of creditors' ac- counts in such a way as to obviate the necessity of keeping the individual accounts in the ledger. 84 All invoices, which are held up until the goods are received and accepted, are attached to voucher jackets, which, num- bered consecutively, show the creditor's name and address, the material received and the account to be charged. 85 The voucher is sent for signature, along with the check, but, as many vouchers are not returned, the system relies largely on duplicate copies. 89 To avoid this, voucher checks have been devised which show upon the check itself what is being paid for. 87 As soon as the voucher jacket is made, it is entered on a voucher register or record which lists these voucher jackets by date, number and firm. 88 Columns are provided to take the credit to the vouchers payable account (another name for accounts payable), for the allocation of the charges to the usual expense accounts, and for the names of unusual accounts with a money column for such items. 88 When a voucher is paid, it is entered in the cash book as would be done in any system. 90 However, this payment is recorded in the voucher register which shows which vouchers are still unpaid, the aggregate of which agrees with the balance of the vouchers 'payable account in the general ledger. 91 The use of voucher-checks combines the advantage of having evidence that the creditor was paid with that of having the creditor's signature as to the payment for a certain invoice. 92 Vouchers are numbered con- secutively as entered in the voucher register. 93 The voucher-checks may have only one number, in which case the number of the voucher-check would agree with the number of the voucher. As vouchers are seldom paid in the order in which they are recorded in the voucher register, the voucher-checks having only one number would not be entered in con- secutive order in the cash book. Sometimes voucher-checks are given two numbers, the first being the number of the voucher and the second the treasurer's number. 94 This method of numbering enables the voucher- checks to be entered consecutively in the cash book. 95 By the use of the first number the entry in the voucher register can be traced and by the use of the second number the cash book entry can be located. The advantages claimed for the voucher system are : 90 First, gives de- tailed analysis of all purchases; second, saves labor by eliminating the purchase ledger; third, secures an up-to-date entry of all liabilities; fourth, 22 C. P. A. ACCOUNTING localizes responsibility by showing authority for auditing, payment, and entry of the items; fifth, secures a receipted bill for all payments of cash; and sixth, increases the effectiveness and decreases the cost of an audit. The chief disadvantages claimed are: 97 First, clumsy provision for returns and allowances, partial payment of bills, and notes payable; second, inadequate showing of volume of business with each creditor; third, the giving out of information about the business which should be kept private; fourth, the expense of filing and recording the vouchers and the labor of having them vised by the various officials; and fifth, no ledger accounts available for future reference. The first of these objections is by far the most important for the volume of business with each creditor can, if desired, be readily computed on an adding machine, and, if only the date and number of the creditor's invoice appear on the voucher check, little secret information will be disclosed. Purchase returns and allowances should be recorded in red ink in both the vouchers payable column and the distributive columns affected. 93 Then the red ink entries may be deducted from the regular entries or both red and black totals may be used, in which case both totals should be posted, the red as offsets to the corresponding black postings." 9 Where partial payments are to be made, the original voucher may be canceled in full and two new vouchers issued in place of it. 100 This adjustment may be made directly on the face of the voucher register by cross-references be- tween the old and new vouchers, usually shown in the "manner of payment" column; or by reversing the voucher register entry for the old voucher in the general journal and recording the new vouchers as usual in the voucher register. 101 Vouchers A voucher is a document verifying the correctness of charges for values paid out or of credits for values received. 102 The fact that one source of information may be missing does not prevent the verification of entries. For instance, sales items may be vouched by customers' orders, shipping clerk's records, carbons of invoices, bills of lading, customers' accounts and cash collections. 10 " 1 Vouchers for returned sales consist of correspondence carbons of credit memos and invoices showing the original charge, customers' settlement statements, and cash refund vouchers. 1 " 1 Copies of deposit slips, stubs of receipt books, and bank pass book are the cash receipt vouchers. 105 The vouchers for cash payments and pur- chases comprise copies of orders, receiving clerk's records, checked invoices, receipts for payments, canceled checks, petty cash vouchers, pay rolls, wages and salary records, and the minute book. 101 Returned purchases may be verified from stock records, shipment records, credit memos, am! specification of requirements. 107 As journal entries are generally of an unusual nature they are frequently supported by formal vouchers approved by proper authority. 108 Correspondence, and the minute book also, arc used to vouch the journal entries. Articulation Statement The articulation statement consists of a sheet ruled so that the accounts are listed under each other, one account to a line, and debit and credit money columns are provided for each class DOUBLE-ENTRY BOOK KEEPING of transactions 1 " 9 or for each ledger account. 110 If a man .started a period with cash $2,000 and merchandise $3,000 and then purchased $5,000 and sold $7,500 worth of goods and incurred expense amounting to $1,000, the articulation statement would be as follows : ARTICULATION STATEMENT Accounts Starting Balances Merchandise Expense Final Balances Cash $2,000 3,000 $1,000 $1,000 500 Merchandise. . . Capital $5,000 $7,500 $5 , 000 $5,000 5,000 Creditors 5,000 Debtors 7,500 7,500 1,000 Expense $1,000 $5,000 $5,000 $12,500 $12,500 $1,000 $1,000 $10,000 $10,000 It is possible to subdivide the headings into basic elements, e. g., the merchandise could be divided into sales and purchases. Sometimes two columns are allotted to cash, on account of the large number of such transactions. 111 The articulation statement is of little or no practical value 112 but the same idea is given a practical application when the interim entries are classified according to the books of original entry. 113 24 ('. P. A. ACCOUNTING QUESTIONS DOUBLE-EXTRY BOOKKEEPING ACCOUNTS I. What do you understand by the term "an account''? (X. J., 1904- 1909; Mo., Dec., 1914; Iowa, Dec., 1918.) 2.- Define: Account stated. (Mich., Dec., 1914; Mo., Dec., 1914.) 3. What various meanings may an entry in a Ledger account have, on (a) the debit side, (b) the credit side? (N. Y., Jan., 1897.) 4. State fully the value of accounts under the following conditions : (a) When correctly kept; (b) when incorrectly kept; (c) as a basis of liquidation; (d) as a going concern; (e] for the purpose of sale of busi- ness. (Pa., Nov., 1906.) 5. Define the principal or main accounts of a corporation of your own selection. (Pa., May, 1905.) 6. State the two primary results to be sought in keeping accounts. In what financial statements are these results shown? Point out the relation between these statements. (Mo., Dec., 1913.) 7. What is the basis of accounts, (a) in a corporation, (b) in a part- nership? (Pa., May, 1906.) 8. What do you consider the most important account in a set of account books? Explain fully. (Pa., Nov., 1899.) 9. Define: Suspense account. (N. Y., Dec., 1896; N. Y., Dec., 1897: N. Y., June, 1898* ; N. Y., Dec., 1899 ; Pa., Nov., 1900 ; N. Y., Jan., 1902 ; Mich., June, 1908; Wash., Aug., 1908; Ohio, March, 1910; Wash., Nov., 1913; W. Va., May, 1917.) 10. Give three instances of items carried to a Suspense account, and state how they may be removed from that account. (N. Y., Jan., 1902.) II. State where and how the Suspense account is employed. (N. Y., Jan., 1902.) 12. Explain the meaning of an item in suspense. (N. Y., June, 1900.) 13. Show proper classification of the Suspense account on the debit and credit sides of a Balance Sheet. Give examples. (Mich., June, 1908.*) 14. Describe the use and purpose of a Suspense account. (N. Y., June, 1898*; Va., Oct., 1912.) DOUBLE-ENTRY BOOKKEEPING 25 15. What do you understand to be the difference between personal accounts, impersonal accounts, real accounts, and nominal accounts'? (111. May, 1913.) 16. Define: Nominal accounts. (N. Y., June, 1899; N. Y., June, 1900; Pa., Nov., 1900; N. Y., Jan., 1906; Cal., May, 1908; N. Y., Jan., 1911; Mich., June, 1912; La., May, 1913; N. Y., Jan., 1914; Mich., June, 1914; N. D., June, 1914; Kan., May, 1916; Ind., June, 1916; N. D., July, 1916*; Minn., Oct., 1916; Ohio, Nov., 1916; N. D., Aug., 1917*; A. I. of A., May, 1919.) 17. What purpose does the use of nominal accounts subserve? (Ohio, Nov., 1913.) 18. When and how are nominal accounts disposed of? (Ohio, Nov., 1913; Ohio, Nov., 1915.) 19. Deft- 3. Real accounts. (N. J., 1904-1909; N. Y., Jan., 1906; Cal., May, 1908; La., May, 1913; Mich., June, 1914; Ind., June, 1916; N. D., July, 1916*; Ohio, Nov., 1916; N. D., Aug., 1917.*) 20. What is the relation of nominal accounts to real accounts? How do these accounts fulfill the purpose for which they are created? (N. Y., June, 1912; Okla., Nov., 1919.) 21. Classify the following accounts as real and nominal : Salary, Notes Payable, Fixtures, Rent, Interest Earned, Discount on Sales. (N. D., July, 1916.) 22. Define: Personal accounts. (N. Y., June, 1899; Pa., Nov., 1900; Md., Oct., 1903; N. Y., Jan., 1906; Cal., May, 1908; Mich., June, 1912; Ind., June, 1916; Ohio, Nov., 1916; N. D. Aug., 1917.*) 23. Define: Impersonal accounts. (N. Y., Jan., 1906; Cal., May, 1908; Mich., June, 1912*; Ind., June, 1916; N. D., Aug., 1917.*) 24. Define: Mixed accounts. (Cal., May, 1916*; N. Y., Jan., 1918.) 25. What are the objections to a mixed account? (Cal., May, 1916.) 26. Illustrate mixed accounts. (Cal., May, 1916*; Mich., June, 1919.) 27. Define: Major accounts. (N. Y., Jan., 1918.) 28. What is a representative account? (N. J., 1904-1909.) 29. Define: Subsidiary accounts. (N. Y., Jan., 1918.) 30. Define: Current account. (N. Y., Jan., 1906; Mich., June, 1912; La., May, 1913; Wash., July, 1917.) 31. Define: Collective accounts. (N. Y., Jan., 1918.) 32. Define: Summary accounts. (N. Y v Jan., 1906*; Mich., June, 1912; La., May, 1913; N. Y., Jan., 1918.) 33. What is meant by the term "primary accounts"? (111., May, 1913* ; N. D., Aug., 1917.) 34. Define: Specific accounts. (N. Y., Jan., 1906; Mich., June, 1912*; La., May, 1913; N. Y., Jan., 1918.) 26 C. P. A. ACCOrXTING 35. Define: Controlling accounts. (N. Y., Jan., 1900; N. Y., June, 1904*; N. Y., Jan., 1906; N. Y., Feb., 1910; Va., Nov., 1910; Mich., June, 1912; La., May, 1913; Wash., Nov., 1913; Ohio, Nov., 1913*; Ohio, Nov., 1915; Kan., Dec., 1915; Mo., Dec., 1915; N. D., July, 1916*; Ohio, Nov., 1916; Cal., Nov., 1916; W. Va., May, 1917; 111., May, 1917; N. C., Aug., 1917*; A. I. of A., Nov., 1917; Ind., Nov., 1918; Iowa, Dec., 1918.). 36. State the purposes of a controlling account. (N. Y., June, 1904; N. J., 1904-1909; Va., Nov., 1910; Ohio, Nov., 1915; Mo., Dec., 1915; Kan., Dec., 1915; N. D., July, 1916*; Okla. Nov., 1919.*) 37. Give an illustration of the use of a controlling account. (N. Y., Jan., 1900; N. Y., June, 1904*; Va., Nov., 1910*; Mich., June, 1913*; Ohio, Nov., 1913*; W. Va., May, 1917.) 38. Give the names of several controlling accounts. (N. Y., June. 1904*; Cal., June, 1904*; N. Y., Feb., 1910; Wash., May, 1911*; Ohio, Nov., 1915; Kan., Dec., 1915; Mo., Dec., 1915; Ohio, Nov., 1916*; Okla., Nov., 1919.*) 39. Name the advantages of controlling accounts. (Mich., June, 1910*; Mich., June, 1913*; Ohio, Nov., 1913; N. D., July, 1916*; Ohio, Nov., 1916.) 40. How do you reconcile a debit to a controlling account and another debit for the same amount to an individual creditor with the fundamental principle of double-entry bookkeeping? (Ohio, Nov., 1915.) 41. In making the audit of the Springfield Grocery Company you find that the controlling account in the general ledger exceeds the aggregate of the balances in the Accounts Receivable Ledger by $25,210.66. What steps would you take to bring this ledger into agreement with the controlling account in the General Ledger? (111., May, 1916.) 42. In designing a set of accounts for a business, how might provision be made for a constant showing of the aggregate sum owing by customers and the aggregate sum owing to creditors, without the necessity of pre- paring a schedule of the accounts of such customers and creditors? (N. Y., Dec., 1896*; N. Y., June, 1901.) 43. Describe a method of keeping accounts so that an independent balance of the ledger, containing only the real, nominal, special and con- trolling accounts, exclusive of the individual accounts of customers and of trade creditors, may be taken. (N. Y., Dec., 1896.) 44. What is meant by "classification of accounts"? (Md., Oct., 1903; Wis., April, 1917; Okla,, Nov., 1919.) 45. Into what general classes should Ledger accounts be divided? State the distinguishing feature of each class. Mention one account belonging to each class. (N. Y., Dec., 1898*; N. Y., Jan., 1901; N. Y., Oct., 1907*; R. I., Dec., 1907*; Wis., April, 1914.*) 46. State what verification you would make of the classification of expenses. (N. C., Aug., 1917; N. C., Nov., 1918.*) DOUBLE-ENTRY BOOKKEEPING 27 47. A wholesale house has on its books 200 individual accounts with creditors, 500 with city customers, and 1500 with country customers, be- sides about 75 impersonal, or representative accounts. Owing to the methods of'Jbookkeeping in force, it is necessary, in order to ascertain the amount of Accounts Receivable or Payable, to take off a complete list of the accounts in question. You are called upon to advise as to how this difficulty can be overcome, and also as to whether the bookkeeping work, on the Accounts Payable cannot be reduced, having regard to the fact that the firm discounts all its bills. Embody your suggestions in a brief report. (Wash., April, 1906.) 48. Draw up a brief but effective classification of General Ledger ac- counts suitable for a company with a total capital investment of say $750,000, doing an annual business of about $1,000,000, employing about 300 men, and with 500 customers' accounts. Assume the company manufac- tures and sells to dealers bicycles of 10 different patterns and styles, and does a small business in the sale of duplicate parts, the accounts to be framed to permit of the preparation monthly of an approximate Balance Sheet and approximate Profit and Loss account without the taking of a physical inventory except at the annual closing on September 30 of each year. State the classification in the order in which, in your opinion, the accounts should appear in the Ledger, giving briefly your reasons there- for, and indicate which accounts, if any, should be supplemented with subsidiary ledgers of other sub-account records. (111., May, 1913.) 49. Classify and group the following accounts according to kind of asset, liability, proprietary interest, income and expense: Interest Collected in Advance. Bonds Payable. Sinking Fund. I nterest Earned on Liberty Bonds. Notes Receivable Discounted. Interest Paid on Liberty Bond Install- Treasury Stock. ments. Work in Progress. Reserve for Depreciation, Buildings. Dividends Unclaimed. Dividends Declared. Capital Stock Subscription. Dividends Payable. Suspense Accounts Receivable. Investments in and advances to corn- Discount on Bonds Issued Written Off. panics for purposes of control. Accrued Property Taxes. Advances to Company Officials. Accrued Income and Excess Profits Insurance Premiums paid by company Taxes. on life of its president (in which Interest Accrued on Notes Receivable. the company is beneficiary). Interest Accrued on Bonds Payable. Installment Payments by employees Reserve for Sinking Funds. on Liberty Bonds bought for them Reserve for Bad Debts. by company. Merchandise Purchases. Liberty Bonds bought for employees. Sales Returns and Allowances. Employees' Liberty Bond Subscrip- Reserve for Building Extensions. tion. (Wis., Nov., 1919.) 50. Classify and group the following accounts of a manufacturing com- pany, according to kind of asset, liability, loss and gain : 1. Accounts Payable. 3. Accrued Salaries and Wages. 2. Accounts Receivable. 4. Advertising. 28 C. P. A. ACCOUNTING 5. Bad Debts Written Off. 6. Bills Payable. 7. Bills Receivable. 8. Bond Discount. 9. Bond Premium. 10. Bond Interest Accrued. 11. Capital Stock. 12. Cash. 13. Credit Department Expenses. 14. Depreciation of Buildings, Ma- chinery and Plant. 15. Depreciation of Workmen 's Cot- tages. 16. Directors' Fees. 17. Discount on Purchases. 18. Discount on Sales. 19. Federal Corporation Tax. 20. First Mortgage Bonds. 21. Freight and Cartage Inward. 22. Freight and Cartage Outward. 23. General Office Expenses. 24. Goodwill. 25. Insurance. 26. Insurance Premiums Unexpired. 27. Interest on Bills Payable. 28. Interest on Bonds. 29. Income from Investments. 30. Inventory, Raw Materials. 31. Inventory, Goods in Process. 32. Inventory, Manufactured Goods. 33. Investments (Outside). 34. Maintenance of Buildings, Ma- chinery, and Plant. 35. Maintenance of Workmen 's Cot- tages. 36. Manufacturing Power, Heat, and Light. (Wis 37. Miscellaneous Factory Expenses. 38. Miscellaneous Selling Expenses. 39. Nonproductive Labor. 40. Office Equipment. 41. Office Salaries. 42. Officers' Salaries and Expenses. 43. Organization Expenses. 44. Patent Rights. 45. Patterns and Drawings. 46. Plant Site. 47. Plant Buildings. 48. Plant, Machinery, and Equipment. 49. Productive Labor. 50. Purchasing Department Expenses. 51. Raw Materials Purchased. 52. Rent of Workmen 's Cottages. 53. Reserve for Depreciation of Build- ings, Machinery, and Plant. 54. Reserve for Depreciation of Work- men 's Cottages. 55. Reserve for Doubtful Accounts. 56. Reserve for Sinking Fund. 57. Returns and Allowances on Pur- chases. 58. Returns and Allowances on Sales. 59. Sales of Manufactured Goods. 60. Sales of Waste Material. 61. Sales Agents' Commissions. 62. Salesmen 's Salaries. 63. Salesmen's Expenses. 64. Sinking Fund Investments. 65. Surplus. 66. Taxes on Plant and Equipment. 67. Taxes Accrued. 68. Workmen's Cottages. ,, April, 1915; S. C., Sept., 1919.) 51. Assuming that these are the principal divisions of the expense accounts of a manufacturing business selling the product through traveling salesmen to the retail trade: (a) Manufacturing Expenses Division; (6) Selling Expenses Division; (c) Administration and General Expenses Division; (d) Profit Deduction Expenses Division, designate in what division you would classify each of the following accounts, by giving the number of account and the letter indicating division opposite: 1. Materials and Supplies Consumed. 2. Interest on Loans Paid. 3. Interest on Bonds Paid. 4. Postage for Correspondence. 5. Postage for Parcel Post. 6. Domestic Taxes. 7. Street Assessments for Street Im- provements. 8. Federal Taxes. 9. Discounts Received on Purchases. 10. Discounts Given on Sales. 11. Discounts Allowed for Prompt Pay- ment of Accounts Receivable. 12. Exchange on Checks. 13. Revenue Stamps. 14. Bonus to Traveling Salesmen. Jo. Bonus to Office Force. 16. Bonus to Factory Operatives. 17. Bonus to Superintendent of Fac- tory. 18. Fire Insurance Premiums on Fac- tory. DOUBLE-ENTRY BOOKKEEPING 29 19. Fire Insurance Premiums on Of- 31. Traveling Expenses of Buyer. fice. 32. Expenses of Lawsuits for Collect- 20. Fire insurance Premiums on ing Accounts. Warehouses. 33. Lawsuit Expenses Defending Suit 21. Liability Insurance Premiums. brought by Employee for Dam- 22. Life Insurance Premiums on Fac- ages tory Operatives' Lives. 34 E ' se of Welfare Work. 23. Credit Insurance Premiums. 35 Fineg Assessed for violation of 24. Tornado Insurance Premiums CMld L b L 2o. Freight Prepaid on Shipments. 0/ , TI , . 26. Claims Allowed on Sales Made. **' Hedging Contract Expenses. 27. Rent of Factory. 37 ' Donations to Employees. 28. Rent of Office ' ** Donations to Other Than Em- 29. (Omitted on Official Docu- ployees. men t.) 39. Freights on Purchases. 30. Traveling Expenses of Superin- 40. Claims allowed on Merchandise tendent to Secure Operatives. Purchased. (N. C., Nov., 1919.) 52. Show by chart or outline the various divisions and subdivisions of all asset, liability, income and expenditure accounts. (Wis., April, 1914.) 53. Into what two general and what three special classes are accounts divided in double-entry bookkeeping? (Mich., June, 1912.) 54. What are the purposes of classifications of accounts in a business, and how should they be grouped to show the proper results? (Pa., Nov., 1906; Okla., Nov., 1919.*) 55. On the theory that accounts may fall into the following classifica- tions, (a) accounts with individuals, (b) accounts with things, (c) ac- counts with forces or ideas, give a number of illustrations or names of accounts in a modern accounting system under each of these heads. (Ohio, March, 1910.) 56. Which group of accounts, if eliminated from double-entry bookkeep- ing, would reduce accounts to an economic history? (N. Y., Jan., 1917.) 57. Which class or classes of accounts close into Loss and Gain ac- count? (N. Y., Dec., 1898.*) 58. What is the nature of the accounts on the debit or left-hand side of the Ledger? (Ohio, March, 1910.) 59. What is the nature of the accounts on the credit or right-hand side of the Ledger? (Ohio, March, 1910.) 60. What are the advantages obtained through numbering accounts? Name and briefly describe two methods of numbering or lettering ac- counts. (Wis., April, 1914; Mich., Dec., 1916.*) 61. In the opening of a Ledger, what principle should be followed as to' the order or arrangement of the accounts? Show the advantages of the different plans. (N. Y., Jan., 1897*; .V. Y., Dec., 1897; N. Y., Jan., 1907*; N. Y., June, 1911*; Cal., Nov., 191.6*; N. Y., Jan., 1918.*) 62. What is the chief consideration in the arrangement of Ledger ac- counts? (Ind., June, 1916.) 63. How may the accounts in a trial balance be best arranged to facili- 30 C. P. A. ACCOUNTING tate the preparation of a business and financial statement? (S. C., Sept., 1919.) (>4. In what order should the accounts be arranged as they successively appear in (a) a Ledger containing all the accounts of a business, (b) a Ledger containing accounts of fixed assets and fixed liabilities, as well as special, nominal, and summary accounts? (N. Y., Jan., 1906.) Go. What is meant by theory of accounts? (X. Y., June, 1917.) JOURNAL ENTRIES CO. What is a Journal entry? When need? (Iowa, Dec., 1918.) 67. Define: Debit. (N. Y., Dec., 1898; N. J., 1904-1909.) 68. Define: Credit. (N. Y., Dec., 1898; N. J., 1904-1909.) 69. Define journalizing in its broadest sense. (N. Y., June, 1900; Wash., May, 1903.) 70. State your opinion in regard to the technic of journalizing. Show wherein your view is in accord with the evolution of the books of account. (X. Y., June, 1912.) 71. Describe the theory of double-entry bookkeeping. (N. Y., June, 1901; N. Y., June, 1902*; Ohio, March, 1910; Mass., June, 1910; 111., May, 1914; Ohio, Nov., 1915; Ind., June. 1916; Iowa, Dec., 1918; N. Y., Jan., 1920.*) 7'2. In a recent work on double-entry bookkeeping it is contended that each transaction involves two entries with the proprietor; do you agree with the author? If so, why? If not, why not? (N. Y., June, 1914.) 73. State a comprehensive general rule for journalizing. (N. Y., June, 1899*; N. Y., June, 1900*; N. Y., Jan., 1901; N. Y., June, 1902*; Wash., May, 1903.*) 74. Why is the word "To" used in connection with debit entries, and is its use necessary? (N. J., 1904-1909.) 75. Why is the word "By" used in connection with credit entries, and is its use necessary? (N. J., 1904-1909.) 76. State how you would verify Journal entries. (Va., Nov., 1910.) 77. Prepare a form of monthly summary Journal entries for the books of original entry. (N. Y., Jan., 1907.) 78. State the general law growing out of the relationship of debtor and creditor that governs double-entry bookkeeping. (N. Y., Dec., 1898.) 79. In double-entry bookkeeping, why are the debits on the left and the credits on the right? (N. Y., June, 1900.) 80. What is the result of a debit entry? of a credit entry? Illustrate in the case of an account of each of the following classes: (a) Personal, (&) real, (c) nominal. (N. Y., Dec., 1898; N. Y., June, 1900.) 81. (a) What may the placing of an item on the debit side of a Ledger account represent? (b) What may the placing of an item on the credit side of a Ledger account represent? (Va., Oct., 1911.) DOUBLE-ENTRY BOOKKEEPING 31 82. Why is an account debited? Why is an account credited? (Iowa, Dec., 1918.) 815. Stale the advantages of double-entry bookkeeping. (N. Y., June, UHil; N. J., 1904-1909*; Mass., June, 1010.) 84. What is the best plan for distributing monthly bills among 500 or more expense and construction accounts? (Mass., Oct., 1914.) 85. In making detailed audits some auditors verify all postings and footings of general and subsidiary ledgers, even though controlling ac- counts are kept. State reasons for and against such procedure. (A. I. of A., Nov., 1919.) 86. Describe the entries necessary to open a set of double-entry books for a firm just starting in business. (N. Y., Dec., 1898*; N. Y., June, 1900; Pa., Nov., 1900*; Wash., May, 1903.) 87. What is the proper course of procedure in taking charge of the bookkeeping of a firm that has either no books of account or very im- perfect ones? (N. Y., June, 1898; Pa., May, 1902.*) TRIAL BALANCE 88. What is a trial balance? (Pa., Nov., 1899*; Pa., Nov., 1901; Pa., May, 1902; Pa., May, 1905; N. Y., Jan., 1906; N. Y., Oct., 1907; 111., Dec., 1907 ; R. I., Dec., 1907 ; Md., Jan., 1909* ; N. J., 1904-1909* ; N. Y., Feb., 1910; La., May, 1913*; Colo., Dec., 1913*; Wis., April, 1914; Kan., May, 1916; W. Va., May, 1917; Cal., June, 1917; N. C., Aug., 1917*; Va., Nov., 1918; N. C., Nov., 1918*; Iowa, Dec., 1918.) 89. What is the purpose of a trial balance? (N. Y., Jan., 1897* ; N. Y., June, 1898 ; N. J., 1904-1909* ; N. Y., June, 1909* ; Ohio, Nov., 1913 ; Ohio, Nov.. 1915; Ohio, Nov., 1916; Ohio, Nov., 1918; Ind., Nov., 1918; Md., Oct., 1919.) 90. If your trial balance shows an account having a debit excess what does the circumstance signify? Does the debit balance shown by the trial balance indicate the true status of the account? Explain. (N. Y., June, 1904.) 91. What are the principal differences between a trial balance taken before the books are closed, and one taken directly after they are closed? (N. Y., Jan.. 1897; N. Y., Dec., 1897*; N. Y., June, 1908; Iowa, Dec., 1918.) 92. How may the accounts in a trial balance be best arranged to facili- tate the preparation of a business and financial statement? (N. Y., Dec., 1896.) 93. What is the character of accounts contained in a trial balance? (N. Y., Jan., 1897; N. Y., June, 1909.) 94. Describe the process of taking a trial balance. (N. Y., June, 1898.) .;_' c. P. A. ACCOUNTING 95. State the scope and value of the trial balance. (N. Y., Jan., 1902.) 96. Submit trial balance taken from the books of a copartnership and also a similar trial balance, as it would appear by the books of a corpora- tion (assuming that in each case the books have been closed at the end of the fiscal period), using your own figures. (Ohio, Dec., 1908.) 97. When accounts are in equilibrium what may be said as to their correctness? (N. Y., Jan., 1917.) 98. Does a trial balance furnish conclusive evidence of the absence of errors? Explain. (Pa., May, 1905* ; Ohio, Nov., 1913* ; Ohio, Nov., 1915 ; N. Y., June, 1918*; Ind., Nov., 1918; Ohio, Nov., 1918; Md., Oct., 1919.) 99. How should one proceed to detect an error in a trial balance? (N. Y., Jan., 1897; N. Y., Dec., 1897*; N. Y., June, 1901*; N. Y., Jan., 1902.) 100. Give the order of procedure and describe tersely in enumerated paragraphs the steps required when called upon to adjust an incorrect trial balance which the bookkeeper cannot agree. (111., May, 1913.) 101. In balancing a set of books consisting of Cash Book, Purchase Book, Sales Book, Journal and Ledger, the debit side of the trial balance is found to be $87.19 in excess of the credit side; how should the error be sought? (N. Y., Jan., 1900.) 102. In taking off a trial balance, a bookkeeper finds that his debit footings exceed the credit by $131.56, which he carries to a Suspense account. Later, he discovers that a purchase amounting to $417.50 has been debited to a creditor as $192.94; that $312.50 for depreciation of furniture has not been posted to depreciation account ; that $500 with- drawn by the principal has been charged against wages account; that a discount of $76.13 allowed to a customer has been credited to him as $71.13; and that the total of sales returned was footed $5 short. Give detailed entries showing how you would remedy these errors, and starting with the original difference prepare a supplemental trial balance showing whether the books balance or not. (111., Dec., 1910.) 103. When an auditor employed to adjust the accounts of a firm finds that the current work is behind and that no trial balance has been made for over a year, what course should he pursue, having regard for his own interests as well as for those of the firm? (N. Y., Jan., 1900.) 104. What deductions may be safely drawn from a trial balance rep- resenting intrinsic values and true economic history of the transactions of a given period? (N. Y., June, 1917.) BOOKS 105. What books of account do you consider necessary for the con- duct of a small business? Describe their form and use. (N. Y., Jan., 1897; N. Y., Dec., 1898*; Pa., Nov., 1900*; Pa., May, 1905*; N. Y., DOUBLE-ENTRY BOOKKEEPING 33 June, 1906*; N. Y., Feb., 1908*; Mich., July, 1909; N. Y., Feb., 1910; Ohio, March, 1910.*) 106. Describe a system of bookkeeping- by which the errors in a trial balance may be localized. (N. Y., June, 1908.) 107. Suggest a plan for recording and posting, with the least possible loss of time, the remittances received from customers by a concern whose Ledger is in several divisions, with a bookkeeper to each division. (Wash., April, 1906.) 108. Describe a condition in which the use of a few books would not result in simplicity of system, while the number of books currently oper- ated could be increased with advantage. (N. Y., Jan., 1907.) 109. What is a Ledger? (N. Y., Oct., 1907; R. I., Dec., 1907.) 110. Do you approve of a business concern keeping more than one Ledger? If so, why, and how would the different ledgers be character- ized? (Mass., April, 1911.) 111. Name seven kinds of ledgers and briefly state the use of each kind. (N. Y., Dec., 1897*; N. Y., June, 1908; N. Y., June, 1911.*) 112. Define: Boston ledger. (111., Dec., 1916.) 113. State arguments briefly for and against the use of Boston ledger. (Cal., Nov., 1916.) 114. Define: Subsidiary ledger. (S. C., Sept., 1919.) 115. What are the advantages of a subsidiary ledger? (S. C., Sept., 1919.) 116. Describe: Self -balancing ledger. (R. I., Dec., 1907; N. Y., June, 1912*; N. Y., June, 1919.) 117. How is a self-balancing ledger operated? (R. I., Dec., 1907*; N. Y., June, 1912.) 118. In a large dry goods business it is considered necessary to divide the bookkeeping in such a way that each ledger shall be balanced sepa- rately. How should this be done? (N. Y., June, 1898.) 119. In making an audit would you consider it necessary to check in detail the postings of subsidiary ledgers? Explain fully. (N. Y., Feb., 1908; Mich., June, 1912.) 120. A Milwaukee corporation has twenty Sales Ledgers and desires to adopt a system of sectional balancing so that each ledger can be balanced separately each month. Outline and illustrate the use of the system. (Wis., April, 1917.) 121. What do you consider the best subdivision of ledgers when sales amount to $6,000,000 to $10,000,000 per annum in a manufacturing business, say, steel? It is desired to ascertain losses and gains monthly. Describe fully your plan or method of connecting up the ledgers em- ployed, also the method of treating the purchases and sales. (Pa., Nov., 1900.) 122. Define : General Ledger. (Wash., Nov., 1913.) 34 C. P. A. ACCOUNTING 123. State your opinion briefly as to the merits or the demerits of General Ledger. (N. J., 1904-1909.) 124. Define: Private Ledger. (N. Y., June, 1899*; N. Y., Jan., 1900; N. Y., June, 1901*; N. Y., Jan., 1902*; Wash., May, 1903; Pa., May, 1903; Cal., June, 1904*; N. J., 1904-1909*; N. Y., Jan., 1906*; Mich., July, 1906*; 111., May, 1907*; Wash., Aug., 1908*; N. Y., Feb., 1910*; Mass., June, 1910*; Va., Oct., 1912*; Wash., Nov., 1913; N. Y., Jan., 1914*; Mich., June, 1915*; Cal., Nov., 1916*; 111., Dec., 1916; Md., Oct., 1919.*) 125. What accounts should be embodied in a private ledger to make it a complete synopsis of the business? How would you prove the cor- rectness of these accounts? (N. Y., June, 1918.) 126. When would it be advisable to use a Distribution Ledger? (Md., Jan., 1909.) 127. Define: Loose-leaf system of bookkeeping. (Va., Nov., 1910; A. I. of A., May, 1918.) 128. Discuss the relative merits of bound books and loose-leaf or card records for various accounting purposes. (N. Y., Jan., 1904*; Cal., June, 1904*; N. J., 1904-1909*; R. I., Dec., 1907*; Fla., April, 1908*; Wash., May, 1910*; Va., Nov., 1910*; Mass., April, 1911*; Va., Oct., 1912*; La., May, 1913*; Cal., Nov., 1916*; A. I. of A., Nov., 1917; A. I. of A., May, 1918*; Ind., Nov., 1918*; Ga., May, 1919.) 129. State your view of the possibility of removal, destruction or sub- stitution of loose leaves or cards to the extent of effectually preventing evi- dence in cases of litigation. (Wash., May, 1910.) 130. Give at least two methods for preventing improper abstracting of leaves from loose-leaf books. (Fla., April, 1908.) 131. In what kind of business would loose-leaf ledgers be most use- ful? Under what circumstances would you advise the use of card ledgers? (Mass., April, 1911.) 132. Describe: Tabular books. (Pa., Nov., 1899; Md., Oct., 1903; Pa., Nov., 1906.) 133. What is the advantage or disadvantage in the use of columnar books? (Pa., Nov., 1899; N. Y., Jan., 1900*; N. Y., Jan., 1902*; Wash., May, 1903*; Pa., May, 1903; N. J., 1904-1909; Pa., Nov., 1906; Md., Jan., 1909.*) 134. State the purposes for which series of perpendicular columns are employed in books of original entry and how these purposes may be ac- complished relative to the following conditions: (a) Several ledgers com- prehended in one system of accounts; (6) several departments com- prehended in one business; (c) several accounts comprehended in income and expenditure. (N. Y., Dec., 1896.) 135. Prepare form of book for small business combining General Ledger, General Journal and General Cash Book in one binding to show transactions involving all three on each double page. (111., Nov., 1904.) DOUBLE-ENTRY BOOKKEEPING 35 136. Illustrate a Columnar Cash Book, a Columnar Journal, and a Columnar Sales Book. What general requirements should be observed in designing such books? (N. Y., Jan., 1900*; Wash., May, 1903.) 137. What is a Journal ? (N. Y., Oct., 1907; R. L, Dec., 1907.) 138. Explain what is meant by "books of original entry" and give two illustrations of same. (Md., Oct., 1903*; Ohio, Nov., 1916.) 139. Describe various uses of the Journal. (N. Y., Jan., 1897; N. Y., June, 1902*; N. Y., June, 1906.) 140. Write a short article upon the Journal: (a) its form; (b) its principle, and (c) how the principle works in all proper bookkeeping, even in the absence of a Journal as a book. (Md., Oct., 1903.) 141. State your opinion briefly as to the merits or the demerits of the Journal; do you consider its use necessary 1 ? (N. J., 1904-1909.) 142. In what does the Journal differ from the Cash Book? (N. Y., June, 1902.) 143. Describe the following books and explain the nature and the objects of each: (a) Summary Journal; (6) Consumption Journal. (N. Y., Jan., 1907.) 144. What do you consider a complete checking of the General Jour- nal? (R. L, Dec., 1907*; Ohio, Nov., 1915.) 145. What are auxiliary books as understood in accounting terminol- ogy? Mention three books of this class and explain their use. (N. Y., June, 1904.) 146. Messrs. "C" and "D" desire that their Ledger shall show all the transactions with their creditors, i.e., purchases and payments with each creditor. Naturally the bookkeeper wishes so to arrange his books as to accomplish the desired end with the minimum of labor. (a) What would you recommend? (6) What would you name your plan? (c) What general instruction would you give to the bookkeeper to enable him properly to maintain your "plan" after its installation by you? (N. J., 1904-1909.) 147. You wish so to keep your accounts that at any given time you may readily ascertain the aggregate balances due from your customers and the aggregate balances due to your creditors, without taking the time to list the same (customers and creditors) and at the same time you wish to maintain your Ledger in perfect balance. (a) How would you arrange your Ledger or Ledgers? (6) How would you name the Ledger or Ledgers? (c) How would you maintain the balance 'of the Ledgers or make it possible to balance or prove one Ledger independent of the other Ledgers? (N. J., 1904-1909.) 148. Define or describe what is meant by the words "a book of original entry" and state what must be shown with respect to the entries therein upon trial of any cause, before such entries become admissible in evi- dence. (Mo., Dec., 1914.) 149. Does any advantage attach to the employment of more than one 30 C. P. A. ACCOUNTING volume for the Ledger of a business requiring only one bookkeeper? Give reasons. (N. Y., June, 1897; N. Y., Jan., 1907.) VOUCHER SYSTEM 150. Describe the voucher system. (N. Y., June, 1899*; Pa., May, 1903* ; Pa., Nov., 1903* ; 111., Nov., 1903* ; Md., Jan., 1909* ; Wash.. May, 1910*; Va., Nov., 1910*; Wash., June. 1915*; Mich., June, 1915*; Mass., Oct., 1915*; CaL, May, 1916*; Cal., June, 1917*; A. I. of A., May, 1918*; 111., Dec., 1918; Mich., June., 1919.*) 151. State the arguments briefly for and against the use of voucher system. (N. Y., June, 1899*; Pa., May, 1903; Pa., Nov., 1903; Cal., June, 1904*; Pa., Nov., 1906; 111., May, 1907*; Md., Jan., 1909; Fla., July, 1909*; Wash., May, 1910*; Va., Nov., 1910; Mass., April, 1911*; 111.,' May, 1912*; Mass., Oct., 1915; Cal., Nov., 1916; 111., Dec., 1916; Cal., June, 1917; N. D., Aug., 1917*; A. I. of A., May, 1918; N. Y., Jan., 1920.*) 152. For what classes of undertaking is the voucher system peculiarly desirable? For what classes of undertakings is it undesirable? Why? (111., Nov., 1903*; Wash., May, 1910*; Cal., May, 1916.) 153. Describe the Voucher Record. (N. Y., June, 1898; N. Y., June, 1899; N. Y., June, 1912; Wash., June, 1915*; W. Va., May, 1917; Wash., July, 1917.) 154. What is the relation of the Voucher Record and Purchase Journal to the General Ledger? (111., Dec., 1916.) 155. Define: Voucher check. (Wash., June, 1915.) 156. What is a voucher? (N. Y., Jan., 1906.) 157. Define: Journal voucher. (Wash., July, 1917.) 158. What is your understanding of the purpose of a voucher? (N. Y., Jan., 1906.) 159. Sketch forms of disbursement voucher and journal voucher. (111., May, 1907.) 160. State how you would satisfy yourself of the correctness or regu- larity of absent vouchers. (N. C., Nov., 1918.) 161. A firm whose accounts have been audited annually for a number of years, loses, through fire, all its receipted expense bills for the past year, which have not been audited. All the other records were saved. The accountant is requested to make the annual audit as usual. How should he proceed to satisfy himself with respect to the expenses for which the vouchers are missing? (N. D., July, 1919.) 162. Would you consider it necessary to place your initials or some other distinctive marks on each voucher, and if so, why? (La., May, 1913.) 163. A corporation, in paying two bills, fastens the bills together, adds to the first bill of the two the amount of the second bill and sends these DOUBLE-ENTRY BOOKKEEPING 37 with a check for receipt. When returned, only the top bill is receipted. Do you consider this a valid voucher? If not, how could you satisfy yourself at the office of the corporation 1 ? (Mass., June, 1913.) 164. How would an auditor protect himself from duplicate vouchers or fraudulent bank books? (N. Y., Dec., 1896*; N. Y., June, 1898*; Pa., Nov., 1899; Pa., Nov., 1901*; Wash., May, 1903*; Pa., Nov., 1903; Mich., Nov., 1907; Md., Jan., 1909*; Wash., May, 1911.*) 165. In an audit of the books of a corporation using the voucher system, what means should be adopted to prevent the reproduction of vouchers already passed, in cases where the auditor is not permitted to deface the vouchers by stamps or writing? (N. Y., Jan., 1902.) 166. Give a broad definition of vouchers as a means of verifying items entered in the books of account. (N. Y., Jan., 1907.) 167. In an audit stipulating for the examination of all vouchers of every description, what would be proper vouchers for the following: purchases, returned purchases, sales, returned sales, cash receipts, cash payments, journal entries? (N. Y., Dec., 1896; 111., May, 1906; Ohio, March, 1910; Mich., June, 1912; Wis., April, 1914*; Wis., May, 1916*; Va., Nov., 1918.) 168. State your method and procedure in an audit, in determining that you have seen all vouchers, even though some of them have been credited to personal accounts, and payments have been made to apply on account. (Colo., Dec., 1913; N. D., Aug., 1917.) 169. How would you vouch the following items appearing in the books of a company you are auditing; and state specifically the papers or docu- ments you would call for in support of the disbursement : 1. The Rapid Typewriter Company Typewriter purchased in exchange for old one. .$ 30.00 2. Alex. Green Real estate for plant site 7,500.00 3. Automatic Sprinkler Company Installment paid on sprinkler system 1,000.00 4. John Mace Stumpage purchased for 625.00 5. Safety Trust Company Par value $3,000 bonds 2,970.00 6. Machinery constructed and erected by the com- pany's staff 10,500.00 7. Thomas Jones, Salesman Traveling expenses for one week 73.20 8. A B Company Note payable discounted 987.50 (111., May, 1914.) 170. What is the purpose of examining vouchers? In a large concern would you attempt to inspect them all? If not, what tests would you make? (N. Y., Jan., 1916.) 38 C. P. A. ACCOUNTING PROBLEMS DOUBLE- ENTRY BOOKKEEPING 1. The following is the Balance Sheet of the A. B. Company, January 1. 1915: Cash $52.864 Accounts Payable $35,482 Accounts Receivable 197,425 Dividends Pavable Preferred Inventories: Stock Feb. 1, 1915 7,500 Raw Material 84,268 Dividends Payable Common Finished Goods 31,597 Stock Feb. 1, 1915 10,000 Office Furniture and Fix- tures 7,500 Mortgage Bonds 20 Year 6% Dated Jan. 1, 1915 100000 Land 180,000 Premium on Bonds 5000 Buildings 150,000 Capital Stock Preferred. . . 250 000 Machinery 250,000 Capital Stock Common .... 500,000 Reserve for Bad Debts 4718 Surplus 40 954 $953,654 $953,654 The transactions for the year ending January 1, 1916, have been as follows: Cash received from customers, $793,501; rent received, $600. There has been purchased 1,232,000 pounds raw material at 20 cents per pound. Sales have been $823,334; discount and allowance on sales, $23,- 519; bad debts written off, $2,143. Disbursements have been made for: Accounts Payable, $243,356; Fac- tory Expense, $7,489; Factory Labor, $351,426; Factory Repairs, $23,843; Office Expense, $1,927; Selling Expense, $52,914; Salaries, $58,471; Taxes, $7,853. Inventories January 1, 1916: Raw material, 412,595 pounds, having market value of 20 cents per pound and finished goods, $30,842. The land is estimated to be worth $200,000. Semiannual dividends of 3 per cent on preferred and 2 per cent on common, declared in June and December, payable August 1 and February 1. Reserves for depreciation of building, 3 per cent ; machinery, 5 per cent ; office fixtures, 10 per cent. Bad and doubtful debts reserve should be 2 per cent of Accounts Receiv- able. Prepare an Operating statement and Balance Sheet as on January 1, 1916. (A. I. of A., Nov., 1917.) 2. The trial balance of the Interstate Manufacturing Company, on June 30, 1918, after closing entries have been made, is given below : DOrBLE-ENTRY BOOKKEEPING 3!) Patents and Goodwill $250,000 Office Furniture 8,746 Inventory, June 30, 1918: Raw Material 83,247 Supplies 4,932 Finished Goods 42,761 Petty Cash 100 Land 270,000 Buildings 165,000 Cash subject to check 69,433 Machinery .... .... ... 235,000 Accounts Receivable 273,842 Common Capital Stock $500,000 Preferred Capital Stock 500,000 Bonds 6%, 50 year First Mortgage, issued June 30, 1918 200,000 Premium on Bonds 20,000 Preferred Stock Dividends, payable August, 1918 . . Common Stock Dividends, payable August, 1918 . . . Reserve for Bad and Doubtful Accounts 17,500 12,500 8,294 Undivided Surplus 66,375 Accounts Payable 78,392 $1,403,061 $1,403,061 During the year ending June 30, 1919, the Company purchased 29,047 tons of raw material at $22 per ton, which was delivered before the books closed. Of the amount purchased, payment has been made for 26,647 tons. They have also made payments for the following accounts: Accounts Payable, $78,392; Salaries, $80,360; Selling Expense, $86,017; Labor, $468,932; Shop Expense, $9,461; Repairs and Maintenance, $30,955; Taxes, $7,842; Office Expense, $2,478; and Supplies, $37,637. Customers have paid $1,502,927 in cash and have been given discounts amounting to $18,395. Returns and allowances amount to $8,474. Bad debts written off, $2,407; rents received, $500; and sales, $1,515,572. $50,000 was borrowed on call on June 30, 1919, the market value of the collateral security being $72,100. The inventory on June 30, 1919, is made up of finished goods, $20,495 ; supplies, $8,129; and 2,163 tons of raw material, the market price of which is $24 per ton. The land is estimated to be worth $300,000. Semiannual dividends of 3*/2 per cent on the preferred stock and 2^ per cent on the common stock have been paid from the earnings of the half year ending December 31, 1918. Dividends at the same rate have been declared on the preferred and common stock for the last half of the fiscal year, payable in August, 1919. You are asked to set up a Balance Sheet dated June 30, 1919, and ac- company it with a statement which will show correctly the operation of the Company. The following annual rates of depreciation are to be assumed : Buildings, 3 per cent; machinery, 7 J /fc per cent; office furniture, 10 per cent. It is 40 C. P. A. ACCOUNTING also assumed that there should be a reserve for bad and doubtful accounts equal to 3 per cent of the balance of accounts receivable. Calculate these percentages to the nearest dollar. (Mo., Dec., 1914; Md., Oct., 1916; Kan., May, 1918.*) 3. The books of Robert West, real estate agent, for the year 1900, disclose the following opening and closing balances and intervening volume of transactions : Titles of Accounts Balances Dec. 30, 1905 Transactions in 1906 Balances Dec. 31, 1906 Cash $9,760.08 1,060.00 $137,797.62 34,656.00 34,788.00 34,610.00 100,934.00 4,841.40 $135,893.70 34,788.00 34,656.00 34,788.00 102,070.00 5,007.40 125.00 3,118.92 180.00 $11,664.00 928.00 $928.00 2,678.00 6.909.00 610.00 125.00 3,118.92 180.00 $1,060.00 2,500,00 5,929.00 444.00 Clients 260.00 104.00 Fees Expenses 1,000.00 1,000.00 2,000.00 500.00 Personal drawings 2,000.00 500.00 Capital 1,647.08 1,647.08 811,580.08 $11,580.08 $350,627.02 $350,627.02 $16,196.00 $16,196.00 An analysis of the books afforded further information as follows: Tenants were allowed $71 for repairs made by them, which sum was applied on account of rent and charged to owners. Owners were charged for commissions on collections, $869.70; trade creditors' bills for repairs, $3,566; and insurance, $52. Clients were charged, insurance, $668; coal, $906; fees, $125; commis- sions on sales, $1,004. Trade creditors presented bills for office supplies, $50; insurance writ- ten, $576; coal, $815.40; they were allowed $180 for discount on settle- ments made. Commissions on sales, collections, insurance written, and coal orders were closed into the General Commission account and Supplies account was transferred to Expense. The cash transactions were as follows: Receipts, tenants, $34,717; clients, $102,070; commission on sales, $1,010.62. Payments, owners, $30,051.30; clients, $98,231; trade credi- tors, $4,661.40; personal drawings, $2,000; expense, $950. Prepare an articulation statement showing in each account the several elements of debit and credit and giving each element' the title of the articu- lation account wherein the contra credit or charge appears. (N. Y., Jan., 1907.) 4. The following statements comprise the trial balances of a business at the beginning and the end of a fiscal period, together with the volume of the transactions during said period : DOUBLE-ENTRY BOOKKEEPING 41 Trial Balance January 1 Interim Transactions Trial Balance December 31 Cash $1,115 5,050 3,110 2,800 $1,575 500 10,000 $16,583 17,665 25,135 505 18,922 693 900 50 1,820 900 1,705 1,333 2,000 $16,338 26,874 24,229 19,410 1,000 360 $1,360 4,016 3,305 333 900 50 1,820 900 1,705 1,333 2.000 $4,159 2,063 1,500 10,000 Merchandise Debtors Fixtures Creditors Loan Capital Interest and discount Rent Insurance Salaries Advertising Carting Expense Drawings, proprietor . $12,075 $12,075 $88,211 $88,211 $17,722 $17,722 (a) The Sale Book shows sales posted to debtors to the amount of $25,135. (6) The Journal shows allowances to debtors for returns of merchan- dise sales, $1,015, and claims on creditors for returns of mer- chandise purchases, $230; also application of debtors' balance to settle creditors' account in the amount of $9,500, both ac- counts being in the name of the same correspondent. (c) The Ledger shows that the nominal accounts entitled Eent, In- surance and Office Salaries contain only cash charges, while the nominal accounts entitled Advertising, Cartage and Expense show cash charges in the total amounts of $100, $200 and $773, respectively, all other charges therein being by invoice duly posted to creditors' accounts. (d) The Merchandise account shows cash charges of $610 and cash credits of $1,509 for cash purchases and cash sales, respectively. (e) The Invoice Books show invoices posted to creditors' accounts to the amount of $19,410. Prepare an articulation statement showing in each account the several elements of debit and credit and giving each element the title of the articu- lation account wherein the contra credit or charge appears. (N. Y., June, 1906.*) CHAPTER III BALANCE SHEET Balance Account The balance sheet is an outgrowth of the old practice, now discarded, of closing all the accounts of the ledger at the end of the fiscal year by closing the nominal accounts through the profit and loss account into the vested capital accounts and the real accounts into a balance account, which was itself closed when the real accounts were reopened at the start of the new period. 1 Balance Sheet The balance sheet may be defined as a statement showing the financial position of a business, its assets and liabilities, the capital employed therein, as well as any reserves, surplus, or deficiency there may be at a specific date. 2 As to content, the balance sheet differs from the prior-closing trial balance in not containing the nominal accounts, 3 but is identical with a post-closing trial balance.* However, the purpose of the post-closing trial balance is merely to prove that the ledger is in balance, 5 while the balance sheet purports showing the financial condition of the business in a manner intelligible to the lay reader." Form of Balance Sheet There are two general classes of balance sheets, namely: (a) The account form; and (b) the report form. 7 The account form is frequently called the technical form of balance sheet. 8 The account form places the asset accounts on one side and the liability and capital accounts on the other. If the assets are on the left the balance sheet is in the American account form ; if on the right, it is in the English account form. 9 The fact that deductions are not used in accounts does not prevent the valuation reserves, etc., being deducted from the related asset accounts in account form balance sheets. 10 There are two general classes of report form balance sheets, namely : (a) Same as the account form if the liability and capital accounts were placed under instead of to the right of the assets;" and (b) a form in which the assets are listed and their totals extended, and under them the liabilities listed and their totals extended and deducted from the total of the assets, the difference being the net worth of the business, which is then itemized and total extended. 12 Classification of accounts is vitally important for balance sheet pur- poses. However, it is seldom that two accountants will agree as to the degree of classification necessary. This results in some accountants dividing the assets into (a) fixed assets, (b) permanent investments, (c) investments of reserve, (d) working assets, (e) current assets, and (f) deferred charges/ 3 while others merely classify thorn as to (a) current assets, (b) deferred charges, and (c) fixed assets. 14 More uniformity is 'For explanation of superior figures see page 337. 42 BALANCE SHEET 43 found on the liability and capital side of the balance sheet, as usually the liabilities are classified as to (a) current liabilities, (b) deferred credits to income, and (c) fixed liabilities, while the net worth accounts are separated into (a) capital stock accounts and (b) surplus accounts. 15 There is little uniformity as to the order in which the classes of accounts appear on the balance sheet. In general, however, there are two plans of marshalling the balance sheet accounts. One lists the current assets and liabilities first, 19 and the other lists the fixed assets and liabilities first. 1 ' A variation from the latter plan is to list the capital stock accounts, followed in order by the fixed liabilities, current liabilities, and surplus. 18 As the reader is usually more interested in the current than in the fixed accounts, it seems preferable to list the current items first. It seems decidedly objectionable to place the liabilities between the net worth accounts, as so doing obscures both the amount of the liabilities and the net worth of the business. There is a decided difference of opinion among accountants as to the place to be assigned to deferred charges to opera- tions and deferred credits to income. Some accountants place these items after the current and fixed assets and liabilities, respectively, 18 while others place them between the current and fixed accounts. 20 As the deferred items have a much shorter life than the fixed items, the latter arrangement seems to be preferable. A special arrangement of the accounts in the account form of balance sheet, called the "double account" form, divides the accounts into two distinct tables. 21 In the first table the fixed assets are placed against the fixed liabilities and net worth accounts. 22 The credit balance of the first table representing the amount of free or available capital is bi'ought down into the second table in which the current assets and current liabilities are listed. 23 Still another noteworthy point in the form of a balance sheet is the number of columns used. Usually three columns are found to be suffi- cient. What is gained in classification by the use of more than three columns is more than offset by the increased complexity of the form, the additional difficulty in having the statement typed, and what is important for C. P. A. candidates, the increased time it takes to prepare the statement. Model Balance Sheet For ordinary purposes, it is comparatively un- important which of the recognized forms of balance sheet is used. How- ever, it is vitally important that all students limit themselves to the use of only one form after they have become familiar with all the forms. This specialization will greatly enhance the speed and accuracy of the student, the two requirements which the C. P. A. candidates find the most difficult to acquire. Valuation in Balance Sheet The accounts shown in a balance sheet are valued at book value, that is, the fixed assets are valued at cost less depreciation, 24 the working assets at cost or market whichever is the lower 25 and the other current assets at the estimated cash value. As there is no asset, other than cash, whose actual value can be definitely ascertained, a balance sheet is a statement of opinion and not a statement of fact. 2 " 44 C. P. A. ACCOUNTING A. B. COMPANY BALANCE SHEET December 31, 1916 Assets Current Assets: Cash: Petty Cash Cash on Deposit. Notes Receivable Accounts Receivable Less Reserve for Bad Accounts. Interest Accrued on Investments . Investments Advances to Salesmen Inventories : Material Work in Process Finished Goods . . Deferred Charges: Unexpired Insurance: Building and Machinery . Finished Goods . . Prepaid Taxes Real Estate . Fixed Assets: Land Buildings Less Reserve for Depreciation. Machinery Less Reserve for Depreciation. Office Furniture. Goodwill. . Liabilities and Capital Current Liabilities: Notes Payable Accounts Payable Interest on Mortgage . . . Accrued Payrolls: Factory Office . . Fixed Liabilities: Mortgage on Plant Net Worth: Capital Stock Less Unissued Capital Stock. Surplus: Start of Period Addition During Period , BALANCE SHEET Since the reserves for depreciation and doubtful accounts and the valua- tions placed upon the inventories are merely matters of opinion, the profit and loss statement and the resultant surplus are also matters of opinion and not of actually ascertained facts. 27 The auditor's responsibility as to the balance sheet largely centers around the valuation of the accounts. The sources of data as to values are (a) books of account, (b) original purchase invoices, (c) catalogs, (d) experience in the business, (e) appraisal concerns, and (f) capitalization (goodwill) of earnings. 28 Condensed Balance Sheets The purposes served by balance sheets are (a) internal use by executives, (b) formal stockholders' report, (c) report to supervising commissions, (d) annual report to state, (e) basis of appli- cation for credit, and (f ) basis for issuing new securities. 29 When used for some of these pin-poses, the amount of detailed information in the balance sheet itself should be reduced to a minimum. This is accomplished by grouping similar accounts under general headings with the detailed information contained in the schedules, references to which are made on the condensed or general balance sheet. 30 The use of only the controlling accounts for the accounts and notes receivable and payable in the balance sheet with lists of the subsidiary accounts appended is the most common illustration of the supporting schedules.' 11 The same idea can be used for the plant and property, investments, inventories, deferred charges, etc. 32 Comparative Balance Sheets One of the most valuable statements an auditor can prepare for his client is a balance sheet which will show the increases and decreases which occurred during the period in the various accounts. Such a statement will detect any tendency to tie up the funds in fixed assets or inventories of merchandise and will warn the client against unusual increases in current liabilities. Practically all of the comparative balance sheets prepared by accountants do not classify the accounts 33 thereby partially obscuring the changes in the classes of accounts. The model comparative balance sheet given below, however, classifies the accounts 34 and shows the increases and decreases which occurred within the classes of accounts : A. B. COMPANY COMPARATIVE BALANCE SHEET Assets Jan. 1, 1907 Jan. 1, 1908 Increase Decrease Current Assets: Cash S800.00 5,400.00 4,200.00 $4,800.00 1,000.00 2,300.00 $4,000.00 Accounts Receivable .... Inventories $4,400.00 1,900.00 Deferred Charges: Insurance Prepaid $10,400.00 $8,100.00 $4,000.00 $6,300.00 $400.00 $200.00 $200.00 Fixed Assets: Plant and Equipment.. . . $17,000.00 $15,000.00 $2,000.00 $27,800.00 $23,300.00 $4,000.00 $8,500.00 40 C. P. A. ACCOUNTING A. B. COMPANY COMPARATIVE BALANCE SHEET Liabilities and Capital Jan. 1, 1907 Jan. 1, 1908 Increase Decrease Current Liabilities: Notes Payable $5,000.00 $5,000.00 11,300.00 Accounts Payable 11,800.00 $500.00 Valuation Reserves: Reserve for Bad Debts. . . Reserve for Depreciation . Net Worth: Capital Stock $16,800.00 $500.00 $16,300.00 $300.00 700.00 $300.00 700.00 $7,000.00 4,800.00 $1,000.00 $1,000.00 $10,000.00 $17,000.00 4,800.00 Net Profits $10,000.00 $21,800.00 $11,800.00 $27,800.00 $23,300.00 $11,800.00 $16,300.00 SUMMARY Current Liabilities: Decrease $16 300 00 Current Assets: Decrease $6,300 00 Increase 4 000 00 $2 300 00 Deferred Charges: Decrease 200 00 Fixed Assets: Decrease 2 000 00 Capital Stock: Increase 7 000 00 11 500 00 Net Profits $4,800.00 The above summary" 5 is not the only recognized method, for many ac- countants would draw up the summary as follows : M Funds Available: Decrease in Current Assets $6,300. 00 Decrease in Deferred Charges 200. 00 Decrease in Fixed Assets 2,000. 00 Increase in Net Worth 1 1 , 800 ' 00 $20,300.00 BALANCE SHEET 47 A pplied as Follows: Increase in Current Assets $4,000.00 Decrease in Current Liabilities 16,300.00 $20,300.00 Assets The assets of a going concern are its property of all sorts ap- plicable or subject to the payment of debts, and amounts expended for the benefit of future periods. 37 Assets of concerns about to liquidate in- clude only such items as are applicable to the payment of the liabilities 38 and do not include the items exempted by law or the amounts expended for the benefit of future payments. The term "net assets" means the proprietor's interest 38 or the difference between the total assets and liabilities of a business. Kinds of Assets The classes into which assets may be divided are : (a) Current (sometimes called circulating, active, or floating) or assets maturing within a short time or those convertible into cash by the ordinary routine of business. 40 (b) Working or trading assets or a sub-group of current assets including the inventories of raw material, goods in process of manufacture, and finished goods. 41 (c) Quick (sometimes called liquid) or a sub-group of current assets including only those assets very readily converted into cash. An advance to a salesman is a current asset, but it is not a quick asset, 42 (d) Fixed (sometimes called permanent, passive, or capital) or assets necessary for the conduct of the business, which are not intended for sale. 43 (e) Secret or assets representing the excess of the appraised value of property over its book value. 44 (f) Wasting (sometimes called diminishing) or fixed assets which are consumed in direct ratio with operations, or merely through efflux of time. 45 The term "wasting assets" includes both the assets subject to depreciation and those subject to depletion, 48 but the term is most com- monly used in reference to natural resources. (g) Contingent or assets that are subject to preceding events or situa- tions which may or may not happen. 47 (h) Accrued or a sub-group of current assets which accumulate gradually with the efflux of time. 48 (i) Deferred charges to operations or those portions of expenses paid in one period and allocated to future periods. 48 Kinds of Liabilities The liabilities, the debts or obligations clue by a firm to its creditors, 50 may be classified as follows: (a) Current (sometimes called floating, active, circulating, or quick) or liabilities maturing in a short time which will be liquidated in the normal course of business. 51 (b) Accrued or current liabilities which accumulate gradually with the efflux of time. 52 48 C. P. A. ACCOUNTING (c) Deferred credits to income or income received during one period applicable to future periods." (d) Contingent or liabilities subject to preceding events or situations which may or may not happen." (e) Fixed (sometimes called capital) or liabilities which will not mature for a long time.'" The assumption that fixed liabilities represent that part of the capital income which has been invested in fixed assets 53 is unwar- ranted because a firm may have large fixed assets and no fixed liabilities at all. (f) Funded or liabilities for which definite provision for payment has been made, usually secured by a mortgage or other lien." (g) Unfunded or liabilities for which no definite provision has been made. 88 (h) Bonded or liabilities evidenced by an issue of bonds. 59 Bonded debt may be either secured or unsecured or either funded or unfunded. Accrued Items There are two bases of accounting. One, the cash basis, is to record the expenses and incomes only when they affect the cash or personal accounts. 00 The other takes into records all of the expenses and incomes including the accruals on the accounting principle that the primary connection between the net assets and the resulting net income is the matter of earnings and expense incurred, and not one of income received in cash and expenses paid in cash. 91 Accruals should be placed on the books at the end of the fiscal period. 12 The plea that they are practically the same at the beginning and end of the period should be disregarded in the interest of accuracy. Some ac- countants do not differentiate between accrued and deferred items, but it is advisable to make the distinction.* 3 Deferred Items There are two kinds of deferred charges to operations, namely, (a) items which will benefit the future periods such as the unex- pired insurance, 1 ' 4 and (b) items which do not benefit future periods such as the cost of equipment suddenly made obsolete through a new invention." Deferred assets may be classified as to whether or not they have realizable values, viz., prepaid insurance has a realizable value while organization expenses have not. Prepaid insurance, rents, and interest and expense inventories are the most usual illustrations of deferred charges.*' The deferred credits to income include income or gains received but applicable to subsequent periods, such as discounts and premiums on securities, unearned fees, and similar items. 07 Aggregates of credits meas- uring the amount of cash receipts for the distribution of which informa- tion is lacking, are also deferred liabilities. 08 The contention that deferred credits to income represent liabilities not payable in cash but in goods or services,* is incorrect because items such as sales paid for in advance include two elements, namely, cost and profit. Even the profit element can not be taken, as prospective profits can not be capitalized. 70 Contingent Items When a note receivable is endorsed and discounted the note is changed from an ordinary to a contingent asset, and a contingent liability is created. 71 When the drawer pays the note, both the contingent BALANCE SHEET 40 asset and liability are canceled.' 2 Other illustrations of contingent assets are pending lawsuits for damages against another firm or individual, or a conditional bequest in a will." Notes receivable discounted, pending law- Miits for damages against firm, guarantees, long-term leases, purchases for future delivery, surety bonds, and accommodation indorsements are the most common contingent liabilities. 74 Except for the notes receivable discounted which should be shown as assets among the other notes and liabilities under the caption "notes receivable discounted," 75 contingent assets and liabilities are not ordinarily shown on the books. 76 Contingent items, other than notes receivable discounted, are usually shown in foot notes on the balance sheet, 7 ' although they may be shown in the body of the balance sheet in the appropriate place, indented and not carried out to the significant money column. 78 If desired, the captions "con- tingent assets" and "contingent liabilities" may appear on the balance sheet. 79 If the notes receivable account is credited when notes are dis- counted, the contingent liability would merely be mentioned in a footnote to the balance sheet. 80 However, when the notes receivable discounted ac- count is credited when notes are discounted, the contingent liability is shown on the balance sheet by deducting the notes receivable discounted from the ordinary notes receivable. 81 It is imperative that the auditor inquire of the executives as to whether any guarantees or indorsements exist and whether any security is available to protect the business. 82 If the officials are interested in other concerns, the investigations should be very searching. 83 The minute books should be scrutinized. 84 Certificates as to the notes receivable discounted at the bank should be obtained from the banker. 85 Certificates should also be obtained from the beneficiaries under a guarantee, as some guarantees are more of a real liability than a contingency. 86 The unfilled purchase orders should also be examined to ascertain whether the financial condition of the business has been jeopardized. 87 Capital Professor Charles J. Bullock, in "The Elements of Economics," defines capital as "all the intermediate products which man creates for the purpose of employing them in the production of finished commodities." This definition of capital from the economic viewpoint makes the capital of the business include all the assets of a business. However, from an accounting viewpoint the capital of a business is the excess of its assets over its liabilities. 88 Working capital is the excess of current assets over current liabilities 89 after the valuation reserves have been deducted from their related current assets. 80 The term is also used occasionally as a synonym for quick assets. 91 In courts, capital is classified into fixed and circulating capital, the terms meaning respectively fixed and circulating assets. 92 Capital is sometimes classified as owned and unowned, the former meaning that contributed to the business by the proprietor or accumulated as profits and the latter meaning that borrowed or obtained from creditors. 93 The term "deficiency" signifies the insufficiency of the assets of a firm to discharge its liabilities; that is, deficiency is the exact opposite of 50 C. P. A. ACCOUNTING capital. 84 The term "deficit" has two meanings, namely, (a) an excess of expenses over income/'' and (b) the excess of liabilities over assets. 9 " Proprietorship Accounts In general, proprietorship accounts are of two classes, namely, accounts with the original investments, and accounts with subsequent changes in net worth. The following chart summarizes the original investments accounts: 9 ' TYPE OF ORGANIZATION Sole Proprietors. Copartnerships Joint Ventures Associations and Societies Joint Stock Associations Stock Corporations Non-stock Corporations Trusts and Holding Companies ORIGINAL CAPITAL ACCOUNTS Proprietor's Investment Account Partner's Individual Investment Ac- count Partner's Individual Investment Ac- counts Membership, Certificate of Indebted- ness and Capital Accounts Capital Stock Capital Stock None Capital Stock A similar chart for the accounts recording changes in net worth subse- quent to original investment is as follows : 98 CAPITAL ACCOUNTS SHOWING CHANGES IN NET WORTH SUB- SEQUENT TO INVESTMENTS Proprietor's Personal Accounts and Re- serves Partner's Individual Personal Accounts and Reserves Partner's Individual Personal Accounts Surplus and Reserves Undivided Profits, Surplus and Reserves Undivided Profits, Surplus and Reserves Surplus and Reserves Undivided Profits, Surplus and Reserves TYPE OF ORGANIZATION Sole Proprietors Copartnerships Joint Ventures Associations and Societies Joint Stock Associations Stock Corporations Non-stock Corporations Trusts and Holding Companies Relation of Proprietor to Business Viewing the business as an entity, it has been claimed that the proprietor is a creditor of the business, whose claim against the business is subject to the prior claims of the creditor. The exponents of this opinion show the right side of the balance sheet under the heading of "liabilities." 99 As the liabilities have contractual rights in the assets, while the proprietorship has merely residual rights, a distinction must be made between proprietorship and liabilities. 100 The fact that losses and gains affect proprietorship and do not affect the liabilities also shows that there is a distinction between net worth and liability accounts. 101 Holders of this opinion use the heading "liabilities and capital" over the right side of the balance sheet. 102 To avoid confusion by including proprietorship and contractual obliga- tions under the caption "liabilities," and to lessen the danger of misunder- standing, the use of the term "equities" has been suggested to represent BALANCE SHEET 51 the right-hand member of the balance sheet equation, viz., assets equal equities. 11 " This term covers all elements of ownership control, risk, and income, the proprietorship equities having more of the control and risk and residual rights to the income, and liabilities having a small amount of the control and risk, and contractual rights to the income. 104 52 C. P. A. ACCOUNTING QUESTIONS BALANCE SHEET STATEMENT 1. Define: Balance Sheet. (Pa., Nov., 1899*; Pa., Nov., 1901*; Pa., May, 1902*; N. Y., Jan., 1906; N. Y., Oct., 1907*; 111., Dec., 1907; R. L, Dec., 1907*; Md., Jan., 1909*; N. Y., Feb., 1910; Va., Oct., 1911*; Mich., June, 1912*; La., May, 1913; Colo., Dec., 1913; Wis., April, 1914; Kan., May, 1916; Wis., May, 1916*; W. Va., May, 1917; Cal., June, 1917; N. C., Aug., 1917; N. C., Nov., 1918*; Va., Nov., 1918; Iowa, Dec., 1918*; N. C., June, 1919*; N. C., Sept. 1919.*) 2. In a general way, what is the difference between a Financial State- ment and a Balance Sheet? (Mich., June, 1910.) 3. Wherein does a Trial Balance differ from a Balance Sheet? (N. Y., Jan., 1897; N. Y., June, 1898*; Pa., Nov., 1899; Pa., May, 1903; Md., Oct., 1903; N. J., 1904-1909; Pa., May, 1905; Md., Jan., 1909; N. Y., June, 1909; Va., Nov., 1910; Ohio, Nov., 1913; Ohio, Nov., 1915; Cal., May, 1916; Cal., Nov., 1916; Mich., Dec., 1916*; N. C., Aug., 1917*; Ohio, Oct., 1919.*) 4. State how the following differ: a trial balance after closing and a Balance Sheet. (Md., Jan., 1909.) 5. Show the relations of a trial balance to the Balance Sheet. (N. Y., June, 1898.) 6. Is the trial balance essential to the making of the Balance Sheet, and if so, why; and if not, why not? (N. J., 1904-1909.) 7. What is the purpose of a Balance Sheet? (Ohio, Nov., 1913; Ohio, Nov., 1915*; Cal., May, 1916; Ohio, Nov., 1916; Ohio, Nov., 1917; Ohio, Nov., 1918*; N. C., Nov., 1918*; Ohio, Oct., 1919.) 8. In submitting a Balance Sheet at the end of the fiscal year, are you stating facts or opinions? Give reasons. (111., May, 1907*; Mich., June, 1912*; Ohio, Nov., 1915*; Mass, Oct., 1916; Ohio, Nov., 1918*; N. Y., Jan., 1920.*) 9. On the Balance Sheet prepared by you from the books of a client, state which items are matters of fact and which matter of opinion. (N. Y., Jan., 1920.) 10. State the general theory of the Balance Sheet. (N. Y., June, 1899.) BALANCE SHEET 53 11. Is strict accuracy as to the facts possible in a Balance Sheet? Why? (Ohio, Nov., 1913*; Ohio, Nov., 1917*; Ohio, Oct., 1919.) 12. Assuming that the amounts are correctly stated, point out several ways in which a Balance Sheet may fail of its purpose. (Ohio, Nov., 1917.) 13. What is meant by a Balance account? (N. Y., Oct., 1907; R. L, Dec., 1907; N. Y., Jan., 1914.) 14. How was the "Balance account" used originally? What has be- come of it in modern bookkeeping practice? (N. Y., Jan., 1914.) 15. How would you determine the character of assets the surplus of a business consists of, and what would be the advantage of such informa- ;ion? (N. C., June, 1916.) 16. Give method of preparing a Balance Sheet where ledgers have not been closed. (111., May, 1905.) 17. Why must the revenue account be completed before a Balance Sheet can be prepared? (N. Y., Oct., 1907; R. I., Dec., 1907.) 18. What is your interpretation of the difference between the total- debit balances and the total credit balances of the accounts belonging to the capital division and to the current division of a Balance Sheet? (N. C., June, 1916.) 19. Draw up a short report on the following Balance Sheet, criticizing such items as you consider abnormal : Buildings $^7.500 Machinery 12,500 Sundry Stock 90,000 Cash 3,200 Bills Receivable 6,800 Customers 20,000 Goodwill and Patents 30,000 $250,000 Capital and Surplus $155,000 Current Liabilities 87,500 Suspense Account 7,500 $250,000 (N. Y., Jan., 1901; Wash., Sept., 1917.) 20. What are the mast important things an auditor has to certify as regards a Balance Sheet? (N. Y., Jan., 1902*; Md., Oct., 1903; Mich., July, 1906.*) 21. In making up a general statement of assets and liabilities, what groups of accounts constitute assets and what constitute liabilities? (N. Y., Dec., 1893.) 22. On what theory does the English form of Balance Sheet differ from the continental and American form? Give an argument either for or against the English form. (N. Y., June, 1899.) 23. The High Pressure Valve Manufacturing Company submit the following trial balance taken from their books in connection with the facts enumerated ; the organization is highly skilled and dependent upon co- operation. Give your recommendations as to what should be done to serve the interest of the business : 54 C. P. A. ACCOUNTING Plant, $14,500; Accounts Receivable, $4,000; Cash, $1,510; Capital Stock, $15,000 ; Loans Payable, $3,000 ; Accounts Payable, $4,000 ; Notes Payable, $3,500 ; Sales, $16,000 ; Cost of Sales, $10,000 ; General Expense, $2,000; Selling Expense, $3,500; Deductions from Income, $4,000. The valves are in demand and in general use. (N. Y., June, 1919.) 24. Criticize the following Balance Sheet from both the auditor's standpoint and that of the Company's financial condition : "X." "Y." "Z." Co. BALANCE SHEET, DECEMBER 31, 1915. Assets Real estate, building, plant, machinery, equipmen and goodwill $230,000 200,000 50,000 200,000 $2,000,000 150,000 1,767,000 Investments in stocks and bonds at cost (market valu $100,000) Current assets: Inventories: Raw materials (market value) Finished stock at selling prices, less discount at 5/ Consignment (selling value) Supplies (estimated) Accounts and bills receivable including advances to employees $ 680,000 225,000 387,000 425,000 50,000 Stock in treasury (unissued) Preferred $150 000 Common 237 000 Investments in subsidiary companies Cash and miscellaneous items Liabilities Capital stock: Preferred stock $110,000 135,000 $3,917,000 $1,000,000 1,800,000 625,000 30,000 398,000 64,000 Common stock Bonds and bankers' loans Reserves: For depreciation Less renewal expenditures written off Balance (debit) $25,000 5,000 50,000 For bad debts ". Other contingencies Current liabilities: Accounts payable $115,000 231,000 52,000 Other indebtedness Accrued items Surplus $3,917,000 (Mass., Oct., 1916.) BALANCE SHEET 55 25. In the case of a company which publishes an annual Balance Sheet but no Profit and Loss account, state whether or not you would recom- mend to your client that the profits earned during the year, less dividends paid, be shown on the face of the Balance Sheet. Give your reasons. (A. I. of A., May, 1920.) 26. How should you arrange the items on a Balance Sheet of a large corporation? Of a partnership? (N. Y., Jan., 1897* ; N. Y., June, 1899* ; N. Y., Jan., 1907*; 111., May, 1907*; Ohio, March, 1910*; Mich., June, 1912*; Ohio, Nov., 1913*; Mich., Dec., 1913*; Mich., Dec., 1914*; 111., May, 1915; Mass., Oct., 1915*; Cal., May, 1916*; N. C., June, 1916*; Mass., Oct., 1916*; Ohio, Nov., 1917*; Ohio, Nov., 1918*; Iowa, Dec., 1918; N. Y., Jan., 1919*; N. Y., Jan., 1920.*) 27. Is the form of a Balance Sheet a matter of principle or conven- tion? (Ohio, Nov., 1917*; Ohio, Oct., 1919.) 28. What is (he mechanism of the double form Balance Sheet? Ex- plain the connection between its sections, stating the theory of its organ- ism. (N. Y., Jan., 1914; Cal., May, 1916*; Md., Oct., 1919.) 29. In drawing up a Balance Sheet, is it desirable to show the assets and liabilities by groups, and if so, into what groups would you classify? Give reasons for your classification. (N. Y., Jan., 1906; Va., Nov., 1918.*) 30. What is meant by marshaling the accounts of a Balance Sheet? (Cal., May, 1916.) 31. State two different theories in relation to the presentation of a Balance Sheet as far as classification is concerned. What is the reasoning on which they are based? (N. Y., June, 1912; Cal., Nov., 1916.*) 32. Under what theory or theories would you classify the Balance Sheet accounts into three cardinal divisions? (N. C., June, 1919; N. C., Sept., 1919.) 33. Give a simple equation for the contents of a Balance Sheet. (Ohio, Nov., 1913; Minn., Oct., 1916.) 34. In making up a business statement or a Balance Sheet, why are the assets placed as debits and the liabilities as credits? Are there any exceptions to this rule? (N. Y., June, 1900; N. J., 1904-1909.*) 35. What special points in the Balance Sheet of a company aside from the correctness of the figures require careful consideration by the auditor? (111., May, 1908.) 36. What is the extent of an auditor's responsibility in respect to the classification of assets and liabilities in a balance sheet which he certifies? (A. I. of A., May, 1918; Ga., May, 1919.) 37. What schedules should support the Balance Sheet in a thorough audit of a manufacturing concern owning its entire plant? (Md., Dec., 1917.) 38. Outline the forms of the Profit and Loss statement and of the Balance Sheet as submitted by the Federal Reserve Board in their pro- 56 C. P. A. ACCOUNTING posal for a uniform system of accounting to be adopted by manufacturing and merchandising concerns. (Wis., April, 1918.) 39. Suppose you had certified the Balance Sheet of a manufacturing concern, and were asked by a stockholder why you had certified it as correct when some of the assets were not salable at the figures placed against them, what reply would you make? (Fla., April, 1908.) 40. On what important points will the Balance Sheet of a trading and non-trading company differ? (N. D., June, 1914.) 41. What should the financial statement of a trading company show? (N. D., June, 1914.) 42. Explain the difference between cost and book value. (La., May, 1913.) 43. Explain the principles that underlie the mechanism of the state- ment of resources and show their application. (N. Y., June, 1913.) 44. Prepare a chart of a Balance Sheet, showing the relationship of all factors involved in its construction that will exhibit a view of what, in your opinion, is the meaning of a Balance Sheet. (N. C., June, 1920.) ASSETS 45. Define: Assets. (N. Y., Dec., 1898; N. J., 1904-1909.) 46. Define: Current assets. (N. Y., June, 1901; N. Y., Jan., 1902; N. Y., Jan., 1904; Mich., July, 1906; Ohio, March, 1910*; Va., Oct., 1911; La., May, 1913*; Colo., Dec., 1913; Mo., Dec., 1913*; Kan., Dec., 1915; Mo., Dec., 1915; Ohio, Nov., 1916; 111., May, 1917; W. Va., 1917; Wash., July, 1917; Va., Nov., 1918*; Iowa, Dec., 1918.) 47. What are quick assets? (N. Y., Dec., 1898; N. Y., June, 1900*; Mich., Dec., 1906; Md., Jan., 1909*; Va., Oct., 1911*; Mich., June, 1914*; Iowa, Dec., 1918.) 48. Prepare an imaginary statement of the net quick assets. (Okla., Nov., 1919.) 49. What items would you designate as "quick assets"? (La., May, 1913.) 50. Define: Floating assets. (N. Y., June, 1899; Cal., July, 1904*; 111., May, 1908; Fla., July, 1909; N. D., July, 1916; 111., Dec., 1916.) 51. Define: Capital assets. (N. Y., June, 1902; N. Y., Jan., 1904; La. May, 1913*; Wash., Nov., 1913; Mo., Dec., 1913*; Kan., Dec., 1915; Mo., Dec., 1915; Va., Nov., 1918; Iowa, Dec., 1918.) 52. Define: Active assets. (Va., Nov., 1910.) 53. Define: Secret assets. (Colo., Dec., 1913.) 54. Define: Cash assets. (N. Y., Dec., 1896; 111., Nov., 1903.) 55. Define: Fixed assets. (N. Y., Dec., 1896; N. Y., Dec., 1898; N. Y., June, 1899; Cal., June, 1904*; Mich., July, 1906; 111., May, 1908; Fla., July, 1909; Ohio, March, 1910*; Mich., June, 1910; Va., Nov., 1910; BALANCE SHEET 57 La., May, 1913*; Wash., Nov., 1913; Colo., Dec., 1913; Mich., June, 1914*; N. D., July, 1916; Ohio, Nov., 1916; 111., May, 1917; N. C., Aug., 1917; Va., Nov., 1918.*) 56. Define: Net quick assets. (111., Dec., 1918.) 57. Define: Passive assets. (N. Y., June, 1900.) 58. State eases where the condition known as "diminishing assets" is likely to arise. How should such cases be treated? (N. Y., June, 1902; N. Y., June, 1914*; A. I. of A., May, 1918*; N. Y., June, 1918.*) 59. Give instances of the manner in which fixed assets and floating assets affect the stability and the credit of a business. (Fla., July, 1909.) 60. Give two examples of fixed assets in one business which become floating assets in another business. (Mich., June, 1912; Mass., June, 1913.) 61. State three examples of fixed assets in some particular business, which are generally floating assets. (Mass., June, 1913.) 62. In the Balance Sheet of a company, as prepared by the secretary, you find the following items: Under "Capital Assets": (a) Factory real estate, buildings, plant and machinery. (b) Keal estate held for investment. (c) Investments in and advances to another company for purposes of control. (d) Franchises having a fixed term. Under "Current Assets" : (e) Company's treasury stock (carried at $.50 on the dollar). (/) Raw material, finished product, and inventory of office sup- plies and stationery. (g) Advances to officials of the company (unsecured). (h) Insurance premiums paid by the company on a policy of the life of the company's president, in which the company is beneficiary. (i) Due by customers, (j) Sinking fund investments. (k) Unexpired fire insurance premium. (I) Cash in bank and on hand. Discuss the correctness or otherwise of the above classification of items under capital and current assets, giving reasons for your opinions, and criticizing the items generally. (Mo., Dec., 1914; Okla., Nov., 1919.) 63. Define: Resource. (N. Y., June, 1899.) LIABILITIES 64. Define: Liabilities. (N. Y., Dec., 1898; N. Y., June, 1899; N. J., 1904-1909.) 65. Define : Current liabilities. (N. Y., June, 1901; Mich., July, 1906; 58 C. P. A. ACCOUNTING Va., Nov., 1910; Wash., Nov., 1913*; Mich., June, 1914*; Kan., Dec., 1915; Mo., Dec., 1915; Ohio, Nov., 1916; W. Va., May, 1917; Va., Nov., 1918*; Iowa, Dec., 1918.) 66. Define : Floating liabilities. (N. Y., Dec., 1896 ; N. Y., Dec., 1897* ; N. Y., June, 1900; Wash., May, 1903*; N. Y., Jan., 1904; Mich., Dec., 1906*; Md., Jan., 1909*; Mass., June, 1910*; Colo.,- Dec., 1913*; N. D., July, 1916; Ohio, Nov., 1916.) 67. Define: Fixed liabilities. (N. Y., Dec., 1896; N. J., 1904-1909; Mich., July, 1906; La., May, 1913*; Mich., June, 1914*; N. D., July, 1916; Ohio, Nov., 1916; N. C., Aug., 1917; Va., Nov., 1918.*) 68. Define: Funded debt. (N. Y., Dec., 1897; Wash., May, 1903; N. Y., Jan., 1904; Md., Jan., 1909; Ohio, March, 1910*; Mass., June, 1910; Va., Nov., 1910; Colo., Dec., 1913; Kan., Dec., 1915; Mo.. Dec., 1915.) 69. Define: Bonded indebtedness. (Wash., Nov., 1913.) 70. Define: Capital liabilities. (La., May, 1913*; Kan., Dec., 1915; Mo., Dec., 1915; Iowa, Dec., 1918.) 71. Define the following accounting and business term : Passive lia- bilities. (N. Y., June, 1900.) 72. Explain the difference between gross and net floating debts, and what is generally meant by the term "floating debt" without the word "gross" or "net" preceding it. (111., Nov., 1904.) 73. A distinction is made between funded debt and unfunded debt. Please define and compare, discussing the advantages and disadvantages, if any, attaching to each. (Mich., Dec., 1916*; A. I. of A., Nov., 1918.) ACCRUED ITEMS 74. Define: Accrued. (N. Y., Jan., 1911*; Mich., Dec., 1914*; Kan., May, 1916.) 75. State the difference between the accrual and the cash basis of ac- counting. (Kan., Dec., 1915; Mo., Dec., 1915.) 76. Define: Accrued liability. (111., Dec., 1916.) 77. In the preparation of a Balance Sheet, explain the basis upon which you would ascertain that accrued liabilities were properly valued. (Wis., April, 1914.) 78. Name some accrued liabilities. (Md., Dec., 1917; Mich., June, 1919.*) 79. An auditor is called upon to verify a Balance Sheet and upon in- vestigation he finds that unexpired insurance, interest paid in advance on discounted notes, taxes accrued, interest accrued on demand notes, bonded indebtedness, royalties, etc., are not included in the same. He is informed that it has not been the custom of the corporation to include in their Balance Sheet such items, as they offset one another, and that the directors do not desire any change in the practice they have adopted. BALANCE SHEET 59 Discuss this proposition, stating reasons for your conclusions. (111., May, 1907.) 80. A corporation wishes to get figures of its earnings early each month. Besides its regular income, it has bonds and stocks from which the interest and dividends are received either quarterly or semi-annually. It has trouble in getting some of its expense bills promptly, as some come in quarterly, semi-annually, and even yearly. State the method of getting out promptly with as little work as possible these monthly figures. (Mass., June, 1913.) DEFERRED ITEMS 81. What do you understand to be the meaning of the word "deferred" when applied to accounts? (Ind., May, 1918.) 82. Define: Deferred charges. (N. Y., Jan., 1911; Wash., Nov., 1913; Colo., Dec., 1913; N. Y., Jan., 1914; 111., May, 1914; Mich., June, 1914; Wash., June, 1915; Minn., Oct., 1916; Ohio, Nov., 1916; Mich., Dec., 1916*; 111., May, 1917; Wash., July, 1917; Mass., Oct., 1917; 111., Dec., 1918; A. I. of A., May, 1919.) 83. Name some deferred charges to expense. (Mass., Oct., 1917; Md., Dec., 1917; Md., May, 1918*; Mich., June, 1919.*) 84. Mention two common kinds of deferred charges. (Ohio, Nov., 1916.) 85. Define: Prepaid expenses and state how you would treat them in a Balance Sheet. (Va., Nov., 1910.) 86. What is the theory applying to deferred debits shown in a Balance Sheet? (N. Y., Jan., 1M7.J 87. Under what circumstances would you permit a client to defer items of unquestionable expense? (Cal., May, 1916.) 88. What do you understand by deferred credits? Give illustration. (Mich., June, 1914; 111., Dec., 1916.) 89. To what extent would you consider it necessary to verify expense paid in advance, and what reference to such verification would you make in your report? (Mass., June, 1913.) 90. State the nature of the items appearing in a Balance Sheet which may properly be classified as "deferred credits" by a private concern. (N. Y., Jan., 1920.) 91. What is the auditor's attitude with respect to organization ex- penses, advertising, and other expenditures which the client claims to have a value extending over more than one year? (N. Y., Jan., 1916.) CONTINGENT ITEMS 92. Define: Contingent assets. (Md., Jan., 1909; La., May, 1913*; Kan., May, 1916; N. C., Aug., 1917; A. I. of A., Nov., 1920.*) 60 C. P. A. ACCOUNTING 93. Give illustrations of contingent assets. (Md., Jan., 1909; Wis., April, 1914; Kan., May, 1916; A. I. of A., Nov., 1920.) 94. How would you treat contingent assets on the books? (Md., Jan., 1909; Mo., Dec., 1914; A. I. of A., Nov., 1920.) 95. How would you treat contingent assets on a Balance Sheet? (Md., Jan., 1909; Wis., April, 1914; Mo., Dec., 1914; A. I. of A., Nov., 1920.*) 96. Define: Contingent liabilities. (N. J., 1904-1909; Mich., Dec., 1906; Md., Jan., 1909; N. Y., Feb., 1910; Mass., June, 1910; Va., Nov., 1910; 111., May, 1913*; La., May, 1913*; Colo., Dec., 1913; Mich., June, 1914; Mass., Oct., 1914; Kan., Dec., 1915; Mo., Dec., 1915; Kan., May, 1916; Ind., June, 1916*; N. D., July, 1916*; Ohio, Nov., 1916; Mich., Dec., 1916*; 111., May, 1917; N. C., Aug., 1917; N. D., Aug., 1917; A. I. of A., Nov., 1917; Ind., Nov., 1918; 111., Dec., 1918; Iowa, Dec., 1918; A. I. of A., May, 1919; A. I. of A., Nov., 1920.*) 97. Give illustrations of contingent liabilities. (Fla., April, 1907; Fla., April, 1908; Md., Jan., 1909; N. Y., Feb., 1910; Wash., June, 1912; 111., May, 1913; Wis., April, 1914; Mass., Oct., 1914; Mass., Oct., 1915; Kan., May, 1916; Ind., June, 1916; N. D., July, 1916; Ohio, Nov., 1916; N. D., Aug., 1917; 111., Dec., 1918*; A. I. of A., Nov., 1920.) 98. How shoiild contingent liabilities be shown on the Balance Sheet? (Fla., April, 1907; Fla., April, 1908; Md., Jan., 1909; N. Y., Feb., 1910; Mass., June, 1910*; Va., Nov., 1910; Wash., June, 1912; 111., May, 1913*; Wis., April, 1914; Mass., Oct., 1914*; Mo., Dec., 1914; Mass., Oct., 1915; Ind., June, 1916; Ohio, Nov., 1916; N. D., Aug., 1917.*) 99. State how contingent liabilities should be treated in the books. (Fla., April, 1907; Fla., April, 1908; Md., Jan., 1909; Wash., June, 1912; Mich., June, 1913*; Colo., Dec., 1913*; Mo., Dec., 1914; Mich., Dec., 1916; A. I. of A., Nov., 1920.*) 100. Explain how you would treat actions pending against your client in your report on audit. (Iowa, Dec., 1918.) 101. How should a guarantee given that machinery sold will last five years be treated on the Balance Sheet? (Ind., May, 1918.) 102. (a) Explain the treatment you would give the following in the books of Account; (b) State the counterbalancing or offsetting accounts; (c) Explain how they would appear in the Balance Sheet: (1) Notes re- ceivable discounted; (2) actions pending against your client; (3) cumu- lative preferred dividends payable; (4) liability as guarantor for third parties; (5) liability as accommodation signer on note; (6) contingent liabilities under contract; (7) unpaid balances on contracts not yet ful- filled; (8) collateral in possession of your banker to secure payment of a note. (Wis., April, 1915.) 103. What contingent liabilities may be encountered and what steps would you take to ascertain their existence in: (a) a wholesale hardware corporation; (b) a manufacturing corporation; (c) a partnership? (Cal., May, 1916.) BALANCE SHEET 61 104. What is an auditor's responsibility and what steps should he take in connection with contingent liabilities? (111., Dec., 1918.) 105. Under what conditions would you carry contingent liabilities among other liabilities on a Balance Sheet and what occurs when the con- tingency ceases to exist ? (Cal., June, 1917.) 106. Give examples of such assets and liabilities not usually found on books of account, as should be considered by the auditor when preparing an Income and Profit and Loss account at the close of the fiscal period. (N. Y., June, 1911.) 107. In the preparation of a Balance Sheet of a manufacturing com- pany how would you handle large patent infringement suits which your client would probably lose? (Cal., June, 1917.) 108. Define: Actual liability. (A. I. of A., May, 1919.) NET WORTH 109. State the object of the Capital account. (N. Y., Dec., 1898; Ohio, Nov., 1913*; Ohio, Nov., 1915.) 110. Differentiate between the economic and the accounting use of the term "capital." (Ohio, Nov., 1913; Kan., Dec., 1915; Mo., Dec., 1915.) 111. Define : Capital. (N. Y., Dec., 1896; N. Y., Dec., 1897; 111., Nov., 1903; Cal., June, 1904; N. J., 1904-1909; Wash., Sept., 1907; N. Y., Jan., 1911; N. D., June, 1914; N. C., Aug., 1917; Iowa, Dec., 1918.*) 112. Define briefly: Guarantee capital. (Cal., May, 1916.) 113. Define: Working capital. (N. Y., Dec., 1897; Wash., March, 1909; Wash., Nov., 1913; Mo., Dec., 1913*; Mich., Dec., 1914; Cal., Nov., 1916; Ohio, Nov., 1916; A. I. of A., May, 1921.) 114. From what items or classes of items in a Balance Sheet would you determine the amount of working capital in the business? (Wash., March, 1909.) 115. Define: Floating capital. (N. Y., June, 1900.) 116. Define: Fixed capital. (N. Y., June, 1900.) 117. How would you differentiate between circulating and fixed capital ? Illustrate the distinction that you would draw, giving examples. (N. Y., Jan., 1919.) 118. Define: Loan capital. (N. Y., Dec., 1896; 111., Nov., 1903; Cal., May, 1916.) 119. Discuss from both standpoints the proposition that capital may be properly regarded in any set of books as a liability. (Md., Oct., 1903* ; 111., Nov., 1903; N. Y., June, 1909; Mich., June, 1915; Ohio, Nov., 1915*; Kan., Dec., 1915; Mo., Dec., 1915; Iowa, Dec., 1918.) 120. Why is capital always shown on a Balance Sheet as a liability? (N. Y., Dec., 1897.) 121. Define: Deficit. (Va., Nov., 1918.) (i-2 C. P. A. ACCOUNTING 122. Distinguish between capital and capital stock. (Ohio, Nov., 1915; Cal., May, 1916*; Ohio, Oct., 1919.) 123. How do the accounts of a corporation and of a copartnership differ in the statement of capital? (N. Y., Jan., 1904.) 12-4. What names are given to accounts that represent the excess of assets over liabilities? Differentiate these names in their application to various kinds of business. (N. Y., June, 1898.) 125. Define the statement of net worth, also describe its function. (N. C., Nov., 1918.) 126. What is the net worth of a business and name the accounts be- longing to the net worth division of a Balance Sheet? (N. C., June, 1916.) 127. How would you determine the net worth or net insolvency? (N. D., July, 1916.) 128. State how you would verify the net worth of a business. (N. C., June, 1916.) BALANCE SHEET PROBLEMS BALANCE SHEET 1. From the following comparative Balance Sheet, make statement showing disposition of income: 1916 1915 Assets Plant and Equipment $37,277.11 $36,551.03 Inventory, Material 24,334.05 29,650.17 Inventory, Supplies 6,077.69 6,070.91 Cash in Bank 2,100.90 1,716.31 Cash on Hand 6.44 1.44 Accounts Receivable 10,792.56 6,512.01 Interest on Accounts Receivable 34.58 Notes Receivable . . . . 2,848.71 Workmen's Compensation Commission 121.71 Deferred Insurance 287.98 650.28 Office Supplies 90.00 95.00 Taxes 41.67 Treasury Stock 400.00 Total $84 413 40 $81 247 15 Liabilities Capital Stock $26,000.00 $26,000.00 Surplus 47,378.46 43,025.81 Accounts Payable 789.42 147.81 Notes Payable 4,000.00 Reserve for Interest 6.12 Reserve for Taxes 387.57 1,051.41 Reserve for Freight and Allowances 215.85 Reserve for Hospital Fund 750.00 Reserve for Depreciation 8,885.98 7,022.12 Total $84 413 40 $81 247 15 Net profit for the year, $33,492.86. Dividends paid during the year, $28,850. Surplus adjustment, debit, $290.21. (W. Va., May, 1919.) 2. In an investigation of the accounts of the American Products Company you find that the Balance Sheets of the company for the past four years are as follows : 04 C. P. A. ACCOUNTING Year Ending December 31 1915 1916 1917 1918 Assets L;uid $30,000 75,500 48,600 8,000 10,000 25,000 40,000 36,000 189,000 15,000 5,000 $30,000 80,500 53,800 8,500 10,000 25,000 58,000 48,000 196,000 12,500 6,000 $45,000 80,500 60,000 8,500 10,000 $45.000 95,000 83,500 9,000 5,000 Buildings Machinery Furniture and Fixtures . . . Bonds Capital Stock in Subsidiary Co.. . Advances to Subsidiary Company Inventories 66,000 202,000 20,000 7,000 125,000 229,500 9,500 8,000 Accounts Receivable Cash Prepaid Expenses Liabilities Common Stock $482,100 $528,300 $499,000 $609,500 $75,000 50,000 30,000 , 75,000 162,500 10,000 10,000 24,000 5,000 40,600 $75,000 50,000 20,000 85,000 177,200 16,500 12,500 32,000 8,000 52,100 $75,000 60,000 10,000 90,000 87,400 18,000 40,000 42,000 10,000 66,600 $75,000 100,003 Preferred Stock Bonded Debt Bills Payable 100,000 90,600 25,000 65,000 63,000 12,000 78,900 Accounts Payable Accrued Wages Accrued Taxes Reserve for Depreciation Reserve for Contingencies Surplus $482,100 $528,300 $499,000 $609,500 The net profits were double the amount of dividends paid each year. Prepare a statement reflecting the disposition of the profits earned and other funds provided each year and the change in working capital since December 31, 1915. (Wis., May, 1919.) 3. From the following comparative Balance Sheets of the A. B. C. Company at December 31, 1917, and December 31, 1918, prepare a short statement showing the funds realized during the year and the disposition made thereof: Dec. 31, 1917 Dec. 31, 1918 Assets Caoital Assets $600 000 $900000 (Replacement values as shown by appraisal were used at December 31, 1918) Inventories ] ,000,000 1,160 000 Accounts Receivable 850000 800000 Cash 200000 550 000 Deferred Charges 20,000 10,000 $2,670,000 $3,420,000 BALANCE SHEET Dec. 31, 1917 Dec. 31, 1918 Liabilities Capital Stock $1,000,000 $1,000,000 Bonds (issued at par) 500,000 Capital Surplus representing excess of sound replacement value of appraisal at December 31 1918, over the book value of capital assets at that date 150000 Bank Loans 750,000 400000 Accounts Payable 500,000 600,000 Reserve for Depreciation and Replacements . . . (The reserve at December 31. 1918, represents the difference between the replacement and sound value of the appraisal at December 31, 1918) Surplus 100,000 320,000 200,000 570,000 $2,670,000 $3,420,000 NOTE The profits for the year were $450,000, and dividends were paid during the year amounting to $200,000. The sum of $100,000 was charged to operation for depreciation during the year and $50,000 was charged against the Reserve for Replacements. (A. I. of A., Nov., 1919.) 4. (a) What is the amount of the net working capital in the following Balance Sheet: BALANCE SHEET, JAN. 1, 1915 Real Estate $10,000 Patents 8,000 Buildings 55.260 Cash 9,320 Inventories 32.600 Interest Prepaid 1,600 Accounts Receivable 40,200 $156,980 Capital Stock $50,000 Bonds 20,000 Notes Payable 10,000 Reserve for Bad Debts 5,350 Accounts Payable 32,502 Reserve for Depreciation, Buildings 20,000 Surplus 19,128 $156,980 (&) What is the amount of the net working capital in the Balance Sheet of the same company as of January 1, 1916, which here follows: BALANCE SHEET, JAN. 1, 1916 Real Estate $17,000 Patents 7,000 Buildings 68,520 Cash 3,260 Inventories 38,710 Interest Prepaid 820 Accounts Receivable 42,200 $177,510 Capital Stock $50,000 Bonds 30,000 Notes Payable 20,000 Reserve for Bad Debts. . . . 6,240 Accounts Payable 25,620 Reserve for Depreciation, Buildings 35,200 Surplus 10,450 $177,510 06 C. P. A. ACCOUNTING Profits, as per Profit and Loss account for the year, amounted to $6,322, and a 30 per cent dividend was declared and paid. (c) Submit a statement accounting for the increase or decrease in the working capital. (Wis., May, 1916.) 5. The bookkeeper of a manufacturing concern could produce only the following statement from its records on January 1, 1907 : Manufacturing Expenses $4,622.89 Capital Stock 10,000.00 Plant and Equipment 17,500.00 Gross Sales 8,469.10 First Mortgage bond (due December 31, 1907) 15,000.00 Material and Supplies (inventory) 4,289.34 Notes Payable 5,000.00 Accounts Receivable 5,423.23 Accounts Payable 2,436.28 Interest on Bonds .(7 months) 393.75 Interest on Notes and Accounts Payable 282.40 Cash 832.14 On January 1, 1907, the management changes, and you are later re- tained as a public accountant to conduct an examination and prepare a Balance Sheet as of January 1, 1908. You find that during the preceding year the directors have subscribed in cash to $7,500 additional capital stock and have retired all the notes and old accounts payable and that no interest was paid on these accounts for the year. You also find that the plant and the equipment was re- valued at $15,000 and 5 per cent of this amount was charged off to provide for depreciation, while an additional 2 1 /^ per cent was ordered placed in Reserve account to cover repairs and renewals, the entire 7^/2 per cent being charged direct to Profit and Loss. The bond outstanding fell due on December 31, 1907, and was paid, principal and interest, in cash. An inventory of materials and supplies placed their value at $2,328.19, the practice being to charge all purchases direct to Manufacturing Ex- penses and to credit back the amount of the inventory. The accounts payable (all for material and non-interest bearing) amount to $546.28. Of the accounts receivable January 1, 1907, $4,968.18 was collected and the balance charged off as uncollectible. In addition to the material used from stock during the year and the amount still due for material purchased, the manufacturing expenses were $3,720.52, all paid in cash, the total manufacturing expenses being 31 per cent of the gross sales for the year ending January 1, 1908. Of these 91.3 per cent were collected in cash and the balance, all of which is considered good, remains on the books in Accounts Receivable. Produce a comparative Balance Sheet of January 1, 1908-1907, and state the amount of gross sales for the year. (N. Y., Feb., 1908.) CHAPTER IV PROFIT AND LOSS STATEMENT Income Income is the gain or remuneration which proceeds from property, labor, or business. 1 It may be classified into (a) rent or income from real estate, (b) wages or remuneration of labor, (c) interest or income from liquid capital, and (d) profits or gain from investment in a business organization. 2 Income may be also classified as primary or operating revenue and secondary or non-operating revenue. 3 Revenue The term "revenue" is frequently used interchangeably with the term "income," 4 the terms "gross revenue" and "net revenue" being used synonymously with "gross income" and "net income," respectively. 5 There is a slight distinction, however, as the term "revenue" is used especially by non-trading concerns. 8 Earnings Earnings are that part of income derived as remuneration for personal services, the term being used in the statements of professional men and public service corporations.' Profits Profit to the economist means only the reward to the ability and enterprise of the successful entrepreneur, 8 while to an accountant it means the realized increment in value of the whole amount invested in a business.* If a sole proprietor made a net income, the accountant would call all of the net income profit, 10 while the economist would classify it as wages, rent, interest, and profits. 11 Gross profits represent the excess of the selling price over the actual cost of the article sold. 12 Net profits represent the excess of earnings over all costs, expenses, and reserves for accrued or probable losses. 13 A broad distinction must be made between capital profits and operating profits. A capital profit or loss is one that arises from a change in the value of fixed assets, and should be shown on the books only if the fixed assets are sold or destroyed. 14 An operating profit or loss is one that arises from the ordinary operation of the business. 15 Capital profits and losses should not be included in the operating profit and loss statement, but should be deferred until the operating profit or loss is ascertained and then charged or credited directly to surplus. 16 Generally, profits and losses are made only on completed transactions, 1 ' accruals being a recognized exception to this rule. This will prevent appre- ciation on real estate from being treated as a profit until the real estate is sold." Profit may not be taken on goods made for stock, for the profit occurs when the sale is made. 1 * No profit may be taken unless a cause of legal action has arisen. 20 'For explanation of superior figures see pnge 337. 67 68 C. P. A. ACCOUNTING The estimated profit on goods made to order may be taken in the pro- portion the share of work done during the period is to the total under- taking. 21 This necessitates a predetermination of profit on the Avhole undertaking, an estimate of the portion of the contract completed, and an adequate provision for unforeseen difficulties in completing the work. 23 Equitable treatment of stockholders requires that the profit on long term contracts be taken as the work is completed. 23 If liberal allowances for contingencies are made, the estimated profit may be prorated to periods on the basis of the estimates of the portion of work completed made by the supervising engineer to secure the periodic payments on the contract. 24 If the contract price is based upon a series of units in the contract, profit should be taken on the number of units completed. 25 Cost-plus contracts may have the accrued profits taken without consideration of the unfinished portion, as the profits are always a definite percentage of the cost. 29 As commercial practice allows buyers to cancel orders for standard goods up to the date of a shipment, profits on undelivered sales should not be taken. 27 The excess of market price over production cost of goods sold by one subsidiary company to another or transferred from one department to another is not a profit, as no profit can be made unless the goods are sold to an outside party. 28 Revenue and Capital Receipts Revenue receipts are the receipts of cash and other assets on account of the regular operation of the business, and include receipts from sales, interest on investments, etc. 29 Capital receipts consist of the cash and other assets received through the sales of capital stock, the issue of capital liabilities, 30 or the sale of a fixed asset. 31 Revenue and Capital Expenses Revenue or operating expenses are in- curred to conduct the business in an endeavor to make a profit. 32 Capital or non-operating expenses are the financial management expenses incurred in providing the capital needs of a business. 33 Revenue and Capital Expenditures The term "revenue expenditures" is synonymous with "revenue expenses." 34 Revenue expenditures appear as assets on the balance sheet only as deferred charges to income. 35 Capital expenditures are the expenditures made for additions or improvments to the more or less permanent, plant. 38 The accounting for capital expendi- tures is outlined in Chapter IV, Volume II. Fixed Charges and Operating Expenses Fixed charges are the expenses of more or less fixed amount, which must be met periodically without ref- erence to the volume of business. 37 Interest on bonds is a fixed charge, 38 but interest on notes payable is not. 3 * Operating expenses are those in- curred directly in connection with operations and which roughly fluctuate with the business done. 40 Summaries of Nominal Accounts The business executive's need for statistics has caused many varied groupings of the nominal accounts, viz., the manufacturing, trading, administrative, and profit and loss accounts. These summary accounts have largely been replaced by reports or state- PROFIT AND LOSS STATEMENT 69 ments containing the same data in more available form. Examples of such statements are the statements of cost of manufacture, cost of sales, and overhead. The need for all these data in one statement has led to the modern profit and loss statement. Synonyms for the profit and loss state- ment are statements of income and expenditures, revenues and expendi- tures, trading and profit and loss, income and profit and loss, etc. "Revenue and expenditures" is usually limited to profit and loss statements rendered by non-profit-making concerns, "income and expenses" to institutions, and "income statements" to large industrial concerns. 41 Account Form of Profit and Loss Statement The origin of the profit and loss statement is shown in its account form, for each one of the original summary accounts has a section in the account form of profit and loss account. 42 A. B. COMPANY PROFIT AND LOSS STATEMENT For Period Ending (Date) MANUFACTURING SECTION Raw Materials Productive Labor . . Factory Overhead: Indirect Labor. . . Superintendence. . Supplies Power. . Manufacturing to Trading f: Cost, carried action . . TRADING SECTION Manufacturing Cost, brought down from Manufacturing Section I Finished Goods (initial inven- tory) 3 Less Finished Goods (final in- ventory) $ . Cost of Sales Selling Expense: Salesmen's Sal- aries Traveling Ex- Advertising. Gross Profit on Trading car- ried to Administration Sec- tion . . ..".... I Sales Less Returned Sales . Net Sales . . 70 C. P. A. ACCOUNTING ADMINISTRATION SECTION Office Expense Directors' Fees Legal Expense Net Profit on Trading carried to Profit and Loss Section. . Gross Profit on Trading brought down from Trad- ing Section PROFIT AND Loss SECTION Bad Debts $ Interest Expense $ Net Profit for period carried to Appropriation Section . . $ Net Profit on Trading brought down from Administration Section $ . Interest Earned $ . APPROPRIATION SECTION Dividends Declared. Addition to Surplus. Net Profit for Period brought from Profit and Loss Sec- tion . . Report Form of Profit and Loss As the account or non-technical form of profit and loss statement is not adaptable to the use of the typewriter and is rather too complicated for the lay reader, most accountants use a report form of profit and loss statement, 43 although a few well known authorities still advocate the account form/ 4 As is the case with the balance sheet, there are numerous forms of profit and loss statements. The chief advantages of the following model form are, (a) the fact that only three money columns are used, thus increasing the speed and accuracy of the student, (b) the subtraction from the gross profit on sales of the total of the selling, administrative, and general expenses, 45 thereby eliminating the unimportant selling profit sub- total, (c) the subtraction from or addition to the net profit on operations of the net figure for the non-operating expenses and incomes, 46 thus eliminating the insignificant total income figure, and (d) the introduction of an appropriation of profit section, 47 which is valuable in that it shows a summary of the effect the profits had on the vested proprietorship accounts. I'K'OKIT AND LOSS STATEMENT 71 A. B. COMPANY PROFIT AND LOSS STATEMENT For Period Ending December 31, 1916 Gross Sales Less Returns and Allowances on Sales. . Net Sales Cost of Sales: Material : Inventory, Jan. 1, 1916 Freight and Cartage in Purchases. . Deduct Inventory, Dec. 31, 1916 Labor Manufacturing Expense: Depreciation, Buildings 1916 Depreciation, Machinery 1916 Factory Expense Fuel Insurance, Buildings and Machinery. Repairs, Building Repairs, Machinery Taxes, Real Estate Inventory Variation Work in Process: Jan. 1, 1916 Dec. 31, 1916 Inventory Variation Finished Goods: Jan. 1, 1916 Dec. 31, 1916 Gross Profit on Sales Operating Expenses: Selling Expense: Advertising Commissions Paid Salesmen Insurance, Finished Goods Salaries, Salesmen General Administrative Expense: Office Expense Office Payroll Salaries, General Officers Net Profit on Operations Non-Operating Items: Income: Discount on Purchases Interest Received. . Expense : Discount on Sales Interest Paid Doubtful Accounts Receivable . . Net Income for Period Appropriation : Organization Expense Written Off. Subscriptions and Donations Income Taxes Surplus Additional 72 C. P. A. ACCOUNTING Statements of Non-Trading Concerns The profit and loss statements of non-trading concerns such as railroads, telephones, banks, and hospitals have the same general divisions as the statements of trading companies. 48 First, all the operating incomes are added, from which sum is subtracted the total of the operating expenses. To the resulting net profit on opera- tions is added the non-operating income. Then the non-operating ex- penses are deducted, leaving the net profit for the period. 49 Comparative Profit and Loss Statements The Federal Reserve Board has developed the form of comparative profit and loss statement given below. 50 The form is compact, yet clear, and may be followed to advan- tage. Of course, some variation in the form may be made. For instance, outward freight may be treated as a selling expense if the accountant so desires. The increases or decreases between periods or percentage figures may be shown in parallel columns to the right of the annual figures. Use of Schedules in Profit and Loss Statements To eliminate detail on the profit and loss statement, schedules may be appended shoAving such items as cost of goods sold, the group of selling expenses, the group of general and administrative expenses, etc. 51 A profit and loss statement where the detail is relegated to schedules is called a condensed profit and loss statement. 52 Working Sheet As the working sheet is not an aim in itself but merely a means of increasing speed and accuracy in the preparation of financial statements, the twelve column working sheets should not be used. Two columns each for the original trial balance, adjustments, balance sheet, and profit and loss are adequate. 53 When the trial balance does not contain all the accrued and deferred accounts, these accounts may be opened, 54 or the adjustment may be kept within the original nominal account by showing the debit and credit entries in the adjustment columns under the original account with the letter "B" after the item affecting the balance sheet. 55 For instance, the new mer- chandise inventory would appear in the adjustment columns as debit "15,000 B" and credit "$15,000," the debit item later being extended to debit balance sheet column and the credit item to the credit profit and loss column. This second method is preferable, as it is quicker and leaves the working sheet in a more compact form. There are two ways of treating inventories in the profit and loss columns of the working sheet, namely, (a) extending into the profit and loss col- umns only the difference between the old and the new inventories,' 1 " and (b) extending the old inventory as a debit and the new inventory as ;i credit." The latter method is the better, as both the old and new inventories are used in the profit and loss statement while the difference between the two inventories is not usually entered. By arranging all the asset and expense accounts on one page and the liability, capital, and income accounts on the other, the number of money columns can be reduced to one for the trial balance, two for adjustments, and one each for the balance sheet and profit and loss statement. 58 PROFIT AND LOSS STATEMENT COMPARATIVE STATEMENT OF PROFIT AND LOSS 73 Year Ended 19 Year Ended 19 Year Ended 19 Gross Sales $ $ $ Less Outward Freight, Allowances, and Returns $ $ $ Net Sales $ $ $. Inventory beginning of year $ $ $. Purchases, Net $ $ $ $. . $.. $.. Less Inventory end of year $ $ $ . Cost of Sales $ $ $. Gross Profit on Sales $ $ $. Selling Expenses (itemized to correspond with ledger accounts kept) $ $. . . $ Total Selling Expense $ $ $. General Expenses (itemized to correspond with ledger accounts kept) f $ $ Total General Expenses $. $ $ Administrative Expenses (itemized to corre- spond with ledger accounts kept) $ $ $ Total Administrative Expenses $ $ $ Net Profit on Sales $ $ $ Other Income: Income from Investments $ $ $. . Interest on Notes Receivable, etc $ $ -$ Gross Income $ $ $ Deductions from Income: Interest on Bonded Debt $ f . $. . Interest on Notes Payable . , . . $ $ $ Total Deductions $ $ $ Net Income Profit and Loss $. $.. $.. Add special credits to Profit and Loss $ $ $ Deduct special charges to Profit and Loss $ $. $ Profit and Loss for Period . $ $. . $.. Surplus beginning of period $ $ $ $ $. . $ Dividends Paid 1 $ $ Surplus ending of period % $ $ 74 C. P. A. ACCOl'NTINC QUESTIONS PROFIT AXD LOSS STATEMENT DEFIXITIOXS 1. Define: Trading- account. (N. Y., Dee., 1896; N. Y., June. 1890*: Pa., Nov.. 1901; Pa., May, 1902*; Cal., June, 1904*; X. Y.. June, 1904*; N. J., 1904-1909*; N. Y., Oct., 1907*; R. I.. Dec., 1907*: Cal.. May, 1908; Wash., Aug., 1908*; Ya., Nov.. 1910: Wash.. June, 1912; Ya.. Oct., 1912*; Wash., Nov.. 1913; Colo., Dec., 1913: W. Ya.. May. 1017; N. Y., Aug., 1917; S. C., Sept., 1919.*) 2. Define: Profit and Loss account. (N. Y.. Dec.. 1896: N. Y., Dec., 1897*; Pa., Nov., 1899*; Pa.. May, 1902*: Pa., May. 1903*: Md.. Oct.. 1903; Cal., June. 1904; N. Y., June, 1904*: Va., Nov., 1910; Wash., Nov., 1913*; Colo., Dec., 1913; W. Ya., May. 1917; N. C., Aug., 1917; S. C., Sept., 1919.*) 3. Define: Loss and Gain account. (N. J., 1904-1909*; Iowa, Dec., 1918.) 4. Define: Revenue account. (N. Y., Dec., 1896; Pa., Nov., 1901*; Md., Oct., 1903; Cal., June, 1904*; N. J., 1904-1909; Cal., May, 1908; Wash., June, 1912; W. Ya., May, 1917; S. C., Sept., 1919.*) 5. Define: Income account. (111., Nov., 1903.) 6. Define: Net income. (Mich., June, 1910.) 7. Define: Income. (N. Y., Dec., 1897 : Wash.. June, 1915* ; Cal., Nov., 1916*; N. C., Aug., 1917; Iowa, Dec., 1918.) 8. Define: Revenue. (N. Y., Dec., 1896: Pa., Nov., 1899; Pa., May. 1903*; N. Y., Jan., 1904; Va., Oct., 1911*; Mich., Dec., 1915; Iowa, Dec., 1918.*) 9. Define: Expense. (N. Y., Dec., 1896*: Pa., May, 1903*; N. Y., Jan., 1904; Ohio, March, 1910*; W. Ya., May, 1917*; N! C., Aug., 1917.) 10. Define: Cost of goods sold. (Wash., Nov., 1913*; N. C., Nov.. 1918.*) 11. Define: Operating expenses. (N. Y., Dec., 1896; N. J., 1904- 1909; Wis., April, 1914; Wash., June. 1917.) 12. Define: Commercial expenses. (Mich., June, 1908.) 13. Define: Fixed charges. (N. Y., Dec.. 1896; N. Y., Dec., 1897; Wash., May, 1903*; N. J., 1904-1909; Mich., Dec., 1906; Md., Jan., 1909; Mass., June, 1910; Wis., April, 1914; Mich., June, 1914*; 111., Dec., 1916: Wash., July, 1917.) PROFIT AND LOSS STATEMENT 75 14. What expenses would you classify as fixed or overhead expenses? (Va., Get., 1911.) 15. Define: Income and expenditures. (Pa., May, 1902*; Wash., June, 1912; N. D., Aug., 1917.) 16. Define: Statement of income and expenditure. (N. Y., Dec., 1896*; Wis., April, 1914; Del., June, 1915*; Wis., May, 1916; Mich., Dec., 1916; 111., May, 1917; W. Va., May, 1917.*) 17. Define: Statement of Revenue and Expenditures. (Kan., May, 1916.) 18. Define: Statement of Revenue and Expenses, and also describe its function. (Ohio, Dec., 1908*; N. C., Nov., 1918.) 19. Define: Statement of Overhead or Administrative Expense; also describe its function. (N. C., Nov., 1918.) 20. What is a Trading statement? (Iowa, Dec., 1918.) 21. Define: Cost statement. (N. C., June, 1920.) 22. What is a Manufacturing statement? (N. C., Nov., 1918*; Iowa, Dec., 1918.) 23. What is a Profit and Loss statement? (Iowa, Dec., 1917; N. C., Nov., 1918*; N. C., June, 1920.*) 24. What are revenue receipts? (N. Y., Dec., 1896; N. Y., Oct., 1907; Mich., June, 1910; Mich., June, 1912; Wis., April, 1914; Wis., April, 1917.) 25. Define: Capital receipts. (N. Y., Dec., 1896; N. Y., Oct., 1907; Mich., June, 1910; Va., Oct., 1911*; Wis., April, 1914; Wis., April, 1917.*) 26. Define: Capital revenue. (Cal., Nov., 1916.) 27. Define: Statement of the Cost of Sales; also describe its function. (N. C., Nov., 1918.) 28. Define: Statement of Capital Receipts; also describe its function. (N. C., Nov., 1918.) 29. Illustrate accounts that are considered as deductions from income. (Mich., June, 1919.) 30. Define: Statement of Capital Expenses; also describe its func- tion. (N. C., Nov., 1918.) 31. Define and distinguish between capital profit and capital loss. (Wis., April, 1914.) OPERATING STATEMENTS 32. Name and define five commonly used subdivisions of revenue ex- penditure accounts. (N. Y., June, 1909* ; Mich., June, 1912; Wash., June, 1912*; Cal., Nov., 1916*; N. Y., June, 1909.*) 33. Submit a pro forma Balance Sheet and Profit and Loss account, without figures, for a manufacturing company. (Wash., Aug., 1908*; Pa., 70 C. P. A. ACCOUNTING Nov., 1908*; Wash.. May, 1911*; Cal., May, 1916; Kan., May, 1916*; Ind., June, 1916*; Mass., Oct., 1917.*) 34. How do the accounts of a corporation and of a copartnership differ in the statement of Operation of Business and Determination of Profits? (N. Y., Jan., 1904.) 35. A manufacturing corporation having several plants decides to shut down one plant because it cannot be run economically. Under what classification in the Operating statement would you include the expenses attending the care and upkeep of the idle plant? (N. Y., June, 1919.) 36. The books of a corporation show balances at the debit or credit of the following accounts: Rents from Tenements, Reserve for Accounts Receivable, Depreciation on Machinery, Depreciation on Furniture and Fixtures, Bond Redemption account, Bills Receivable, Dividend on Pre- ferred Stock. State which should enter into Profit and Loss account and which should appear in the Balance Sheet, and why. (N. Y., June, 1911.) 37. The following accounts are found in the books of a corporation. State which of them would enter the Profit and Loss account and Balance Sheet, and which would show debit and credit balances; Reserve Fund, Depreciation on Furniture, Bad Debt Reserve, Bond Redemption account, Bills Receivable, Rent on Properties Owned, Dividend on Preferred Stock. (N. Y., Oct., 1907; R. I., Dec., 1907.) 38. Name the principal elements of a statement of the Cost of Sales of a manufacturing business and prepare a form which vou would use. (X. Y., Nov., 1919.) 39. Prepare a skeleton form of a Manufacturing statement showing classification of accounts. (Ind., June., 1916*; Iowa, Dec., 1918.) 40. Explain the functions of a Manufacturing account. (N. C., Aug., 1917.) 41. Prepare a skeleton form of a Tr^ cUng statement showing classifica- tion of accounts. (Mich., Dec., 1913*; Iowa, Dec., 1918.) 42. What is the purpose of a Trading account, and what general result should it show? In closing the Ledger what disposition should be made of the balance of the Trading account? (N. Y., Jan., 1901.) 43. In making up a Profit and Loss statement at the end of a fiscal year, are you stating a fact or an opinion? Give reasons. (111., Nov., 1908; Colo., Dec., 1913; Del, June, 1915.) 44. State what is indicated by the Loss and Gain account (a) when the account shows a debit balance; (b) when the account shows a credit balance. Explain fully. (N. Y., Dec., 1897*; N. Y., Jan., 1900; N. Y., June, 1911.*) 4"). What accounts on the Ledger are generally considered as "de- duction from income"? Why? As "other income"? (Md., Dec., 1917; N Y., June, 1919.) 46. From what accounts is a Profit and Loss account prepared? (N. Y., June, 1901; N. C., June, 1920.*) PROFIT AND LOSS STATEMENT 77 47. How is the profit or loss arrived at from a double-entry set of books? (N. Y., Oct., 1007*; R. I., Dec., 1907*; Cal., May, 1908*; N. Y., June, 1909*; N. Y., Feb., 1910*; Va., Nov., 1910; Wash., June, 1912*; Va., Nov., 1918,*) 48. Describe the different methods of determining- the loss or gain of a business. (N. Y., Dec., 1898.) 49. In a general way what distinguishes manufacturing expenses from commercial expenses? (Mich., June, 1910.) 50. May interest on floating debt be properly considered a fixed charge? (N. Y., Dec., 1897; Wash., May, 1903; Md., Jan., 1909; N. Y., June, 1909; Mass., June, 1910.) 51. State explicitly and fully the function of the Profit and Loss account. (N. Y., June, 1899.) 52. Show the relationship between trial balance, Trading statement, Profit and Loss account, assets and liabilities. (Fla., July, 1908; Cal., Nov., 1916.*) 53. Differentiate as fully as possible a Manufacturing account, a Trading account, and a Profit and Loss account, and state what the balance in each indicates. (N. Y., June, 1898; N. Y., June, 1899; N. Y., June, 1906*; Md., Jan., 1909*; N. Y., Feb., 1910*; 111., May, 1913*; Mich., June, 1915; N. D., Aug., 1917*; N. D., July, 1918*; Md., Oct., 1919*; N. Y., Jan., 1920.*) 54. Give your mode of procedure in ascertaining the correctness of the Profit and Loss account. (N. Y., June, 1898*; N. Y., June, 1901*; N. Y., Jan., 1902; Pa., May, 1903; Md., Oct., 1903*; Pa., Nov., 1904; Mich., June, 1913.*) 55. What particular accounts in a mercantile business would you in- vestigate to see that all entries had been made before ascertaining the correct profit or loss of the business? Answer very fully. (Pa., Nov., 1901.) 56. A manufacturing concern on closing the books at the end of the fiscal year finds that they show a loss, whereas there is good ground for the belief that a profit was earned. With a view to settling the question, what particular, etc., would you examine, and how? (Mass., Oct., 1915.) 57. In a test audit what verification should be made of the accuracy of the Profit and Loss account? Assume that there is no reason to suspect any intent to misstate the profits. Would it make any difference if you were employed by the prospec- tive purchaser of the business and he suspected that the profits had been overstated so as to increase the selling price of the business? (111., May, 1917.) 58. In preparing a Profit and Loss account and Balance Sheet, how are gains, losses, assets, liabilities, capital, drawings, and expenditures ascertained and dealt with? (111., Nov., 1908.) 78 C. P. A. ACCOUNTING 59. Give proper disposition of any bal moe appearing in a Profit and Loss account at the end of the fiscal year. (111., May, 1907; 111., May, 1909.*) 60. (a) What is the purpose of a Profit and Loss account and how is it made up? (&) What does the balance of a Profit and Loss account represent? (111., May, 1909.) 61. An attorney-at-law joined an established firm in partnership with- out having the books investigated, relying on the firm's statement that they were making certain profit. After several months have elapsed, the new partner, not being satisfied, instructs you to audit the accounts for the year prior to his joining the firm. You discover that no break has been made in the books for years. What steps would you take to ascertain the exact profit for the year! (111., May, 1910.) 62. Give examples of such assets and liabilities not usually found on books of accounts, as should be considered by an auditor when preparing an Income and Profit and Loss account at the close of a fiscal year. (N. D., July, 1916.) PROFITS 63. Define: Net profit. (N. Y., June, 1900; Pa., Nov., 1900; N. Y., Jan., 1901*; Wash., Aug., 1908; Mich., June, 1910; Va., Nov., 1910; Colo., Dec., 1913; Kan., May, 1916; N. D., June, 1917.) 64. Define: Gross profit. (Pa., Nov., 1900; Wash., Aug., 1908*; Mich., June, 1910; Va., Nov., 1910; Colo., Dec., 1913; Wash., June, 1915.*) 65. Define: Profits. (Wash., Sept., 1907.) 66. Define: Trading profit. (Cal., Nov., 1916.) 67. Define: Manufacturing profit. (N. Y., Jan., 1919.) 68. Explain the significance of the term "profits" as used: (1) in ordinary parlance; (2) in commercial parlance; (3) in law; (4) in economics. (Mo., Dec., 1913*; Mo., Dec., 1914.) 69. Legally, income is cash received in excess of expenses. What is the theory of income of a partnership as expressed by their Profit and Loss account, where values are not actually reduced to a cash basis? (N. Y., June, 1917.) 70. How may the gross profit or loss on merchandise be ascertained"? (N. Y., Dec., 1897.) 71. State your understanding of the difference between gross profit and net profit. (111., May, 1908; Mass., June, 1910.) 72. What, in your opinion, is the difference, if any, between net in- come and net profit? Answer fully. (Kan., Dec., 1915; Mo., Dec., 1915.) 73. When is a profit made? (Iowa, Dec., 1918.) 74. State the general rule as to anticipation of profits. What excep- tion, if any, is there to this rule? (Ohio, Oct., 1919.) PROFIT AND LOSS STATEMENT 79 75. May any fluctuation in the value of permanent assets be permitted to affect the result of the Profit and Loss account? Give reasons. (Fla.. April, 1907*; N. Y., Jan., 1918.) 76. What methods have your audits revealed by which manufacturing concerns attempted to inflate profits'? If you have not met any, explain how it could be done. (Mich., Dec., 1913.) 77. When the cost of making a product is known, also the overhead and other expenses, and the amount of the sales, what other information would you require to determine the profits or losses in the sales of the product? (N. C., June, 1916*; N. C., Sept., 1919.) 78. In auditing a manufacturer's accounts would you incorporate as a part of profits work in process of manufacture and finished stock on hand? (Ind., June, 1916.) 79. The Profit and Loss account of a manufacturing company, for six months ending June 30, 1897, contains on the debit side (a) stock on hand January 1, 1896, (6) purchases of raw material, (c) manufacturing expenses, (d) expenses of selling; on the credit side (a) sales, (6) stock on hand June 30. Does the balance of these amounts constitute the net profit for the six months, or should other charges be taken into account? If so, state them. (N. Y., Dec., 1897; Ohio, March, 1910.) 80. A manufacturer has become convinced that he is not making the profit he should, and you are asked to find out the condition of affairs. Explain fully what should be done to analyze the situation and determine the facts in the case. (Del., June, 1915.) 81. State the final disposition of net profit in the books of a partner- ship. (N. Y., June, 1900.) 82. State briefly what the effect is, if any, on the current operating profits of each of the following: (a) Failure to provide adequate reserve for cash discounts; (6) return of goods sold in previous period; (c) cre- ating a reserve for a bond sinking fund; (d) creating a reserve for con- tingencies; (e) sale of machinery in excess of book value; (/) excess re- serve for depreciation; (g) revaluing merchandise inventory at beginning of period; (h) writing up the value of securities from cost to market; () bonds issued at a discount; (j) allowing interest on partners' capital. (Mass., Oct., 1917.) 83. State briefly the difference between income, profits, and gain. (N. Y., June, 1917.) CAPITAL AND REVENUE EXPENDITURES 84. Name and define two classes of expenditures. (R. I., Dec., 1907.) 85. Define: Capital expenditures. (N. Y., Dec., 1896; N. Y., Jan., 1901*; 111., Nov., 1903; N. Y., Oct., 1907; Cal., May, 1908*; Mich., June, 1910; Va., Nov., 1910; Va., Oct., 1911*; Mich., June, 1912; Wis., April, 1914; 111., May, 1914; Del., June, 1915; Wash., June, 1915; Wis., May, 1916; Wis., April, 1917; Va., Nov., 1918; S. C., Sept., 1919.) 80 C. P. A. ACCOUNTING 86. Define: Revenue expenditures. (N. Y., Dec., 1896; N. Y., June, 1899*; N. Y., Qct., 1907; Mich., June, 1910; Va., Nov., 1910; Va., Oct., Hill*; Mich., June, 1912; Wis., April, 1914; Wis., May, 1916*; Wis., April, 1917.*) 87. (a) Define charges to capital; (6) charges to revenue. (Mass., Oct., 1917.) 88. Explain the general principles to be observed in differentiating between capital and revenue expenditures. (N. Y., Jan., 1902*; Wash., May, 1903*; 111., May, 1904*; N. Y., Jan., 1907*; N. Y., June, 1908*; Wash., Aug., 1908*; Md., Jan., 1909*; 111., May, 1909*; Mass., June, 1910*; Va., Nov., 1910*; Va., Oct., 1912; Ohio, Nov., 1913*; Wis., April, 1914; Ohio, Nov., 1915*; Cal., May, 1916*; Ohio, Nov., 1916*; Mass., Oct., 1917*; Ohio, Nov., 1917*; A". I. of A., May, 1918; Ohio, Nov., 1918*; A. I. of A., May, 1919*; Ohio, Oct., 1919*; Md., Oct., 1919.*) 89. What class of expenditures should be treated as assets at the close of a fiscal period? (N. Y., Jan., 1901; 111., May, 1910.*) 90. It has been stated that "revenue expenditures do not create assets." What is .jour opinion? (111., May, 1909.) 91. Under what condition would a revenue expenditure appear in the Balance Sheet as an audit? (Mo., Dec., 1913.) 92. Explain the difference between capital expenditures and revenue expenditures. What rule controls in determining whether certain pay- ments belong to capital or to revenue? When in doubt, to which should the payment be charged? (N. Y., June, 1901.) 93. Distinguish between capital expenditure and expense. (N. D., July, 1916.) 94. If in the course of an audit it should be found that capital ex- penditures had been charged up against Profit and Loss account, what would be the duty of the auditor in respect to such charges? (N. Y., Dec., 1897; A. I. of A., May, 1919.*) 95. Under what circumstances, if any, may capital expenditures be charged against revenue? (Ohio, Nov., 1915*; Ohio, Nov., 1917*; Ohio, Nov., 1918.) 96. What on the books of a company would be the proper method of treating cash payments for capital expenditures? (Ohio, May, 1910.) 97. In the audit of the accounts of a corporation for a year in which the business has made a loss and at the close of which no profits are avail- able for dividends, would you consider it your duty to direct the same attention as usual in distinguishing between expenditure on fixed assets chargeable to capital and that chargeable against operations? Give your reasons. (111., Dec., 1916.) 98. What is the auditor's general duty in regard to capital expendi- tures? (A. I. of A., May, 1919.) 99. State which of the following should be charged or credited to capital and which to revenue: (a) Repairs to machinery and plant; (&) PROFIT AND LOSS STATEMENT 81 replacements of machinery and plant; (c) royalties on machines owned and used by the company owning the patents, similar machines being leased under royalty to competitors; (d) brokei'age on a piece of property purchased; (e) costs attending a mortgage given; (/) costs of patents, including lawyer's charges and government fees; (#) expenses of incor- porating a company; (h) discount on bonds sold; (i) premium on bonds sold. (Wis., April, 1915; Mass., Oct., 1917.*) 100. Expenditures are made by a corporation for items of each of the following classes: (a) Taking down a machine in one part of a factory, moving it and putting it up in another part; (6) expenses of incorporat- ing the company, including State charges and lawyer's services; (c) brok- erage on purchase of a piece of property; (d) commission on an issue of debenture bonds; (e) costs attending a mortgage; (/) furniture and fittings of a city office and salesroom; (g) cost of patents, including solicitor's charges and government fees. Which items should be charged to capital and which to revenue'? State reason for your answer in each case. (N. Y., June, 1900.) 101. Would an auditor be justified in certifying the accuracy of ac- counts in which a capital expenditure appeared without making inquiry into the real character of same? If not, why not? If he would, why? (Cal., May, 1908.) C. P. A. ACCOUNTING PROBLEMS PROFIT AND LOSS STATEMENT 1. Following: is condensed trial balance of the Blank Manufacturing Company on December 31, 1908, before closing- the books for the year: Inventories, raw materials and work in progress January 1, 1908 Purchases of raw materials and freight thereon Productive labor Factory expenses other than labor and materials Inventories of manufacturing goods. January 1, 1908. . . Administration and general expenses Sales, gross Freight outwards Discounts allowed Bad debts written off Interest Discounts received Cash and accounts and bills receivable Accounts and bills payable Real estate and buildings Machinery and tools Furniture Capital stock Undivided profits Profit from sale of real estate in 1908 . . Debits $31.500 253.500 56,500 11,500 4,100 23,700 25,800 1,600 600 3,500 172,700 20,000 67,000 1,300 $673,300 Credits $408,700 2,300 95000 100,000 63,300 4,000 $673,300 The inventories of December 31, 1908, are: Raw materials and work in progress, $65,648; manufactured goods, $1,991. A reserve of $7,000 is to be set up for depreciation on machinery and tools, and another reserve of $3,000 is to be provided for doubtful ac- counts. A commission of 5 per cent on the net profits for the year is to be credited to the manager. After taking the foregoing items into account, prepare the following: Lists of ledger balances after closing books ; Manufacturing account ; Trading account; Profit and Loss account; Balance Sheet. (Note: Use technical form of statements.) (Wash., March, 1909.) 2. From the following trial balance of Maker and Sellers' books, PROFIT AND LOSS STATEMENT 83 extracted on December 31, covering six months' operations, prepare a Manufacturing, Trading and Profit and Loss account and Balance Sheet. (Note: Use technical form.) Debits Credits Cash at bank $3,000 Pettv cash in hand 15 Bills receivable on hand 1,000 Sundry debtors 36,825 Buildings 20,000 Plant and machinery 15,000 Sundry creditors $9,850 Loan on mortgage ... ... 22500 Material on hand July 1 (raw material) 13,705 Purchases 42,000 Wages 7,020 Discounts allowed on purchases 1,950 Discount allowed customers 4,690 Returns (customers' returns for half-year) 1,650 Sales 80000 Patent rights (expenses) 250 Rent and taxes 500 Advertising 2,300 Traveler's salary 2,150 Carriage, outward 1.950 Bad debts written off 500 Repairs 420 Patent royalties received in advance 2,500 Royalties on patents attributed to half-year 200 General expense 2,510 Interest on loans 600 Reserve for bad and doubtful debts 2,700 Reserve for discounts on book debts 985 Maker capital account 30,000 Maker drawing account 6,000 Seller capital account 15,000 Seller drawing account 3,600 $165,685 $165,685 The goods on hand (raw material) on December 31, are valued at $17,500. Write off 5 per cent from plant and machinery for depreciation for the half year. The profits are to be apportioned as follows : Maker, two- thirds; Seller, one-third. (Minn., Oct., 1916.) 3. The American Manufacturing Company commenced business on January 1, 1918, with a paid-up cash capital equal to the sales for the year 1918. The net profits for the year 1918 were $26,100. Of the total charges to manufacturing during the year, 40 per cent was for materials, 30 per cent for productive labor, and 30 per cent for manu- facturing expenses (including 5 per cent depreciation on plant and machin- ery, amounting to $3,000). 84 C. P. A. ACCOUNTING The value of the materials used was SO per cent of the amount pur- chased, and 90 per cent of the amount purchased was paid during the year. The inventory value of finished goods on hand at December 31, 1918, was 10 per cent of the cost of finished units delivered to the warehouse, and the work in process at that date was equal to 50 per cent of the cost of units delivered to the warehouse. The selling and administrative expenses were equal to 20 per cent of the sales; also to 40 per cent of the cost of goods sold. Ninety per cent of these expenses were paid during the year 1918. Plant and machinery purchased during the year were paid for in cash. All labor and manufacturing expenses (exclusive of depreciation) were paid in full up to and including December 31, 1918. Of the total sales for the year, 80 per cent was collected and 1 per cent charged off as worthless. From the given data you are required to prepare a Balance Sheet, and a Profit and Loss statement, showing cost of goods delivered to the ware- house, cost of goods sold, and net profit for the year. (Ohio, Oct., 1919.) 4. The following figures are shown on a Balance Sheet for January 1, 1913: Real Estate $100000 Capital Stock $400,000 Machinery 500,000 Funded Debt 200,000 Merchandise . . 150,000 Bills Payable 50,000 Accounts Receivable 50,000 Accounts Payable .... 75,000 Cash 50000 Surplus 125,000 $850,000 $850,000 The following is the Income Sheet of the year 1912 : Sales $1,000,000 30,000 20,000 100,000 $900,000 $840,000 Goods in process, December 31, 1912 Stores on hand, December 31, 1912 Merchandise, December 31, 1912 Less: Selling costs $1,150,000 250^000 Goods in process, January 1, 1912 $20,000 15,000 80,000 175,000 320,000 30,000 200,000 Stores on hand, January 1, 1912 Merchandise on hand, January 1, 1912 Supplies purchased Wages paid Wages due and unpaid General manufacturing expenses Cost of Product Net profit $60,000 32,000 Dividends declared, but not yet paid Surplus for the year $28,000 PROFIT AND LOSS STATEMENT 85 Is the Balance Sheet consistent with the Income Sheet? If not, assume the Ledger and the totals of both sides of the Balance Sheet to be correct, and any error to have been caused by unwarranted combinations or can- cellations of accounts, and then correct the Balance Sheet. Show the Ledger with both sides of all manufacturing accounts when closed for December 31, 1912. The Balance Sheet on January 1, 1912, was as follows : Real Estate $100,000 Capital Stock . . $400 000 Machinery 500,000 Funded Debt 200,000 Goods in Process .... 20,000 Bills Payable 40 000 Finished Goods 80,000 Accounts Payable . . . 60 000 Stores 15,000 Surplus 97000 Accounts Receivable . 75,000 Dividends 28000 Cash 35,000 $825,000 $825,000 Is this consistent with the Income Sheet and with the 1913 Balance Sheet as corrected? (Cal., June, 1917.) 5. The Metal Products Company rents the ground on which its plant stands for a long term of years; it sells its own product only and maintains a downtown office. Its books disclose the following data for its last fiscal year; 25 per cent of the office expenses and wages and salaries of officers are considered as entering into the cost of production; 65 per cent of these accounts are deemed to be selling expenses and 10 per cent are unallocated. METAL PRODUCTS COMPANY, BALANCES OF OPERATING ACCOUNTS Advertising $54,600 Cartage on purchases 120 Cartage on sales 1,000 Depreciation : Factory furniture 320 Office furniture 580 Machinery and buildings . 19,120 Discount on sales 10,150 Discount on purchases 12,500 Factory expenses 5,100 Office expenses and wages . . . 20,200 Interest paid 70 Insurance, machinery and buildings 3,880 Inventory beginning of period 100,000 Labor 37,900 Light, fuel, and power $8.350 Purchases 381,500 Royalty on output 30,000 Repairs to equipment 7,600 Rent of factory 4,300 Salesmen's salary and expense 2 1 ,000 Superintendent and factory clerks 9,050 Salaries of officers 24,000 Supplies at factory 19,000 Taxes on real estate 1,700 Plating expenditures 20,500 Reserve for doubtful accounts 1,000 Sales 660,000 Inventory at close of period . 160,000 Prepare from the figures (1) the cost of goods sold; (2) the manu- facturing profit; (3) the gross and net realization from sales; (4) the trading profit; (5) the other profits, losses and expenses, as the case may be; and, lastly, the net profit for the period. (Kan., Dec., 1915; Mo., Dec., 1915.) CHAPTER V PARTNERSHIP AT ORGANIZATION Partnership Defined A partnership may be defined as an association, not incorporated, of two or more persons who have agreed to combine their labor, property, and skill, or some of them, for the purpose of engag- ing in any lawful trade or business and sharing profits and losses as well between them. 1 A partnership may also be defined as, (a) a contract of mutual agency, each partner acting as a principal in his own behalf, and as an agent for his copartners, 2 and (b) the contract relation existing between persons who have combined their property, labor, and skill in an enterprise or business as principals, for the purpose of a joint profit. 3 It is extremely difficult to lay down any definite tests for determining the existence of a partnership, as each case must be judged upon pertinent facts, it being necessary to prove the intention of the parties to form a partnership 4 in addition to proving the other necessary elements of an ordinary contract. 8 Kinds of Partnerships There are two broad classes of partnerships, namely, (a) general, or partnerships in which all the partners are tenants in common, each partner bearing with his associates the liabilities incurred by individual partners acting as agents for their copartners, 8 and (b) limited, or partnerships composed of general partners who are liable for the debts of the firm as in the general partnerships, and special partners who are liable only for the amount of their investments.' The law also recognizes the following kinds of partners : (a) Silent (sometimes called dormant), or partners who take little if any active part in the partnership's activities. 8 (b) Secret, or partners who are not known as partners, although they may be actively engaged in the business." (c) Nominal, or those who are not partners by contract or agreement, but may legally be so considered, due to having knowingly permitted them- selves to be held out to the public as partners. 10 (d) Ostensible (sometimes called public), or those who hold themselves out and are known as partners. 11 Advantage.* and Disadvantages of Partnership The chief advantages of the partnership form of organization are (a) larger capital and therefore access to fields closed lo sole proprietorships, (b) the combining of the business wisdom, experience, and skill of several, and (c) the subdivision of duties with the resulting increase in specialization." The chief disad- vantages are (a) the possibility of friction between partners, (b) slower 'For explanation of superior figures see page 337 86 PARTNERSHIP AT ORGANIZATION S7 action than in sole proprietorships, and (c) unlimited liability of partners to extent of entire personal fortunes." Liability of Partners Except for the limited partners who risk only their investments, 14 partners are considered as sureties for their copartners, and so are ultimately liable even to the amount of their private estates for the full extent of the firm's debts. 15 They are, however, entitled to contributions from copartners for the proportionate share of the firm's debts which the copartners should have paid. 18 Retiring partners are liable as sureties for the due and undue obligations at the time of retirement even though the vendees have agreed to liquidate the liabilities and have given the vendors an indemnity bond against any liability for the firm's debts. 11 Continuing partners are jointly liable with the retiring partners for the debts of the old firm. 18 Incoming partners are not liable for the debts of the old firm unless they agree to undertake such liability, or unless they perform an act indicating such intent. 18 However, they may be considered to have accepted the liability if they fail to state their freedom from such liability. 20 Authority of Partners Every general partner is an agent of the partner- ship in the transaction of business, and has authority to transact the ordi- nary business of the concern. 21 However, unless his partners have left the administration of the business entirely to him or are incapable of acting, he cannot legally do such acts as (a) dispose of the goodwill of the busi- ness, (b) as would render the continuation of the ordinary business im- possible, (c) sell at one time all the partnership property, unless it con- sists entirely of mereliandi.se, (d) confess a judgment, (e) submit a part- nership claim to arbitration, and (f ) assign any or all of the partnership property to a creditor, or to a trustee for the benefit of one or more creditors. 22 Articles of Copartnership The leading features which should be pro- vided for in the articles of copartnership are (a) date of commencement, (b) parties, (c) nature of business, (d) location of business, (e) firm name, (f) duration of partnership, (g) individual investments (if other than cash, the basis of valuation should be stated), (h) rights and duties of partners, (i) division of profits and losses, (j) salaries, (k) personal draw- ings, (1) books of account, (in) auditing of books, (n) interest on invest- ments and drawings, and (o) settlement at dissolution including valuation of goodwill and possession of firm name. 23 General Partnership Rules Unless specific provisions to the contrary are contained in the articles of copartnership, or unless it can be proved that the partners intended otherwise, the following rules prevail: (a) Partners are entitled to interest on their advances and on payments personally made for the benefit of the firm. 24 (b) Interest is not allowed on investments. 25 (c) Interest is not charged on withdrawals."" (d) Interest is not charged on money held by a partner during liquida- tion of partnership.* 88 C. P. A. ACCOUNTING (e) If no rate is mentioned, the legal rate of interest prevails in interest- bearing transactions. 28 (f ) Profits and losses are shared equally. 28 (g) Salaries are not allowed to partners. 30 (h) All partners have an equal duty to keep books of account to which each has free access." Partners' Proprietorship Accounts The capital accounts of a partner- ship record the difference between the assets and liabilities of the business. 32 The components of the equity of partners are sometimes classified thus : 33 Negative Positive Deferred Debit Items Deferred Credit Items Drawing Account (Debit Balance) Drawing Account (Credit Balance) Undivided Profits This classification, however, differs from the ordinary one in that de- ferred charges and credits to income are considered to be capital items instead of assets and liabilities, respectively. The proprietorship accounts of partnerships may be divided into three classes : (a) Capital, or accounts which show the original investment plus the profits left in the business minus withdrawals of capital, if the articles of copartnership permit this to be done. 34 Where a partner has agreed to invest a specific sum, his capital account should show this sum, 35 and any deficiency due to insufficient actual investment should be shown on the books as a charge against the partner's personal account. 38 (b) Personal, or accounts which show the charges for losses, with- drawals, or interest on same, and credits for additional investments, interest on investment, salary, and profits. 37 The personal account may be sub- divided into a salary account and a di'awings account. 38 Where charges to a partner's personal account represent payments made in currency, the auditor should have the partner approve the account as it appears in the ledger. 39 (c) Undivided profits accounts, or those representing the balance of the profit and loss account which has not yet been allocated to the partners. 4 ' The proprietorship accounts of copartnerships appear in the appropria- tion section of the profit and loss statements, as follows : 41 Net Profit for Period remainder of statement omitted) xxxxxxx Appropriation: Jones, Personal Account (3/5) xxxxxxx Smith, Personal Account (2/5) xxxxxxx xxxxxxx The partners' net worth accounts may be shown on the balance sheet without detail, thus: 42 Net Worth: Jones, Capital xxxxxxx Smith, Capital xxxxxxx xxxxxxx PARTNERSHIP AT ORGANIZATION 80 If it is desired to show all elements of the proprietorship accounts of the partners on the balance sheet, they would appear as follows : 48 Net Worth: Jones, Capital, Jan. 1, 1920 xxxxxxx Share of net profits for 1920 xxxxxxx Salary for 1920 xxxxxxx xxxxxxx Drawings for 1920 xxxxxxx xxxxxxx Smith, Capital, Jan. 1920 xxxxxxx Share of net profits for 1920 xxxxxxx Salary for 1920 xxxxxxx xxxxxxx Drawings for 1920 xxxxxxx xxxxxxx xxxxxxx Some accountants classify a partner's undrawn salary as a current liability, and the debit and credit balances to a partner's drawing account as a current asset and current liability, respectively. 44 As a partner cannot bring suit on these items and as the individual creditors of the partner cannot consider such items as part of the partner's private estate until the firm's debts have been paid, it seems preferable to list these items separately under the net worth accounts. Loans of Partners A partner may loan money to his firm either by con- tributing capital in excess of the amount agreed upon or by leaving his profits in the business." These loans which may or may not be covei-ed by notes, are sometimes included in the ordinary capital accounts, but it is preferable to show the amounts in special-loan accounts. 48 Partners' loans rank with equal status 47 after the claims of outside creditors and before the ordinary proprietorship accounts in case of insolvency and dissolution of the partnership. 48 Partners' loan accounts, like partners' undrawn salary accounts, should be considered as net worth items rather than liabilities. Unless specifically stated otherwise in the articles of copartnsr- ship, partners' loans bear interest, and, if no rate of interest is specified, the court will allow the legal rate. 49 If profits or losses are distributed on the basis of capital invested, partners' loans are not counted as capital. 80 Opening Entry for Partnership Books When a partnership agreement is made and it is decided how much capital each partner should furnish, the opening entry would be framed as follows : B1 A, Personal Account xxxxxxx B, Personal Account xxxxxxx A, Capital Account xxxxxxx B, Capital Account xxxxxxx Then when each partner contributes the capital agreed upon, the follow- ing entries would be made :" 9u c. P. A. ACCOUXTLM; Sundry Assets (itemized) xxxxxxx A, Personal Account xxxx xx Sundry Assets (itemized) xxxxxxx Sundry Liabilities (itemized) xxxxxxx B, Personal Account xxxxxxx Guaranteed Assets Sometimes a partner turns into the new firm assets which he guarantees to be worth the value assigned to them. Upon subse- quent default the loss must be borne by the partner. The entry to be made in case a guaranteed account receivable proved worthless would be. 53 (Partner), Personal Account xxxxxxx Accounts Receivable (Customer) xxxxxxx Losses on assets accepted by the firm as of a certain value, without the guarantee of the contributing partner, cannot be charged to that partner, but must be charged to the firm's profit and loss account. 54 Buying Interest in Business The purchase of an interest in the profits must be distinguished from the purchase of a share in the business." Assuming that B wishes to purchase a half interest in the business of A, whose net worth is $5,000, there are ten possible entries, viz. : (a) If B pays into the business exactly book value of interest in busi- ness purchased, the entry would be : M Cash $5,000 B, Capital Account $5,000 (b) If B pays to A personally exactly book value of interest in business purchased, the entry would be: 57 A, Capital Account $2,500 B, Capital Account $2 , 500 (c) If B pays into the business less than book value of interest in busi- ness purchased, without bringing in goodwill, the entry would be : M Cash $4,000 A, Capital Account 500 B, Capital Account S t , 500 (d) If B pays into the business le.ss than book value of interest in busi- ness purchased but brings in goodwill, the entry would be: 5 * Cash $4,000 Goodwill 1 ,000 B, Capital Account $5,000 (e) If B pays A personally less than book value of interest in business purchased without bringing goodwill into the business, the entry would be." 1 A, Capital Account $2 . 500 B, Capital Account $2 , 500 (f) If B pays to A personally less Ili.-ui book value of interest in busi- ness purchased but brings goodwill into the business, the entry would be: Goodwill $1 ,000 A, Capital Account 2 , 000 B, Capital Account $3 , 000 I'AKTXKUSIUP AT ORGANIZATION 91 (g) If B pays into the business more than book value of interest in business purchased, the entry, if goodwill is eliminated, would be:" 1 Cash $6,000 A, Capital Account $500 B, Capital Account 5,500 (h) If B pays into the business more than book value of interest in business purchased, the entry, if goodwill is shown, would be : r ' 2 Goodwill $1 ,000 A, Capital Account $1 , 000 Cash 6,000 B, Capital Account 6 , 000 ( i ) If B pays to A personally more than book value of interest in busi- ne purchased, the entry, if goodwill is eliminated, would be:" 3 A, Capital Account $2,500 B, Capital Account $2, 500 (j) If B pays to A personally more than book value of interest in business purchased, the entry, if goodwill is shown, would be : M Goodwill $1 ,000 A, Capital Account $1 , 000 A, Capital Account 3,000 B, Capital Account 3,000 Buying Share in Profits As profits are not necessarily distributed according to capital investments, all that is necessary to do, when a share in the profits is purchased by the incoming partner, is to make the following entry : rs Assets (itemized) xxxxxxx (New Partner) Capital Account xxxxxxx Audit of Partnerships Having partnership books adjusted by profes- sional accountants is especially important, because they will act impartially and comply fully with the articles of copartnership, thus eliminating fric- tion between partners." 8 In the case of the limited partnerships, an inde- pendent audit is absolutely necessary for the protection of the limited partners, who have no legal right to interfere with the active management of the business. 67 In an audit of a partnership, the partnership agreement should be called for and very detailed notes taken of its contents. 68 An attempt should be made to secure a certified copy for the auditor's permanent files. The auditor should conform to the spirit of the partnership agreement, and where this is impossible, his first resort should be to interpret the articles in the light of ordinary business practices, and this failing, to seek assistance from the law of partnerships. 70 Joint Stock Cutn/xn/ies A joint stock company is a partnership whose capital is divided, or agreed to be divided, into shares transferable without Hie express consent of all the copartners. 71 Joint stock companies are created by contract. 72 In some states a cer- tificate of association containing the name of the joint stock company, 92 C. P. A. ACCOUNTING the date of its organization, the number of its stockholders, the names and residences of its directors, and the principal place of business must be filed with the Secretary of State." Joint stock companies are governed by directors, the members not being agents as is the case in partnerships.' 4 The legal relation of the members to the company, and the liability of members to creditors is practically the same as in partnerships." Joint stock companies are not terminated by transfer of shares, bank- ruptcy or death of members, or war, but terminate on lapse of period shown in articles of association, on bankruptcy of company, on dissolution by court, or if all shares are owned by same member.'" PARTNERSHIP AT ORGANIZATION 93 QUESTIONS PARTNERSHIP AT ORGANIZATION 1. Explain fully a partnership. (Pa., Nov., 1903; Iowa, Dec., 1918.) 2. Explain fully a limited partnership. (Pa., Nov., 1903; Iowa, Dec., 1918.) .'5. What is a joint stock company 1 ? (Iowa, Dec., 1918.) 4. Define: Partners' Capital account. (Wash., Nov., 1913*; Wash., July, 1917.) 5. Give an example of opening the books of a partnership, using your own figures. (Pa., Nov., 1903; Iowa, Dec., 1918.*) 6. Give an example of opening the books of a limited partnership, using your own figures. (Pa., Nov., 1903.) 7. Give the necessary books and papers in a partnership. (Pa., May, 1902; Mich., July, 1906.*) 8. Explain the ways in which the books and accounts kept by a firm conducting any line of business would differ from those of an individual conducting the same business. (Mich., June, 1913; Mich., Dec v 1914.*) 9. Wherein do the books of a copartnership differ from those of a corporation in the same line of business? (Mich., Nov., 1907.) 10. What points should be covered in a partnership agreement? (Mich., June, 1910*; 111., May, 1913; Del., June, 1915.) 11. What is the value of the partnership papers and what effect have they in opening and closing of books? (Pa., Nov., 1901.) 12. What records and documents should an auditor have access to in an audit of a partnership? Give reasons. (N. Y., Jan., 1901*; Pa., May, 1902*; Kan., May, 1916.) 13. In making an audit of a partnership, what information of im- portance would an auditor get from the partnership agreement (a) in determining the partners' profits; (b) in determining the partners' in- terest in business? (Md., Oct., 1903*; N. Y., Jan., 1916*; Mass., Oct., 1917.) 14. How would you organize a set of books for a partnership? (Ohio, Dec., 1908.) 15. In arranging accounts for a partnership, how should original capital be treated? (Fla., July, 1909.) 16. In auditing the accounts of a private firm where there are several 04 C. P. A. ACCOUNTING partners, to what points should the auditor look in order to be assured that the partner's accounts are correctly stated in the Balance Sheet? (X. Y., June, 1899; N. Y., June, 1902*; Wash., March, 1909*; Ind v June, 1916.*) 17. Name some of the distinctive elements in an audit of partnerships. (N. C., June, 1916.) 18. Analyze and discuss the following clause taken from a certain partnership agreement : "VIII. And it is further agreed that the said party of the second part is to pay to the said party of the first part the sum of three thousand dollars ($3,000) ; for which the said party of the second part shall receive a one-third (1/3) interest in said business of the said party of the first part." (N. Y., Jan.. 1917.) 19. In making a general audit of a Minnesota corporation of which C. D. Boyd is secretaiy and manager, you find among its papers what appears to be a contract of partnership between it and George Owens, signed respectively by Owens and by C. D. Boyd for the corporation, but not witnessed as to either signer and without the seal of a corporation. No other papers concerning this arrangement are on file, but the Ledger shows a cash charge to the partnership for the amount of capital required to be contributed, by the corporation, to the partnership. In making your report how will you ti'eat this transaction, both as to the initial payment and any unstated accrued results of the partnership from its commencement down to the date of your audit ? (Minn., Oct., 1916.) PARTNERSHIP AT ORTIAXTZATTOX 05 PROBLEMS PARTNERSHIP AT ORGANIZATION 1. "A" has $5,000 invested in a business. He sells "B" a half interest for $2,000 and. places the money in the business. Make the entry. (N. Y., Dec., 1898*; Pa., Nov., 1903*; Mich., Nov., 1907*; Wash., Aug., 1908*; Mich., June, 1915.) 2. "A" has $5,000 invested in a business. He sells "B" a half interest for $3,000 and keeps the money. Make the entry. (N. Y., Dec., 1898* ; Pa., Nov., 1903*; Mich., Nov., 1907*; Mich., June, 1914.) 3. "X" and "Y" bought merchandise to the amount of $12,000. "X" contributed $7,500; "Y" $4,500. They afterwards sold "Z" a one-third interest for $6,000. How much of this amount should "X" and "Y" receive respectively in order to make "X," "Y" and "Z" equal partners, assuming (a) money paid into business with no goodwill; (6) money paid into business with goodwill; (c) money not paid into business? (N. Y., June, 1914.*) 4. Two partners, Wilson and Peters, find at the end of the first year's business that the Balance Sheet shows Wilson's interest to be worth $18,000 and Peters' $9,000. The goodwill of the firm is worth $3,000. Each partner draws profits in proportion to his investment. They conclude to take in another partner and to give him a one-quarter interest in the new firm. What sum must the new partner contribute? How will the partnership accounts appear after the payment in of the new capital? How will the profits be divided? (Cal., May, 1903.) 5. "A" and "B" enter into a partnership and will share profits in the proportions indicated by their investments. "A" furnishes $25,000 and "B" $15,000, which is invested in lands and buildings, $10,000, and merchandise $30,000. However, before they have actually commenced business, "C," realizing that "A" and "B" have a promising venture, offers to buy a one-third interest in the business for $20,000. "A" agrees to sell provided "B" will consent to pay him a bonus of $4,000 out of his ("B's") share. This "B" agrees to do and consents to the sale. How should the $20,000 "be divided between "A" and "B" so that the interest of all three partners will be equal? (111., May, 1914.) 6. "A" and "B," each carrying on a similar business, agree to form a partnership under the name of "A and B" and that the new firm should take over the assets of each partner in the business, and assume liabilities of each. The following trial balances were presented by each of the partnerships on commencing business : 96 C. P. A. ACCOUNTING A ] 3 Capital $20,000 $35,000 Mach'n rv and Fixtures $25, (XX) $45,500 Cash 4,000 8,000 Bills Receivable 3,000 3,000 Book Accounts Receivable 20,000 25,000 Inventory Merchandise 10,000 15,000 \Vages 2,000 4,000 Unpaid wages 500 3,000 Expense \ccount 15,000 18,000 Bills Payable 20,000 26,000 Suspense Account 1,000 3,000 Merchandise Account 26,000 35,000 Book Accounts Pavable 15,000 25,000 Repairs Account . 2,000 3,000 Rentals 1,000 1.000 Rent 500 500 $82,500 $82 ; 500 $125,000 $125,000 Formulate the opening entries for new partnership. (Pa., Nov., 1906.) 7. "A" and "B" carried on business in partnership and divided profits and losses in proportion to their capital, three-fifths and two-fifths, re- spectively. On January 1, 1915, "A's" capital was $52,500 and "B's", $35,000, as shown by a Balance Sheet of that date. They agreed to admit "C" as a partner from the same date on the following terms: (1) Assets and liabilities and capital to be taken as shown in the Balance Sheet; (2) $12,500 to be added to the assets for goodwill; (3) the amount of goodwill to be added to "A's" and "B's" capital in the proportion in which they divide profits: (4) "C" to pay to the partnership such a sum as will give him a one-fifth share in the business. (a) State what amount of capital "C" has to bring in. (b) Set out the Capital accounts of each partner in the new partnership; and (c) state in what proportions the profits will be divided in the future, "A" and "B," as between themselves sharing in the same proportions as before. (Wash., May, 1916.) 8. "A" and "B," who had hitherto been in business separately, decide to enter into partnership on July 1, 1905. The Balance Sheets of "A" and "B" were on that date as follows : A B A B Liabilities Accounts Pavable $1,000 $1,500 Assets Furniture $750 $600 Capital Account 5,000 3000 Accounts Receivable (face value) 2,500 1,500 Merchandise 2,550 2,000 Cash 200 400 $6,000 $4,500 - $6.000 $4,500 PARTNERSHIP AT ORGANIZATION 97 It was agreed that "A" and "B" should take over their respective Accounts Receivable at $200 and $150 less than the face values shown in the Balance Sheets, these amounts to be charged against their Capital accounts and carried on the partnership books as a Reserve for Bad and Doubtful accounts. Of "B's" furniture only $250 was to be taken over by the partnership. With the above exceptions the assets and lia- bilities of the 'parties were to be taken over by the partnership at the Balance Sheet figures, except that "B" was to invest in the partnership in cash, a sum which, after making the adjustments above referred to, would make his Capital account the same as that of "A." Draw the Balance Sheet of the "A" and "B" partnership on July 1, 1905, giving effect to the foregoing provisions. (Wash., April, 1906.) 9. New, Knott and Moore are partners, sharing profits in the pro- portion of their investments. On December 31, 1915, the Balance Sheet of the partnership is as follows : Cash $18,000 Other Current Assets 23,000 Fixed Assets 20,000 $61,000 Accounts Payable $1,000 Moore Capital 24,000 New Capital 24,000 Knott Capital 12,000 $61,000 Moore decides to retire from active business and agrees to sell his interest to the other two partners for $26,400, taking $14,400 in cash and the balance in three equal installments payable July 2, 1916, January 2 and July 2, 1917, evidenced by notes payable. The business is very prosperous, but it becomes increasingly evident that more capital is required, especially in view of the approaching maturity of the first note given to Moore. New and Knott decide to admit John Less as partner as of date July 1, 1916, at which time the current assets have increased by $16,000, accounts payable by $10,000 and the partners' Capital accounts by $6,000. They value the goodwill at $12,000. Less buys a one-third interest, but stipulates that all he pays must remain in the business and that the goodwill shall not appear upon the books. How much must he pay for the one-third interest? Present the Balance Sheet of the firm of New, Knott and Less as of date July 1, 1916. (Ig- nore accrued interest on Moore notes.) (Cal., May, 1916.) 10. January 1, 1913, "A" and "B" signed articles of copartnership to engage in a mercantile business, agreeing to invest $15,000 and $25,000 respectively. Profits were to be divided in proportion to capital con- tributed, and interest at 5 per cent was to be allowed on investments in excess of the agreed contributions and was to be charged on deficits under the agreed contributions. The trial balance of their books on December 31, 1913, was as follows: C. P. A. ACCOUNTING Purchases $60,000 Office Expense 1,000 Real Estate 5,000 Building 10,000 Accounts Receivable 12,000 Cash on Hand 1,000 Notes Receivable 8,000 Furniture and Furnishings 2,000 Discounts Earned $1,000 Accounts Payable 7,000 Salaries and \Vages 4,000 Notes Payable 4,000 Sales . 55,000 A 9,000 B 27,000 The merchandise on hand is valued at $10,000. After allowing for interest on investments, divide the net profits ac- cording to the agreement. Give the Capital accounts of each partner and the Balance Sheet as of January 1, 1914. On this date a third party, "C," desired to enter the partnership, and it was agreed: (a) That "C" pay $9,000 in cash for a one-fourth (^4) interest in the new concern; (6) that goodwill of "A" and "B" be valued at $3,000; (c) that "A" and "B" adjust their capitals so that they hold a one-fourth (*4) and one-half (*/) interest, respectively, in the new firm; (d) that profits and losses are to be divided according to capital contributions. In the adjustment, "A" received cash (out of the $9,000 paid in by "C") for his excess investment, while "B" received the remainder of the $9,000 paid in by "C" and the balance due him was considered a loan to the partnership. Give Journal entries necessary to record the above facts and the opening Balance Sheet of the new firm. April 1, 1914, "A," "B" and "C" agreed to sell the business. Up to this time each partner had withdrawn $500. The assets were disposed of for $24,500 cash, and the vendee assumed the liabilities of the partnership. How should this sum of $24,500 be divided among the partners? Show the exact relation of the partners to one another bv accounts or statements. (Wis., April, 1914.) 11. The firm of "A" and "B" have the following statement : Store $15,000 Accounts l.eceivable. 12,000 Cash 9,000 Furniture and Fixtures 2,800 Merchandise 37,000 Miscellaneous Equipment. . . . 4,200 $80,000 Accounts Payable $10,000 Bills j ayable 5,000 A, Capital 30,000 B, Capital 35,000 $80,000 "C" is admitted as a special partner with the following arrangement : "C" to contribute $30,000 and to be entitled to one-third of the profit for PARTNERSHIP AT ORGANIZATION 00 one year. Before making the contribution, the following changes to be made in the books: Store to be marked down 5 per cent; allowance for doubtful accounts to be created amounting to 2 per cent; merchandise to be revalued at $35,000; furniture and fixtures to be valued at $2,500. At the end the amount of goodwill to be fixed at three times the net profits for the year in excess of $20,000, this goodwill to be set up on the books, the corresponding credit being to "A" and "B" equally ft A," "B" and "C" each to draw $3,000 in cash, the remaining profits to be carried to their Capital accounts. During the year the following transactions took place: Merchandise bought on credit, $240,000 ; cash purchases, $25,000 ; cash sales, $125,000 ; sales on credit, $175,000; accounts payable paid (face, $245,000, discount 2 per cent), $240,100; accounts receivable collected (face, $170,000, all net except $50,000, on which 2 per cent allowed), $169,000; buying ex- penses, paid cash, $1,500; selling expenses, paid cash, $21,000; delivery expenses, paid cash, $9,000; management expenses, paid cash, $4,500; miscellaneous expenses, paid cash, $3,000; interest on notes payable, paid cash, $250; partners each withdrew $3,000 cash as agreed. In closing the books for determining profits and goodwill, the following were agreed upon : Value of merchandise on hand, $60,000 ; depreciation on store, $285; additional allowance for doubtful debts, $165; furniture and fixtures written down, $200. Goodwill having been estimated and duly entered, "C" then contributes enough cash so that his Capital account equals just one-third of the total capital. Prepare statements showing how the accounts are to be adjusted and the balance sheet after the final adjustment. (A. I. of A., June, 1917.) 12. "Y" and "Z" are partners, drawing equal amounts for services and sharing profits in accordance with capital investment, after allowing 5 per cent on capital. In order to acquire additional capital they agree to admit "X" to the firm, who is to own a one-fourth interest in the business. According to the balance sheet, "Y" has $8,000 and "Z," $4,000 invested. Goodwill is valued at $4,000. What sum must "X" contribute? How will partners' accounts appear after payment into the firm of "X's" capital, and how will future profits be divided? Show the accounts in skeleton form. (Ind., Jan., 1916.) 13. John Jones, William Brown, and Alexander White are partners in a business, their respective interests in the profits of the business being five-tenths, four-tenths, and one-tenth. It is agreed between the partners that Mr. Jones's son be taken into the business as at January 1, 1916, on the understanding that White's interest in the business be increased to 12 per cent, which increased share is now considered to be applicable to the four previous years, while the shares of Mr. Jones and Mr. Brown are to be 40 per cent and 39 per cent, respectively, while Mr. Jones's son is to be given 9 per cent interest in the profits of the business. It is further agreed that the value of the goodwill of the business, amounting to 100 C. P. A. ACCOUNTING $50,000, be set up on the books. This amount is to be divided between Mr. Jones and Mr. Brown in proportion to their original interests in the profits. Mr. Jones is to transfer the sura of $6,000 to his son's credit, which wilF be in addition to the sum to be allowed him out of profits of previous years. The profits divided during the four years to December 31, 1915, were as follows : 1912, $41,030 ; 1913, $49,000 ; 1914, $52,000 ; 1915, $48,000; total, $190,030. The balances at credit of the Capital accounts at December 31, 1915, were, John Jones, $230,310; William Brown, $185,112; Alexander White, $21,809. Prepare a detailed statement showing the balances at credit of the various partners on January 1, 1916, after giving effect to the provisions of the new partnership agreement as above indicated. Ignore any question of interest. (111., May, 1916.) CHAPTER VI PARTNERSHIP DURING OPERATION Division of Profits In the absence of a specific agreement to the con- trary, all profits are shared, and all losses are borne, equally among part- ners. 1 The partners, however, may agree that profits and losses be divided according to (a) original investments, 2 (b) net investments, 3 (c) average investments,* and (d) arbitrary ratios. 5 For an illustration of these four methods of distributing profits, assume that Jones and Smith, whose proprietorship accounts are given below, made a net profit of $6,000 for the year ending December 31st : JONES, CAPITAL ACCOUNT January 1 $10,000.00 JONES, PERSONAL ACCOUNT May 1 $1,000.00 June 1 1,000.00 Oct. 1 $1,000.00 SMITH, CAPITAL ACCOUNT January 1 $5,000. 00 SMITH, PERSONAL ACCOUNT Feb. 1 $1,000.00 Mar. 1 1,000.00 Aug. 1 2,000.00 Nov. 1 $2,000.00 Dec.l 3,000.00 If the profits are divided according to original investments, Jones would receive two-thirds, and Smith one-third of the net profits, or $4,000 and $2,000, respectively, as they contributed the original capital of $15,000 in the ratio of 2 to 1. If the profits are divided according to net investments, Jones and Smith would receive profits according to their net investment at the end of the period, viz., capital accounts together with personal accounts. Jones then would receive 9/15 of $6,000, or $3,600, while Smith would receive 6/15, or $2,400. If the profits are divided according to average investments, the basis of profit-sharing would be the amount of capital furnished by each partner and the duration of its use in the business. There are two methods of 'For explanation of superior figures sec page 337. 101 10'2 C. P. A. ACCOUNTING determining this basis, which may be calculated either on the day-dollar or month-dollar basis. The first method, illustrated below, in finding Jones' average invest- ment, multiplies each investment and withdrawal by the number of months elapsing betAveen date of transaction and date of profit determination, the difference between the month-dollars for the investments and the with- drawals showing the average investment in terms of month-dollars." The second method, illustrated below in finding Smith's average invest- ment, calculates the average investment in terms of month-dollars by adding the products obtained by multiplying the net investments by the number of months they remained unchanged. 7 Both methods of calculating average investment necessarily are equally accurate, but the second method is slightly preferable in that the "months" column will always total the same as the length of the fiscal period, if each partner had an investment at the start of the period, 8 and the last net investment figure will always be the balance of the capital and personal accounts of the partner,' thus giving two checks on the mathematical accuracy of the calculation. First Method (Jones) : Amount Months Month Dollars Month Dollars Investments : Jan.l $10,000 12 120 000 Oct. 1 1 000 3 3 000 123 000 Withdrawals : May 1 1 000 8 8 000 June 1 1 000 7 7 000 15 000 108,000 Second Method (Smith): Month Investment Months Dollars $5,000 1 5.000 4,000 1 4,000 3,000 5 15,000 1,000 3 3,000 3,000 1 3.000 6.000 1 6,000 12 36,000 PARTNERSHIP DURING OPERATION 103 In distributing the pro tit of $6,000 on the basis of average investment, Jones receives 108/144, or $4,500, while Smith receives 36/144, or $1,500. Profits may be distributed without reference to investment. 10 Indeed, in some cases partners receive a share in the profits without having an investment at all. This disparity between profit and capital ratios is usually due to one man having unusual skill or to the fact that one partner devotes more time to the business than the others." Interest on Capital Allowing interest on partners' investments has no effect when the capital and profit sharing ratios are identical, but, where these ratios are dissimilar, it benefits the partner having the greater capital at the expense of the partner having the smaller investment, and operates to the detriment of the partner whose profit-sharing ratio is the greater and benefits the partner with the smaller profit-sharing ratio. 1 ' The interest on investments is usually credited to the partners' personal accounts, 13 but there is little uniformity as to the debit entry, as sometimes the profit and loss account 14 is charged directly, while frequently either the interest account 15 or the interest on partnership investments account 16 is debited. The charge to the intei'est account is faulty, because the interest account is commonly interpreted as the account reserved for interest pay- ments between the firm and outsiders, Avhile interest on capital affects only the proprietors. 17 The adjustment between partners on account of interest on capital may well be made by crediting each partner's personal account with the amount due him, and then charging the same account with its prorata share of the total allowance made to all partners as interest on investments. 18 For instance, if A and B, whose profit and loss ratio is equal, are allowed $100 and $50, respectively, as interest on capital, the entry would be : A, Personal Account $75 . 00 B, Personal Account 75. 00 A, Personal Account $100. 00 B, Personal Account 50. 00 or, showing only net results : B, Personal Account $25. 00 $25.00 The interest on capital investment is sometimes treated as a financial expense, 19 and at other times as an allocation of profit. 20 The latter treat- ment seems preferable, unless the articles of copartnership require interest on investment to be treated as an expense. Interest on capital must be considered, if provided for in the articles of copartnership, even though there are not enough net profits to satisfy these requirements." 1 There is no complexity in the calculation of the amount of interest to be allowed on investment, when it is allowed on either original investment or net investment. However, the calculation is quite complicated when interest is allowed on the average investment. The two methods of cal- 104 C. P. A. ACCOUNTING culating the interest to be allowed on average capital given below use the Jones, Capital Account, and Jones, Personal Account, shown on page . First Method: Interest on Investment: $10,000.00 for 12 mo. @ 6%=. 1,000.00 for 3 mo. @ 6%=. Interest on Withdrawals : $1,000.00 for 8 mo. @ 6%=. 1,000.00 for 7 mo. @ %= $600.00 15.00 $40.00 35.00 $615.00 75.00 $540.00 Second Method: Investment Months Dollar Months $10,000 9,000 8,000 9,000 4 1 4 3 40,000 9,000 32,000 27,000 12 108.000 $108,000.00 @ 6% for one month = $540.00. The second method is much simpler in the cases which occur in actual practice, where an uneven number of days must be used in the calculation. Interest on Excess or Deficit of Capital Interest allowed to a partner on excess capital is really interest on borrowed money, while the interest charged a partner for a deficit of capital is an income offsetting the interest the firm probably has to pay on money borrowed to operate the business. 23 Therefore, interest on excess or deficit of capital is an item to be entered into the profit and loss account through the interest account. 23 A, B, and C, partners sharing profits and losses equally, agreed to furnish $20,000 each with interest on an excess or deficit of capital to be figured at 6%. If they actually contributed $25,000, $20,000, and $10,000, respectively, the entry for the adjustment between partners would be : C, Personal Account (6% on $10,000) $600. 00 A, Personal Account (6% on $5,000) Interest Account . . Interest Account 300. 00 A, Personal Account B, Personal Account C, Personal Account $300.00 300.00 100.00 100.00 100.00 PARTNERSHIP DURING OPERATION 105 Some accountants differ from the above method of treating interest on excess or deficit of capital, considering it merely an adjustment between proprietors. 24 Interest on Drawings Interest can not be charged on drawings unless the articles of copartnership so provide. 25 The intention to charge such interest can not be implied even if interest is allowed on investments, as partners' drawings should be regarded as drafts on accruing profit rather than on initial investment. 28 Interest also can not be charged if the part- ners allow one partner to draw more than the amount stipulated in the agreement, unless interest was agreed upon at the time of the overdraft. 27 Partners' drawings are charged directly against their net worth accounts and not against the profit and loss account. 28 Partners' Salaries Adjustment for variation in the ability or activity of partners may be made by compensating the more skilled or more active partners by salaries. 29 Salaries are not allowed to partners unless the articles of copartnership so provide. 30 Salaries of partners are some- times treated as administrative expense, 31 and sometimes as allocations of profit, 32 the latter treatment seeming preferable. Partners' salaries must be considered, if provided for in the articles of copartnership, even though there are not enough net profits to satisfy these requirements. 33 Tabular Form of Partners' Accounts While the capital accounts of partners are in the regulation "T" form in the ledger, it is customary to present these accounts in tabular form when the detail of the accounts is desired in a schedule or report. 34 This tabular form gives one money column for the combined capital and personal accounts of each partner. The following is a simple example : Total A B Original Investment $15,000.00 $10,000.00 $5,000.00 Salaries 5,000.00 3,000.00 2,000.00 Interest on Investment 1,500.00 1,000.00 500.00 Drawings $21,500.00 7,500 00 $14.000.00 4,000 00 $7,500.00 3,500.00 Profits in Excess of Interest and Salaries $14,000.00 10 000 00 $10,000.00 5,000 00 $4,000.00 5.000 00 New Capital ' $24,000.00 $15.000.00 $9,000.00 106 C. P. A. ACCOUNTING QUESTIONS PARTNERSHIP DURING OPERATION* 1. Give a rule for adjusting partners' accounts: (a) when the gains or losses are to be divided in proportion to each partner's investment and the time it remains in use; (6) when the proportion of gain or loss is fixed, and interest is calculated on excess or deficit of capital. (X. Y., Jan., 1901; W. Va., May, 1917.) 2. Explain a method for apportioning the profits or losses of a partner- ship, where the partners may make additional investments or withdrawals during the year. (N. D.. June, 1914.) 3. In arranging accounts for a partnership, how should increases to capital be treated! (Fla., July, 1909.) 4. In arranging accounts for a partnership, how should accumulated profits of each partner be treated? (Fla., July, 1909.) 5. In case of a partnership, how would you dispose of the balance of the profit and loss account? (Mich., Dec., 1906*; N. Y., Oct., 1907; R. I., Dec., 1907.) 6. Where do a joint stock company and a copartnership differ in method of profit distribution? (N. Y., June, 1909.) 7. How is the profit of a cooperative association divided? (Mich.. Dec., 1906.) 8. Upon the audit of the partnership accounts of a manufacturing business the following condition is revealed : A loan to the firm has been credited by mutual consent to the capital account of one of the partners. What would you deduce from this fact, and what would you feel called upon to do? (Kan., May, 1916.) 9. How should the auditor deal with the ledger accounts of partners (a) in the division of profits, (b) in the assessment of losses, (c) in case a partner's drawings exceed the amount specified in the partnership agree- ment, (d) in case a partner's drawings are less than the amount to which he is entitled? (N. Y., June, 1901.) - 10. What distinction, if any, would you make as to salaries and draw- ings of the partners in a partnership firm, as affecting profit and loss? (Ind., Nov., 1917.) 11. Explain fully in what way, if at all, partners' salaries should enter into Trading and Profit and Loss statements, with reason for inclusion or exclusion. (N. Y., June, 1898*; N. Y., Jan., 1911; Mass.,- June, 1913*; Kan., Ma;-, 1916.) PARTNERSHIP DURING OPERATION 107 12. John Smith owns a painting and decorating business, employing twenty men. He is in active charge and prepares estimates and supervises all the work. He draws no salary. You are asked to advise him relative to the propriety of this procedure, and as to whether he should charge a salary for himself, and how much, and if it should be regarded as a part of his overhead expense or as a general administrative expense. (111., May, 1917.) 13. Explain fully in what way, if at all, partners' drawings should enter into Trading and Profit and Loss statement, with reason for inclusion or exclusion. (N. Y., Jan., 1911; Mass., June, 1913*; Kan., May, 1916.) 14. Classify the Interest on Invested Capital account properly, accord- ing to the subdivision of assets, liabilities, proprietary interest, income and expenses, under which it should be grouped. (Wis., May, 1919.) 15. "A," "B," and "C" are equal partners, each having subscribed $5,000 to the partnership. "A" pays in $3,000, leaving $2,000 still due tlie partnership on his capital account. It is agreed for the present that this $2,000 can remain unpaid, provided "A" pays interest on the same, which he does. Later a dispute arises as to how this interest shall be credited. "A" claims that it should be included with the earnings of the business, the profits of which are to be divided equally among the three partners. "B" and "C" claim that this interest should be divided between them only, as they fully lived up to their obligations under the partnership agreement, while "A" had only partially done so. To what account should the interest on the deferred payment be credited? (N. Y., June, 1913.) 16. In examining the partnership accounts of Black and Brown you ascertain that the capital of $20,000 has been provided equally, and the articles of partnership provide that if any excess capital is supplied either partner, interest at the rate of 5 per cent per annum shall be allowed. Black pays $5,000 additional and is credited at the end of the year 5 per cent on same which equals $250, which is debited to Brown. State whether you consider this correct and give reasons for your answer. (N. Y., June, 1898*; 111., Nov., 1908; Mich., Dec., 1913.*) 17. What method should be pursued in adjusting interest on capital among partners whose investments differ in amount 1 ? Give reasons for such book entries as you would recommend in the premises. (N. Y., Jan., 1904.) 18. Under what conditions may interest on partners' capital invested in a firm be charged and credited to the partners' accounts in the absence of an agreement to that effect under the terms of a partnership? (Mo., Dec., 1914.) 108 C. P. A. ACCOUXTIXd PROBLEMS PARTNERSHIP DURING OPERATION 1. "A," "B," and "C" are partners. "A" is to receive a salary of $2,000 per annum; "B" $2,500 and "C" $3.000. The balance of profits after payment of salaries is to be divided as to the first $20,000, 2/3 to "A," and 1/6 each to "B" and "C" ; and profits above $20,000 are to be divided equally among the three. "A" retires from active business, and gives up his right to salary for 1906. The profits for the year, before charging salaries, amount to $35,000. To what extent are "A," "B," and "C," respectively, affected by "A's" concession? (Fla., April, 1907.) 2. Jones and Johnson form a copartnership, January 1, 1909, each in- vesting $10,000 ; April 1, Jones pays in an additional $2,500, and Johnson draws out $1,500. August 1, Johnson pays in $3,000 and Jones withdraws $1,000. The profits for the year ending December 31, 1909, are $5,000. Prepare statements showing each partner's investment and portion of profits, the profits being divided in proportion to capital invested and the time it is employed. (Ind., June, 1916.) 3. "A" and "B" form a partnership, "A" investing $30,000 and "B," $50,000. They agree to share expenses, profits and losses equally. They further agree to and do leave their original investments intact. At the end of the first year, the profits from the operations of the business amount to $30,000, against which "A" has drawn in twelve equal monthly install- ments on the last day of each month an aggregate amount of $9,000. "B" has drawn against his profits on the last day of each quarter the sum of $2,500. Prepare Journal entries adjusting interest at 5 per cent per annum between the partners in respect to both their investment and drawing ac- counts and render statements showing the amount each partner has in the business at the end of the year. (Mass., June, 1912.) 4. The capital of three partners, "A," "B," and "C," in a manufactur- ing business January 1, 1896, was $26,000, of which "A" owned 1/5, "B" 2/5, "C" 2/5. On December 31, 1896, one year thereafter, the condition was found to be as follows: Real Estate. $15,000; Plant and Machinery, $7,000; Stock on hand, $2,000; Book Debts Receivable, $6,000; Cash in Bank, $2,500 ; Creditors' Notes Payable, $8,000 ; Partners' Withdrawals "A" (including interest), $1,500; Partners' Withdrawals "B" (including interest), $1,200; Partners' Withdrawals "C" (including interest), $2,000. PARTNERSHIP DURING OPERATION 109 After crediting- up interest on Capital at the rate of 6 per cent, show the net result for the year, and distribute the same, in proper proportions, to the partners' accounts. Prepare individual partners' accounts, showing the condition of each at the end of the year. (Mass., June, 1910.) 5. "A" and "B," partners, finding themselves in want of further capi- tal in their business, and both being possessed of real property, "A" de- posited deed with the bankers of the firm as security for a loan of $2,000 to the firm. "B" arranged on some of his own property a mortgage for $1,500 with a private friend and paid the proceeds into the firm's bank account. The bankers were eventually obliged to realize the security held by them which produced, after payment of all expenses, the sum of $2,850. Prepare entries recording these transactions in the firm's books. (Mass., Oct., 1916.) 6. "A," "B," and "C" agree to start in business with a capital of $200,000, of which "A" is to^ furnish $100,000 and "B" and "C," $50,000 each. "A" is to have one-half interest in the business and "B" and "C," each one-quarter. Interest at 5 per cent is to be credited on excess, or charged on deficiency of capital. "A" contributes $100,000; "B," $45,000; and "C," $40,000. How would the capital accounts stand on the books after adjusting the interest at the end of the year? (N. Y., Dec., 1898.) 7. "A" offers to take "B" into partnership on equal terms, upon pay- ment by "B" of a premium of $12,500 but as "B" is unable to pay the money for three years, the following arrangement is agreed upon. The profits are to be divided in the proportions of two-thirds to "A" and one- third to "B." "B" will draw one-third of his share of the profits, leave one-third in the business, and hand over the remainder to "A" in part payment of the premium as above. The profits for the first three years are as follows : First year, $8,000 ; second year, $10,000; third year, $11,000. Draw up the partnership accounts for these three years, and show the amount due from "B" to "A" at the end of the period. (Wash., May, 1910.) 8. "A" having a capital of $10,000, took "B" into partnership on condition of his bringing in $5,000. In ascertaining profits each year, "A" was to have $3,000 salary and "B" $1,500 and 5 per cent interest upon capital was to be allowed to each partner, but no interest charge was to be made on withdrawals. The pi'ofits thereafter were to be divided: Up to $9,000, two thirds to "A" and one third to "B," any excess equally. No limitations as to withdrawals in anticipation of profits were shown in the deed of partnership and at the end of the first year "A" had drawn $3,000, and "B" $750 in excess of their salaries. The profit for the year, before making the above charges, amounted to $17,500. Complete the Profit and Loss account and show the partners' accounts as they should appear. (Wash., Sept., 1907.) 110 C. P. A. ACCOUNTING 9. "X" and "Y" enter into partnership. "X's" capital being $20,000 and "Y's" $15,000. Capital is to bear interest at 10 per cent per annum ; profits are to be divided equally between the parties. The profits for the first two yeai's (after charging interest on capital) were: First year, $6,000; second year, $7,500. The drawings of the partners (in excess of salaries) were: First year, "X," $1,500; "Y," $1,200; and second year, "X," $1,750; "Y," $1,500. At the end of the second year "Z" was admitted to partnership, and put into the business the same amount of capital as "Y" had in the business at that time, and on the same conditions as to interest and division of profits. The profits of the business for the third year were $12,000, and the partners' drawings in excess of salaries were: "X," $1,750; "Y," $1,600; "Z." $1,500. Construct the Capital accounts of the partners for each of the three years, showing the balance on each at the end of the third year. (Wash., April, 1906.) 10. "A," "B," and "C" formed a partnership. "A" agreed to furnish $10,000, "B" and "C" each $7,000. "A" was to manage the business and receive one half of the profits; "B" and "C" were each to receive one fourth. "A" supplied merchandise worth $8,500, but no additional cash. "B" turned over to "A," as managing partner, $9,000 cash and "C" turned over $5,500. The business was conducted by "A" for some time, but with- out keeping exact books. While managing the business "A" purchased additional merchandise amounting altogether to $75,000 and made sales of $100,000. The cash received and paid out for the partnership was not kept separate from "A's" personal cash. In order to straighten out mat- ters, "B" took over the management. lie found receivables amounting to $20,000 and of these he collected $4,500. The merchandise still on hand he sold for $500. These receipts he deposited in a bank to the credit of the firm. The remaining accounts proved worthless. The outstanding accounts payable amounted to $2,000 of which $1,590 had been incurred in purchasing merchandise and $500 for expenses. These accounts he paid. "A" presented vouchers showing that during his management he had paid other expenses of $2,400. By mutual agreement "15" was held to be entitled to $100 on account of interest on excess capital contributed and "A" and "C" were to be charged $75 eacli for shortage in contribution of capital. (a) Prepare Trading and Profit and Loss accounts and accounts of each of the partners, indicating the final adjustment to be made in closing up the partnership. (6) Show how the above final adjustment would be modified if "A" proved to have no assets or liabilities outside the partnership. (A. I. of A., June, 1917; Ind., Nov., 1917.*) 11. John Jones and Samuel Smith go into the hardware business January 1, 1910, investing as follows : Jones, $23,874 ; Smith, $19,228.50 ; total $43,102.50. Within the year Jones draws out for private use over the additional in- PARTNERSHIP DURIX(! OPERATION 111 vestment made by him $7,863; Smith draws out over investments $10,057.30. A year later Jones makes additional investments from private sources, and over and above the amount drawn out for private use, $11,269.70. Smith also invests over amounts drawn out for his private use $4,732.60. At the end of the year 1911 they make the following state- ment of assets and liabilities: Assets Merchandise $27,860 .00 Cash on Hand 10,246 .00 Personal Accounts Due .. 12,354.30 Bills Receivable 16,452 .00 Real Estate 10,000 .00 Samuel Smith owes firm .. 5,324.70 $82,237.00 Liabilities Bills Payable $20,480 .00 Personal Accounts 16,553.40 Firm owes John Jones . . 3,406 . 70 $40,440.10 By agreement they are to divide the gains or losses pro rata according to investment at the commencement of business, the partner of the small investment not paying to the other partner any interest upon the differ- ence of capital. Show the Drawing account and Investment account of each and the net investment or worth of each partner and also of the firm at December 31, 1911. (Wash., June, 1912.) 12. H. Pratt, F. Jones and J. Todd entered into partnership on July 1, 1914. Pratt brought in as capital $15,000; Jones, $10,000; and Todd, $5,000. They were to share profits in the proportion of one-half, one- third, and one-sixth, but as Jones and Todd were the working partners, they were to be credited at the close of each current year, by way of salary, with the respective sums of $1,250 and $750. Pratt was to be allowed to draw each year, as against profits, $2,500; Jones, $1,650; and Todd, $1,250; interest at 6 per cent was to be charged on such drawings. The partnership agreement also provided that Jones and Todd should have the right to bring in extra capital not exceeding $8,000 each, and that upon such capital they were to be credited with 6 per cent interest. Upon closing the books on June 30, 1915, it was found that the partners had drawn as follows : Pratt Jones Todd Sept. 1 $500 00 Allf* 1 $400 00 Aug. 1 $300.00 Nov. 1 750 00 Sept 1 350 00 Sept. 1 250.00 Dec. 1 1,000 00 Oct 1 500 00 Nov. 1 400.00 Dec. 1 400 00 Jan. 1 100.00 On October 1, Jones brought into the business as additional capital the sum of $1,200 and Todd $2,000. On closing the books at June 30, 1915, 112 C. P. A. ACCOUNTING and before the salary or interest to partners had been dealt with, the balance to the credit of Profit and Loss stood at the sum of $13,000. Make the closing entry and prepare Capital and Drawing accounts showing the exact position of the partners on July 1, 1915. (Wash., May, 1916.) 13. In making an audit of the books of the partnership of "A" and "B" you find that the agreed division of profits was to be on the basis of the capitals and of the time that they were left in the business. The books show as follows : "A V account paid in January 1, $6,000 ; March' 1, $2,000; June 1, $4,000; November 1, $1,000; withdrew April 1, $3,000; October 1, $2,000. "B's" account, paid in January 1, $4,000; February 1, $1,000; August 1, $3,000 ; withdrew May 1, $2,000 ; December 1, $1,000. Prepare a state- ment showing method of arriving at correct profit distribution. (Ind., Nov., 1918.) CHAPTER VII PARTNERSHIP AT LIQUIDATION Causes of Dissolution Partnerships may be dissolved by (a) the with- drawal of any partner, (b) sale of a partner's interest or admission of a new partner, (c) lapsing of time limitations and completion of object specified in partnership agreement, (d) mutual consent of the partners, (e) misconduct, insanity, death, disability, assignment, or bankruptcy of a partner, (f) illegality of object, (g) war between nations represented by partners, (h) bankruptcy of the firm, and (i) sale and transfer of all property of firm. 1 As a safeguard, it is important that all special reasons which will dissolve the firm, be mentioned specifically in the articles of copartnership." Adjustment Upon Partner's Death To avoid the necessity of taking an inventory and an appraisal of all the firm's assets, the articles of copartnership may provide for the continuation of the business and the purchase of the interest of the deceased partner by the remaining partner. 3 In such cases, the deceased partner's share in the current period's profits is usually the proration of the profits over the part of the period prior to his death. 4 The deceased partner's estate is usually paid an allowance for the deceased partner's share in the goodwill, 5 and usually allowed interest from the date of death until settlement is made." Liquidating Partners All partners have equal rights to share in the work of liquidating the firm, but, as there is seldom sufficient work for all, it is customary to appoint one partner (or an outside party) as liquidator. 7 After the fact of the dissolution and name of liquidator have been announced through the local newspapers, the liquidator proceeds to sell the assets, fulfill the existing contracts and complete the partly manu- factured goods. 8 If necessary, he may purchase such materials as are needed to realize upon the assets." The salary or commission of the liquidating partner may be paid privately by the other partners 10 or by the representatives of a deceased partner," but it is preferable, for record purposes, to have the remuneration charged to the firm's liquidation ex- penses. 12 Value of Assets at Dissolution The usual valuation rules used for going concerns should not be followed when assets are appraised upon the dissolution of a partnership. 13 For instance, if a machine, whose estimated life is ten years, cost $1,000 three years ago, it would be carried on the books at $1,000 minus $300 (depreciation) or $700, in spite of the fact that the selling price may have doubled. The machine would, however, be 'For explanation of superior figures see page 337. 113 114 C. P. A. ACCOUNTING valued at its reproduction value less accumulated depreciation on the date of dissolution, say $1,500, in calculating the retiring partner's interest. 14 Liquidation of Uncompleted Contracts The uncompleted contracts at the dissolution of a partnership would be valued at market price, which would approximate the cost of the work done plus that proportion of the estimated profit on the completed contract that the cost of the work done is to the estimated cost of the completed contract. If the partners do not wish to estimate the profits on the contracts, the hooks of the firm may be held open until the uncompleted contracts are finished by one of the partners or by an outside firm acting as the agent of the partners. After the completion of the contracts, the assets would be realized upon, the liabilities liquidated, and the profit on the contracts distributed to the old partners. 15 Reserves at Dissolution In cases where the interest of a retiring partner is purchased by the continuing partners, the valuation reserves are closed into the related assets which are then raised or lowered to their appraised value. Contingency, sinking fund, and other surplus reserves are, how- ever, part of the net worth of the business and directly affect the amount to be allowed for the interest of the retiring partner. Application of Assets at Dissolution The proceeds from the assets are applied in the following order: first, against outside liabilities; second, against partners' loans and advances; third, against partners' capital ac- counts; and fourth, in the distribution as profits of the residue to the partners on the profit-and-loss ratio. 1 * If, however, there is a loss, this must be distributed in the profit-and-loss ratio before the capital con- tributions may be withdrawn. 17 If losses have been so great as to wipe out the capital account of a partner who has loaned money to the firm, a sufficient amount should be transferred from his loan account to his capital account to cancel the debit balance in the latter account, before payment is made on the loan account. 1 " Losses and Expenses of Liquidation There is considerable dispute among accountants as to the distribution of liquidation losses and gains, some prorating them according to capital investments, 19 others, on the ordinary profit-and-loss ratio. 20 As the partnership is not dissolved until the capital investments are returned, the latter view is the correct one. Purchasing Partner's Interest When a partner agrees to sell his interest in the business, the lx>oks are closed and the profit or loss up to date of sale is distributed to the partners' personal accounts. The retiring partner's personal account is then closed into his capital account, which is, in turn, closed by a debit offsetting the cash, notes, or other property given the retiring partner for his interest. 21 These entries take the fol- lowing form: Jones, Capital Account xxxxxxx Jones, Personal Account xxxxxxx Jones, Capital Account xxxxxxx Cash xxxxxxx Notes Payable xxxxxxx PARTNERSHIP AT LIQTIDATION 115 If the retiring partner sells his interest for less than the book value, the difference is credited to the continuing partner's personal account." The transaction would be journalized thus : Jones, Capital Account xxxxxxx Cash xxxxxxx Smith, Personal Account xxxxxxx However, if the retiring partner receives more than the book value of his interest, the difference may be debited either to the continuing partner's personal account or to the goodwill account. 23 The first method is jour- nalized thus : Jones, Capital Account xxxxxxx Smith, Personal Account xxxxxxx Cash. The second method is recorded by the following entry : Jones, Capital Account xxxxxxx Goodwill xxxxxxx Cash xxxxxxx Personal Insolvency of One Partner Any loss on a debt owed to the firm by an insolvent partner, whether occasioned by withdrawings of capital, operating losses, or liquidating losses, should be borne by the other partners according to the ordinary profit-and-loss ratio. 24 Illustrative Problem To illustrate the effect of dissolution of a part- nership upon the accounts of the firm, assume that the following balance sheet shows the condition after the realization of the assets. The profit- and-loss ratio of Jones, Smith, and Johnson is 3:2:1, respectively; Jones is bankrupt and will not be able to pay anything on his debts. The problem is to close the books. BALANCE SHEET OF JONES, SMITH, AND JOHNSON Cash . . Liquidation Loss. $8,500.00 12,000.00 $20,500.00 Accounts Payable $3,000.00 Jones, Loan Account 2 , 000 . 00 Smith, Loan Account. Jones, Capital Account. . . . Smith, Capital Account. . . Johnson, Capital Account . 1,500.00 1,000.00 5,000.00 8,000.00 $20,500.00 The order and character of the journal entries required to close the partnership books are as follows : (a) Prorating loss on liquidation: Jones, Capital Account (3/6) $6,000.00 Smith, Capital Account (2/6) 4,000.00 Johnson, Capital Account ( 1 /6) 2 , 000 . 00 Liquidation Loss . $12,000.00 .110 ('. P. A. A('( ()l'NT!X(i (b) Transferring Jones' Loan to Capital: Jones, Loan Account $2,000. 00 Jones, Capital Account $2,000. 00 (c) Prorating lo.s on Jones: Smith, Capital Account (2/3) $2,000.00 Johnson, Capital Account (1/3) 1 , 000. 00 Jones, Capital Account $3,000. 00 (d) Transferring Part Smith's Loan to Capital: Smith, Loan Account $1 ,000. 00 Smith, Capital Account $1 ,000. 00 (e) Payment of Accounts Payable: Accounts Payable $3,000. 00 Cash $3,000.00 (f) Payment of Smith's Loan: Smith, Loan Account $500. 00 Cash $500.00 (g) Payment of Johnson's Capital : Johnson, Capital Account $5,000.00 Cash $5,000.00 Capital Deficit As general partners are liable to the extent of their personal fortunes for the debts of the firm, any deficits in the partners' capital accounts created by the distribution of operating and liquidating losses must be canceled by additional contributions. 25 For instance, if Jones and Smith, who shared profits and losses equally and whose capital contributions were $10,000 and $2,000, respectively, had only $3,000 in cash after realizing on the assets and liquidating the liabilities, then Jones would receive all the cash the firm had, together with the $2,500 which Smith would pay into the firm. The journal entries would be : Jones, Capital Account $4,500.00 Smith, Capital Account 4,500.00 Profit and Loss $9,000. 00 Cash 2,500.00 Smith, Capital Account 2,500.00 Jones, Capital Account 5,500.00 Cash 5 , 500. 00 Goodwill in Liquidation When a business is sold as a unit for more than its book value, this excess is goodwill which may be recorded in the books by debiting the goodwill account and dividing the credit among the partners' capital accounts on the profit-and-loss ratio. 26 Goodwill would then be closed with the other assets when the sale is recorded. 27 If the sale is made at decease of one partner, his estate is entitled to its share of the goodwill. 28 PARTNERSHIP AT LIQUIDATION 117 When goodwill is allowed to a retiring partner, the value for the goodwill for the firm must be calculated, but only the goodwill allowed to the retiring partner may be placed on the books because the share of the goodwill belonging to the continuing partners has not been purchased. 2 * Closing Partnership Books After Sale If a partnership sells out, the old books must be closed. This, of course, can be done by simply debiting the liability and capital accounts and crediting the assets. However, it is pref erable to show the closing by steps as follows : 30 Entry No. 1 Jones-Smith Company, Vendee xxxxxxx Assets (itemized) xxxxxxx Entry No. 2 Liabilities xxxxxxx Jones-Smith Company, Vendee xxxxxxx Entry No. 3 Cash xxxxxxx Jones-Smith Company, Vendee xxxxxxx Entry No. 4 Jones, Capital Account xxxxxxx Smith, Capital Account xxxxxxx Cash xxxxxxx If stock is received instead of cash, the first and second entries would be as above, but the third and fourth entries would be as follows : 31 Jones-Smith Company Stock xxxxxxx Jones-Smith Company, Vendee xxxxxxx Jones, Capital Account xxxxxxx Smith, Capital Account xxxxxxx Jones-Smith Company Stock xxxxxxx Liquidation by Installments As the liquidator is personally responsible if he overpays a partner, 32 it is important when partnerships are liquidated by installments to have the capital investments reduced to the profit-and- loss ratio as soon as possible. 33 The rule for finding the amount that should be given to each partner is to consider that all the property besides the dividend is worthless, and that any partner, who may owe the partner- ship when this loss is prorated, is bankrupt. 34 After these assumed losses are prorated, the i-emaining capital represents the correct distribution of the dividend. 35 As an example, assume that the capital accounts of Jones, Smith, and Johnson, after prorating the operating losses, are $20,000, $10,000, and $5,000, respectively. If the partners share profits and losses equally, liquidating dividends of $14,000, $9,000, and $9,000 would be prorated in the manner sho\vn on page 118. 118 C. P. A. ACCOUNTING Total Jones Smith Johnson 1st Capital ... $35,000.00 $20,000.00 $10,000.00 $5,000.00 1st Dividend 14,000.00 Assumed Loss $21,000.00 7,000.00 7,000.00 7.000.00 1st Dividend Unadjusted. Adjustment $14,000.00 $13,000.00 1,000.00 $3,000.00 1,000.00 $2,000.00 2,000.00 1st Dividend Adjusted . . . $14,000.00 $12,000.00 $2,000.00 nil 2nd Capital $21,000.00 $8,000.00 $8,000.00 $5,000.00 2nd Dividend 9,000.00 Assumed Loss. . . . $12,000.00 4,00000 4,000.00 4,000.00 2nd Dividend Adjusted. . . $9,000.00 $4,000.00 $4,000.00 $1,000.00 3rd Capital $12,000.00 $4,000.00 $4,000.00 $4,000.00 3rd Dividend 900000 Assumed Loss. . . . $3 000 00 1 00000 1,00000 1,000 00 3rd Dividend Adjusted . . . $9.000.00 $3,000.00 $3,000.00 $3,000.00 SUMMARY Dividend Jones Smith Johnson 1st . . $12 000 00 $2 000 00 nil 2nd 4 000 00 400000 $1 000.00 3rd 3,000.00 3.000.00 3000.00 As the capital accounts in the above problem are in the profit-and-loss ratio, after the second dividend, the actual loss of $3,000 could be directly prorated on the profit-and-loss ratio, leaving the capital accounts totaling the amount of the last dividend. PARTNERSHIP AT LIQUIDATION Hi) QUESTIONS PAKT.VERSI-HP AT LIQUIDATION 1. As the bookkeeper of a firm that had no articles of copartnership, what would be your duty on learning 1 of the death of a partner? (N. Y., June, 1898.) 2. Describe two or more bases of valuation of a merchandising business, in contemplation of purchase or sale thereof. Illustrate a basis of valua- tion of a professional business in contemplation of admission of a third partner and show how the capital accounts and profits would work out. (111., Dec., 1910.) 3. In arranging- accounts for a partnership, how should Losses on Dissolution of Partnership be treated? (Fla., July, 1909.) 4. How may a partnership terminate? Name the different ways. (Iowa, Dec.. 1918.) 5. A firm of three partners divided their profits as follows : "A," 11/25 ; "B," 8/25 ; "C," 6/25. By the partnership agreement it was pro- vided that in the event of the death of either, the survivors should take the deceased's share in the proportion they already shared the profits. "A" dies. What proportion of the profits would "B" and "C" respectively take afterwards? (111., May, 1910.) 6. In dissolving a solvent partnership in what order should the pro- ceeds of the assets be distributed? (N. D., July, 1916.) 7. What is the status of a partner's loan in the liquidation proceedings f (N. D., July, 1916.) 120 C. P. A. ACCOUNTING PROBLEMS PARTNERSHIP AT LIQUIDATION 1. The capital of a partnership is contributed as follows: "A," $90,000; "B," $45,000; "C," $15,000. The partnership agreement provides for profit-sharing as follows: "A," 50 per cent; "B," 30 per cent; "C," 20 per cent. The partners' salaries are as follows: "A," $5.000; "B," $3,000; "C," $2,000. At the close of the first year's business, "C" dies. The books are closed and the net assets of the business are shown to be $152,500. "A" and "B" liquidate the affairs of the partnership and distribute the surplus assets as follows: First distribution, $42,410.20; second distribution, $74,622.30; final distribution, $31,967.50. Prepare a statement of the partners' accounts, showing how the distribu- tion of the assets should be made and the apportionment. (Md., Feb., 1915; N. Y., June, 1917; S. C., Sept., 1919.) 2. "A," "B," and "C" were in partnership, "A's" capital being $90,000, "BV $50,000 and "C's" $50,000. Their agreement is to share profits in the following ratio : "A," 60 per cent ; "B," 15 per cent ; "C," 25 per cent. During the year "C" withdrew $10,000. Net losses on the business during the year were $15,000, and it is decided to close out the business. It is uncertain how much the assets will ultimately yield, although none of them is known to be bad. The partners therefore mutually agree that as the assets are liquidated, distribution of cash on hand shall be made monthly in such a manner as to avoid, so far as feasible, the possibility of paying to one partner cash which he might later have to repay to another. Collections are made as follows: May, $15,000; June, $13,000; July, $52,000. After this no more can be collected. Show the partners' ac- counts indicating how the cash is distributed in each installment, the essential feature in the distribution being to observe the agreement given above. (Ind., May, 1917; A. I. of A., June, 1917.) 3. "A," "B," and "C" were partners in a business on the following basis : Capital Contributed Share of Profits Salaries "A" . . $45 000 50 per cent 40 per cent 10 per cent $6,000 4,000 2,400 "B" 22 500 -C" 7500 PARTNERSHIP AT LIQUIDATION 121 At the end of the second year's business, "A" died. The partners' draw- ing accounts before crediting their year's salaries appeared with the fol- lowing debit balances: "A," $2,572; "B," $1,218; "C," $1,710. The net assets of the business after finally closing the books were found to be $74,780. "B" and "C" liquidate the affairs of the partnership. Three distributions of the proceeds of liquidation were made as follows: $25,000, $35,000, $11,780. You are asked to prepare a tabulation showing the share of each of the distributions to each of the partners. (Wis., Nov., 1919.) 4. "A" and "B," on winding up their partnership, found their assets realized as follows : Factory premises standing in their books at $10,000 realized $4,000; machinery standing in their books at $7,500 realized $2,500; merchandise standing in their books at $5,500 realized $4,500; accounts receivable standing in their books at $9,500 realized $6,500. Their unpaid liabilities were $10,500. "A's" capital stood at $15,000, and "B's" capital at $7,000. In respect of profits and losses they were equal partners. Divide the proceeds of the realization between them after paying off the liabilities, and debit them as having been paid the proportion to which each was entitled, and show what amount would be payable (if any) by either partner to the other to settle the accounts. (111., May, 1910; N. D., Aug., 1917.) 5. "A," "B," and "C" are in partnership. "A" invested $11,000; "B" invested $5,000 ; and "C" invested $1,200. Their agreement provides that profits or losses shall be divided as follows: A," 4/9; "B," 3/9; "C," 2/9. The partnership has become insolvent and has therefore decided to dis- solve. The cash value of assets is $10,000. The deficit is, therefore, $7,200. How should the assets be divided and how much money will each partner receive? (Wis., May, 1916.) 6. "A" and "B" are partners sharing losses and gains equally. "A" invested $3,000, "B" invested $4,000. They are ready to wind up the business. The firm owes $5,000 of which $1,000 is due "A," and $500 is due "B." They have $7,000 in cash. Prepare the accounts showing the closing. (Mich., June, 1914.) 7. Jones and Brown are partners, sharing profits equally. Their capi- tal as it appears on the books of the partnership on June 20, 1908. the date on which they dissolve partnership, is Jones $2,000 and Brown $500. The total amount owing by the firm is $5,000 which includes $1,000 due to Jones on a loan and $500 due to Brown on a loan. The whole of the assets of the firm realize $6,000. Prepare accounts closing up the part- nership and show the position in which the partners stand with each other. (Mich., July, 1909.) 8. Two parties, "A" and "B," have been in business for the three years ending December 31, 1904, on which date they agree to dissolve partner- 122 C. P. A. ACCOUNTING ship. "A" takes over the business, paying "B" $7,500 for his share of the goodwill. "A" has drawn out each year $2,000 and "B" $3,000. "A's" capital at start was $10,000, and "B's" $12,500, and the profits of each year have been $3,500, $4,200 and $4,600, respectively. There was no deed of partnership, nor any agreement as to interest on capital. Draft ac- counts showing "A's" capital on taking over the business, and the amount "B" will receive on retiring. (Wash., April, 1906.) 9. "A," "B," and "C" engage in business, "A" contributing $10,000 capital, "B" contributes $5,000, while "C" in lieu of any capital contribu- tion, agrees to undertake the active management, at a salary of $3,000 a year, to be paid monthly. After allowing 5 per cent interest on capital, they are to divide the net result in the proportions of 5, 3 and 2, respectively. At the end of eighteen months they ascertain the position to be unfavorable and decide to wind up. The assets realize $12,500; there are no liabilities except for capital and interest thereon and one month's salary, due to "C." Make up the partners' accounts showing the amount to be received by each. (Mass., Oct., 1914.) 10. "A" and "B," partners in a commercial enterprise, share profits and losses equally. At the end of five years the partnership terminates and the balance sheet shows as follows : Assets Cash on hand and in bank .... $5,600 Accounts Receivable . . 28,000 Merchandise Inventory 38,000 Plant and Machinery 15,400 $85,000 Liabilities Accounts Payable $30,000 -Bills Payable 10,000 Capital : "A" $30,000 "B" 15,000 45,000 $85,000 After studying the Balance Sheet an offer to buy at $30,000 (except cash) is accepted. Make final adjustments and closing entries and show amount each partner receives. (Ind., June, 1916.) 11. By partnership agreement existing between Brown and Gray, Brown has 2/3 of the profits and Gray 1/3. Brown's capital account stands credited $50,000. Gray's capital account stands credited $40,000. The assets of the partnership consist of the following: Factory and Ma- chinery, $75,000; Stock as per inventories, $30,000; Accounts Receivable, $15,500. The liabilities are as follows: Accounts Payable, $15,000; Notes Payable, $10,000; Overdraft Bank, $5,500. Gray takes over the liabilities as above mentioned, and the assets at the following agreed valuation : Factory and Machinery, $70,000 ; Stock as per inventories, $26,000; Accounts Receivable, $14,000. An arrangement is made whereby Gray received $500 from Brown for accepting sole liability for the discounted bills receivable. PARTNERSHIP AT LIQUIDATION 123 Make up a statement showing the amount that Brown should receive it being understood that the losses on capital are borne by the partners' in the proportion in which the profits are divided. (W. Va., May, 1919.) 12. Brown, Black and Green were engaged in a merchandise business as partners. On December 31, 1913, a Balance Sheet, to which all of the partners agreed, showed the following financial position in the business: Assets Real Estate $10,000 Horses, Wagons, and Fixtures 5,000 Liabilities Mortgage Payable $4,000 Accounts Payable 30,000 Merchandise on hand 14,000 Brown: Accounts Receivable 38,000 Capital account $25,000 Cash in bank and on hand. . . 14,000 Green 1,000 $82,000 Drawing account 10,000 35,000 Black: Capital account $15,000 Drawing account 2,000 13,000 $82000 The profits are shared in the following proportions : Brown, ^2 > Black, 1/3; and Green, 1/6. It was decided to dissolve the partnership as at the date of the above Balance Sheet. The real estate was sold for $13,000. Bad debts and discounts allowed amounted to $5,000. The merchandise realized $12,000, and the horses, wagons and fixtures were sold for $3,000. The mortgage on the property was paid off, interest thereon amounting to $80. The accounts payable were paid, less discounts amounting to $1,000. The expenses incurred during the period of realization amounted to $3,000. After the assets had been realized and all the liabilities had been dis- charged, Green became bankrupt, and a claim was made against his estate for the amount due from him to the firm on the dissolution and a dividend thereon at the rate of 20 cents on the dollar received. By the end of the year 1914 all matters were disposed of. Write up the Realization (Profit and Loss) account, Cash account (in summary form), and the Capital and Drawing accounts of the partners, and close the books of the firm. (Wash., June, 1915.) 13. "A" and "B" were partners trading under the name of "A," "B" and Company. June 30, 1908, the following balances appear on their ledger : "A" Capital account $70,000 "B" Capital account 50,000 Real estate 22 ; 000 Buildings 20,00 Machinery and tools 44,00 Furniture and fixtures 2,00 Accounts receivable 50 000 Cash 7,000 Materials and merchandise 53.000 Accounts payable ^ /Si Bills payable 48,00 Bills receivable 5,UUU 124 C. P. A. ACCOUNTING On June 30, 1908, the business is incorporated as the "X" Company, on the following plan: (1) Capital Stock, $150,000. (2) "X" Company takes over entire assets and liabilities of "A," "B" and Company, at the book figures as above, except (a) real estate of the book value of $5,000, which is retained by "A," "B" and Company; (b) the Accounts Receivable, which are taken over at $48,000, and (c) the Capital accounts of the partners. (3) "X" Company pays "A," "B" and Company $30,000 for the good- will of the business. (4) Payments to "A," "B" and Company are made as follows: viz., $50,000 in first mortgage bonds, and the Balance in capital stock of the "X" Company. (5) After paying off "A," "B" and Company the remainder of the capital stock is sold for cash to sundry persons. The real estate which is retained by "A," "B" and Company is bought from "A," "B" and Company by "A" for $7,000 and is to be charged to "A's" Capital account. After the completion of the foregoi'ig described transactions "A" and "B" dissolve partnership. You are required : (a) To prepare closing entries for the books of "A," "B" and Company. (6) A statement setting forth the partners' accounts down to their final closing, beginning with the balances shown by the books on June 30, 1908. (Wash., Aug., 1908.) 14. "A" and "B" trading in partnership decide to admit "C" as from January 1, 1919. They agree with "C" as follows: "C" is unable to contribute any tangible assets as his capital investment, but agrees to allow his share of the profits to be credited to his capital account until he shall have one fifth interest. "C" is to share profits and losses to the extent of one fifth. "C" is to receive a salary of $3,000 per annum, payable monthly in addition to his share of profits. Balance Sheet of "A" and "B" at December 31, 1918, >is as follows : Assets Cash $1,500 Accounts receivable 10 ; 000 Merchandise 7.500 Furniture and fixtures 1 ,500 Goodwill 2,500 $23,000 Liabilities Accounts payable $8,000 Capital accounts "A" $10.000 "B" 5,000 15,000 $23,000 During the six months ended June 30, 1919, the business has sustained unusual losses and it is decided to dissolve the partnership. PARTNERSHIP AT LIQUIDATION The Balance Sheet at that date is as follows: 125 Assets Cash $500 Accounts Receivable 12,f>00 Merchandise Furniture and fixtures Goodwill Deficit Being loss on trading for six months . . 5000 i;500 2,500 5,500 $27,500 Liabilities Accounts Payable $12.500 Capital Accounts "A" $10,000 "B" 5,000 15,000 $27,500 Accounts Receivable were sold for $9,000, the buyer assuming all re- sponsibility for collection and loss, if any. Merchandise realized $6,500, and furniture and fixtures, $500. You are asked to make an examination of the accounts from January 1 and to prepare statements showing the realization of assets, the adjust- ment of the partnership accounts, and the distribution of the funds. In your examination you find that "C" has not drawn his salary for four months and that "B" has advanced to the partnership $2,500 by way of a temporary loan. These liabilities you find are included in the sum of $12,500 shown as Accounts Payable. "C" is ascertained to be worthless. (A. I. of A., Nov., 1919.) CHAPTER VIII CORPORATION STOCK Corporation Defined Chief Justice Marshall has defined a corporation as "an artificial being, invisible, intangible, and existing only in contem- plation of law." A corporation is an artificial legal person, or entity, having an existence distinct from that of the members composing it, and having in addition to the powers granted by its charter, the implied powers of a natural person. 1 Classes of Corporations From the standpoint of purpose, corporations may be divided into two classes, viz.: (a) those for profit, and (b) those not for profit. 2 From the standpoint of ownership, corporations may be classified into public or governmental organizations, and private corpora- tions. 3 Quasi-public corporations are those privately owned companies, which, although operated for profit, promote some public enterprise. 4 Private corporations are of two types, (a) stock companies, or firms operated for profit, and (b) non-stock companies, or non-profit-making enterprises, such as libraries, churches, etc. 5 Stock corporations are called sole corporations if all the stock, except a few shares, is held by one person, 6 open corporations if the stock is freely bought and sold, 7 and close corporations if the stock is not traded in and the control is retained within a small compass of ownership. 8 From the standpoint of the sovereignty to which allegiance is due, cor- porations are either domestic or foreign, depending upon whether the corporation is in the state or country within which it was organized.* From the standpoint of the fact of incorporation, corporations may be classed as (a) de jure, or those legally incorporated, and (b) de facto, or those which have not fully met all legal requirements but are to all intents and purposes corporations in fact. 10 Advantages and Disadvantages of Incorporation The chief advantages of incorporating are (a) limited liability of stockholders, (b) distinct legal entity, (c) stability and permanency of organization, (d) transferability of shares, (e) increased available capital, and (f ) centralized control." The chief disadvantages of incorporating are (a) lack of motivation on the part of officials, (b) onerous taxation, (c) required filing of many reports, (d) limitations on business activities, (e) limitation of credit to the amount of net assets, and (f ) illegality in some states of owning stock of other corporations." Procedure of Incorporation The state laws governing incorporation usually require that three or more persons prepare an application for 'For explanation of superior figures see page 337. 126 CORPORATION STOCK 127 incorporation, which, after proper publicity and when approved by the proper official after the payment of prescribed fees, becomes the charter or certificate of incorporation of the company. 13 The stockholders then complete the organization by electing directors, adopting by-laws, and making necessary arrangements for the conduct of the corporate business." Charter The charter, or certificate of incorporation, recites (a) name of corporation, (b) purpose of corporation, (c) amount and kinds of capital stock, (d) number and par value of share of stock, (e) location of principal office, (f) duration of corporation, (g) number of directors, (h) names and addresses of first directors, and (i) names and addresses of subscribers to the certificate with number of shares subscribed for by each. 15 By-Laws By-laws are the rules of corporate action which are adopted at stockholders' meetings. 19 By-laws i-egulate the relations of the stock- holders with the directors, of the directors with the stockholders and officers, and of the corporation with outsiders who have knowledge of the existence and import of the by-laws. 17 If especially authorized by the charter or by the state laws, directors can adopt by-laws. 18 The auditor should ascertain the duties and powers of each officer from the by-laws, 18 which information is needed before the authenticity of the records can be thoroughly verified. Stockholders Stockholders have the common law right to make or change the by-laws of the corporation. 20 They may insist on having cer- tificates of stock issued to them showing the number of shares they own. 21 When this ownership of the certificates is recorded in the books of the corporation, the owners are called stockholders of record. 22 Stock- holders of record alone may vote and receive dividends, and, although a transferee has equitable title to any dividend declared after date of pur- chase, he can not receive it except by recovery through the payee, the stockholder of record. 23 Stockholders have a common law right to inspect the books of the corporation, but state statutes and corporate by-laws usually require that good i-eason be shown for such inspection, which, when arbitrarily enforced, reduces to nil the stockholders' right to inspect the books of account." Stockholders may vote to elect directors, increase or decrease the capital stock, amend the charter, and dissolve the cor- poration. 25 Stockholders may subscribe to their due proportion of all increases in capital stock. 29 At stockholders' meetings each stockholder is entitled to a vote for each share of stock standing in his name on the books. 27 In the election of directors, some states allow each share of stock one vote for each director to be elected, which votes may be cumulated upon one director or scattei-ed at the option of the stockholders. 28 When a stockholder desires, he may delegate his voting powers to another stock- holder who is said to be his proxy. Auditors are sometimes called upon to make an audit of proxies, which is done by obtaining a list of the >tookholders of record from the stockholders' ledger and then verifying the transferal of the voting privileges. 30 128 C. P. A. ACCOUNTING In the event of insolvency, stockholders are not liable for the firm's debts, provided their stock is fully paid, 31 but they are liable for the dif- ference between that which they paid and that which they should have paid to make their stock fully paid, even though the corporation agreed to accept the payments made as full consideration. 33 This liability is fre- quently avoided by having the directors, whose valuation in the absence of the proof of fraud is final, 33 issue all or a large part of the stock for property, the former owners of which then donate part of this stock to the corporation which can then sell this once-issued stock below par. 3 * Innocent purchasers for value are not liable for the unpaid balances on their holdings. 35 Directors The powers of directors vary largely because of the lack of uniformity in state statutes and corporate by-laws. In general, directors have the power to borrow money, to create new debts, to liquidate old debts, to lease corporate property if such lease does not force the dis- continuation of corporate business, to declare dividends out of surplus, to conduct corporate litigation, to ratify a debt which has been barred by the statute of limitations, to make and transfer negotiable paper, to fix the salaries of corporate officers, to prepay wages, and to make con- tracts with persons for services for periods of one year and more. 3 " Unless especially authorized by state statutes or corporate by-laws, directors must secure the sanction of the stockholders before they can make any change in the authorized capital stock of the company, issue mortgages, cancel subscriptions for stock, or dissolve the company. 37 They can not issue more stock than is authorized, 38 or execute leases divesting the corporation of its physical assets. 38 Unless permitted by statutes, directors can not issue stock below par. 40 They can not vote by proxy at meetings of the directors as the position of director is a fiduciary one involving trust and confidence." Since directors are trustees, both for the stockholders and creditors, they can not secure for themselves any advantage which the stockholders can not share, or which would cause the rights of the creditors to become inferior to theirs. 43 As many states hold directors personally responsible for debts con- tracted under certain circumstances and in excess of certain sums, it is important, in examinations for credit purposes, for the auditor to ascer- tain from the statutes whether or not the directors have automatically made themselves liable for any part of the indebtedness. 43 Directors are held personally liable for declaring a dividend in excess of profits or surplus. 44 Minute Books There is no special form of minute book, but the most modern and convenient form is a loose-leaf book. 45 In large corporations, separate books are kept for the stockholders' and directors' minutes, but in small corporations the stockholders' and directors' minutes are recorded in the front and back, respectively, of the same book. 48 The minute book should contain, first, a copy of the charter; 47 second, a copy of the by- laws; 48 and lastly, a complete record of the kind of meeting, whether CORPORATION STOCK 129 regular, special, or adjourned,* 9 and of the action taken at the stock- holders' and directors' meetings. 80 The minutes are examined by auditors with regard to the election of officers, the compensation of officers, extra compensation, bond of the treasurer, depositories, contracts with manager, contracts for the purchase of a business, contracts for additions to plant, contracts for future de- livery of materials in unusual quantities, valuation fixed on purchased property, depreciation rates, possibility of litigation, settlement of pending litigation for a sum in excess of liability carried therefor in the books, and contingent liabilities." If the auditor is denied an inspection of the minute book, he should mention that fact in his report and in a footnote to his balance sheet." Corporate Officers The duties of the officers of a corporation are as- signed by by-laws, custom, common consent, or action of the board of directors. 53 The number, titles, and powers of these officers vary accord- ing to the size and internal organization of the corporation. 54 A corpora- tion usually has a president, one or more vice-presidents, a secretary, a treasurer, and an auditor.'" These officers are chosen either by the directors or stockholders, 58 usually the former. No officer is personally liable for the acts of another officer, and no officer can involve the corporation by unauthorized acts." Capital Stock The capital stock of a corporation is the amount of stock which it is authorized to issue. 58 The amount of authorized capital stock can be changed only by compliance with the requirements of the state laws. 58 It is sometimes claimed that capital stock represents the total number of shares of stock outstanding/ but the term is more inclusive than that, as unissued authorized stock is also capital stock." 1 The capital stock may be called the nominal or share capital of the corporation.' 2 If the actual capital stock of the corporation, the excess of assets over liabilities, 13 is greater than its capital stock, the difference is called surplus."* This difference between the nominal and actual capital of a corporation causes the capital stock to have two kinds of value, namely, par value, or the nominal value printed on the certificate, and book value, or the quotient of the net worth of the corporation divided by the number of shares outstanding. No Par Stock Ten states permit the issue of capital stock with no par value." 5 The stock certificates must show the number of shares they represent and the number of shares the corporation is authorized to issue.* 1 The value of no par stock is its book value found by dividing the net worth by the number of shares outstanding, 87 each share repre- senting an aliquot interest. 88 When a company issues both par and no par stock, care must be taken to show the portion of the profits belonging to each, though this division may or may not be shown on the balance sheet.* When all the stock is without par value, and there is but one class of stock, there is no necessity for maintaining a surplus or undivided profits account, for the result of current operations can be closed into the capital 130 C. P. A. ACCOUNTING stock account. 7 " However, no par stock may be held on the books at its book value just after the organization, and fluctuations in value may be shown in a surplus or deficit account.' 1 The latter method, which is called holding the no par stock at its stated value, seems preferable. In either case, specific proprietoi-ship reserves should be stated separately." It is sometimes contended that, if current profits are closed into the capital stock account instead of into the surplus account, the profits would not be available as dividends on the ground that combining the capital stock and current profits has the same effect as a stock dividend in an ordinary corporation." This contention overlooks the fact that stock dividends involve the issue of new shares of stock. The no par capital stock account should be credited for the value re- ceived for the stock. 74 The number of shares outstanding should be shown either on the balance sheet' 5 or in a footnote thereto. 76 Unsubscribed no par stock should not be shown at all on the balance sheet as it may be subscribed for at prices other than the stated value. 77 When unsubscribed stock is sold after a company has accumulated a surplus, the amount received in excess of the stated value of the then outstanding stock should be credited to the surplus account, if that account is maintained. 78 The number of donated shares may be earned without value in the treasury stock account, 79 but, if a surplus account is maintained, it would seem preferable to value the donated shares at their stated value and credit the capital surplus account therefor. No par stock repurchased may be debited to the treasury stock account at cost price, 80 but, if a surplus account is maintained, it would seem preferable to debit the treasury stock account for the stated value, the difference between the stated value and cost being charged or credited to the capital surplus account. The advantages of issuing no par stock are (a) the checking of the tendency to inflate value of assets in order to offset the nominal value of certificates issued therefor, 81 (b) the assurance given the investor that stock is fully paid and non-assessable,*" (c) the special facilities afforded in case of consolidation or reorganization,"' and (d) the fact that the investor is put on his guard to find out the real value of the stock. 84 The objection that no par stock provides more opportunities for improper manipulation does not seem to be justified, as there are many well known legal methods of evading the statutory requirements as to a fixed par value. 85 Kinds of Stock with Par Value The corporate stock having par value may be divided into the following classes : (a) Unsubscribed, or shares not only unissued but for which no sub- scription has been received. 8 " (b) Unissued (sometimes called potential), or shares for which cer- tificates have not, been issued. 87 (c) Treasury, or shares of issued fully paid stock reacquired and held by the corporation subject to disposal by directors.* 1 (d) Authorized, or total number of shares the corporation has permis- sion to issue. CORPORATION STOCK 131 (e) Canceled, or the shares of authorized stock which have been de- clared void, thus reducing the number of shares the corporation can issue. (f ) Outstanding, or issued shares in the hands of the public. 8 * (g) Non- voting, or shares not giving owners votes in stockholders' meetings. 90 (h) Common, or shares with no financial preference over any other stock of the company. 91 (i) Preferred, or shares with financial preference, either as to divi- dends or principal, or both, over other stock of the company. 82 (j) Non-participating, or shares of preferred stock which do not share in the profits beyond their preferential dividends. 8 ' 1 (k) Non-convertible, or shares which cannot be exchanged for some other form of ownership or obligation. 84 (1) Cumulative, or shares whose dividends, if not paid in one year, continue as a charge against the profits of succeeding years. 95 (m) Redeemable, or shares issued under contract to redeem them after a certain length of time, at a named figure. 9 ' 1 (n) Foundei's, or shares of English origin (issued to promoters) which are preferred as to their share of dividends; for instance, founders' stock might receive one-half more dividends than the ordinary common stock. 97 (o) Guaranteed, or shares which, as to dividend or principal, or both, have been actually guaranteed by some person, concern, or corporation other than the issuing corporation. 98 (p) Debenture, or shares issued under contract to pay absolutely there- on, at specified intervals, a specified return. 99 In England debentures are unsecured loans issued in irregular amounts. 100 Debenture stocks are to be classified as liabilities. 101 (q) Watered, or shares fictitiously designated as paid-up stock. 102 (r) Forfeited, or shares taken back because of failure to make the agreed purchase payments. 101 (s) Bonus, or shares given extra upon the purchase of other stocks or bonds. 104 (t) Donated, or shares of issued paid-up stock which have been given back to the corporation. 105 Donated stock should be entered on the books as treasury stock. 10 "' As each of these classes contains only shares having special characteris- tics, stocks not having these characteristics must fall into classes whose titles are generally the opposite of the above, viz., subscribed, participat- ing, irredeemable, etc. Capital Stock on Balance Sheet While unsubscribed stock is not an asset as far as the outside creditors are concerned, yet it is a matter of which the stockholders should have knowledge. 107 The unsubscribed stock should, therefore, be deducted from the authorized stock, as this would not list the unsubscribed stock as an asset. 108 As unissued stock is not an asset, it should be deducted from the authorized capital stock. 109 Some accountants believe that treasury stock is an asset, as it represents an actual value received by a corporation, either through purchase or .132 ('. P. A. ACCOrXTTN(! donation, lin and they so list it on the balance sheet. 111 Some accountant - classify treasury stock as an "accrued item," 112 but this seems incorrect, for, even if treasury stock were an asset, it does not accrue. Other accountants see in treasury stock a decrease in stock proprietorship, and deduct it at par from the authorized capital stock. 113 It seems that the last view is preferable, especially as treasury stock does not fulfill the functions of an asset when the corporation is dissolved ; it liquidates neither the liabilities nor the outstanding capital stock. Stock Certificate Book Stock certificates are usually bound together with a stub for each certificate. 114 Both the certificate and the stub are numbered consecutively, 11 " and contain spaces for the purchaser's name and the number of shares issued. 110 The stub also lists for what the stock was issued, name and address of former owner of shares, number of original certificate, number of shares on original certificate, number of shares transferred, and a receipt for the certificate. 117 The certificate is a formal document under corporate seal, and with the signatures of the authorized officers. 118 On the back of the certificate there is usually a blank for assignment of the stock. 118 The certificates for the stock that has been transferred or canceled should always be pasted back on the stubs from which they were taken. 120 The stubs that have no certificates attached would then represent the outstanding stock. 121 Stockholders' Ledger Except in New York and a few other states where the form of the stockholders' ledger is prescribed by law, there is little or no uniformity in stockholders' ledgers. 122 The object of this ledger is to keep with each stockholder an account which will show the date and num- ber of the certificates and the number of shares on each certificate issued to him, and if any certificates are transferred, the date, name of trans- feree, number of surrendered certificates, number of reissued certificates, and the number of shares transferred." 3 Any form tabulating this data conveniently is satisfactory. A capital stock account is sometimes opened on the front page of the stockholders' ledger, and debited with the aggregate amount of shares credited to the stockholders' accounts, which practice makes the ledger self -balancing and shows at any time the amount of outstanding stock. 124 Opening Entries for Corporation There are so many satisfactory methods of opening corporate books that most authors give more than one way. The following procedure 125 is recommended for three reasons, namely, (a) unissued stock is shown on the books, (b) the practice of not issuing stock until fully paid is recognized, and (c) the distinction between un- issued and unsubscribed stock is drawn : Entry No. 1 Unissued Capital Stock xxxxxxx Capital Stock Authorized xxxxxxx Entry No. 2 Subscribers xxxxxxx Subscriptions xxxxxxx CORPORATION STOCK 133 Entry No. 3 Cash Subscribers . Entry No. 4 Subscriptions xxxxxxx Unissued Capital Stock xxxxxxx For a briefer procedure the following is recommended. 121 Unsubscribed Capital Stock xxxxxxx Subscribed Capital Stock xxxxxxx Authorized Capital Stock xxxxxxx Cash xxxxxxx Subscribed Capital Stock xxxxxxx Subscriptions Unconditional accepted subscriptions for capital stock bind the subscribers, as they can be enforced either by the company itself or the creditors after insolvency. 1 " The uncalled subscriptions for capital stock are accounts receivable, but they must be kept in a class by them- selves." 8 Sometimes unpaid calls are deducted from the authorized capital stock, 129 but it seems preferable to treat them as assets. The practice of classifying subscriptions as "accrued items" 130 seems incorrect, as they do not accrue. Subscription Ledger There is no set form to the subscription books, but it usually contains columns showing when the calls are to be made, when actually made, when paid, and the balance due. 131 In general, these columns are grouped so that the ledger follows roughly the "T" form, the asset subscriptions being entered on the left and payments thereof, on the right. 132 The subscription account acts as the controlling account for this ledger. 133 Transfer Journal The stock transfer journal or register contains the original entries of stock transfers which are posted to the stock ledger. 134 Sometimes the transfer journal is combined with the stock ledger, but the laws of many states, including New York, require separate books and prescribe the form of the transfer journal. 135 The New York form records in separate columns the date, serial number of canceled certificate, number of shares, by whom surrendered, to whom issued, serial number of new certificate, number of shares, and number and value of revenue stamps. 1J " The transfer journals outside the state of New York approximate the same form except for the data .on revenue stamps. 137 Sometimes, the transfer book is merely a duplication of the assignment ordinarily appearing on the back of each stock certificate. 138 In such cases, the book used as a posting medium for stock transfers is called the register of transfers. 13 " Installments If the subscribers do not settle for their stock in one pay- ment, the first, second, and fourth entries in the proposed detailed pro- cedure for opening corporate books would be used, but, instead of the third entry, the following would be used : 1<0 134 C. P. A. ACCOUNTING Entry No. 3 (a) Installment (or Call) No. 1 xxxxxxx Installment (or Call) No. 2 xxxxxxx Subscribers Entry No. 3 (b) Cash xxxxxxx Installment (or Call) No. 1 Installment Ledger The purpose of the installment book or ledger is to give a classified record of original subscriptions, installments due and paid, and balances still unpaid.' 41 Separate records should be kept for each installment. 143 There are two general forms of installment books. One of these is based on the "T" form and contains on the left side columns for date, shares, how acquired, percentage unpaid, certificate number of scrip, and amount ; and on the right side, columns for date, shares trans- ferred, how settled, percentage unpaid, certificate number of scrip, how many shares paid, installment number, and amount. 143 The other form is based on the Boston ledger form, and contains a list of subscribers, num- ber of shares subscribed by each, amount of installment, date of payment, amount received, and remarks relating to the particular installment. 144 The installment account is the controlling account for the installment ledger. 145 Installment Scrip Book The installment scrip book contains blank re- ceipts to be filled out and signed by the authorized corporate officers when the installments are paid by the subscribers. 146 The details of each receipt issued are recorded on its stub, from which the proper entries may be obtained for the stockholders' ledger and for the other books. 147 Upon the payment of the last installment, the scrip is taken up and replaced by a certificate of stock. 148 Instead of giving individual receipts for the pay- ment of each installment, sometimes a more elaborate receipt called a stock scrip is given on the first payment, and subsequent installments are en- dorsed on the back of the stock scrip. 148 Both the installment scrip and the stock scrip are transferable. 150 Forfeited Stock Unpaid subscriptions to capital stock can be declared forfeited only if the statutes specifically grant the corporation that power. 151 In some states the entire amount paid in may be declared forfeited, 152 while in others only enough to cover the cost of placing the corporation in as good condition as it would have been had the subscriber fulfilled his obli- gation, may be retained by the corporation. 153 When a corporation declares a subscriber's stock forfeited for nonpayment of any balance, all liability on the part of the subscriber ceases both to the creditors of the corpora- tion and to the corporation on account of the subscription. 154 The profit arising from the forfeiture of stock is sometimes credited to profit and loss," 5 but as the profit is not an opei-ating item, it is preferable to credit it directly to surplus. 15 ' Any discount or premium on the sale of forfeited stock should be closed into the surplus arising from the forfeiture. 1 " Surplus from forfeited stock should not be declared as dividends, although CORPORATION STOCK 135 such action is not illegal. 108 The auditor should verify forfeited stock with data from the minute book. 1 ''* By way of an illustration of the entries for forfeited stock under the proposed detailed procedure for opening corporate entries, assume an authorized capitalization of $1,000,000, one-half subscribed and subscrip- tions payable in four equal installments. The following entries 100 would be necessary if one hundred shares were declared forfeited for failure to pay the second, third, and fourth installments and these shares were resold at $90 a share. The entries have been divided into four parts to show what entries take the place of the four usual entries in the proposed pro- cedure for opening corporate books. Part 1 Unissued Capital Stock $1,000,000.00 Capital Stock Authorized SI , 000 , 000 . 00 Part 2 Subscribers 500,000. 00 Subscriptions 500,000. 00 Part 3 Installment No. 1 125,000. 00 Installment No. 2 125,000.00 Installment No. 3 125,000.00 Installment No. 4 125,000. 00 Subscribers 500,000. 00 Cash.. 492,500.00 Installment No. 1 125,000.00 Installment No. 2 122, 500. 00 Installment No. 3 122,500.00 Installment No. 4 122,500.00 Subscribers 7,500.00 Installment No. 2 2,500.00 Installment No. 3 2,500.00 Installment No. 4 2,500.00 Subscribers.. 2,500.00 Surplus from Forfeited Stock .... 2 , 500 . 00 Subscriptions 10,000.00 Subscribers 10,000. 00 Subscribers 9,000.00 Surplus from Forfeited Stock 1 ,000. 00 Subscriptions 10,000.00 Cash . 9,000.00 Subscribers -.'.-. 9,000.00 Part 4 Subscriptions . . 500 , 000 . 00 Unissued Capital Stock 500 , 000. 00 136 C. P. A. ACCOUNTING Payment for Stock As is shown by the above illustration, the method of payment for stock affects only the third section in the proposed pro- cedure for opening corporate books. This section may be further compli- cated because stock may be paid for by cash, services, or property. In all these cases, the credit is to subscribers. However, if cash is received, then the cash account is debited; 1 " 1 if services are received, accounts like manager's salary, commissions, etc., are debited ; M and if property is received, the fixed asset accounts are debited. 183 When going concerns are taken over by new corporations, it is customary to debit the itemized assets and credit a vendor account, to credit the itemized liabilities and debit the vendor account, and then to close the vendor account against the sub- scriber's account. 1 ' 4 These entries are illustrated in Chapter VI, Volume II, under the caption "opening entries for amalgamated companies." Some- times a sundry asset account and a sundry liabilities account are used instead of the vendor account. 1 ' 5 In auditing the payments for stock, the auditor should refer to the minute book to verify the authorization of issues for property or for cash at varying rates of discount or premium. 1 "" Premium and Discount on Stock Since the subscriber's account used in the second section of the proposed detailed procedure for opening cor- porate books is an asset representing the amount the subscriber promised to pay for the stock, premium and discount on capital stock are recorded in the second section. If the stock is sold at a premium, the debit to subscribers offsets credits to both the subscriptions and premium on stock accounts. 1157 If the stock is sold at a discount, the debits to subscribers and discount on stock accounts are offset with the single credit to subscriptions account. 1 ' 8 Discount on stock should not be regarded as organization expense. 1 " It may and should be extinguished by premiums, assessments, surplus, or by the retirement of an equivalent amount of stock. 170 Some accountants show discount on capital stock on the balance sheet as a deferred asset, 171 while others list it as a deduction from the par value of the outstanding stock. 171 The latter method seems preferable as the discount really causes a capital deficit. Premium on stock is a capital surplus, 173 and should therefore not be distributed as dividends, although such action is not illegal. 174 The premium on stock account should be kept open as a special surplus account and this special surplus should not be transferred into general surplus where it will be looked upon as available for dividends. 175 The Interstate Commerce Commission requires that the discount on issued stock be subtracted from the premium on issued stock, and that any balance be shown on the balance sheet as a deferred item. 17 * Donated Stock When stock is donated to the corporation, it is recorded at par value. 177 There are two methods of handling donated stock, which are illustrated in the following entries required for a donation of shares having a par value of $10,000, but which realized only $7,500. CORPORATION STOCK 137 Entry No. 1 (Same both methods) 178 Treasury Stock $10,000.00 Donation Account (or Working Capi- tal Donated) $10,000.00 Entry No. 2 (Same both methods) 179 Cash 7,500.00 Donation Account 2 , 500 . 00 Treasury Stock 10,000.00 Entry No. 3 (First Method) 180 Donation Account 7 , 500 . 00 Contributed Surplus 7 , 500 . 00 Entry No. 3 (Second Method) 181 Donation Account 7 , 500 . 00 (blank) Account (Insert name of fictitiously valued asset) 7 , 500 . 00 The second method is preferable in that it gives a conservative pres- entation of conditions, but the choice of method is a matter to be decided by the treasurer and directors of the corporation. 182 If desired, the discount or premium on treasury stock may be shown in separate accounts under those titles, instead of being recorded directly in the donation account, but such accounts would be merged into the donation account when all the stock was sold. 183 Sometimes the subscriptions to treasury stock and subscribers to treasury stock accounts are also used. 184 Bonus Stock Stock given as a bonus to subscribers for the issue of other corporate securities is usually treated as organization expense and written off over a period of years. 188 However, as a bonus is practically discount on treasury stock, it seems preferable to treat a bonus as discount on stock instead of as organization expense. 186 Bonus stock is iisually treasury stock, as original stock cannot be issued below par as paid-up stock. 187 Redemption of Stock Reduction in capital stock cannot be accom- plished without the consent of at least a majority of the stockholders 188 and authorization by the state. 189 In most states a corporation cannot reduce its capital stock to an amount less than that of its liabilities. 1 * Redemption at book value is accomplished by debiting capital stock for its par value and surplus for the pro rata share in the surplus, and crediting cash. 1 Redemption at par affects only the capital stock account, but redemption at other than par affects both the capital stock and surplus accounts. 1 " Audit of Capital Stock The charter, by-laws, and minutes should be examined by the auditor for information relative to authorized capital, method of payment, and all other provisions governing the issuance of stock. 1 * 3 A complete record of the authorized and issued stock should be made. 1 * 4 The stock certificate book should be examined and reconciled with the stockholders' ledger, 1 " 5 all canceled certificates being inspected or accounted 138 C. P. A. ACCOUNTING for. 1 " The uucaiiceled certificates represent the outstanding stock. 197 An auditor is not required, as a general thing, to examine the transfers. 188 He should, however, obtain a certificate from the transfer agent as to the capital stock outstanding. 10 * A trial balance should be taken of the stockholders' ledger to see that the aggregate outstanding stock agrees with the general ledger account. 200 The auditor should see that the certificates of treasury stock have been endorsed over to the corporation or its trustee, and, if the treasury stock was donated, the intent of the donors should be ascertained. 201 The pro- ceeds of stock sold during the period should be verified. 202 The auditor must assure himself that all issued shares have been fully paid/ 03 but he is not called upon to challenge the good faith of the di- rectors. 204 If stock has been sold on the installment plan, he should ascer- tain whether or not the calls have been promptly met. =os Stock pledged as collateral should be properly designated and shown on the balance sheet as a deduction from the outstanding stock.'' 100 Organization Expense Organization expenses are those costs neces- sarily incurred for the purpose of getting a corporation started. 207 Some accountants stress the fact that a corporation organized and ready to commence business is in a better position than an unorganized company, and the fact that the value of these costs will last as long as the corporate existence. 2 " 5 They therefore classify organization expense as an intangible asset. 208 Other accountants, while admitting these two facts, stress the need of keeping the balance sheet free from assets which have no salable value, and therefore regard organization expense as a deferred charge to income, which should be written off in about five years. 210 A few account- ants are still more conservative and advocate charging off organization expenses as they are incurred, or, at most, over the first two years' opera- tion. 211 Since organization expense is an unsalable asset, it should be written off, but it would be better to write it off in five years than in two, as this would not reduce the dividends so severely. Organization expense written off is sometimes treated as a financial expense" 12 and sometimes as an administrative expense, 2 " but it seems preferable to charge it directly to surplus. 214 As organization expense should be written off directly against surplus, it should be shown on the balance sheet as a deduction from the net worth accounts. Investments in Stocks Sometimes stock investments are listed under a special caption, 218 but temporary stock investments, or stocks of ready marketability in which current funds are tied up temporarily," 1 ' may be classified as current assets/ 17 and permanent stock investments, or stocks representing control in affiliated or subsidiary companies, 218 may be classi- fied as fixed assets. 21 * Temporary investments in stocks should be valued, for balance sheet purposes, at cost or market, whichever is the lower. 220 Many accountants advocate valuing them at market, regardless of cost;" 21 indeed, insurance companies are legally compelled to do so.'" It is, however, preferable, in order to avoid bringing unrealized profits into the current period, to value CORPORATION STOCK 139 them at cost or market, whichever is the lower. If desired, the market value may be shown in a footnote to the balance sheet. 223 As it is undesirable to have the value of the temporary investments changed on the books every time the books are closed, these stocks should be booked at cost, and, whenever the market value is less than cost, the discrepancy should be .shown in the reserve for investment fluctuations account which would be subtracted from the investment account on the balance sheet."" Many accountants value at cost the permanent investments in stocks of other companies. 225 However, it is preferable to use the actual value of the stock as shown by the certified balance sheet of the affiliated company. 228 The dividends received on stock investments should be entered as non- operating income in the profit and loss statement," 27 unless the stock is booked at its actual value as per the certified balance sheet of the affiliated company, in which case the dividend would lie credited lo the investment account instead of to the income account. 228 The auditor should list all the stocks held during the period of the audit so as to ascertain that all divi- dends have been properly recorded. 229 All the stocks owned should be verified by actual inspection, 230 and a very complete and detailed list of them prepared. 231 Securities out as collateral should be verified by correspondence,*" and those in transit to the firm under audit should be checked upon their receipt, and the transmitter circularized. 233 Stocks purchased during the period of audit should be verified by correspondence, by brokers' notices, and by inspection." 4 140 C. P. A. ACCOrXTINd QUESTIONS CORPORATION STOCK GENERAL 1. What is a corporation? (Mich., July, 1906; Iowa, Dec., 1918.) 2. What is a close corporation? (Iowa, Dec., 1918.) 3. What are the distinguishing; characteristics of the "corporation" as compared with other forms of business organization ? (Mich.. July, 1906* ; A. I. of A., Nov., 1918.) 4. State the advantages and disadvantages of conducting a mercantile business as a corporation as compared with a partnership. (Mich., June, 1913; Mass., Oct., 1914; Del., June, 1915*; A. I. of A., Nov., 1918.) 5. In the case of an important public corporation having a number of stockholders throughout the country, vigorous action is displayed between two opposing interests to obtain control of the directorate and officers, ren- dering it important that the proxies from the stockholders should be cor- rectly reported at the meeting. For this purpose you are requested to certify to the number of proxies received in favor of the respective in- dividuals. State what information, papers, or records you would require to examine, and how yon would proceed. Also draft a form of certificate you would furnish. (111., May, 1914.) 6. A trading corporation incorporated under the laws of Maine, whose stockholders are citizens of Massachusetts, decides to reincorporate under the laws of Massachusetts, (a) State a strong reason to influence the stockholders in this decision, (b) Desci'ibe briefly what the minutes of each corporation should contain to complete this change. (Mass., Oct., 1914.) 7. You are called upon by the organizers of a manufacturing company to advise as to process of securing charter. Company to have a capital of $50,000. To be incorporated under the laws of Pennsylvania. Give method of procedure. (Pa., May, 1900.) 8. A. B. has a chance to buy 49 per cent of the stock of the Johnson Sales Company. All of the stock is now owned by C. J. and he will con- tinue to hold the balance of 51 per cent. A. B. is anxious to invest, as the business is very profitable, but hesitates for fear that C. J., who is heavily involved in outside matters, may be forced to sell his stock, and that the new owners might try to "freeze him out." C. J. has offered to protect A. B. as far as possible in this respect. What would you advise A. B. to do? (111., May, 1915.) CORPORATION STOCK 141 0. Sketch the history of corporations. Define a modern corporation jving examples of tlie various kinds. Describe safeguards against the abuse of corporate powers or privileges which are in force in countries other than Florida, and give reasons for and against the adoption of similar safeguards here. (Fla., July, 1909.) 10. What is the principle underlying capital stock having no par value? How should it appear on the Balance Sheet of the corporation issuing it ? How should it appear on the Balance Sheet of the owner thereof? (111., Dec., 1918.) 11. In setting up the Balance Sheet of a corporation which has an issue of 100,000 shares of stock of no par value but a stated value of $5 a share and an excess of assets over liabilities of $1,500,000, how would you show the capital on the balance sheet? (A. I. of A., Nov., 1919.) 12. What evidence would you consider satisfactory for the correctness of the following expenditure: Commissions on sale of stock? (N. C., Nov., 1919.) 13. What are the underlying principles of corporation accounting? (N. Y., Jan., 1920.) 14. Name accounts and use of each that are peculiar to corporation accounting. (N. Y., June, 1901*; Pa., Nov., 1904*; Mich., June, 1914.) 15. What is the meaning of the word "stock" in reference to a corpora- tion? (a) What stock does it represent? (b) How is it transferred? (c) What right have stockholders in and to the corporate profit? (Mich., July, 1906.) 16. How should the right to remuneration claimed by officers and direc- tors of a corporation be verified? (N. Y., Dec., 1898.) 17. In an audit of the books of a company, it is found that the Presi- dent's Salary account is credited with a bonus of $5,000 for "extra service," in addition to the usual salary paid him; what steps should be taken to ascertain that this item is correct? (N. Y., Dec., 1897; N. Y., Feb., 1910*; Ind., June, 1916.) 18. What would you consider satisfactory evidence of the correctness and propriety of expenditures of directors' remuneration. (A. I. of A., May, 1918; N. C., Nov., 1919.*) 19. In examining the books of a corporation you find that an officer is a partner in a business from which the corporation makes purchases. Upon scrutiny you find that all the transactions are at proper figures. Would you, under such conditions, call attention to the fact when making your report to the directors? (R. L, Dec., 1907.) 20. After having been employed as auditor of a firm for several years, the partners advise you that they have decided to conduct their business as a corporation and have secured a charter under the general laws of the state accordingly. In what way would your duties as an auditor be affected by such a change? (111., Nov., 1908.) 21. The Best Store Company was incorporated for $50,000 on March 142 C. P. A. ACCOUNTING 15, 1918, by the three partners, "A," "B," and "C." The change in or- ganization was not given effect upon the books of the company. Proprie- tary interest on January 1, 1918, was $75,000. The profits for the year 1918, determined in January, 1019, are found to be $10.000. Specifically state how you would correct this condition on the books of the Company when yon are called in February, 1919. (Wis., Nov., 1919.) 22. A company is organized under the laws of Florida to purchase a patent and to manufacture and sell the patented article. The patent is paid for by the entire issue of stock, and the patentee gives back to the company 49 per cent of the entire stock, to be used for developing pur- poses. Describe the formalities which must be complied with, and draw the opening entries in the books, stating what books are required. (Fla., July, 1909.) 23. A corporation has a capital stock of $100.000. It has assets at inventory value amounting to $160,000. With a view to reducing the number of its enterprises, it sells two of its stores for $85.000 at inventory value. This $85,000 is distributed among its stockholders. What entries should be made upon the books, and what procedure would you recommend in order to safeguard all interest in making such distribution? (111., Nov., 1904.) 24. Give an example of that portion of the Balance Sheet of a corpora- tion which deals with the Share and Debenture Capital account. State and set out the same in proper columns, assuming the following to be the position of the company's share and debenture capital: (a) share capital, authorized, $100,000; (6) share capital, issued or subscribed, $80,000; (c) share capital, called up, $60,000; (d) calls paid in advance, $5,000; (e) calls in arrear, $1,000; (/) debenture capital, authorized, $50,000; (g) de- benture capital, issued or subscribed, $40,000; (h) debenture capital, paid up, $35,000. (111., Dec.. 1910.) 25. Name the different kinds of persons who would have an interest in audit reports prepared for a corporation ; indicate what the interest is, and show the responsibility of the auditor to each class. (Mich., June, 1914.) 26. Formulate, in an imaginary case, the Journal entry or entries for the conversion of a partnership into a joint stock company with the same resources and liabilities. (N. Y., June, 1898: Wash., May, 1903; Va., Nov., 1918.*) 27. State the entries necessary to open a set of corporation books so that the assets may appear properly on the Ledger. (N. Y., Dec., 1898; Pa., Nov., 1903*; Va., May, 1917; Va., Nov., 1918*; Iowa, Dec., 1918.*) 28. A corporation is owned by four persons who have an equal number of shares. During the operations of the company each one of the above parties is credited through the Cash Book at various times with equal amounts as loans to the corporation, and the Cash Book is kept in balance by increasing the payroll by the amounts credited. Each of the parties is credited also with interest on undrawn credit balances thus obtained. CORPORATION STOCK 143 In what manner does such action affect the results of the business? Please explain fully. (Pa., Nov., 1904.) 29. A corporation has the following items in its Balance Sheet: Ac- counts Payable, Accounts Receivable, Cash, Capital Stock, Expense Ac- crued not due, Expense Paid in Advance, Goodwill, Merchandise, Machin- ery, Notes Payable, Patents, Real Estate, Reserve for Depreciation on Plant, Surplus, Trade Marks, and Treasury Stock. You are asked to figure the value of the stock. State which items you would take to get the gross, and which items you would deduct from the gross to get the net amount, and how you would obtain the value of each share. (Mass., June, 1913.) 30. What knowledge must a transfer agent possess in order to safe- guard his company in the transfer of its certificates of stock? (N. Y., June. 1913.) 31. A manufacturer having turned his business into a joint stock com- pany and as yet owning all the stock himself only a few shares standing nominally on the company's books as belonging to friends finds after a time that the business needs more capital. Thereupon he agrees to sell a portion of the stock to outside parties for cash, stipulating that the money so obtained shall be put into the business; that is to say, shall be at once expended in purchasing new machinery and in repairs and im- provements, which is done accordingly. How is the transaction properly to be brought into the company's accounts? (Mich., June, 1910.) CORPORATE BOOKS 32. List books and give purpose of each, used by a corporation but not by a partnership. (N. Y., Dec., 1898*; Pa., Nov., 1899*; N. Y., Jan., 1901; Pa., Nov., 1901*; N. Y., Jan., 1902; Pa,, May, 1902; Md., Oct., 1903*; Mich., July, 1906*; Mich., Dec., 1906*; Ohio, Dec., 1908*; Va., Oct., 1911*; La., May, 1913*; Mich., June, 1913*; Mich., June, 1914; W. Va.. May, 1917*; A. I. of A., May, 1918.*) 33. How would you organize a set of books for a corporation? (Ohio, Dec., 1908.) 34. What would be your procedure in examining the capital stock books of a corporation? What books would you require? Give reasons why such an audit may be necessary. (N. Y., June, 1911.) 35. In auditing the accounts of a corporation, for the first year of its existence, what records and documents should be examined in addition to the books of accounts and the vouchers? (Ind., May, 1917.) 36. In auditing the accounts of a corporation for the first time, for what books and records would you ask and what purpose would you expect each to serve in connection with the audit? (N. Y., Dec., 1896; N. Y., Jan., 1900*; Wash., May, 1903*; N. Y., Jan., 1904*; Cal., May, 1908*; Mass., June, 1910; Va,, Nov., 1910*; A. I. of A., June, 1917*; Ohio, Oct., 1919.*) 144 C. P. A. ACCOUNTING 37. What records and documents should an auditor have access to in an audit of a corporation? (N. Y., Dec., 1898*; Pa., Nov., 1899*; Pa., May, 1902*; 111., Nov., 1903*; Mich., July, 1906*; N. Y., June, 1908*; Kan., May, 1916; A. I. of A., May, 1918*; Iowa, Dec., 1918.*) 38. In the case of a corporation which has been in existence for several years, if you were engaged to audit the accounts for the last year only, would you consider it necessary to inspect the Minute Book, Stock Ledger, Bond Register, or any of the entries in the books of accounts at dates prior to that covered by your audit? Give reasons. (N. Y., Jan., 1906*; Va., Nov., 1910.) 39 Describe the correct manner of writing up, and keeping the fol- lowing books : Stock Certificate Book, Stockholders' Journal, Transfer Record, Stockholders' Ledger. Sketch a simple form of each of the above books. (111., Nov., 1904.) 40. Distinguish between the registration of stock certificates and the registration of negotiable bonds of a corporation and explain fully the purposes of such registrations. (Md., Jan., 1909.) 41. What is a Stock (or Shares) Ledger? (N. Y., Jan.. 1897*; N. Y., June, 1900.) 42. Describe how the Stock Ledger (Shares Ledger) of a corporation is kept. (N. Y., Jan., 1897; N. Y., Jan., 1900; Pa., May, 1903*; N. Y., Jan., 1906*; N. Y., Feb., 1910; Mass., April, 1911*; N. Y., June, 1911*; Va., Oct., 1912.*) 43. Give the ruling of a Stock or Shares Ledger for a corporation. (N. Y., Jan., 1900; N. Y., Feb., 1910; N. Y., June, 1912.*) 44. State the full procedure leading up to the entry of the following transactions in the shares of a corporation, the par value of which is $100. April 5, 1901, James Williamson received certificate No. 75 for 100 shares full paid. May 3, 1901, James Williamson requests a transfer to Geo. T. Jenkins of 30 of his 100 shares. Outline a form of Stockholders' Ledger and properly enter the above items therein. (N. Y., Jan., 1902.) 45. What relation does the Stock or Shares Ledger bear to the general books of the corporation ? (N. Y., Jan., 1900 ; N. Y., June, 1900 ; N. Y., Feb., 1910.) 46. Explain the nature of the records of a Stock (or Shares) Ledger, and describe the manner in which they are made. (N. Y., June, 1900.) 47. What is the purpose and method of registering stock certificates and other corporate securities? (Pa., Nov., 1906.) 48. Describe the method of determining the number of shares of capital stock, both common and preferred, held by each of the several stockholders of a corporation. (N. Y., Jan., 1906; N. Y., June, 1911* ; Va., Oct., 1912.) 49. Give reasons for or against the necessity of an auditor's verifying the Stock Ledger of a corporation. (N. Y., Jan., 1900; Wash., May, 1903*; N. Y., Feb., 1910*; N. Y., Jan., 1918.*) 50. How would you audit the Stock Certificates book of a corporation CORPORATION STOCK 145 (n) when the corporation has no register, (b) when the corporation ha~ a register? (Pa., Nov., 1904; Md., Jan., 1000.) 51. In an audit of the accounts of a corporation, should the auditor accept as conclusive the certificate of the registrar of the stock as to the total amount of capital stock outstanding f If not, why not? (N. Y., June, 1904.) 52. In making an audit of the accounts of a corporation, would you consider it part of your duty to verify the transfers of the certificates of capital stock occurring during the period covered by your examination? (111., May, 1908.) 53. Submit rulings of Transfer Journal suitable to record heavy trans- fers of a listed stock and all necessary transfer records to be used therewith. Explain fully the use of each record and its relation to the others. (N. Y., Jan., 1911.) 54. Describe the Minute Book and how used. (Pa., May, 1903.) 55. Do you consider it necessary, and if so, why, for an auditor of a corporation to peruse the minutes of directors' and shareholders' meetings? (X. Y., June, 1909; Wash., Nov., 1913; Del., June, 1915; N. Y., June, 1917.*) 56. Of what use is the Minute Book of a corporation to an auditor? (Pa., Nov., 1899; Md., Oct., 1903; N. Y v June, 1909; Md., Jan., 1909; Va., Oct., 1911*; Del., June, 1915*; Ohio, Nov., 1917.) 57. What should an auditor do in case he is refused access to the Minute Book? (N. Y., June, 1909* ; Del., June, 1915 ; N. Y., June, 1917.*) 58. State how you would deal with the following items in auditing a cash book of a large corporation : (a) Payments of an exceptional nature, such as the expenses of officials visiting the corporations in England, a large political contribution, and gifts to members of the board of directors; (b) payments to directors for special services in addition to the ordinary and regular directors' fees. (N. D., July, 1918.) 59. What is the value of a Minute Book in opening the books of "a corporation? Explain fully. (Pa., Nov., 1904.) 60. Mention three classes of transactions the verification of which in a corporation audit would lead you to refer to the Minute Books of the corporation. Give reasons in each case. (Ohio, Nov., 1918.) 61. (a) Would you refuse to sign an audit certificate if you had been refused access to the Minute Book of a corporation? (b) If the answer is "yes" would you sign the certificate with a quali- fication? (c) Mention five items for which you would look in examining a Minute Book. (d) If the corporation were a "close" one and practically no minutes were kept, what action would you take and why? (A. I. of A., May, 1919.) 62. Describe the necessary precautions to be taken by a transfer agent 14G C. P. A. ACCOUNTING to safeguard his corporation, when an executor presents a certificate of stock for transfer. Outline entries which should appear on the Transfer Books. (X. Y.. Jan., 101S.) 63. To what extent should the auditor of a corporation check the pre- ferred and common stock certificate registers? (X. D., July, 1918.) 64. What method would you adopt to prove the outstanding- certificates of stock to be correct as represented on the Transfer Ledger? (X. Y.. June, 1913.) CLASSES OF STOCK 65. Define: Stock. (Mich., June, 1908.) 66. Name the various forms of capital stock and how created, stating the rights and privileges of each. (Mich., July, 1906*; Mich., Dec., 1906; Mich., June, 1913.*) 67. Define: Capital stock. (X. Y.. Dec., 1896; Pa.. May. 1903; 111., Nov., 1903: Wash., Sept., 1907; Ohio, March, 1910; La., May,' 1913*; Cal., May, 1916.) 68. How would you verify the liability of a corporation as to capital stock? (111., May, 1904; Ohio, Dec., 1908.) 69. To what extent would you consider it necessary to verify the capital stock, and what reference to such verification would you make in your report? (Mass., June, 1913.) 70. How would you proceed to determine the book value of capital stock? (N. Y., June, 1919.) 71. State what verification you would make of stock. (N. C., Aug., 1917.) 72. In making a detailed audit, what procedure would you follow to verify the capital stock issued? (N. Y., June, 1909*; Mo., Dec., 1915; Kan., Dec., 1915; Ohio, Nov., 1916*; A. I. of A., June, 1917*; Wash., July, 1917.*) 73. To what extent do you think it is necessary to verify the outstand- ing capital stock of a corporation? (A. I. of A., June, 1917.) 74. State what course you would advocate to prevent an over issue of stock. (Mass., April, 1911.) 75. If called upon to verify the outstanding capital stock of a cor- poration, what records would you consult? (Mass., April, 1911*; Ohio, Nov., 1916.) 76. Define: Common stock. (N. Y., Dec., 1896; N. Y., June, 1898*; N. Y., Dec., 1898; Wash., May, 1903*; Pa., Nov., 1903: Mich., Nov., 1907*; Wash., May, 1911 ; Wash., June, 1915; Cal., May, 1916; N. D., July, 1916*; W. Va., May, 1917; N. C., Nov., 1918; S. C., Sept., 1919; N. C., Nov., 1919; N. C., June, 1920.) 77. Define: Preferred stock. (N. Y., Dec., 1896; N. Y., Dec., 1898; Pa., May, 1903 ; Wash., May, 1903* ; Pa., Nov., 1903* ; Mich., Nov., 1907* ; Wash., June, 1915; Cal., May, 1916; N. D., July, 1916*; W. Va., May, CORPORATION STOCK 147 1917; Wash., July, 1017; N. C., Nov., 1918; S. C., Sept., 1919; N. C., Nov., 1919; N. C., June, 1920.) 78. How would you verify the Preferred Capital Stock account in mak- ing a Balance Sheet audit?' (Mass., Oct., 1914; Ohio, Nov., 1915.) 79. You are elected the auditor of a corporation by the holders of both common and preferred stock and it is your duty to safeguard the interests of both classes of stockholders. The preference stock bears 7 per cent, and is noncumulative. Mention what precautions you would adopt to safeguard the interests of the preference shareholders, giving reasons therefor. (111., May, 1907; Mich., June, 1912*; Wis., April, 1914*; Ind., June, 1916*; Ohio, Nov., 1916.*) 80. Define: Cumulative preferred stock. (Wash., May, 1911; Wash., Nov., 1913; Cal., May, 1916; N. D., July, 1916.*) 81. In its prospectus a corporation represents that it has an issue, of "cumulative, nonvoting, nonparticipating, 6 per cent preferred stock." Give your interpretation of this expression. (Mass., Oct., 1915.) 82. Define: Founders' stock. (N. C., Nov., 1918; N. C., Nov., .1919.) 83. Define : Guaranteed stock. (N. C., Nov., 1918; N. C., Nov., 1919; N. C., June, 1920.) 84. Define: Debenture stock. (111., May, 1914*; N. C., Nov., 1918; N. C., June, 1920.) 85. Define: Share capital. (N. Y., Dec., 1896; Cal., May, 1916.) 86. Explain fully and state how Authorized Capital Stock account should be carried upon the books. (Mich., Nov., 1907.) 87. What is "watered stock" 1 ? (N. Y., Dec., 1898; Mich., Dec., 1906; Wash., May, 1911; Mich., June, 1914*; Wash., June, 1915; Cal., Nov., 1916; W. Va., May, 1917; Cal., June, 1917; Mich., June, 1919.) 88. How should watered stock appear on the books? (Mich., Dec., 1906; Cal., June, 1917.) 89. How should watered stock be treated in audit reports? (Mich., June, 1919.) 90. A company whose stock is widely distributed and much dealt in, increases its capital stock of $500,000 by a stock dividend of 100 per cent. Some years subsequently an original stockholder brings suit for elimination from the capital stock of what he claims is "water." How can the stock issued as dividend be eliminated from the $1,000,000 of stock outstanding? (111., May, 1905.) 91. How do you determine the amount of watered stock? (Cal., June, 1917.) 92. Define: Donated Stock. (Mass., Oct., 1917.) 93. How would donated stock affect the book value of capital stock? (Mass., Oct., 1917.) 94. State how you would show capital stock donated to the company on the Balance Sheet. (Ohio, Nov., 1917.) 148 C. P. A. ACCOUNTING !).">. Mention and explain two common views concerning tlie treatment of donated capital stock. (A. I. <>!' A., Nov., 1II1S; l';i., Nov., l!U!).) 96. Does unsubscribed stock in ;i corporation constitute a liability? If it does, under what account would it appear in a ledger 1 ? (Mich., -June, 1908.) 97. Say how you would show capital stock aiithori/ed but not sub- scribed on the Balance Sheet. (Ohio, Nov., 1917.) 98. How would you treat in the accounts bonus stock issued with bonds? (Cal., Nov., 1916.) 99. A corporation has two classes of stock fully issued: $5,000,000 7 per cent cumulative preferred as to dividends and assets, 10 per cent divi- dends are in arrears ; $12,000,000 common, on which no dividend has been paid. The corporation proposes to retire by purchase $2,000,000 com- mon. What would be the effect, if any, on the interests of the preferred stockholders? Give reasons supporting your answer. (Mass., April, 1911.) 100. A corporation is formed whose capital slock has no par value. Shares issued, 1,000; assets, $S,000; liabilities, $4,000. Prepare the Journal entries to open the books. (N. Y., Jan., 1919.) 101. Differentiate unsubscribed stock, unissued stock, issued stock and treasury stock. (N. Y., Jan., 1916.) TREASURY STOCK 102. Define: Treasury stock. (N. Y., Jan., 1902*; Pa., May, 1903*; 111., Nov., 1904*; N. D., June, 1914; Wash., .June, 191T,; \\'is., May, l!M(i; Cal., May, 1916; Pa., Nov., 1917; N. Y., June, 1918; Va., Nov.,' J91S ; N. C., Nov., 1918; Iowa, Dec., I'MS; A. I. of A., May, 1!M9: N. C., June, 1919; N. C., Sept., 1919*; N. C., Nov., 1919; N. ('., June, 1920.) 10.'!. ''Treasury stock or bonds are merely so many legalized pieces of paper, and cannot in any sense be considered as assets of the corporation creating and issuing them." (Dickinson.) Defend. (Kan., May, 1916.) 104. Discuss briefly the following statement: "Treasury stock is unis- sued capital stock." (Cal., Nov., 1910.) 105. In your opinion, what is the correct accounting procedure in cases where an incorporated company sells its treasury stock at premium? (Wash., June, 1912.) 106. A corporation having issued its capital stock at par buys 1,000 shares at 95. It later sells 500 of these shares at 98, and 300 at 85, and 200 at 101. Give the journal entries covering these transactions. How should the items appear on the Balance Sheet immediately after purchas- ing the stock, and immediately after each of the sales? (A. I of A.., June, 1917.) 107. On which side of the ledger should the balance of the treasury stock account appear? (Mo., Dec., 1914.) CORPORATION STOCK 149 10S. Explain fully and state how accounts should be carried on th books with treasury stock. (Mich., Nov., 1907; Mich., June, 1915.*) 109. How would you show treasury stock on a Balance Sheet ? If your answer is "as an asset," state your reason. (Cal., May, 1916; Pa., Nov., 1917' : \ < . Nov., 191- June, 1919; N. O, Sept, 1919.) 110. (a) How would you deal in the Balance Sheet of a corporation with shares recovered from a vendor to whom they had been issued as fully paid and who had returned them in settlement of a claim for fraudulent misrepresentation in respect of the property sold by him to the corporation ? (b) How would you deal with these shares for the purposes of a dividend? (A. L of A., June, 1917; Ind., Nov., 1917.*) 111. A corporation is organized with an authorized capital stock of $50.000 of which only $40,000 is sold, and stock certificates issued therefor. Two conflicting methods of recording the capital stock on the books are urged by rival accountants as follows: (a) Treasury stock to capital stock $50,000. cash and properties to treasury stock $40,000; (6) cash proper- ties to capital stock $40,000. Which method is the better and why? ( X. Y., Jan., 1906; Cal., June, 1917.) 112. A company has acquired at $90 per share 100 shares of its own capital stock, of the par value of $100 per share. Its Balance Sheet shows treasury stock $9,000. Is this correct? If so, why? If not, state how you would adjust the books. (X. Y.. June, 1912; Mich., Dee., 1913; Ohio," Nov.. 1917; N. Y.. June, 19ia*) 113. What is involved in the verification of treasury stock? (CaL, May. 1916: Mich., Dec., 1916.*) 114. It frequently happens that a corporation contracts to purchase property at an agreed price, which on the face of the contract is declared to be its value, and that by another clause in the contract, or by another contract, the vendors agree to provide in addition to the property, a cer- tain sum for working capital or even for free surplus. It is sometimes maintained that this free sum so provided is a profit or surplus of the new corporation available for payment of dividends if the directors so determine. Write a brief expression of your opinion as to the proper treatment of the sum turned back. (A. I. of A., May, 1919.) 115. Prepare Journal entry for retiring treasury stock of the par value of $100 acquired at $50 and the book value of $125. (X. C.. June. 1920.) 116. A company with an authorized capital stock of $3,000,000, $100 j>ar value, issues 2.400,000 of shares in payment of various properties. In order to secure working 1 capital the shareholders return to the eoni- 1 any three eighths of their holdines to be sold at $50, and on the same lay 3,000 shares are so sold and paid for. How would you treat this matter? 150 C. P. A. ACCOUNTING (a) Draft entries and show Ledger accounts and balances. (6) After all the treasury stock has been sold, state what should be done as to entries, and the resultant effect upon property account. (Mich., Dec., 1916*; Okla., Nov., 1919.) 117. A financing corpoi'ation which had paid $450,000 for six patents of equal value, sold one of these patents during the first year of its exist- ence and received as the consideration for the sale 1,500 shares of pre- ferred stock (par value $100) in a subsidiary company organized for the purpose of working the patent. During the second year of its life the financing corporation sold the 1,500 shares of preferred stock for $100,000. State how you would treat the accounts in respect to these two transactions in the financing corporation at the end of the first and second years respectively. (N. D., July, 1918.) ORGANIZATION EXPENSE 118. What are organization expenses? (Wash., Nov., 1913; A. I. of A., June, 1917; Ind., May, 1918.) 119. What class of expenditures do you consider properly belong to "organization expense account," on the books of a corporation? Give examples and reasons. (N. Y., Jan., 1919.) 120. How should organization expense be treated on the books of a cor- poration? (N. Y., Jan., 1904*: N. Y., Jan., 1906*; Mass., June, 1910; Va., Nov., 1910*; Mich., June, 1913*; Colo., Dec., 1913; A. I. of A., June, 1917; Mass., Oct., 1917*; Ohio, Nov., 1917; Ind., May, 1918*; Va., Nov., 1918; Iowa, Dec., 1918*; A. I. of A., May, 1!)20.) 121. At what point do expenses cease to be organization expenses and become operating expenses? (A. I. of A., June, 1917; Ind., May, 1918.) 122. What is usually included in the account, Organization Expenses, in the books of a company? (Mass., June, 1910; Colo., Dec., 1913.) 123. Upon what basis should O7-ganization expense, carried as a de- ferred asset, be valued? (Cal., Nov., 1916.) 124. Classify the accounts properly recording the following items ac- cording to the subdivision of assets, liabilities, proprietary interest, in- come and expenses under which it should be grouped, (a) organization ex- pense, (b) organization expenses written off. (Wis., May, 1919.) 125. A pei-son is interested in the profits of a corporation, but is not a shareholder therein. He objects to having tlie preliminary expenses enter into the Profit and Loss accounts. Is his position tenable? Give reasons. (R. I., Dec.. 1907.) SUBSCRIPTIONS 126. Define: Subscription. (N. D., June, 1914.) 127. Describe the nature of the Subscription account. (N. Y., Dec., 1896; N. Y., June, 1899; Wash., Aug., 1908; Va., Oct., 1912*; \V. Va., May, 1917.) CORPORATION STOCK 151 128. On which side of the ledger should the balance of the Capital Stock Subscription account appear? (Mo., Dec., 1914.) 129. Explain fully and state how accounts should be carried upon the books with unsubscribed stock. (Mich., Nov., 1907.) 130. Of the authorized capital stock of $100,000 one-half, or $50,000 has been subscribed and only $25,000 has been paid in in subscriptions. Submit the Balance Sheet. (Cal., May, 1916.) 131. Define: Stock right. (N. Y., Jan., 1911; Kan., May, 1916.) 132. (a) State the purposes for which subscription privileges or "rights" may be given stockholders. (6) How may a stockholder use the "right"? (c) What is the value of a "right" in the following case: The par value of the outstanding capital stock of a corporation is $1,000,000 ; market value, $150 per share. The stockholders of a certain date are of- fered $500,000 more of this same class of stock at $125. (Wis., May, 1919.) 133. "B" contracts for $5,000 of capital stock in the Stone Manu- facturing Company, which is to be paid for in ten equal installments. He fails to pay the last installment and forfeits the stock to the corporation who sells it for $3,800. The cost to the corporation was $50. Journalize the transaction. (N. D., June, 1914.) 134. If you found a Journal entry in the General Journal of a cor- poration cancelling an obligation due from subscriber to capital stock, for his subscription to capital stock, what evidence would you require in support of such entry? (N. Y., Jan., 1920.) 135. How should money received on account of stock subscriptions and forfeited by nonpayment of installments as they mature, be treated on the books of the corporation? (N. Y., June, 1906; Fla., July, 1909.*) 136. A corporation is organized under the laAvs of this state, with an authorized capital of $50,000 divided into shares having a par value of $100 each. Six men agree to subscribe to 10 shares each. Omitting the explanations that should accompany original entries, draft three types of opening entries for the corporation and point out which one you would favor. Give reasons. (N. Y., Jan., 1917.) 137. A corporation was duly authorized to .do business in this state, capitalized at $100,000, which amount was fully subscribed for before in- corporating. Only 50 per cent of that amount was called in, viz., $50,000; and, after completing the first year's operations, it was decided that it would be unnecessary to call in the balance of the amount subscribed for. At a general meeting of the members of the corporation, a resolution was passed unanimously, and recorded in the minutes, reducing the capital to $50,000, and authorizing and directing the bookkeeper to clear off the bal- ance of $50,000 standing at the debit of Subscription account. As auditor, would you consider that those entries called for comment? If so, state fully for what reason. (Wash., April, 1906.) 152 C. P. A. ACCOUNTING STOCK DISCOUNT AND PREMIUM 138. How should the losses on shares of stock issued at a discount be dealt with in the accounts of a corporation? (N. Y., June, 1898; Wash., May, 1903; Ind., June, 1916; Va., Nov., 1918.) 139. How should stock sold at a premium be treated in the books of a corporation? Give reasons for your answer. (N. Y., June. 1904*; R. L, Dec., 1907*; Wash., May, 1910; Ohio, Nov., 1917*; Ohio, Nov., 1918*; N. Y., Jan., 1919.*) 140. May premiums received on account of sales of capital stock be applied against discounts of former years? (Cal., Nov., 1916.) 141. How should the discount and premium arising from the sale of a company's own securities held in its treasury be treated on the books? Give examples. (N. Y., June, 1902.) 142. Is it proper for a corporation to pay a dividend out of surplus arising from the sale of treasury stock at a premium? Why? (N. D., July, 1918*; Ohio, Nov., 1918*; N. Y., Jan., 1919.) 143. A corporation increases its capital stock, which it sells at auction, receiving therefor, as premiums above the par value, $3,000. The treasurer credits this amount to Profit and Loss account and, in his statement, shows it as a part of the profits. State: (a) your opinion thereof; (b) to what account, if other than Profit and Loss, the amount should be credited; (c) how it should be shown in the*treasurer's statement; and (d) vour reasons. (Mass., April, 1911.) 144. What, in your opinion, is the correct method of recording on its books of account the purchase of property and plant by a corporation where payment is made in capital stock of the purchasing company, the par value of such stock being greatly in excess of the actual value of the assets acquired? (N. Y., June, 1918.) SECURITIES 145. Under what circumstances, if any, would you examine the securi- ties owned by a corporation, and, if you think this course unnecessary, rive your reasons why, and should you think it necessary, state how you would proceed in the event the securities are not in the company's pos^cs- sion. (111., May, 1913; Ohio, Nov., 1915.) 146. How would you. as auditor of an incorporated company, satisfy yourself of the existence of shares or bonds given as security for loans to the company? (Wash., Aug., 1908.) 147. In examining securities what data should be recorded to protect the auditor? \Vhat is to be apprehended/ (N. Y., Jan., 1914; Ohio. Nov., 1915; Ohio. Xv., 191 14S. What precautions should be taken to avoid substitution or other manipulation during the inspection of securities/ (111., Dec., 1918.) CORPORATION STOCK 153 149. How may the correctness of securities in a Balance Sheet be de- termined? (N. Y., June, 1897*; N. Y., Dec., 1897*; N. Y., Jan., 1902*; N. Y., Jan., 1906* ; N. Y., June, 1906* ; N. Y., Feb., 1908* ; Ohio, March, 1910*; Mass., June, 1910; Mich., June, 1912*; Kan., May, 1916; N. C., June, 1916; Mass., Oct., 1916*; Ind., Nov., 1917*; 111., Dec., 1918.*) 150. To what extent are you justified in accepting the certificates of officials of a corporation as to bonds and stocks of outside companies owned? (Ind., Nov., 1917.) 151. How would you record on the books of account the purchase of securities which had been only partially paid for? (N. Y., June, 1919.) 152. In the course of an audit you find the following classes of security : (1) Real estate, (2) mortgages on real estate, (3) chattel mortgages, (4) stocks and bonds held as collateral security. For each of these classes state (a) the method of examination, (6) special points to be examined, (c) form of report. (Fla., July, 1909.) 153. A manufacturer makes extensive investments in stocks and bonds, buying and selling from time to time as the market conditions warrant and clearing all such transactions through his regular books of account. How should such transactions be isolated from his manufacturing operations and what books and accounts should he employ to record the details of the principal and income from such investments? (N. Y., Jan., 1906.) 154. Your verification of the securities of a corporation has to be made at a date about two months subsequent to the date of the Balance .Sheet you are asked to certify. Can you suggest steps which will enable you to do this without risk of overlooking serious overstatement? (A. I. of A., Nov., 1918; 111., Dec., 1918.) 155. In making a detailed audit what procedure would you follow to verify the proceeds from sale of marketable investment? (Kan., Dec., 1915- Mo., Dec., 1915.) 15(5. In preparing a Balance Sheet of a corporation how would you classify or deal with securities representing (a) an interest in a competing company, (b) the entire ownership of a plant, (c) an investment of a temporary surplus of cash? (A. I. of A., June, 1917.) 157. Classify the Income from Stocks and Bonds Owned account prop- erly, according to the subdivision of assets, liabilities, proprietary interest, income and expenses under which it should be grouped. (Wis., May, 1919.) 15.S. A concern has an authorized issue of bonds to the amount of $100,000; $40,000 are sold at par, $10,000 are sold at 10 per cent pre- mium, $30,000 are put up as collateral to a $25,000 loan at the bank, and $20,000 are on hand. Prepare a Balance Sheet showing the above trans- actions, supplying the other needed accounts. (N. Y., June, 1908*; Mich., June, 1910*; N. Y., Jan., 1914*; Mich., June, 1914; Md., Oct., 1919.) 159. The Oak Furniture Company placed $50,000 of its undivided earn- ings in the hands of a broker to invest in United States 4 per cent bonds. The bonds were for $1,000 each and cost 101%, commission Vs. Prepare 154 C. P. A. ACCOUNTING detailed entries to record properly the transaction of the company's books. (N. Y., June, 1915.) 160. The Bristol Manufacturing 1 Company issued and sold on the 1st of January, 1911, to "A" and "B" (50 to each at the same price), first mort- gage bonds of $500 each, bearing interest at 4 per cent per annum, and received $48,000 in cash. What records of the transactions should be made, and in what books? (111., May, 1911.) 161. An investment company purchased for investment $100,000 of 6 per cent 10-year municipal debentures at 96, and $200,000 of 5 per cent industrial bonds, 15 years to run, at 104. How would you treat the dis- count and the premium in the accounts? Give the Journal entries. (Wis., April, 1914*; Wash., June, 1915.) 162. In auditing the books of a corporation you find record of the ownership of stocks and bonds, some of which are in hand, some are deposited with bankers or others for safekeeping, and other? are lodged as security for loans. State what kind of evidence you would require in each case, specifying particularly in the case of stocks and registered bonds; if not registered in the name of the corporation, what would you consider necessary to protect your client's interests? (A. I. of A., May, 1920.) 163. What means should be employed to verify the value of investment securities? (N. Y., Dec., 1896*; N. Y., June, 1898*; N. Y., Dec., 1898*; Pa., May, 1900*; N. Y., Jan., 1907; N. Y., June, 1909*; Ohio, March, 1910*; N. Y., Jan., 1911*; Va., Oct., 1912*; Cal., May, 1916*; Mass., Oct., 1917.*) 164. What procedure would you follow in determining the correct valuation, for Balance Sheet purposes, of investment securities purchased at a premium or at a discount? (Ohio, Oct., 1919.) 165. Finance corporations holding a large number of shares in other corporations are in the habit of valuing their securities for Balance Sheet purposes at either (a) cost price, or (b) market price at the date of the balance sheet. Discuss the respective merits of the two methods and say which you consider the soundest from an accountant's point of view. (111., May, 1905.) 166. Discuss generally the duty of an auditor in relation to the question of depreciation of outside investments of fluctuating value. (Mich., June, 1913*; Wash., Nov., 1913; Mass., Oct., 1917.*) 167. A corporation formed to invest in certain classes of securities has made a serious loss on paper, by a fall in the price of some of its pur- chases, while it has earned enough on income to pay the usual dividend. How should this be dealt with in the annual accounts? (111., May, 1910; Mich., June, 1913.*) 168. Where would you place the Appreciation of Securities account in the Income and Profit and Loss account? (Md., Dec., 1917.) 169. How would you classify investments in stocks in preparing a CORPORATION STOCK 155 certificate of condition, to be filed with the Secretary of the Common- wealth? (Mass., April, 1911.) 170. A corporation has a number of investments in stocks and bonds which are listed, and have a definite market price from day to day. It carries them at their cost prices in the Ledger and wishes to retain these cost prices, but at the same time wishes to have them show in the Balance Sheet at the market prices. State a convenient method of doing this with- out changing the cost values in the Ledger. (Mass., June, 1913.) 171. A. B. is a heavy speculator on margin on the stock exchange, buying and selling in numerous transactions a large variety of securities. His broker, C. D., renders him monthly a statement of transactions and an account current. State the steps you would take to completely audit C. D.'s monthly account current and statement. (Mass., June, 1913.) 172. In consolidating two banks, at what value should the bond invest- ments be set up? (Mich., June, 1919.) 173. In auditing the accounts of a large corporation you find an account with Liberty Bonds, charged with $200,000.00, representing the cost of bonds subscribed and paid for by the company. At the date of the balance sheet to which you are to certify, the bonds had a market value of $187,500.00. What attitude would you take as to their valuation in the balance sheet? (A. I. of A., Nov., 1920.) 174. What steps should be taken in the most complete possible verifica- tion of the capital stock account of a corporation in an audit for a year, if during that year the authorized capital was increased and new stock was issued, and certain shares were acquired and held by the company (assuming that it was legal to do so), and if (a) there is a registrar of the stock and (b) there is not? (A. I. of A., Nov., 1920.) 156 C. P. A. ACCOUNTING PROBLEMS CORPORATION STOCK 1. A corporation incorporated under the laws of the State of South Dakota with an authorized capitalization of $2,000,000 offers stock for subscription under the following terms and conditions: The sale of shares of preferred stock, par value $100, at a discount of 25 per cent, payable in five installments. To each purchaser of preferred stock shall be donated one share of common stock, par value $100. At the end of the year it was found that the money had been received from installments paid on subscriptions to preferred stock as follows : First installment, $120,750; second installment, $96,600; third install- ment, $96,600; fourth installment, $96,600; fifth installment, $96,600. The organizer of the corporation had purchased a vacant building and real estate suitable for the factory site, paying therefor $27,500. The property purchased was appraised by disinterested appraisers and valued conservatively at $45,000. The owner (organizer) then turned the said property over to Ihe cor- poration at the appraised value, viz., $45,000, and received therefor pre- ferred stock at same price as subscribers, which was at 25 per cent dis- count, and also received one share of common stock (donated) for each share of preferred stock. The expense of organization and sale of stock at the end of the year was found to be as follows : Commissions on sale of stock, $10,000 ; office expenses, clerk hire, heat and light, stationery and other expenses, $3,000 ; appraisal, $250; betterments and remodeling building for occupancy, $2,000. Draw up a statement showing the condition of organization, using re- ceipts and disbursements as above and showing the condition of stock sub- scriptions and stock issue. (Iowa, Dec., 1918.) 2. The Unique Manufacturing Company, a corporation, was organized July 1, 1913, with an authorized capital stock of $215,000, par value of shares, $100 each, for the purpose of manufacturing novelties. The five in- corporators subscribed and paid for five shares each, organization expenses were incurred to the amount of $5,000 and paid for in stock, ami the bal- ance of the stock was disposed of on the following conditions: 10 per cent upon subscription, and three equal calls for the balance at 30, 60 and 90 days. On July 31, the Unique Manufacturing Company secured an option for 30 days on the plant of "A" and "B" for $10,000, agreeing to take over the assets, exclusive of cash, and assume the liabilities of the partnership CORPORATION STOCK 157 as at July 31, for the sum of $200,000, payable $90,000 immediately after taking over the business, and the balance in 90 days. At the expiration of the option, the corporation took over the plant as agreed. The following- is a transcript of "A" and "B's" ledger balances as at July 31, 1913: Land $30,000 Buildings 35,000 Machinery 20,000 Furniture and fixtures 5,000 Raw Material 10,000 Tools 2,500 Finished goods 10,000 Work in process 5,000 Supplies 7,500 Accounts Receivable 25,000 Cash 8,200 Mortgages on Buildings 10,000 Reserve for Depreciation machinery 2,500 Reserve for Bad Debts 1,000 Accounts Payable 15,000 "A" 77,820 "B" 51,880 During the interval "A" and "B," with the consent of the corporation, had sold finished goods for $5,000, which was 25 per cent above cost. The subscriptions to the stock of the corporation were met on call with the exception that on the second call a subscriber for 25 shares notified the corporation that lie was unable to complete his agreement, and he was released without further liability. The forfeited stock was sold for cash, at par. From the foregoing, draft : (a) Journal entries necessary to close the books of the partnership. (6) To open the books of the corporation and to show all transactions on the Unique Company's books. (c) Balance Sheet of the Unique Manufacturing Company, September 1, 1913. (Ohio, Nov. 1913; Minn., Oct., 1916.*) 3. On June 30, 1917, Mace & Morgan, partners operating a manu- facturing plant, decided to incorporate under the general laws of the State of Virginia. The corporation purchased all the assets and assumed all the liabilities of the partnership as set forth in the Balance Sheet dated June 30, 1917. The corporation has an authorized capital of $500,000 and it gave its entire issue of capital stock as the consideration for the purchase of the partnership. The entire stock was taken by Mace & Morgan. BALANCE SHEET, JUNE 30, 1917 Assets Plant and Machinery $175,000 Inventory 102,625 Accounts Receivable 113,750 Notes Receivable 7,500 Cash 32,125 $431,000 Liabilities Mace's Investment $300,000 Morgan's Investment .... 100,000 Accounts Payable 26,250 Notes Payable 3,500 Wages Due and Unpaid . . 1,250 $431,000 158 C. P. A. ACCOUNTING The change in organization was not reflected on the books at the time of incorporation, but at the close of the first fiscal year (June 30, 1918) of the corporation's existence the condition of the boots was shown by the following trial balance : Debits Credits Mace's Investment Morgan's Investment Plant and Machinery $187,500 Material Inventory, June 30, 1917 102,625 Sales Purchase 240,000 Labor 172,500 Office Salaries 35,000 Traveling Expenses 12,000 Interest 3,000 Stationery and Printing 875 Rent and Taxes ' 21,000 Allowances on Sales 1,250 Cash Discounts 10,000 Fuel 23,000 Insurance 875 Freight Inward 8,750 Commission 31,875 Advertising 2,500 Notes Receivable 30,575 Notes Payable Accounts Receivable 180,575 Accounts Payable Cash 37,875 $300,000 100,000 657,025 5,500 39,250 $1,101,775 $1,101,775 Depreciation on Plant and Machinery, 5 per cent ; Tin expired Insurance, $375; Bad Debts, $4,625; Inventory of Material on hand June 30, 1918, $98,025. The bad debts represent a part of the Accounts Receivable taken over by the corporation June 30, 1917, which accounts were guaranteed by Mace & Morgan individually on a basis of the investment of each at the time the business was incorporated. Make such entries as would convert the partnership books into those of the corporation and prepare an Income account and analysis of Profit and Loss for the year ending June 30, 1918, and a Balance Sheet as of June 30, 1918. (Va., Nov., 1918.) 4. A stockholder desires to know the book value of his stock in a cor- poration for the purpose of accepting an offer from a purchaser who agrees to buy his stock at the book value as shown by the following Balance Sheet. Prepare a statement showing the book value of the stock. CORPORATION STOCK Ifi!) Assets Cash on hand $25,000 Liabilities Accounts Pavable $15,000 50,000 200,000 25,000 50,000 100,000 50,000 300,000 200,000 190,000 Accounts Receivable. 100,000 Notes Payable Notes Receivable. . . . 30,000 Bonds Outstanding Inventories 100 000 Reserve for Shrinkage of Inventories . Treasury Stock (1 shares) 000 125 000 Reserve for Depreciation Reserve for Extinguish- ment of Bonds Cost of I lant . . 800 000 Reserve for Additions to Plant . . . Capital Stock (3,000 shares) Reserve for Working Capital Undivided Profits $1,180.000 $1,180,000 (N. C., Nov., 1918.) 5. In Mr. Jones' Private Ledger he keeps accounts with each invest- ment he makes, one of which is an investment of 1,000 shares (par value $100) of the A. B. Company which he acquired in July, 1914, for $85,000. After this date and up to December 31, 1918, he makes further purchases and sales of this stock. A certified public accountant called in to prepare Mr. Jones' income tax return for 1918 finds that these and other transac- tions have been written up in the following manner, no effort to show the profit of the sale of 1,000 shares on June 1, 1918, having been attempted. INVESTMENT A. B. COMPANY ACCOUNT Debits Credits July 1, 1914 1,000 shares purchased $85,000 Dec. 31, 1914 Entry to carrv this stock at par 15,000 May 31, 1915 Purchased 1,500 shares at par 150,000 Nov. 30, 1915 Sold 300 shares at 125 $37,500 Dec. 31, 1915 July 1, 1916 Profit and loss profit on sale of 300 shares Stock dividend of 50 per cent on 2,200 shares declared from profits, accumulated prior to Mar. 1 , 1913 7,500 110,000 Feb. 28 1917 Sold 700 shares at 110 77,000 Dec. 31, 1917 Profit and Loss, profit made on sale of 700 shares 7,000 June 1, 1918 Sold 1,000 shares at 125 125,000 Rewrite this entire account to show how it should have been kept in order to show actual profit on each sale and also calculate the actual profit on the last sale of 1,000 shares. What is the book value of the total shares on hand December 31, 1918? (A. I. of A., Nov., 1919.) TOO C. P. A. ACCOUNTING 6. The directors of (he Charles Manufacturing Company decide to change their plan of capitalization by retiring their common stock and issuing preferred stock and new common stock in place of it. On De- cember 31, 1917, (heir books showed .$1,000.000 common stock and $300,000 surplus. The new plan offered each common stockholder 1.3 shares of pre- ferred stock and 1 share of new common stock for each share of old com- mon stock, fractional shares amounting to $6,400 to be redeemable in cash. Amendments to the articles of incorporation were duly made pro- viding an authorized amount of $1,500,000 of preferred stock and $2,000,000 of common stock. On April 1, all exchanges had Been com- pleted with the following exceptions: unissued common stock, 1,000 shares; unissued preferred stock, 1,300 shares; fractional shares, $300. The par value of each kind of stock is $100 per share. Draft the necessary Journal entry or entries to record the above changes. (Wis., April, 1918.) 7. The authorized capital stock of a corporation is $500,000, divided into 5,000 shares, par value $100. Of this amount $400,000 has been sub- scribed and paid for in full. The corporation purchases ten shares of a dissatisfied stockholder for $75 a share, and five other stockholders each donate five shares to the company. Five shares of the purchased stock and all the donated stock are sold for $50 a share. (a) Draft proper entries and show the Ledger accounts and balances. (b) How would the balances of the accounts in (a) appear in a Balance Sheet? (c) Give the entries and show the Ledger accounts and balances if the capital stock were of no specified par value, but 5,000 shares had been issued at $80 and the other conditions remain as stated in the first paragraph, (d) How would the balances of the accounts in (c) appear in a Balance Sheet? (Wis., April, 1917.) 8. J. B. Brown and L. C. Smith are partners, and in order to raise more capital and to preserve the organization they decide to incorporate. A company was duly incorporated under the name of The Eclipse Com- pany, with an authorized capital of $800,000, divided into 8,000 shares of the par value of $100 each. The partners agreed to sell for the sum of $800,000, payable in capital stock of the corporation at par, all rights to and title in the net assets of the partnership, exclusive of the cash, which was divided between the partners in proportion to their several interests at the time of the sale of the property. According to the articles of partnership, Brown and Smith were equally interested in the assets, but the profits and losses were on a basis of GO per cent and 40 per cent, respectively. The partnership Balance Sheet at the time of the sale was: CORPORATION STOCK 161 Land and Buildings $200,000 Cash 10,000 Inventories 100,000 Accounts Receivable 150,000 Machinery and Equipment 100,000 $560,000 Notes Payable $100,000 Accounts'Payable 40,000 Brown's Capital 210,000 Smith's Capital 210,000 $560,000 For the purpose of providing working- capital, the partnership donated $300,000 of the capital stock to the corporation, which was subsequently sold at $50 per share. You are required to (1) close the partnership books, showing Ledger accounts of partners only; (2) open corporation books; (3) prepare a Balance Sheet of the corporation before sale of donated stock; (4) prepare a Balance Sheet after sale of donated stock. (Ohio, Oct., 1919.) CHAPTER IX INTEREST Intercut and Discount Although both discount and interest are fre- quently recorded in the same account, 1 they must not be confused. Dis- count is the allowance made for the realization upon an undue asset, 2 while interest is the payment made for the use of capital. 3 Discount includes allowances made for prompt payment, or cash discounts; allowances made to customers from list prices, or trade discounts; differences between par and a purchase price less than par, or discount on securities; and interest paid in advance, or commercial discount, 4 the last being the only kind of discount included in the interest and discount account/ If simple interest is collected in advance, it is called commercial discount; if compound in- terest is collected in advance, it is called true discount." It has been claimed that as bank discount is prepaid interest, 7 it should be designated interest and not discount. 8 However, interest is calculated on principal only, while bank discount is calculated on both principal and interest.* The interest on a note for $1,000 due at six per cent for one year would amount to $00 at the end of the year, but if money is worth six per cent, the bank discount at the beginning of the year would be six per cent of $1,060, or $63.60. If interest is figured on a constant principal, it is called simple interest, while if it is figured on a principal periodically increased by the simple interest, it is called compound interest. 10 Prepaid Interest Prepaid interest on notes payable and receivable are, respectively, deferred charges to operation" and deferred credits to in- come. 12 Both kinds of prepaid interest may be created directly upon the receipt or payment of the money, in which case the prepaid interest would be prorated between the accounting periods, 13 or by adjusting entries which separate the real and nominal elements in the interest expense and interest income accounts. 14 Accrued Interest Accrued interest receivable and accrued interest pay- able are current asset 1 '' and current liability accounts, 1 " respectively. They are created by charging or crediting the accounts, as the case may be, with the amounts of the accrued interest, the offsetting entries being made to the interest expense 17 and interest income accounts." While it is desirable to show the full accrued interest on doubtful notes and accounts receivable for which reserves have been established, the interest should be credited to the reserve instead of to income. 19 There has been a tendency to neglect adjusting the books for prepaid and accrued interest on the ground that the amount at the beginning is 'For explanation of superior figures see page 337. 162 INTEREST 103 about the same as at the end of the period. This is absolutely unscientific and untrustworthy. Financial institutions have met this situation by having the amounts of the loans recorded on a tickler under the due date. When the adjustments are calculated, the unpaid loans are totaled each day and then the interest is figured. Interest Expense and Income It is advisable, though not absolutely necessary, to have separate accounts for the expenses and incomes arising from interest. 20 The interest expense account may be divided into interest on notes payable, interest on bonds payable, etc. ; and the interest income account also may be divided so as to indicate the source of the income. 21 All of these accounts should be classed as non-operating items in the profit and loss statement, 22 although some accountants treat interest on bonds and loans payable as an administrative item." Calculation of Interest In calculating time in connection with interest, the first day should be excluded and the last day included, or vice versa. 24 When the interest period is expressed in months, the due date is the same in the proper month, but if the period is expressed in days, the due date is found by counting the actual days. 26 For instance, a note dated April 11 would be due on July 11 if the interest period is three months, or would be due on July 10 if the interest period is ninety days. In calculat- ing discount, banks always count the number of days regardless of the way the interest period is stated on the notes. 2 " The legal rule for calculating interest, which is used by the government and by accountants in computing interest on judgments and whenever judicial actions and decisions are involved, is based on a 365-day year, while the ordinary business rule is based on a 360-day year. 27 Interest on Partial Payments The United States rule for calculating interest on partial payments applies a payment first against the interest due. If payment exceeds the interest, the surplus reduces the principal on which the future interest is computed. If a payment is less than the accrued interest, it is held in reserve, and interest on the old principal continues until a payment, together with the payments held in reserve, exceeds the accrued interest, in which case the excess is used as above. 28 The merchants' rule charges interest on the principal from its creation to its cancellation, and allows interest on all payments from the date of each payment till the date the whole principal is canceled. 29 Audit of Interest When the auditor is verifying the assets and liabili- ties, he should make lists showing the securities and notes receivable owned and the notes and bonds payable owed during the period. 30 All interest arising therefrom should then be checked against the interest income and expense accounts. 31 The verification of interest paid is especially impor- tant, as notes payable which are not shown on the books may be dis- covered. 32 The interest on bank deposits should be verified by ascertaining the rate of interest and by roughly checking the average daily balances." Interest as a Cost of Manufacture -One school of accountants believes that interest should be included on the books as a cost of manufacture, 34 while another school holds the opposite view. 36 164 C. P. A. ACCOUNTING The contention that interest is an element in the selling price cannot In- dented. Whether interest should be shown on (he books as a cost of manu- facture, however, depends on whether it is preferable to include interest in the manufacturing burden or in the profit charged on the product ; in either case the interest charge affects the selling price." The objections frequently raised to including interest as a cost of manu- facture are: first, the difficulty of determining the rate to be charged; 7 second, that interest is usually charged only on fixed investments;* third, the difficulty of handling the credit offsetting the interest;" fourth, that a more or less constant element representing interest tends to obscure fluctua- tions in the other costs; 40 and fifth, that the inclusion of interest as a cost in financial statements confuses the business world/ 1 The first of these objections is not unsurmountable, for the interest rate to be charged does not represent the actual cost of the capital invested but only the market rate of interest.* 1 The second objection is faulty, as interest is unimportant except where the element of time is vital. 43 Thus, interest need not be charged on inventories whose turnover is rapid, to justify the inclusion of interest as a cost in the case of seasoned lumber, etc. 44 The fourth objection may be answered by stating that correct cost figures may be preferable to incorrect cost figures even though the correct figures may be harder to analyze. The third and fifth objections to the inclusion of interest as a cost of manufacture are very real and vital. The credit offsetting the interest charge is usually made to profit and loss, which is absolutely incorrect as it anticipates a profit. The charge to manufacturing burden is transferred to finished goods where it may enhance the inventory another illustration of the anticipated profit." Some cost accountants are meeting these objections by crediting a reserve account when interest is charged to manu- facturing burden,* 1 and then writing off to profit and loss all of the reserve except an amount equal to the interest included in the inventories at the end of the period. 47 This reserve account is then deducted from the inven- tories on the balance sheet. 48 As the calculation of the interest in the final inventories is very compli- cated, and as most of the advantages of including interest as a cost manu- facture can be obtained by including it in statistical studies and excluding it on the books, it would seem expedient to refrain from including interest in burden, except in cases where the time element is unusually important and where the accounting departments of the firms are competent to clear the interest charge through the books in such a way that it will not cause an anticipated profit. Compound Interest Processes A knowledge of compound interest pro- cesses is necessary in dealing with the valuation of bonds, the writing off of bond discounts and premiums, the calculation of depreciation by cer- tain methods, the computation of sinking funds or the amounts required to redeem an obligation at maturity, and the handling of all transactions involving annuities. 48 Annuities are payments of specified sums of money made at regular intervals for a stated duration of time/' INTEREST 165 Compound interest processes are all based upon the ratio of increase, or one added to the rate of interest (1 + i). 51 They may be classified, how- ever, into those involving interest and those involving discount. The class involving interest is calculated by using the rate of increase as a multiplier, while the latter class is calculated by using the rate of increase as a divisor. Process Involving Interest Compound interest processes involving in- terest are used in calculating (a) the amounts of principals payable at future dates at compound interest, (b) the amount of annuities, and (c) sinking fund installments. (a) The amount of a given principal payable after a given number of periods, interest being compounded at a given rate, is found by multiply- ing the given sum by the ratio of increase multiplied by itself as many times as there are periods. 52 Illustration. Formula for Find the amount that $10,000 will aggregate Amount of Principals if invested for four periods at two per cent per P X (l + i) n period. $10,000 X (1.02) 4 = $10,824.32 (b) The amount of an annuity at the end of a given number of periods, if the payments have been invested at compound interest at a given rate of interest, is found by multiplying the amount of each payment, called the rent of the annuity, by the quotient of the total interest (amount of $1 for the given time at compound intei-est at given rate minus one) divided by the rate of interest. 53 Illustration. Formula for Find what a four-payment annuity, whose Amount of Annuity rent is $10,000, will aggregate if payments are ( 1 -f i ) " 1 invested at compound interest at two per cent i per period. (1 02) 4 1 $10,000 X- - = $41,216.08 V0 (c) The amount of annuity payments (sinking fund installments) re- quired to produce a given sum in a given time, if the payments are invested at a given rate of interest, is found by dividing the desired sum by the amount of an annuity of $1 for the same time at the same interest rate." The terms "sinking fund installments" and "rents of annuities" are synonyms. Illustration. Formula for Find the amount which, set aside at four Sinking Fund equal intervals at compound interest at two per Installments cent per period, will amount to $41,216.08 at (1 + i) n 1 end of the four periods. n o^ \* i $41,216.08 -r- - = $10,000.00 166 C. P. A. ACCOUNTING The connection between the formulas for finding the amounts of an- nuities and of sinking fund installments can be seen from the following equations : Rent X amount of annuity of $1 = Amount of given annuity. Rent amount of given annuity -4- amount of annuity of $1. The following illustration may show the reasoning back of the above formulas. If $1 were left on deposit in one bank at two per cent interest for four years, and the annual interest of two cents withdrawn annually and deposited in another bank at two per cent, compounded annually, formula (a) shows that at the end of the four years there would be the original $1 in the first bank and $.082432 in the second bank. The latter sum is the amount with interest of the periodic payment (an annuity) of two cents. If the amount of an annuity of two cents is $.082432, the amount of an annuity of $1 must be $41216 ($.082432 X Vz X 100). Processes Involving Discount Compound interest processes involving discount are used in calculating (a) the present worth of payments to be made at future dates, (b) the present worth of annuities, (c) the rent of annuities, (d) premium on bonds, and (e) discount on bonds. (a) The present worth of an amount payable at a future date is found by dividing the amount by the product of the ratio of increase multiplied by itself as many times as there are periods. Illustration. Formula for Find the present worth of $10,824.32 payable Present Worth at the end of four periods, if money is com- of Future Amounts pounded at two per cent per period. A -=- (1 + i) n $10,824.32-=- ( 1.02 ) 4 =$10,000.00. (b) The present worth of an annuity is found by multiplying the rent of the annuity by the quotient of the total discount (one minus the present worth of $1 payable at the end of the annuity) divided by the rate of interest. 58 Illustration. Formula for Find the present worth of a four-period an- Present Worth nuity of $10,000 when the money is worth two of Annuity per cent per period. i- *' i- -L, (14-i) 11 (1.02) 4 R X - ^ $10,000.00 X - - = $38,077.29 l .\j (c) The rent of an annuity that can be purchased for a given sum, when money is worth a given rate of interest, is found by dividing the sum by the present worth of an annuity of $1 for the same number of periods at the same rate of interest." Illustration Formula for Find the rent of a four-period annuity that Rent of Annuity can be purchased for $38,077.29 when money 1 is worth two per cent per period. ~ _ $38,077.29 -i- - = $10,000.00 .02 INTEREST 167 (d) The premium on a bond is the present worth of an annuity whose rent equals the excess of the actual interest receivable over the interest it would bear at the current rate of interest, whose life is the life of the bond, and whose interest rate is the current rate. 68 Illustration. Formula for Find the premium on a bond whose par, Bond Premium $3 0,000, due after four periods, bearing interest 1 at two and one-half per cent per period, if the n _i_ \ \ 11 current interest rate is two per cent per period. (AI Cl)X - V . 1 i i __ $50.00 X - -^^ - = $190.39 (e) Bond discount is calculated like premium on bonds, except that the rent of the annuity whose present worth must be computed, is the excess of the interest that the bond would bear at the current rate of interest over the actual interest receivable. 69 Illustration. Formula for Find discount on above mentioned bond if Bond Discount current rate of money is three per cent per 1 period. (ci-Ai)x $50.00 X - -~ = $1 85.85 .Uo The connection between the formulas for finding the present worth and rents of annuities can be seen from the following equations: Rent X present worth of annuity of $1 = present worth of given annuity. Rent = present worth of given annuity -r- present worth of annuity of $1. The connection between the formulas for finding the amount and present worth of annuities can be seen from the fact that the amount of the annuity is a sum payable in "n" periods, money worth "i" per cent interest. The amount of the annuity discounted back to the present would be its present worth, or 1 s Valuation of Serial Bonds When bonds mature at different dates, the initial value of the series can be found only by calculating the initial values of each installment and then adding these initial values. 10 After the value of the series lias been thus calculated, the amortization of premium or discount would be computed as if the bonds were not in a series." 1 Valuation of Short Terminal Bonds When bonds do not mature on one of their interest dates, there is a short terminal period to be considered in evaluating the bonds. The rule for evaluating bonds with short terminals 108 C. P. A. ACCOrXTIXG is to ascertain the value for the full number of periods, disregarding the terminal ; and to this value add the short interest (that part of the nominal interest per period that the short term is to the normal interest period) and then to divide the sum by the short ratio (one plus that part of the effective interest period that the short term is to the normal interest period)/ 2 Suppose a five per cent bond, par $10,000, yielding four per cent, maturing October 1, 1919, interest payable May 1 and Nov. 1, was pur- chased May 1, 1914; the bond runs 105/6 periods; short ratio rate is 1.016667; and short interest rate .020833. The bond for the ten periods is worth $10,449.13, which together with $208.33, is $10,657.46, which amount divided by 1.016667 gives $10,482.75, the value of the bond. If a bond were issued between interest dates and matured between interest dates, this process is applied twice." Amortization of Bond Premium and Discount The scientific ad Justin? of the valuation of bonds purchased above or below par so that the bonds will be valued at par when they mature, is called the amortization of bond premium and discount/ 4 Bond investments have two interest rates, namely, the coupon or nominal interest rate, and the effective rate or the real income rate on the basis of the price paid for the bonds. 9 " At the end of each period the bonds are revalued by adding the excess of the effective over nominal interest to the value of the bonds if the bonds were puvchased below par, or by subtracting the excess of the nominal over the effective interest from the value of the bonds if the bonds were purchased at a premium/ 6 The following table" 7 shows the amortization of bond premium and the revaluation of the bond at each interest date. 5% bond, par $10,000; purchased Jan. 1, 191 /, on a 4^ basis for $10,190.39; 2 years to run; interest January and July. Date Nominal Interest (a) Effective Interest (b) Amorti- zation (c) Value of Bond (d) 1/1/17. . $10,190.39 7/1/17 $250 00 $203.81 $46 19 10,144.20 1/1/18 250.00 202.88 47 12 10.097 08 7/1/18 250 00 201 94 48 06 10 049 02 J/l/19. . . 250 00 200 98 49 02 10 000 00 $1.000.00 $809.61 $190.39 (a) 2% per cent of par. (b) 2 per cent of (d). (c) (a) minus (b). (d) Value on previous date minus (c). A similar table, 8 " showing the amortization of bond discount and the periodic revaluation of the bond, is as follows ; INTEREST 169 5%. bond, par $10,000; purchased Jan. 1, 1917, on a 6% basis for $9,83 4.15; 2 years to run; interest January and July. Date Nominal Interest (a) Effective Interest (b) Amorti- zation (c) Value of Bond (d) 1/1/17 $9,814 15 7/1/17 $250 00 $294 42 $44 42 9,858 57 1/1/18. 250 00 295 75 45 75 9,904 32 7/1/18 250.00 297.13 47.13 9,951.45 1/1/19 250 00 298 55 48.55 10,000.00 $1.000.00 $1.185.85 $185.85 (a) 2J^ per cent of par. (U\ o _ <. fj\ (c) (b) minus (a). (d) Value on previous date plus (c). In both of the above tables the nominal interest is the product of the nominal interest rate multiplied by the par value of the bonds, while the effective interest is the product of the purchase price of the bonds multi- plied by the rate of interest the bonds actually yield on the money invested. As the amortization of bond premium and discount is accomplished through the bond interest account, this subject will be further discussed in Chapter XI. Bond Purchased at Intermediate Dates When bonds are purchased between interest dates, the buyer pays the seller accrued (simple) interest on the bonds, and the premium or discount is considered to vanish by an equal portion each month. 1 * If the bond mentioned in the preceding section as purchased at a premium on January 1, 1917, was sold on a 4% ba is on February 1, 1917, the accrued simple interest would be $41.67 ( 1/6 X $250) and the amortizement, $7.70 (1/6 X $46.19), so the seller would receive $10,224.36 ($10,190.39 $7.70 + $41.67). A simpler rule is to add the simple interest for the lapsed time on the value at the previous interest date calculated at the effective interest ra*e. ;0 By this rule the seller would receive $10,224.36 ($10,190.39 + ($10,190.39 X .04 X 1/12) ). Interest Bearing Debt Paid by Equal Annual Installments The amount of equal periodic installments including principal and interest which will repay an interest-bearing debt in a given number of payments is found by multiplying the principal by the amount of the sum of $1 under the given conditions and by dividing that product by the amount of an an- nuity of $1 under the same conditions.' 1 For example, what equal annual payments including principal and interest will repay in four annual payments a debt of $10,000 bearing two per cent interest? 1 1 02 V 1 ($10,000 X (1.02)') -f- - -=$2,626.24, annual payment. 170 C. P. A. ACCOUNT INC Optional Bond Redemption When the issuer has the option of redeem ing bonds prior to maturity, the premium or discount on the bonds will be affected, if it is to the issuer's advantage to call the bonds. If the issuer can redeem at par before maturity, the purchase price should be calculated on the assumption that the right will be used if the bonds are bought at a premium, or that the right will not be used if the bonds are bought at a discount. 72 Bonds which will be redeemed above par before maturity, should be valued by separately calculating, at the effective interest rate, the present worth of the principal as a future sum and the present worth of the coupons as an ordinary annuity." For example, find, on a four per cent basis, the value of a five per cent $10,000 bond, due in ten years, but to be redeemed at 110 in two years. Value of $11,000 in two years: $11,000 -=- (1.02) 4 =$10,162.30 Value of coupons : $250 X - ^ 95.1.93 Sum of value of principal and interest $11,114.23 Computing an Unknown Pate The C. P. A. candidate need not fear questions in compound interest when the rate is the unknown, as such problems are solved by reference to annuity tables, but he should be able to approximate the rate, if given access to annuity tables or data therefrom. Assume a problem asking at what rate an ordinary annuity of four rents of $10,000 would amount to $41,216.08, if the available annuity table did not show the amounts at a 2 per cent basis, but showed the amounts at 1% and 2*4 per cents. The closest amounts in the four-period line would be taken, and the difference made by an increase in one per cent ascertained. Amount at 2H%- - $4.13703639 Amount at 1%% .............................. 4.10623036. Differences %% $.03080603, or Differences 1% " $.06161206 Amount at unknown rate $4.12160800 Next lower amount 4.10623036 Difference $.015 7764 If an increase $.06161206 is caused by an increase of 1 per cent, the increase of $.01537764 must be caused by an increase of .249 (.01537764 .06161206) per cent. Hence the approximate rate is 1.999 (1.75 + .249) per cent. 74 Computing Effective Bond Rates When a bond is purchased at a price not listed on a bond table, the effective interest rate may be approximated by interpolation. 75 Assume that a $10,000 5 per cent bond, due in two INTEREST 171 years, was sold for $10,190.39. The purchase price should be looked up on a bond table on the four-period line, which would show the price in the two per cent column. If the price was not given, the nearest prices on the four-period line would be taken, and the difference made by an increase of one per cent ascertained. Price at 1%% ............................... $10,287.32 Price at 2^% ...................... 10,094.62 Differences %% ............................... $192.70, or Differences 1 % ............................... $385.40 Next higher price ............................... $10,287.32 Price at unknown rate ........................... 10,190.39 Difference ...................................... $96.93 If an increase of $385.40 is caused by an increase of 1 per cent, the increase of $96.93 must be caused by an increase of .2515 (96.93 H- 385.40) per cent. Hence the approximate effective bond rate is 2.0015 (1.75 + .2515) per cent. Computing an Unknown Time The unknown time can be approximated if the other facts regarding the annuity are available. 79 For example, find in how many periods rents of $5,000 will amount to $93,196.43 at 2 per cent. Dividing $93,196.43 by 5,000, the amount of an annuity of $1 is found to be 18.639286. 18.639286 = ( (1.02)" 1) -=- .02 .37278572= (1.02) 1 1.37278572 = (1.02) 1.37278571= (1.02) 1 ", so annuity runs sixteen periods. It should be noticed that in the above illustration sixteen periods is not quite correct, but it is close enough for all practical purposes. The raising of 1.02 to a high power in the effort to match 1.37278572 can be readily done by remembering that in raising numbers to powers the exponents are added. (1.02) ia can be calculated by four successive multiplications, viz., (a) 1.02X1.02= (1.02) 1 ; (b) (1.02)' X (1.02)' = (1.02)*; (c) (1.02) 4 X (1.02) 1 = (1.02)*; and (d) (1.02)' X (1.02) 8 = (1.02) 16 . Amount of Annuities with Interim Interest Dates If the interest is compounded more frequently than the rents are payable, the amount of such an annuity would be found by dividing the total compound interest by the effective interest rate per rent period." Letting the annual interest rate, the frequency of conversion, and the number of years be respectively represented by "j," "m," and "n," the formula for the amount of an annuity with interim interest dates is 75 R (1 + j/m)"" 1 * (l + j/m) 1 172 C. 1'. A. ACCOUNTING For example, find the amount of an ordinary annuity of four annual rents of $100, if the rents are invested at 4 per cent per annum, com- pounded semi-annually. (1 02) 8 1 The amount would be : $100 X ' = $424.90 ( -I .Ot ) _L Present Worth of Annuities with Interim Interest Dates If the interest is compounded more frequently than the rents are payable, the present worth of the annuity would lie found by dividing the total compound discount by the effective interest rate per rent period. 7 * Letting the annual interest rate, the frequency of conversion, and the number of years be respectively represented by "j," "m," and "n," the formula for the present worth of an annuity with interim interest dates is 80 RX . ' J/ ' For example, find the present worth of an ordinary annuity of four annual rents of $100, if the rents are invested at 4 per cent per annum, compounded semi-annually. 1- JL (1.02)" The present worth would be : $100 X 77-7^-1 -= = $362.65 ( i . ' '_ _) J. Present Worth of Deferred Annuities If the rents of an annuity do not commence to run until after a certain number of periods have elapsed, the annuity is called a deferred annuity. 81 If an annuity of $1 for "x" periods is deferred for ''y" periods, its present worth can be found either (a) by multiplying the present worth of an ordinary annuity of $1 for "x" periods by the present worth of $1 due "y" periods hence, 92 or (b) by subtracting the present worth of an ordinary annuity of $1 for "y" periods from the present worth of an ordinary annuity of $1 for "x" plus "y" periods. 83 If a bond table is available, the second method is preferable, but otherwise the first should be used. For example, find the present worth of a four-period annuity, whose rent is $10,000, when money is worth two per cent per period, if the annuity is deferred five periods. First Method. i 1 (1 02 V 1 X X $10,000 = $34,487.77, present worth. .02 (1.02)' Second Method. 1 i (1.02) 9 (1.02)' }> Q9 09 I X $10,000 = $34,487.77, present worth. INTEREST 173 Amount of An unit if* Due Annuities whose rents are due at the end of the periods are "ordinary" or "immediate" annuities, but annuities whose rents are due at the beginning of the periods are called "annuities due." 84 The amount of an annuity due of "n" rents can be found either (a) by multiplying the amount of an ordinary annuity under the same conditions by the ratio of increase, 85 or (b) by subtracting one rent from the amount of an ordinary annuity under the same conditions except for "n + 1" periods, 8 " or (c) by adding the compound interest on the first rent for "n" periods to the amount of an ordinary annuity of "n" periods. 87 For example, find the amount of a four-period annuity due, whose rent is $10,000, when money is worth two per cent per period. First Method. (1 02V _ 1 X 1.02 X $10,000 $42,040.40, amount of annuity due. a Second Method. f (1 02) 5 1 _L_. -- i f- x $10,000 = $42,040.40, amount of annuity due. Third Method. I [ (1 02 ) 4 1] + (LO ") ~ I x $10,000 = $42,040.40, amount of annuity 2 J due. Present Worth of Annuities Due The present worth of an annuity due of "n" rents can be found (a) by multiplying the present worth of an ordinary annuity under the same conditions by the ratio of increase, 88 or (b) by adding one rent to the present worth of an ordinary annuity under the same conditions except for "n 1" periods,* 9 or (c) by adding the compound discount on the first rent for "n" periods to the present worth of an ordinary annuity of "n" periods. For example, find the present worth of a four-period annuity due, whose rent is $10,000, when money is worth 2 per cent per period. First Method. X 1.02 X $10,000 $38,838.83, present worth. Second Method. ! L_ 3 1 1-L+ 1 1* X $10,000 = $38,838.83, present worth. * J Third Method. i- 1 (1 02)* 1 ~~ (102)*' + " 02 f X $ 10 > 000 = $ 38 > 838 - 83 > present worth. 174 C. P. A. ACCOUNT TNI! QUESTIONS IXTEKKST 1. Distinguish between simple and compound interest. (N. Y., June. 1913.) 2. Define: Discount. (Wash., July. 1917.) 3. Explain four different uses of the word "discount" as used in ac- counting. (Colo., Dec., 1913.) 4. Classify the Interest account. (Iowa, Dec., 1918.) 5. How should interest appear on a Trading statement? (Iowa. Dec., 1918.) 6. (a) What are the elements of interest? (b) What is the rate of discount corresponding to 2 per cent interest? (c) In a 4 per cent bond to net 2*/ 2 per cent, what is the difference of rates? (Mich., June, 1912.) 7. Why is unearned interest on bills receivable seldom taken into con- sideration in ordinary business houses? (S. C., Sept., 1919.) 8. How would you treat such account as the following, if closing the books at a certain period, with a view to ascertaining the loss or gain : Mortgages, Notes, and other paper as to interest? (N. J., 1904-1909.) 9. In making an audit of a company, you find that they have notes receivable bearing interest, some paid in advance and included in the face of the notes, others with interest accruing. Kxplain your handling of this interest in your report. (Mich., June, 1910.) 10. State what is indicated by the Interest account (a) when the ac- count shows a debit balance; (b) when the account shows a credit bal- ance. Explain fully. (N. Y., Jan., 1900.) 11. In order to facilitate the preparation of monthly Profit and Loss statements by a corporation, how would you recommend that the Interest Payable be treated on its books from month to month? (Wash., April, 1906.) 12. Explain the inaccuracies from an accounting standpoint of the ordinary Interest and Discount account. (Mich., Dec., 1913; N. Y., Jan., 1919.*) 13. Describe fully the Interest account, showing what entry may be made on each side and what disposition should be made of the balance. (N. Y., June, 1898.) INTEREST 175 14. Explain by entries the proper accounting for each case in which interest and discount is involved in handling both Bills Receivable and Bills Payable. (Midi., Dec., 1913; N. Y., Jan., 1919.*) 15. "A" purchases "B's" business as a going concern, paying part of the purchase price in cash on the date of the transfer, and giving interest- bearing notes for the balance. How would you, as auditor, expect to find the interest on the notes treated in "A's" books? (Wash., April, 1906.) 16. A large hotel is furnished on the installment plan. Explain, giving reason, whether the question of interest is of importance to (a) the seller; (6) the buyer. (N. Y., June, 1913.) 17. In making a detailed audit what procedure would you follow to verify the Interest Prepaid on Notes Payable? (Kan., Dec., 1915; Mo., Dec., 1915.) 18. In preparing the Balance Sheet of a business at the close of a year, how should you treat Interest Paid in Advance on Notes Payable Discounted? (Mass., June, 1910.) 19. In a statement of condition, requiring classification of assets and liabilities into fixed assets, current assets, etc., in what class would you ^lace prepaid interest? State reasons for your answer. (Mass., June, 1912.) 20. A corporation redeems part of its outstanding mortgage bonds and holds the bonds as an asset, collecting the interest thereon through its fiscal agent. The interest thus collected is regarded by the officers of t-^e company as income. In preparing a statement for publication how should the account treat such interest? (N. Y., June, 1917.) 21. On which side of the Ledger should the balance on the Interest Collected in Advance account appear? (Mo., Dec., 1914.) 22. Define: Accrued interest. (A. I. of A., May, 1919.) 23. How would you verify the correctness of accrued interest? (N. Y., June, 1909.) 24. Formulate Journal entries to express fully the following transac- tion: The adjusting of an Interest account for interest earned but not yet collected. (Wash., May, 1903.) 25. What in your opinion is the proper treatment of the accounts named below in arriving at the profit or loss of a business for a specific fiscal period: Accrued Interest on Notes Receivable; Accrued Interest on Notes Payable? (Ohio, Dec., 1908.) 26. On which side of the Ledger should the balance of the Interest Accrued on Notes Receivable account appear? (Mo., Dec., 1914.) 27. In what section of the Balance Sheet and in what order would you show the Interest Accrued Payable? (A. I. of A., Nov., 1919.) 28. State in the form of Journal entries the following transaction: the adjustment of interest accrued but not yet payable on a mortgage. (N. Y., June, 1898.) 17<> ( . l. A. ACCOUNTING 29. Define: Annuity. (Ohio. Nov., 1916.) 30. Define: Ratio of increase; accumulation. (Kan., Dec., 1915; Mo., Dec., 1915.) 31. Define: Effective rate; Nominal rate. (N. Y., June, 1913*; Kan., Dec., 1915; Mo., Dec., 1915.) 32. What do you understand by : "present worth of a deferred pay- ment"; "amount of an annuity"? (Kan., Dec., 1915; Mo., Dec., 1915.) * 33. Define: Amortization. (N. Y.. Jan., 1911; Colo., Dec., 1913; 111., May, 1914*; Mich., Dec., 1914; Del., June, 1915*; Kan., Dec., 1915; M,... Dee., 1915; Ohio, Nov., 1916; Wis., April, 1917; A. I. of A., Nov., 1917: Ind., Nov., 1918*; 111., Dec., 1918; A. I. of A., May, 1921.) 34. What is an Amortization account? (N. D., July, 1916.) 35. (a) What is the principle of amortization? (ft) How and when used? Illustrate. (Iowa, Dec., 1918.) 36. Explain the method of valuing permanent investments in bonds on an amortization principle. (Mass., Oct., 1914.) 37. Under what theory is the present value of deferred payments ascer- tained? (N. Y., June, 1917.) 38. Describe the annuity method of writing- off the premium. Is there any objection, in your opinion, to this method? If so, state it. (Mo., Dec., 1913.) 39. What mathematical procedure would you adopt to amortize the premium on bonds having a number of years to run? (N. Y., Jan., 1914; N. D., Aug., 1917.) 40. How would you determine the amount of a sinking fund install- ment if you were unfamiliar with the use of mathematical tables and knew no mathematics beyond arithmetic? Explain and illustrate. (N. Y., Jan., 1917.) INTEREST 17", PROBLEMS INTEREST 1. What sum invested at 6 per cent compounded annually will amount to $1,000 in five years? (Cal., June, 1904.) 2. The present value of an annuity of $1 for four periods at 2 per cent is $3.80772870. What is the value on January 1, 1914, of a 5 per cent per annum bond issue of $100,000 bought on a 4 per cent per annum basis (semiannual coupons), due January 1, 1916? Prepare amortization table as follows: Total Interest Income Amortization Book Value Par Value Date 1-1-14 7-1-14 1-1-15 7-1-15 1-1-16 2^4 per cent 2 per cent $100,000 Insert values under the various heads to the nearest cent. (Kan., Dec., 1915; Mo., Dec., 1915.) 3. In auditing the books of a corporation you find that in order to provide a sum to redeem a mortgage of $100,000 falling due at the end of ten years, a reserve of $8,000 per annum has been set aside annually for three years, but that contrary to intention, the company has failed to accumulate interest thereon. Assuming interest at 4 per cent (convertible annually), what should have been the total accumulations to date, and what amount should now be set aside annually for the next seven years in order to complete the sinking fund? ( 1.04 ) 7 =1.31593. (A. I. of A., May, 1918.) 4. A lease has 5 years to run at $1,000 a year, payable at the end of each year, with an extension for a further 5 years at $1,200 a year. On a 6 per cent basis, what sum should be paid now in lieu of 10 years' rent (V 5 at 6 per cent=.7473)f (A. I. of A., May, 1919.) 5. "A" owns an annuity of $50 per annum, the first payment on which falls due 1 year hence and which continues for a period of 20 years certain. State: (a) the present value of the benefit; (b) the amount which he will have accumulated at the end of the period if he invests each moiety as it becomes due. 178 (.'. P. A. ACCOUNTING Assume interest at 4 per cent annually. In this connection the value of 1.01 20 is stated to !><> equal to 2.191123. (A. I. of A., Nov., 1917.) 6. An annuity of $3,000 at 6 per cent compound interest is to be paid in four quarterly payments. Furnish the annuity depreciation account with quarterly balances. (N. Y., June, 1919.) 7. The present value of an annuity of $1,000, payable in half-yearly installments for 45 years, at the rate of 6 per cent, semiannually, being 1 $15,501.20, what is the value of the same annuity if paid annually, the rate being the same as before? (Ohio, Nov., 1915.) (Note: 45th power of 1.06 is 13.76461083, whose reciprocal is .07265007.) 8. Purchased May 1, 1904, ex coupon, $100,000 of 5 per cent bonds, interest payable May 1 and November 1, on the basis of 4 per cent semi- annually, principal to mature May 1, 1929. Required the amortizeinent of the premium for the half year ending November 1, 1924. (Ohio, Nov., 1915.) (Note: 9th power of 1.02 is 1.19509257, whose reciprocal is .83675527.) 9. The discount on $1 for 35 years, at 3% per cent, semiannually, being $0.7031133, what is the value of $100,000 of bonds paying 5 per cent, semiannually, and maturing in 34% years, the investment rate being the same as before? (Ohio, Nov., 1915.) 10. If $100,000 of bonds, paying $3,000 each six months (May 1 and November 1) is worth $123,468.34 on May 1, 1915, ex coupon, and the investment rate is 4 per cent semiannually, what is the present value of an annuity of $1,750, payable annually during the life of the bonds, the investment rate being the same as before? (Ohio, Nov., 1915.) (Note: 32nd power of 1.02 is 1.88454059, whose reciprocal is .53063330. 16th power of 1.04 is 1.87298125, whose reciprocal is .53390818.) 11. Smith's baby owns an annuity of $100 per annum, the first pay- ment on which falls due 1 year hence, which continues for a period of 20 years certain. You are asked to state: (a) The present value of the benefit; (&) the amount which he will have accumulated at the end of the period, if he invests each payment as it becomes due; (c) an arithmetical formula for computing compound interest for the period. Assume interest at 4 per cent, payable annually. The value of $1 at 4 per cent compound interest is assumed to be $2.191123. (Ind., May, 191S.) 12. If a principal of $1 will amount to $3.3863549 in 25 years, at 5 per cent per annum, what would be the present value of an annuity of $1,250 for 30 years at the same rate? (Ohio, Nov., 1915.) (Note: 30th power of 1.05 is 4.32194238, whose reciprocal is .23137745.) 13. A manufacturer owes $100,000 on his plant at 5 per cent per annum, due at the end of the 5 years from date. He secures the agree- ment, however, to pay the debt in equal installments, which will include interest and principal. What amount is he required to pay each year? INTEREST 170 (Pa., Nov., 1912.) (Note: 5th power of !.()."> is 1.27628156, whose recip- rocal is .78352617.) 14. A corporation needing some additional capital for a short term of years, issues $300,000 of debenture bonds carrying 6 per cent interest, payable one-fifth each year for five years. Coupons are attached to the bonds maturing every six months; the bonds are sold at 90 flat. What average rate of interest does the company pay for the money, excluding interest on interest? (111., Nov., 1904.) 15. A certain issue of $100,000 4 per cent bonds is dated September 1, 1908, and interest begins at that date, but interest is payable on Feb- ruary 1 and August 1, and the principal (with 4 months' interest) is payable December 1, 1912. What is the value of these bonds on a 3.60 basis at that date of issue? What is their value on the same basis, if pur- chased on December 1, 1908? (Note that you are interloping into a five- month period, not a six-month, in the beginning.) (Mich., July, 1909.) (Note: 7th power of 1.018 is 1.1330121, whose reciprocal is .882603.) CHAPTER X RESERVES AND FUNDS Classes of Reserves The term "reserve accounts" has been indiscrimi- nately applied to items which are essentially different. 1 In financial insti- tutions, the term "reserve" indicates the amount of cash and cash items on hand and on deposit, which may legally be counted as a cash reserve fund held against deposits. 2 The following table shows the classes of reserves found in ordinary businesses : A. Valuation Reserves : (a) Asset valuation reserves. I. Depreciation reserves. 1. For buildings. 2. For machinery. 3. For equipment. 4. For merchandise, etc. II. Depletion reserves. 1. For mines. 2. For timber. 3. For oil, etc. III. Bad debts reserves. 1. For uncollectible accounts receivable. 2. For sales discounts. 3. For uncollectible notes receivable, etc. IV. Market fluctuations reserves. 1. For merchandise inventories. 2. For securities, etc. (b) Liability valuation reserves. I. Operating reserves. 1. For taxes. 2. For accrued wages. 3. For accrued salaries. 4. For accrued rents, etc. B. Proprietorship Reserves : (a) Recorded reserves. I. Appreciation reserves. 1. For buildings and machinery. 2. For land. 'For explanation of superior figures see page 337. 180 RESERVES AND FUNDS 181 II. Contingency reserves. 1. For fire insurance. 2. For flood loss. 3. For accidents. 4. For guarantees. 5. For pending law suits. 6. For obsolescence, etc. III. Open reserves. 1. For debt extinguishment. 2. For plant extension. 3. For betterment and improvements. 4. For working capital. (b) Unrecorded reserves. I. Secret reserves. 1. Understatement of assets. 2. Overstatement of liabilities. 3. Overstatement of asset valuation reserves. Asset Valuation Reserves Asset valuation reserves represent the provi- sion made for losses actually sustained in the value of assets, or anticipated losses known to be certain. 3 Their balances are suspended or deferred cred- its to the corresponding assets, and are neither liabilities nor surplus. 4 Al- though occasionally found on the right side of the balance sheet, 5 asset valuation reserves should be deducted from their related assets on the balance sheet." The depreciation and bad debts reserves are thoroughly discussed in Chapter XV, Volume I, and Chapter III, Volume II, respectively. As leasehold property and patents become valueless after a certain length of time, reserves for amortization of improvements on leasehold property 7 and for expiration of patents should be created ; 8 both reserves being asset valuation reserves of the depreciation group. The depletion reserves are credited with the estimated amount of wasting assets consumed. 9 The related asset minus the reserve gives the net book value of the remaining wasting asset. Market fluctuation reserves are credited for excess of the cost price of the related asset over its market price. 10 At the close of each period the reserve is adjusted so that it equals this excess, the offsetting entry being to profit and loss. 11 Fluctuations above cost are disregarded on the balance sheet except for parenthetical references." Operating Reserves Operating reserves are not appropriations of sur- plus, 13 but are liabilities." They may be divided into those offsetting estimates of expenses, the exact amounts of which are not known, and those offsetting expenses, the exact amounts of which are known but are unpaid. 15 The reserve for taxes is an illustration of the first group, while the reserves for accrued wages, salaries, and rents are illustrations of the second group." 182 C. P. A. ACCOUNTING The use of the title "reserve" for items covered by the operating reserves is unfortunate, except in cases where the amount of the expense items can not be approximately predetermined. 11 Thus it would be preferable to use the title "wages accrued" rather than "reserve for wages," but the use of the title "reserve for taxes" may be justified. 18 Many accountants, however, use the term "accrued taxes" instead of "reserve for taxes."' 9 Appreciation Reserves An appreciation resei've represents the un- realized profit put on the books when the assets were raised to the appraisal value, the reserve being credited instead of surplus to prevent the un- realized profit from being declared as dividends. 20 Contingency Reserves It is extremely difficult to draw a dividing line between operating and contingency reserves, it being a matter of degree as to the certainty of the events happening for which provision is being made. 21 Since the liabilities covered by contingency reserves are not likely to materialize, the reserves are surplus temporarily debarred from dividend distribution." The operation of a contingency reserve is shown in Chapter XIV, Volume I, under the caption "reserve for insurance." Secret Reserves Secret reserves represent the excess of the actual net worth of a concern over the amount indicated on its balance sheet." They may be created either by undervaluing the assets 24 or overstating the liabilities; 26 the former is the more popular method as the creditors them- selves check up all actual liabilities. 28 The actual value of the firm's net worth should be conservatively valued, but an auditor should not counte- nance secret reserves as they prevent the balance sheet from being a true statement of condition." An advantage claimed for secret reserves is that extraordinary losses, which would result in very unfavorable fluctuations in stock values, may be charged against them. 2 * However, an extraordinary loss should not be concealed from the prospective investor. The claim that secret reserves have the advantage of permitting the maintenance of a uniform dividend rate must be admitted, but the desired result can also be obtained with an open surplus account. Secret reserves are objectionable because they prevent stockholders from receiving their share of the profits made during the period of their stock ownership, 80 and from receiving the true value of the stock in case of sale." Secret reserves are also objectionable as they afford the directors an opportunity of concealing losses due to speculation and mismanagement." Open Proprietorship Reserves The open proprietorship reserves repre- sent profits reinvested in the business and withheld from distribution to stockholders. 33 These reserves are frequently called the true reserves." They are nothing but subdivisions of surplus and should be shown as such on the balance sheet." The separation of a portion of surplus into open proprietorship reserves is almost entirely a matter of bookkeeping, de- signed to inform stockholders that the amounts so set aside will not be distributed as dividends.* 9 A surplus account is an open proprietorship RESERVES AND FUNDS 183 reserve account representing profits reserved for general rather than for specific purposes." Open proprietorship reserves are created by debiting surplus directly, 35 and after the purposes of accumulating the capital, such as debt extinguishment and plant extension, have been accomplished, the reserves should be closed back into surplus. 8 ' Funds Funds are debit accounts consisting of money or securities set aside for specific purposes. 40 They are financial expedients to ensure the possession of ready money to meet the object for which the fund is estab- lished when the necessity for its use arises. 41 Unless protected by directors' resolutions, funds can be used for pur- poses other than those for which they were created, 42 or can be reverted to general cash.* 3 Funds are current assets. 44 Reserve Funds Some accountants use the term "reserve fund" to mean a surplus reserve." This use is incorrect, for reserve funds are assets set aside for a purpose, for the accomplishment of which a reserve has also been established. 40 If money is set aside for a definite purpose, a fund is created. 47 If profits are retained in the business for the same purpose, a reserve is created. 48 If both a fund and reserve are created for the same purpose, the fund is a reserve fund. 48 Sinking Fund A sinking fund is assets set aside for the purpose of meeting a debt or retiring an issue of stock. 50 Sinking funds are usually increased by more or less regular amounts set aside at regular intervals." These installments are usually placed in the hands of trustees, 62 who either place the money in banks or purchase gilt-edged securities with it." Re- gardless of the fact that many deeds of trust require that sinking funds be created out of profits, the sinking fund should be still created by setting aside cash, but, when this is done, an equal amount should be reserved from profits thus creating a sinking fund reserve in addition to the sinking fund. 54 If the sinking fund is in the hands of the company, the auditor should verify the sinking fund securities and deposits. 55 If the sinking fund is controlled by a trustee, the auditor should secure a certificate as to the funds. 5 " If the sinking fund has been invested in the corporation's own bonds which have been surrendered by the trustee, the auditor must ex- amine them and ascertain whether illegal use of them has been rendered impossible." When sinking funds are shown on the balance sheet, differentiation should be made between the investments which have been made and the cash on hand/' 8 Sinking fund holdings of the corporation's own bonds payable may be either listed on the balance sheet among the assets 6 * or deducted from the outstanding bonds payable, 90 the latter method seeming preferable as treasury bonds are not assets any more than treasury stock. If the sinking fund bonds are canceled, they must either be deducted from the outstanding bonds payable on the balance sheet 81 or only the net out- standing bonds shown," 2 the latter method seeming preferable as canceled debts are not usually shown on the balance sheet. 184 C. P. A. ACCOUNTING Income derived from sinking funds may be turned over to the company, retained by the trustee as an addition to the sinking fund, or applied as a deduction from the next sinking fund installment." 3 This income should be shown in a special account, which should be closed into the corpora- tion's ordinary profit and loss account." Although premium or discount on bonds purchased as sinking fund investments is frequently written off at once to the profit and loss account,' 8 it should be amortized over the life of the bonds.' 9 If the bonds are can- celed, the pi-emium or discount thereon should be written off at once to profit and loss." When the bonds covered by the sinking fund mature, the sinking fund (outside) securities are converted into cash,' 8 any difference in the realized and book values of the securities being written off to the profit and loss account. The cash is then used by the trustee to redeem the bonds,' 8 and any cash remaining after the redemption of the bonds is turned over to the corporation. 70 Treasury bonds in sinking fund would then be canceled and written off against bonds outstanding." Entries for Sinking Fund The following entries show a complete his- tory of a sinking fund. The account titles are suggestive only, as many varying titles are used. Entry No. 1 Sinking Fund Cash Held by Trustee xxxxxxx Cash xxxxxxx (For sinking fund installment.) Entry No. 2 Sinking Fund Investments xxxxxxx Premiums on Sinking Fund Investments xxxxxxx Sinking Fund Cash Held by Trustee xxxxxxx (Purchase at premium of bonds for sink- ing fund.) Entry No. 3 Sinking Fund Expenses xxxxxxx Sinking Fund Cash Held by Trustee xxxxxxx (For expenses chargeable to fund.) Entry No. 4 Sinking Fund Cash Held by Trustee xxxxxxx Sinking Fund Income xxxxxxx Premium on Sinking Fund Investments .... xxxxxxx (For interest received on sinking fund bonds and amortization of premium on same.) Entry No. 5 Sinking Fund Income xxxxxxx Sinking Fund Expenses xxxxxxx Profit and Loss Account xxxxxxx (For closing net sinking fund income into profit and loss.) RESERVES AND FUNDS 185 Entry No. 6 Sinking Fund Cash Held by Trustee xxxxxxx Loss on Sale of Sinking Fund Investments . . . xxxxxxx Sinking Fund Investments xxxxxxx (For cash received and loss incurred on sale of sinking fund securities.) Entry No. 7 Profit and Loss Account xxxxxxx Loss on Sale of Sinking Fund Investments . . xxxxxxx (To close loss on sale into profit and loss.) Entry No. 8 First Mortgage 6% Bonds xxxxxxx Sinking Fund Cash Held by Trustee xxxxxxx (For redemption of bonds.) Entry No. 9 Cash xxxxxxx Sinking Fund Cash Held by Trustee xxxxxxx (For cash turned over by trustee to com- pany.) Reserve for Sinking Fund While it is not necessary to have a sinking fund reserve to have a sinking fund, and vice versa, accounts are usually seen together due chiefly to the fact that so many deeds of trust require that sinking funds be created out of profits." As sinking funds can only be created out of assets, a sinking fund reserve account is usually created by charging surplus 73 immediately on the creation of the fund (Entry No. 1, page 184). The profit and lows account is frequently debited at the creation of sinking fund reserves, 74 but it is preferable to debit surplus directly as such action emphasizes the fact that the reserve is a part of surplus. If the premium or discount on sinking fund "investments is gradually amortized, as shown in entry No. 4 above, no adjustment with the sinking fund reserve is necessary. If the premium and discount are written off immediately, the former should be debited and the latter credited to the sinking fund reserve, as the reserve should be kept in harmony with the fund. 75 After the net profit or loss from the sinking fund has been trans- ferred to profit and loss (see entry No. 5 above) and then to surplus, the net increment or decrement should be transferred from surplus to the sinking fund reserve. 7 * After the losses and gains on sale of sinking fund investments have been transferred to profit and loss (see entry No. 7 above), the sinking fund reserve must be brought into agreement with the sinking fund, 77 the off- setting entries being to surplus. After the bonds have been redeemed and the excess cash has been turned over by the trustee to the company (see entries No. 8 and No. 9 above), the sinking fund reserve is turned back into surplus. 78 180 C. P. A. ACCOUNTING QUESTIONS RESERVES AND FUNDS RESERVES 1. Define: Reserve account, (Md., Oct., 1903*; N. Y., Feb., 100S*; Mich., June, 1908*; Ohio, March, 1910*: Va., Nov., 1910: Wash.. May, 1911*; Wash., June, 1912; Mich., June, 1912*; Wis., April, 1914; Wis., May, 1916; Ohio, Nov., 1916*; N. D., Aug., 1917; Mass., Oct., 1917; Va., Nov., 1918; Iowa, Dec., 1918.) 2. Define: Qualified reserve. (Ill, Dec., 1918.) 3. Name various ways in which reserves may appear on, or affect the items of, a Balance Sheet. (Wis., April, 1914.) 4. Discuss briefly the various kinds of reserves yon are familiar with and state how they should be handled on the books and on the Balance Sheet. (Pa., Nov!, 1917.) 5. Distinguish between "voluntary reserves" and "necessary reserves'' and how would you treat such on a Balance Sheet? (N. C., June. 1916.) 6. Are sinking fund or debt extinguishment reserves a charge against income or are they allocations of the surplus? (N. C., June, 1916.) 7. Under what conditions would you group reserves with surplus upon a general Balance Sheet? (Cal., Nov., 1916.) 8. Distinguish and name some of the reserve accounts created or pro- duced by a charge to operating expenses, from that class of reserve ac- counts created or produced by a charge to the surplus account. (N. C., June, 1919; N. C., Sept., 1919; N. C., Nov., 1919.*) 9. Define operating reserves and illustrate briefly their uses in two separate instances. (Minn., Oct., 1916; 111., Dec., 1918.) 10. What is your understanding of the difference between Liability Reserves and Surplus Reserves, and name examples of each class? (N. C., Nov., 1918.) 11. Explain the difference between real reserves and nominal reserves. Give two examples of each. (A. I. of A., May, 1920.) 12. From the viewpoint of a Balance Sheet, what is the logical place of (a) reserves for depreciation of physical assets, created by charges to operations; (b) operating reserves; (c) reserves for redemption of lia- bilities; (d) reserves for contingencies? Give reasons for your opinion (N. Y., Jan., 1914.) RESERVES AND FUNDS 187 13. Under what condition and upon what basis would j^ou set up the following reserves and how would you finally dispose of them: (a) Sinking funds; (b) appreciation of leasehold; (c) depreciation of leasehold; (d) exhaustion of oil wells* (Cal., Nov., 1916.) > 14. (a) State whether each of the following accounts is a liability account or a proprietary interest account: (1) Reserve for Depreciation; (2) Reserve for Extensions; (3) Reserve for Bad Debts; (4) Reserve for Contingencies; (5) Reserve for Inventory Adjustment; (6) Reserve for Sinking Fund. (b) Discuss the accuracy of the terminology employed in each of the above account names. (Wis., April, 1917.) 15. How are reserves created? (Wash., May, 1911.) 16. For what purpose are reserves created? (Md., Oct., 1903; Mich., June, 1912.) 17. How are the Reserve accounts used? (Ohio, March, 1910.) 18. Show proper classification of a reserve on the debit and credit sides of a Balance Sheet. (Mich., June, 1908.) 19. How may a Reserve account be properly established and for what purpose 1 ? What, if any, contra account should be maintained? Under what circumstances should these accounts be maintained? Why? (N. Y., Feb., 1908.) 20. How would a Reserve affect the book value of capital stock? (Mass., Oct., 1917.) 21. Discuss briefly the following statement: A reserve is always cap- ital. (Cal., Nov., 1916.) 22. A corporation having issued first mortgage bonds to the amount of $50,000 sets aside out of the profits $5,000 each year and pays off at par bonds to a similar amount. Plow shall these items appear in a Balance Sheet at the end of five years? (Mass., Oct., 1916.) 23. What is a "contributed reserve"? Commonly employed by what kind of organization? (Iowa, Dec., 1918.) 24. Explain "contingency reserve." How would it affect the book value of capital stock? (Mass., Oct., 1917; A. I. of A., May, 1921.*) 25. In the Balance Sheet of a corporation how should the Reserve for Contingencies be stated? (111., May, 1912.) 26. In connection with the audit of the books of a corporation describe briefly the procedure you would consider to be essential in verifying the Reserve for Allowances and Discounts. (Wash., July, 1917.) 27. Define : Reserve for Amortization of Improvements on Leasehold Property. (Wash., July, 1917.) 28. Define: Reserve for Expiration of Patent Rights. (Wash., July, 1917.) 29. Classify Reserve for Depreciation on Buildings according to the subdivision of assets, liabilities, proprietary interest, income and ex- 188 C. P. A. ACCOUNTING penses under which it should be grouped. (N. Y., Jan., 1907*; Mass., June, 1912; Wis., May, 1919.) 30. Classify Reserve for Income and Excess Profits Taxes according to the subdivision of assets, liabilities, proprietary interest, income and expense under which it should be grouped. (Wis., May, 1919.) 31. To what extent would you consider it necessary to verify the Reserve for Depreciation of Plant and the Reserve for Sales Discount, and what reference to such verification would you make in your report ? (Mass., June, 1913.) 32. What provision, if any, would you make for income and excess profits taxes in closing accounts before the passing of a pending act levying these taxes, either in general circumstances or when profits are partly divisible under some special contract or arrangement? (A. I. of A., Nov.,' 1918.) 33. As at December 31, how would you disclose upon a Balance Sheet the surplus appropriated for additions and betterments on the books of a steel plant? (Cal., May, 1916.) 34. A corporation owns nearly all of a block of land. The remaining portion is purchased subject to an existing lease. The corporation sets aside out of surplus an amount believed to be sufficient to extend its plant over the entire block at the expiration of the lease. What ledger title should be given to the amount set aside and how should the amount be set up in the Balance Sheet? (A. I. of A., Nov., 1919.) 35. An interurban railway company, wishing to provide against pos- sible accidents, adopted the plan of depositing 2 per cent of their gross receipts each month in a local savings bank as a reserve for that purpose, charging the funds so set aside to an account which they designated "Re- serve for Accidents." The total fund for the year amounted to $4,869.26, out of which they paid $950 for accidents occurring and settled during the twelve months, debiting such payment to Accident account, and leaving cash balance in the bank on December 31 of $3,919.26. The bookkeeper endeavored to close the books by showing the $4,869.25 as a charge against operating for the year arising out of accident liability, carrying over the balance in bank ($3,919.26) to provide for future acci- dents, and making a corresponding credit to the "Reserve for Accidents" account. This left the company with cash assets of $3,919.26 not repre- sented on the books. Wherein did the bookkeeper err, and what entries should have been made to show the transaction correctly? (111., Dec., 1907.) 36. Define: Reserve for Bad and Doubtful Accounts. (Wash., July, 1917.) 37. When preparing a Trading and Profit and Loss account at the end of a fiscal year, in what manner would you treat the Reserves for Bad Debts? (N. Y., Jan., 1907.) RESERVES AND FUNDS 180 38. Would a Reserve for Doubtful Accounts, the account of which is based entirely upon the amount of loss of the year preceding, be shown on a Balance Sheet as a liability, or as an allocation of the surplus? State your reason. (N. C., June, 1919; N. C., Sept., 1919.) 39. In connection with the audit of the books of a corporation describe briefly the procedure you would consider to be essential in verifying the Reserve for Bad and Doubtful accounts. (Wash., July, 1917.) 40. In what respects, if any, does a Reserve for Replacement differ from a provision for depreciation? (Ohio, Oct., 1919.) 41. In conducting an audit: (a) What would be your object in ex- amining reserve accounts that were allocations of the surplus and are not liabilities? (b) If you found liability reserve excessive or deficient, what would be your procedure? (N. C., Nov., 1918.) 42. State fully how you would deal with excessive and deficient re- serves. (N. C., June, 1916; N. C., Nov., 1919.*) 43. What is a secret reserve? (Wash., Sept., 1907*; Mich., June, 1908; Fla., July, 1909*; Wash., May, 1911*; Mo., Dec., 1914*; Ohio, Nov., 1916; Cal., Nov., 1916*; N. C., Aug., 1917; Mass., Oct., 1917*; Md., Dec., 1917; Iowa, Dec., 1918.) 44. (a) How are secret reserves usually created? (&) What is the effect of such practice? (c) What, if anything, can be said in extenuation of this practice? (Ohio, Nov., 1913*; Ohio, Oct., 1919.) 45. (a) Illustrate different kinds of secret reserves. (6) Are secret reserves legal? (Mich., June, 1919.) 46. Briefly discuss the question of an understatement of the financial condition and state whether this is ever justifiable, giving your reasons. (Ohio, Oct., 1919.) 47. Discuss briefly the ethics of charging expenditures for construc- tion and betterments to profit and loss. (Cal., Nov., 1916.) 48. Describe the object and effect of a Secret Reserve. (Wash., May, 1911.) 49. You are employed to make an audit by a stockholder who believes the management of the corporation is piling up large secret reserves with the view of buying up the stock of the minority holders. You are given free access to the books. Explain in detail what investigations you would make to determine the truth or falsity of this belief. (Mich., Dec., 1913.) 50. Give your opinion as to the advantages or dangers arising from secret reserves. (Fla., July, 1909.) 51. Give some examples of secret reserves and state your opinion 34 to the propriety, or otherwise, of the creation of such reserves, giving reasons. (Wash., Sept., 1907; Mich., June, 1908*; Md., Dec., 1917.*) 52. State what you would consider an auditor's duties relative to secret reserves. (Fla., July, 1909*; N. Y., Feb., 1910*; Mo., Dec., 1914; Mich., June, 1919.*) 1i><) C. P. A. ACCOUNTING 53. How would a secret reserve affect the book value of capital stock? (Mass., Oct., 1917.) 54. Where do secret or hidden reserves differ from ordinary reserves? How are such reserves created and for what purposes? (Mo., Dec., 1913; 111., May, 1914.) 55. Define: Hidden reserve. (111., May, 1906*; Pa., Nov., 1906*; Pa. Nov., 1912*; Mich., Dec., 1914; Mass., Oct., 1916.*) 56. Describe two instances of hidden reserves and their treatment in the accounts. How would you deal with these in a Balance Sheet? (Mass., Oct., 1916.) 57. How far in your opinion is an auditor justified in omitting to mention hidden reserves in a certified statement? Would you treat them differently in a statement for credit purposes, a statement to stockholders, and a statement to the State of Massachusetts? If so (a) how, and (b) why? (Mass., April, 1911.) 58. Express your opinion of the soundness of hidden reserves from an auditor's standpoint. (111., May, 1906; Pa., Nov., 1906; Pa., Nov.. 1912.*) 59. Support your views on the use of secret reserves. (N. D v June, 1914.) 60. Express your opinion of the soundness of hidden reserves from the viewpoint of a shareholder, and a director, respectively. (111., May, 1906; Mich., June, 1913.*) 61. Define: Reserve for Sinking Fund. (Wis., April, 1917.*) 62. State clearly under what conditions reserves for sinking funds should be carried. (Cal., June, 1917.) 63. Indicate the pro forma entries for the creation of a sinking fund reserve. (Cal., June, 1917*; Wis., May, 1919.) 64. If a reserve has been created out of profits to provide for a sinking fund to pay off a bonded debt at maturity, what does the Reserve account represent after the redemption and cancellation of the bonds? (Ohio, Nov., 1917.) 65. Discuss the disposition of a Sinking Fund Reserve account which is no longer necessary. (Wis., May, 1916; Cal., June, 1917*; Ohio, Nov., 1917*; Wis., May, 1919.) 66. The officers of a company of which you are the auditor elected by the shareholders, submit to you for audit a Balance Sheet in which the following item appears: "Miscellaneous Reserves (including premium on stock), $248,000." On investigation you find the item is made up as follows: General Reserve, $86,000; Operating Reserves, $6,000; Provision for Plant Depreciation, $46,000; Provision for Amortization of Lease- holds, $40,000; Provision for Bad Debts, $36,000; Premium on Capital Stock sold, $34,000; Total, $248,000. What recommendation would you make to the officers and what course would you take if your recommendation were not followed? (A. I. of A., June, 1917.) RESERVES AND FUNDS 191 67. The Balance Sheet of a corporation shows the following credit balances: Reserve for Depreciation; Reserve for Extension of Plant; Reserve for Bad and Doubtful Debts; Sinking Fund Reserve; Insurance Reserve; Reserve for Pensions; Reserve for Contingencies; Reserve for Taxes. What would you assume to be the nature of each of these items? Can better terms be submitted for any of those used? In what circumstances would each of the above accounts be debited, and when debited, what would be the corresponding credit? If the business were to be sold for the amount of its net worth, as shown by the Balance Sheet, which of these items would represent a proper addition to the capital stock in determining the selling price? (A. I. of A., June, 1917.) 68. With the present trend toward prohibition, what accounting propo- sition would you make in the books of a corporation owning a brewery in order to maintain its financial integrity before authorizing the declara- tion of a dividend? (Mich., Dec., 1916.) 69. Assuming that a Balance Sheet consists of three principal divisions of accounts, viz., assets, liabilities, and net worth, state in what division you would place the following accounts: (a) Reserve for Depreciation; (b) Reserve for Improvements and Additions; (c) Reserve for Shrinkage of Inventory Values; (d) Reserve for Losses on Hedging Contracts; (e) Reserve for Federal Taxes (Income and Excess Profits) ; (/) Reserve for Unpaid or Accumulated Dividends of Preferred Stock; (g) Reserve for Doubtful Accounts; (h) Reserve for Contingent Losses; (i) Reserve for Non-admitted Assets; (j) Reserve for Extinguishment of Bonds. (N. C., Nov., 1918.) 70. You are called upon to examine the accounts of a corporation for the purpose of certifying its Balance Sheet. An item is carried on the "liability" side described "Sundry Reserves $375,000." You find that this amount is made up as follows: Reserve for Contingencies $50,000 Plant Depreciation Reserve 80,000 Reserve for Bad Debts 10,000 Reserve for Collection Expenses 15,000 Premium on Sale of Capital Stock 12.00J Reserve for Personal Injury Suit which has just been decided against the Company 8,000 Reserve for Patent Litigation pending 20,000 Reserve for Income and War Excess "Profits Taxes 40,000 Special Reserve against a possible drop in market values of merchandise on hand 30,000 Sinking Fund for Retirement of bonds 48,000 Provision against dismantlement of Aurora Works 34,000 Pension Fund . . 28,000 $375,000 The president is unwilling to change the company's Balance Sheet with- out consulting the board of directors and states that if you take exception 102 C. P. A. ACCOUNTING lo this item you should write him your views so that he may bring the matter formally before them. Write such a letter stating clearly the reasons for any exceptions you may take. (111., Dec., 1918.) 71. A company incorporated with a capital of $200,000, fully paid up, has sold its stock at a premium of 25 per cent, thus realizing in cash $250,000. The by-laws, which cannot be amended except in a stock- holders' meeting and after proper notice of such amendment, having been mailed to each stockholder ten days prior to the meeting, contain a provision that the $50,000 so received over and above the capital stock at par, shall be placed to the credit of a Special Reserve account, and that this fund shall not be applicable towards the payment of dividends. At the close of the first fiscal year, it is found that the company has made a net profit of $4,000, after charging $6,000 for depreciation on the buildings and machinery. The directors desire to pay a cash dividend of 5 per cent and pass a resolution ordering that the depreciation referred to above shall be charged against the above Special Reserve account instead of against Profit and Loss, and they then proceed to declare a dividend of 5 per cent. Discuss the above situation from the standpoint of an ac- countant. (111., Nov., 1904.) 72. A public utility company issues $500,000 first mortgage bonds due in equal installments from the tenth to the twentieth year. The mortgage required that a reserve for sinking fund must be provided at the rate of $15,000 per year. What is the effect of such a provision 1 ? What entries should be made each year and what entries when the bonds are paid? (111., May, 1915.) 73. What reason can you give for the creation of a reserve for a sinking fund when the reserve is not to be funded? (N. Y., June, 1912; N. D., July, 1916.) 74. A sinking fund reserve is created out of annual earnings. How is the book value of the company's stock affected by such policy? Explain. (Mass., Oct., 1917.) 75. How would you classify the sinking fund reserve in the Balance or Profit and Loss account? (Kan., Dec., 1915; Mo., Dec., 1915.) 76. Classify Reserve for Sinking Fund according to the subdivision of assets, liabilities, proprietary interest, income and expenses under which it should be grouped. (Wis., May, 1919.) 77. What is involved in the verification of reserves for sinking funds? (Cal., May, 1916.) 78. How should a Reserve account and a sinking fund, both relating to the redemption of the same debt, be simultaneously operated? What pur- pose is accomplished thereby and how do said accounts respectively appear on the Balance Sheet? (N. Y., Jan., 1906; Cal., June, 1917; N. Y., Jan., 1920.*) 79. Are sinking fund reserve appropriations a satisfactory protection to the bondholder? (Wis., May, 1916.) RESERVES AND FUNDS 193 FUNDS 80. Distinguish between a fund and a reserve. (Mo., Dec., 1913.) 81. Define: Reserve fund. (N. Y., Dec., 1897*; N. Y., June, 1900; Pa., May, 1903*; 111., May, 1904; Wash., April, 1906; Wash., June, 1912; La., May, 1913*; Wis., May, 1916; W. Va., May, 1917*; N. D., Aug., 1917; Mass., Oct., 1917.*) 82. State the object of the Reserve Fund account. (N. Y., Dec., 1898; Mich., July, 1906.*) 83. How are reserve funds created on the books? (Mich., July, 1906.) 84. If asked to criticize a Balance Sheet prepared by a client's book- keeper, state what you would say regarding the following caption found on the liability side of the Balance Sheet : "Reserve Fund for Redemption of Bonds $50,000." Explain fully. (N. Y., June, 1918.) 85. How would a reserve fund affect the book value of capital stock? (Mass., Oct., 1917.) 86. Support your views on the use of reserves that are funded and reserves that are not funded. (N. D., June, 1914.) 87. Distinguish between a reserve account and a reserve fund. (N. Y., June, 1902; N. Y., Feb., 1908; 111., Dec., 1908; Mo., Dec., 1914; 111., Dec., 1916; Mich., Dec., 1916.*) 88. On which side of the Balance Sheet should a reserve fund be found? (N. Y., Jan., 1917.) 89. State whether or not you consider the keeping of reserve funds advisable, and your reasons. (Wash., May, 1911.) 90. Under what circumstances, if any, may a reserve fund or a reserve appear on the books of a company without the other? (111., Dec., 1916.) 91. Should a reserve fund be invested in interest-bearing securities? State the custom. If so invested, what account should be credited with the income? (N. Y., June, 1897.) 92. State your views fully of (a) how Reserve Investment Funds shoul^ be invested. (6) Why is it not advisable to keep reserve funds in the business? (Md., Oct., 1903.) 93. Define: Sinking fund. (N. Y., Jan., 1900*; N. Y., June, 1900; Pa., May, 1903*; 111., May, 1904*; Pa., Nov., 1904*; N. Y., Jan., 1906*; Md., Jan., 1909*; Mass., June, 1910*; Va., Nov., 1910*; 111., May, 1912*; Mich., June, 1912*; Wis., April, 1914; Cal., Nov., 1916; Wis., April, 1917; W. Va., May, 1917*; N. Y., June, 1918*; Va., Nov., 1918; Iowa, Dec., 1918; Wis., May, 1919.) 94. What is the purpose of a sinking fund? (Md., Oct., 1903* ; Mich., July, 1906; 111., May, 1909*; Mich., June, 1912; Ohio, Nov., 1913*; Cal., Nov., 1916.) 95. State the plan most frequently approved by writers on corporation finance as being the most satisfactory for accomplishing the purpose for which a "sinking fund" is created. (Wis., May, 1919.) 1!)4 C. I'. A. ACCOUNTING 96. What is the effect on a business of a sinking fund? (Pa., May, 1906.) 97. State how a sinking fund should be treated in the books of a corporation. (N. Y., Jan., 1900*; N. Y., Jan., 1901*; N. Y., Jan., 1906; 111., May, 1906*; N. Y., June, 1909; Va., Nov., 1910; Mich., June, 1919.*) 98. Indicate the pro forma entries for the creation of a sinking fund. (N. Y., June, 1902*; Mich., July, 1906*; Wash., March, 1909*; 111., May, 1914*; Mich., June, 1915*; Mass., Oct., 1915*; Wis., May, 1919.*) 99. Give the entries for sinking fund required when the bonds are paid off at maturity. (111., May, 1912* ; Mass., Oct., 1915; N. Y., Jan., 1920.*) 100. (a) Stout and Company, acting as trustees in an issue of $250,000 thirty year bonds of the Modern Gas and Electric Company, engage you as an accountant to advise them as to the merits of the various methods of recording funded debt transactions upon the books of the utility. In your report construct hypothetical balance sheets to show four methods of handling the funded debt and explain fully the advantages and disadvantages of each, bearing in mind that you are working for the trustee whose chief desire is security for the bondholder. (6) A director of the utility argues that if appropriations are made out of profits for sinking fund purposes, then it is unnecessary to make pro- visions for depreciation on the property of the utility. Include in your report to your client recommendations upon this point. (Wis., April, 1918.) 101. Argument has been strongly urged that aside from any question of possible mismanagement, or of the difficulty of making satisfactory investments to j T ield the same rate as is paid on the bonds, a sinking fund for bonds is more expensive than an arrangement for the serial payment of bonds. This is illustrated by the case of $20,000 5 per cent bonds. If these are paid off in a series, one each year, the total payment made will be principal $20,000, interest $10,500, total $30,500. The annual sinking fund to pay these bonds would on a 5 per cent basis amount to $604.85, making in twenty years $12,097, and the interest paid on the bonds would be $20,000, total payments $32,097. The apparent excess burden is ac- cordingly $1,597. Discuss the above argument and show clearly just what the figures mean and in what the apparent saving actually consists. (A. I. of A., June, 1917.) 102. State the theory and purpose of each of the following, and show wherein they differ: (a) reserve fund; (I) sinking fund. (N. Y., June, 1899; Dec., June, 1915*; N. D., July, 1916.*) 103. Name various ways in which sinking funds may appear on, or affect the items of a Balance Sheet. (Wis., April, 1914; Wis., May, 1916.*) 104. Should a sinking fund represent actual investments or may it be offset by contra entries? (X. Y., Jan., 1918.) 105. Classify the account Sinking Fund for Bond Redemption, ac- RKSKK'VKS AND FUNDS 105 cording to the subdivision of assets, liabilities, proprietary interest, in- come and expenses under which it should be grouped. (Wis., May, 1919.) 10P>. You are auditing the accounts of a corporation and you find the following entries in one month without sufficient explanation: Profit and Loss $8,333.33 To Accrued Sinking Fund $8333 33 Accrued Sinking Fund 100,000.00 To Reserve for Sinking Fund 100,000 00 Union Trust Company, Trustee 100,000.00 To Accounts Payable 100000 00 Accounts Payable 100,000 00 To Cash 100,000.00 Sinking Fund No. 1 100,000.00 To Union Trust Company 100000 00 Reserve for Sinking Fund 100,000.00 To Profit and Loss 100000 00 What would you conceive the situation to be and what recommendation would you make? (Cal., May, 1916; Mich., Dec., 1916.*) 107. On which side of the Ledger should balance of the Sinking Fund account appear? (Mo., Dec., 1914.) 108. Name the various ways of figuring a sinking fund. (111., May, 1912*; Wis., April, 1914; Wis., May, 1916.) 109. What are the usual sinking fund provisions to be found in a trust deed securing an issue of bonds of a corporation? (111., May, 1912*; 111., May, 1914; Wis., May, 1919.*) 110. Compare the sinking fund provision of typical preferred stock issues with the sinking fund provisions of typical bonds issues as to entries to be made: (1) When the sinking fund is set up; (2) when the purpose of creating the sinking fund has been attained; (3) when any balances remain in the sinking fund or allied accounts. (Wis., Nov., 1919.) 111. A city wishes to borrow $90,000 for 30 years, this debt to be extinguished either by a sinking fund or by an issue of serial loan bonds, payable so much per annum. Which, in your opinion, would be the better way, and why? Answer fully and differentiate clearly between these two methods of extinguishing the debt. (Mass., April, 1911.) 112. A mortgage provides for a sinking fund to be accumulated in the hands of a trustee from profits prior to dividend payments. Prepare skeleton Balance Sheet to disclose the state of the fund, dividends declared and payable, appropriation of profits for purpose of the fund and an unappropriated surplus. What effect would losses in excess of such un- 196 C. P. A. ACCOUNTING appropriated surplus have on the sinking fund? (N. Y., Jan., 1911.) 113. From a theoretical point of view, are the contributions to a sink- ing fund a proper charge against profits? Give your reasons. (Ohio, Nov., 1913.) 114. From what source is a sinking fund derived and what account is charged? (Pa., Nov., 1904; Md., Jan.. 1909.) 115. May a sinking fund be established by appropriating profits? (Cal., Nov., 1916.) 116. Where the establishment of a sinking fund is compulsory, is it theoretically correct to charge income with the annual appropriations required by the mortgage? Give reasons. (Ohio, Nov., 1917.) 117. If not set aside, in compliance with requirements of a bond issue, how may a sinking fund affect a corporation? (Pa., Nov., 1904; Md., Jan., 1909.) 118. In the course of a Balance Sheet audit state how you would proceed to verify the correctness of a sinking fund. (Ohio, Oct., 1919.) 119. In preparing a Balance Sheet of a corporation, how would you classify or deal with securities representing the investment of a sinking fund? (111., May, 1906*; N. Y., Jan., 1907*; A. I. of A., June, 1917.) 120. How may sinking funds be invested ? (Wis., May, 1916.) 121. A concern has established a sinking fund for the retirement of a mortgage. An investment has been made in bonds, the present market value of which is below cost. Would you inventory them at market value or at book value? Why? (Mich., Dec., 1914.) 122. Define: Sinking Fund Investment account. (Wash., Nov., 1913*; Wash., July, 1917.) 123. Explain in some detail the procedure you would follow as an auditor in verifying Sinking Fund Investment account appearing in the books and accounts' of a company. (Wash., June, 1915.) 124. How should interest on sinking fund investments be treated in the accounts? (Cal., Nov., 1916.) 125. Define briefly the following terms: (a) Redemption fund; (b) Depreciation fund; (c) Contingent fund; (d) Investment fund. (111., May, 1904.) 126. Describe the nature of the following accounts: (a) Sinking fund; (6) Reserve Fund; (c) Redemption Fund; (d) Depreciation Fund; (e) Contingent Fund; (/) Investment Fund. (N. Y., Dec., 1896; W. Va., May, 1917; S. C., Sept., 1919.) 127. State the object of the following: Redemption Fund account. (N. Y., Dec., 1898.) 128. Define the difference, if any, between a sinking fund and a depre- ciation fund. Explain fully. (N. Y., June, 1906*; Mass., Oct., 1915*; Cal., Nov., 1916; N. Y., June, 1918*; Md., Oct., 1919.) RESERVES AND FUNDS 197 129. A municipality has built a public building from the proceeds of a bond issue. Should the municipality write off depreciation of the building and at the same time also create a sinking fund? (Wis., May, 1916.) 130. Explain in some detail the procedure you would follow as an auditor in verifying the invested funds appearing in the books and accounts of a company. (Wash., June, 1915.) 131. Define and differentiate sinking fund and Reserve account. Where does each appear on the Balance Sheet, and what does each represent? (Va., Oct., 1912.) 132. Under the conditions of a general mortgage given by the Red Clay Brick Company to protect its issue of bonds, provision is made for pay- ments to the trustee at stated periods, which, together with all accretions from interest and profits, are to be held and disbursed by the trustee as one fund. Should any distinction be shown on the books of the brick company between interest and profit so obtained? If so, give reasons. (N. Y./June ; 1918.) 198 C. P. A. ACCOUNTING PROBLEMS RESERVES AXD FUNDS 1. On the 1st of July, 1905, a company borrowed $100,000 at 4 per cent per annum, payable half-yearly, and payment of loan to be made at end of 10 years at 105 per cent. It was decided to set aside annually out of the profits such a sum as would with interest at 4 per cent per annum provide for the payment of the premium on the loan at the end of the term. (What was this sum?) (Fla., April, 1907.) 2. A corporation wants to retire a debt of $10-5,000. bearing- 5 per cent interest, payable annually. The tenth payment, including interest, is to be $15,000. The other nine periodical payments are all to include interest and to be of the same amount. Required : the amount of each of such nine payments. (1.05 9 = 1.551 328.) (A. I. of A., Nov., 1918.) 3. A company is under obligations to pay $10,000 to sinking fund trustees "out of profits." The following transactions take place: 1914 Dec. 31, $10,000 cash paid to sinking fund trustees. 1915 Jan. 5, Trustees invest in $10,000 of the 5 per cent bonds of the company at 98 and interest (from Jan. 1). July 1, Coupons on above bonds collected. Dec. 31, $10,000 paid to sinking fund trustees. 1916 Jan. 1, Coupons collected. Jan. 2, $11,000 bonds bought for sinking fund at 95. July 1, Coupons collected. Dec. 31, $125 paid for expenses of sinking fund. Dec. 31, $10,000 paid to sinking fund trustees. 1917 Jan. 1, Coupons collected. Jan. 10, $10,000 bonds bought at 101 and interest. Give the Journal entries on the company's books for the above transac- tions. (A. I. of A., June, 1917.) 4. "C," "D" and "E" are partners with equal capital and share equally in the profits. After trading for three years, "E" wishes to retire and "D" elects to remain and purchase the share of the former. The part- nership agreement provides that the retiring partner shall receive a share of the goodwill. The value of the latter to be equal to two-thirds of the average of the profits of the last three years preceding his retirement. The following are the figures and we are requested to prepare a Balance Sheet and a Profit and Loss account as of June 30, 1916, and an account showing the amount due to "E" from the remaining partners: RESERVES AND FUNDS 1!K) Capital Account, "C" $8 000 Capital Account. "D" 8*000 Capital Account, "E" 8*000 Plant and Equipment 14*840 Trade-marks 4*,500 Inventory, June 30 1916 7 % 600 Inventory, July 1, 1915 4*800 Accounts Receivable 19',400 Merchandise Creditors 13.'402 Sales '. 55^188 Purchases 27,804 Wages and Salaries 4 QOO General Expenses 1,560 Partners' Drawing Accounts: " C " Debit Balance 5,500 " D " Debit Balance 5,500 "E" Debit Balance 5,500 Cash in bank and on hand 3,974 The following adjustments are to be made for the year just closed: Ten per cent depreciation on the plant and equipment; 15 per cent on the trade-marks; 10 per cent reserve for bad and doubtful debts. There is on the books a special Reserve account to cover depreciation of the stock on hand, which is of a very perishable nature. The reserve amounts to $5,388 and must be equitably dealt with in the dissolution of the partnership. The previous two years' profits were $17,816 and $22,020, respectively. (Minn., Oct., 1916; Cal., Nov., 1916.) 5. The Jones Company, Inc., acquired the business from S. R. Jones, who took bonds amounting to $50,000 in part payment. These mature in 20 years and can be canceled by payment after 15 years, and bear interest at the rate of 6 per cent per annum. A sinking fund is to be established for their redemption by payment to the Bankers Trust Co., Trustees, of $2,500 a year, the interest on this fund to accumulate to help in retiring the bonds before 20 years. November 30, 1918, was the end of the first fiscal year and the trial balance of that date is as follows: Real Estate $30.000.00 Buildings ... 30.000.00 Machinery . 43,150.00 Accounts Receivable 4,260.00 Cash 12.759.60 Merchandise 46J540.00 Labor 20,000.00 Office Expense 1,950.00 Miscellaneous Investments 440.40 Bond Sinking Fund 2,500.00 Interest Paid on Bonds 3,000.00 Capital Stock $50,000.00 Bonds Payable 50,000.00 Net Sales 68,090.00 Notes Payable 5.000.00 Accounts Payable 21,450.00 Miscellaneous Income 60.00 $194,600.00 $194,600.00 200 C. P. A. ACCOUNTING Inventory of merchandise is $28,500. Under date of May 30, 1918, the company paid the Bankers' Trust Co. $2,500. Under date of November 30. 1918 the Bankers' Trust Co. reported that they had received the $2,500 ; that on June 15, 1918, they purchased two $1,000 bonds at par and accrued interest. Rate of interest 5 per cent, payable in November and May each year; that they collected $50 interest on November 1, 1918; and that they have allowed 4 per cent interest per annum, computed semiannually, on the lowest amount of cash in the fund during- the period. They show the cash in the fund which you are asked to compute from the above to verify the correctness of their balance. (1) Make the necessary Journal entries to close the books for the fiscal year. (2) Construct Income and Expense account for the year. (3) Construct Balance Sheet as of November 30, 1918. (4) Prepare statement of sinking funds in hands of Bankers' Trust Co. (Iowa, Dec., 1918.) 6. A corporation issued 10-year first mortgage bonds on April 1, 1914, bearing 6 per cent interest, payable semiannually (April and October). The bonds provided for annual contributions to a sinking-fund trustee, a trust company, that allowed 2 per cent compound interest. The bonds were sold at a premium and payment was received therefor on April 1, 1914. Show pro forma entries as of the following dates: (a) April 1, 1914; (b) October 1, 1914; (c) April 1, 1915; (d) April 1, 1924. (N. Y., June, 1915.) 7. A contractor proposes to build a bridge to Belle Isle and accept the city's 4 per cent 20-year bonds to the amount of $2,000,000 in payment. He advocates as a means of retiring the bonds the establishment of a toll system on foot passengers and automobiles at the respective rates of 1 and 5 cents each. Assuming the ratio of foot passengers to automobiles to be 10 to 1, how many of each would be necessary to pay the interest annually and create a fund which, placed at the same rate of interest, would be suf- ficient to retire the bonds at maturity. (Note: $1 compounded at 4 per cent for 20 years equals $2.19112314.) (Mich., Dec., 1915; Mich., June. 1919.) 8. You are called upon to state what is the annual sinking fund neces- sary to redeem a principal sum of $1,000,000 due 30 years hence, it being assumed that the annual sums set aside are invested at compound interest at 5 per cent. (Note: 30th power of 1.05 is 4.32194238.) (A. I. of A., Nov., 1917.) 9. A municipality borrowed $150,000 for 5 years at 4 per cent interest, payable annually. To meet the debt when it became due, a sinking fund was created by depositing at 5 per cent compound interest an equal sum at the expiration of each of the five years. What was the annual amount deposited? (Mich., June, 1910.) 10. A company wants to set aside a sinking fund on a 3 per cent basis so as to retire $100,000 in three equal annual payments. Required RESERVES AND FUNDS 201 the amount necessary to be annually invested at 3 per cent per annum. (Kan., Dec., 1915; Mo., Dec., 1915.) 11. What amount, including interest, must be set aside annually to provide a sinking fund sufficient to retire an issue of bonds amounting to $100,000, originally sold at 90, interest payable semiannually at 6 per cent, and maturing in ten equal annual installments after the fifth year? Show method. (Mich., Dec., 1914.) (Note: Assume sinking fund install- ments set aside at beginning of each year and first bonds redeemed at beginning of sixth year.) 12. A company is issuing $100,000 of 4% 20-year bonds, which it wishes to pay at maturity by means of a sinking fund, in which equal annual deposits are to be made. The board of directors wishes to assume that this fund will earn 5^% interest for the first five years, 5% for the next five years, and 4% for the last ten years. What is the annual deposit required ? Given: 5y 2 % 5% 4% S 6 5.581 5.526 5.416 12.875 12.578 12.006 (l+i) B 1.307 1.276 1.217 (1+i) 10 1 708 1.629 1.480 (A. I. of A., May, 1920.) CHAPTER XI BONDS Classes of Bonds Bonds are sealed documents promising to pay a cer- tain sum of money with interest thereon at a specified rate. 1 Bonds have been classified by Lawrence Chamberlain in "The Principles of Bond In- vestment" under the following headings : A. Character of Issuing Corporation (a) Governmental (b) Commercial B. Character of Security (a) Unsecured (b) Secured I. Guaranty Security II. Lien Security (1) On Personality (a) Paper Collateral (b) Rolling Stock (c) Funds (2) On Realty (a) General Property (b) Specific Property (c) Mortgage Priority C. Purpose of Issue D. Payment of Interest (a) Conditional (b) Unconditional (c) Registei'ed (d) Coupon E. Payment, of Principal F. Maturity of Principal (a) Fixed Date (b) Unsettled Date I. Option of Payer II. Option of Payee (c) Perpetual Unsecured bonds or debenture bonds are merely formal acknowledg- ments of debts under seal. 2 Income bonds may or may not secure the 'For explanation of superior figures see page 202 BONDS 203 principal by a pledge of! specific property or by a preference claim against corporate property, but payment of interest always depends entirely on the existence of net profits. 3 Guaranty security bonds are those which, in case of default, will be paid both as to principal and interest by the sponsor. 4 The chief kinds of guaranty security bonds are assumed bonds, guaranteed bonds, en- dorsed bonds, stamped bonds, and joint bonds. Collateral trust bonds are good examples of bonds secured by a lien on personality consisting of securities. 5 Car trust and equipment bonds are likewise secured by lien on personality, but the property is in the form of railroad rolling stock." The personalty securing sinking fund bonds is in the form of funds. Bonds secured by liens against real estate may be safeguarded by mortgages on the general corporate property, or on realty of a certain class, or on sections of the corporate property. 7 Land grant bonds are railroad bonds secured by liens on lands granted by the government. 8 Railroads sometimes issue divisional bonds secured by mortgages on specific railroad divisions.* The matter of mortgage priority is vital as the pledged property may be sufficient to liquidate only the senior issues, thus leaving the junior issues unprotected except for the general corporate property. 10 Bonds may be designated according to the purpose for which the money was raised. For instance, funding bonds represent the consolidation of the corporate unfunded debt. Purchase money bonds are issued in full or part payment for a property." Refunding bonds are issued in lieu of maturing obligations and have the same security as the redeemed bonds. 12 Consolidated bonds replace several prior issues and unite the securities for the retired issues. 13 Ordinary bonds contain unconditional promises to pay a specified amount of interest. However, there are some exceptions, like income bonds which pay interest only if a net profit is made by the corporation, 14 or participating bonds, the interest of which may run from a specified minimum to a specified maximum (in limited participation), or to what- ever is earned (in unlimited participation). 15 Bonds may be registered as to interest, in which case the interest is remitted by check, or they may have interest coupons attached, which are cut and cashed when due. 1 " Bonds may be registered as to principal, regardless of whether they are registered as to interest." Bonds are sometimes designated according to the exchange medium in which they are redeemable, viz.: Gold bonds, silver bonds, and currency bonds. 18 The bonds which mature at a settled date are either straight bonds, those nominally maturing all at one time, or serial bonds, those maturing in regular installments. 18 Redeemable bonds and callable bonds are illustra- tions of bonds the maturity of which is affected by the payer's right to retire them before the obligatory maturity date. 20 Convertible bonds are, at the option of the payee, convertible generally into other securities of the 204 C. P. A. ACCOUNTING same corporation. 21 Perpetual bonds are those containing no promise to liquidate the principal. 22 Unissued Bonds Some accountants list unissued bonds among the assets on the balance sheet, 23 while other accountants deduct the unissued bonds from the authorized bonds. 24 The latter procedure seems preferable, as it shows the right to issue the bonds and yet does not tend to confuse the lay reader. Unissued bonds are sometimes called reserved bonds," but this practice is not good because the title is not self-explanatory. Treasury Bonds As bonds may be issued below par, it is not very im- portant to distinguish between unissued and reacquired bonds. 29 However, it is preferable to reserve the term "treasury bonds" for reacquired bonds. 2 ' The method of presenting treasury bonds (sinking fund secuiities) on the balance sheet is discussed in Chapter X under the caption "sinking funds." It must be remembered, however, that the Intel-state Commerce Commission compels transportation companies to classify authorized bonds, signed and sealed by the mortgage trustee, as working assets. Bonds as Collateral As treasury bonds out as collateral are still the property of the borrowing company, they need be accounted for only by memorandum entries, 28 although the fact that they are pledged should be indicated on the balance sheet by showing the pledged and unpledged bonds separately. 2 * Issue of Bonds There are two methods of recording the issue of bonds. Assuming the authorized issue of $1,000,000, of which $750,000 are sold at par for cash, the balance remaining unissued, the entries would be : First Method 30 Unissued Bonds $1,000,000.00 Bonds Payable $1,000,000.00 Cash 750,000.00 Unissued Bonds 750,000.00 Second Method 31 Cash $750,000 00 Bonds Payable $750,000. 00 The second method, which presupposes that the authorized issue would be carried parenthetically in the account title, is preferred by accountants who depreciate the use of memorandum accounts. 32 The first method seems preferable, however, as the accounts themselves then give a complete his- tory of the transaction. If the above-mentioned bonds were sold on the installment basis instead of for cash, the bonds would not be issued until the subscriptions were paid. 33 The entries would be as follows : BONDS 205 Unissued Bonds $1 ,000,000.00 Bonds Payable $1 ,000,000. 00 Bond Subscribers 750,000. 00 Bond Subscriptions 750,000.00 Cash (1st Installment) 375,000. 00 Bond Subscribers 375,000.00 Cash (2nd Installment) 375 , 000 . 00 Bond Subscribers 375,000.00 Bond Subscriptions 750,000.00 Unissued Bonds 750 , 000 . 00 Bond premium and discount are entered on the books in the same manner as the premium and discount on stock. 34 Using the above data, and assuming that $150,000 of the unissued bonds were sold at 102 and the remaining at 99, the entries, illustrating the first method only, would be: Cash $153,000.00 Unissued Bonds $150,000.00 Premium on Bonds Payable 3,000.00 Cash 99,000.00 Discount on Bonds Payable 1 , 000. 00 Unissued Bonds 100,000. 00 Discount on bonds payable is an asset, as it represents the privilege of using money at less than the market interest rate, while premium on bonds payable is a liability, as it represents an obligation to pay more than the market rate of interest. is Discount and premium on bonds payable should be shown on the balance sheet as deferred charges 38 and deferred credits to income, 37 respectively. This procedure is prescribed for transportation companies by the Interstate Commerce Commission. Discount on bonds is sometimes treated as a valuation item, 38 but this seems incorrect. Bond discount should not be deducted from bonds payable because the incurred liability is the par value of the bonds issued. Expenses incurred in floating a bond issue may be shown in a bond issue expense account, 39 or an underwriting expense account, 40 or may be shown together with bond discount in a bond discount and expense account. 41 The last method seems preferable as the expense should be prorated on the amortization principle. It is sometimes advocated to charge the issuing expenses to organization expense, 42 but this seems in- advisable. The opening entries for an issue of collateral trust bonds should be preceded by an entry debiting pledged investments and crediting invest- ments for the amount of the collateral. 43 When equipment trust bonds are issued, the transaction is in the nature of a conditional sale or lease, the company paying installments annually and the trustee, acting for the vendees, holding a lien on the entire prop- erty until the last installment, or rental, is paid, when a release is given. 44 j(M5 ('. I'. A. ACCOUNTING The entries for the issue of $100,000 of equipment, trust bonds and tho payment of the first installment would be : 4r ' Leased Equipment $100, 000. 00 Equipment Trust Bonds $100, 000. 00 Equipment Trust Bonds 10 , 000 . 00 Cash (assuming ten equal payments) 10,000.00 Equipment 10,000.00 Leased Equipment 10,000.00 Bond Interest Interest on registered bonds is sent to the bondholders either by the treasurer or fiscal agent of the corporation. 4 " As coupons are frequently unredeemed at the end of the fiscal period, it is unsatisfactory to record the interest only as it is paid. The correct procedure would be to debit bond interest and credit bond interest accrued at the end of each month for one-sixth of the semi-annual interest charges, and to debit bond interest accrued and credit cash when coupons are redeemed. 47 Accountants usually record the interest on treasury bonds, 48 although it is not necessary to do so, unless the treasury bonds are held by a trustee under a sinking fund provision requiring that the trustee receive the interest and control its investment. Interest on guaranteed bonds is normally paid by the issuing company in the usual way, but, in cases of default, the guaranteeing company must make the payment. 48 The entry would be a debit to advances to subsidiary company and a credit to cash on the books of the parent company, and a debit to the bond interest and a credit to advances from parent company on the books of the subsidiary company.''' Although interest on income bonds is unusual in that it is paid only in the event that the company's profits are sufficient to pay it, 51 there are no irregularities in the accounting procedure in recording the interest payments. 62 Since bond premium represents the present worth of an annuity the rent of which is the excess of the stated bond interest over the effective interest, the periodic payments extending over the life of the bonds, the premium is not an earning but an offset to excess bond interest. 63 On the other hand discount on bonds is an addition to the interest paid on bonds. 54 Bond premium and bond discount are therefore gradually written off as a credit and debit, respectively, into the bond interest account." The usual way of prorating bond premium and discount is to write off an equal amount annually over the life of the bonds." 6 The scientific or effec- tive rate method is to amortize the difference between the stated and effec- tive bond interest through the bond interest account." If a bond $10,000 par value, bearing five per cent, life two years, interest payable January and July, was sold on a four per cent basis for $10,190.39 on January 1, 1917, the entry on July 1, 1917, for bond interest and the amortization of bond premium would be as follows : BONDS 207 Bond Interest $203 . 81 Premium on Bonds Payable 46. 19 Cash '. $250. 00 If the bonds were sold on a six per cent basis for $9,814.15, the entry to be made would be : Bond Interest $294 . 42 Cash $250.00 Discount on Bonds Payable 44. 42 The mathematics for the above entries is shown in the bond premium and discount amortization tables given in Chapter IX under the caption "Amor- tization of Bond Premium and Discount." Bond Register While no record of ownership need be kept for coupon bonds, a record of the holders of registered bonds must be kept either by the corporation or by its transfer agent. 58 This bond ledger or register consists of a sheet or card for each class of bonds ruled into columns for number and date of bond, name and address of person to whom bond is issued, names and addresses of transferees, par value of bond, and interest payments under the different due dates. 68 Coupon Register Paid and canceled interest coupons may be recorded in a coupon register in which an entire page is allotted to each bond for the pasting of the coupons in spaces numbered to correspond with the particular coupons." However, the modern practice is to deliver all paid and canceled coupons to the trustee of the mortgage, who destroys them and issues a certificate to that effect. Audit of Bonds Payable The auditor must read the bond .agreement and ascertain that all provisions have been fulfilled. 01 A complete schedule of authorized and issued bonds should be made." 2 All bonds certified by a trustee and delivered to a corporation must be accounted for." 3 The proceeds of all bonds sold should be traced into the proper accounts. 64 On account of the safeguards placed by bond holders on bonds, little difficulty is incurred in determining the outstanding bonds.' 8 They may be shown, (a) by the bond register which should be checked against the ag- gregate shown in the general ledger;" 6 (b) from the cash receipts journal if sold for cash, or from general journals if sold for property or other as- sets; 87 (c) through the interest checks or interest coupons if all have been returned; 68 (d) by obtaining final proof through a certificate of the trustee. 08 The auditor must see that bond interest is correctly shown in the accounts. 70 -He should see that interest on income bonds is taken care of before any dividends are paid out of profits. 71 Investments in Bonds Bonds purchased may be classified into those held temporarily and those held permanently. The former are valued and accounted for in the same way as temporary stock investments (see Chapter VIII), while permanently held bonds are accounted for on the 208 C. P. A. ACCOUNTING amortization principle. As to the application of the amortization prin- ciple to bonds purchased at a discount, it is desirable to set up a reserve for possible losses, if the discount on the bonds was influenced by the bad credit of the issuing company." The entries covering the purchase and the first interest payment of a bond, $10,000 par value, bearing five per cent, life two years, interest receivable January and July on a four per cent basis, for $10,190.39 would be : Bond Investment Account $10,000.00 Premium on Bonds Purchased 190.39 Cash $10,190.39 Cash. 250.00 Premium on Bonds Purchased 46. 19 Interest on Bonds Purchased 203.81 If the the bonds had been purchased on a six per cent basis for $9,814.15, the entries would be : Bond Investment Account $10.000.00 Discount on Bonds Purchased $185 . 85 Cash 9,814.15 Cash 250.00 Discount on Bonds Purchased 44 . 42 Interest on Bonds Purchased 294. 42 The calculation of the amounts that should be written off from the bond premium and bond discount is illustrated in the amortization tables given in Chapter IX under the caption, "Amortization of Bond Premium and Discount." If there are only a few transactions involving the purchase of bonds, no special ledger is needed, it being satisfactory if a separate account is kept in the general ledger for each purchase. If such transactions are numerous a special "bonds owned register" should be used, which would allot to each transaction a page, containing space for the name of the issuing company, name of bonds, how, when, and where payable, nominal and effective interest rates, numbers of the bonds, and columns for the date, voucher, principal, par value, original cost, book value, and market value." The bonds owned should be verified by actual inspection, 74 and a very complete and detailed list of them prepared. 75 The auditor should also list all bonds owned during the period of the audit and ascertain therefrom whether all interest has been properly collected and recorded. 79 Bonds out as collatei-al should be verified by correspondence. 77 Bonds purchased during the period under audit should be verified by correspondence, by brokers' notices, and by inspection. 78 The auditor should ascertain that the coupons on bonds are intact. 79 BONDS 209 QUESTIONS BONDS GENERAL 1. What is a bond? (Iowa, Dec., 1918.) 2. Do unsold treasury bonds constitute a liability? Why? (Mich., June, 1908; N. Y., June, 1919.) 3. Do unsold bonds of a railroad company constitute a liability? If they do, under what accounts would they appear on the Ledger? (N. Y., Jan., 1919.) 4. In examining the accounts of a corporation you find the following accounts on the books in connection with Liberty loans : Dr. Cr. Company's subscriptions $100 000 Subscription for employees 80000 Loans from banks secured by $100,000 Liberty bonds .... Payments by employees $72,000 12,000 (a) State how you would proceed to verify each of the above accounts, assuming the examination is made two months after the close of the year. (6) State how you would enter these transactions in the Balance Sheet of a corporation. (111., May, 1915.) 5. A corporation has issued $1,000,000 5 per cent debenture bonds, redeemable at par, out of profits, at the end of twenty years. State what method should be adopted to provide for such redemption so that each year's profit may bear its due proportionate burden of contribution. (N. D., July, 1918.) 6. The Ledger of a corporation has an account entitled: "First Mort- gage Bond Script," showing a credit balance of $967.54. What does this balance represent and how would you treat the item in the Balance Sheet? (N. Y., Jan., 1904.) 7. Explain fully in what way, if at all, the loss on bonds held and disposed of during the period should enter into the Trading and Profit and Loss statements of a mercantile concern. Give reasons for including or excluding. (Kan., May, 1916.) 210 C. P. A. ACCOUNTING 8. Sketch the form of a Bond Ledger which will provide the purchaser of a bond at a premium with a perpetual detail record of each bond transaction. (Wis., April, 101").) 9. Make entries in journal form, with proper explanations, for all the various ways in which bonds issued by a corporation may be sold by it and afterwards paid. (Mich., Dec., 1914.) 10. A company, having $500,000 of debentures, bearing 5 per cent interest, which have been in existence for some years, and which are re- payable February 1, 1907, arranges to provide the necessary capital by the issue, at par, of $500,000 4 per cent permanent debenture stock, the interest on which runs from January 1, 1907; the accounts of the company are made up to June 30, 1907. What, in your opinion, is the proper amount of debenture interest to be charged against the profits of the half year? Give the reasons upon which your opinion is based. (111., Dec., 1910.) 11. Outline an entry recording bond interest due but not paid at time of making the entry. What are the advantages of such an entry? (N. Y., June, 1902.) 12. How would you disclose on a Balance Sheet dated December 31 bond interest due January 1? (Cal., June, 1917.) 13. What is the advantage of amortization in regard to the valuation of bonds? (Del., June, 1915.) 14. A company has issued bonds of a par value of $100,000 redeemable 20 years hence at a premium of $105. The trust deed provides that the company must set aside out of profits and invest at the end of each year the sum of $5,000; the bonds issued were sold for $95,000. 1. Included in the sinking fund are certain of the company's bonds purchased at 98. Should these bonds purchased he stated at 98, 100 or 105? 2. How should the interest from the investment of the sinking fund be treated in the preparation of the accounts of the company? 3. Would it be correct to write off the discount of $5,000 on the bond issue during the first year's operations because the company had a successful year? 4. How should the company provide for the repayment of the bonds at the end of 20 years? Would this provision apply to the bonds purchased as part of the sinking fund investment? Explain the reasons for the answers of this question. (Kan., Dec., 1915; Mo., Dec., 1915.) 15. How would you show in the Balance Sheet bonds which have been put up as collateral and the indebtedness for which they are collected? (Mich., June, 1919.) 16. In the Balance Sheet of a corporation, how should the following item be stated: 5 per cent mortgage bonds authorized, $1,000,000; certified BONDS >! i and issued by the trustees, $750,000, viz., (1) in the hands of the public, $400,000; (2) pledged as collateral to secure the company's notes pay- able, $100,000; (3) in the custody of the treasury, $250,000. (111. May, 1912.) 17. On March 15, 1919, you received instructions to audit the accounts of a large corporation whose fiscal year ended December 31, 1918. The corporation has subscribed for Liberty bonds through various banks and at December 31, 1918, certain subscriptions had been paid for in full and delivery of bonds accepted, while in other cases part payments only had been made. Bonds have also been delivered to employees who have sub- scribed and paid for them in full. Describe how you would proceed to verify the asset shown on the Balance Sheet at December 31, 1918, repre- senting bonds on hand and part payments made on subscriptions, so that you can give an unqualified certificate to your clients as of December 31, 1918. (A. I. of A., Nov., 1919.) 18. How would you deal with Bond Issue Expense account in prepar- ing the annual accounts of a company? Comment briefly on any points which would need special consideration. (A. I. of A., May, 1920.) 19. When preparing a Trading and Profit and Loss account at the end of a fiscal year, in what manner would you treat the interest on bonds? (N. Y., Jan., 1907.) 20. A company authorizes its officers to borrow for its account $100,000 and give as security $200,000 of the first mortgage bonds of the company. How should this transaction be treated in the Balance Sheet? (Ohio, Nov., 1917.) 21. How would you disclose on a Balance Sheet dated December 31, bonds put up as collateral when there is a strong probability of their not being released? (Cal., June, 1917.) 22. What advantage, if any, has the serial plan of paying bonds over the sinking fund plan? (Del., June, 1915; Wis., May, 1916.*) 23. A certified public accountant, having performed the duty at the close of several years, takes up for the year just past the examination of bonds the property of an institution. At his last examination he found coupon bonds in three classes, registered as to principal, registered as to principal and income, and unregistered. In his examination of the books of account of the institution, he found that bonds had been bought during the year. To make an efficient examination in the most expeditious way, how might he treat these various classes? (Mass., June, 1913.) 24. If called upon to verify the integrity of a trust fund consisting principally of bonds, state specifically what particulars of said bonds you would examine critically. (N. Y., Jan., 1918.) 25. What entries would you, as auditor, deem proper to record the redemption of bonds by a company with the cash deposited with its fiscal agent, where such bonds were cancelled? (N. Y., June, 1918.) 26. A corporation borrows $120,000 for a period of ten years to pay off an existing loan at a higher rate of interest, paying therefor in broker- 212 C. P. A. ACCOUNTING acre and costs $2,750. How would you treat this item on the books? (Ind., Nov., 1917.) CLASSES OP BONDS 27. Name five classes of bonds, describing briefly each class with regard to issue, purpose, redemption, etc. (Mich., June, 1908; Mich., June, 1913*; N. Y., Jan., 1917*; N. C., Aug., 1917.*) 28. Define: Mortgage bond. (N. Y., June, 1898*; Wash., May, 1903*; Pa., Nov., 1906*; N. C., June, 1916; N. C., Nov., 1918; N. C., Nov., 1919.) 29. Define: First mortgage bonds. (Wash., Sept., 1907.) 30. Define: Second mortgage 6 per cent serial gold bonds. (Wash., July, 1917.) 31. Define: Collateral trust bonds. (Pa., Nov., 1906*; N. C., Nov., 1918; N. C., Nov., 1919.) 32. Define: Guaranteed bond. (N. C., Nov., 1918; N. C., Nov., 1919.) 33. Define: Income bonds. (N. Y., June, 1898* ; Wash., May, 1903*; Pa., Nov., 1906* ; Wash., June, 1912 ; 111., May, 1914* ; Wis., May, 1916 ; N. C., June, 1916; N. D., Aug., 1917; N. C., Nov., 1918; N. C., Nov., 1919*; A. I. of A., May, 1921.) 34. Define: Serial bond. (Kan., Dec., 1915; Mo., Dec., 1915.) 35. Define: Coupon bonds. (N. C., June, 1916.) 36. Define: Registered bonds. (N. C., June, 1916.) 37. Define : Debenture bond. (N. Y., June, 1898* ; Wash., May, 1903* ; Cal., May, 1916; N. C., June, 1916; N. C., Nov., 1918; N. C., Nov., 1919.) 38. Define: Underlying bond. (Cal., May, 1916.) BOND DISCOUNT AND PREMIUM 39. Define: Bond discount and bond premiums. How should each be treated in the annual statement of a concern? (Minn., Oct., 1916.) 40. Show the method by which entries would be made for receipts from bonds sold below or above par. (Mich., June, 1913; Mich., June, 1919.) 41. How would you treat the discount on bonds on the Balance Sheet of issuing company? (111., May, 1914*; Mo., Dec., 1914*; 111., May, 1915.*) 42. In the Balance Sheet of a manufacturing concern, how should commissions paid and discounts allowed on bonds sold be treated? (111., May, 1912.) 43. On which side of the Ledger should the balance on the Bond Dis- count Amortization account appear? (Mo., Dec., 1914.) 44. The Fort William Manufacturing Company has created a first and second issue of mortgage bonds which have been placed through a syn- dicate. The first mortgage bonds are to run 20 years and were sold at 115. BOXD< 213 The second mortgage bonds are to run 40 years and were sold at 60. State how the same should be entered on the books of the company, as- suming the total par value of the first mortgage to be $5,000,000 and the second $2,500,000. (Md., Oct.. 1919.) 45. A corporation has issued $1,000,000 of 6 per cent 20-year bonds at 90 and for 8 years has written off 5 per cent of the discount" each year. Last year an opportunity occurred to buy in $200,000 at 85, which was done and the bonds cancelled. The directors propose to take up into their year's revenue $30.000, the discount saved upon extinction of this liability. Do you approve? If not, what course would you advise, or, if thev insist, how would you act? (A. I. of A., Nov., 19lS; W. Va., May, 1919.) 46. "What proportion of $15,000 commission paid for negotiating a sale of bonds, to run 10 years should be treated as an asset at the end of the first year? Give reasons. (N. Y., Jan., 1901.) 47. If a company sells its own bonds at a premium, is the premium received a legitimate profit of the company? (Ohio, Nov., 1915; W. Va^ May. 1919; X. D., July, 1919.) 4S. Explain the different ways in which the discount on bonds sold below par may be written off by the issuing concern. Which is the best? (Mich., Dec., 1913; Mich., Dec.,* 1914.*) 49. "Discounts and premiums on bonds are in effect an addition to or a deduction from the interest rate paid on the bonds over their life." (Dickinson.) Defend and illustrate this statement in view of your defi- nition of interest. (Kan., May. 1916.) 50. Classify according to the subdivision of assets, liabilities, pro- prietary interest, income and expense under which they should be grouped: (a) discount on bonds purchased; (b) amortization of discount on bonds purchased; (c) amortization of premium on bonds issued; (d) premium on bonds issued. (Wis.. May, 1919.) 51. State the various accounts which should be kept for: (1) recording bonds issued and bonds purchased; (2) the premium and discount on these bonds; and (3) outline four methods of treating premium and discounts on bonds. (Wis.. Nov.. 1919.) 52. A corporation sells its first mortgage bonds at $10,000 premium and its second mortgage bonds at $10,000 discount. Give your views as to the proper treatment of these items of premium and discount (N. Y., Jan., 1901: Wis., April, 1914.*) 53. What does the Interstate Commerce Commission require in con- nection with the recording and the financial presentation of premiums and discounts on bonds, and premiums and discounts on stocks? State the theoretic reason for the difference, if any, in the handling of these two classes of facts. (X. Y.. Jan., 1914.) 54. Frame any entries necessary to record the action of the directors as it appears in the minutes of the meeting. The president reported that a firm of bankers had offered to purchase $200,000 of the company'? 20- year 5 per cent bonds to be dated October 1, 1917, at 93 and accrued 214 C. P. A. ACCOUNTING interest. He was authorized to accept the offer and deliver bonds on that date. (A. I. of A., Nov., 1917.) 55. A company having sold its bonds at a rate above par, how should the premium received be treated on the books of the company? (N. Y., June, 1906*; AVash., Sept., 1907*; Ohio, Nov., 1913.) 56. What, in your opinion, is the most equitable basis of writing off discount incurred on an issue of serial bonds by a corporation? Mention at least two other bases which might be followed, stating wherein the method you suggest is more equitable than the others. (111., May, 1914.) 57. A firm purchased ten $1,000 bonds at 97y 2 , due January 1, 1915, bearing 5 per cent interest, payable semiannually. What procedure would you adopt to care for the discount at maturity? (N. Y., Jan., 1914; N. D., Aug., 1917.*) 58. How should the interest received en a bond bought at a premium be treated? (N. Y., June, 1897.) 59. Give various methods of treating premiums and discounts on bonds purchased. Give the advantages and disadvantages of each method and state which you consider the best, with reasons for your belief. (111., May, 1907*; Fla., July, 1909; Va., Nov., 1910*; Mich., Dec., 1916.*) 60. A company having an issue of $1,000,000 of bonds running for the period of 30 years and bearing interest at the rate of 6 per cent per annum, payable annually, has asked your advice as to an equitable method of disposing in its accounts of a discount of $50,000 paid to its brokers for the negotiation of the bonds. You have ascertained that the bonds are payable in annual installments of $25,000 during the first 20 years and in installments of $50,000 per annum during the next 5 years, the final payment of $250,000 being due at the end of the 30th year. In answering this question, submit details of the process you adopt in arriv- ing at your conclusion. (Wash., July, 1917.) 61. Illustrate in the form of Journal entries the accrual of discount and the amortization of the premium on bond investments. Explain or illustrate the relation of each to the interest receipts and to the income returns. (Md., Jan., 1909.) 62. A concern of which you are the auditor buys for investment $10,000 worth of 7 per cent 15-year gold bonds at 115. How would you show these in the Balance Sheet of the concern and what disposition would you make of the premium on the books? (N. Y., Dec., 1897*; N. Y., Feb., 1910*; Ohio, Nov., 1918.) 63. In case of bonds purchased at a premium or at a discount, to be held until maturity, state how the price should be disposed of on the books at purchase, at maturity, and at any intervening time. (N. Y., June, 1898.) 64. How would you treat in the accounts bonds bought at 90, with 11 years yet to run? (Cal., Nov., 1916.) BONDS 215 AUDITING 65. State how you would verify the Bonds Payable. (Ohio, Dec., 1908; N. C., June, 1916; N. C., Aug., 1917*; 111., Dec., 1918.*) 66. State in detail what steps you would consider necessary to verify the First Mortgage Gold Bonds. (111., May, 1904*; 111., May, 1916.) 67. How would you verify the Investment Bonds in making a Balance Sheet audit? (Mich., June, 1912; Mass., Oct., 1914*; Ohio, Nov., 1915.) 68. State for Balance Sheet purposes the rules of valuation that apply in long-time bonds bought at a discount for speculation, the market value of which has advanced. (N. Y., Jan., 1911.) 69. State for Balance Sheet purposes the rules of valuation that apply in long-time bonds bought at a premium for investment, the market value of which has advanced. (N. Y., Jan., 1911.) 70. Under what circumstances would you permit a client to carry bonds at cost when the market is lower? (Cal., May, 1916.) 71. What is the general rule as to bonds of other corporations held as an investment? (N. Y., Dec., 1898*; Va., Oct., 1912*; Ohio, Nov., 1918.) 72. What would you consider satisfactory evidence of the correctness and propriety of expenditures of Commission Paid to Bankers for Sale of Bonds? (A. I. of A., May, 1918.) 73. How would you proceed to verify the Liberty bonds on hand rep- resenting company's and employees' subscriptions? (111., Dec., 1918.) 216 C. P. A. ACCOUNTING PROBLEMS BONDS 1. A $10,000 5 per cent semiannual coupon (bond) is bought on a 4 per cent basis, due 1^ years hence. What did it cost? (A. I. of A., Nov., 1918.) 2. Determine the price of a 4% per cent bond in the amount of $10,000, with four years to run, purchased so as to net 3 l /z per cent. The interest is payable semiannually. Construct a schedule of amortization. (Pa., Nov., 1918.) (Note: 8th power of 1.0175 is 1.14888178, whose reciprocal is .87041157.) 3. What must be paid for a bond $1,000 par maturing in 10 years with 4 per cent interest, payable semiannually, to net the purchaser 6 per cent? (Mich., Dec., 19130 (Note: 20th power of 1.03 is 1.80611123, whose reciprocal is .55367575.) 4. "X" and "Y" are dealers in bonds and securities, sharing profits and losses in the proportion of: "X," three- fourths and "Y," one-fourth. They employ "Z" to sell securities, agreeing to pay him, in lieu of a salary, an amount equal to 25 per cent of the net profits to be divided between the partners. During the period of "ZV employment the firm purchased $100,000 Topeka Traction Company first mortgage 5 per cent bonds, on a 3 per cent basis. The bonds mature in one year and one-half. Interest is payable semiannually. These bonds are held by "X" and "Y" until maturity. Prepare a statement of the Topeka Traction Company bond accounts, showing cost, amortization, and interest. The total profit to be adjusted in the contract with "Z" is $15,000. Show the division of this profit. (Kan., May, 1916.) 5. A bond, bearing interest at 5 per cent per annum, payable annually, and repayable in five years, with bonus of 10 per cent, is for sale. What price can a purchaser pay who desires to realize 6 per cent on his invest- ment? (V 5 at 6 per cent = .7473.) (A. I. of A., May, 1919.) 6. On January 1, 1915, an investor purchased (ex interest) a 5 per cent $10,000 bond, the interest being payable, $250 on January 1 and $250 on July 1, of each year. Assuming that the bond matured on July 1, 1917, and yielded 2 per cent semiannually on his investment, what price did he pay? It is given that (1.02)' = 1.104081. Using the figures derived from your computation, make illustrative entries for income and amortization covering the first two periods. (Mass., Oct., 1917.) (Note: 5th power of 1.02 is 1.10408080, whose re- ciprocal is .90573081.) 7. A savings bank on July 1, 1916, purchased 50 bonds of par value $1,000 each of the "A. B." R. R. Company. The bonds mature January 1, 1925, and bear interest at the rate of 4^2 per cent per annum, payable semiannually. They were purchased on a semiannual basis of 2 per cent. (1) What was the total cost of the bonds? (2) Construct a schedule of amortization for the premium on the bonds. (3) Set up an account with the bond issue, showing what entries would be made on each interest date. (Pa., Nov., 1916.) (Note: 17th power of 1.02 is 1.40024142, whose reciprocal is .71416256.) 8. A corporation decided to issue and sell bonds to the amount of $100,000. The denomination of such bonds, $1,000 each; term of bonds, 15 years; interest rate, 5 per cent, payable semiannually. On January 1, 1914, these bonds were sold for $105,411.33, or on a 4 l / 2 per cent return basis. July 1, 1914, interest was paid, amounting to $2,500. (a) What entry should the corporation have made when the bonds were sold? (&) What entry should the corporation have made when it paid the $2,500 interest referred to above? (c) What entry should the purchaser of these bonds have made when he received the first interest payment? (Wis., April, 1915.) 9. An issue of $500,000 of bonds is made by a corporation, redeemable at par in 10 yeai's. The trust deed provides for the creation of a sinking fund for the redemption of the bonds, and for investment of the sinking fund. The bonds are issued at a discount of 2 per cent. You are required : (a) To prepare entries setting up the bond issue on the books of the corporation. (&) To prepare (for one year only) the entries which must be made on the books each year with respect to the sinking fund and the sinking-fund investment. (c) To prepare the entries which will be required on the redemption of the bonds. (d) To show how, during the life of the bonds, the various accounts relative thereto should appear on the books of the corporation. Note: In your answer disregard interest. (Wash., May, 1910.) 10. On December 15, 1914, the stockholders of the "A" Corporation authorized an issue of $100,000 10-year 5 per cent first mortgage bonds. These bonds were sold on January 1, 1915, at 95. On January 1, 1916, another duly authorized issue of $100,000 20-year 6 per cent bonds was sold at 102. In accordance with the terms of the bond recitals the sinking fund in- stallments were to be invested in outside securities, and on January 1, 1916, a portion of the pro rata installment of the first bond issue was 218 C. I'. A. ACCOrNTIXC used in purchasing 100 5 l / 2 per cent bonds of the "X" Corporation at 9$. On January 1, 1917, the pro rata installments were invested as follows: Issue No. 1, 100 6y 2 per cent bonds of the "T" government at 102 ; issue No. 2, 50 7 per cent bonds of the "W" government at par. Draft the proper entries to record the above transactions, and show the ledger accounts and balances as of January 2, 1917. Interest calcula- tions need not be given. (Wis., April, 1917.) 11. Corporation "A" issues 50 bonds, par value $50,000, bearing 5 per cent interest, payable annually. The bonds are numbered serially, and are to be retired in consecutive groups of 10 each year. They are to be sold at date of issue for an average price of $950. (a) Submit, in form of ledger accounts, all entries required to handle this bond issue, in what you consider the most equitable manner, from date of issue to retirement. (b) Corporation "B" buys bonds Nos. 21 to 40, inclusive, on date of issue, at $950 each, and sells Nos. 21 to 30 at the end of two years for $1,000 each. The other ten bonds are retired when due. Submit, in the form of ledger accounts, all necessary entries in Cor- poration "B's" books for handling the matter in what you consider the most equitable manner. (Wis., May. 1916.) 12. What could a purchaser who wished to realize 3 per cent on his investment give for a bond for $10,000 which had four years to run at 5 per cent interest, payable yearly, and thereafter was payable with a bonus of 10 per cent? (Note: 3rd power of 1.03 is 1.12550881; whose recipro- cal is .88848705.) (A. I. of A., Nov., 1920.) 13. The 4% per cent Victory notes mature at par on May 20, 1923. If a purchaser buys at $96.20 on May 20, 1920, calculate the approximate yield per cent. Given : 2M% 3% A e . . 5.4264 5.4172 V 6 .8498 .8375 (A. I. of A., May, 1920.) CHAPTER XII DIVIDENDS AND SURPLUS Classes of Dividends Dividends are those profits of a corporation which are divided among the stockholders. 1 However, in common parlance, any payment made to a stockholder is called a dividend. Dividends may be classified according to source of funds and manner and time of payment. There are two classes of dividends divided according to source of funds, namely, those paid out of profits and those paid out of capital.* The five kinds of dividends, classified according to manner of payment, are the dividends paid in cash, 1 property, 4 stock, 5 bonds,' and scrip. 7 If the com- pany is unusually successful, a special dividend in addition to the regular dividend may be declared, or an interim dividend, a dividend between regular dividend dates, may be declared." Dividends Out of Capital Except in case of liquidation or a legally authorized reduction of capital stock, dividends paid out of capital are illegal, and the directors responsible for them are usually jointly and severally liable therefor. 8 It is legal in some states for extractive industry corporations to disregard the wasting assets and thus declare dividends in excess of real profits. 10 Modern practice is now requiring the setting up of reserves for wasting assets, an improvement the adoption of which has been greatly popularized by the federal income tax requirements. If an extractive industry corporation wishes to pay its stockholders more than the net profit after depletion has been charged, the excess should be charged to the capital payments account, which account would be deducted from the capital stock account on the balance sheet. 11 Dividends Out of Profits Both operating and capital profits, if realized, may be declared as dividends." Unrealized profits 13 and premium on capital stock," however, should not be so distributed. The old English rule for dividends was that fixed assets could be lost and yet the excess of current receipts over current payments could be divided, but that the current assets must be maintained." This rule has not been changed as to current assets, but all waste, both of fixed and current assets, inci- dental to the process of making profits must now be made good out of the profits earned before dividends can be paid. 18 Declaration of Dividends The declaration of dividends is subject to the provisions of the corporate charter and by-laws, and the rights of other stockholders, 17 but otherwise, in the absence of fraud, is under the control of the directors. 18 However, obligation is. incumbent on the directors if any improper withholding can be shown." The minute 'For explanation of superior figures see page 337. 219 220 C. P. A. ACCOUNTING books should give the dividend rate, date and manner of payment, and to whom payable. 20 Dividends are paid to stockholders of record as of a set date; 21 they may be postdated but may not be antedated." Stock- holders are entitled to be notified of each dividend declaration. 23 The declaration of dividends may be revoked up to the time, but not after, notice has been given except in the case of illegal dividends which may be revoked any time previous to payment," and after payment to stock- holders cognizant of the source. 25 Treasury stock does not draw dividends. 26 Payment of Dividends When dividends are declared and notice thereof given, a liability is incurred." This liability should be shown in the dividends payable account, if the dividend is not payable on the day it was declared. 28 Sometimes declared dividends are not recorded until paid, but this overlooks a current liability which should appear on a balance sheet prepared between the dividend declaration and dividend payment dates, 29 and also overlooks unclaimed but payable dividends which should be shown among the current liabilities. 30 Unclaimed dividends can be returned to surplus only by action of the directors. 31 When the dividends paj r able are set up, either the current profit and loss account 31 or the surplus account may be charged, 33 but, as dividends frequently ex- ceed the profits of any one year, it seems preferable to debit the surplus account. If the dividends are charged to profit and loss, the debit is frequently made through the dividends declared account," which account would appear in the appropriation section of the profit and loss state- ment.* 8 If dividends are payable in cash, the entries to record them would be :" Entry No. 1 Surplus (or Profit and Loss) xxxxxxx Dividends Payable xxxxxxx Entry No. 2 Dividends Payable xxxxxxx Cash xxxxxxx Sometimes property, instead of cash, is distributed as dividends. 37 On account of the difficulty of equitably distributing property, dividends paid in property are rare, except for the property dividends which distribute corporate securities. 38 Property dividends are recorded the same as cash dividends, except that the property distributed, instead of cash, is credited in the second entry above. 38 Directors sometimes declare dividends payable in either unissued or treasury stock, the entries being the same as for cash dividends except that, instead of cash, unissued stock or treasury stock, as the case may require, is credited in the second entry.* If directors are unwilling to issue stock and cannot borrow money to advantage, they may declare a scrip dividend, if they wish to liquidate the debt within a short time, 41 or a bond dividend, if the obligation is not to mature in the near future." The entries for such dividends would consist of entry No. 1, as above, followed by a debit to dividends payable and a DIVIDENDS AND SURPLUS 221 credit to bonds payable or scrip payable, and, at the maturity of the obliga- tions, by a debit to bonds payable or scrip payable and a credit to cash." The entry for the interest on the bonds or scrip would be a debit to interest and a credit to cash." Dividends are sometimes applied on unpaid installments on capital stock subscriptions." In such cases the dividends payable account is debited and the installment on stock account credited for the amount so applied. 48 Cumulative Dividends When a preferred dividend is "passed," the sur- plus account may be debited and the unpaid preferred dividend account credited, but this procedure is poor in that it reduces the surplus, and, indeed, may change a surplus into a deficit, for the sake of a liability which is only contingent. 47 A substitute entry is to debit preferred stock divi- dends account (an asset) and credit unpaid preferred dividends account, a procedure which offsets a contingent asset with a contingent liability. 4 * Another way of handling "passed" cumulative dividends is simply to men- tion them in a footnote to the balance sheet. 49 The last method seems the best, as cumulative dividends are not really liabilities until they are de- clared. Dividend Book The dividend book is a bound or loose-leaf book, con- taining for each declared dividend an alphabetical list of the stockholders entitled to receive dividends, together with their addresses, number of shares held, amount of dividends paid, and, if the dividends are paid by mailed checks, the check numbers, or if the dividends are paid in the office, the stockholders' signatures. 60 Audit of Dividends The authority for the dividend should be verified from the minute book. 51 The list of stockholders' holdings in the dividend book should be verified by checking a few of the larger amounts, taken at random, with the capital stock ledger, and by checking the addition of the number of shares, as listed in the dividend book, against the aggregate shares outstanding, as shown in the general ledger. 52 The audit of the dividend payments consists in comparing the verified list of the amounts due to stockholders with the dividend checks or warrants which have been paid after endorsement by the stockholders. 53 The outstanding dividends payable must then be traced." Profit Sharing When a part of the profits is distributed to employees as such, the process is known as profit-sharing and should be recorded by debiting surplus or profit and loss and crediting the "bonus to employees" account, which account is closed when payment is made. 55 Undivided Profits Account Most corporations make little or no dis- tinction between undivided profits and surplus, 50 but banks usually treat surplus as a part of the permanent capital created by systematic alloca- tions of current profits, and treat undivided profits as a reservoir to hold profits remaining after the declaration of dividends and the allocations to surplus." '2-2'2 C. P A. .UTOrXTING Surphis Defined In the broadest sense, surplus represents the excess of the net worth of a corporation over the par value of the capital stock outstanding. 68 Under this definition, true reserves are the part of surplus called restricted or appropriated surplus, while the surplus available for dividends is called free surplus. 10 In the narrower sense, surplus repre- sents the retained past profits which are available for dividends.* 1 As the narrower use of the word tends toward clearness, it is the preferable. Kinds of Surplus Surplus may be classified by sources into (a) con- tributed, or surplus created by contribution either at the sale of stock by issue at a premium or after donation of stock; 83 (b) revaluation, or surplus created either by increasing the book valuations of fixed assets, 64 or by reducing par value of capital stock, 85 and (c) revenue, or surplus accumulated out of past profits. This classification is noteworthy as con- tributed and revaluation surplus should not be declared in dividends although such declaration is not illegal, 67 while revenue surplus may be distributed as dividends. "Capital surplus" is sometimes used as a synonym for "contributed surplus."' 8 Statement of Surplus All mistakes made in prior periods in the valua- tion of inventories, or in the estimate of losses due to depreciation and bad debts, or in the failure to differentiate between capital and revenue ex- penditures should be adjusted directly into the surplus account and not through the pi'ofit and loss account." Losses and gains not occasioned by the ordinary operation of the business are also recorded directly in the surplus account. 70 If these adjustments are few and simple, a statement of surplus may be either annexed to the profit and loss statement 71 or em- bodied in the balance sheet." If the adjustments are numerous and com- plex, a separate statement of surplus should be prepared. 73 The statement of surplus is prepared somewhat as follows:' 4 Statement of Surplus, December 31, 1920 Balance of Surplus as of December 31, 1919. . . . xxxxxxx Adjustments applicable to period ending Decem- ber 31, 1919: Additions (itemized) xxxxxxx Deductions (itemized) xxxxxxx xxxxxxx True Surplus as of December 31, 1919 xxxxxxx Extraordinary Profits (or Losses) this period.. . . xxxxxxx Net Profit this period xxxxxxx xxxxxxx Amount available for appropriations xxxxxxx Appropriations of Surplus: Reserves (itemized) xxxxxxx Dividends declared . . xxxxxxx xxxxxxx Net Surplus as on December 31, 1920. Audit of Surplus The auditor must secure a detailed analysis of the surplus account. 75 This is accomplished through the preparation of a statement "reconciling the surplus balances on the balance sheets of the DIVIDENDS AND SURPLUS 223 previous and current years, viz., the drawing up of a statement of surplus. 7 " The books should be examined to ascertain if- the surplus was earned, and, if it was not, a careful record of its creation should be made." Deficit A deficit is the excess of the par value over the actual value of the stock issued. 78 Although the deficit account is sometimes shown on the balance sheet as an asset, 7 " it should be deducted from the other net worth accounts as it is not an asset. 80 224 C. P. A. ACCOUNTING QUESTIONS DIVIDENDS AND SURPLUS DIVIDENDS 1. Explain the meaning and use of the Dividend account. (La., May, 1913.) 2. Describe the nature of the Dividend account. (N. Y., Dec., 1896; W. Va., May, 1917.) 3. Describe fully the Dividend account. (N. Y., Jan., 1902; Pa., May, 1903; Ohio, March,^1910.*) 4. Give the theory of dividends. (N. Y., Jan., 1920.) 5. What is a dividend? (Mich., July, 1906; Iowa, Dec., 1918.) 6. What is an interim dividend? (Wash., June, 1915.) 7. What is a cash dividend? (Wash., June, 1915.) 8. State where the Dividend account is employed. (N. Y., Jan., 1902* ; Ohio, March, 1910.*) 9. When may dividends on common stock be paid? (Iowa, Dec., 1918; S. C., Sept., 1919.*) 10. What examination should the auditor make of the items in a Bal- ance Sheet to determine whether a dividend is justified? (S. C., Sept., 1919.) 11. (a) Out of what funds may dividends be paid? (b) If dividends are not paid in accordance with your answer to the preceding question, have the creditors of the corporation any grounds for action against the company or its stockholders? (N. D., July, 1916.) 12. From what funds are dividends payable and what penalties attach to improperly declaring or paying them? (Fla., April, 1907.) 13. State how declaration and payment of dividends are usually re- corded in books of accounts. (Mich., July, 1906; A. I. of A., May, 1919.*) 14. How would you treat the following dividends on common stock in preparing a Balance Sheet : Dividends declared and receivable on stock of subsidiary company which is controlled and whose accounts are consolidated? (Mo., Dec., 1914.) 15. How would you treat the following dividends on common stock in preparing a Balance Sheet: Dividends declared on stock in treasury; declared in reduction of capital? (Mo., Dec., 1914.) DIVIDENDS AND SURPLUS 225 16. How would you classify the following item in the Balance Sheet or Profit and Loss account: Capital stock dividend? (N. Y., Jan., 1907*- Kan., Dee., 1915; Mo., Dec., 1915.) 17. How would you indicate on the Balance Sheet, December 31 : Or- dinary dividends for the year, declared the following January 22? (A. I. of A., Nov., 1918; W. Va., May, 1919.) 18. How would you deal with the noncumulative preferred dividends declared June 30, 1914, in auditing a Balance Sheet as at June 30, 1914, to be certified by you? (Mo., Dec., 1914; A. I. of A., Nov., 1918* ; W. Va., May, 1919.*) 19. How would you deal with the preference dividends declared July 1, 1914, in auditing a Balance Sheet as at June 30, 1914, to be certified by you? (Mo., Dec., 1914.) 20. Classify Dividends Declared and Dividends Payable according to the subdivision of assets, liabilities, proprietary interest, income and ex- penses under which they should be grouped. (Wis., May, 1919.) 21. In preparing the Balance Sheet of a corporation, how would you treat arrears of cumulative dividends on preferred stock? (N. Y., June, 1901*; N. Y., June, 1902*; Wash., Sept., 1907*; 111., May, 1908*; N. Y., Feb., 1910*; Va., Nov., 1910; Va., Oct., 1912*; La., May, 1913*; Wis., April, 1914*; 111., May, 1914*; Mass., Oct., 1914*; Ohio, Nov., 1915*; Ohio, Nov., 1916; Md., Dec., 1917*; N. Y., June, 1918*; Pa., Nov., 1918*; A. I. of A., Nov., 1918*; W. Va., May, 1919*; Mich., June, 1919.*) 22. How would you handle cumulative dividends in arrears on the Balance Sheet in the case of a corporation owning the stock with respect to which the cumulative dividends are in arrears? (Pa., Nov., 1918.) 23. When is it proper to record on the books of a corporation a divi- dend on cumulative preferred capital stock? (N. Y., June, 1919.) 24. When do dividends on preferred stock become an obligation of the company? (Iowa, Dec., 1918.) 25. How would you classify the Dividend Declared on Preferred Stock but not paid until the following year, in the Balance Sheet or Profit and Loss account? (Kan., Dec., 1915; Mo., Dec., 1915; Iowa, Dec., 1918.*) 26. What relation do cumulative preferred stock dividends bear to the cost of operating? (Mich., July, 1906.) 27. Explain in some detail the procedure you would follow as an audi- tor in verifying the Preferred Stock Dividends in Arrears, appearing in the books and accounts of a company. (Wash., June, 1915.) 28. What do you understand by the term "Dividends Paid Out of Capital"? What, in your opinion, would constitute such payment, and mention any circumstances that may occur to you to justify such pay- ment? (Ilf., May, 1913; Wis., April, 1915*; Ind., June, 1916; Md., Oct., 1919.) 29. A corporation has been accused by a stockholder of paying divi- dends unlawfully. How should he proceed in the matter? You as an 2(1 C. P. A. ACCOUNTING accountant have been called in. What would you do to prove or clisprovr Ihe accusation? (Del., June, 1915.) 30. The llayward Company has declared a dividend of 10 per cent on its capital stock of $100,000, payable July 1, 1910; stock books close on June 15, 1910. Describe the accounting procedure incident thereto and state who may participate in the dividends. (N. Y., June, 1911.) 31. On which side of the Ledger should the balance on the Unclaimed Dividends account appear? (Mo., Dec., 1914.) 32. How would you deal with the Unclaimed Dividends account in preparing the annual accounts of a company 1 ? Comment briefly on any points which would need special consideration. (A. I. of A., May, 1920.) 33. What evidence would you consider satisfactory for the correctness of the dividends? (N. C., Nov., 1919.) 34. How would you treat unclaimed dividends? (A. I. of A., May, 1919.) 35. What is your method of checking dividends paid? (R. I., Dec., 1907.) 36. In case a corporation of five persons owning all the stock should credit each party in proportion to their several holding's with the profits as shown by the books, without formally declaring a dividend, and the said stockholders were also credited with interest on the undrawn credit bal- ance, what would be your action? (Pa., Nov., 1904.) 37. Discuss the subject of dividends: (a) when declared out of pre- mium secured from sale of capital stock; (b) when company's sole invest- ments are in diminishing (or wasting) assets. (Wis., April, 1915.) 38. Can you mention any distinction between dividends declared out of income and dividends declared out of profits realized from the incre- ment of invested values? (A. I. of A., May, 1919.) 39. How would excessive dividends affect the individual holders or subscribers? (Mich., June, 1913.) 40. It has been stated that the right to declare a dividend depends upon the state of a company's finances at the time when the dividend is declared. Give your opinion as to conditions under which a company may borrow money for the purpose of paying- a dividend. (111., May, 1910; N. D., Aug., 1917.) 41. Under the law permitting payment of dividends solely out of surplus earned, a corporation pays a dividend out of general surplus after carrying its losses for the period against the account. Would you make mention of the fact in the recital accompanying your statements or would you let it go without specific mention? Give reasons. (R. I., Dec., 1907.) 42. What is a stock dividend? (Wash., June, 1915; Iowa, Dec., 1918.) 43. In what respect do stock dividends differ from cash dividends? (N. Y., Jan., 1920.) 44. What must be the condition of the business to justify the issue of stock dividends? (Iowa, Dec., 1918.) DIVIDENDS AND SURPLUS 227 45. In three successive fiscal years a manufacturing corporation values its supplies, etc., in hand at cost, with deductions for deterioration as follows: At end of first year 5 per cent; at end of second year 10 per cent, and at end of third year 15 per cent. With the inventory taken on this basis the profits for the second year did not equal the dividends de- clared and in the third year the dividend paid was so much in excess of profits that the surplus was entirely exhausted and a debit balance created in the Profit and Loss account. In auditing the books, how would you treat the above condition in your report? (Pa., May, 1905.) 46. Prepare Journal entries for dividend paid out of treasury stock acquired at half of its book value. (N. C., June, 1920.) 47. The stockholders of the Farmers Cooperative Store share the store's earnings in proportion to purchases made during the year, and dividends may be withdrawn in trade or in cash. The fiscal year corresponds to the calendar year, but the dividend year runs from March 15 to March 14. (a) The following facts are given you with the request that you ascer- tain the status of the Surplus account on December 31, 1917, and indicate the disposition of any dividends which may have been paid out in excess of available surplus. The balance of the Reserve for Dividends account on December 31, 1916, was $2,540.15. This represented the dividends which might be withdrawn in cash during the period, January 1, 1917, to March 15, 1917. The dividends withdrawn in cash during the year 1917 amount to $1,015.37, and those withdrawn in trade during 1917 amount to $24,786.29. In order to reduce trade dividends to a cash basis, 20 per cent is deducted from the selling price of goods so withdrawn and charged back against the sales. The balance of surplus available for dividends on December 31, 1916, was $20,710.43. An examination of the accounts shows that dividends to the amount of $2,496.63 (cash basis) may be withdrawn between January 1, 1918, and March 14, 1918. During the period January 1, 1917, to March 14, 1917, dividends were withdrawn to the amount of $1,720.15, cash basis. (b) The sales to members for the year 1917 are $162,280 and the net profits are $20,285. In your judgment, what dividends should be declared in trade and in cash for the year 1918? (c) Briefly criticize the plan followed by this company in distributing the earnings to the stockholders. (Wis., April, 1918.) 48. A firm is incorporated under the laws of the State of New York to do business within the state, with an authorized capital of $100,000. Its assets, including $10,000 for goodwill, aggregate $30,000; the lia- bilities other than capital stock, aggregate $30,000. When the books were closed at the end of the first year, the net profits shown amounted to $8,000. Are the directors warranted in declaring a dividend? If so, for what amount? (N. Y., June, 1917.) 228 C. P. A. ACCOUNTING 49. The books of a corporation (with a capital stock of $800,000) at the beginning of the last fiscal year showed a surplus of $28,450. During your examination, immediately subsequent to the close of the fiscal year, you learn the following facts : That the net profit on goods delivered to customers during the year amounted to $115,350. That prior to, and at the close of the year, the company owned bona fide contracts for the delivery of goods during the next few months. That the company had purchased a sufficient quantity of merchandise in order to fill these contracts. That the company after making due allowances for all production cost, expenses incidental to the delivery of the contract goods, cost of selling, etc., had arrived at a net profit amounting to $51,120, which was carried to Profit and Loss account. This made a total net balance of $166,470. That there was declared and paid a dividend of 20 per cent (or $160,000) and that $6,470 was carried to surplus account. Would you consider it necessary to call particular attention to this matter in your report to the stockholders? State your reasons. (Wis., April, 1914.) 50. An Indiana company is incorporated with a capital stock of $100,000, of which $90,000 was paid in. In making their application for the charter all the stock was subscribed. The full capital, however, was not required. It was recently decided that, inasmuch as a surplus of $15,000 had accumulated, they would declare a stock dividend, pro rata, for the $10,000 of stock unissued but subscribed for by one of the present stockholders. No action on the transaction was taken by the board of directors, and no record of it appears in the minutes of the corporation. Is it necessary that a transaction of this character be recorded in the minutes, inasmuch as all of the stock was originally subscribed? Will not this stock dividend have to be reported as income for the current year if the surplus was earned since 1910 ? What would be your recommendations in regard to the proper procedure in this matter? (Ind., May, 1918.) 51. By a charter provision a company is directed annually to retire out of the ordinary profits arising from the conduct of the business 5 per cent of its 7 per cent dividend paying preferred stock. This pre- ferred stock is now worth, say, 110 in the market and during the past year the company succeeded in buying in 1,000 shares of the par value of $100 at $80, borrowing for that purpose $80,000 for four months at 4^ and paying the note at maturity. (1) What is the amount of the profit? (2) How should the amount be treated in the company's published accounts? (3) Would the directors be justified in utilizing the amount for the payment of a common stock dividend, and should this be treated as a cash dividend or a repayment of capital? (Kan., Dec., 1915; Mo., Dec., 1915.) DIVIDENDS AND SURPLUS 220 52. Under what circumstances would you permit a client to distribute capital stock as dividends prior to dissolution? (Cal., May, 1916.) 53. Define: Scrip. (N. Y., Jan., 1911.) 54. Explain briefly the following term: Dividend scrip. (Ill, Nov 1903.) 55. May dividends be paid in other than cash? Explain. (Iowa, Dec 1916.) 56. State when and how dividends become effective. (Mich., July, 1906; Fla., April, 1907.) SURPLUS 57. Define: Surplus. (N. Y., Dec., 1896; N. Y., Dec., 1897*; N. Y., June, 1900; N. Y., Jan., 1901*; N. Y., Jan., 1902*; Pa., May, 1903*; 111., Nov., 1903*; N. J., 1904-1909; Ohio, March, 1910*; La., May, 1913*; \Vash., Nov., 1913*; Wis., April, 1914; N. D., June, 1914; Cal., Nov., 1916; Mass., Oct., 1917*; Va., Nov., 1918; Iowa, Dec., 1918; N. C., June, 1920.) 58. Define: Appropriated surplus. (Wis., May, 1916; Wis., April, 1917*; Mass., Oct., 1917.*) 59. Define: Free surplus. (Wis., April, 1917.) 60. What do you understand by capital surplus? Is it invested capital ? (Wis., Nov., 1919.) 61. How is the Surplus account used? (N. Y., Jan., 1902*; N. J., 1904-1909; Ohio, March, 1910.) 62. What is the purpose of the surplus of a stock company? (N. Y., Dec., 1898*; N. Y., Jan., 1901.) 63. How would surplus and appropriated surplus affect the book value of capital stock? (Mass., Oct., 1917.) 64. May surplus be created by "marking up" the value of fixed assets? May such surplus be used as a basis for declaring dividends? (Iowa, Dec., 1918.) 65. Mention and differentiate between accounts properly belonging to Profit and Loss and Surplus accounts. (Mass., June, 1913.) 66. (a) What items do you consider should be charged or credited direct to surplus? (6) Would you regularly make small adjustments of subsequently discovered errors through this account? (c) Is the balance at credit of surplus ever in any circumstances a liability, and if so, to whom? (A. I. of A., Nov., 1918.) 67. When preparing a Trading and Profit and Loss account at the end of a fiscal year, in what manner would you treat the surplus or deficit brought fonvard from prior year? (N. Y., Jan., 1907.) 68. Distinguish between reserve and surplus. (Wis., April, 1914; Ohio, Nov., 1916.*) 230 C. P. A. ACCOUNTING 69. Define: Undistributed Profit account. (Iowa, Dec., 1918.) 70. How do the accounts of a corporation and of a copartnership differ in the statement of division and distribution of profits'? (N. Y., Jan., 1904; Va., Nov., 1910*; Cal., Nov., 1916.*) 71. How is the profit of the following concern divided: Stock com- pany? (Mich., Dec., 1906.) 72. Give three sound accounting principles governing: the determination of profits distributable as dividends of a corporation. (Mass., Oct., 1915.) 73. When is surplus available for dividends? When not available? (Cal., Nov., 1916.) 74. On which side of the Ledger should the balance on the Undivided Profits account appear? (Mo., Dec., 1914.) 75. A corporation purchased a business as a going concern on January 1, 1908, with a right to the profits from October 1, 1907. Its capital is : Five per cent first preferred stock, $250,000; 6 per cent second preferred stock, $250,000; common stock, $124,000. The year's profits to September 30, 1908, are found to have been $38,320. What appropriation of such profits would you consider to be correct ? (111., May, 1910; N. C., Nov., 1918.*) 76. What in your opinion would be the proper accounting record for a business corporation to make for an appropriation from its surplus profits for the account of a permanent investment in property? (Md., Jan., 1909.) 77. On which side of the Ledger should the balance on the Building Appropriation account appear? (Mo., Dec., 1914.) 78. What support is usually necessary, in addition to approval vouch- ers, for the distribution chargeable to Undivided Profits or Surplus ac- count? (N. C., Nov., 1918.) 79. If assets taken over by a company are in excess of its capital stock, would you credit the excess to surplus? If not, why and to what account would you credit such excess? (111., May, 1906.) 80. How would you treat the deficiency in the early years of a corpora- tion's activities? (Ind., May, 1918.) 81. Can surplus be created in any way other than through profits earned from operations? Explain. (A. I. of A., May, 1920.) 82. The books of a company, when closed for the fiscal year, show a substantial net profit. No dividends were paid during the year and there is no cash available with which to pay dividends, (a) What would account for this condition? (6) Illustrate your explanation by a statement sup- plying the figures. (Mass., Oct., 1916.) 83. Is the deficiency in the early years of a corporation's activities (whether an actual loss or a deficiency between the earnings and the nor- mal rate of return) similar to organization expenses? How should such deficiencies be treated in the accounts? To what extent is such a deficiency DIVIDENDS AND SUKPLIS 231 similar to interest paid during construction? Should such deficiencies be carried on the Balance Sheet ? If so, should they be written off, and how and when? May the deficiencies representing the difference between actual earnings and normal rate of return be capitalized, in the strict sense of having capital stock issued to a corresponding sum? State clearly just who is affected, and how, by the different methods of treating the items mentioned above. (A. I. of A., June, 1917.) 84. How would you distinguish between: (a) Earned surplus, (b) paid-in surplus, (c) capital surplus, (d) appropriated surplus? (A. I. of A., May, 1921.) 232 C. P. A. ACCOUNTING PROBLEMS DIVIDENDS AND SURPLUS 1. A corporation's profits for the year ended December 31, 1908, amount to $451,000. The by-laws require a reserve equal to 10 per cent of any dividend paid to common stockholders, and any surplus remaining after such dividend has been paid is also to be applied to the reserve, until such reserve account amounts to $250,000. The reserve at December 31, 1907, was $156,020. The capital is $2,000,000, one-half cumulative preference 6 per cent and one-half common, all fully paid. On December 31, 1908, the preferred dividend is two and one-half years in arrear. On December 31, 1907, Profit and Loss account was in debit $202,000. Set out your treatment of the profit for 1908. (111., Dec., 1910; Colo., Dec., 1913.) 2. The profits of a corporation with a paid-up capital of $5,000,000 amount to $337,193.08 for a given year, without allowing for its mort- gage interest. At the end of the previous financial year, there was left a balance of undivided profits of $27,806.92. Its 4 per cent mortgages are $500,000 and its 6 per cent mortgages are $750,000. How much must be taken from the previous year's surplus balance to pay the stockholders a dividend of 6 per cent? (111., May, 1911.) 3. Frame any entries necessary to record the action of the directors as it appears in the minutes of the meeting. The treasurer reported that the profits for the year as audited amounted to $59,287. Voted that a dividend of $40,000 be paid on October 1 to the stockholders of record September 15 and that $10,000 of the profits be appropriated as a reserve for relief of employees disabled while in the service of the United States and invested in Liberty Bonds. (A. I. of A., Nov., 1917.) 4. Before making the charges referred to below, the Profit and Loss account of a corporation for the year shows a credit balance of $60,000. The accounts receivable are $40,700 and the Plant and Machinery account is $55,000. The 6 per cent preferred stock is $50,000, and the common stock $150,000. It is decided (a) to provide out of the above-named Profit and Loss balance 7 J /2 per cent depreciation on plant and machinery; (b) to write off as uncollectible $1,500 of the accounts receivable and to make a reserve of 2 per cent on the remainder of the accounts receivable to provide for possible losses thereon; (e) to provide for the preferred stock dividend for the year; (d) to provide for a bonus of $7,500 to the DIVIDENDS AND SURPLUS 233 employees; (e) to provide for a dividend on the common stock of 15 per cent for the year, and (/) to carry the balance then remaining on Profit and Loss account to Undivided Profits account. Draft entries to comply with the above provisions. (Wash., April, 1906; Mo., Dec., 1913.) 5. In an audit of the Acme Motor Car Company you find the Reserve for Depreciation account and the Surplus account composed of the itema as here enumerated : The Reserve for Depreciation account was opened on December 31, 1915, the close of the first business year, by debiting the depreciation accounts of the various assets with $265,000. The Reserve for Depreciation account was also credited with $25,000 on December 31, 1916, and with $20,000 on December 31, 1917. During 1916 and 1917 the following items have been charged against this Reserve for Depreciation account: assets scrapped, $125,000; bad debts, $25,000; repairs, $10,000; fire loss on building and equipment, $7,500; organization expense, $65,000; salesmen's extra commission, $12,000. The Surplus account for 1915 and 1916 has been closed, the balance having been paid out in dividends. The Surplus account on December 31, 1917, is found to consist of the following credit items: reserve for car guarantees, $50,000; premium on stock sold, $50,000; reserve for obsolescence, $50,000; bonus from Com- mercial Club, $50,000; reserve for income and excess profits taxes, 1917, $80,000; operating profits, $750,000. You are requested to make such adjustments in the Reserve for Depre- ciation account and Surplus account as are appropriate, and to show how the several items and accounts should appear in the financial statement. (Wis., April, 1918.) 6. The books of the "X" Manufacturing Company were audited to De- cember 31, 1913, and in making up the Balance Sheet and Profit and Loss account at that date the auditors recommended the following adjustments: (a) Transferred to profit and loss, $4,231.07, which had been charged to real estate and buildings in error; (6) provided for depreciation of build- ings, etc., $7,200; (c) adjusted salaries amounting to $1,400, due for 1913 services but not entered on the books until January, 1914; (d) reduced tho amount of inventory because of errors, $12,000. The same auditors were again called in to audit the books to June 30, 1914, and found that the above adjustments had not been entered on the books. They also found that during the half-year $1,000 had been charged to real estate, buildings, etc., instead of to expense ; that no provision had been made for depreciation for the period, amounting to $3,600 ; and that the inventory had been footed $10,000 too much. Also that the unexpired insurance amounted to $750 more than was entered on the books. The following are condensed trial balances of the "X" Manufacturing Com- pany's books as the auditor found them as of December 31, 1913, and June 30, 1914: 234 C. P. A. Dec. 31, 1913 June 30, 1914 Real Estate, Buildings, Etc. Capital Stock $102,840.26 14,672.14 22,436.10 17,502.50 246,153.42 1,471.23 $200,000.00 100,000.00 9,431.17 10,000.00 85,644.48 $115,226.80 22,143.21 28,250.40 19,150.00 288,360.14 742.26 $200,000.00 100,000.00 11,698.21 5,000.00 85,644.48 71,530.12 Debentures Cash . . Accounts Payable . . ... . . . Accounts Receivable Loans Stocks and Bonds Inventory Unexpired Insurance Surplus Profit and Loss, 1914 $405,075.65 $405,075.65 $473,872.81 $473,872.81 From the above facts prepare: (1) A correct Balance Sheet, June 30, 1914; (2) state the adjusted arabunt of profits for the half-year to June 30, 1914; (3) prepare statement reconciling the Balance Sheet figures with the original trial balance of June 30, 1914. (Mass., Oct., 1914.) 7. On January 1, 1919, the close of its third year's business, the fol- lowing accounts were open upon the General Ledger of the Winner Manu- facturing Company : Preferred Capital Stock $376,000 Common Capital Stock 600,000 Cash on Deposit $50,000 Imprest Cash Fund 500 Real Estate 250,000 Buildings 300,000 Notes Receivable 8,000 Factory Equipment 450,000 Accounts Payable 53,000 Notes Payable 25,000 Reserve for Depreciation Buildings ... 6,000 Reserve for Depreciation, Factory Equipment 75,000 Accounts Receivable 75,000 Patents 1 Patterns 25,000 Auto Trucks 10,000 Bonds Issued 200,000 Premium on Bonds Issued 2,000 Inventory Raw Material 180,000 Inventory Finished Goods 40,000 Inventory Goods in Process 70,000 Reserve for Depreciation, Auto Trucks 4,000 Surplus, January 1, 1918 50,000 1918 Operating Profit and Loss 67,501 $1,458,501 $1,458,501 DIVIDENDS AND SUKPU'S 235 The preferred capital stock was $400,000 7 per cent cumulative, and the provisions of its issue require that 3 per cent of the authorized amount be set aside annually as a sinking fund for its redemption at $125. The common capital stock of the company is without par value; 20,000 shares have been authorized ; 12,000 shares issued. The Real Estate account is found to consist of the following items : Factory Real Estate $ 20,000 Fertile Farms Investment 120 000 City Eeal Estate Investment llo',000 The bonds of the company are 20-year, 7 per cent gold bonds, sold on September 30, 1918, for 101. Interest is payable October 1 and April 1. The bond recital provides for the creation of a pro rata sinking fund to be reserved out of the profits of each year and for the setting aside of cash equivalent to such reservation. The income taxes for the year are estimated at $5,000. You learn that the directors met on January 10, 1919, and declared a dividend of 7 per cent upon the preferred stock, authorized the purchase of shares of preferred stock in accordance with the terms of issue and declared a dividend of five dollars ($5) per share of common stock. The dividends were paid on January 15, 1919, and the preferred stock was purchased on that date. In view of the above conditions, you are asked to prepare a financial statement of the Winner Manufacturing Company as of January 1, 1919, after the books for the year have been closed finally. (Wis., Nov., 1919.) 8. At the close of its fiscal year, December 31, 1915, the trial balance of the Nau-Pace Company was as given on next page. You are to take into consideration the following facts : 1. Real Estate, Machinery and other Factory Equipment, and Patents are stated at cost. 2. Of the Real Estate, $25,000 is for land, and $200,000 is for buildings. 3. All capital stock authorized has been issued and is outstanding. 4. Allowances for depreciation are: machinery and factory equipment, $15,000; buildings, 3 per cent on cost; patents, 1/17 of cost. 5. $15,000 is to be set aside as a reserve for bad accounts. 6. Ten per cent of the book values of Stable Equipment and Office Equipment and one-sixth of the book value of Drawings and Patterns are to be charged off. 7. Inventories at the close of the year were: raw materials, $63,580.40; finished goods, $58,864.56; goods in process, $27,024.52; fuel, $4,823.43; factory supplies, $1,525; office supplies, $500; prepaid insurance, $500. 8. The accruals are: taxes, $7,000; Direct Labor, $12,618.75; Indirect Labor, $2,040.50; Interest on Bonds, $1,000; Advertising, $4,718.50. 236 C. P. A. ACCOUNTING TRIAL BALANCE, NAU-PACE COMPANY, DECEMBER 31, 1915 Real Estate $225,000.00 Fixed Machinery 150,000.00 Movable Equipment 18,000.00 Shaftings Pulleys, etc 10,500.00 Stable Equipment 3,500.00 Office Equipment 2,915.90 Drawings and Patterns 9,000.00 Patents 75.000.00 Capital Stock $500,000.00 First Mortgage Bonds 100000 00 Profit and Loss . Surplus 86,140 28 Dividends 300 00 Interest on Bonds 5,000.00 Other Interest Paid 1,323.10 Interest Received 2,469 50 Cash Discount on Purchases 13 389 52 Cash Discount on Sales 2,861.50 Sales 1,540816 75 Return Sales - 8,258.25 Cash 27,750.65 Bills Receivable 50,750.00 Accounts Receivable 298J650.25 Raw Materials 622,190.90 Finished Goods, January 1, 1915 62,735.06 Goods in Process, January 1, 1915 24,747.27 Fuel 38,688.28 Insurance 4,000.00 Taxes 5,000.00 Bills Payable 40,000.00 Accounts Payable 46,585.85 Reserve for Depreciation: Machinery and Equipment 50,000 00 Buildings . ... . 30,000 00 Patents 22,058 80 Bad Accounts 6,240.75 Salaries, Offices and Clerks (General) 56,150.00 General Office Supplies 2,950.75 Postage, Telegraph, and Phone 1,560.00 Miscellaneous General Expenses 850.00 Advertising 35,000.00 Salaries and Expenses, Salesmen 72,350.31 Agents' Commissions 30.141.40 Credit Department Salaries 7,560.00 Miscellaneous Expenses, Selling 610.00 Stable Expenses 3,963.46 Direct Labor, Manufacturing 508,311.39 Indirect Labor, Manufacturing 44,981 01 Superintendence, Factory 6,000.00 Factory Supplies 8,547 . 18 Repairs, Machinery and Equipment 7,418.52 Repairs of Buildings 2,860.47 Power, Heat, and Light 2,875.80 $2,438,001.45 $2,438,001 .45 DIVIDENDS AND SURPLUS 237 9. The depreciation on stable equipment (see item 6) is to be charged to Stable Expenses, and one-third of the latter is apportioned to Manufacturing Expenses, and two-thirds to Selling Expenses. 10. The cost of fuel used is to be charged to Power, lleat and Light. 11. Maintenance of Real Estate is to be charged with cost of repairs to buildings, depreciation on buildings, 20 per cent of taxes for the year, and $1,000 for insurance. The total cost for such main- tenance is to be shown as an item of manufacturing expense on the Statement of Cost of Sales. 12. The portion of insurance remaining after charging Maintenance of Real Estate is to be allocated to Manufacturing Expenses. 13. Thirty per cent of the taxes for the year is to be apportioned to Manufacturing Expenses, and 50 per cent is to be charged against Income. 14. Of the Salaries of Officers and Clerks, General, $3,600 should be apportioned to selling expenses. 15. Amongst the Bills Receivable is a note for $5,000, pertaining to a previous fiscal year, which is considered to be worthless. No provision was made for such loss. 16. Regardless of theory, cash discounts on purchases and sales are to be treated as pertaining to income. 17. On the 10th of December, 1915, a dividend of 10 per cent on the capital stock was declared and made payable on January 10, 1916, for which no entry was made prior to taking off the trial balance. Given the foregoing information, you are asked to prepare the following statements in approved form for the information of your clients: 1. Cost of Sales. 2. Profit and Loss, showing (a) the gross profit and the per cent of same on sales; (6) selling expenses and per cent of same on gross profits; (c) general expenses and the percentage that such ex- penses bear to gross profits; and (d) the net profits and the per cent of same on sales. 3. Balance Sheet, showing the surplus at the beginning of the fiscal year, and the amount at the close of the year. (Ohio, Nov., 1916.) CHAPTER XIII TRADING ACCOUNTS Old Merchandise Account The old merchandise account was an ac- count in which were gathered all the factors affecting the gross profit on sales. 1 The structure of the merchandise account was as follows :' Debits Credits 1. Initial inventory. 2. Purchases of the period. 3. Freight and cartage inward on pur- chases. 4. Freight and cartage outward on sales. 5. Returned sales. 6. Freight and cartage inward on re- turned sales. 7. Trade discounts on sales. 8. Gross profit on merchandise. 1. Sales. 2. Returned purchases. 3. Freight and cartage inward, paid at time of purchase, on purchases now returned. 4. Trade discounts on purchases. 5. Merchandise destroyed as unfit for sale. 6. Deterioration of merchandise. 7. Freight and cartage inward on pur- chase applicable to goods unsold. 8. Closing inventory. In objecting to the use of the old merchandise account great stress is frequently made about its being a mixed account. 3 As the inventory account, one of the accounts which replaces the merchandise account, is a mixed account as soon as a sale has been made, this objection does not seem vital. The real objection is that the old merchandise account makes it impossible, without a laborious analysis, to give the executives statistics which will show how business is progressing. 4 Modern accountants, there- fore, use a separate account for each of the factors listed above, although some of the closely-related factors are sometimes combined for convenience. 6 Purchase Records When the storeskeeper discovers a shortage of a cer- tain material, he sends a requisition for an order to be placed by the pur- chasing department, and files a carbon of the requisition." The purchasing agent sends the order to the jobber and a carbon of the order (details not usually shown on this copy) 7 to the receiving department and to the stores- keeper; he then files a copy, together with the original requisition, in his own files. 8 When the jobber ships the material, he submits an invoice which the purchasing agent files with the order. 8 On receipt of material the receiving clerk makes out a report of material received, two copies going with the material to the storesroom and the third copy being placed in the receiving clerk's files with the carbon of the original order. 10 After inspection, a copy of the report of material received, properly signed, is sent by the storekeeper to the purchasing agent, who compares it with 'For explanation of superior figures sec page 337. 238 TRADING ACCOUNTS 239 the order and invoice, and then files the order and report of material re- ceived and sends the invoice, properly endorsed, to the disbursing officer, who pays it with a voucher check." Of course, this procedure varies greatly in different concerns, but these records, or substitutes therefor, are the vouchers the auditor uses to verify the purchases. 12 The auditor should never attempt to verify all of the purchase vouchers but should only make copious checks. 13 Some auditors -check each invoice against the purchase journal for only three or four months out of the twelve months, always including the last month of the period," while others check them all. 15 In either case, purchases recorded during the first few weeks after the date of closing should be scrutinized to prevent the goods from being included in the inventory without having been recorded in the purchase journal." The form of the purchase book or register depends on whether the busi- ness is departmentalized, as separate columns should be assigned to each department. Again, purchases may be classified as to the kind of ma- terial, viz., woolens, and trimmings, in the clothing industry. However, the accounting procedure is the same whether there is only one purchase account or whether there are a dozen. The auditor must check the dis- tribution of the charges, 17 but the checking of the distribution of about every fifth voucher will suffice, 18 if vouchers for substantial sums are chosen. In a fairly large concern, the purchase journal footings of about every tenth or twelfth page in addition to the last page of each month should be verified, but, in a smaller concern, proving every fifth or sixth page, including always the last page of each month, will suffice. 19 The posting of the totals of all the columns in the purchase book must be verified, 20 but the checking of the credit postings can usually be omitted 31 (see audit of accounts payable in Chapter III, Volume II). Unrecorded Purchase Orders Some accountants believe that small un- recorded orders for merchandise, whether unshipped, in transit, 22 or de- livered at or just before inventory time, 23 may be ignored on financial statements, unless there is a wide difference between the contract and market price, although important orders must be recorded. Other ac- countants add all unrecorded purchase orders to the inventory and to the accounts payable." As the firm under audit is liable for the purchase price of the material, the second view seems preferable. Sales Records Systematic record should be kept of all sales orders, which should be checked with the invoices before the latter are sent out." The shipping clerk should keep an independent record of shipments. \Vhen practicable, the sales book should consist of the first carbon of the invoices, as this makes the sales book admissible in court as an exact copy of the invoices. 2 " The auditor should vouch the sales book with the original orders of sales and the original record of shipments." It will suffice, how- ever, if the sales for three or four months scattered over the year, but always including the last month, be vouched in detail. Where the business is departmentalized, an elaborate sales journal with columns for each department may be kept. 28 These columnar sales journals 240 C. P. A. ACCOUNTING should be audited as to the total sales column in the same manner as the simpler forms and the distribution of the sales should be only test-checked. The monthly or other aggregates of the sales postings should be checked, but the individual debit postings need not be verified 2 * (see audit of ac- counts receivable in Chapter III, Volume II). As to sales journal foot- ings, every eighth page in large concerns and every third or fourth page in small concerns should be verified, but in every case the last and some- times the next to last page of each month should be checked. 30 Cash Sales In regard to cash sales, the auditor should first examine the system of internal check; any weaknesses discovered should be mentioned in the report and should be thoroughly tested during the audit. Where the system of internal check is good, the auditor need test only the sum- maries of the cash sales as posted in the general books, but, where the system is not extensive, he must make thorough tests of the cash sales. 31 C. 0. D. Sales When merchandise is sold on a C. 0. D. basis, a credit is made to the sales account and a debit to the C. 0. D. account. 32 When collections are made, cash account is debited and C. 0. D. account credited. The balance of the C. 0. D. account represents undelivered sales, 33 and the auditor must verify this balance. 34 The C. 0. D. department charges each route for the new C. 0. D. sales and credits it with the cash returned and goods returned into stock as refused, and prepares for the driver a route sheet which shows the held-overs from the previous day, the new C. 0. D. sales, and the returns made. 35 Some accountants make only memorandum entries until collection has been made for C. 0. D. sales. 3 * Installment Sales Theoretically the profit and loss account should be credited with the profit on installment sales and debited with the estimated bad debts and estimated collection expenses, but the calculation of the necessary reserves is too difficult for practical purposes. 37 Assume that an installment house, whose gross profit percentage based on sales was 100 per cent, sold an article for $60, terms $10 down and $5 a month. If the books were closed for the end of the fiscal period after the first monthly payment, the entries, according to the procedure approved by the income tax authorities, would be: 38 Installment Sales Contracts (1920) $60. 00 Goods Sold $30. 00 Unrealized Gross Profit on Installment Sales Contracts (1920) 30. 00 (For sale) Cash. 15.00 Unrealized Gross Profit on Installment Sales Con- tracts (1920) 7. 50 Installment Sales Contracts (1920) 15. 00 Realized Gross Profit on Installment Sales Contracts 7 . 50 (For deposit and first monthly payment.) Realized Gross Profit on Installment Sales Con- tracts 7 . 50 Profit and Loss 7. 50 (For closing books) TRADING ACCOUNTS 241 Sales for Future Deliver}/ Under ordinary conditions sales for future delivery are not booked until delivery, 39 and profit thereon should not be taken. 40 If a valid contract exists, upon which a customer can be sued, the profit may be taken if the goods are ready for shipment, but the profit should not be taken if the goods are unmade. 41 Selling expense incurred on undelivered sales is a deferred charge to income. 43 Goods for current shipment delayed in delivery should be added to the accounts receivable and sales accounts, and profit thereon taken. 43 Sales to Branches Shipments to branches should be credited to a branch shipment account to differentiate them from the real sales. 44 The branch shipment account in the head office's books is offset by the "purchases from head office" account in the branch office's books, when the accounts of the main office and the branch are consolidated at the end of the period. 45 If the goods have been billed to the branch at a figure other than cost, an adjustment entry must be made at the end of the period to bring the branch inventory to a cost basis. 40 Consignment Sales As shipments to commission merchants are still owned by the consignors, they must be differentiated from the real sales. 41 The accounting for consignments is treated in Chapter XV, Volume II. Sales of Scrap or By-Products Sales of scrap material or by-products are credited to a special account instead of to the regular sales account. 48 The accounting for scrap material and by-products is treated in Chapter XVI, Volume I. Sales to Proprietor Theoretically, sales to the proprietor should be charged at cost to the proprietor's personal account and credited to the purchase account.* 9 If, for convenience, they are recorded in the sales journal, a correcting entry in the general journal, debiting the proprietor's personal account and crediting the accounts receivable, must be made for the aggregate of such transactions. 50 As these transactions are too small to vitiate percentages based on sales, the transferal of the credit from the sales account to the purchase account may be omitted." Sales on Approval As goods sent out on approval are not sold until they have been accepted, they must not be entered directly into the sales account. 52 The prevailing practice is to charge approval accounts receiv- able at selling price and credit approval sales, reversing the entry if the goods are returned. 53 If the sale is consummated, it is recorded as a regular cash or credit sale, 54 and the original entry to approval accounts receivable and approval sales is reversed. For balance sheet purposes, all goods out on approval should be shown in the inventory. 55 On account of the risk involved, a very liberal reserve for losses should be set off against this part of the inventory. Sales of Fixed Assets Sales of fixed assets should not b*j credited to the sales account. 56 The special features involved in such sales are treated in Chapter IV, Volume II. The Turnover Turnover is sometimes defined as the prime cost of sales. 57 This use of the term is unfortunate, as it is frequently confused 242 C. P. A. ACCOUNTING 1 with the rate of turnover, or the number of times the stock has been turned over in the period/'" The rate of turnover is the quotient of the cost of sales divided by the initial (if normal) inventory. 50 Merchandise Expenses The merchandise expenses which affect the cost of purchases are freight in; 10 cartage in;" 1 warehouse rent, wages, and supplies; 92 insurance during transit and storage; 63 duty; 94 seasoning or aging costs; 60 and buying expense. 86 Sometimes warehouse expenses are classified as selling expense, 1 ' 7 but it seems preferable to prorate them between the purchases and sales. 6 * Sometimes buying expense is shown on the profit and loss statement as a separate kind of operating expens^," but, where practicable, it seems preferable to have the buying expense affect the cost of purchases. These costs are recorded separately, and added to the invoice price of the stock-in-trade at the end of the period.' Freight outward and cartage outward are considered as deductions from sales by some accountants, 71 and as selling expenses by others/" If the firm ordinarily sells goods F. 0. B. destination, such freight and cartage outward should be deducted from sales, but, if this is not the custom, these outlays should be treated as selling expenses/ 3 The cost of delivering goods to local customers should be regarded as a selling expense/ 4 Ship- ping expenses, salesmen's salaries, traveling expenses, commissions, and advertising are selling expenses." The auditor, in examining the contracts with the salesmen to verify the payments made to them, should pay special attention to the bases on which commissions should be calculated and to any limits that may have been placed on traveling expenses/ 6 Advertising in current newspapers and magazines should be closed into profit and loss, 77 but special advertis- ing campaigns entailing heavy outlays, the results of which can not possibly become evident until some future date, may be treated as deferred assets and written off as soon as practicable/ 8 Although sometimes classified as selling expense, 7 * credit department expense appears to be a general administrative expense.* Returns on Sales and Purchases Returned sales and returned pur- chases are deductions from the sales and purchases accounts, respectively." For the recording of these transactions, separate journals called returned sales books and returned purchases books, respectively, should be used as posting media. 82 In auditing the returned sales book the auditor should prove the foot- ings, check entries against approved credit slips and stock records for returned merchandise, and check the postings to the controlling accounts. 83 The footings in the returned purchases book must be checked, 8 ' the entries vouched with the stock records, shipment records, and credit memos from the vendors," and the postings to the controlling accounts verified. Rebates and Alloicances Rebates are of much the same nature as allowances and have the same effect as special allowances. 89 The allowances on sales and on purchases should be separated from the returns on sales and on purchases, respectively. 97 It is sometimes claimed that rebates TRADING ACCOUNTS 243 and allowances on sales are deductions from sales when they are beyond Hie control of the sales department, and selling expenses when they are controlled. 88 Some accountants treat allowances to customers as a financial expense, 8 " while other accountants always regard them as deductions from sales."" The latter view appears preferable, as transactions occurring after the sales have been consummated can hardly create selling or financial expenses. For administrative purposes it is sometimes advisable to classify the allowances on sales according to the reason therefor, viz., defective goods, breakage, damage, loss, etc. 61 Rebates and allowances on purchases should be deducted from the cost of the purchases. 93 The procedure in auditing the sales allowances and purchases allowances should be to check them with the credit memoranda. 93 An auditor has little to fear in regard to purchases allowances. He must, however, take unusual care in auditing the sales allowances, as they are frequently used as a cover for fraud. 94 Guaranteed Sales Guarantees of goods are contingent liabilities, and an estimated amount based upon past experience should be charged to a suitable expense account and credited to an appropriate liability reserve therefor." 5 The treatment of contingent liabilities is discussed in Chapter III. Sales in Transit If goods are lost in transit and another shipment made, the railroad company would be debited and a "lost in transit" account credited. 90 When the damages are received, cash is debited, the railroad company credited, 97 and the "lost in transit" account closed into sales. If a financial statement is prepared prior to settlement of the damages, the goods lost in transit would appear at cost in the inventory, as, if located, they can be returned by the railroad company. Book and Physical Inventories Inventories may be defined as itemized lists of goods or valuables with prices attached. 98 If the lists are prepared after actual count of the goods, the inventories are called physical inven- tories." If separate accounts showing the various receipts and disburse- ments are kept for each kind of goods, a list of the balances of these accounts would constitute a perpetual or book inventory. 100 Even where book inventories are maintained, their accuracy should be verified by physical inventories taken from time to time. 101 This can be readily done by inventorying each kind of goods when its stock is low. 101 Where the large bulk of stocks like ore, pig iron, etc., makes a physical inventory impracticable, and, where it may be several years before the supply is materially reduced, it is customary that a small percentage on the consumption be allowed for waste or loss. 103 Verifying Inventories In checking merchandise inventories, an auditor should (a) have the stock sheets if possible, the originals 104 certified by persons responsible therefor; 105 (b) test the calculations including all large items; 106 (c) prove the footings; 107 (d) compare the book and physical in- ventories; 105 (e) see that invoices for inventoried goods are ^recorded; (f ) verify the handling of consignments and branch shipments; 110 (g) check 244 C. P. A. ACCOUNT IXC the additions of duties, freight, etc., to cost of purchases; 111 (h) compare prices with those of the latest purchases of similar goods; 112 (i) determine whether the quantities of goods on hand are reasonable and in accordance-, in particular instances, with the average consumption and average pur- chases over a fixed period; 113 (j) use the "gross profit check" and compare the percentage of gross profit with that of former years; 114 (k) compare quantities and prices of classes of stock with corresponding data in pre- vious inventories; 113 (1) see that proper allowances have been made for damaged and obsolete goods; 119 and (m) compare the inventory prices and the selling prices of some of the goods sold after the computation of the inventory, to determine whether there is sufficient margin between the two prices to indicate a profit ; otherwise it may be inferred that the inventory prices have been padded." 7 In complying with rules (g) and (h) above, care should be taken to have the merchandise inventories valued at cost or market, whichever is the lower. 118 If it is desired to show inventories at cost when the prices have declined, a market fluctuation reserve should be used. 11 " The use of market fluctuation reserves is discussed in Chapter X. The "gross profits check" mentioned in rule (j) above is applied by calculating the average gross profit in the past and then computing a theoretical final inventory by using the actual figures for the sales, pur- chases, and initial inventory, and an estimated figure for the cost of sales based upon the average gross profit percentage. If the gross profit per- centage is based on sales, the cost of sales is the product of the sales multiplied by unity minus the gross profit percentage, 120 but, if the gross profit percentage is based on the cost of sales, the cost of sales is the quotient of the sales divided by unity plus the gross profit percentage. 121 The average gross profit percentage is sometimes calculated as the simple arithmetic average of the annual averages. 122 but greater accuracy would be obtained by using a weighted arithmetic average. Trade Discount A trade discount is a deduction from list price made by wholesalers to retailers. 123 Usually trade discounts do not appear on the books, being deducted directly from invoices. 124 Where trade discount is shown on the books, it should be deducted from the sales 125 or pur- chases 128 as the case may be. Sometimes trade discounts have a time limit such as when seven per cent is allowed for payment within thirty days. The test of a trade discount is the rate, it being the usual rule that terms exceeding "2 per cent 10 days, net 30 days" are trade discounts." 7 The auditor is supposed to have a general knowledge of the prices of commodities and trade discounts, and in vouching the purchase journal should be able to detect any flagrant irregularities. 128 Cash Discount on Purchases An allowance from the billed price for payment within a specified time is a cash discount, if the rate of discount does not exceed what a business could afford to pay for the use of the money for the credit period. 128 Some accountants look upon cash discounts on purchases as a reduction in the price of the goods, and therefore deduct it from purchases; 130 while other accountants emphasize the element TRADING ACCOUNTS 245 of financing the business and treat the discount as a financial profit. 131 As the realization of the reduction in price depends on having sufficient capital, the latter treatment seems preferable. Where payments are made by checks, the auditor has little to fear about discounts on purchases. He should, however, scrutinize in a general way the payment of accounts payable on which no discounts are recorded. 132 Cash Discount on Sales Some accountants regard a cash discount on sales as an overstatement of a revenue, and therefore deduct it from the sales ; 133 .others regard it as an inducement offered to prospective customers, and treat it as a selling expense ; 134 while still others regard it as composed of the two factors, interest and bad debts expense, and accordingly treat it as a financial expense. 133 . The last treatment seems preferable. The auditor should secure from his client an authoritative list of cash discounts allowed and use it as the basis for a fairly exhaustive test of the discounts stated in the cash book. 136 As overstating discount allowances is a frequently used method of fraud, this test should be exhaustive for the period covered, but it need only extend over a few days or weeks, depend- ing on the volume of collections. 137 Neglected Discounts Some accountants, who consider that cash dis- counts should be deducted from the invoiced prices, consider it advisable to have the neglected discounts shown on the books. 138 This is accomplished by debiting purchases discount account for all the discounts which are offered and crediting it with those taken. 138 Another method of handling this matter is to debit a neglected discounts account, and to credit cash for the discount not taken, the purchase being originally charged to purchases and credited to accounts payable at the best available price. 140 Reserve for Cash Discounts Some accountants favor the use of reserves for cash discounts, 141 while others do not. 142 The use of the reserves seems preferable, for, if prospective sales discounts are ignored, the balance sheets do not reflect true condition of the business. Reserves for sales dis- counts should be deducted from the accounts receivable on the balance sheet, 143 although they are sometimes classified as current liabilities, 144 and are sometimes shown on the right side of the balance sheet under the caption "reserves." 14 The reserves for purchase discounts should be de- ducted from the accounts payable on the balance sheet. 14 " Unless the pros- pective discounts are of a considerable amount, however, they may be disregarded. 147 246 C. P. A. ACCOUNTING QUESTIONS TRADING ACCOUNTS GENERAL 1. How should the guarantee given that machinery sold will last five years be treated in the Balance Sheet? (A. I. of- A., June, 1917.) 2. In an accounting system embodying a storeroom, how should pay- ments on account, covering an investment charge, be treated, and how should the final bill be treated? (111., May, 1905.) 3. Define: Freight in and freight out. (Mich., June, 1908.) 4. Describe the proper method of handling discounts, freights and haulage on goods and machinery purchased. On goods sold. (Ind., Nov., 1917.) 5. A corporation that has been lax in its accounting methods carries a freight account into which it charges all payments of whatever nature it makes to railroad companies, even payments made on delivery of goods purchased f. o. b. location of said corporation. If called upon to reor- ganize their methods, what suggestions and alterations would you make in the matter? Give reasons. (111., May, 1906; Ind., June, 1916.) 6. In examining the affairs of a manufacturing concern you find among the assets finished goods inventory of $175,798 and ascertain that included in the above total is the sum $50,000 covering goods deposited as collateral to secure notes which are included in the Notes Payable account. How would you treat this in statement prepared for credit purposes? Explain why. (A. I. of A., May, 1919.) 7. A grain dealer charges his customers 15 cents apiece for sacks that cost him 10 cents. He agrees to receive back any sacks returned in good condition at 12 cents each, calculating that they would be worth iy z cents each. How should these transactions be treated on the dealer's books? (N. Y., June, 1906; N. Y., Jan., 1918.*) 8. A manufacturing company ships its products in packages costing 7% cents each. They are charged to customer at 10 cents each but subject to credit when returned in good order at same price as charged. At close of year, package account shows an apparent gain, being the difference between the cost of package and amount of contingent sales. What disposition should be made of the ledger gain at close of year? (Mich., Dec., 1906.) 9. Define: Turnover. (Mich., June, 1912*; N. Y., Jan., 1916*; Ohio, Nov., 1916; Iowa, Dec., 1918; A. I. of A., May, 1921.) TRADING ACCOUNTS 247 10. What is meant by percentage on turnover and how is it ascertained? (N. Y., June, 1917.) 11. How can the amount of turnover be shown in the Trading ac- count? (Mich., June, 1912.) 12. The ABC Manufacturing Company shipped a bill of goods amounting to $300 to a customer, rendering the usual invoice therefor. The goods were destroyed in transit by a railway wreck. The ABC Company subsequently made a second shipment to its customer to replace the lost goods, and collected $300 from the railway company in payment for the lost shipment. To what account should this last $300 be credited? (N. Y., June, 1915.) 13. Suppose, in examining a set of books for an importer of tea, you find that upon arrival all tea is placed in bonded warehouse for subse- quent withdrawal, the tea having been received by the importer on orders previously placed against six months' acceptances bearing interest, and that the importer has omitted the tea from his inventory and the ac- ceptances as his liability. How would you, as auditor, treat such matters in preparing a certified statement of the importer's financial affairs? (N. Y., Jan., 1919.) 14. A wool merchant has entered into an agreement to take 1,000,000 pounds of wool, in the grease, on joint account with the shipper, to have it washed, scoured, combed, etc., and sell the product, the profit or loss to be shared equally. The grease wool is sent to the scourer in lots as received from the shipper and returned from day to day in smaller quantities as grades A, B, C, D, and E; these lots (or some of them) and combinations of said lots are sent to combers and again returned in smaller quantities from day to day as grades Nos. 1, 2, 3, 4, and 5. The wool may be sold in any form that is in the grease as grades A, B, C, D, and E, or as grades Nos. 1, 2, 3, 4, and 5. It will be necessary for the merchant to report the results of the transactions in each lot separately. Submit a method for keeping a record of this stock and accounts from which proper statements can be made to the shipper showing the loss in the various processes, the quantities sold, to whom, prices, etc., and the net loss or gain. (Pa., Nov., 1908.) INVENTORY 15. Define: Inventory. (Wash., June, 1915.) 16. Give your definition of a correctly extended inventory. (111., May, 1908.) 17. A concern inventories its property and makes statement of assets and liabilities on the first of the year. The business continues and up to October 1, $10,000 additional capital is paid in. Plant amount during the same period increased $5,000. From trial balance of October 1, how 248 C. P. A. ACCOUNTING would you determine the amount of merchandise and supplies necessarily on hand to show neither gain nor loss for the period between January 1 and October 1? (Mich., Dec., 1906.) 18. What responsibility attaches to an auditor as to the inventory? (N. Y., Dec., 1896*; N. Y., Jan., 1904*; Pa., Nov., 1904; Fla., April, 1907*; Fla., April, 1908*; 111., May, 1909*; Fla., July, 1909*; Mich., June, 1910*; Va., Nov., 1910*; Wash., May, 1911*; Mich, June, 1913*; 111., May, 1914*; 111., May, 1915; Ind., June, 1916*; Ohio, Nov., 1916; Mass., Oct., 1917*; Ohio, Nov., 1918*; N. D., July, 1919*; S. C., Sept., 1919; A. I. of A., May, 1919.*) 19. An auditor is required to certify to the correctness and value of an inventory with which he is unfamiliar. Should he decline to do so? Give reasons. (N. Y., Jan., 1914; Ohio, Nov., 1915.) 20. Would you examine the inventory of a firm, in view of the fact that the auditor is not responsible for the inventory? If so, why? If not, why not? (N. Y., June, 1915.) 21. In making the audit of a concern doing a mercantile business, what would you require to enable you to certify to the correctness of the in- ventory of merchandise that they had prepared? (N. D., July, 1916.) 22. How would you verify the inventory? (N. Y., Jan., 1902*; 111., Nov., 1903*; N. Y., June, 1912*; Mass., Oct., 1914*; Mo., Dec., 1914*; 111., May, 1915* ; Mass., Oct., 1915* ; Ohio, Nov., 1915* ; Kan., Dec., 1915* ; Mo., Dec., 1915*; N. Y., Jan., 1916*; Cal., May, 1916*; Ohio, Nov., 1916*; W. Va., May, 1917; Ind., May, 1917* ; A. I. of A., June, 1917* ; Cal., June, 1917*; Pa., Nov., 1917*; N. D., July, 1918*; Ga., May, 1919*; Mich., June, 1919.*) 23. To what extent would you consider it necessary to verify the mer- chandise, and what reference to such verification would you make in your report? (Mass., June, 1913.) 24. How would you prove in quantities the inventory of materials at beginning of year, if you had superintended an actual inventory at end of year? (A. L of A., May, 1919.) 25. State briefly the essential points to be considered in ascertaining the correct profits so far as the inventories are concerned? (N. D., July, 1919.) 26. Under what circumstances should an auditor require the officials of a company which manufactures and sells to retailers, to furnish him with a certificate as to inventory prices and any other items that may be con- sidered necessary? Draft such a certificate or certificates and indicate the circumstances under which the different paragraphs or clauses should be included in the certificate. Who should sign the certificate? Is the auditor released from all liability for the accuracy of the items covered by the certificate? Why? (111., May, 1915.) 27. State fully how you would test the accuracy of inventory values. (N. Y., Dec., 1898*; Pa., May, 1902*; N. Y., Feb., 1910*; N. Y., June, 1911*; Mich., June, 1915*; N. D., July, 1918*; N. C., Nov., 1919.) TRADING ACCOUNTS 240 28. At what value should inventories be shown on the Balance Sheet? (111., May, 1904*; Mich., June, 1908*; Va., Oct., 1911; Wash., June, 1912*; La., May, 1913*; Wash., Nov., 1913*; Mich., June, 1914*; N. Y., Dec., 1916*; 111., May, 1917*; N. C., Aug., 1917*; Ohio, Nov., 1917*; A. I. of A., Nov., 1918*; Iowa, Dec., 1918; A. I. of A., May, 1919*; Ga., May, 1919*; N. Y., June, 1919*; Ohio, Oct., 1919*; N. C., Nov., 1919.*) 29. (a) What is the reason for the general rule as to valuation of merchandise for inventory purposes? (&) Is it based on any accounting principle? Explain. (Ohio, Oct., 1919.) 30. For inventory purposes what principles should govern the valua- tion of second-hand goods taken in trade? In your opinion how should transactions in second-hand goods be reflected in the Profit and Loss ac- counts? (111., Dec., 1918.) 31. Can you suggest circumstances in which you would approve a de- parture from the general rule for valuation of merchandise? Would you be influenced by events of conditions subsequent to the date of closing the accounts? Give reasons. (111., Nov., 1908*; 111., May, 1913*; A. I. of A., Nov., 1918; Ohio, Oct., 1919.*) 32. Discuss fully the proper principles to be observed in the valuation on a certified Balance Sheet of inventories of (a) goods of last season's styles, (&) goods in cases awaiting shipment. (Pa., Nov., 1919.) 33. The theory has recently been advanced that inventory should be taken up at cost on the Balance Sheet, even if the market price is lower, on the ground that you are no more justified in anticipating losses than in anticipating profits. Wherein is the theory faulty? (Cal., May, 1916.) 34. A wholesale and retail company, which also manufactures most of the goods sold by it, determines through its cost system in the factory the cost of manufacture, and proposes to bill its wholesale department for all goods manufactured at cost plus 10 per cent. What effect will such pro- cedure have on statements issued by this company? (A. I. of A., Nov., 1919.) 35. A manufacturing corporation has been accustomed to estimate its inventory value at the end of each year, and did so December 31, 1915, and December 31, 1916. What method would you suggest for refiguring the profits of 1916? (Mass., Oct., 1917.) 36. In valuing inventories, what does the term cost mean? What does the term market mean? (Wis., May, 1919.) 37. In an inventory, how should stock purchased on credit subject to usual discounts be valued? (N. Y., June, 1897; Pa., Nov., 1911*; Mass., Oct., 1915.*) 38. You are auditing the accounts of a corporation which carries on its books and Balance Sheet an account called "Adjustment of Inventory," which represents the difference between the actual inventory of raw ma- terial on hand and the book inventory carried as part of its cost records. What would vou recommend doing in regard to this account? (Ohio, Nov., 1917.) 250 C. P. A. ACCOUNTING 39. If the market price of items shown on the inventory is less than inventory value, how would you adjust the difference? If inventory values were less than market? (Va., Oct., 1912.) 40. Explain fully in what way, if at all, overvaluation of opening inventory should enter into Trading and Profit and Loss statement, with reason for inclusion or exclusion. (N. Y., Jan., 1911; Mass., June, 1913; Kan., May, 1916; N. C., Nov., 1919.*) 41. In anatyzing the inventory of a corporation you find that the fol- lowing have been included therein: (a) raw material, (6) in process merchandise, (c) finished merchandise, (d) factory supplies, (e) advertis- ing, (/) office supplies, (g) insurance prepaid, (h) construction materials, (i) repair parts for equipment. In preparing your Balance Sheet, would you include all of these items as Merchandise Inventory? If not, how would you classify the various items? Give reasons. (Ohio, Nov., 1917.) 42. Give some reasons why the professional auditor should, under pres- ent-day conditions, give even more attention than in the past to inventories. (A. I. of A., May, 1920.) 43. Assuming an automobile manufacturing company made a contract for rubber tires at $35 each with the understanding that it was to receive a rebate of $5 a tire if the purchases exceeded 40,000 tires, and that at the end of the season when the accounts were made up, say on July 31, it was found that 45,000 tires had been purchased and a claim for the rebates Avas thereupon made and a check in settlement was received on August 31 following. On July 31, there were 15,000 tires on hand. At what price should they be valued for inventory purposes, and how should the rebate be dealt with in the accounts for the year ending July 31? (111., May, 1913.) 44. Smith, Jones, and Smith, as a firm, have transacted business for a number of years, dealing in Irish linens. Jones decides to retire from the firm on January 1, 1919. The linens still on hand have been purchased from time to time, during which period the market fluctuations were fre- quent and extensive in range, the prevailing prices on December 31, 1918, being considerably higher than any previously paid. What prices should be used in preparing the inventory of December 31, 1918, in determining Jones's interest in the business? (N. Y., Jan., 1919.) 45. How would you treat through the books, the amount of the un- sustained loss representing the difference between the cost and the market price of inventories, in case the market price is less than cost, and your method of taking inventories as reported to the Commissioner of Internal Revenue was "cost or market whichever is lower" as provided in T. D. 2609? (N. C., June, 1920.) 46. What effect has an overestimated inventory on the business of a mercantile firm? AYhat effect has an underestimated inventory on the business of a mercantile firm? (Md., Jan., 1900; Cal., June, 1917.*) 47. Define: Perpetual inventory. (Wash., May, 1911*; Pa., Nov., 1912*; Cal., Nov., 1916; Wash., July, 1917.) TRADING ACCOUNTS 251 8. Describe a perpetual inventory, how used, its advantages and dis- advantages, if any. (Wash., April, 1906*; Pa., May, 1906; Pa Nov 1906*; Fla., July, 1909*; Va., Oct., 1912; Mass., Oct., 1914*; Mass., Oct'' 1916; N. C., Nov., 1918.) 49. Explain the method of maintaining a perpetual inventory. (Pa. May, 1902*; Wash., Sept., 1907*; Fla., July, 1909*; Pa., Nov., 1912*; Mich., June, 1913*; Mich., June, 1915; Mass., Oct., 1916.*) 50. How may a perpetual inventory be verified? What would you require in relation to such an inventory before accepting it in a Balance Sheet under your audit without qualifying your certificates. (Pa., Nov 1912.) 51. Describe the method of determining points of actual stock-taking under a system providing for a perpetual inventory. (Wash., May, 1911.) 52. To what extent or under what circumstances could you certify to book inventories in the absence of physical inventories? (Cal., Nov., 1916*; Cal., June, 1917.) 53. In the case where it is impossible to take physical inventories but once each year, how would you ascertain the monthly profits? (N. C., June, 1919; N. C., Sept., 1919; A. I. of A., Nov., 1920.*) 54. What safeguards in accounting would you suggest to a client to prevent loss of stock by theft? (Mass., June, 1910.) 55. Define: Book inventory. (A. I. of A., May, 1918* ; 111., Dec., 1918.) 56. Indicate in what circumstances and for what purposes you would consider a "book inventory" to be used in a manufacturing business: (a) for current information; (6) for use in the preparation of interim state- ments of accounts; (c) for use in the preparation of final yearly or half-yearly accounts. Assuming your client decided to rely entirely upon such records, what steps should be taken to guard their accuracy? (A. I. of A., May, 1918.) 57. A. B., a manufacturer, states that he has had a loss in his factory during his last fiscal period which he can not understand, and calls you in to ascertain where the loss has occurred. State the nature of the business used for illustration and describe fully what methods you would employ to discover where the loss occurred, and how you would prove the correct- ness of your deductions. (Mass., June, 1912.) 58. For several successive terms, a corporation has regularly deducted $15,000 from its inventory of stock in process, the inventory prices being conservatively below market value. Then, for the quarter ended June 30, 1908, while following the same conservatism regarding prices, the $15,000 deduction was discontinued, and the treasurer made his statement of earnings during the term, based upon the inventory amount of stock in process. State (a) whether you agree therewith; (6) the reasons for your agreement or disagreement, and (c) if you disagree with the treasurer's statement of the matter, how you would deal with the item on your statement of earnings and of surplus? (Mass., April, 1911.) 252 C. P. A. ACCOUNTING BOOKS 59. Prepare a ruling for a Sales Book to provide: (1) Total monthly postings to three good accounts; (2) the separation of cash sales from charge sales, (3) supplementary distribution of sales among four sales- men's columns. (N. Y., Jan., 1897; N. Y., Jan., 1907.) 60. Prepare a ruling for an invoice book to provide for total monthly charges to three Material accounts and two Expense accounts, and also to detail postings to sundry accounts of capital and revenue. (N. Y., Jan., 1897; N. Y., Jan., 19070 61. Submit rulings for correlated Cash Book, Purchase Book and Sales Book, to classify purchases and sales in three divisions and to provide for miscellaneous purchases. Provision must be made to record cash sales in Sales Book and in Cash Book and for customers' and creditors' controlling accounts. Submit pro forma monthly summary entries for the foregoing books. (N. Y., Jan., 1911.) 62. The proprietor of a mercantile store asked you to prepare a set of blanks to be used by him for checking all of his delivery wagons, in- cluding the returned goods which the drivers collected. He wants to be able to trace every package. Outline such a set. (Mich., June, 1914.) 63. About a year ago the Ford Motor Company agreed to make a refund to each purchaser during the succeeding year, if a stated number of machines were sold during the year. If you had been asked to deter- mine a method by which the necessary records should be kept in order that the least inconvenience should be experienced at the close of the year when this refund was made, it being apparent that the requirement would be met, what orders would you have given? Write a report embody- ing same. (Mich., June, 1915.) 64. What do you consider a complete checking of the Purchase Journal 1 (R. I., Dec., 1907.) 65. According to the regulations of the United States Food Administra- tion, wholesale and retail dealers must base the selling price of certain commodities upon the cost price rather than upon the replacement or the market value. Outline a stock system for a wholesale grocer to use for this purpose and record hypothetical data upon such forms as you may design, showing in detail the application of your recommendations. (Wis., April, 1918.) MERCHANDISE ACCOUNT 66. Define: Merchandise account. (N. Y., Jan., 1897*; N. Y., June, 1899*; N. Y.. June, 1901*; Pa., May, 1903*; Mich., July, 1906; N. Y., June, 1909*; Fla., July, 1909; La., May, 1913*; W. Va., May, 1917.*) 67. State how, in your opinion, the Merchandise account should be kept. (N. Y., Dec., 1898; Mich., July, 1906.*) 68. Is the common old-fashioned method of adding the inventory of merchandise on hand to the credit side of the Merchandise account before TRADING ACCOUNTS 253 closing: the books theoretically correct? Explain fully. (N. Y., Jan., 1901; Mich., June, 1908.) 69. What is the theoretic aspect of the Merchandise account when kept in modern books? Consider the proposition in connection with the modern books of original entry. (N. Y., Jan., 1914.) 70. State what is indicated by the Merchandising account (a) when the account shows a debit balance; (b) when the account shows a credit balance? Explain fully. (N. Y., Jan., 1900.) 71. State your objections, if any, to the Merchandise account fre- quently appearing on ledgers. (N. Y., June, 1904*; N. Y., June, 1909*; Mass., June, 1910*; Ohio, Nov., 1913*; Mo., Dec., 1914.) 72. Explain the proper method of handling Merchandise account, and outline the various subdivisions. (N. Y., Jan., 1897*; N. Y., June, 1904*; N. Y., June, 1909*; Fl.a., July, 1909*; Mass., June, 1910*; Mo., Dec., 1914*; Mich., June, 1915; N. D., Aug., 1917.*) PURCHASES 73. State how you would verify purchases. (Va., Nov., 1910; Kan., Dec., 1915; Mo., Dec., 1915.) 74. What elements enter into the cost of goods purchased for sale? (Ohio, Oct., 1919.) 75. If you should contract for an audit which provides for an examina- tion of all vouchers, what would you accept as proper vouchers for pur- chases? (Ohio, March, 1910*; Wis., May, 1916*; Va., Nov., 1918; Ohio, Oct., 1919.*) 76. State how you would deal with missing invoices for goods purchased in auditing .the Cash Book of a large corporation? (N. D., July, 1918.) 77. Trace the various operations in an office where you have full charge as an accountant from the time an order is given for the purchase of material until such material is paid for, to protect the company from any possible loss in the transaction. (N. Y., Jan., 1900*; Mich., Nov., 1907; Mass., June, 1910.) 78. Describe a means for the protection of a manufacturing company in the purchase of necessary materials and supplies and in the payment for such materials and supplies. (N. Y., Jan., 1900.) 79. When auditing the books of a firm you find that no invoice transac- tions are recorded on the firm's books until they have matured. Give your opinion upon this method and show how the Balance Sheet of the firm would be affected. (Wash., June, 1915; Va., Nov., 1918.*) 80. What check has the auditor on fictitious entries showing pur- chases? (N. Y., June, 1900; Wash., May, 1903.) 81. In the course of an audit of a stove manufacturer's books as of March 31, 1912, you notice that three invoices, respectively for pig iron, sand, and fire brick, dated March 22, 27, and 28, were entered on the 254 C. P. A. ACCOUNTING books in April. What does this signify and how may it affect your report? (111., May, 1913.) 82. When you audit the accounts of the ABC Dry Goods Company, you find that the books do not show any asset or liability in respect of spring goods in transit. What would you report on this situation, and why? (111., May, 1916; 111., Dec., 1916*; Cal., June, 1917.) 83. In connection with the audit of the books of a corporation, describe briefly the procedure you would consider to be essential in verifying the goods in transit. (Wash., July, 1917.) 84. In the trial balance of a corporation, December 31, 1910, the end of the fiscal term, there is a debit of $50,000 against John Doe for a pay- ment to him on account of material purchased from him. The material is to be delivered after said date. How should this be classified in the Balance Sheet, December 31, 1910? (Mass., June, 1912.) 85. Should you be informed that liabilities representing merchandise received but not inventoried were omitted, would the explanation be satis- factory? (Ohio, Nov., 1915.) 86. What routine would you recommend in the checking of invoices of goods or materials purchased? (N. Y., June, 1901.) 87. How would you classify the following items in preparing a state- ment of condition, to be filed with the Secretary of the Commonwealth : (a) Duty paid on foreign merchandise received, invoice for same being unpaid; (6) an ascertained loss on a contract for the purchase of mer- chandise to be delivered in the following month? (Mass., April, 1911.) RETURNS AND ALLOWANCES 88. Define : Returns and allowances. (111., May, 1908.) 89. Describe a safe and easy system of keeping the account of goods returned, (a) as buyer, (6) as seller. (N. Y., June, 1899; Pa., May, 1900.*) 90. State how you would verify the returned sales. (N. Y., Dec., 1898*; N. Y., June, 1900*; N. Y., Jan., 1901*; N. Y., Feb., 1909*; Mass., June, 1910*; Va., Nov., 1910; Kan., Dec., 1915*; Mo., Dec., 1915.*) 91. Classify the Returned Sales account properly according to the sub- division of assets, liabilities, proprietary interest, income and expenses, under which it should be grouped. (Wis., May, 1919.) 92. Under instructions calling for a complete audit and verification of all entries, what supporting data would you require for returned sales? (Ohio, March, 1910; Va., Nov., 1918*; Ohio, Oct., 1919.*) 93. State what means should be adopted to verify allowances on sales. (N. Y., Jan., 1901*; N. Y., Feb., 1909*; Mass., June, 1910.) 94. Under instructions calling for a complete audit and verification of all entries, what supporting data would you require for returned pur- chases? (Ohio, March, 1910; Va., Nov., 1918.*) TRADING ACCOUNTS 255 SELLING EXPENSES 95. Define: Selling expenses. (Wash., June, 1917.) 96. Where would you place the Entertaining- Customers' account in the Income and Profit and Loss account? (Md., Dec., 1917.) 97. Classify Expenses Advanced Salesmen according to the subdivision of assets, liabilities, proprietary interest, income and expenses, under which it should be grouped. (Wis., May, 1919.) 98. In making a detailed audit, what procedure would you follow to verify the advances to salesmen? (Kan., Dec., 1915; Mo., Dec., 1915.) 99. Would you consider it proper under any circumstances for a com- pany to treat all or any of its advertising expenses incurred during the year as an asset for the purpose of its annual accounts to be submitted to the stockholders? In your answer state fully the grounds for your views and explain how you would recommend such expenses should be dealt with. (N. Y., June, 1908*; 111., May, 1914; Ind., June, 1916.) 100. In closing the books of a company at the end of its first fiscal year, how would you treat advertising booklets on hand, estimated to last another year? (Mass., Oct., 1917.) 101. State what is indicated by the Commission account (a) when the account shows a debit balance, (b) when the account shows a credit bal- ance. Explain fully. (N. Y., Jan., 1900.) 102. What in your opinion is the proper treatment of the unpaid com- missions to salesmen in arriving at the profit or loss of a business for a specific fiscal period? (Ohio, Dec., 1908.) 103. Would you consider it proper to include as an asset the advertis- ing expenses? (N. Y., Jan., 1897.) DISCOUNTS 104. Explain the various kinds of discounts found in the business world and the methods by which they should be distinguished in the books of account. (Fla., July, 1909*; Mich., June, 1913.) 105. Define: Trade discount. (111., May, 1908; Va., Nov., 1910; Iowa, Dec., 1918.) 106. Classify: Trade discount. (Iowa, Dec., 1918.) 107. State how trade discount is used on a Profit and Loss statement or Balance Sheet, also its classification. (Iowa, Dec., 1918.) 108. Define: Cash discount. (111., May, 1908; Va., Nov., 1910; Iowa, Dec., 1918.) 109. State two methods of considering merchandise discount. Give reasons for your preference. (N. D., June, 1914.) 110. State how cash discount is used in a Profit and Loss statement or Balance Sheet, also its classification. (Iowa, Dec., 1918.) 256 C. P. A. ACCOUNTING 111. (a) State three methods of treating commercial cash discounts. (&) Sketch sufficient rulings of Purchase and Casli Book to show the use of each method, respectively. (Wis., May, 1916.) 112. Give your opinion regarding the following, and reasons : Should ordinary discount of 2 1 /2 per cent a month be considered as a trade or a time discount? (Mich., June, 1908.) 113. In a given trade goods are purchased on terms of 5 per cent dis- count for cash in ten days or net thirty days. In certifying a Balance Sheet in this trade how would you deal with the question of this discount in stating the value of the inventory of merchandise on hand ? Give reason for the treatment you would advocate. (Pa., Nov., 1911.) 114. Describe the system of running a discount column in the Cash Book and show how the entries are made both in the General Ledger and in the Subsidiary Ledger. (N. Y., Oct., 1907.) 115. To what extent should an auditor hold himself responsible for the correctness of discounts? (N. Y., Dec., 1896; Va., Nov., 1910; Mich., June, 1912.) 116. In passing upon discounts, how would you state them in reports? (111., May, 1905.) 117. State what means should be adopted to verify: (a) Discounts Al- lowed, (6) Discounts Received. (N. Y., Jan., 1901*; Mass., June, 1910; Mich., June, 1912.*) 118. How should cash discounts on purchases be treated? (N. Y., June, 1902*; Ohio, Nov., 1918.) 119. Assuming that all cash discounts on purchases made during the year have been taken advantage of, and the Ledger account shows a substantial credit, to what account would you close the balance? In the case of a jobbing concern? Of a manufacturer? (111., Dec., 1907; Mich., June, 1912*; Ind., Nov., 1918.) 120. Classify Cash Discounts on Merchandise Sales and on Mer- chandise Purchases according to the subdivision of assets, liabilities, pro- prietary interest, income and expenses under which they should be grouped. (N. Y., Jan., 1897*; N. Y., June, 1908*; N. Y., Jan., 1919*; Wis., May, 1919; N. Y., Jan., 1920.*) 121. In auditing department store "A," you find that cash discounts on purchases are regularly deducted from invoices when they are entered in the books, while in store "B," the invoices are entered in full and the dis- counts are credited to a discount account as and when received. Discuss the relative advantages and disadvantages of the two methods, and state what variations, if any, would occur in the valuing of inventories under the two methods. (A. I. of A., May, 1920.) 122. In preparing the Balance Sheet of a business at the close of a year, how should you treat Discount on Accounts Payable? (Mich., June, 1908*; Mass., June, 1910.) TRADING ACCOUNTS 257 123. What is the proper treatment of Cash Discounts on Sales? (Ohio, March, 1910*; Ohio, Nov., 1918.*) 124. Should provision be made out of revenue to provide for Discount on Accounts Receivable outstanding after the date of closing? Give reasons for your answer. (N. Y., Jan., 1904.) 125. In preparing the Balance Sheet of a business at the close of a year, how should you treat Discount on Accounts Receivable? (Mass., June, 1910.) 126. A manufacturing company buys its material on 30 daj's' credit, or 5 per cent cash discount if paid in 10 days. In order to take advantage of the cash discount, the company borrows money from the bank at 3 per cent. How should this discount and interest be treated on the books of the company? (N. Y., Jan., 1918.) 127. A corporation sells all of its manufactured product at 5 per cent 10 days, 3 per cent 30 days, or net 60 days. In making the annual audit you find that ninety per cent of the concern's customers take one of the two discounts. What provision would you think desirable to make to pro- vide for the discounts that will be taken in the period next to the one under audit? Give arguments for or against such provision. (N. D., July, 1918.) SALES 128. Under instructions calling for a complete audit and verification of all entries, what supporting data would you require for Sales? (Ohio, March, 1910; Va., Nov., 1918*; Ohio, Oct., 1919.*) 129. State how you would verify the Sales. (N. Y., Jan., 1901; Mass., June, 1910; Va., Nov., 1910.) 130. How would you discover and subsequently prevent defalcations when a shipping clerk and driver steal merchandise ostensibly sent to customers? (Cal., May, 1916.) 131. How would you discover and subsequently prevent defalcations when the manager and cashier of a manufacturing plant in collusion de- stroy original orders, fail to enter bills against customers in regular books, and keep returns on same when made? (Cal., June, 1917.) 132. A firm of export merchants desires a thorough investigation of the past year's transactions, having reason to suspect fraud. State con- cisely upon what lines you would proceed to satisfy yourself that: (a) Goods had been taken out of the store on bond in the way shown by the books; (b) they had been shipped to account of proper consignee; (c) that no goods had been removed without being charged; (d) that no ficti- tious entries had been made in the books. (Wash., Aug., 1908.) 133. Sales aggregating $25,000 were entered on the books as at Decem- ber 31, 1915, but the goods were not all delivered until January 25, 1916. Indicate what adjustments you would make of the books or of the ac- counts for the purpose of statement on the Balance Sheet. Give Journal entries. (111., May/ 1916.) 258 C. P. A. ACCOUNTING 134. If in auditing the accounts of a manufacturing corporation you found that certain orders booked for products to be manufactured subse- quent to the closing pei-iod, had nevertheless been entered upon the books as actual sales, how would you treat such entries in the sales record? (N. Y., June, 1919.) 135. Upon the audit of the partnership accounts of a manufacturing business the following condition is revealed. Sales toward the end of the period are unusually large. What would you deduce from this fact and what would you feel called upon to do? (Kan., May, 1916.) 136. What means should be employed to detect the willful omission to enter in the books under audit sales made? (X. Y., Dec., 1896.) 137. A bookkeeper of a manufacturing concern fails to make all the proper charges of time sales. No order book was kept. He retains $1,200 to $1,500 yearly for five years of payments received on account of time sales by cashing the checks received in due course out of the cash drawer, and deposits of said checks regularly in the firm's bank account, properly endorsed by the firm. How would you detect this? (Md., Jan., 1909.) 138. How would you require manufactured goods, shipped to customers for sale to them, as and when used by them, to be stated in a Balance Sheet you are asked to certify? How would you ascertain that all goods so shipped come under your notice? (111., Dec., 1916.) 139. "A" operates a five and ten cent cash store and for the purpose of selling out the strength of large profits shown in the books, makes false entries increasing the sales and corresponding entries on the disburse- ment side of the Cash Book purporting to represent withdrawals. The records by which the sales might be verified are destroyed. "A" makes a proposition to "B" to sell the business and gives statements drawn from the books showing the profits of the business. "B" engages a certified public accountant to make an examination, who discovers the fraud. How and by what procedure could he discover the fraud? (Mass., Oct., 1916.) 140. A house sends out many goods on approval and treats the transac- tions as sales. How should such items be treated by the auditor when set- ting up statements for the period? (N. Y., Jan., 1904.) 141. Illustrate how to handle goods sent out for sale or return. (Mich., June, 1919.) 142. A firm is in the habit of supplying goods on the principle of sale or return, taking payments by installments covering principal and interest, the purchaser having the option to return the goods at any time, forfeiting the installments paid. How would you recommend that such conditional sales should be entered in the books of the selling firm, and how should the outstanding amounts be from time to time valued? (111., Dec., 1910.) 143. A manufacturer disposes of a special machine, partly by direct sales to customers and partly by lease with the provision that it may later TRADING ACCOUNTS 259 be purchased. If a customer takes advantage of this provision, the pay- ment made on the machine from the date of the lease may be applied as a reduction of the purchase price. Prepare Journal entries supplying figures showing the necessary ac- counts for recording the sale and lease transactions of this business. (Mass., Oct., 1916.) 144. Suggest a plan whereby a department store might adequately counts for recording the sale and lease transactions of this business, submit forms. (N. Y., Jan., 1914.) 145. Explain fully transaction involving the sale of a piano on what is termed an installment lease. Explain how you would handle this on the books and records from time the transaction is entered into until completed. (Pa., Nov., 1918.) 146. In the audit of the books of an installment merchandise dealer, in what particular would you examine the books that would not be neces- sary in other classes of business? (N. C., June, 1919; N. C., Nov., 1919.) 147. On certain lines of business (e.g., real estate companies, sewing machine agencies, retail furniture houses) a large proportion of the sales is made on the installment plan, and at the close of any period a large number of such transactions may be uncompleted. How should the profits from such uncompleted sales be treated in the Balance Sheet? (Fla., July, 1909.) 148. A concern located in a village and employing 400 people, fur- nishes them with coal, wood and ice at cost, collecting for same in weekly installments. Describe the best method of keeping the accounts. (Mass., June, 1913.) 149. You have been called upon to audit the books of a furniture com- pany which sells on the installment plan. The books have been closed when you reach the office, and you are handed a completed Profit and Loss account and Balance Sheet. The company has been in business one year only. On investigation you find that all installment sales are credited to an account designated "Installment Sales." A controlling account and sub- ledger are kept for the installment customers. You find that the total of the installment sales has been credited to "Installment Sales" account, which has been closed into Profit and Loss. All accounts, installment and otherwise, that were known to be uncol- lectible have been charged off. There are no reserves against balances due from customers on the books. What criticisms or corrections have you to suggest as to the correctness or otherwise of the Balance Sheet and Profit and Loss statement handed to you? (A. I. of A., May, 1920.) 150. (a) Of the total sales of the X Company, a considerable por- tion is made on approval for 5, 10, or 30 days, according to the com- modity. If unsatisfactory, the articles may be returned within the 260 C. P. A. ACCOUNTING specified time. State how such sales should be treated in the following: (1) books of original entry, (2) ledgers. (3) revenue acrount, (4) Balance Sheet, (b) Returnable packages are charged to customers at a price in excess of cost. State how such items should be treated at time of sale and of return, in the following: (1) books of original entry, (2) cus- tomers' accounts, (3) revenue account, (4) Balance Sheet. (Wis., May, 1910.) 151. A retail bookstore agrees to deliver certain sets of books at $20, on payment of $2 down, the purchaser agreeing to make $3 payments for each of the six months next following. It is expected that sales on this plan will aggregate several hundred sets. Suggest a method of keeping the accounts, so that results may be readily shown. (N. Y., June, 1902.) 152. A furniture installment dealer made a sale on installments, amounting to $200, which was double the cost. During the year install- ments were collected amounting to $50. During the second year no in- stallments were collected, but goods were repossessed which were un- damaged. Journalize the transactions. (N. C., June, 1919.) 153. The Western Farm Machinery Company sells its product to farm- ers on three years' credit, payable in three equal annual installments. The cost of production for one year is $10,987,600; sales, $13,210,900; selling and administration expenses, $223,300, including all contingencies. Find an equitable method of stating profits for the year. (N. Y., Jan., 1914; N. Y. ; June, 1937.*) TRADING ACCOUNTS 201 PROBLEMS TRADING ACCOUNTS 1. JONES MANUFACTURING COMPANY TRIAL BALANCE, DECEMBER 31, 1913 (Before Closing) Debits Credits Accounts Payable . . $22,560.71 Accounts Receivable $42,739.66 Capital Stock 150,000.00 Cash in Banks 3,706.82 Commissions 7,750.71 Depreciation 12,067.30 Discount on Sales 4,986.22 Discount on Purchases 6,792.40 Finished Product (Inventory at December 31, 1912) 110,630.84 Freight Inward 4,709.81 Freight Outward 3,542.39 Factory Expense 52,796.57 Insurance 5,372.90 Interest 3,850.00 Labor 179,473.82 Machinery and Equipment 120,672.96 Material Purchased 158,691.26 Material Inventory (at December 31, 1912) . . . Notes Payable 10,786.90 60,000.00 Office and Selling Expenses 14,790.82 Petty Cash 150.00 Prepaid Taxes 672.80 Prepaid Interest 375.00 Power 7,500.00 Reserve for Depreciation 20,978.23 Repairs 5,281.76 Rent 15,000.00 Salaries 32,250.00 Sales 570,478.31 Supplies 6,872.90 Surplus . . 42,146.08 Taxes 2,937 50 Traveling Expenses 4,836.24 Unexpired Insurance 6,821.16 Work in process (Inventory December 31, 1912) 53,689.39 $872,955.73 $872,955.73 262 C. P. A. ACCOUNTING Inventories at December 31, 1913, are: Material, $9,877.44; work in process, $56,091.29; finished product, $71,170.10. From the above trial balance and facts prepare: (a) Balance Sheet, De- cember 31, 1913; (&) statement showing cost of manufacture and goods sold; (c) Profit and Loss account. Importance will be attached to the form and classification of these statements in marking answers. (Mass., Oct., 1914.) 2. From the following trial balance of the A. B. Stevens Manufacturing Co. prepare a Balance Sheet at December 31, 1915, and a statement of profits for the year. D'bits Credits Accounts Payable Accounts Receivable $70,000 Accrued Taxes Advertising 3,000 Allowances 2,200 Capital Stock Cash 15,000 Depreciation of Equipment 3,500 Discount on Sales 3,100 Discounts Received Electricity 1,300 Factory Supplies and Expenses 3,600 Freight of Purchases 9,000 Income from Bonds Insurance 300 Interest Paid 300 Inventory December 31, 1914 50,000 Investment in Bonds 15,000 Notes Payable, secured by deposit of $15,000 of Bonds Office Expenses 900 Out Freight 8,500 Plant and Equipment 40,000 Purchases 100,000 Rent 2,500 Repair Parts 1,100 Return Sales 1,000 Salaries, Office and Officers 10,000 Salaries. Salesmen 6,000 Salaries, Shipping Department 1,500 Salary, Superintendent 2,000 Sales Salesmen's Expenses 2,100 Sales of Waste Surplus Taxes 400 Unexpired Insurance 800 Wages in Factory 15,000 $368,100 $15,000 1,200 100,000 1,800 1,000 10,000 200,300 1,200 37,600 $368,100 The inventory at December 31, 1915, amounted to $45,000. (111., Dec., 1916.) TRADING ACCOUNTS 263 3. Smith, Hill and Davis form a partnership under an agreement that Smith is to have a salary of $200; Hill, $150; and Davis, $100 a month, respectively. The profits are to be divided in proportion to the amount of business secured by each partner. The partners are to be individually responsible for any direct losses arising from their own business. They are in business nine months, at the end of which time their books state as follows: Smith's sales, $5,310; Hill's sales, $3,100; Davis' sales, $3,200; net profits, $2,468.50. They then decide to rescind the salary agreement, treating any salary drawn as an advance, but otherwise to divide the profits according to the original arrangement. You find errors during the nine months' period, namely : office furniture, charged to operation, $65; funds lent by Davis, credited to his salary account, $400 ; and open items not entered on the books as follows : Smith's salary (ninth month), $200; Hill's salary (ninth month), $150; advertis- ing, $27.50; clerk hire, $130; telephone, $6; rent, $50; stationery, $15; ac- counts receivable, Smith's business, uncollectible, $210; and that the sales represent a gross profit of 100 per cent over cost of merchandise. State the Journal entries necessary to readjust the accounts and prepare a corrected Profit and Loss account and a statement of the distribution of the profits. (Va., Nov., 1910*; A. I. of A., May, 1918.) 4. "A" and "B" were copartners, sharing equally the net profits of the business ; "B" had exclusive charge of the business and of the accounts of the firm, with duty of furnishing to "A" at the close of each year a statement of the condition of the firm's accounts, together with details of the Profit and Loss account for the year. According to statements rendered by "B" for the years 1900, 1901, 1902, the following conditions of account appeared : On January 1, 1900, "A's" capital account was $135,000 and the in- ventory amounted to $175,000 ; the purchases during the year were $950,000, the sales were $1,175,000, expenses were $110,000, and the inventory, December 31, amounted to $160,000. For the year 1901 the inventory, January 1, was $160,000, the purchases were $875,000, the sales were $1,180,000, the expenses were $125,000, and the inventory, December 31, amounted to $150,000. For the year 1902 the inventory, January 1, was $150,000, the purchases were $910,000, the sales were $1,210,000, the expenses were $130,000, and the inventory, December 31, amounted to $110,000. "A" had an examination made of the books, and the following irregu- larities in the accounts were thereby discovered : (1) There were included in the sales for 1902 goods at an estimated cost of $20,000, which formed no part of the inventories or purchases. (2) Goods were omitted from the inventories of the several years as follows: January 1, 1901, valued at $30,000; January 1, 1902, valued at $50,000; January 1, 1903, valued at $50,000. State "A's" Capital account for the several years as it would appear 264 C. P. A. ACCOUNTING from the statements rendered by "B" and determine and state what modi- fication of it will result from a correction of the above irregularities, giving the correct amount of his capital for each year. Give details of process by which you reach your results. (Pa., May, 1905; Wash., Sept., 1907.) 5. The board of directors of the "X," "Y," "Z" Company removed their manager on April 30, 1915, on the general suspicion that his books mis- represented the true financial condition of the business. Prepare a state- ment showing the nature and probable extent of his misrepresentation, also an approximate Statement of the Profit and Loss for the four months ending April 30, 1915, and a Balance Sheet as of April 30, 1915. The following is a trial balance taken from the books April 30, 1915 : Capital Stock $75,000 Fixtures $10,000 Inventory, January 1, 1915 128,600 Cash 15,450 Accounts Receivable 24,600 Accounts Payable 39,000 Loans Payable 10,000 Sales 51,000 Purchases 40700 Salaries, Salesmen 2200 Advertising 1,650 Salaries, Office 1,100 Rent 400 Interest ... 200 Insurance, January 1 to December 31, 1915 999 Stationery and Printing 105 Reserve for Depreciation of Fixtures 2,710 Surplus, January 1, 1915 48294 226,00-1 $226.004 An analysis of the Purchases and Sales accounts revealed the follow- ing: purchases, year 1912, $122,000; sales, year 1912, $153,750; inventory, January 1, 1912, $101,000; purchases, year 1913, $123,000; sales, year 1913, $153,170; inventory, January 1, 1913, $100,000; purchases, year 1914, $121,000; sales, year 1914, $154,722; inventory, January 1. 1914, $102,000. (N. Y., Jan., 1915.) 6. The Good Music Company sells pianos on the installment basis. On January 2, 1914, Jones purchases a piano from the company for $375, to be paid for as follows : $25 down and the balance in quarterly in- stallments of $50 each, bill of sale to be given on date of final payment. The piano cost the company $125. The four installments for 1914 were duly received, the last having been paid on December 31. (a) Set up the proper Ledger accounts covering this sale and the payments thereon. (b) Give the Journal entry (at the close of the year) by which the year will be credited with its proper proportion of the profit on this transaction. (Wis., April, 1915.) TRADING ACCOUNTS 265 7. From the following data (a) prepare one Trading account for the years 1916 and 1917, stating the gross profit for the two years; (b) pre- pare a Trading account with estimated inventory for 1918 : Sales 1916 $290,696 .81 Sales 1917 292,548.21 Purchases 1916 241,709.33 Purchases 1917 253,791 .95 Sales discounted 1916 . . . 1,238 .55 Sales discounted 1917 . . . 1,955 .26 Freight in 1916' 3,384 .35 Freight in 1917 4,094 .70 Inventory Jan. 1, 1916 . . 63,784.78 Inventory Dec. 31, 1917. 107,317.80 Sales nominal $493,476.87 Sales in carload lots 39,351 .68 Return sales 15,304 .58 Sales discounts 4,267 .30 Purchases 443,685 . 15 Freight in 6,211.53 Gross gain on carload lots . 1 ,956 . 42 (N. Y., June, 1919.) 8. The office of a firm of traders, doing business in San Francisco, was destroyed by an earthquake. The books of account, which had been fully posted, were badly damaged. The following Ledger accounts were found to be legible: Purchases, net, $69,000; Discounts lost, $640; Dis- counts gained, $3,450; Sales, $54,000; Bills Receivable, $33,000. Inquiry at the bank disclosed a balance on deposit, $129,000. Bills receivable amounting to $45,000 had been discounted at the bank. An audit of the checks paid by the bank showed that $99,000 had been paid creditors (including $60,000 notes payable). A Balance Sheet prepared at the last closing of the books was produced containing the following items : Cash, $00,000 ; Accounts Receivable, $126,- 000 ; Loans Receivable, $24,000 ; Real Estate, $90,000 ; Notes Receivable, $78,000; Capital, $318,000; Notes Payable, $60,000. Prepare a trial balance supplying the missing accounts. (N. Y., June, 1915.) CHAPTER XIV INSURANCE AND GENERAL EXPENSE Unexpired Insurance As fire insurance premiums are paid in advance for services extending over a duration of time, unexpired insurance is a deferred charge to income. 1 In case of cancellation of a policy, the pre- mium for the period when the insurance was in force would he figured upon a "short rate," which is considerably higher than the usual rate, and the excess of the unexpired actual premium over this "short rate" premium would be returned by the insurance company. 2 For financial statement purposes unexpired insurance is valued on the pro rata basis, except in case of bankruptcy or in the statement of affairs, when the "short rate" basis would apply. 3 In the case of a fire, that proportion of the unexpired insurance, which will represent the ratio of the amount of the settlement made by the insur- ance company to the face of the policy, should be charged off to the fire loss account. 4 In order to include insurance in monthly statements, it is advisable to debit unexpired insurance or prepaid insurance when the premiums are paid, and then to write that account off to expense (or insurance) monthly. 5 Fire Insurance Register When there are numerous insurance policies, an insurance register may be used, which will record the policy numbers, names of companies, dates of policies, dates of expiration, nature and amount of insurance, and amounts of premiums. 6 The insurance register contains twelve columns in which the insurance expense applicable to each month is recorded. 7 The use of an insurance register greatly aids the auditor in verifying the unexpired insurance.* Reserve for Insurance If a large firm desires to carry its own insurance, it makes an annual charge, equivalent perhaps to regular insurance pre- miums, to profit and loss, and credits a reserve for insurance.' Any fire losses would be written against this reserve. 10 In case of liquidation, the reserve is a part of profits, 11 but going concerns must maintain the reserve, although they should show it on the balance sheet as a surplus reserve. If the reserve increases until it is out of proportion to the fire risk, it may be written down directly into surplus. 12 Frequently the insurance reserve is funded in order to insure the possession of liquid assets in case of a fire." Audit of Fire Insurance The auditor should call for all fire insurance policies for the purpose of assuring himself that adequate insurance is carried" and that the policies are in the company's name." The policies 'For explanation of superior figures see page 337 266 INSURANCE AND GENERAL EXPENSE 267 will also furnish additional proof of the properties not having been hypothecated. 18 The auditor should examine the coinsurance and other restrictive clauses of the policies. 17 All canceled policies should be noted and the return premium verified. 19 If no register is kept, a detailed schedule of unexpired policies should be prepared. 19 The auditor should ascertain that the policies properly describe and locate the insured prop- erty, and that mortgage clauses are attached, if the property is mortgaged. 20 Coinsurance Clause An 80% coinsurance clause, sometimes called the average clause, makes the insured a coinsurer with the insurance company for the difference between 80% of the cash value of the property and the face of the policy. 21 Let "P" represent the face of the policy; "L," the amount of the loss; "C," the cash value of the property; and "A," the amount that may be recovered from the insurance company; then, in accordance with the provisions of the coinsurance clause, 22 PL In using this formula, it must be borne in mind that the insurance company is never liable for more than the face of the policy. 23 Fire Losses After a fire, a fire loss account should be charged with the full amount of the loss, including related expenses and canceled unexpired insurance, and credited with the allowance made by the insurance com- pany. 24 The balance of the account represents the net loss or gain due to the fire and should be closed directly into surplus. 25 Depreciation accruing from close of last fiscal period to date of fire should be debited to the depreciation expense account and credited to the related asset account. 26 The portion of the depreciation reserve applicable to the destroyed asset should be written off to the related asset account, and then the balance of the asset account should be closed into the fire loss account. 27 A point in theory, usually disregarded in practice, is to adjust any difference between the book value and the valuation allowed by the insurance company directly to surplus as an item occasioned by faulty depreciation allowances in former periods. 28 When perpetual inventories are not maintained, losses in merchandise are estimated on the assumption that the gross profit for the period in which the fire occurred would be the same percentage as normal. 29 The procedure is that used in the "gross profit check" on inventories (see page 244). Marine Insurance Professor Solomon S. Huebner in "Property Insur- ance" states that the law of general average covers all those losses which result from the sacrifice of any interest voluntarily and deliberately made by the master of a vessel in time of distress for the common safety of the ship, cargo, and freight. Such losses must be repaid proportionately by all the parties benefited. Assuming a loss of $5,000 when the ship, cargo, and freight were valued at $50,000, $25,000, and $1,000, respectively, the loss would be borne in the ratio 50:25:1. It will be noted that jettisoned 268 C. P. A. ACCOUNTING property bears its share along with the saved property. An insurance company pays such losses in the proportion which the insured value of the property bears to its contributory value. Life Insurance Premiums on straight life insurance policies of which the firm is the beneficiary may be capitalized at their cash surrender value, 30 the excess of the premiums over the increase in the cash surrender value of the policies being charged to operating expense. 31 In case of the death of the insured, the surrender value account would be closed and the excess of the payment over the surrender value would be credited to surplus. 32 Employers' Liability Insurance All premiums paid to insurance com- panies for insurance against claims for damages for injuries to employees are proper charges to factory burden. 33 As the premiums are paid in ad- vance, the unexpired insurance must be shown as an asset at the end of a fiscal period. 34 The auditor should secure a statement from the firm's attorneys as to pending claims and suits, and should provide reserves for possible liabilities. 35 Burglary Insurance Premiums for burglary insurance are charged to factory burden or administrative expense, depending on whether the property so safeguarded belonged to the manufacturing or sales branch of the business. Premiums paid for the bonding of employees are usually regarded as administrative expense. 38 Accrued and Prepaid Wages An auditor must ascertain that the ac- crued wages at both the beginning and end of the fiscal period are reflected in the accounts. 37 Under ordinary conditions, accrued wages are calculated on the fractional basis rather than by reference to each individual time card. 38 Prepayments of wages are current assets, but, although they are personal accounts, they must not be included among the accounts re- ceivable. 39 Payroll Book The payroll book is a subsidiary book to the general cash book, containing the names of employees and the payments made to each. 40 In its form and content there is little uniformity. Sometimes it lists all the employees," and sometimes it omits those working for wages. 42 It may or may not contain the signatures of the employees for each pay- ment. 43 The payroll book is sometimes merely a memorandum record, and sometimes a book of original entry. 44 Audit of Payroll The extent of an audit of the payrolls depends on the system of internal check, 45 a subject treated in Chapter I. The auditor should call for all the payrolls, which should be signed by the officials responsible therefor. 4 " Unsigned payrolls should be carefully compared with those signed. When salaries are paid by checks, the payroll book should be thoroughly tested with the canceled checks. 47 The auditor should verify the footings of the payroll book of, say, every third week. 48 Where employment cards are kept, they should be used to vouch the payrolls. 48 Accrued wages must be verified. 60 The auditor should suggest all needed improvements in the payroll system. 51 Officers' salaries should be verified from the directors' minutes. 52 INSURANCE AND GENERAL EXPENSE 269 Insurance, Eent, and Taxes as Costs Most accountants hold that ex- penses incurred for insurance, rent, and taxes should be prorated between factory expense and administrative expense in proportion to the capital invested in the factory and office departments." Others view insurance and taxes as payments made for the protection of capital, and rent as an expense due to lack of capital, and therefore treat them as non-operating expenses. 54 Income and excess profits taxes are levied on the assumption that the government is a partner in the business, i. e., that the government shai-es in the profits in return for benefits conferred on the business by the gov- ernment. 55 They should, therefore, be charged directly to surplus 58 and shown in the appropriation of profits section of the profit and loss state- ment. 57 This procedure is not universally followed, for income taxes are sometimes seen classed as administrative expense 58 and sometimes as financial expense. 58 Assessment taxes for improvements are not expenses but outlays in- creasing the value of the property taxed, and they should, therefore, be charged to the related asset account/ Rent as Income When rent is received on property owned, it is non- operating income; 61 but if the rent-bearing property is a part of property which the firm itself is leasing, the rent received may be deducted from the rent paid, 62 or the rent paid may be allocated to operating or non-operating expense, and all of the rent received treated as non-operating income." 3 The latter procedure gives the truer costs. Postage In most audits, postage is unimportant financially, but, as it is a frequent source of petty theft, the auditor should scrutinize carefully the payments for postage, and, if possible, suggest safeguards which will reduce the future losses and at the same time remove a source of serious temptation to junior clerks. 84 Postage is usually treated as a general and administrative expense, 65 although it may be allocated to the various de- partments of the business. Donations Donations, from which an indirect benefit is not expected, should be charged directly to surplus and shown in the appropriation of profits section of the profit and loss statement, 96 but donations incurring indirect benefits are administrative expenses. 87 Adjustment Entries Entries required to bring the ledger into accord with actual facts are called adjustment entries. 68 There are five kinds of adjustment entries, namely, those pertaining to (a) merchandise inven- tories, (b) valuation reserves, (c) deferred assets and liabilities, (d) ac- crued assets and liabilities, and (e) the correction of errors. Closing Entries Closing entries are those made for the purpose of closing the nominal accounts into the vested proprietorship accounts." Some accountants use the manufacturing and trading accounts in addition to the profit and loss account, 70 a practice which seems inadvisable as the modern use of analytical statements makes the opening of manufacturing and trading accounts unnecessary. Some accountants close the subsidiary 270 C. P. A. ACCOUNTING sales and subsidiary purchase accounts into the sales account and purchase account, respectively, before closing these accounts into the profit and loss account. 71 Other accountants close all nominal accounts directly into profit and loss," a short-cut which seems warranted by the fact that the analysis of accounts is usually studied from the financial statements instead of from the ledger. Accountants prefer the journal method of closing to the direct or "red ink" method because it gives a complete record of transfers in the books of original entry, 73 and because it collects all the closing entries in one place. 74 The auditor should examine the closing entries in order to prevent a misstatement of income. 75 INSURANCE ANT) GENERAL EXPENSE 271 QUESTIONS INSURANCE AND GENERAL EXPENSE FIRE INSURANCE 1. In preparing a statement of the cost of making the product would you include as cost, expenses of the fire insurance premiums on the fire policies covering the plant? State your reason. (N. C., June, 1919; N. C., Sept., 1919.) 2. In order to facilitate the preparation of monthly Profit and Loss statements by a corporation, how would you recommend insurance to be treated on its books from month to month? (Wash., April, 1906.) 3. State what is indicated by the Insurance account (a) when the account shows a debit balance, (6) when the account shows a credit bal- ance. Explain fully. (N. Y., Jan., 1900.) 4. What in your opinion is the proper treatment of the Unexpired Insurance Premiums account, in arriving at the profit and loss of a busi- ness for a specific fiscal period? (Ohio, Dec., 1908; Mass., June, 1910.*) 5. On which side of the Ledger should the balance on the Insurance. Premiums Unexpired account appear? (Mo., Dec., 1914.) 6. Would you consider it proper to include Insurance Premium Un- earned as an asset? Explain briefly and give reasons. (N. Y., Jan., 1897; N. Y., June, 1908.) 7. How would you treat insurance premiums paid in advance, if clos- ing the books at a certain period, with a view to ascertaining the loss or gain? (N. J., 1904-1909.) 8. Classify the following account : Prepaid Insurance. (Mass., April, 1911*; Mass., June, 1912*; Iowa, Dec., 1918.) 9. A concern owning a fleet of twenty vessels decides to carry its own insurance. How will this be dealt with on the books, and what entries would you make at the close of each fiscal year? (111., May, 1904; Cal., Nov., 1910.*) TO. A corporation invests its capital in a number of subsidiary com- panies, each subsidiary company having a distinct organization, but its dividends being payable to the parent company. The parent company decides to carry insurance for all the subsidiary companies and each pays in to the parent company monthly a specific sum. Fire losses as in- curred are payable by the parent company. How are such entries treated and what should the books show; also, what entries are necessary at close of fiscal years? (Mich., Dec., 1900.) 272 C. P. A. ACCOUNTING 11. The Insurance account as kept upon the books of the Good Mer- chandise Company is charged with the premiums paid on the following kinds of insurance: Fire insurance on buildings, merchandise and fix- tures; sprinkler leakage; employer's guarantee bond; safe burglary; rob- bery and hold-up; automobile fire; theft and liability; general liability; elevator liability; steam boiler; tornado; plate glass; use and occupancy; insurance on officers' lives. You are asked to indicate the proper treatment to be given each of the above items; i.e., indicate the name of the account or accounts to which they should be charged, give the adjusting entries, state the section of the revenue account or income statement in which each would appear, etc. (Wis., Nov., 1919.) 12. A certain concern decides that instead of paying insurance pre- miums it will establish its own insurance fund, depositing therein an amount equal to the premiums which it would otherwise have paid. The insurance fund is invested in certificates of deposit bearing 3 per cent interest. Using imaginary figures, construct (or) Journal entries covering the insurance fund transactions as above described for one year; and (b) the Journal entries required in the event of a fire loss which the said fund does not fully cover. (Wash., May, 1910.) 13. Give some reasons why the professional auditor should, under present-day conditions, give even more attention than in the past to in- surance carried. (A. I. of A., May, 1920.) 14. A corporation manufacturing explosives was compelled to pay exorbitant rates for a very limited amount of insurance, and in conse- quence was obliged to install an automatic sprinkler system at a cost of $75,000. This additional fire protection enabled it to secure a full line of insurance, though in mutual companies and at a much lower rate than was obtainable prior to such installation. At the end of the fiscal year the company received dividends from these mutual insurance companies aggregating $2,000. To what account should the cost of the sprinkler system be charged and to what account should this dividend be credited? State your reasons fully. (N. Y., June, 1915; N. Y., Jan., 1920.*) 15. Assuming that you are a certified public accountant and employed as auditor by a corporation, state what you would consider it your duty to do in order to safeguard your clients regarding the fire insurance that they carry on their stock of merchandise. (N. Y., June, 1912; N. Y., June, 1915.) 16. What notice, if any, should an auditor take of the fact that the client has, at risk of loss by fire, property on which no insurance is car- ried? What is the duty of an auditor to his clients regarding the amount of insurance that they carry on their stock of merchandise? (Wis., April, 1915.) 17. Define: Coinsurance. (Wis., May, 1916; A. I. of A., May, 1021.) INSURANCE AND GENERAL EXPENSE 273 18. Describe the practical application of the coinsurance clause. (Pa., May, 1906; Mich., July, 1909.*) 19. Describe the practical application of (a) the average clause; (&) the three-fourths value clause; (c) the three-fourths loss clause; (d) the use and occupancy form, in the insurance business. (Mich., July, 1909.) 20. A company shows among its assets $2,675 as unexpired insurance on January 1, 1907. On February 1, 1907, the plant is destroyed by fire and a total loss of $57,875 occurs, which the insurance company pays. How would you treat the $2,675 unexpired insurance item? (111., May, 1909; Mass., Oct., 1916.*) 21. How would you determine the loss in case of a fire if the books had been saved but were not kept so as to show a perpetual inventory? (Pa., May, 1900*; N. Y., June, 1902*; Pa., May, 1903*; 111., May, 1905*; Pa., Nov., 1906*; Mich., Dec., 1906*; Wash., Aug., 1908*; Md., Jan., 1909*; Mich., July, 1909*; 111., May, 1910*; Va., Nov., 1910*; Mass,, June, 1913*; Mich., Dec., 1913; Mass., Oct., 1914*; Wis., April, 1915*; Ohio, Nov., 1915*; Ind., June, 1916*; Mich., Dec., 1916*; A. I. of A., June, 1917*; Cal., June, 1917; Ind., May, 1918*; Md., Oct., 1919*; A. I. of A., May, 1921.*) 22. What methods would you adopt to determine the value of stock or merchandise on hand at an odd date in case of total loss by fire in a manufacturing business, under each of the following several conditions: (1) Inventories taken in detail annually on closing only? (2) Running inventories kept on cards by quantities only, except as to work in progress and under a system of estimating costs for finished product? (3) Run- ning inventories kept on Ledgers according to true cost in value and mia ntities, but not posted for three months back, and posting media destroyed, through general books intact? (Mich., June, 1914.) 23. State in the form of Journal entry the following transaction : Loss by fire of buildings, fixtures and merchandise; loss sustained by owner over and above the insurance carried, and the amounts due and collected from the insurance companies. (111., Nov., 1903.) 24. Draft a form of statement you would prepare to support a claim for loss by fire which was suffered by a retail dry goods store, six months since an inventory was taken and allowing for all depreciation, discounts, and freights. A portion of the stock was not damaged, a portion was damaged to some extent and the remainder was entirely destroyed. (Wash., Aug., 1908*; Fla., July, 1909.) 25. A clothing store carries fire insurance to the amount of $30,000 on a stock of $50,000. The policies contain the 80 per cent coinsurance clause. State (a) the amount collectible if a partial loss of $15,000 was suffered and (b) the amount collectible if a total loss occurred, (c) If you believe that a merchant should carry 100 per cent insurance protection upon his property, draft the entry or entries to record the annual insur- ance charge. Assume that it is only necessary for him to carry 80 per cent in outside companies to take advantage of the coinsurance clause. (Wis., April, 1918.) 274 C. P. A. ACCOUNTING 26. What is the difference, theoretically, between expenditures by a manufacturing concern for fire and burglar insurance, health and accident insurance and watchmen? In which section of a Profit and Loss account should each item be allocated? (N. Y., June, 1917.) 27. An audit discloses payments for insurance during a year amounting to $1,600, which is approximately a normal yearly expenditure, and the unexpired insurance, unadjusted, amounts to $600. No account was raised for the unexpired insurance at the beginning of the year. What adjustment should be made on the books and how made? (Ohio, Nov., 1913.) 28. The Ledger of a manufacturing corporation contains a Fire In- surance Fund account. The treasurer submits, for credit purposes, a statement showing, as "Surplus Funds," the sum of the amount at the credit of the Insurance Fund account, and of the amount at the credit of the "Surplus" account. State (a) your comments thereon; (b) the reasons supporting your answer. (Mass., June, 1912.) 29. Under what circumstances would you permit the inclusion of profits of excess amount recovered from an insurance company over the book value of a plant destroyed by fire? (Mo., Dec., 1914.) 30. A fire in a manufacturing concern resulted in a loss on machinery, $5,000; merchandise (raw material), $10,000; manufactured goods, $25,- 000 ; which amount of $40,000 was agreed upon and paid by the insurance companies. Give the entries necessary to record properly the above trans- actions on the books of the concern. (N. Y., June, 1914.) LIFE INSURANCE 31. A corporation authorized the securement of life insurance of its treasurer for $50,000 payable at death to the corporation. How should this subject be treated in the accounts? (Mass., Oct., 1914.) 32. How would you classify the following item in the Balance Sheet or Profit and Loss account : Premium on Life Assurance Policy on which there is a surrender value? (Kan., Dec., 1915; Mo., Dec., 1915.) 33. A company has insured the life of its president for its own benefit, and is carrying the amount of premium paid in its Balance Sheet. What position would you as an auditor take in regard to these premiums? (Ind. f May, 1917; A. I. of A., Nov., 1917.) 34. The partnership, Black & White, has insured the lives of its partners for equal amounts. The policies are payable to the firm. Pre- miums have been paid for five years, (a) Show the annual entries for each of the five years. At the end of the fifth year White dies, (b) What would be the proper entries to make upon receipt of the amount of the policy? (Wis., April, 1915; Wash., June, 1915.*) 35. A firm of jobbers, Shea, Kargeau and Company, to provide against financial strain in the event of the death of one of the partners, takes out a joint life insurance policy for $15,000, the annual premium ($750) being INSURANCE AND GENERAL EXPENSE 275 charged as a feature of the Profit and Loss account. Eight years there- after the junior partner dies; assuming that they are equal partners, you are called in to adjust the accounts upon receipt of the insurance money. Explain the method you would follow. (111., May, 1912.) 36. It is now becoming quite the common practice for corporations to insure the lives of their principal officers, so that upon their deaths the corporations may be in a measure reimbursed for their loss to the business. In this connection you are asked to indicate what sort of entries would be made by a company from time to time if it paid the insurance for $50,000 carried on the life of its president under the four classes of insurance policies indicated below: 10-year renewable term policy. 20-payment life policy. Straight life policy. 20-year endowment policy. Also indicate what entries should be made in the books for the receipt of the $50,000 principal, of the different classes of policies supposing the president of the company died during, say, the fifth year of the insured term. (Wash., July, 1917; A. I. of A., Nov., 1920.) PAYROLL 37. Classify the following accounts : (a) Payroll; (b) officers' salaries; (c) bookkeepers' salaries. (Iowa, Dec., 1918.) 38. Define: Payroll Bank account. (Wash., July, 1917.) 39. Define: Payroll advances. (Wash., June, 1915.) 40. Classify the accounts properly recording the following items ac- cording to the subdivision of income and expenses, assets, liabilities, pro- prietary interest, under which they should be grouped: (a) Wages paid workmen and office staff; (b) wages due workmen and office staff. (Wis., May, 1919.) 41. What plan would you suggest for minimizing the risk of fraud in the payment of wages in a factory where large numbers of men are em- ployed partly by piece-work and partly at fixed wages'? (N. Y., June, 1899*; Pa., Nov., 1906; Mass., Oct., 1915*; Pa., Nov., 1916*; 111., Dec., 1916.*) 42. In handling large factory payrolls, which do you consider the better practice for the prevention of fraud, the taking of receipts from each employee for the amounts paid or the establishment of a good system of accounting for handling payrolls. Give reasons and explain why you think one method is better than the other. (N. Y., Feb., 1909.) 43. Classify: Night watchman wages. (Iowa, Dec., 1918.) 44. Would you consider wages in a manufacturing concern to be a nominal account, or, if not, how should it be classified? (Minn., Oct., 1918.) 276 C. P. A. ACCOUNTING 45. In what section of the Balance Sheet and in what order would you show wages? (A. I. of A., Nov., 1919.) 46. An accountant is employed to audit the personal accounts of a retired capitalist who maintains several estates. What data is required concerning the employees to form an important schedule of the report? (N. Y., Jan., 1914.) 47. Give some methods used by dishonest timekeepers and foremen to falsify records. (Pa., Nov., 1900.) 48. To what extent do you consider it necessary to verify the payrolls? (N. Y., Dec., 1896*; Va v Nov., 1910; Mich., June. 1912'*; 111., May, 1914*; Pa., Nov., 1916.*^ 49. As an auditor, to what extent would you charge yourself with re- sponsibility for the accuracy both as to facts and figures of the wages? (111., May, 1913.) 50. What would you consider satisfactory evidence of the correctness and propriety of expenditures of wages paid? (N. Y., Jan., 1899*; Pa., Nov., 1900*; N. Y., Jan., 1901*; Mich., June, 1915*; Wis., May, 1916*; A. I. of A., May, 1918.) 51. In making a detailed audit, what procedure would you follow to verify the payroll? (N. Y., June, 1897*; Wash., May, 1903*; N. Y., Jan., 1906*; Mich., June, 1912*; Pa., Nov., 1913*; Kan., Dec., 1915; Mo., Dec., 1915; Mass., Oct., 1916*; Mich., Dec., 1916*; N. C., Aug., 1917.*) 52. State how you would satisfy the correctness and regularity of an unsigned payroll. (N. C., June, 1916; N. C., Nov., 1918.) 53. What evidence would you consider satisfactory for the correctness of the salary of officers? (N. C., Nov., 1919.) 54. What would you consider satisfactory evidence of the correctness and propriety of expenditures of salary of president? (A. I. of A., May, 1918.) 55. The president of a corporation engaged four salesmen on a salary and a profit-sharing basis. To one he gave 40 per cent of the profits, to the other three, 20 per cent each. The profits of the corporation were $102,608.18. Show proportion of profits payable to each salesman (N. Y., June, 1919.) ADMINISTRATIVE ITEMS 56. Define: Administration expense. (Mich., Dec., 1914.) 57. How would you classify Rents Collected in Advance in the Balance Sheet or Profit and Loss account? (Kan., Dec., 1915; Mo., Dec., 1915.) 58. State what is indicated by the Rent account (a) when the account shows a debit balance; (6) when the account shows a credit balance. Ex- plain fully. (N. Y., Jan., 1900.) 59. The Chicago Grocery Company owns and occupies a warehouse which cost $1,000,000. The management has decided to charge operations INSURANCE AND GENERAL EXPENSE 277 of the various departments with an annual rental aggregating $75,000. The accounts as finally prepared show the various departments charged and surplus account credited with this amount. Does this transaction meet with your approval, and why? (111., May, 1917.) 60. The Jones Manufacturing Company, needing a larger building for its increasing business, finds a property desirable in every respect except- ing that the building is much larger than is necessary. They lease the property at an annual rental of $18,000, after considering that they can probably sublease part of the building. Owing to the desirability of the property and other favorable conditions, they execute a sublease for one- half of the building at an annual rental of $18,000. How would you treat these facts in compiling the annual income statement of the Jones Manufacturing Company? (Wis., April, 1915.) 61. In making a detailed audit, what procedure would you follow to verify Rents Collected? (Kan., Dec., 1915; Mo., Dec., 1915.) 62. In large establishments, where the outlay on postage is consider- able, what system would you advise to prevent loss by theft? (111., May, 1904.) 63. Where would you place the Factory Office Expense account in the Income and Profit and Loss account? (Md., Dec., 1917.) 64. What would you consider satisfactory evidence of the correctness and propriety of expenditures of pensions paid to ex-employees? (A. I. of A., May, 1918.) 65. What would you consider satisfactory evidence of the correctness and propriety of expenditures of expenses of president? (A. I. of A., May, 1918.) 66. In what respect would you satisfy yourself of the regularity of "Unclassified Expenses" in absence of any support other than the itemi- zation on the voucher or check stub? (N. C., June, 1916.) 67. What information is required in respect of a full and complete voucher for expenses incurred? (Wis., May, 1916.) TAXES 68. Classify the following account: Taxes. (Iowa, Dec., 1918; A. I. of A., Nov., 1919.*) 69. In order to facilitate the preparation of monthly Profit and Loss statements by a corporation, how would you recommend Taxes to be treated on its books from month to month? (Wash., April, 1906.) 70. Would you consider it proper to include Taxes Paid in Advance as an asset? Explain briefly and give reasons. (N. Y., Jan., 1897; N. Y., June, 1908.) 71. Classify the accounts properly recording the following items ac- cording to the subdivision of assets, liabilities, proprietary interest, in- come and expenses under which they should be grouped: (a) Property Taxes; (&) Income and Excess Profits Taxes. (Wis., May, 1919.) 278 C. P. A. ACCOUNT I NTJ 72. Would you advise showing profits for prospectus purposes before or after deducting war profits and income taxes? State your reasons briefly. (A. I. of A., Nov., 1919.) 73. Define : Accrued taxes. (Iowa, Dec., 1918.) 74. To what extent would you consider it necessary to verify the Taxes Accrued and what reference to such verification would you make in your report? (Mass., June, 1913.) 75. State how Accrued Taxes are used in a Profit and Loss statement or Balance Sheet; also state classification. (Iowa, Dec., 1918.) 76. On which side of the Ledger should the balance in the Tax Accruals account appear? (Mo., Dec., 1914.) 77. In connection with the audit of the books of a corporation de- scribe briefly the procedure you would consider to be essential in verifying the Accrued Taxes. (Wash., July, 1917.) 78. You ascertain that a client owes a substantial amount for assess- ments against local benefits. No liability therefor appears on the books. How would you proceed to determine the amount due? How would you reflect such amount on the Balance Sheet? (A. I. of A., Nov., 1919.) 79. Give some idea of what taxes you would charge against income and what against surplus. Of the former, which, if any, would you take up into manufacturing costs? (A. I. of A., Nov., 1918.) 80. In a statement of condition, requiring classification of assets and liabilities into fixed assets, current assets, etc., in what class would you place taxes paid, but not accrued? State reasons Supporting your answer. (Mass., June, 1912.) 81. In auditing the accounts of a corporation for the first time you find that during prior years the federal income tax returns (which had not been audited by the Government) were, in your opinion, inaccurate, and that a substantial additional amount of tax is due to the Government. Your client claims that the returns were correct, having been prepared under the advice of counsel. You believe that the client is acting in good faith. What, if anything, would you recommend? What bearing, if any, would the facts have upon a Balance Sheet to be certified by you? (A. I. of A., Nov., 1919.) ADJUSTING AND CLOSING ENTRIES 82. Define: Closing entries. (Pa., Nov., 1900.) 83. Describe the nature and purpose of closing entries at the closing of a fiscal period. (N. Y., Jan., 1907.) 84. State the process of closing a Ledger. (N. Y., Jan., 1897*; N. Y., Dec., 1898*; N. Y., June, 1900*; N. Y., Jan., 1901; N. Y., June, 1902*; Pa., Nov., 1903*; N. Y., Jan., 1906; N. Y., Oct., 1907; R. I., Dec., 1907*; Iowa, Dec., 1918.*) INSURANCE AND GENERAL EXPENSE 279 So. How should inventories be treated in closing the Ledger at the end of a fiscal year? (N. Y., Jan., 1901.) 86. Why is property unsold credited to the account to which it belongs before closing? (N. Y., Dec., 1898.) 87. Describe in detail the process of closing the accounts of a business contained in Ledger "A" and transferring them to Ledger "B." (N. Y., Jan., 1904.) 88. In preparing annual accounts from a set of books maintained on the double-entry system, what general rules or principles would guide you in deciding whether an account should be closed by an entry debiting or crediting Profit and Loss account, or whether the balance of an account should be included as an item in the Balance Sheet? (111., May, 1916.) 89. In summarizing the nominal accounts of a manufacturing concern to determine the results of operations for a period (a) what would be the order and character of the three closing accounts? (&) What nature of accounts form the elements of each? (c) Give your reasons. (111., May, 1911.) 90. How should expiring accounts, such as premiums on fire insurance, taxes, etc., be treated? (Md., Oct., 1903.) 91. In closing a set of books at any given period, how would you treat the different accounts therein (a) of a partnership; (&) of a corporation? Explain fully. (Pa., Nov., 1900; La., May, 1913.*) 92. Name all the accounts which contribute to the Profit and Loss account when closing the books. (Pa., May, 1905.) 93. Define: Adjusting entries. (Pa., Nov., 1900; N. Y., Jan., 1907.*) 94. How would you deal with the items accrued and due (such as rent, commission, and salaries) when closing the accounts of a business at the end of a fiscal period? (N. Y., Dec., 1898*; N. Y., Jan., 1904*; N. Y., Feb., 1910; Va., Oct., 1912*; N. Y., Jan., 1914*; Kan., May, 1916*; W. Va., May, 1919.*) 95. Explain the methods of treating accruals, indicating advantages and weaknesses of each. (W. Va., May, 1919.) 96. Illustrate prepaid accounts and accrual accounts used by concerns making monthly showings of operations. (Wis., April, 1914.) 97. How would you treat tax assessments on real estate, if closing the books at a certain period, with a view to ascertaining the loss or gain? (N. J., 1904-1909.) 98. What is the necessity of taking into account accruals of interest, taxes, rent, etc? How should prepaid rents, insurance, etc., be treated at the end of a fiscal period? (Ohio, Oct., 1919.) 99. In auditing the books of a company whose fiscal year ends Decem- ber 31 you find charged: (a) Rent for the year ending September 30;. (6) insurance premiums for the year ending March 31, paid in advance; (c) discounts actually allowed during the year; (of) taxes paid during the year, assessed for the previous calendar year. 280 C. P. A. ACCOUNTING You are informed that in the opinion of the company no adjustment should be made as a full year's charge for each of these items has been recorded in the accounts. State your views. (Wash., June, 1915.) 100. An auditor is called upon to verify a Balance Sheet, and upon investigation he finds that unexpired insurance, interest paid in advance on discounted notes, taxes accrued on demand notes and bonded indebted- ness, royalties, etc., are not included in same. He is informed that it has not been the custom of the corporation to include in their Balance Sheet such items, as they offset one another, and that the directors do not desire any change in the practice they have adopted. Discuss this proposition, stating reasons for your conclusions. (Ohio, Nov., 1917.) 101. Describe the method of closing the books of a concern, stating how you provide for depreciation, bad debts, surplus, and dividend ac- counts. (N. Y., Jan., 1906*; Fla., July, 1909.) 102. In closing a set of books, state how you would treat the following on Ledger on financial statement: Depreciation on machinery, $1,500; expenses prepaid, $500; discount on customers' accounts, 3 per cent, $1,080; salaries and wages accrued, $675. (N. Y., Jan., 1904.) 103"* What are some of the important things to consider before closing a set of books for a fiscal period? (Iowa, Dec., 1918.) 104. What is meant by an "Expense Inventory" and how would you treat this item in drawing up the Profit and Loss account and Balance Sheet? (Colo., Dec., 1913.) 105. Describe three methods of treating accruals and the advantage or weakness of each. (Ind., Nov., 1917.) 106. Give the treatment of deferred accounts at the close of the ac- counting period. (Ind., May, 1918.) INSURANCE AND GENERAL EXPENSE 281 PROBLEMS INSURANCE AND GENERAL EXPENSE 1. A merchant effected $40,000 insurance on property worth $60,000; his policies contained the usual 80 per cent coinsurance clause. A loss of $30,000 was sustained. What sum should the merchant receive from the underwriters in correct settlement of the loss? (Colo., Dec., 1913.) 2. A fire in a manufacturing concern resulted in a loss on machinery, $5,000; merchandise (raw material), $10,000; manufactured goods, $25,- 000, of which amount $40,000 was agreed on and paid by the insurance companies. Give the entries necessary to record properly the above trans- actions on the books of the concern. (N. Y., June, 1914.) 3. (a) If the value of the property insured is $10,000 and the actual insurance at the time of the fire is 80 per cent, what should be the settle- ment if the loss was 50 per cent of the total value? (6) If the property value was $10,000 with an 80 per cent coinsurance clause and the actual insurance in force at the time of the fire was $6,000, what would be the owner's deficiency? (c) How much if the loss was only 40 per cent of the total? (Mich., July, 1909.) 4. Robert Adams and William Stevens are equal partners. On the night of July 3, their stock and fixtures were destroyed by fire. A trial balance which Adams had at his home showed the following condition of the Ledger at the close of the business June 30 : Robert Adams $600 $7,450 William Stevens 600 7,450 Cash 3,309 Fixtures 1,500 Merchandise Purchases 32,600 Merchandise Sales 24,800 Notes Receivable 1,000 Notes Payable 2,000 Interest 120 50 Expense 780 Customers 4,500 Creditors 3,259 $45,009 $45,009 The property is fully covered by insurance. The insurance company, for the purpose of estimating the value of the merchandise destroyed, has 282 C. P. A. ACCOUNTING agreed to allow 35 per cent as the average gross gain on the sales and to pay 66% per cent on the value of fixtures as shown by the Ledger. On the basis of this agreement, state the result of the business and the capital of each partner. (Mass., June, 1910.) 5. On October 31, 1919, the store of the Good Merchandise Company was destroyed by fire. It was a total loss. The books and records were found to be complete, and the trial balance as of October 31 was as follows : Accounts Receivable $7,000 Accounts Payable $5,000 Cash 2,000 Merchandise Inventory, January 1, 1919 15,00( Merchandise Purchases 85,000 Real Estate 3,000 Dividends Paid 4,000 Buildings and Fixtures 18,000 Furniture and Furnishings 5,000 Reserve for Depreciation, Buildings and Fixtures 3,000 Reserve for Depreciation, Furniture and Furnishings 300 Unexpired Insurance 2,500 Merchandise Sales 99,000 Miscellaneous Income 1,500 Clerks' Salaries 5,000 Light, Heat, and Power 1,000 Advertising 2,000 Office Salaries 2,500 Officers' Salaries 5,000 Postage 700 Treasury Stock 10,000 Taxes 2,500 Telephone and Telegrams 150 Sundry General Expense 500 Capital Stock 50,000 Surplus 12,050 $170,850 $170,850 An average gross profit of 331/ per cent was agreed upon by all parties concerned. Stock, buildings, fixtures, and furnishings were insured under the 80 per cent clause, the buildings, etc., for $15,000 and the stock for $32,000. Settlement is made on the basis of these facts. You are asked to give (a) the profit or loss due to fire, (&) the oper- ating statement for the period ending October 31. (Wis., Nov., 1919.) 6. The Star Department Store, organized January 1, 1911, suffers a fire loss just before inventory December 31, 1913. The books disclose the following facts: INSURANCE AND GENERAL EXPENSE 283 Dec. 31, 1911 Dec. 31, 1912 Dec. 31, 1913 Inventory Beginning $44,244.04 $51,894.68 $50,396.40 Purchases During Year 171,133.33 173,478.81 157,188.09 Allowance on Purchases 11,900.12 15,182.62 8,293.54 Sales 197,474.49 209,397.00 195,937.98 Allowance on Sales 4,294.37 4,594.50 5,179.19 Advertising 3,487.39 3,334.45 2,987.56 Salaries 8,295.92 9,196.72 9,196.72 Wages 16,684.30 16,628.75 17,531.22 Delivery 567.34 567.38 1,053.34 Depreciation of Furniture 169.31 372.92 112.94 Stationery and Printing 282.40 309.30 300.00 Gas 75.09 45.55 62.02 Rent 5,350.00 5,400.00 5,400.00 Insurance 927.15 856.42 770.40 Interest 1,571 02 1,506.89 1,695.80 Light 612 53 567.40 525.06 Water 29 21 28 51 27.63 Taxes 438.80 597.00 891 .07 Telephone 33.75 52.27 54.00 General 2,041.30 3,343.37 2,581.32 Traveling 352.94 351 .93 278.28 Furniture and Fixtures 9,000.00 9,500.00 10,500.00 You are asked by the appraisers: (a) To determine the value of assets destroyed. (&) To arrive at correct amounts to effect a complete adjustment under the following concurrent policies containing 1 the 80 per cent coinsurance clause. Stock Furniture Home Insurance Co $10000 $2,000 Glen Falls Insurance Co 15 000 3,000 Globe Insurance Co 5,000 1,000 Equitable Insurance Co 10,000 2,000 (c) If the property loss had been 50 per cent, what amounts would have been the proper adjustments'? (Mich., Dec., 1913.) 7. A merchant's ledger disclosed the following statement on March 31, 1915: Inventory of goods on hand January 1, 1914, $26,000. January 31, merchandise purchases, $1.0,800; merchandise returned to store, $700; sales, $13,800; purchases returned to seller, $250. February 28, merchandise purchases, $8,600 ; merchandise returned to store, $375 ; sales, $10,575; purchases returned to seller, $325. March 31, merchandise purchases, $9,675; purchases returned to store, $567; sales, $16,425; mer- chandise returned to seller, $435. April 30, merchandise purchases, $6,756 ; 284 C. P. A. ACCOUNTING merchandise returned to store, $437; sales, $12,150; goods returned to seller, $193. May 31, merchandise purchases, $7,693; merchandise re- turned to store, $842 ; sales, $14,236 ; goods returned to seller, $178. June 30, merchandise purchases, $6,957; merchandise returned to store, $359; sales, $20,789; goods returned to seller, $237. July 31, merchandise pur- chases, $10,764 ; merchandise returned to store, $653 ; sales, $15,283 ; goods returned to seller, $364. August 31, merchandise purchases, $12,786; merchandise returned to store, $689; sales, $19,476; goods returned to seller, $113. September 30, merchandise purchases, $19,436; merchandise returned to store, $347; sales, $8,679; goods returned to seller, $147. October 31, merchandise purchases, $10,798 ; merchandise returned to store. $878; sales, $17,124; goods returned to seller, $236. November 30, mer- chandise purchases, $12,745; merchandise returned to store, $1,087; sales, $22,187; goods returned to seller, $475. December 31, merchandise pur- chases, $8,649; merchandise returned to store, $983; sales, .$4,851 ; goods returned to seller, $122. Inventory as of December 31, 1914, $32,232. January 31, 1915, merchandise purchases, $9,786; sales, $14,287; goods returned to seller, $342; goods returned to store, $329. February 28, sales, $11,364; goods returned to store, $597; merchandise purchases, $9,873; merchandise returned to seller, $239. March 31, sales, $17,747; goods returned to store, $324; merchandise purchases, $11,397; merchan- dise returned to seller, $539. On the morning of April 1, 1915, previous to time of opening the store for business, the building and contents were destroyed by fire. It will, therefore, be necessary for you to state what [was] the book value of the merchandise on hand at the time of the loss, as of March 31, 1915. You will make a Ledger account of the foregoing. [Make a] Profit and Loss statement. What [did] the goods cost that went out of the house, as of January 31, 1915. What was the ratio of profit to cost of goods and sell- ing price? Show how you arrive at same. Make statement of the loss. (Texas, June, 1915.) 8. A severe fire occurred on March 1, 1917, at the factory of the Pitts- field Woolen Company, by which practically the whole of the buildings and contents were destroyed, with the exception of the offices. . The insurance adjusters paid a lump sum of $10,000 in respect of the buildings, $1,500 for the machinery, and $12,000 for the stock on hand, the salvage being sold to the Pittsfield Woolen Company for $1,000, which salvage was deducted from the insurance money on settlement. The Pittsfield Woolen Company realized $2,000 from the salvage. In the Pittsfield Woolen Company's books, land and buildings stood at $17,500, and the value of the buildings not destroyed was $1,000, the land being valued at $5,000; the machinery stood at $1,600 and was a total loss; the stock on hand at date of last inventory (June 30, 1916) stood at 13,500. The sales for the eight months from date of last inventory (June 30, 1916) to date of fire (March 1, 1917) amounted to $30,000, and the purchases and expenses for the period to $26,000. The gross profit INSURANCE AND GENERAL EXPENSE 285 on sales was known to be 8% per cent. There were expenses in con- nection with the fire insurance adjustment of $200. Show how the above matters should be entered in the books of the Pittsfield Woolen Company. (N. D., July, 1918.) 9. The B. Moose Printing Company, a corporation, had a capital of $50,000, which was held by B. Moose, $25,000 ; U. Moose, $15,000, and L. Moose, $10,000. The plant was destroyed by fire December 15, 1917. All books and records were saved, except the sales records, which were not written up for December. The insurance companies paid $28,000 on the machinery and equipment and $7,000 on the stock, which was distributed to the stockholders as received in proportion to their holdings. On December 30th, the trial balance disclosed the following conditions: Capital Stock $50,000 Machinery and Equipment $30,000 Stock on Hand, June 1, 1917 8,750 Accounts Receivable 19,640 Accounts Payable 12,590 Reserve for Bad Debts 1,250 Insurance Adjustment 28,000 Cash 3,900 Engraving 77,600 Printing 99,350 December Sales, not segregated 24,175 Merchandise Purchases 58,800 Wages 130,180 Rent 1,800 Salaries 5,750 Surplus 855 L. Moose 7,000 U. Moose 10,500 B. Moose 17,500 $293,820 $293,820 The accounts receivable realized $18,320, and the liquidation expenses were $1,850. The stockholders turned in their stock for cancellation and received their proportionate amount in cash. Prepare Journal entries closing the books of the corporation, and a Profit and Loss account. In- clude Journal entries for final distribution of cash and for final disposition of loss or gain. (Va., Nov., 1918.) 10. A firm manufacturing but one grade of cloaks, insured against burglary, claims to have been robbed on the night of September 10. The proof of the loss filed by the assured contained two items for 600 cloaks, $12,000; silk, 1,000 yards, $1,500. An inventory of the stock on hand, consisting of cloaks, cloth and silk, had been taken January 1, amounting to $118,500, the particulars of which have been lost or destroyed. 286 C. P. A. ACCOUNTING An analysis of the firm's books produced the following information: purchase of cloth, 37,500 yards, at $1; purchases of silk, 10,000 yards, at $2; 6,000 cloaks were manufactured, consuming cloth, 40,000 yards, at $1; silk, 10,000 yards, at $2; 9,000 cloaks were sold between January 1 and September 10. Cost of sales, per cloak, for material, $10; cost of sales, per cloak, for labor and sundries, $7. Inventory, September 11 : 2,500 cloaks, at $17; 12,500 yards cloth, at $1; 5,000 yards silk, at $2. Prepare a report proving or disproving the claim. (N. Y., June, 1909; N. Y., Jan., 1917.) CHAPTER XV DEPRECIATION Nature of Depreciation Depreciation may be defined as the shrinkage in value of an asset through use, the passing of time, decay, or obsoles- cence. 1 Repairing property tends to decrease the rate of depreciation but cannot prevent the loss. 2 Depreciation must not be confused with loss in efficiency. 3 The efficiency of most machines is almost constant up to the period in which they are scrapped, yet the depreciation accumulates during the entire life of the machine. 4 Depreciation is a cost of doing business, 5 the charge being made to the department of the business using the related asset. The statement that the reserve for depreciation is a division of surplus 8 therefore seems incorrect. Causes of Depreciation The following table summarizes the causes of depreciation on tangible property. 7 Causes of Depreciation. I. Physical Depreciation (a) Wear and tear from operation (b) Action of time and the elements II. Functional Depreciation (a) Inadequacy or supersession (b) Obsolescence III. Contingent Depreciation (a) Accidents (b) Diseases (c) Depletion Depreciation on intangible property is caused either by the expiration of time or by the abandonment of the assets. 8 Inadequacy Inadequacy indicates inability fully to perform the in- tended function." It is caused by (a) changes in original financial policy, (b) motives of engineering economy, and (c) unforeseen developments. 10 Losses occasioned by inadequacy should be provided for under the head of a contingent reserve, and not included in the estimate of depreciation, except in those cases when the loss can be intelligently foreseen." Obsolescence Obsolescence, or the shrinkage in value due to the fact that property has been rendered out of date by new inventions and im- provements," is usually too uncertain to constitute an element in the cost Tor explanation of superior figures see page 337. 287 288 C. P. A. ACCOUNTING of operations. 13 Whenever possible, a reserve for contingent losses due to obsolescence should be created out of surplus. 1 * In industries where obso- lescence can be foretold with reasonable certainty, however, obsolescence should be included in the depreciation charge." Depletion Depletion, or the "giving out" of assets, must be differen- tiated from depreciation, or the "wearing out" of assets." However, the fact that a mine is subject to depletion frequently has a vital effect on the depreciation of the mine equipment, which is of little value when the ore is exhausted, i. e., mine buildings having a longer estimated life than the ore body depreciate at the same rate as the ore body, but, if the life of the buildings is less than that of the ore body, the buildings depreciate at their normal rate." Actual and Theoretical Depreciation The term "actual depreciation" signifies the decrease in the selling value of an asset from its state when new to its used condition. 13 Theoretical depreciation is the loss due to wearing out of the asset prorated more or less uniformly over the life of the asset. 1 * The use of theoretical depreciation in accounting records is justified by the fact that going concerns usually replace, instead of sell, their fixed assets. 20 Appreciation and Depreciation Since fixed assets normally are not sold, fluctuations in the selling prices of fixed assets are not recognized on the books of account and appreciation can not therefore be used to offset depreciation. 21 In fact, if appreciation is booked, the charge for deprecia- tion will be automatically increased. 22 Booking of Depreciation When the periodic charge to the depreciation expense account is made, the credit can be carried directly either to the assets or to a reserve for depreciation account ; 23 the latter procedure is the better, in order that the asset may be shown at its original cost figures. 24 The recording of depreciation in connection with the sale of a depreciated asset is shown on page . Although there are some accountants who advocate showing the de- preciation reserves on the right side of the balance sheet either under the caption "appropriated surplus" 25 or under the caption "reserves," 29 the majority deducts the reserves from the related assets 27 in order to show the net book value of the assets. Depreciation Fund Depreciation or replacement funds are, like all funds, created by investing in marketable securities an amount equal to the charge for depreciation. 28 The entry for the establishing of a deprecia- tion fund consists of a debit to the depreciation fund account and a credit to the cash account. 29 When a depreciating asset is replaced, the fund securities are sold, the entry being a debit to the cash account and a credit to the depreciation fund account, the money being used to replace the asset. 30 It is vitally important to remember that there is no connection between the depreciation fund and the depreciation reserve. 31 The former is the means of accumulating current assets to replace a depreciated asset, 32 while the latter is the means of writing off a depreciating asset into operat- ing expense. 33 Whether a depreciation fund is created depends upon the DEPRECIATION 289 financial policy of the business, 34 but a depreciation reserve must be created unless the credit is made directly to the related asset account. 35 A de- preciation fund is especially serviceable in the case of expensive and short- lived assets. 30 Depreciation Bates An auditor would do well to equip himself with the tables for depreciation rates prepared by the United States Government, by the various state commissions, and by large private appraisal firms. 87 The C. P. A. candidate should be familiar with the general range of the rates in these tables but should not attempt to memorize the tables. Plant Ledger As practically every kind of fixed asset has an individual depreciation rate, the details of the plant and machinery controlling ac- count are carried in a subsidiary ledger, called the plant ledger. 38 This ledger usually has a separate account for each plant unit. 39 These plant ledger accounts may be ruled to show the year of installation, estimated life, first cost including installation costs, and annual depreciation charges for a number of years. 40 As these accounts usually provide for the sub- traction of the annual depreciation charges from previous book values of the assets, the balance of the plant ledger usually corresponds with the difference between the cost figures of the plant and equipment less the reserve for depreciation.* 1 Calculation of Depreciation The determination of depreciation rates is an engineering problem, but an accountant should understand how and when to use the various methods of determining depreciation charges." These methods may be broadly classified, though with some overlapping, under the following heads : 43 Methods of Calculating Depreciation. I. Proportion Methods (a) Straight Line (b) Working Hours (c) Composite Life (d) Service Output II. Variable Percentage Methods (a) Fixed Percentage on Diminishing Value (b) Sum of Year Digits (sometimes known as "Sum of Expected Life-Periods") III. Compound Interest Methods (a) Sinking Fund (b) Annuity IV. Miscellaneous Methods (a) Maintenance (b) Replacement (c) Fifty Per Cent (d) Appraisal (e) Insurance (f ) Gross Earnings 290 C. P. A. ACCOUNTING Straight Line Method The straight line method of calculating deprecia- tion, so called because its graphical representation is a straight line," figures the periodic charge by dividing the difference between the initial and scrap value of the asset by the number of periods in its service life. 45 Assuming an asset costing $100, service life 3 years, scrap value $10, the annual charge would be $30 (1/3 X ($100 $10)). Where the output is uniform and obsolescence and inadequacy are unimportant, and where the cost of repairs is uniformly prorated over the life of the asset, the straight line method gives satisfactory results. 48 The straight line method has the advantage of simplicity. 47 It approximates the actual depreciation about as closely as the more elaborate methods, 48 but it makes no provision for the increased maintenance charges toward the end of the life of the asset. 49 The method is rigid and does not satisfactorily allow for overtime and other fluctuations in wear and tear. 50 The method is especially adapted to the calculation of depreciation on short-lived assets." Working Hours Method The working hours method of calculating de- preciation figures the periodic charge by prorating the difference between the initial and scrap value of the asset between periods, according to the ratio of actual hours the asset works during each period. 62 Assuming an asset costing $100, service life 9,000 working hours, scrap value $10, the charge for a period in which the asset works 3,000 hours would be $30 (3,000/9,000 X ($100 $10)). Where the asset performs only a few processes equally wearing in their effects, where the rate of operation never exceeds the asset's normal speed, and where the up-keep costs are equitably distributed, the working hours method gives fairly satisfactory results. 83 The method makes the periodic charge agree with the use made of the asset, 54 but fails to provide for the increase in the maintenance charges toward the end of the asset's life. 53 Composite Life Method The composite life method operates the same as the straight line method, the outstanding feature being that depreciation is calculated on the plant as a whole, rather than on the individual assets. 59 Assume two machines, one costing $5,000 and having a service life of 10 years and a scrap value of $1,000, and the other costing $4,000 and having a service life of 5 years and; a scrap value of $500. The composite life depreciation rate can be calculated by the following two methods : First Method. Cost Value Life Periods Scrap Value Depre- ciation Times Replaced (a) Total Loss in 10 Years (b) Dollar Years (c) $5,000 4,000 10 5 $1,000 500 $4,000 3,500 1 2 $4,000 7,000 $50,000 40,000 $9,000 $11,000 $90,000 DEPRECIATION 291 (a) Number of times renewal of the asset will be required during the longest life period. (b) Product of depreciation multiplied by times replaced. (c) Product of cost value multiplied by life periods multiplied by times replaced. $11,000 -f- $90,000 = 12.22 + per cent, rate of depreciation. It is a noteworthy fact that all accountants do not agree with the 'above method of calculating the depreciation on a composite group of assets. Some accountants calculate the "dollar years" by multiplying the "depre- ciation" by the "life periods" multiplied by the "times replaced." 57 This would seem incorrect as the resulting depreciation rate will be applied on the cost values and not on the cost less scrap values of the assets. That 12.22 + per cent is the correct rate can be seen from the fact that its use creates a reserve of $11,000 within the ten years, which will exactly offset the loss due to depreciation. During the ten years the cost of the assets will total $13,000 ($5,000 + (2 X $4,000) ), while the scrap value will total $2,000 ($1,000+ (2 X $500)), the difference of $11,000 being the loss due to depreciation. Second Method. Rate of Annual Cost Life Scrap Cost Less Deprecia- Deprecia- Value Periods Value Salvage tion tion (a) (b) $5,000 10 $1,000 $4,000 10 $400 4,000 5 500 3,500 20 700 $9,000 $1,100 (a) Quotient of 100 divided by Life Periods. (b) Product of Cost less Salvage multiplied by Rate of Depreciation. $1,100 H- $9,000 == 12.22 + per cent, rate of depreciation. Of the above methods, the second is the better, as it is more simple and direct. The composite life method of calculating depreciation is subject to all the limitations of the straight line method and has the additional disadvantage of losing sight of the depreciation on individual assets. However, the method is serviceable in estimating the cost of depreciation for the plant as a whole, and in furnishing a basis for the comparison of two similar plants. 68 Service Output Method The service output method of calculating de- preciation is the same as the working hours method, except that the service life is measured in output instead of working hours. 6 * Assume a machine, costing $100, capable of making 9,000 units of product, scrap value $10, the charge for a period in which the machine produces 3,000 units would be $30 (3,000/9,000 X ($100 $10)). As this method requires the pre- 292 C. P. A. ACCOUNTING determination of output, the conditions must be uniform and the asset must perform only a few processes. 60 The method is frequently used in connec- tion with wasting assets,' 1 and is also adapted to calculate the depreciation on machines which have special functions and which are used only at irregular times. 82 Fixed Percentage on Diminishing Value Method The fixed percentage on diminishing value method of calculating depreciation estimates the periodic charge as a fixed percentage of the appraised or book value of the asset as at the time of the last appraisal.' 3 Letting "n" equal the number of periods, "r" equal the periodic depreciation rate, and "sv" and "cv" equal the scrap and cost values, respectively, the formula for this method, which in complex cases requires the use of logarithms to solve, is : M r = CV For an asset costing $100, service life 3 years, scrap value $10, the de- preciation rate by the above formula is approximately 3/10 r = l ' TOO=: 100 = .536. The periodic charge on such an asset would be $53.60 ($100 X .536) for the first period, and $24.87 ( ($100 $53.60) X .536) for the second period. The chief advantage claimed for this method is that the periodic charges under it are heavy at the beginning and decrease toward the end, and thus tend to equalize the increase in the up-keep costs which it is claimed normally increase with the age of the machine. 65 However, as repairs frequently do not increase uniformly during the life of the ma- chine, but may be incurred very irregularly, this argument is of doubtful value. The method also involves complex calculations, 8 " is distasteful to new concerns on account of the heavy initial charges, 87 and is subject to the objections that it prorates the charges on a time rather than a service or output basis, 68 and that the life of the asset is not clearly indicated by the depreciation rate. 68 The method can not logically be used in connection with an asset having no residual value. 70 Sum of Tear Digits Method The sum of year digits method, sometimes called the sum of expected life periods method, prorates the loss due to depreciation (the excess of the cost over the scrap value) over the periods in the ratio of fractions whose numerators are in the order of the expected life periods and whose denominators are the sum of all the expected life periods. 71 Assume an asset costing $100, service life 3 years, and scrap value $10. As the expected life at the beginning of each period would be 3, 2, and 1 periods, respectively, making a total of 6, the loss due to depreciation of $90 ($100 $10) would be prorated 3/6, or $45, to the first period ; 2/6, or $30, to the second period, etc. The sum of year digits method gives the same general effect as the fixed percentage on diminish- DEPRECIATION 293 ing value method/ 2 and is subject to the same objections except that it is easier to calculate. 73 Sinking Fund Method The periodic charge for depreciation under the sinking fund method consists of a constant amount, representing the sum of money, which, placed at compound interest at the end of suc- cessive periods, will accumulate to the amount of the total depreciation of the asset during its life term. 74 Assume an asset costing $100, whose scrap value after 3 years will be $10. If interest is reckoned at 5 per cent, the constant amount would be $28.55, calculated by the formula for sinking fund installments given in Chapter IX, thus: R = $90 -r- * 1 ' 5 < ?~ 1 = $28.55 .05 As the interest on the fund would be debited to the fund and credited to income, the interest must be added to the periodic charge and credited to the reserve. 75 The entries for the second year would be : Entry No. 1 Depreciation Fund $29 . 98 Cash $28.55 Interest Earned ($28. 55 X . 05) 1 . 43 Entry No. 2 Depreciation Expense 29 . 98 Reserve for Depreciation 29 . 98 If desired the sinking fund method can be used to calculate the periodic depreciation charge without the use of a fund. 78 In this case entry No. 1 would be omitted but the depreciation charge would be calculated as though a fund were maintained 77 and entry No. 2 would be made. In the foregoing illustration the total depreciation charge for the first year would be $28.55; for the second year $28.55 plus $1.43 ($28.55 X .05), or $29.98; for the third year $28.55 plus $2.92 (($28.55 + $29.98) X .05), or $31.47. 78 The chief objections to the method are that the periodic charge increases as the asset advances in age, 79 and that the assumed constant rate of in- terest may vary materially from the current rates of interest, 80 but it is adapted, if the fund is maintained, to the handling of the depreciation on a large single piece of property." 1 The fund feature of the sinking fund method is especially advisable for terminable businesses which will retire securities when the assets are exhausted, and for continuous businesses which do not require funds for additions and betterments." . The sinking fund method is sometimes called the annuity method, 83 a practice which is unfortunate as it ignores the difference between the sink- ing fund and annuity methods. Annuity Method The annuity method of calculating depreciation is based on the theory that interest is a cost of production. 84 The annuity method determines the annual charge by finding such sum as, when de- ducted each year from the sum of the remaining investment and interest 294 C. P. A. ACCOUNTING thereon at a given rate, will reduce the investment to scrap value, and in addition return the full amount of the interest on the investment as it stands from beginning to end of the plant's life. 85 The annuity method of calculating depreciation treats the investment in the fixed asset as the present worth of an annuity. 86 The calculation of the periodic charge for an asset costing $100, whose scrap value after 3 years will be $10, interest to be figured at 5%, is shown by the following table: 87 ELEMENTS IN PERIODIC CHARGES Appraised Depre- Periods Total \ alue ciated or Fixed Amount Interest on Fixed Amount Interest on Invest- ment Charge Plus Interest Appraised Value (a) (b) (c) (d) (e) (f) s . $ $ $ $ $100 00 1 28.55 5 00 33 55 105 00 71 45 2 28.55 1.43 3.57 33.55 75.02 41.47 3 28.55 2.92 2.08 33.55 43.55 10.00 $85.65 $4.35 $10.65 $100.65 (a) Calculated as in Sinking Fund Method. (b) Calculated as in Sinking Fund Method. (c) 5 per cent of (f). (d) Sum of (a), (b), and (c). (e) Sum of (d) and (f). (f) Difference between (e) and (d). The "total charge" in the above table can be computed by the use of the following formula, by letting "D" stand for the total charge or periodic depreciation; "C", the cost of the asset; "S", the scrap value; "p", the present value of $1 at given rate due at scrapping of asset; and "P", the present value of annuity of $1 at given rate for as many periods as life of asset. 88 __ C-(SXp) The total depreciation charge or "total charge" then would be: T,- 100 -dO X .86383760) _ ^^ 2.72324803 The annuity method of calculating depreciation automatically secures a charge for interest on investment as a part of the depreciation charge, a result that should be avoided because, whether or not interest is an element in cost, its inclusion under the title of depreciation is misleading and indefensible. 88 The real depreciation charge is the same under the DEPRECIATION 295 annuity as under the sinking fund method. 90 The journal entry for the second period in the foregoing illustration would be : 91 Depreciation $33 . 55 Interest on Investment $3 . 57 Reserve for Depreciation ($28 . 55 + $1 . 43) .... 29. 98 The method is subject to the objection that the periodic charges in- crease with the age of the asset. 82 The application of the mefehod is mathematical rather than practical, 93 but the method is adapted for cal- culating depreciation on long-term leases and similar assets. 94 Maintenance Method The maintenance method periodically charges depreciation with an amount equal to the cost of maintaining the asset during the period. 85 The method is faulty because it makes the charging of depreciation a matter of business convenience, instead of a necessary cost of production, and because under it the charge fluctuates violently and tends to increase with the age of the asset." Replacement Method The replacement method makes no charge for depreciation but in lieu of such an expense item, it charges all renewals and replacements to revenue. 97 This method may prove a satisfactory way of making good the loss due to depreciation after the point of normal replacements has been reached in a plant large enough for the law of averages to equalize the replacement charges. 98 The method is suitable only if the asset consists of short-lived units. 98 It disregards accrued depreciation up to the point of normal replacements. 100 The Fifty Per Cent Method The fifty per cent method is the same as the replacement method except that after the assets have reached the re- newal stage, the total depreciation, which may or may not be booked, is held to be fifty per cent of the cost of the property, the constant renewal of parts preventing its exceeding that percentage. 101 Although this method is inadequate as a means of prorating the depreciation cost over the prod- uct, it may serve fairly well as a method of valuation. 102 Appraisal Method By the appraisal method, the periodic charge for depreciation is the difference in value between the appraisals at the begin- ning and end of the period. 103 This method is inadequate, as the physical facts of depreciation are not usually discernible at such short intervals. 104 The method leads to inaccuracy because appraisals usually take into account market fluctuations. 103 The appraisal method is expensive on account of engineers' fees, 108 but it is useful as an occasional check upon the other methods. 107 Insurance Method The insurance method, so called because of the analogy between it and the policy practiced by some firms of carrying their own fire insurance, is a means of financing replacements and renewals rather than a means of distributing the depreciation cost to the product. 108 The f undprovided by this method is neither designated for the replacement of any specific asset nor reserved until it can be expended in replacing the identical asset upon which it was figured, but it is spent, wholly or partly, 296 C. P. A. ACCOUNTING during the same year in. which it is created, in replacing other equipment or purchasing new equipment. 108 Gross Earnings Method The gross earnings method of calculating the periodic charges for depreciation estimates the expected gross earnings during the composite life-period of the plant, and then prorates the loss due to depreciation to the periods on the basis of the gross earnings for each period as compared with the estimate. 110 If the product is standardized and has a fairly constant selling price, gross earnings fluctuate with out- put, and in such cases the gross earnings method may be satisfactory." 1 The method is sometimes used because it tends to make the periodic net profits equal, but this reason alone does not justify its use. 1 " DEPRECIATION 297 QUESTIONS DEPRECIATION THEORY 1. What is depreciation f (Pa., Nov., 1899* ; N. Y., June, 1900* ; N. Y., June, 1902*; Md., Oct., 1903*; Pa., Nov., 1904* ; Wash., April, 1906*; N. Y., Feb., 1908*; Md., Jan., 1909*; Ohio, March, 1910*; N. Y., Jan., 1911*; Colo., Dec., 1913*; Wis., April, 1914*; N. D., June, 1914*; W. Va., May, 1917*; A. I. of A., Nov., 1917*; Va., Nov., 1918*; Ind., Nov., 1918*; N. D., July, 1919.) 2. Give your understanding of the term "depreciation" and state wherein it is or is not equivalent to "wear and tear." (111., May, 1909.) 3. State the theory of depreciation. (Mich., Dec., 1914*; Ohio, Nov., 1915; Ind., Nov., 1918; Ohio, Nov., 1918.) 4. Why ought depreciation to be considered? (N. D., July, 1919.) 5. Is the necessity of a provision for depreciation commonly recog- nized in the accounts of American corporations? (Ohio, Oct., 1919.) 6. What are your views as to the necessity of a provision for depre- ciation on fixed or capital assets? (N. Y., June, 1901*; Mich., June, 1908*; Mo., Dec., 1914; Ohio, Oct., 1919.*) 7. It is contended that it is unnecessary to write off depreciation on (a) Freehold premises; (b) plant and machinery, provided that they are maintained in a full state of efficiency out of revenue. Give briefly your own views on this subject. (111., May, 1905.) 8. From an audit of a public service corporation it is found that no depreciation of capital assets has been provided by a charge against earn- ings, the officials believing that appreciation of certain real estate offsets a fair amount of depreciation. Is this a proper disposal of the matter? Give reasons. (Mass., June, 1912*; 111., May, 1916*; Mass., Oct., 1916; Ohio, Nov., 1917*; A. I. of A., Nov., 1918*; A. I. of A., May, 1921.*) 9. Do you consider it good accounting practice to charge off deprecia- tion on machinery in years when the operation of the plant results in a loss? Give reasons. (N. Y., June, 1919; N. C., Nov., 1919.*) 10. State the object of the Depreciation account. (N. Y., Dec., 1898; Mich., July, 1906*; Va., Oct., 1911.*) 11. What is the effect on a business of depreciation? (Pa., Nov., 1900*; N. Y., Jan., 1901*; Pa., Nov., 1904*; Pa., May, 1906; A. I. of A., May, 1920.*) 298 C. P. A. ACCOUNTING 12. Define: Obsolescence. (111., Dec., 1918.) 13. What is the difference, if any, between depreciation, obsolescence and depletion? (W. Va,, May, 1919.) 14. A company manufacturing tin tags charges to cost of manufacture (as depreciation) one-fourth of the cost of the stamping machine, which had been in service about one year. The life of this machine was esti- mated to be ten years, but owing to the discovery by a competitor of a new method of stamping, which, while still imperfect, promises to revolu- tionize the business, the stamping machine now in use will probably be obsolete within a period of three years. What would you say concerning the propriety of the above charge to prime cost? (X. Y., Jan., 1918.) 15. Define the difference between fluctuation and depreciation in the value of assets. (X. Y., June, 1919.) 16. Define and distinguish "depletion" and "depreciation" and state how you would handle these through the Balance Sheet and the operating statement. (N. C., June, 1920.) 17. Name three of the principal elements that cause obsolescence. (N. Y., June, 1919.) 18. Can you name some other reason why depreciation should be con- sidered in respect to machinery other than that of wear and tear? (111., May, 1904; Mass., June, 1910.) 19. Name the advantages or disadvantages of the following methods of bringing on to the books of a company the depreciation on its machin- ery: (a) Crediting Machinery account with 10 per cent of the balance of the account each year and charging profit and loss; (6) crediting a reserve for machinery depreciation with 10 per cent of the balance of the account each year and charging profit and loss. How can you combine the best features of both the above methods? (111., May, 1907.) 20. A company engaged in the manufacturing business has instructed its accountant to show depreciation as an opei'ating expense and a credit to plant, to set up a depreciation reserve and create a depreciation cash fund. Prepare the necessary Journal entries to illustrate the idea of the company, and discuss the question. (111., Nov., 1904.) 21. What do you consider the best way of entering on the books of a manufacturing company the amount written off to profit and loss for depreciation on (a) buildings; (6) large or fixed tools; (c) small or expense tools? (X. Y., Feb., 1908.) 22. A public service corporation that regularly sets aside from its profits a sufficient amount to provide for depreciation removes part of its old plant and replaces it with a larger and more costly one. The old plant is sold for scrap. How should the cost of the new plant and the proceeds from the sale of the old plant be treated in the accounts of the company? Give reasons. (X. Y., Feb., 1909; Kan., May, 1916; N. ('., Nov., 1919*; N. C., June, 1!20.*) 23. State various ways of treating depreciation upon the books. (N. Y., June, 1S98*; N. Y., Jan., 1901*; N. Y., Jan., 1904*; 111., May, 1904*; DEPRECIATION 299 Mich., July, 1906*; N. Y., Feb., 1908*; 111., May, 1908*; Md., Jan., 1909*; 111., May, 1909*; N. Y., Feb., 1910*; Ohio, March, 1910*; Wash., May, 1910*; Va., Oct., 1911*; Wash., June, 1912*; Mass., June, 1912*; Ohio, Nov., 1913*; Wis., April, 1914; Mo., Dec., 1914*; Mo., Dec., 1915*; Kan., Dec., 1915*; Mich., Dec., 1916*; W. Va., May, 1917*; Ohio, Nov., 1918*; S. C., Sept., 1919.*) 24. What disposition would you make of any depreciation reserve account when constructing the Balance Sheet? State your reason for above answer. (111., May, 1904*; Md., Jan., 1909*; Mass., June, 1910*; Va., Oct., 1912; Ohio, Nov., 1913*; Ohio, Nov., 1915*; Cal., May, 1916*; Ohio, Nov., 1917*; Ind., Nov., 1918.*) 25. How would you treat in the Balance Sheet of a company you were auditing: Reserve for depreciation of capital assets; (a) invested in se- curities; (6) not specially invested? (111., May, 1914.) 26. What, in your opinion, is the proper treatment of the depreciation on plant and equipment in arriving at the profit or loss of a business for a specific fiscal period? (Ohio, Dec., 1908.) 27. Are depreciation charges properly considered to be in the nature of expense items, or as an application of the profits? Explain. (N. Y., Jan., 1918.) 28. In order to facilitate the preparation of monthly Profit and Loss statements by a corporation, how would you recommend depreciation be treated on its books from month to month? (Wash., April, 1906.) 29. The balance on Machinery Depreciation account shows an increase for the year of the amount provided out of income which is computed at the rate of 4 per cent on the balance of Machinery account at the com- mencement of the year. The method of keeping the Machinery and Ma- chinery Depreciation accounts has been in force from the commencement of operations. Draft your comments as auditor of these accounts, assum- ing that no item other than those above mentioned call for any comments. (A. I. of A., May, 1918.) 30. The book value of the plant of a corporation has been reduced to merely a nominal sum. Under this condition, state (a) whether, periodi- cally, a reservation should be made of an amount estimated to cover depre- ciation; (b) the reasons supporting your answer. (Mass., June, 1912.) 31. How should expenditures for repairs or replacements be treated in so far as they relate to the question of depreciation? (Mich., June, 1913.) 32. Corporation "X" makes a practice of charging to expenses and carrying to Depreciation Reserve account every half year a certain per- centage of the book value of its plant and machinery. What, in your opinion, is the correct method of dealing in this case with repairs and re- newals, i.e., should the latter be charged to Profit and Loss or can they be properly charged to Depreciation Reserve account? Give reasons for your answer. (Wash., Sept., 1907.) 300 C. P. A. ACCOUNTING 33. What is the effect on a business of reserve for depreciation ? (Pa., May, 1906.) 34. Explain the theory of a depreciation reserve. As auditor of a manufacturing concern, what would be your duties in respect thereto ; and what, if any, charges would you permit to be made to the account? (111., May, 1912.) 35. What are the two principal purposes of a Reserve for Deprecia- tion account? (111., May, 1912.*) 36. You are asked by a client to discuss with him the question of reserves for depreciation and depletion of his various capital assets. State your position on this subject and enumerate the considerations you would advance in support thereof. Would you, or would you not, be guided by the rules laid down by the internal revenue authorities in deciding upon the rates to be used? (A. I. of A., May, 1918.) 37. Explain the relationship between a sinking fund and an allowance for depreciation. It is claimed that in municipal enterprises the require- ments that rates must be high enough to provide both for a sinking fund to pay off the bonds and also for a reserve for depreciation with which to replace the plant results in a double charge to consumers. Criticize or explain this theory. (A. I. of A., June, 1917.) 38. Under what circumstances should deduction be made for deprecia- tion? (N. Y., Dec., 1897.) 39. What classes of property, if any, in your opinion, are exempt from depreciation? Give reasons. (N. Y., Dec., 1897*; Mich., Dec., 1906.) 40. If asked to give advice concerning the proper rates per cent to be adopted in providing for the account for depreciation on buildings, ma- chinery, tools, etc., what could you recommend? (N. Y., Jan., 1901*; N. Y., Jan., 1907; N. Y., Jan., 1908.*) 41. Name a fair allowance for depreciation per annum on the follow- ing plant assets: (a) Real estate, including fences, sidewalks, tracts, etc.; (b) building and building fixtures fireproof construction; (c) factory equipment, including benches, cupboards, etc.; (d) machinery, both iron and woodworking; (e) fixed tools, both iron and woodworking; (/) loose tools, both iron and woodworking; (g) power plant; (h) electric wiring and apparatus, including dynamos, motors, etc.; (i) blower system; (j) office furniture and fixtures, including typewriters, adding machines, graphophones, multigraphs, etc.; (&) horses and mules; (I) wagons, har- ness and trappings; (m) patterns, iron and wood, and drawings. (Mich., June, 1908.) 42. A machine costing $81 is estimated to have a life of four years, with a residual value of $16. Prepare a statement showing the annual charge for depreciation according to each of the following methods: (a) Straight line; (b) constant percentage of diminishing value; (c) annuity DEPRECIATION 301 method. (For convenience in arithmetical calculation assume the rate of interest to be 10 per cent.) Discuss the significance of each of the meth- ods. (A. I. of A., June, 1917.) 43. Explain six different ways of apportioning depreciation charges from year to year and point out clearly their distinguishing features. (N. Y., June, 1913.) 44. A manufacturing concern owning lands, buildings, engines, boilers, and machinery, has been in operation for ten years, but has made no allowance for depreciation, current repairs having been charged to Oper- ating Expenses and new machinery bought having been charged to Plant account. You are given carte blanche in the matter of arranging for such depreciation at fhe time of the audit and also in the matter of providing for it in the future. State the steps you would take and the entries you would direct for both cases, using your own figures. (Fla., July, 1909.) 45. An individual buys a fleet of ships. He then forms a corporation to take them over at double the sum paid by him, payable one-half in debenture bonds of the company and one-half in its capital stock. A sink- ing fund is to be provided for the gradual retirement of the debenture bonds. A public accountant is called in at the end of five years to make up the accounts. He insists on creating a depreciation fund based on the full consideration paid by the corporation. The directors argue that the depreciation fund should be based on the amount of debenture bonds issued, on the theory that the capital stock issued to the vendor was in the nature of a bonus and did not represent any real value. State your views regarding the two propositions. (N. Y., June, 1904.) 46. What do you consider to be the proper basis for providing for depreciation or exhaustion of the following classes of property: (a) buildings; (&) machinery; (c) small tools; (d) freight cars; (e) motor trucks; (/) patterns; (g) patents; (h) mine equipment; (i) ore mine; (j) special machinery for the manufacture of war munitions. (111., Dec., 1918.) 47. Give rates of depreciation commonly used for the following classes of property, stating the method of applying them; it being understood that ordinary repairs and maintenance are charged against earnings: (a) buildings, brock mill construction; (6) machinery, large machinery such as used in automobile manufacturing; (c) steam boilers, stationary; (d) office furniture. (Mass., Oct., 1914.) 48. Mention four items of assets subject to depreciation in the Balance Sheet, and state the annual rate that you would recommend to be charged. (N. Y., June, 1902.) 49. Name the elements essential to the proper calculation of a depre- ciation charge. (N. Y., June, 1911*; N. Y., June, 1913*; Mo., Dec., 1914*; Mass., Oct., 1915*; A. I. of A., May, 1919; S. C., Sept., 1919*; Wis., Nov., 1919.*) 302 C. P. A. ACCOUNTING 50. List the various kinds of plant assets and indicate the various per cent of allowances for depreciation, making: such explanations as are necessary. (Mich., June, 1914.) 51. Name some reasons why it is important to keep distinct the various items of cost in the construction of a building containing boilers, engines, shafting and heating plant. In the erection of the building itself, why should the cost of the foundations be kept distinct from the balance of the building? (111., May, 1904.) 52. Give some general principles which will guide you in determining whether too much or too little provision has been made for depreciation of buildings, machinery, tools, goodwill, patents, franchises. "Would a flat rate cover all these assets satisfactorily? (A. I. of A., Nov., 1918; W. Va., May, 1919.) 53. Where a plant is purchased as a whole without valuation of its different parts, how would you provide for depreciation? (Pa., May, 1902* ; Pa., Nov., 1904.) 54. In the event of a difference of opinion between auditor and direc- tors concerning the rate of depreciation on plant and machinery as would involve an important alteration in the proposed rate of dividend, how can the matter be settled to the satisfaction of both parties? (N. Y., June, 1899.) 55. Upon the audit of the partnership accounts of a manufacturing business, the following condition is revealed : Depreciation or discount from the value fef a certain class of the inventory instead of being 30 per cent as in prior years is shown as 10 per cent. What would you deduce from these facts and what would you feel called upon to do in this instance? (Kan., May, 1916.) 56. What is your understanding of the relationship between a sinking fund and an allowance for depreciation? (Ind., Nov., 1917.) 57. State three important methods of calculating depreciation, briefly explaining each. (Fla., April, 1907*; Wash., June, 1912*; Mass., Oct., 1914; Del., June, 1915; Mass., Oct., 1915*; N. Y., Jan., 1916*; Mich., Dec., 1916*; Ohio, Nov., 1917*; Mich., June, 1919*; N. D., July, 1919*; Ohio, Oct., 1919*: Md., Oct., 1919; A. I. of A., May, 1920.*) 58. In what cases should depreciation be calculated as a percentage to cost? In what cases as a percentage to the net value (cost less deprecia- tion reserve) ? Give the reasons in each case. (111., May, 1915.) 59. The following are the methods usually adopted for the writing off of depreciation: (a) A fixed proportion of original value; (&) a fixed percentage of reduced balances throwing the greater part of the loss on the first few years; (c) a sinking fund. Illustrate the three methods to reduce $200 to $100 in ten years. (Md., Oct., 1903.) 60. Why is an excessive allowance for depreciation objectionable? (b) On what grounds is this usually condoned? (Ohio, Nov., 1917.) DEPRECIATION 303 61. What is the effect of an excessive charge for depreciation? (Ohio, Nov., 1917*; Ohio, Nov., 1918*; Ohio, Oct., 1919.) 62. State what verification you would make of the reserve for deprecia- tion. (N. C., Aug., 1917.) 63. To what extent should an auditor hold himself responsible for the correctness of depreciation? (N. Y., Dec., 1896; N. Y., June, 1899*; Va., Nov:, 1910*; Mich., June, 1912*; Mich., June, 1913*; Wash., Nov., 1913*; 111., May, 1914.) 64. State how you would determine that the amount of depreciation charged off annually was correct. (Wash., May, 1910*; Mich., June, 1912*; N. C., Nov., 1918; N. C., June, 1919*; N. C., Sept., 1919.*) 65. Discuss concisely your conception of an auditor's duties in con- nection with an annual audit, where a difference of opinion exists between the auditor and the client as to the sufficiency of depreciation or depletion charges. (Ohio, Oct., 1919.) 66. In an audit of the books of the "A" Company you find that the fixed depreciable asset accounts, their reserve for depreciation accounts and the operating expense accounts have been improperly kept. Charges which should have been made against the reserve for depreciation accounts have been made, in some cases, to the operating expense account and, in other cases, to the asset accounts. Scrapped assets have been allowed to remain in the asset accounts at original cost. The balances in the reserve for depreciation accounts exceed the balances of the depreciable ass^t accounts. Outline the procedure which you would follow in analyzing these accounts and state all the effects upon the net profits for the years under review. (Wis., Nov., 1919.) 67. What are the duties of an auditor when he finds no charges made against maintenance or other accounts for depreciation of plant? Should he be concerned with the condition in this respect which obtains through- out the period prior to the one to be covered by his audit? How should he report to his client having regard for the possibility of his report being used for purposes of obtaining loans, obtaining additional capital in the business, or selling some part of the existing capital interests? (N. Y., Feb., 1909.) 68. In the preparation of a Balance Sheet explain the basis upon which you would ascertain that reserve for depreciation was properly valued. (Wis., April, 1914.) 69. What are the principal conditions which would influence you in fixing the rate of depreciation on buildings, machinery and tools, fixtures and patterns? State your reasons pertaining to each class of property. (N. Y., June, 1918.) 304 C. P. A. ACCOUNTING PROBLEMS DEPRECIATION 1. A factory consists of two blocks of buildings, "A" and "B." On the 1st of January, 1907, "A" contains engine and boiler which cost $4,000, and machinery costing $13,000; "B" contains machinery costing $7.000. The following are purchases of machinery : October 1, 1907, "A," $1,000 ; July 1/1908, "A," $750; "B," $1,500; April 1, 1909, "A," $600; "B," $900; October 1, 1909, "B," $250. On January 1, 1908, machinery (costing January 1, 1907, $1,000) is sold from "A" for $625, and on July 1, 1908, machinery (costing $1,300 January 1, 1907) is sold from "B" for $1,000. The accounts are made up to December 31 each year. On December 31, 1909, the whole premises and contents are destroyed by fire and the fire insurance company agrees to pay upon the following basis : engine and boiler, cost price, less depreciation 8 per cent per annum upon that sum; machinery in "A," cost less depreciation at 10 per cent per annum and upon diminishing value; machinery in "B," cost, less depreciation at 7 l /2 per cent per annum upon diminishing value. Prepare Ledger accounts showing how much is recoverable upon this basis. (111., May, 1910.) 2. In your examination of the Automobile Delivery Truck account of a company, you find the following entries: Debits January 1, 1914, Trucks 1, 2, 3, 4, at $1,200 $4,800 July 1, 1914, Truck 5 1,500 August 1, 1914, Truck 6 1,500 Credits August 1, 1914, Truck 2 $900 September 1, 1914, Truck 4 750 Balance, September 1, 1914, $6,150. The Reserve for Depreciation for Automobile Delivery Truck account stood credited on January 1, 1914, with $1,800. Upon analyzing the transactions represented by these items, you find the following facts: (a) Truck 5, purchased July 1 replaced Truck 1. The portion of the reserve for depreciation accumulated on January 1 for Truck 1 amounted to $900. Truck 5 was purchased on open account. (b) Truck 2 was traded in for $850 on the purchase of Truck 6 costing $1,500. The difference was paid in cash. The reserve which had DEPRECIATION 305 been accumulated for depreciation on Truck 2 on January 1 amounted to $300. (c) Truck 4 was totally destroyed by an accident September 1. The reserve for depreciation on this truck amounted on January 1 to $300 and it was insured for $750. Assume the rate of depreciation to be 25 per cent per year. Give Journal entries which would properly record the above facts and show the balances of all accounts affected, as of September 1, 1914. (Wis., April, 1915.) 3. From the data given below, state clearly and explain at least three different methods of arriving at the amount to charge annually for the depreciation of any one or all of the following items: Items Value Estimated Life Scrap Value Buildings $50,000 50 years $1,000 Machinery 20,000 20 years 2,000 Tools 5,000 5 years 100 Patterns 10.000 3 years 100 (Wis., April, 1915.) 4. A corporation has been accustomed to charge the purchase of ma- chinery to the Machinery account, and each year to charge the Manufac- turing account and to credit a Reserve for Depreciation account with an amount which will offset the cost of the machinery by the time it is esti- mated that it will be advisable to scrap the machines. During the period that you have been employed to audit the account, you find that the corporation has sold two machines for $500 each, and this amount has been credited to the Machinery account. One of them cost $1,000 and the amount reserved for depreciation on this machine is $600. The other cost $1,500 and the amount reserved for depreciation on this machine is $850. Make the adjusting entries to correct the books. (Mass., June, 1913.) 5. An engine installed in a factory January 1, 1914, at a cost of $1,000 is replaced by one of larger capacity December 31, 1917, costing (second hand) $2,800. The discarded machine was sold for $900. The cost of making the change was $200. It has been the practice of the company to charge off 10 per cent depreciation annually (on the diminish- ing basis) carrying the credit to a Depreciation Reserve account. Make the necessary Journal entries. (111., Dec., 1918.) 6. A machine costing $12,000 was estimated to have a life of twelve years with a residual value of $1,500. At the close of each year a charge of $875 was made to depreciation and a like amount credited to "reserve" for depreciation. Just prior to closing the books at the end of the twelfth year the machine was discarded and sold for $2,000 (cash) and a similar machine was bought, costing $16,000. Show the Journal entries you would make to close the books at the end of the twelve years, in order 306 C. P. A. ACCOUNTING to close the transaction? and to make necessary adjustments. (A. I. of A., June, 1917*; Incl., Nov., 1918.) 7. The "A" Manufacturing Company has four general types of de- preciable assets. Rate Cost Scrap Value Buildings 2% $51,000 $1,000 Machinery "A" iu% 11,000 1.000 Machinery "B" 20% 12,000 2,000 Office Equipment 10% 4,100 100 The directors desire to keep but one Reserve for Depreciation account and request you to determine the composite rate which may be used in determining the annual depreciation charge. Determine the composite rate as requested, tabulate the necessary facts used in determining it, and comment upon the practicability of such a plan. (Wis., Nov., 1919.) 8. A manufacturing concern has annually for the past six years made provision at the rate of 10 per cent per annum for depreciation of its plant and machinery, crediting the amount of such depreciation to a suitable Reserve account. During the year an engine which cost originally $5,000 was replaced by an improved engine costing $6,800. The cost of the new engine was charged to Machinery account at time of purchase. $300 was realized from the salvage of the old engine, this amount being credited to "Scrap Sales," when received, and later closed to Profit and Loss. Draft the adjustment entries which you consider necessary and explain the principle upon which these entries are based. (Ohio, Nov., 1918.) 9. "A," "B," and "C" form a partnership January 1, 1917. "A" invests $65,000; "B," $45,000; and "C," $40,000. Profits are to be deter- mined semiannually and are to be shared in the ratio of the original investments. No interest to be calculated on Partners' Capital accounts. At the end of six months the Ledger contains the following balances : Accounts Receivable . . . . $100,000 Sales $592,600 Accounts Payable 32,400 Sales Returns 2,000 Insurance 6,000 Sales Allowances . 500 Interest Paid 200 Salaries and \Vagcs 30000 Interest Received 500 Rent 5,000 Notes Receivable 20,000 Securities Owned . 5000 Notes Payable .... 20000 "\Iiscellaneous Expense 11 800 Purchases 600,000 Cash 25.000 Purchase Allowances 1,000 "A" Capital Account . 65,000 Purchase Discounts 6,000 "B" Capital Account 45,000 Purchase Returns 3.000 ; 'C" Capital Account. . . . 40,000 DEPRECIATION 307 The inventory of stock on June 30 amounted to $110,000. Of the ac- counts receivable, it is estimated that 2 per cent are uncollectible. During the six months the firm discounted notes receivable amounting to $10,000 of Avhich a note of $1,000 will not be due until August 1. The insurance premiums paid were for insurance covering a three-year periotl, expiring January 1, 1920. The following minor bills are outstanding: telephone and telegraph, $20; electric light, $130; drayage, $100. The estimated taxes for the year 1917 are $6,800. The notes payable are represented by two notes of $10,000 each, for four months at 6 per cent interest, dated May 1 and June 1, respectively. The first note was discounted; interest on the second note was payable at maturity. On July 1, 1917, "A." withdraws from the firm, his interest being pur- chased by "B," "C," and "D" in such proportions that the capital of all partners shall be equal. It is agreed by all parties that the value of the goodwill is $15,000, which has been created during the period of the partnership, and which amount it is decided should be set up on the books. (a) Construct trial balance as at July 1; (b) prepare Journal entries indicating the necessary adjustments; (c) prepare a Profit and Income Statement for six months ending June 30; and (d) prepare a Balance Sheet as of July 1 after the withdrawal of "A" and the entrance of "D." (111., Dec., 1917.) 10. (a) The X Y Z company established for ten years has a machinery and equipment account which has been increased from year to year as new equipment purchases have been made. It appears also that certain renewals and repairs have been charged to this account. Each year a credit has been made to the account for depreciation, offset by correspond- ing debit to profit and loss account, the ratio of depreciation being ade- quate. The company now disposes of a part of its plant at a price equal to what was paid for it seven years previously and credits the entire amount to machinery and equipment account. What adjustments, if any, are needed to correct the account? (b) The company also has several delivery trucks charged to truck account at cost, against which it has set up depreciation at end of each year by credit to a separate reserve for depreciation of trucks, debiting the amount to profit and loss account. A truck was purchased January 1, 1918, for $4,000. Depreciation has been provided at 20 per cent per annum. On December 31, 1919, the truck is wrecked by collision. $1,000 is obtained from the insurance company and $250 obtained from salvage. What entries are needed to adjust the ledger accounts'? (A. I. of A., Nov., 1920.) 308 C. P. A. ACCOUNTING ]1. (a) Determine the average life of the following fixed assets belong- ing to the Western Hardware Company : Assets Cost Estimated Scrap Value Estimated Life in Years Buildings $100,000 $35 000 20 Machinery. ... 70 000 25 000 15 Tools 20,000 5.000 10 Patterns .... ... 10 000 8 (b) After determining the average life of the fixed assets, state the amount of annual depreciation by the straight-line method. A. I. of A., May, 1921.) 12. A company has acquired machinery, which cost $100,000, which it expects to be able to u: ; e for 10 years. The scrap value at the end of that lime i.s estimated at .^25,000. A bond issue of $75.000 due in 10 years, bearing 6 per cent interest and secured by a mortgage on the machinery, was floated at 98 soon after the purchase of the machinery. The trust indenture requires that at the end of each year, before the payment of divi- dends, a sum shall be set aside and charged against earnings sufficient to prove a sinking fund on a 5 per cent basis for the redemption of the bonds at maturity. The president of the company is in favor of providing a reserve for depreciation on the machinery by the sinking-fund method, using 5 per cent as a basis, although he does not advocate creating a replacement fund for the machinery as well as a sinking fund for bonds. (a) Compute the amount of the annual contribution to sinking fund for the redemption of the bonds. (b) Set up a table showing the accumulation of the fund, on the as- sumption that it earned exactly 5 per cent. Also indicate the annual entries for the sinking fund and for the sink- ing-fund reserve. ( 1.05 ) 10 = 1.62889463. (A. I. of A., May, 1921.) CHAPTER XVI MANUFACTUPxING ACCOUNTS Nature and Function of Cost Accounting Cost accounting is that specialized application of the principles of accounting that results in the collection of the data used to determine the cost of producing a unit of product in a factory. 1 It is possible to obtain from the general books certain ideas as to the manufacturing costs, but it is quite impossible to obtain from the general accounts the cost of a particular unit of product in case more than one kind of article is turned out. Cost finding, the method used in determining in advance what the cost of an article should be under existing conditions, must not be confused with cost accounting, the method of determining costs while the article is being produced. 2 The purposes of cost accounting are: (a) to determine the cost, or the profit on each unit of product, (b) to determine the profitable lines for manufacture, (c) to secure accurate and perpetual inventories, and (d) to secure information necessary to lay down wise managerial policies. 8 Components of Cost Data The ordinary manufacturing concern natu- rally divides itself into three parts : a fabricating section, an administrative section, and a selling section. Each of these sections has its own charges to contribute to the final cost of the product placed in the hands of the pur- chaser. The fabricating section, however, has three kinds of charges quite different in nature, namely, material, direct labor, and overhead. 4 Upon the addition of each of these various classes of expenses to the value charged against the product, a new kind of cost is secured, as shown in the follow- ing chart 5 : Material Direct Labor Factory Overhead Selling Expense General Expense Prime Cost Factory Cost Selling Cost . .Total Cost. . The outlays with which cost accounting is concerned include the charges necessary to put the product through the factory. 6 The analysis of factory expenses demands an understanding of the terms "direct" and "indirect" 'For explanation of superior figures see page 337. 309 310 C. P. A. ACCOUNTING as applied to labor. The cost of direct, or productive, labor is the charge for services rendered directly at the tool-point in the fabricating process. 7 The cost of indirect labor is the outlay necessary to the conduct of plant, but is not directly chargeable to certain specific units of product, as the salaries of foremen, of timekeepers, and of repairmen. 8 The usually accepted cost of raw materials is the invoice price plus in- freight. This cost, added to the cost of direct labor, makes up the prime cost.* Manufacturing expense, or factory overhead, includes such charges as taxes, insurance, maintenance and depreciation of factory buildings and machinery, power, heat, light, superintendence, and other indirect labor, and miscellaneous supplies. 10 Relation of Cost to General Accounting General accounting is the rec- ord of facts involving the economic relationship of the manufacturer to the world at large, while cost accounting is the record of facts involving the internal relationship of the various cost elements and production depart- ments. General accounting is fiscal in its nature, while cost accounting is statistical. General accounting shows the net profit made on the business as a whole, while cost accounting shows the net profit made on each oper- ating department, job, contract, or class of product." Cost accounting is not a system per se to be set aside and distinguished, as we distinguish single entry and double entry as bookkeeping "systems" ; it is rather the application of double entry principles for the purpose of determining unit cost in manufacturing." The manufacturing accounts are controlled by certain accounts in the financial books. 13 This control may be accomplished by either of two gen- eral methods. Under the first, a general ledger account, termed "factory ledger," is debited with all charges against manufacturing operation and credited with all products coming from the factory." A similar account in the factory ledger is used, bearing the name "general ledger," the entries to which are contra to those in the factory ledger account in the general books." The second method is to carry in the general ledger several ac- counts by means of which the cost accounts are controlled. Such general ledger accounts would be "productive labor," "raw materials," "factory ex- pense," "goods in process," and "cost of sales." 16 Wherever practicable, the factories are divided into departments, and departmental accounts are set up." The advantage of having separate de- partmental accounts for rent, depreciation, power, etc., can readily be seen from the fact that one department may have little machinery and a large amount of floor space, while another department may have very little floor space and very costly machinery. Comparison of Cost and Non-Cost Systems In order to illustrate the difference in the operation of the accounts under cost and non-cost systems, journal entries covering the various classes of transactions under the two systems will be tabulated and posted to the accounts given in a starting balance sheet, which is the same under both systems, and then trial balances and financial statements will be drawn up for the accounts under each system. MANUFACTURING ACCOUNTS 311 JOHN KAY MANUFACTURING COMPANY INITIAL BALANCE SHEET Assets Cash $3,000.00 Accounts Receivable 2 , 000 . 00 Raw Materials 6,000. 00 Finished Goods 7,000.00 Goods in Process 3 , 000 . 00 Plant and Equipment 75,000. 00 $96,000.00 Liabilities and Capital Accounts Payable $4,000.00 Bonds Payable 30,000. 00 Capital Stock 50,000. 00 Surplus 12,000.00 $96,000.00 JOURNAL ENTRIES Under Non-Cost System : Under Cost System : When purchases of raw materials are made: Raw Materials. $50,000.00 Accounts Raw Materials. $50,000.00 Accounts Payable. . . $50,000.00 Payable. . . $50,000.00 When raw materials are requisitioned: (No entry) Goods in Pro- cess $45,000.00 Raw Mate- rials $45,000.00 When productive labor is paid: Goods in Pro- cess $30,000.00 Cash $30,000.00 Productive Labor $30,000.00 Cash $30,000.00 Factory Ex- pense Cash . . (Not done) When factory expense is incurred: Factory Ex- pense $10,000.00 Cash $10,000.00 Salesmen's Salaries $2,500.00 Advertising 1,000.00 Office Expense . Legal Expense. Cash . . $10,000.00 $10,000.00 When factory expense is prorated over jobs: Goods in Pro- cess $10,000.00 Factory Ex- pense $10,000.00 When operating expenses are incurred: Salesmen's Salaries $2,500.00 Advertising 1,000.00 Office Expense . 3,000.00 Legal Expense. 500.00 Cash. . Interest Ex- pense Cash. . (No entry) 3,000.00 500.00 $7,000.00 When non-operating expenses are incurred: Interest Ex- $2,000.00 pense Cash.. $2,000.00 $2,000.00 When work in process is completed: Finished Goods $80,000.00 Goods in Pro- $7,000.00 $2,000.00 cess. $80,000.00 312 C. P. A. ACCOUNTING JOURNAL ENTRIES Continued Under Non-Cost System: Under Cost System: When sales are made: Accounts Re- ceivable.. .$125,000.00 Sales $125,000.00 Accounts Re- ceivable.. .$125,000.00 Sales $125,000.00 When non-operating profits are made: Cash $1,000.00 Interest Earned. . Accounts Pay- able $45,000.00 Discount on $1,000.00 Cash $1,000.00 Interest Earned. . When creditors are paid: Accounts Pay- able $45,000.00 Discount on Purchases. $2,000.00 Purchases. Cash 43,000.00 Cash When customers settle their accounts: $1,000.00 $2,000.00 43,000.00 Cash $105,000.00 Accounts Re- ceivable. . . $105,000.00 (No entry) Cash $105,000.00 Accounts Re- ceivable. . . $105,000.00 When cost of sales for period is determined: Cost of Sales. . . $75,000.00 Finished Goods $75,000.00 TRIAL BALANCES Non-Cost Cost Cash $17,000.00 22,000.00 56,000.00 3,000 00 $17,000.00 22,000.00 11,000.00 8,000 00 Accounts Receivable Raw Materials Goods in Process Finished Goods 7 000 00 12,000 00 Plant and Equipment 75,000.00 75,000.00 Productive Labor 30,000.00 nil nil 75,000.00 2,500.00 1,000.00 Factory Expense 10,000.00 nil 2,500.00 1,000 00 Cost of Sales Salesmen's Salaries Advertising Office Expense Legal Expense 3,000.00 500.00 2 000 00 3,000.00 500.00 2,000 00 Interest Expense Accounts Payable $9,000.00 30,000.00 50,000.00 12,000.00 125,000.00 1,000 00 $9,000.00 30,000.00 50,000.00 12,000.00 125,000.00 1,000.00 2,000.00 Bonds Payable Capital Stock Surplus Sales Interest Earned Discount on Purchases . . . 2,000 00 $229,000.00 $229,000.00 $229,000.00 $229,000.00 MANUFACTURING ACCOUNTS 313 From the above it can be seen that the non-cost ti-ial balance can be turned into the cost system trial balance by the following journal entry : Goods in Process $5,000.00 Finished Goods 5,000.00 Cost of Sales 75,000.00 Raw Materials $45,000.00 Productive Labor 30,000.00 Factory Expense 10,000.00 The above credit items, totaling $85,000, represent the total manufactur- ing cost charged to goods in process. Of this, $80,000 represents the pro- duction costs of goods in process completed during the period and trans- ferred to the finished goods account, and the remaining $5,000 represents the amount added to the inventory of the goods in process. Of the $80,000 charged to the finished goods account, $75,000 represents the production cost of the goods sold that was transferred from the finished goods account to the cost of sales account, and the remainder represents the amount added to the finished goods inventory. Before a financial statement can be made from the non-cost trial bal- ance, the inventories must be ascertained. The inventories are : raw ma- terials $11,000, goods in process $8,000, and finished goods $12,000. It will be noted that these inventories are the balances of the respective accounts in the cost system trial balance. 18 The balance sheet is the same for both systems of accounting, so the following statement will be the balance sheet that would be obtained from both trial balances : JOHN KAY MANUFACTURING COMPANY FINAL BALANCE SHEET Assets Cash $17,000.00 Accounts Receivable 22 , 000 . 00 Raw Materials 11,000.00 Goods in Process 8,000.00 Finished Goods 12 , 000 . 00 Plant and Equipment 75 , 000 . 00 $145,000.00 Liabilities and Capital Accounts Payable $9 , 000 . 00 Bonds Payable 30,000. 00 Capital Stock 50,000. 00 Surplus 56,000.00 $145,000.00 As cost accounting is merely an addition to financial accounting, which by internal adjustments shows the cost of the goods manufactured, the profit and loss statements on page 314 show that the statements obtained from the cost and non-cost trial balances are identical, after the gross profit on sales has been obtained. Kinds of Cost Systems The particular cost system established, the method of control, and the accounts used must depend upon the type of business. The collection of costs is dependent upon the manner in which articles proceed through the processes of manufacture. Where a prac- 314 C. P. A. ACCOUNTING tically steady flow of material is put into operation and goes uninter- ruptedly through the plant to turn out a uniform product, one lot of material following another without relation to a particular order or article, the "product or process system" of calculating costs is used; 1 ' and where unlike orders are put through the plant, each having its own special list of material and method of processing, costs are collected upon each order or "job," under the "special order system." 20 JOHN KAY MANUFACTURING COMPANY PROFIT AND LOSS STATEMENT (DATE) Under Non-Cost System Under Cost System Sales $125 ,000 $125 ,000 Cost of Sales: Raw Materials: Initial Inventory and Purchases $56,000 Final Inventory 11 ,000 $45,000 30,000 10,000 Productive Labor Factory Expense Goods in Process: Final Inventory $8 ,000 3,000 $85,000 Initial Inventory 5,000 Finished Goods: Final Inventory $12 ,000 7,000 $80,000 Initial Inventory 5,666 75,000 75 ,000 Gross Profit on Sales $50 ,000 $50 ,000 Operating Expenses: Selling Expenses : Salesmen's Salaries $2 ,500 1,000 $2,500 Advertising $3,500 1,000 $3,500 General Expenses: Office Expense $3,000 500 $3,000 500 Legal Expense 3,500 7,000 3,500 7,000 Net Profit on Sales $43,000 $43 ,000 Non-operating Items: Income : Discount on Purchases... Interest Earned $2,000 1,000 $2 ,000 $3,000 2,000 1,000 1,000 $3 ,000 2,000 Expense : Interest Expense 1,000 Net Profit for Period $44 ,000 44 000 $44 ,000 44 ,000 Appropriation of Profits: Surplus MANUFACTURING ACCOUNTS 315 There are also two general methods of applying costs over the product, known as the "productive labor method" and the "process method."" 1 Under the first name, the costs of labor (figured by hours or by wages) and of material are charged against the product or order direct, and to this total is added a pro rata share of the indirect expenses, determined by the amount, or the time of the productive labor used to produce that product or order, the grand total being manufacturing cost. 22 Under the ''process method," all charges are made against the various processes or operations, and the total cost so ascertained is then distributed over the product on a convenient basis weight, number, or measure, according to the nature of the product. 23 A specialized form of the "process method" of distributing expenses, applicable where the greater part of the processing is done by machines, is called the "machine cost method." 24 All indirect expenses having been calculated for a given period, each element of the total is charged against various machines or groups of machines, according to the floor space or some other equitable basis, so that the grand total of manufacturing ex- pense for the period is charged to all the machines in the plant. 25 Usually the unit of measurement taken is the "machine hour"; that is, the total charge against a machine is divided by the number of hours of running time of the factory over the period considered. 28 Product is then charged and the machine credited with the machine's hourly burden rate multi- plied by the number of hours the machine works. If the machine fails to run full time, it will have a debit standing against it at the end of the period. 27 This debit is due principally to idle time, and is ordinarily absorbed by a "supplementary rate" added to the product, sufficient in size to cover the deficiency. 28 Combinations of the two systems of collecting costs and the two methods of distributing them produce the four general types of cost accounting systems: (a) special order system, distributing indirect expense by the productive labor method; (b) special order system, distributing by the process or machine cost method; (c) product system, distributing by the productive labor method; (d) product system, distributing by the process or machine cost method. 29 One or the other of these types can be used in any factory. The choice between the special order and the product systems depends on the nature of the product, uniformity being required for the successful operation of the product system. 30 The method of distributing factory burden should be chosen according to the importance of labor and machinery in produc- tion. Factories, where labor is the predominating element, should use the direct labor method as the basis of prorating burden, while those where expensive and complicated machinery predominate should use the process or machinery cost method. Control of Material When material is received, checked, and delivered into storage, record of the transaction is made both in the financial books and the cost records. 31 In the financial books, the entry is usually made in the voucher register, debiting raw materials and crediting vouchers pay- 316 C. P. A. ACCOUNTING able. 82 In the cost records, the individual items are entered in a stores ledger, wherein an account is kept with each item of stock. 33 The stores ledger thus carries the particulars of the materials account carried in the general ledger. 34 The effect of the issue of materials from the store room to be put into production is a debit to the goods in process account and a credit to the materials account. 38 If any of the material so issued is later returned to stock, a reverse entry is used to cover the transaction.* 9 The charge for materials, which is to be entered against a specified unit of product, is obtained by the use of a lot number or job number. The requisition ticket, bill of material, or other paper, which authorizes the removal of material from store rooms, contains a space in which is placed the number against which they are to be charged. 37 The various amounts chargeable against a certain job are later assembled on a cost sheet. 38 The individual records of raw materials show the balances which should be on hand. 38 The balance of the raw materials account shows the money value of these materials, 40 which the stores records usually carry both by number and value. 41 The stores records should be compared with physical counts made independently of the materials records. 42 In this way there are three sources from which a careful scrutiny of materials may be made, viz., the control account in the financial books, the stores ledger accounts, and the physical inventory. Control of Labor Costs The purposes served by a proper accounting for labor are three: (a) the measuring of the relative efficiency of labor as to production value; (b) the discovery of means of increasing produc- tion and lowering costs; and (c) the determination of a basis for distribut- ing overhead expenses. The charges for labor are secured originally from a time-card or time- ticket which shows the operator, the operation, the time worked, and the job or lot to which the cost is chargeable, also whether the labor is to be classed as direct or indirect. 43 Wage Systems The more commonly employed plans of paying wages are as follows: (a) Day Rate. A flat rate per day regardless of output. 44 (b) Piece Work. A flat rate per unit of output. 45 (c) Differential Rate. A rate per unit of output, which increases when output is increased. 4 * (e) Premium Plan. A flat rate per hour plus extra pay for time saved; the time saved equals difference between standardized and actual time. 47 (f) Bonus Plan. A rate per hour which increases when output is in- creased. 48 (g) Stint Plan. A flat day rate, with privilege of going home when the assigned day's work is completed.* The above mentioned plans contain the main points of divergence, but there is a large number of combinations of systems. For instance, Santa Fe efficiency plan 50 has a standardized output which is regarded as 100 MAN [JFACTTJRING ACCOUNTS 317 per cent efficiency, all other outputs being scaled as percentages of efficiency. The workmen are paid by the hour, the hourly rate consisting of a guaranteed flat amount plus an additional amount which varies according to the efficiency of the workmen. Thus the Santa Fe plan com- bines the day rate plan and a rather complicated bonus plan. Control of Manufacturing Expense As it is not practicable to ascertain the exact amount of the manufacturing expenses that have occurred during the time a given job or order is in process, some sort of estimate is made to cover the job. Distribution of expenses over product may be made upon any number of the following bases: (a) cost of productive labor,' 1 (b) cost of direct materials, 62 (c) prime cost, 83 (d) hours of labor spent, 9 * (e) units of product, 65 and (f ) machine hours. 68 The use of each of these methods is indicated in the following table : Last Year Factory This Year Job No. 6 COST OF JOB UNDER VARIOUS METHODS OF PRORATING BURDEN Labor Cost Material Cost Prime Cost Labor Hours Units of Product Machine Hours Material Cost. . . . Labor Cost $10,000 $16,000 $14,000 56,000 42,000 10,000 $1.00 $1 . 60 1 (?) 6 4 1 * $1.00 1.60 |1 . 40a $1.00 jl.60 1.406 $1.00 1.60 1.40c $1.00 1.60 1.50d $1 . 00 1.60 1.40e $1.00 1.60 1.33/ Burden Cost. Labor Hours Machine Hours . . Pieces Made $4.00 $4.00 $4.00 $4.10 $4.00 $3.93 a. (14,000 b. (14,000 c. (14,000 16,000) X $1.60 10,000) X$1.00 26,000) X $2.60 d. ($14,000 -T- 56,000) X 6 e. ($14,000 -f- 10,000) X 1 /. ($14,000-7-42,000) IX 4 By-Products A by-product is a secondary commodity of value inci- dental to the manufacture of the primary product of a factory." Where no direct labor is applied, after the separation from the main product, the by-product is classed as waste, or scrap, or offal, and is disposed of at the best going price obtainable, the amount realized therefor being credited to the material account involved, if both the primary and secondary ma- terial are clearly denned. When, however, the practice is to accumulate varying percentages of waste of a given kind and grade, such as borings, turnings, etc., and no economic purpose would be served by the application to material costs of such salvage prices obtained, then the credit is passed to the ovei'head accounts of the departments contributing such secondary commodities. In the latter case, statistics are compiled and the volume of waste for given periods is compared with the volume of raw material put into process. 318 C. !'. A. ACCOUXTIXd Where direct labor is applied, the secondary commodity is called a by- product. No fixed rule for all classes of production can be formulated as to the basis for levying charges and passing credits for by-products, but each ca-e must be governed by physical conditions. Where such by- product is of comparatively small consequence, the cost involved can be based on percentages secured by careful tests. On the other hand, where the by-product is an important feature and where the raw material in- volved is subject to speculative market conditions, the by-product portions thereof will in like manner usually reflect market conditions. In such cases, it is customary to use current quotations for the scrap, as such, in crediting such scrap or by-product material, to the primary raw material account. This method is fair to both the primary and secondary product departments, where each has its own problems to contend with and its own profits to earn. The cost of direct labor, materials, and manufacturing overhead used in producing by-products, is debited to the by-products account, and the cost of the by-products sold is credited to the by-products account 58 and debited to the sales of by-products account. 58 The income from the sales of by- products is credited to the sales of by-products account 80 and the balance of this account is shown in the profit and loss statement either as non- operating income 81 or as an item to be shown separately and then added to the ordinary sales. The latter method seems preferable as the sales of by-products appear to be operating items. Inventories The rules given in Chapter XIII for the valuation and verification of merchandise inventories should be used in the valuation and verification of the inventories of the raw materials, goods in process, and finished goods. The inventories should be valued at cost or market, which- ever is the lower, cost meaning for the raw materials the invoice price plus freight-in, and other expenses incurred in placing the goods in the store room, 62 and for goods in process and finished goods, the cost of the ma- terials and labor expended thereon plus a proper share of the manufactur- ing overhead. 63 The dispute as to whether interest is an element of manu- facturing overhead does not extend to the inclusion of interest in the price of inventories of goods in process and finished goods, as the advocates of including interest as a cost reduce the inventory valuations to prices ex- clusive of the interest element. In cases when a cost system is maintained, the auditor should leave the inventory prices at the cost figures, as any excess of the cost over the market values should be shown in a reserve for inventory fluctuations, which reserve should be deducted on the balance sheet from the inventories valued at cost. 94 Perpetual inventories should be tested, and, if any material discrepancies are found, they should be investigated. 65 The adequacy of the cost of the system should be examined, and, if the system is faulty, the methods of calculating the prices quoted on the inventories should be cai-efully scrutinized. 88 MANUFACTURING ACCOUNTS 319 QUESTIONS MANUFACTURING ACCOUNTS GENERAL 1. What is understood by "cost" or "factory" accounting? (N. Y., Dec., 1898; Wash., Sept., 1907; Va., Nov., 1910.) 2. State your opinion as to the relative advantages and disadvantages of a modern system of cost account ing for a manufacturing business. (Mass., June, 1913.) 3. How many functions are contained in the business of a manufac- turer? (Minn., Oct., 1916.) 4. What are the main purposes in keeping cost accounts? (Mass., Oct., 1915*; Cal., Nov., 1916; Cal., June, 1917.) 5. Name the principal elements of manufacturing cost. (N. Y., Dec., 1898*; Pa., Nov., 1899*; N. Y., June, 1901*; Pa., Nov., 1903*; Pa., Nov., 1904*; Mich., July, 1906*; Wash.. Sert., 1907*; Ohio, March, 1910*; Va., Oct., 1911*; Cal.,' Nov., 1916*; Cal., June, 1917*; Ohio, Oct., 1919.) 6. In determining the cost. of manufactured goods, what are the ele- ments of indirect expenditures which should be included? Give your reasons. (N. Y., Jan., 1920.) 7. What information would be required by a manufacturer in order to determine the price at which he can afford to sell an article? (Mass., Oct., 1915*; Minn., Oct., 1916; Cal., June, 1917.*) 8. State wherein manufacturing or factory costs differ from commer- cial or selling costs. (Pa., May, 1900*; N. Y., June, 1908*; Va., Nov., 1910.) 9. Define the following terms as used in factory accounting: Store- keeper, general charges, writing off. (N. Y., Jan., 1901.)' 10. Define: Storeroom. (Mich., June, 1908.) 11. Define: Stores. (N. Y., Jan., 1901; Mich., June, 1908.) 12. Define: Cost of production. (N. Y., Jan., 1901 ; Mich., June, 1903; Fla., July, 1909.) 13. Define: Shop cost. (Mich., June, 1908; Fla., July, 1909.) 14. Define: By-product. (N. Y., Jan., 1911.) 15. What constitutes selling cost? (Pa., Nov., 1904; Mich., July, 1906; Va., Oct., 1911.) 320 C. P. A. ACCOUNTING 16. Define: Prime cost. (N. Y., Jan., 1901; Mich., June, 1908; Fla., July, 1909; Cal., Nov., 1916.) 17. Define: Warehouse. (Mich., June, 1908.) 18. Name and define five accounts peculiar to a manufacturing cor- poration. (Cal., Nov., 1916.) 19. What books and records are essential to the use of the double-entry system in a manufacturing business? Give list and description. (Mich., July, 1909.) 20. What accounts are generally opened to ascertain the cost of the details included in operating expenses of manufacturing? (Pa., May, 1902; Pa., Nov., 1904.*) 21. Define cost accounts of a manufacturing business and state what information they furnish. (N. Y., June, 1908.) 22. Define: Departmental accounts. (Wash., June, 1915.) 23. In what manner, if any, will cost accounts differ from results ob- tained in general books? Explain fully. (Pa., Nov., 1904.) 24. State generally how the books of a firm doing a manufacturing business would differ from those kept by a trading concern as to (a) books of record; (1) Ledger accounts. *^N. Y., Jan., 1902.) 25. Name any three important accounts carried in the financial books of a manufacturing company, which are directly connected with the con- trol of a complete cost system and briefly explain each account. (Mass., Oct., 1914.) 26. Select some manufacturing business with which you are familiar and illustrate the accounts you would use in a cost system, and how you would prove their correctness at the end of the fiscal period. (Mass., June, 1912.) 27. How would you classify the accounts in preparing a statement of a manufacturing business? (N. Y., June, 1901; Mich., July, 1906.) 28. A company engaged in the manufacture and sale of products, de- sires a separation of their expenses under proper divisional or department heads. Illustrating, make you own selection of some manufacturing busi- ness, and prepare classification of accounts. What ledger headings would you use? (111., Nov., 1904.) 29. What js shown in the Cost Books? (N. Y., Dec., 1898.) 30. Mention four items of information in addition to those usually shown in the books of a mercantile business, which should appear in a set of books for keeping the accounts of a factory. Give reasons for your answer. (N. Y., Jan., 1901.) 31. What is a Cost Book? (Pa., Nov., 1899.) 32. Show the method and the advantages in cost accounting of the process of articulating the General Ledger, Factory Ledger, and Stores Ledger by summary accounts. (N. Y., Jan., 1911; Wis., April, 1914*; Mo., Dec., 1914* ; Mass., Oct., 1917.*) MANUFACTURING ACCOUNTS 321 33. What value has a Cost Book in connection with the general books? (Pa., Nov., 1903; Wash., May, 1911.) 34. (fl) What are the respective functions of the Cost Ledger and the General Ledger? (b) How should the said ledgers be harmonized or reconciled with each other? (Wash., March, 1909.) 35. Define: Cost Sheet. (N. Y., Jan., 1919.) 36. State the aim and object of a Cost Sheet. Give an example from a business of your own choosing. (111., Nov., 1908.) 37. State what is meant by a Cost Sheet, showing its advantages and how it is made up. Give a form of Cost Sheet for some manufacturing business with which vou are familiar. (N. Y., Dec., 1897; Pa., May, 1900*; Wash., May, 1903; W. Va., May, 1917.) 38. Design a combined Production Order and Summary of Cost form for any business with which you are familiar. (Md., Dec., 1917.) 39. (a) Differentiate between waste and shrinkage as found in manu- facturing plants. In cost accounting: (b) state three methods of treating waste; (c) state two methods of treating shrinkage; (d) state three meth- ods of treating defective goods. (Wis., May, 1916.) 40. Discuss the treatment of idle time in Cost accounts. (Wis., May, 1916*; A. I. of A., June, 1917; Wis., May, 1919.) 41. What do you understand is meant by the "machine rate" system of cost accounting? How is it operated, and in what particulars does it differ from any other system of accounting ? (Wash., May, 1911.) 42. Name some of the general methods of applying costs in a factory. Describe briefly. (Ind., Nov., 1917.) 43. Are working or job orders covering a company's expenditures on its own account of any value to the auditor when examining the general books? (111., May, 1904.) 44. Discuss the peculiar problems encountered in factory cost account- ing, briefly outlining the methods of treating with same. (Kan., Dec., 1915; Mo., Dec., 1915.) 45. (a) Explain the difference between cost accounting and cost finding. (b) Which is preferable, and why? (Wis., April, 1914.) 46. The United States Government, through the Federal Trade Com- mission, is investigating many lines of business and is "fixing costs." Select some business with which you are familiar and state what infor- mation you would require to assist in fixing costs in fairness to all con- cerned. (Mass., Oct., 1917.) 47. (a) Grive a general definition of costs, (b) What are the four requirements of cost finding? (c) What is understood by "cost plus" contract? (d) What is the Government ruling as to "defective work" aa applied to cost plus contract? (e) How may information be compiled to support direct labor costs? (Iowa, Dec., 1918.) 48. Describe a cost system with which you are familiar, covering de- 322 C. P. A. ACCOUNTING tails, and give your views as to its correctness, or otherwise, and its bearing upon the general books. (Pa., May, 1900*; Md., Jan., 1909.) 49. Mention the principles that are involved in cost accounting and state what should be accomplished by properly applying and executing them. (N. Y., June, 1909; Wash., May, 1910*; Mich., Dec., 1914.*) 50. Outline a system of cost accounts with which you are acquainted. Classify the accounts in their sequential order. (Wash., April, 1906; Fla., July, 1909.*) 51. In designing a cost system for a manufacturing business, what fundamental principles are necessary to maintain? (N. C., June, 1916.) 52. What do you consider the important features of a modern adequate system of accounting for a manufacturing concern? (111., May, 1908.) ?>3. Would you recommend that monthly cost department statements of a manufacturing concern be incorporated in the financial books or otherwise? Give reasons for your answer. (Mass., June, 1913.) 54. Prepare a chart of accounts of a manufacturing business making and selling three distinct classes of goods. Using this chart, explain how profits are traced from group to group until they reach the Surplus account. (Mich., June, 1912.) 55. Lay up a complete administrative chart for a large manufacturing concern to show the different departments and departmental heads, from the board of directors down, so as to place responsibility, indicate con- trol, and to show to whom reports should be made. (Mich., June, 1912.) 56. State as concisely as possible a proper system of factory cost accounts. (N. Y., June, 1906.) 57. Describe briefly at least four different types of cost accounting systems and give a sufficient illustration of each clearly to identify the types. (Wis., May, 1919.) 58. You are engaged to install a complete factory cost and accounting system in a large manufacturing plant. Describe the various steps in the handling of such a proposition and show by charts the accounts (prop- erly grouped, etc.) of the departments (productive and nonproductive), logically arranged, and give a list of the various forms, etc., that would be required to record the factory operations intelligently to handle them from an accounting viewpoint as an integral part of the accounting system. (Mich., July, 1909.) 59. In making an examination of the accounts of a manufacturing company, you criticize the method of handling invoices for incoming goods and payments therefor and are then requested by the management to outline a plan which will overcome your objections and provide the com- pany with a proper internal check. Submit to them your recommenda- tions in the matter, dealing successively with all steps from the time the need for the goods is apparent to the time of paying the invoice, explain- ing fully the different forms or advices that should be prepared, their origin and disposition, how the accounting department would be satisfied MANUFACTURING ACCOUNTS as to the correctness of the invoice, and how the officers would be satisfied as to the propriety of the payment before signing the check. (111., May, 1915.) 60. Making your own selection of a manufacturing industry conducted on a large scale, outline a complete cost system, showing clearly the prin- cipal productive departments jind briefly describing their functions. On what basis, if at all, would you distribute to each of the departments you have named the following elements of overhead: (a) Purchasing depart- ment expense; (&) accounting department expense; (c) executive salaries; (d) heat and light; (e) power; (/) inward freight and handling charges; (g) advertising? (Pa., Nov., 1919.) 61. A manufacturing concern has been operating for a period of nine months, but owing to incomplete development of the plant the production during that period was greatly below the capacity and the cost of pro- duction consequently abnormal. The directors are anxious to obtain a statement not only showing the result of operations for the nine months, but one which would be fairly indicative of what the results would have been had conditions been normal. Assuming that the actual time lost on account of the frequent stoppages amounted in the aggregate to four months, would the auditor be justified in furnishing the latter statement as well as the former, and if so, how would you proceed to show the desired results from the following items? Manufacturing materials . . $39,865 . 69 Taxes Freight 5,489 .22 General Productive Wages 8,827 .84 Sales Non-productive Labor .... 4,441 .73 Finished Salaries 6,877.29 and Interest $1,398 . 59 " Expenses 6,537 . 14 42.363.33 goods at cost .... 7,346.45 (Mich., June, 1910*; Mich., Dec., 1913.) 62. A manufacturer produces 100 different kinds of goods for sale and for each kind he has a formula or unit cost. Detailed records are kept of sales, returns and allowances, name and quantity of each kind of goods sold. He wishes to know at the end of the fiscal year the net sales of each kind and the profit thereon, (a) How would you ascertain the information desired? (6). How would you prove the profits thus ascertained? (Mass., Oct., 1915.) 63. Discuss the practicability, or otherwise, of installing a uniform cost system in a given line of manufacturing, as, for instance, furniture manufacturing. Outline the basic principles of a cost system for furni- ture manufacturers which you believe could be used by all manufacturing plants, whether large or small, or whether the furniture manufactured was diversified or confined largely to one line of furniture, as, for instance, tables. Submit your answer in report form. (Pa., Nov., 1919.) 64. State what you consider to be the essential principles of cost ac- counting. Give your opinion as to the manner in which a system of cost accounting may effect great savings to a business, either directly or indi- 324 C. P. A. ACCOUNTING rectly. A financier is interested in several businesses of different natures. He instructs you to install a uniform system of cost accounting for all the businesses. State what you would do first in such a case. (111., May, 1916.) 65. What are specification costs? What are their special advantages and disadvantages? (A. I. of A., Nov., 1917; 111., Dec., 1918.*) 66. Explain the various ways of determining the cost of manufactured articles. (Mich., June, 1913.) 67. What different methods have come under your observation of as- certaining the cost of articles manufactured ? Explain each method fully, stating which, in your opinion, is preferable, giving reasons. (Mich., Dec., 1906.) 68. Explain the manner of arriving at the cost of mechanism, the parts of which are made in various departments and brought together in an assembling room, and also discuss the various headings of costs that you would expect to deal with and manner of arriving at same. (111., May, 1904.) 69. Of what value in auditing is a unit of production? (Mass., June, 1912.) 70. In auditing the cost accounts of a corporation, what ultimate object has the auditor in ascertaining the correctness of the cost of production? (N. Y., Jan., 1917.) 71. In auditing the accounts of a manufacturing firm, what salient features of the Cost Ledger should receive attention? (N. Y., June, 1913.) 72. In auditing the accounts of a manufacturing contractor, what manipulations of the cost accounts should the auditor anticipate, to guard against inflating profits? (N. Y., June, 1913.) 73. What common expedient is resorted to by manufacturing contract- ors to hide their losses in the Cost Ledger? (N. Y., June, 1913.) INVENTORIES 74. What is the auditor's responsibility as to the correctness of inven- tories of raw material, goods in process and finished goods as to quantities, prices, and amounts? (N. Y., Jan., 1902*; Mich., June, 1912*; Ohio, Nov., 1915*; Ohio, Oct., 1919.) 75. In the audit of a manufacturer's books, what advantage would there be in preparing a cost statement of the product? (N. C., Nov., 1918*; N. C., June, 1919; N. C., Sept., 1919.) 76. To what extent are you justified in accepting the certificates of officials of a corporation as to raw materials and finished product on hand? (Ind., Nov., 1917.) 77. What points in connection with the inventories of a manufacturing company would you consider as essential to be brought out in estimating the correct profits of the company? Answer fully. (Md., Dec., 1917*; Md., Oct., 1919.) MANUFACTURING ACCOUNTS 325 78. What are the duties of an auditor as to examination of inventories of finished product, product in process, and materials and supplies which have been taken and appraised by representatives of the client in case he is not permitted to make tests for the purpose of satisfying himself as to the integrity of the quantities shown? How should he cover such a situa- tion in his report? (N. Y., Feb., 1909.) 79. What are the special points to which an auditor's attention should be directed in examining and verifying an inventory consisting of raw stock, supplies, goods in process, and manufactured goods? (N. Y., June, 1902.) 80. Write out in detail the general instruction for taking the inventory of raw materials, work in process, and finished goods of a small company manufacturing- automobiles. Show the general divisions that the inven- tory requires and provide against errors in recording the items. (N. Y., June, 1908; Mich., June, 1910.*) 81. What principle in the theory of cost accounting procedure is in- volved in determining the cost of inventories of materials and supplies used or consumed in manufacturing and maintenance purposes, that may not be necessary in determining the cost of merchandise purchased for resale? (N. C., Nov., 1918; N. C., Sept., 1919.) 82. State the general principles to be adopted in valuing the inventory of a concern engaged in selling various articles, some of which it manu- factures and others of which it buys complete. (A. I. of A., Nov., 1917.) 83. Describe the procedure and value of a storeroom audit. (Cal., Nov., 1916.) 84. How is the position of auditor affected if the system of the concern under the audit is defective as to cost methods? (A. I. of A., May, 1918.) 85. When the cost of making a product is known, also the overhead and other expenses and the amount of the sales, what other information would you require to determine the profits and losses in the sale of the product? (N. C., June, 1919.) 86. As an auditor, in what respect would you be concerned with the methods of cost accounting employed by the concern under audit and what steps would you take to verify the correctness of the accounts affected thereby? (Ohio, Nov., 1918.) 87. Discuss fully the proper principles to be observed in the valuation of inventories of partially used supplies on a certified Balance Sheet. (Pa., Nov., 1919.) 88. To what extent do you deem it necessary to verify the following, in order that you may certify to the correctness of a Profit and Loss statement: (a) Materials and supplies; (b) goods in process, and (c) finished goods? (Mass., June, 1912.) 89. In a manufacturing concern which you are requested to audit, you find what appears to be a careful book inventory of raw materials, sup- plies, and work in process maintained, but no physical inventory has 326 C. P. A. ACCOUNTING been made for some years. Would you consider this a satisfactory state of affairs? And if so, on what safeguards would you insist to insure constant accuracy in the records? (A. I. of A., May, 1920.) 90. You have been retained by a manufacturing company as a con- sulting accountant and are requested to advise the officers what steps to take in order to determine the cause of an apparent deficiency in the inventory of factory material and work in process. How would you pro- ceed to inform yourself of the circumstances and what would you suggest as a possible remedy? (A. I. of A., May, 1920.) 91. You are auditing the accounts of the LaPorte Crane Company and ascertain that the inventory at December 31, 1915, is carried in the fol- lowing accounts : Supplies in Store Room $ 75,000 Work in Process Labor and Material only 300,000 Manufacturing Overhead 350,000 Selling Overhead 175,000 You also ascertain the following facts: The actual inventory taken at December 31, 1915, amounted to $50,000. The work in Process Labor and Material only, at December 31, 1914, was valued at $200,000, while the manufacturing overhead at that date was $150,000 and the selling overhead $200,000. What steps would you take to determine the accuracy of the inventories at the date of your examina- tion? (111., May, 1916.) RAW MATERIALS 92. Explain the meaning and use of the Material and Supplies ac- counts. (La., May, 1913.) 93. Briefly outline the principles of cost accounting with reference to accounting for materials and supplies in the factory. (Md., Oct., 1919.) 94. A concern making baskets buys wood lots, stumpage, logs and lum- ber. How would you keep the accounts? (Mass., June, 1912.) 95. A company issues an order for material. From that point on, recite the accounting operations relating to its purchase which a well- organized concern would employ to safeguard its interests until the bill is paid. (111., May, 1914.) 96. Describe the method of maintaining a check upon the materials of a manufacturing plant and of insuring the proper charging out to jobs of the materials used on them. (Wash., May, 1911.) 97. Discuss various methods of pricing commodities withdrawn from storerooms. (Wis., May, 1916.) 98. What, on the books of a company, would lie the proper method of treating cash payments on expenditures for ni:ilo.i-i:t! for manufacturing purposes? (Ohio, March, 1910.) 99. If you should contract for an audit which provided for an exami- MANUFACTURING ACCOUNTS 327 nation of all vouchers, what would you accept as proper vouchers for raw material on hand? (Va., Nov., 1918.) 100. Give a brief outline of the procedure you would adopt to verify the inventory of raw material. (N. Y., Dec., 1897*; Ohio, Dec., 1908*; Ohio, March, 1910*; Mass., June, 1910*; Mich., June, 1912*; 111., May, 1914*; Kan., Dec., 1915; Mo., Dec., 1915; Ind., Nov., 1917*; N. C., June, 1920.*) 101. What test should be made of the prime cost of manufactured goods to guard against loss of raw material through theft by employees? (N. Y., June, 1897; N. Y., June, 1908.) 102. On what basis should the raw material be valued in the prepara- tion of a Balance Sheet? (N. Y., Dec., 1896; N. Y., June, 1898*; N. Y., Jan., 1900*; Pa., May, 1900*; N. Y., Jan., 1902*; N. Y., Jan., 1906*; N. Y., June, 1908* ; Ohio, March, 1910 ; Wis., April, 1914* ; Mass., Oct., 1914*; Wis., May, 1916*; Wis., April, 1918*; S. C., Sept., 1919*; N. C., Nov., 1919.*) 103. A manufacturer stated that he wished to have the market value of raw materials purchased considerably below the market recorded on his books for insurance purposes. What would have been your reply ? (Wis., April, 1918.) 104. In closing the books of a company at the end of its first fiscal year, how would you treat pig iron on hand costing $20 per ton, the market value being $18? (Mass., Oct., 1917.) 105. At the end of the fiscal year a concern inventories its raw material at cost. Do you approve of this method? State your reason fully. (N. Y., June, 1911.) 106. A manufacturing concern buys raw materials in advance for its needs. These are liable to fluctuations. At what prices should they be inventoried? Why? (R. I., Dec., 1907.) 107. Discuss fully the proper principles to be observed in the valuation on a certified Balance Sheet of inventories of raw materials in excess of normal requirements. (Pa., Nov., 1919.) 108. A manufacturing company purchases a large stock of material during the yeai* at low prices, but at time of annual inventory, values had abnormally increased. How in your opinion should inventory and loss and gain be shown on the books? (Mich., Dec., 1916.) 109. In a Balance Sheet audit, how would you verify as to quantities and amounts the inventory items of repair and replacement parts for the concern's product? (A. I. of A., May, 1919.) 110. In auditing the accounts of a manufacturing company, what means should the auditor adopt to satisfy himself as to the inventory of miscellaneous supplies? (Ohio, Dec., 1908.) 111. In what manner would you treat "scrap" as to cost in manufac- turing? Give reasons. (Pa., Nov., 1904.) 112. The Chicago Silversmith Company has a revenue of $10,000 from 328 C. P. A. ACCOUNTING the sale of silver and copper scrap. The sales of the year under review amounted to $300,000 and the material cost was $100,000. How should this scrap revenue be treated: (1) as a sale; (2) as a deduction from material cost; (3) as a deduction from overhead, which was applied on the basis of labor cost; (4) as a miscellaneous revenue; or (5) as a credit to surplus? (111., May, 1917.) 113. A manufacturing company imports its raw materials and pur- chases exchange on Europe for use in payment therefor. How should the exchange account be treated with respect to the cost of production? (N. Y., Jan., 1920.) 114. A manufacturing corporation is obliged to carry at least six months' supply of a special kind of raw material, and because such ma- terial cannot be purchased every day they are obliged to buy when the material is in the market; consequently the prices fluctuate considerably. When purchasing such material the company pays spot cash for it. What method would you adopt to arrive at the cost of the raw material con- sumed monthly in manufacturing? (Pa., Nov., 1911*; N. Y., Jan., 1919.) GOODS IN PROCESS 115. Define: Work in process. (N. Y., Jan., 1911; Wash., Nov., 1913* ; Kan., May, 1916.*) 116. State how you would verify the Stock in Process. (N. Y., June, 1906; Wash., Sept., 1907*; Ohio, Dec., 1908*; Mich., June, 1912*; Kan., May, 1916*; Cal., May, 1916*; N. C., Aug., 1917*; 111., May, 1918; A. I. of A., May, 1919*; N. C., June, 1920.*) 117. If you should contract for an audit which provided for an ex- amination of all vouchers, what would you accept as proper vouchers for goods in process? (Va., Nov., 1918.) 118. How should the partly manufactured goods be valued for use in a Balance Sheet? (N. Y., Dec., 1896*; N. Y., June, 1898*; N. Y., Jan., 1900* ; Pa., May, 1900 ; N. Y., Jan., 1906* ; Wash., Sept., 1907* ; N. Y., June, 1908* ; Ohio, March, 1910* ; Wis., April, 1914* ; Mass., Oct., 1914* ; Del., June, 1915*; Ohio, Nov., 1918*; S. C., Sept., 1919.*) 119. Discuss fully the proper principles to be observed in the valuation on a certified Balance Sheet of inventories of work in process which has produced salable by-products. (Pa., Nov., 1919.) 120. To what extent or under what circumstances could you certify to work in process in the absence of a cost system? (Cal., June, 1!)17.) 121. In auditing the books of a manufacturing concern, you learn that the goods in process have been inventoried at material and labor value only. State how to determine the amount of manufacturing expense that should have been added properly to complete the inventory. (Mich., June, 1910.) 122. In auditing the accounts of a manufacturing company, how would you determine the accuracy of the overhead included in the inventory of work in process? (111., May, 1917.) MANUFACTURING ACCOUNTS 329 FINISHED GOODS 123. Define: Finished product. (Wash., June, 1915; Wash., July, 1917.) 124. State how you would verify the finished products. (N. Y., Dec., 1897* ; N. Y., June, 1900* ; Ohio, Dec., 1908* ; Ohio, March, 1910* ; Mass., June, 1910*; Mich., June, 1912*; 111., May, 1914*; Wash., June, 1915*; Kan., May, 1916*; N. C., June, 1916; N. C., Aug., 1917*; Ind., Nov., 1917*; N. C., June, 1920.*) 125. If you should contract for an audit which provided for an exam- ination of all vouchers, what would you accept as proper vouchers for finished product? (Va., Nov., 1918.) 126. How should the completely manufactured goods be valued for use in a Balance Sheet? (N. Y., Dec., 1896*; N. Y., June, 1898*; N. Y., Jan., 1900*; Pa., May, 1900; N. Y., Jan., 1906*; N. Y., June, 1908*; 111., Nov., 1908*; Ohio, March, 1910*; Wis., April, 1914*; Mass., Oct., 1914*; Cal., May, 1916*; Ohio, Nov., 1918*; S. C., Sept., 1919*; Pa., Nov., 1919.*) 127. How can an auditor satisfy himself that the finished product is listed at proper valuations in a statement of condition? (Mass., April, 1911.) 128. Are there any circumstances where a manufactory might in- ventory finished goods at selling price instead of at cost? (111., Nov., 1903.) 129. If called on to verify the Merchandise account of a manufacturing concern, what steps would you take to make the necessary investigation? (N. Y., June, 1911.) 130. In case of an audit of the books of a manufacturer, how would you verify the figures, furnished by the superintendent, of the quantity produced? (N. C., Nov., 1918; N. C., Nov., 1919.*) 131. In the preparation of a Manufacturing and Trading account and a Balance Sheet, state on what basis the following asset should be valued : Manufactured product. Give fully your reason. (N. Y., June, 1908.) 132. At what price would you carry recently manufactured goods of a factory, assuming the market price to have dropped below cost? (Cal., May, 1916.) 133. The physical inventory of the manufactured stock of a factory, taken December 31, 1908, is considerably less than the balance shown by the perpetual inventory carried on the financial books. When the previous inventory was taken, six months before, the difference was very slight. You are asked what steps should be taken (a) to ascertain the cause of the difference, and (b) to prevent a recurrence of the difference. (Wash., May, 1909; Wash., May, 1911; Mass., June, 1913.*) 330 C. P. A. ACCOUNTING WAGES 134. Briefly outline the principles of cost accounting with reference to reporting and analysis of labor. (Md., Oct., 1919.) 135. Given a plant employing 25 yard laborers at $1.15 per day; 70 mechanics at $2.50 to $3.25 per day; 40 helpers in machine shop at $1.50 per day; 30 molders at $2.75 to $4 per day; 10 helpers and 20 laborers in foundry at $1.50 and $1.25 per day; 25 patternmakers, $3 to $4 per day; 10 helpers in pattern shop at $1.50 per day; 20 foremen and under-bosses, in all three departments. Devise a timekeeping system for these various classes of labor and give your reasons in full for the action you take. (Pa., May, 1906.) 136. Describe in detail the principles underlying the following systems of wages, and their effect on the efficiency of labor in a large plant : day rate, differential piece rate, premium plan, bonus plan, efficiency system. (Mich., July, 1909*; Mich., June, 1914.) 137. Define: Nonproductive labor. (Wash., Nov., 1913.) 138. What classes of salaries and wages should be charged directly against the cost of manufacture? Give reasons. (N. Y., Dec., 1898.) 139. Outline in order the various steps you would take in handling labor tickets. (Mich., June, 1919.) OVERHEAD 140. What is usually meant by burden? (111., May, 1912*; Ohio, Oct., 1919.) 141. Define: Indirect charges. (Mich., June, 1908; Fla., July, 1909.) 142. Define: Nonproductive cost. (N. Y., Jan., 1919.) 143. What do you understand by overhead charges? (Fla., July, 1909*; 111., May, 1912*; Mich., June,' 1913; 111., May, 1915*; Ohio, Oct., 1919.*) 144. What do you mean by accrued manufacturing expense? (Mich., June, 1919.) 145. In cost accounting, what is meant by "on cost"? (Mich., June, 1908*; 111., May, 1912; Wash., June, 1915.) 146. Upon what basis do you consider "on cost" should be calculated? Give reasons. (Wash., June, 1915.) 147. What items can properly be considered as part of "overhead"? (111., May, 1915*; 111., May, 19i7.) 148. Define the following and give a list of expenses which would properly come under each heading: (a) Shop overhead; (b) general over- head. (A. I. of A., May, 1920.) MANUFACTURING ACCOUNTS 331 149. In formulating a Profit and Loss account for a manufacturing concern, in which factory rent is an element, under what classification would you allocate it in order to be economically sound? (Wash., June, 1915.) 150. Is depreciation an element in the cost of production, or should provision therefor be made out of net profits'? Give your reasons. (111., May, 1904*; N. Y., Feb., 1910*; "Vs., Oct., 1912*; Cal., Nov., 1916*; Ohio, Nov., 1916*; Cal., June, 1917*; Ohio, Nov., 1917; Ohio, Oct., 1919.*) 151. Is interest on capital invested in factory of machinery generally regarded as a proper charge to cost of manufacturing? Explain. (Mich., June, 1913*; Mo., Dec., 1914*; N. Y., Jan., 1917*; 111., May, 1917*; Cal., June, 1917*; Pa., Nov., 1917*; Ohio, Nov., 1918; Iowa, Dec., 1918; A. I. of A., Nov., 1919.*) 152. (a) A manufacturing concern owning its own building included interest and rent amounting to $35,000 in its distribution of burden during the year, crediting this amount to income accounts. Assuming that the production of the factory was worth $200,000 at factory cost, and the final inventory of finished goods amounted to $50,000, what changes, if any, would you make in the valuation of the inventory? (b) If the $35,000 had been actually expended for interest and rent during the year, what difference, if any, would that make in your pro- cedure? Give reasons for the position you take. (Wis., May, 1916.) 153. Explain what is meant by distribution of overhead. (N. Y., Jan., 1916.) 154. Briefly outline the principles of cost accounting, with reference to distribution of "overhead" expense. (Md., Oct., 1919.) 155. Overhead factory expense is computed on the hour basis in a paint shop with skilled labor. How would such application affect costs? (Wash., June, 1915.) 156. Show how the appropriateness of each system of distributing overhead burdens in cost accounting may be affected by the nature of the business in which it is employed. (A. I. of A., June, 1917.) 157. Two manufacturing companies pay rent for their factories, though one company pays twice as much rent as the other; in all other respects the cost of the production is the same. What effect should such rents have on the unit cost? (N. Y., June, 1917.) 158. A manufacturing corporation carries on its books an unapplied balance of overhead expense, which it adds to the inventory when closing the accounts. Is this correct in principle? Explain. (N. Y., June, 1917.) 159. Name the various methods of distributing "Factory Expense" or "Factory Burden," so as to apportion same to the cost of the article or articles manufactured, stating advantages of each in various kinds of business. (111., May, 1007; Md., Jan., 1909*; 111., May, 1909*; Va., Nov., 1910*; Mass., April, 1911*; 111., May, 1912; Mich., June, 1912*; 332 C. P. A. ACCOUNTING N. Y., June, 1913*; Mich., Dec., 1913*; Wis., April, 1914*; 111.. May, 1914*; 111., May, 1915*; N. Y., Jan., 1916*; Mass., Oct., 1916*; CaL, Nov., 1916*; CaL, June, 1917*; A. I. of A., June, 1917*; N. D., Aug., 1917* ; Mass., Oct., 1917* ; Md., Dec., 1917* ; A. I. of A., May, 1918* ; Ga., May, 1919*; Mich., June, 1919*; Ohio, Oct., 1919*; A. I. of A., May, 1920*; N. C., June, 1920.*) 160. Name and explain the various methods by which cost accounts may be handled, bringing out clearly, among other items, the difference between the specific order plan and the process plan. (Mich., June, 1919.) 161. Discuss at least two theories of accounting for unearned burden in a cost system. (Wis., Nov., 1919.) 162. Design a form for recording the distribution of the various items of estimated factory burden over three operating departments. Indicate the basis of distribution used for each item, and explain and illustrate three methods of charging this departmental burden to the work which passes through each department. (Wis., May, 1919.) 163. A mill usually shuts down three weeks during the year, for general renovation. State (a) how you would provide, in the accounts, through the cost system, for this contingency; (&) how you would treat the fixed charges during such period. (Mass., June, 1912.) 164. Is rent of factory a proper charge under the caption of Cost of Production? Explain. (N. Y., June, 1917.) 165. In formulating a Profit and Loss statement for manufacturing concern in which factory rent is an element, under what classification would you allocate it in order to be economically sound? (N. Y., June, 1913.) 166. Overhead factory expense is computed on the hour basis in a paint shop with unskilled labor and in a machine shop with skilled labor. How would such application affect cost? (N. Y., June, 1913.) MANUFACTURING ACCOUNTS 333 PROBLEMS MANUFACTURING ACCOUNTS 1. The Federal Manufacturing Company commenced business on Janu- ary 1, 1917, with a paid up capital of $2,000,000. It has a system of cost accounts which are controlled by the general books. The trial balance of the company at December 31, 1917, was as follows : Debits Credits Cash $30,000 Accounts Receivable 130,000 Notes Receivable 25,000 Raw Material 150,000 Overhead Burden .... . Work in Process 100,000 Finished Goods 300,000 Dividends Paid 70,000 Plant and Machinery 1,369,750 Profit and Loss $23,250 Interest on Plant Investment 60,000 Accounts Payable 41,000 Notes Payable 500 Reserve for Depreciation 50,000 Capital Stock 2,000,000 $2,174,750 $2,174,750 The general books of the company show charges and credit to Over- head account as shown on the following page. On making an examination of the accounts, you find that the pur- chases of raw material during the year amounted to $500,000; that the cost of direct labor was $375,000; and that the sales amounted to $723,250. An analysis of the orders in process discloses the following charges: Materials, $25,000; Direct Labor, $37,500; Burden (100 per cent direct labor), $37,500; and Total, $100,000. The number of units completed and delivered to the warehouse was 100,000 and of this number 70,000 units were sold. You find that a dividend of S 1 /^ per cent was declared during the fiscal year and that no entry was made on the books. 334 C. P. A. AC COrXTIXfl OVERHEAD ACCOUNT Factory Executive Salaries (one-third) $15.0')0 Indirect Labor 30,000 Cost Department Salaries 10,000 Superintendents' Salaries 10,000 Repairs of Machinery and Buildings 25,000 Power 5,000 Factory Supplies and Expenses 5,000 Interest on Plant and Equipment 60,000 Salesmen's Salaries 20,000 Salesmen's Expenses " 10,000 Advertising 30,000 Freight outbound 10,000 Shipping Department, Labor and Expenses 15,000 Officers' Salaries (Executive, two-thirds) 30,000 Office Salaries (clerks) 15,000 Office Expenses 5.000 Cash Discount on Sales 15,000 Interest on Notes Payable 10,000 Allowances to Customers 10,000 Bad Debts 5,000 Depreciation of Plant and Machinery 50,000 Total $385,000 Credits: Cash Discounts on Purchases 10,000 Burden applied to cost orders in process during the year (equal to 100 per cent of direct labor) $375,000 You are asked to prepare a Balance Sheet and a Profit and Loss state- ment; also a statement showing the cost and net profit per unit. Submit your working sheet. (Ohio, Xov., 1918.) 2. The Ohio Manufacturing Company commenced business on January 1, 1918, with a paid-in-cash capital of $100,000. The transactions for the year 1918 were as follows : purchases on credit, land, $5,000; buildings, $20,000; machinery and equipment, $30,000; raw material, $100,000; factory supplies and expenses, $10,200; and office expenses, $3,000. The cash payments for the year included, factory productive labor, $40,000; factory non-productive labor, $20,000; officers' salaries, $10,000; other office salaries, $8,000 ; and salaries and expenses of salesmen, $10,000. Inventories at December 31, 1918, were: raw material, $20,000; factory supplies, $1,000; and work in process amounting to $30,000, two-thirds of which amount was for materials and one-third for productive labor. The open accounts receivable amounted to $20,000, after charging off $1,000 for bad debts; and the accounts payable amounted to $18,200. The units completed during the year amounted to 10,000, of which 8,000 were sold at $20 each. Provide 10 per cent for depreciation on machinery and 3 per cent on buildings. You are required to prepare a Balance Sheet and a Profit and Loss statement as of December 31, 1918. (Ohio, Oct., 1919.) (Note: Prorate burden according to direct labor.) MANUFACTURING ACCOUNTS 335 3. (a) From the following data, explain and illustrate four methods of distributing the indirect expenses of a factory to production: Department A Department B Department C Materials Used $10,000 $5,000 $5,000 Productive Wages ... . $3,200 $2,500 $3,500 Productive Labor Hours . . 8,000 5,000 10,000 Indirect Exoenses. . $4.000 $2.500 $2.800 The factory is supposed to run 2,400 hours a year. (b) Apply the results obtained in (a) to the facts given below for job No. 10, in order to show the different total job costs obtained by each of the methods. Assume the material and labor (value and time) charge- able to job No. 10, to be as follows: Department A Department B Department C Total Material $1.00 $2.00 $1.00 $4.00 Labor Value 1.60 1.50 1.05 4.15 Labor Hours . . 4 3 3 10 (Wis., April, 1915.) 4. The books of Factory "A," the product of which is charged to the main office of the X, Y, Z Company, at factory cost, shows the following facts January 1, 1910 : Cash (imprest fund), $500; raw materials, $17,688.51; wages unpaid and distributed, $2,348.67; goods in process, at prime cost, $62,258.61, plus $11,352.75 for factory expenses, and $9,007.50 for management charges; finished goods, $45,290.20. The invoices for purchases of raw material for the year amounted to $78,375.65; wages paid, $133,041.27; management charges, $53,695; fac- tory expenses, $36,967.08. The cash receipts for one year's rent of loft were $1,200 and for 11 months' sale of power, $330, the twelfth month being unpaid. The raw materials consumed for the period amounted to $64,188.33; management charges distributed, $55,761.90; factory expenses distributed to cost amounted to $43,033.23. There was also a loss on machinery re- placements of $107.50. The finished-product output for the year amounted to $324,583.43, in- cluding all costs. The transfers to the main office were $338,297.90. At the close of the period, December 31, 1910, there remained unpaid and undistributed to Goods in Process the regular factory payroll for three days, amounting to $2,857.93, and also 1,500 hours of operatives' overtime at an average rate of 45 cents per hour, payable on a basis of 2^ hours' overtime as the equivalent of 3 l / 2 hours' regular time. Raise all the factory Ledger accounts affected and show final trial balance. (N. Y., June, 1911; N. Y., Jan., 1920.) 336 ('. P. A. ACCOUNTING 5. A company of bicycle manufacturers makes up its accounts Decem- ber 31, 1907, for the year. The following are the debits to the profit and loss account: Raw Material on hand January 1, 1907 $12,500.00 Finished Machines on hand January 1, 1907, 1,600 Wheels at $30 48,000.00 Purchases of Material 62,500.00 Labor, productive 82,500.00 Manufacturing Expenses: Coal, repairs, paint, varnish, superintendents' salaries, unproductive labor and sundry other expenses 23,000.00 Agents' Commissions 90,000.00 Branch Expense: Rents, salaries and miscellaneous 40,000.00 Selling Expense: Travelers' expenses and salaries, dis- counts, rebates and miscellaneous 30,000.00 Bad Debts 8,000.00 Depreciation on Machinery and Plant 5,500.00 The sales for the year 1907 were 6,000 wheels, yielding $540,000; the raw material on December 31, 1907, taken at cost, were $4,000, and the finished wheels in stock ready for sale numbered 800. Prepare an account from the above showing: (a) Number of wheels manufactured ; (b) The cost per wheel; (c) The gross manufacturing profit; (d) The final net result, including in the profit and loss account the stock of finished wheels on hand December 31, 1907, at their cost as shown by the accounts. (Mich., July, 1909.) APPENDIX The Appendix contains a "KEY TO REFERENCES," and "REFERENCES FOR CHAPTERS." In each chapter of the text there are superior figures after certain words. Corresponding figures will be found under the same chapters enumerated under the heading; "REFERENCES FOR CHAPTERS," on pages 345 to 367 inclusive. Immediately following the figures are the Key Letters, and following these are the pages to which reference is made in the books designated by the Key Letters, in the KEY TO REFERENCES, on pages 339 to 344 inclusive. To utilize the Appendix, proceed as follows: In Chapter I, page 2, the first superior figure is 9 (after recommends). Turning to the Contents, page xiii, we find that References for Chapter I are on page 345. On that page, the number 9 refers to A50. Turning to the KEY TO REFERENCES, we find the Key Letter "A" on page 339. Opposite this Key Letter is the name of the book, on page 50 of which you will find the reference desired. 337 APPENDIX KEY TO REFERENCES A. Montgomery, B. H., Auditing Theory and Practice (Text Edition), 1915, The Ronald Press Company, New York. B. Bennett, R. J., Corporation Accounting, 1917, The Ronald Press Com- pany, New York. C. Castenholz, W. B., Auditing Procedure, 1918, La Salle Extension Uni- versity, Chicago, 111. D. Dickenson, A. L., Accounting Practice and Procedure, 1913, The Ron- ald Press Company, New York. E. Esquerre, P. J., The Applied Theory of Accounts, 1914, The Ronald Press Company, New York. F. Bentley, H. C., The Science of Accounts, 1911, The Ronald Press Com- pany, New York. G. Gilman, S., Principles of Accounting, 1916, La Salle Extension Uni- versity, Chicago, 111. H. Hatfield, H. R., Modern Accounting, Its Principles and Some of Its Problems, 1909, D. Appleton and Company, New York. I. Hodge (A. C.) and McKinsey (J. 0.), Principles of Accounting, 1920, The University of Chicago Press, Chicago, 111. J. Klein, J. J., Elements of Accounting Theory and Practice, 1913, D. Appleton and Company, New York. K. Kester, R. B., Accounting Theory and Practice, Vol. 2, 1918, The Ronald Press Company, New York. L. Greendlinger, L., Financial and Business Statements, 1917, Alexander Hamilton Institute, New York. M. Madden, J. T., Accounting Practice and Auditing, 1917, Alexander Hamilton Institute, New York. N. Willis, H. P., The Principles of Accounting, 1911, La Salle Extension University, Chicago, 111. O. Chase, W. A., Auditing and Cost Accounting, 1911, La Salle Extension University, Chicago, 111. P. Paton (W. A.) and Stevenson (R. A.), Principles of Accounting, 1918, The Macmillan Company, New York. Q. Day, C. M., Accounting Practice, 1908, D. Appleton and Company, New York. 3:59 340 C. P. A. ACCOUNTING R. Racine, S. F., Accounting Principles, 1913, The Western Institute of Accountancy, Commerce and Finance, Seattle, Wash. S. Scovell, C. H., Cost Accounting and Burden Application, 1916, D. Appleton and Company, New York. T. Sprague (C. E.) and Perrine (L. L.), The Accountancy of Invest- ments, 1914, The Ronald Press Company, New York. U. Wildman, J. R., Principles of Auditing, 1916, The William G. Hewitt Press, Brooklyn, N. Y. V. Walton, S., Auditing, 1911, Alexander Hamilton Institute, New York. W. Wildman, J. R., Principles of Accounting, 1913, The William G. Hewitt Press, Brooklyn, N. Y. X. Hardcastle, J., Accounts of Executors and Trustees, 1903, New York University School of Commerce, Accounts and Finance, New York. Y. Ilenn, G. B., Renn's Practical Auditing, 1905, George B. Renn, Chi- cago, 111. Z. Spear, R H., Scientific Auditing, 1912, Commercial World Publishing Company, Detroit, Mich. A A. Dicksee, L. R., Auditing, 1905 (Authorized American Edition), Rob- ert H. Montgomery, New York. BB. Sprague, C. E., The Philosophy of Accounts, 1907, The Ronald Press Company, New York. CC. Cox, H. C., Classified C. P. A. Problems and Solutions 1915 (1916 Edition), The Ronald Press Company, New York. DD. How to Audit, 1919, The McArdle Press, Inc., New York City. EE. Saliers, E. A., Accounts in Theory and Practice, Principles, 1920, McGraw-Hill Book Company, New York. FF. 1914 C. P. A. Problems and Solutions, Vol. 1, 1914, The Ronald Press Company, New York. GG. 1914 C. P. A. Problems and Solutions, Vol. 2, 1914, The Ronald Press Company, New York. HH. C. P. A. Problems and Solutions 1915, Vol. 1, 1915, The Ronald Press Company, New York. II. C. P. A. Problems and Solutions 1915, Vol. 2, 1916, The Ronald Press Company, New York. JJ. Cole, W. M., Accounting and Auditing, 1910, Cree Publishing Com- pany, Minneapolis. KK. Greendlinger, L., Accountancy Problems with Solutions, Vol. 1, 1910, Business Book Bureau, New York City. LL. Greendlinger, L., Accountancy Problems with Solutions, Vol. 2, 1911, Key Publishing Company, New York. MM. Saliers, E. A., Principles of Depreciation, 1915, The Ronald Press Company, New York. KEY TO REFERENCES 341 NN. Cole, W. M., Accounts, Their Construction and Interpretation, 1908, Houghton, Mifflin and Company, Boston. 00. Nicholson. J. L., Cost Accounting, Theory and Practice, 1913, The Ronald Press Company, New York. PP. Nicholson (J. L.) and Rohrbach (J. F. D.), Cost Accounting, 1919, The Ronald Press Company, New York. QQ. Baugh, F. H., Principles and Practice of Cost Accounting, 1915, F. H. Baugh, Baltimore, Md. RR. Kester, R. B., Accounting Theory and Practice, Vol. 1, 1917, The Ronald Press Company, New York. SS. Mitchell, T. \V., Accounting Principles, 1917, Alexander Hamilton Institute, New York. TT. Klein, J. J., Bookkeeping and Accounting, 1917, D. Appleton and Company, New York. UU. Miner (G. W.) and Elwell (F. H.), Principles of Bookkeeping, 1912, Ginn and Company, Boston. VV. Rowe, H. M., Rowe's Bookkeeping and Accountancy, 1910, The H. M. Rowe Company, Baltimore, Md. WW. Baker, J. W., 20th Century Bookkeping and Accounting, 1912, South- western Publishing Company, Cincinnati, 0. XX. McKinsey, J. 0., Bookkeeping and Accounting, 1920, South- Western Publishing Company, Cincinnati, O. YY. Finney, H. A., Introduction to Actuai'ial Science, 1920, American Institute of Accountants, New York. ZZ. Rittenhouse (C. F.) and Clapp (P. F.), Accounting Theory and Practice, Unit I, 1918, McGraw-Hill Book Company, Inc., New York. AAA. MacFarland (G. A.) and Rossheim (I. D.), A First Year in Bookkeeping and Accounting, 1913, D. Appleton and Com- pany, New York. BBB. Approved Methods for the Preparation of Balance Sheet State- ments, 1917, Government Printing Office, Washington, D. C. CCC. Webner, F. E., Factory Accounting, 1918, La Salle Extension University, Chicago, 111. ODD. Sherwood, J. F., Public Accounting and Auditing, 1920, South- western Publishing Company, Cincinnati, 0. EEE. Gilman, S. W"., Cost Accounts, 1911, Alexander Hamilton Insti- tute, New York. FFF. Rittenhouse (C. F.) and Clapp (P. F.), Accounting Theory and Practice, Unit II, 1918, McGraw-Hill Book Company, Inc., New York. <]. A 55; K 76. A 56 ; N71. : N71. 77. A57; J351. 78. A57; .133-1; [J108; GG131 1136; DUD98; O000281. REFERENCES FOR CHAPTER II 1. R2; V23; JJ30-1. 34. 2. G3; HI; RR15. 35. 3. G4-11; H3-5; RR15. 36. 4. F16 ; J175 ; R17 ; W46 ; NN21 ; 37. RR56; VV3; DDD241. 38. 5. RR57. 39. 6. RR69; HHH176. 40. 7. RR62-3. 41. 8. D14; E131; R20; W51; 42. FF149; RR248; SS103; 43. VV5; WW9; VVV112. 44. 9. K22; W51; FF149; SS103; 45. DDD248. 46. 10. E131. 47. 11. E131; R22; EE18; FF149. 48. 12. E131; RR248 49. 13. R22; EE19; FF80; LL212; 50. WW9; AAA22. 14. R55. 51. 15. FF149. 52. 16. R52. 53. 17. R52. 54. 18. R54; W64; CC405-6; 55. DDD253; ZZZ204. 56. 19. R55. 57. 20. R54; SS106. 58. 21. E126; R220; GG10; SS106; 59. ZZZ177. 60. 22. J31. 61. 23. H5; W50. 62. 24. W50. 25. E73; W51. 63. 26. RR414; SS106. 64. 27. E129; R220; RR420. 65. 28. R224; JJ178; RR422; SS115. 66 29. RR423; SSI 21. 67. 30. RR414. 08. 31. A301; U107. 69. 32. A 302-3; C20; JJ177. 7(1. 33. A310-11. 71. K556. K556-7. B165. K556. K559; R226; AVWW164. K559;R226. K559. RR267; XX98; OOO34. RR267-8; XX98. RR268; WW139; 00035. RR268. P27; P62. K568-9. 1344-5; XX417-9. K565-6. K567; FF178-80. F20-. J7-8; P64; SS84; AAA23; ZZZ191. Y23. P60; V29. E209; J9; KK119; NN33. P60-1 ; V29. RR234; WW67. A366; V214; AA39. A 366; C22; V214. A366; C22. A298-9; M293. A 308; C192; A A 30. A 301; V216. A301; PPP7; BBBBB226; CCCCC70. A308; V216. A 308-9. A 301. A 303. A 301. A303. M294; U89. A 310. A307. REFERENCES FOR CHAPTERS 347 72. AA32. 90. 73. E396; H35; J5; K62; N165; 91. P152; V23; FF282; GG8; 92. JJ140; SS152. 93. 74. J160; P153; V12; FF282; 94. JJ146; KK187; NN37. 95. 75. J160; NN39; SS154; AAA36. 96. 76. SS154; SS157. 77. J161; FF146; GG8; NN53. 97. 78. E116; G82-3; K590-1; R227; 98. EE139-40; SS111-12; 99. VVV137. 100. 79. G82-3; R227; EE139-40; 101. SS111-2; VVV137. 102. 80. R27. 103. 81. P96; R27-8. 104. 82. E113; 1131; JJ204; NN392; 105. SS260-1; QQQ251; VVV140. 106. 83. R31; NN392. 107. 84. K28; W41; JJ205; DDD254; 108. ZZZ207. 109. 85. K29. 110. 86. K29. 111. 87. D26; K32; R259-61. 112. 88. E118-20; K34-5; P94-6. 113. 89. E119; K35; P95. WW269. K36; SS257. K32; V137. K34. K37. K37. K47-8; R259; II209; FFF127. K48; R259; II209; FFF127-9. K41. K41. K42. K42. V136; ZZZ207. HH55; PPP16; BBBBB226. HH55; PPP16. J338; V213; AA34; HII56; PPP16. HH55-7; PPP15-6. HH56-7; PPP16. A366; D29; HH56; PPP16. KK95. GG110; III413. KK96. III413. CC392. REFERENCES FOR CHAPTER III 1. F55; H41-3; K65-6; V144; AA208; FF72-3; SS244; WWW286-7. 2. F50; N166; 0266; W286; CC392; HH44; SS168-9; ZZZ169. 3. K63; R246. 4. G141 ; H39 ; J331 ; K63 ; P202 ; R246; JJ173; KK188; SS244. 5. RR142. 6. N173; R248; W286; KK188. 7. T33-4; TC63; P202-3; W286; \v\vw:?09. 8. K75; RR240. 9. F55; H42; J263; K65; A A 207-8. 10. H54; J169; R250; W289; RR241. 11. D34-5; E407-8; F254-5; HHH126. 12. A249-50; B339-40; K75-6; RR240. 13. D34; D38. 14. 1325; SS227; WW153; XX394; III286-7; JJJ205; TTT226; VVV238. 15. J169; III287. 16. F52-3; K76; SS226. 17." F52; JJJ52-3. 18. A250; PFF1 00-10. 19. 1325; WW153; XX394; III286-7; JJJ205; VVV238. 20. SS227; TTT226; WWW314. 348 C. P. A. ACCOUNTING 21. E410; H48; 0105; R104; 52. FF75-6. 53. 22. E410; H48; 0105; R104. 23. E410; H48; 0105; R104. 54. 24. K96-7; R86; V217. 25. C31; K226; R71; AA212. 55. 26. D31;G147;K97-8;HHH125; 56. WWW308. 57. 27. K97-8; V152. 58. 28. K85-6. 59. 29. K79; W287; DDD8. 60. 30. P205; W295; SS231. 61. 31. K693; RR411. 62. 32. K693; W289-91; RR411-2. 63. 33. J231; CC65-6; HH22; 64. II248-9; KK48-9; LL35; 65. NN110; RR36; SS55; 66. XX471; JJJ94-5; 67. WWW26-7. 34. B340-3; F273; 1354; P588; 68. JJ330. 69. 35. CC66 ; HH23 ; II250 ; S S53. 70. 36. CC66-7; II250-1; SS57. 71. 37. E136. 72. 38. E136. 73. 39. LL212. 74. 40. F22; G157-8; H81; J163; K71; N169; O103-4; Pill; 75. W53; FF280; ZZZ168. 76. 41. G158; J165; K71; W53. 77. 42. DD54-6; BBB25; DDD40. 43. F22 ; G157 ; H81 ; J163 ; N169 ; 78. 0103; Pill; R99; W53; 79. FF281; GG263; 1153; 80. JJ316; WW9; CCC59; 81. ZZZ168. 82. 44. FF283. 83. 45. GG107. 84. 46. K118. 47. TTH166. 85. 48. LL212. 49. G158; 1310; J165; M92; 86. N109; W54; CCC59; 87. QQQQ384. 88. 50. W52; ZZZ192. 51. F23; J163; L179; N170; W55; FF281; KK185; 89. WW10; CCC60. 90. LL212; RR29. W55; CC395; DDD247; QQQQ385. K344; R155; CC394; FF284; GG202; HH166. J165-6; WW10; HHH66. L180; R85. L180. L180. L180; CCC59; ZZZ170. E299; K249. E300; K249-50. G133; P155; JJ281-2. AAA142. FF79; HH63; WW146. C76-77; Tv396; FF79. C59; F56; 1310. E366; K343; L186-7; P320; HH217-8. E366. G200. A210; K403; III36. J30; RR323. J31; HH166; RR324. HH47. C141; D146-7; F58; K352; FF153; HH47; LL211. C19-20; J30; RR323. 1116. D147-8; F58; FF154; HH48; 1116; LL211. C140; FF154; HH47. D148. G200-2. C19; G200-2; FF154; RR325. C141. C141-2. A178-9; C142; XXXX228-9; BBBBB234. CIS; Z26; DD14; HH255; JJ435-6; DDD67. C142. C142. F34; J254; N41; W18; EE23; LL212; DDD245; HHH22; 00015. F79; K475; GG263. C310-3. REFERENCES FOll CHAPTERS 34i) 91. H179; NN222. !I12. 11116; H208. !)3. W18. 94. ZZZ179-80. 95. L80; ZZZ180. 96. ,7258; ZZZ180. 1)7. W20. 98. W20. 99. Q312; Y81; FF192; HH286; JJ330; NN110; JJJ193. 100. P23. 101. M5. 102. B359; F254-5; G143; J169; K76; L191; W289; CC39; DD65; LL69; SS227; ZZ153; FFF68; HHH103; III287; JJJ134; SSS82. 103. P23-4. 104. P23. REFERENCES FOR CHAPTER IV 1. ZZ4; DDD249; ZZZ188. 31. 2. W6-7. 32. 3. L48; W225; W304; UU367. 4. W58. 5. D63; F82. 33. 6. K478. 7. A207; NN226. 34. 8. K388; 1117; SS23-5. 35. 9. D67; K390; SS32. 36. 10. W7; SS32. 11. W6. 37. 12. F26; K482; R71 ; W209; FF280. 38. 13. A205; F26; FF280. 14. K405; HH45; III34. 39. 15. HII45. 40. 16. D217; G216. 41. 17. D107; K399; V151; AA170. 42. 18. E229; K404. 43. 19. H224; K399-400. 20. A209. 21. A209; K400. 44. 22. K400. 45. 23. D106; K401; AA171-2. 24. K402; AA171-2. 25. K402. 46. 26. K402. 47. 27. A210; A214-15; A331; K403. 48. 28. A213. 49. 29. M22; R85; CC403; HH45; 50. 00015; VVV422. 51. 30. F80; K87; M21; CC392; 52. HH45; UU317; DDD245; 53. 00015. F80; K87. F26; M22; L49; N176; R85; CC403; KK197; 00015; PPP65. F60; F80; K87; L49; W231; III296. UU317. K403; GG271; 000113. K87; R84; CC393; HH45; II103; KK197. HH45; JJ312; NN226; DDD248; 00041; ZZZ185. HH45; NN226; DDD248; O0041; ZZZ185. 00041. L74-5; HH45. K478. H276-7; J212-4; W2; EE193. A274-5; B343-9; D64-5; E433-7; F265; G236-7; L192-4; P195; RR47-8. J223-5; M96-8; R239-43. 1324; DD57; EE196; RR48; XX289; WW217; FFF66; JJJ238; VVV63; YYYY70. HH12; UU416; TTTT466. J227; EE196; RR48; FFF67. K479. D64-5; K485-6. BBB24. K489. RR509. G119; RR388-9; SS170; WW212. 350 C. P. A. ACCOUNTING 54. G122-3; P216-7; II42-3. 55. RR388-90. 56. G122-3; J347; P216-7; II42-3. 57. RR388-9. 58. E402-4; U5G-7; GG144. REFERENCES FOR CHAPTER V 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 24. 25. 26. E20; F31; AV23; GG82; HH196; KK1; RR271; AAA113; FFF1; HHH18. E20. G218; P255; FF307. HH85; KK214. HH85. E20; RR275. E21-2 ; P256 ; W25-6 ; KK216 ; LL240-1; RR275; VVV217-8. E21; P256; RR277; VVV218; ZZZ201. P256; KK213; RR277; VVV218. E22; P256; RR276. KK213; RR276; VVV218. J86; GG186; RR20. GG186; RR20-1. E21; P256-7; RR275. E21; F31; G218; P256; W25; GG84; HH197; LL235; RR21; AAA114. GG84; HH197; RR20. E26-7. E27. E27; GG85. E27. E20; W25; GG83; HH199; RR272. GG83. A186-90; E22; G276; J88-9; M44-6; Y117; FF151-2; KK4; NN354; RR274; UU128; WW98; XX254; AAA113-4; FFF1; VVV222; XXXX135. E24. E25; FFF2; VVV229; XXXX140. E25; FFF2; HHH348; XXXX143. 30. 31. 32. 33. 34. 35. 30. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 62. E25. E25; M75. E25; G219; J94; GG137; RR280; FFF9; XXXX139. E25; RR280-1; FFF2. E25. E380; F23; H10; Ml. E381. E381-2; F187-8; G214; NN55; RR80. M47-8; R21. M47-8. YV22; WW101. E382; M6; ZZ11. A385. E382. RR48. FF206; HH36; II233; KK57; RR30. F261; KK76. HH218-9; FFF68. M74; P257; RR347. E382; M74-5; RR353-4. M80. E25; M77; RR353; TTTT321. E24; M75; FF137. NN353. M47-8. M48. J92. J93: H317-8. (i27S: H320; M40. J105; RR358: FFF4. G280; H320; J106; EE100; II141; RR286. G278; H319-20; J106-7; M53. H319; M53. G280; P260; EE100; RR286. G279; H319; J106; M51; P261 ; EE100. G279; H319; M51; P261; EE100;RR362; FFF5. REFERENCES FOR CHAPTERS 351 63. G280; EE100; RR286; FFF4; JJJ187. (34. JJJ186-7. 65. G280; H318; M52; FFF4. 66. A24; M250; U5. 67. A25; M250. 68. A185; J336-7; U63. (if). M270. 70. E23. 71. P257; W28; FF307; RR276. 72. LL240. 73. W29;LL268-9. 74. W29; LL241; RR276. 75. P257 ; W29 ; LL240-1 ; RR276. 76. LL240. REFERENCES FOR CHAPTER VI 1. E25; J04; M53; RR280. 2. J94; M58; HHH344. 3. J94; M58. 4. ,194; M54; KK27; RR281; 1 1 HH345-6. 5. M59; HHH344. (i. J95-6 ; M56-7 ; KK27 ; RR281 ; XXXX138. 7. M56-7; 1^282-3; HHH346; XXXX138. 8. M56 ; RR283 ; XXXX138. 9. M56; XXXX138. 10. M59; HHH344. 11. M58-9 ; RR280. 12. M61-3. 13. J97; LL111. 14. LL111. 15. H323; JJ378; KK44. 16. J97-8; HHH349; JJJ29. 17. G281; M64. 18. H323; J98; M66-7; P264; EE95. 19. KK45. 20. R243; KK155; RR349; FFF11; QQQQ462; RRRR69. 21. M65; RR374. 22. M65; RRRR69. 23. G283; H324-7; M65; RRRR69. 24. P264. 25. E25; M46; RK372; FFF2. 26. M73. 27. M74. 28. J90; LL212; RRRR68; XXXX145. 29. P265; RR371. 30. E20; RR280-1; FFF2. 31. M97; LL212; XXXX144. 32. KK155; RR370. 33. RR374. 34. M61-3; KK145; KK160. REFERENCES FOR CHAPTER VII 1. E22; EE!)1; HII196; RR393; FFF11. 2. A188; E22-3. 3. KK9; RR394. 4. RR394. 5. M70; GG168; RR395. 6. RR395. 7. M78; RR395. 8. RR395. 9. RR395. 10. M78; RR395. 31. GG168. 12. RR395. 13. A480; R71; AA322. 14. A480; A482; AA322. 15. FF48. 16. M76; P267; V160; EE91; FF309; KK7; RR396; FFF12. 17. M77; M164; P267-8; V160; RR396. 352 ('. P. A. ACCOUNTING IS. M77-8; V160-1. 19. CC356-7; HH25!>. 20. G284; H327-9; M78; Yl<>2; KK395; JJJ36; HRK62-3. 21. J101. 22. J101. 23. J102. 24. H328-9; RR399. 25. H328; RR398. 26. RR400; FFF94; JJJ59. 27. B193; RR400. 28. M70; GG168; RR395. 29. R 145-6. 30. B192-4; J140; M197-9; P277-8; EE164; RR459; FFF94; JJJ57; TTT210-1 ; VVV247-51. 31. 13194; J140; M199; P278; EE164-5; RR460; FFF94; JJJ58; VVV247-51. 32. M82. 33. K652; M82-3; V162; LL169-70; NN353; RR399-400; HHH356. 34. K654; LL168-9; NN353; FFF13; JJJ40. 35. K654; LL168-9; JJJ40. REFERENCES FOR CHAPTER VIII 1. W29; FF306; KK211. 21. 2. B2; FF63. 3. Kl; KK214; LL239; 22. DDD198. 23. LL239. 24. B2-3; E28; K2; W19-20; W29-30; KK214; DDD198; FFF72-3. 25. 6. K3. 26. 7. K2-3; EE148. 27. 8. BIO; J128; K3; EE147-8. 9. B4; K2; FFF73. 28. 10. K2. 29. 11. B13; C131; J115; K3; 30. GG186; LL234-5; RR439; 31. FFF73-4; AAAAA231. 32. B14; GG186-7; RR440; 33. FFF74; AAAAA232. 34. B5; F33; J115-6; W30; 35. KK211; LL230; RR441-2; 36. VV193. 37. 14. B5; P270; KK211 ; RR442-3 ; 38. VV193. 39. 15. BO; F33-4; J110-7; W31 ; 40. FF63; RR441-2. 41. 16. B6. 42. 17. E39. 43. 18. B6; E39. 44. 19. U62. 45. 20. K41; GO 87. 46. fill; E41; F43; GG87; HH201. f BIO; F43-4* F44; HH89. B45; E41; GG87; HH89; HH201; 1171; KK213; LL237. GG87; HH201. E41; GG87; HH202; LL232. B12; J118; GG88; HH202; KK213; FFF75. B12; B36-7; GG88; HH202. B33; KK213. II143. B13; F32; EE151. B113; E41-2; F175. E32; K299. F175; G310. HH87;LL237. E40; 1170. E40. E40; 1170. E40. B113; D127; E40; J132. E40-1; FF55. E41. A138. 1170. B47; E46. B47; M178. REFERENCES FOR CHAPTERS 353 47. B48; J119; K24; Y101. 87. 48. B48; E44; K24; Y101; 88. KK207. 49. B48. 50. B48; E44; J119; K24; Y101; KK207. 89. 51. A179-80; C142; U62-3; 90. XXXX228-9; BBBBB234. 01. 52. A179; C144. 53. K3. 92. 54. E42. 55. E42-3; G296; U62; W15; 93. RR444; VV194. 56. KK212. 94. 57. F33. 95. 58. B8; J118; HH87. 59. E33-4. 96. 60. F36. 97. 61. E29-30; HH87. 98. 62. B16. 99. 63. E29;F34;G220; J118; 100. RR450. 101. G4. G221; J118; RR450. 102. 65. DDD195; BBBBB249. 66. B17; K10. 103. 67. B17-8; M16. 104. 68. B17; M15; DDD195; 105. BBBBB247. 106. 69. B91;.BBBBB391-2. 107. 70. B91; M16; CCCCC232. 108. 71. B91; M16; CCCCC232. 72. M16; BBBBB252. 109. 73. BBBBB390. 74. M15-6; HHH422; III200; BBBBB252. 75. B90; DDD197; III201;- BBBBB253. 76. B89-90; III201. 110. 77. BBBBB389. 78. UUUU297; BBBBB390. 111. 79. DDD197; BBBBB253. 80. DDD197; BBBBB253. 81. BBBBB389. 112. 82. K10; BBBBB250. 113. 83. BBBBB248. 84. K10; BBBBB388. 85. D128-9. 86. J129. B19; E329. B21; G303; J129; K10-11 ; L173; V117; HH91; VV194; DDD202; FFF76; HHH371; III201. B19. CC174; II188 E30; J118; K4; HH90; KK186. E30-1; J118; K5; HH91; KK186; RR451. B26; K6; CC174; II138; DDD201. B26; K7. B25; K5; HH91; KK186; FFF75;DDD200. K7. K7-8; DDD201. B27; K7; DDD201. K9; DDD201-2. K8. K8; DDD202. B27; K10; DDD202; FFF76; 00067; ZZZ207. K12;DDD202. K13; DDD202. DDD202. G310; H176; K15-6. II149; VVVV233. B359; J130; M201; TT326; RRR88. C132; E329; F37; G304; K384; M188-9; P285; CC39; DD56; GG222; KK80; LL105; WW215; FFF80; III193; JJJ298; SSS98; TTT27; VVV269. B22; C132; F173; L173; W197. A133-4; B369; C132; F87; DD54; LL83; RRR109; SSS120; TTT26; VVV279. B369. D132; K248; P290; Y81; WW215; BBB25; DDD41; FFF81; HHH406; III209; JJJ178; TTTT236; DDDDD225. 354 C. P. A. ACCOUNTING 114. B61; E46-7; F4G; J120; 151. P293. 152. 115. B62; F41; F46. 153. 116. B62; E47. 154. 117. E47; F46. 155. 118. E47; F46. 156. 119. B64; E47; F41-2; J120; 157. M181. 158. 120. F46; P293; V114; Z41; 159. XXXX231. 160. 121. Z41; XXXX231. 161. 122. B72; F47. 123. B73; E48; F47; J120; K22; 162. M180; P292;LL237; 163. NN400; VVV264. 164. 124. B72; E48; P291; Z41; 165. 00031; PPP74. 166. 125. BIOS; M189; RR453; III192; 167. SSS94-5. 168. 126. M190; RRR77. 169. 127. E31; W33; YYY171. 170. 128. A82-3; F171-2; H147; J153; 171. TT326; YYYY263. 172. 129. LL105; JJJ154; RRR133. 130. B369. 173. 131. E45; RR446. 174. 132. E45. 133. P290-1;RR446. 134. E48; M183; P293. 175. 135. E53; M183. 176. 136. E53; K23. 177. 137. B68; E51; M179; VVV262. 178. 138. B66-7; F47. 139. B67. 140. BIOS; G309; J124; EE158; 179. JJ215-6; RR456; III194. 141. B57; J119-20; M181. 142. M181. 180. 143. M180; JJ218; NN399; VVV265. 181. B57-8. P291. B54-5 ; Jl 19-20 ; M181 ; 182. RR447. 183. 147. B54. 184. 148. B54; J124; M181; RR447. 185. 149. B55. 150. B.55. 186. E32. J124; K12; III210. K12. GGKL68. B175; SSS96. H222-3; K19; III211. K20; R168; III211. K19. AA194. K19-20; III211. J122; K19-20; DDD204; III211. B117-8. J130; V113; DDD204. G307-8;RR458. B164; J152-3; M202. V113. RR455. RR455. L166;R102. E332; K379. B113; J133; L166; TTTT393. D128; 1339; YYYY264; AAAAA322. B115; G303; K379; JJ294. A194; A375; B115; G303; H156; K379; R167; TTTT394. A194; C114; E331; R167. E332; FF93; III203. F175; G312; H177; LI 74. B120; F175; G312; H176; J126; L174; W197; II145; NN405; III203; TTT206. B120-1; F176; G312; J128; H177; L175; W197; NN405; III203; TTT207. B120-2; F176; G312; H178-9; L175-6; W197-8; III203. B123; G312-3; P287; W198; CC380; HH42; IIT205; YYY175. B124-5. K16; SSS118-9. F175; J127. B125; LL24; III209; YYY176-7. K17-8. REFERENCES FOR CHAPTERS 355 187. B125; K16-17; III209. 214. 188. E40; K381. 189. B473; E33; K381. 215. 190. E33; M205. 191. HlGO;K381-2. 192. D129; H159-60; K381-2. 216. 193. A192; C132; M318-9; Q42. 217. 194. Q42. 195. A388; C131; M319; V113-4; 218. BBB21. 196. A388; CC161. 219. 197. V114. 198. V114. 220. 199. A193; C132; CC161; DD41; JJ436; DDD204; 221. XXXX229. 222. 200. A388; C132; V113; DD41; 223. DDD204; XXXX229. 224. 201. C132. 202. DD42; BBB21; DDD204. 225. 203. A192-3; C133. 226. 204. A193. 227. 205. A193; DD42; BBB21; 228. DDD204. 229. 206. CC162. 230. 207. A345; E316-7; H76; K330; FF289. 208. K330. 231. 209. K330; TTT26. 210. B93; F178; AA191; GG50; III17; DDDDD314. 232. 211. A345; C66-7. 233. 212. FFF135. 234. 213. B357; CC18; RRR259; NNNN174. WWW296; YYYY71; DDDDD314. B129; C38; D51; UD54; BBB25; DDD230; III288; JJJ297. C38; E262; K241. D34; W294; DD24; BBB10; VVV40. C38; D38; K259; L141; DD24. A99; P577; W294; DD24; BBB10; VVV40. C39; D117; G189; K242; L143; 0121; VVV41. A102. A131; L143. K243. C39; D117-8; K243; W281; DD25; DDD75. E283. C40; K260;L239;R92. W230. D84. A323; DD25; DDD75. C38; M302; Q40; CC42; DD25; FF217; BBB10; DDD74;GGG53;PPP9. C38-9; Q40; CC42; DD24; HH162; BBB10; DDD74; GGG53; PPP9. C38; DD25; BBB10; DDD74. C38. C40; M303; Q25; DD25; BBB10-11; DDD75. REFERENCES FOR CHAPTER IX 1. R58; RR320. 2. AAA153. 3. F133; R58; W251 NN159; AAA53. 4. AAA53. 5. R58; RR320-1. 6. W254; RR551. 7. P355; RR551. 8. F133. 9. NN25; RR551. 10. P350; RR543-4. NN25; 11. F133;FF78;RR252; WW94. 12. RR253; WW94. 13. C62; F133. 14. RR223-4. 15. F137; H97; L152; P189; V103; JJ68; RR118. 16. F137; P189; RR119. 356 C. P. A. ACCOUNTING 17. B256; W254; III142. 53. IS. W330; WW151; XX3S1. 19. L152. 20. G231; P189; AA59; RR255. 21. W252. 22. G231; 1325; L62; RR255. 54. 23. B357; EE197; FF256; VV244; AAA178; RRR99. 24. W251; RR199. 25. RR198. 26. RR199; UU119; AAA56. 27. W252; RR199. 28. M135; RR550; YYY89; WVV316; BBBBB397-8. 29. RR549; YYY89; VVVV316; BBBBB397. 30. GG49-50. 31. C175. 57. 32. A384; V97; XXXX229-30; 58. YYYY151; AAAAA75. 33. A 324-5. 34. S98; JJ356; NN279; 0033; 59. PP139; EEE374; 60. UUU241-2. 61. 35. A95 ; D206 ; K472 ; L233 ; W9 ; 62. 1113; BBB14; NNN443; 63. CCCCC155. 64. S97-8. 65. K470; L234; S116; CC202; 66. 1113; 0041; CCCCC156. 67. 38. K470; 0041. 39. K470. 40. K470; CC202; 1113. 41. K471; CC202; II13-4; 0041. 68. 42. S104; S116; S118. 43. S123-4. G9. 44. S123. 45. L235; 0040. 70. 46. PP140. 71. 47. PP140; NNN434. 72. 48: PP140; NNN434. 73. 49. P349. 74. 50. K272; CC391; NN166; 75. SS285; YY13; DDD244; III146; RRR47; SSSS406. 76. 51. T120; CC401; SS281-2; YY3. 77. 52. P352; T121 ; NN420; SS282; 78. YY5; XXX48; SSSS407. 79. B286; H271; P361 ; Tl>; CC111; NN42G; QQ58; SS2S8; YY15; III147-8; XXXGJ; SSS408; YYYY77; AAAAA245. B287; G341; H271: P372; T122; CC111; NN428; YY21; III152; RRR52; XXX76; PPPP361; SSSS413; AAAAA247-8. P359; T121; NN421; QQ56; SS285; YY12;XXX52. K272; P367; T122; LL65; NN427; QQ56; SS289; YY31; 111149-50; XXX66; YYYY77; AAAAA245; CCCCC314. P375; T122; NN428; YY40. H95-6; K273-4; T122; LL64; NN168; YY46; VVV320; AAAAA246. T122; YY49-50. T108; NN200. T108. T104-6. T106. A130; K269. K269. K270. K270; P383; T89; CC119; LL65; NN171; YY48; JJJ150; BBBB45; VVVV321. K270; P381; T90; NN172; YY52; DDDDD217. T95; NN179; YY52-3; XXX107-8. T96. SSSS419. YY54-5. NN201; YY50-7. YY28. T100; YY58-60; 0000338-9; VVVY322; DDDDD216. YY29; CCCCC470-2. YY24-5. P363. YY36. REFERENCES FOR CHAPTERS 357 SO. P368. 81. T63; YY37; XXX70; ZZZ179; SSSS406. 82. YY38; XXX70. 83. T64; XXX70. 84. T62; YY18; III147; XXX68. 85. YY19; XXX69. 86. T63; XXX68. 87. SSSS419. 88. YY34; XXX70. 89. T63; XXX70; DDDDD215. REFERENCES FOR CHAPTER X 1. A181; D149; G329; K411; 27. R171. 2. K411. 28. 3. C103; M17; HH(54. 4. E373; F54; G329; K411 ; 29. WW9. 30. 5. B331; E408; W182. 31. 6. C103; D150; F53-4; G334; 32. R173; K411; HH64; 33. RR252-3. 34. 7. B434; G186; DD'^D; BBB15; 35. DDD135. 8. E252; K322; W278; III259. 36. 9. B332. 37. 10. C33;K228. 38. 11. C33. 39. 12. L223. 13. E373. 40. 14. K415; M17; P311; 41. XXXX476. 42. 15. K413. 43. 16. K413. 44. 17. K415. 45. 18. K415-6. 46. 19. C99; F161; R166. 47. 20. F140; K305; R117; R182. 48. 21. K416. 49. 22. E374; G221 ; K416; P310; 50. FF83; XXXX476. 23. B325; C116; F151; G342; R183. 51. 24. B326; D151; E377; F151; 52. G342; L208; 0147; R183; 53. V119; KK189; 0000298. 54. 25. B326; G342: L209; 0147; R184; V119; KK189; 0000298. 55. 26. K418. 56. A143; C119; F151; G342; K419; R184; 1160. D152; G342; K419; L209; R184. B326; L210. K420. G343; K420. K420; L210; R184. G221; K417; HH45; HH64. G330. A197; C114; G334; M18; W174; HH64. A196; L219; M18. E369; G330; W56. K461; CC113; EE187. K463; L219; W185; EE187; CC114. B289; L220; V108; GG260. B336; G335; V108. E292; G335. E292. E292. R194. B324; HH64; DDD252. B289; L220; V108; GG260. E369; G330; L220. B324; E293; G335-6. B204; B279; B324; K448; R190; V104; HH64; III143; PPP106; ZZZ201. B280; G336-7; K448; R190. B280; B289; L218. B280; E294; R190. B324-5; D148; E376; L218; L220; FFFF395; KKKK263. M307. A128; M307. 358 C. P. A. ACCOUNTING 57. A 128; M307. 69. 58. A128;B294; B302. 59. B203; B302; K458; HH65. 70. 60. A128; B302; 0141; P327; 71. HH65. 72. 61. A128; P327; JJJ154. 73. 62. K458; G211; H192; DDD73. 63. B292. 64. B292; K461; L222; R195; 74. DDD73; III158; SSSS392; 75. WWWNV203; XXXX478. 76. 65. B297; DDD73. 77. 66. K460; FF115; SSSS390; 78. WWWW202; XXXX478. 67. B299. 68. K462;L218; DDD73; III160. L218; 1186; DDD73; 111159-60. K462; DDD73; III161. 1186; III159. B299; D148; L218. F179; K459; P306; CC113; EE187; 1186; DDD72; III157. B299; III157; PPP106. B300-1. K461; PPP106. K462. B308; F179; K463; L219; P308; W181; CC114; EE187; 1186; NX120; DDD74; III161; PPP106. REFERENCES FOR CHAPTER XI 1. E34; P323; W114; W169; 22. ZZZ170. 23. 2. B208; E37; Y99; W170; 24. II103; NN242; DDD180; IIII276. 3. B217; E37; W170; II103-4; 25. KK196; DDD180. 26. 4. B217; B245; DDD181. 27. 5. B217; B245; E35; P325; 28. NN242. 29. 6. B248-9; E35; P325; NN243. 30. 7. E36. 31. 8. E36. 32. 9. E36-7. 33. 10. B209. 34. 11. B220; E37; DDD181. 12. B218; E38; DDD181. 35. 13. B218; E38. 36. 14. B217; E37; P325; W170; II103-4; KK196; DDD180. 15. B216-7: DDD182. 37. 16. B211; U149. 17. B231; U148; DDD182. 38. 18. B213; K360; DDD182. 39. 19. B214; B313; P325; CC404; 40. DDD182. 41. 20. B215;E37-8; U148; DDD182. 21. B213; E38; P325; DDD182. 42. P327. RRR87. B242; G211; K369; V99; DDD184; SSS186; VVV273. R157. H191. E339; G211. K370. K370; O142; FF78. B241-2; K364; R157; III140. B242; K364; R157; III139. K364-5; R157. B244; DDD184. B268-9; E341-2; K365; NN199. NN199. C59; D35; F91; G205; CC16; FF93; 1182; FFF87; JJJ155. B96; D45; G207; FF93: LL69; FFF87; YYYY68. P577. B268; DDD185. J134. B268; F91; CC117; 1 1287; DDD185; DDDDD313. J134; TTTT235. REFERENCES FOR CHAPTERS 359 43. B247. 63. 44. B249. 64. 45. B250-1. 65. 46. B252. 66. 47. B254; K366; U150; W173. 67. 48. B259-60. 68. 49. B261. 69. 50. B261. 51. B262; E37; W170; II103-4; 70. KK196; DDD180. 52. B262. 71. 53. B269; D134; K367;,DDD185. 72. 54. B269; D134; DDD185. 73. 55. A374-5; B270; D134; E305; 74. R166-7; NN199-200; DDD185. V102; DDD185. 75. B270; P407; FF123; NN199; DDD186. 58. B231; F182. 76. 59. B232-4; F182-3. 60. B237; B253; F183; U150. 77. 61. A158; A388; C122-3; M316; V98-9; DD40; BBB20; 78. DDD188. 79. 62. Q42. A388. A388; C123. M316. A388. A 388; C123; U149. C124; U149-50. C124; U150; DD40; HH152; JJ435; BBB20; DDD188. A389; M316; DD40; BBB20; DDD188. V99. D118. T152; W113. M302; C38; Q40; FF217; DD25; BBB10; DDD74; PPP9. C38; Q40; CC42; DD24; FF122; GG204; HH161; BBB10; DDD74; PPP9. A323; DD25; BBB11; DDD75. C38; DD25; JJ435; BBB10; DDD74. M303; Q25. DD25; BBB11; DDD75. REFERENCES FOR CHAPTER XII 1. E30; E355; J136; K428; 14. L212; EE183; RR461. 15. 2. L213; P301-2. 16. 3. B142; P302; K436; III72. 17. 4. B153; K436; L211; V160. 18. 5. B151; E361; K439; L211 ; P303; V157. 19. 6. B152; K438; III72. 20. 7. B144; K438; L216; P303; 21. V156;III72. 22. 8. B145-6; III86-7. 23. 9. A230-1; F45; K433; L213; 24. V156. 25. 10. L105; P233; FF160; III57; 26. YYY211. 11. K446. 27. 12. D74; K406. 28. 13. E358-9; G184; HH69; 1161. 29. K379; CC235. D70; H208. D73. K433; L216. B133; F45; J118; V156; K429; L212; RR461. K431; V157. K432. E361; J137; V159. B135; K432; III63. B136; K432. B136; E356-7; K434; I.II66. E357. F174; L173; III69; VVVV66; XXXX410. K434; L212-3; III66. B142; K442;L212; JJ213. K349; L213; AAAAA76. 360 C. P. A. ACCOUNTING 30. B153; E362; K349; JJ437. 53. 31. E362; K349. 54. 32. B142-3; E362; G199; K442; 55. JJ213; KK77; RR462; 56. III82. 33. B143; E362; F181; G199; 57. K442 ; P301 ; V159 ; GG329 ; 58. RR463; III83. 34. L212. 59. 35. RR460-1. 60. 36. B142; G32G; J136-7; P301-2; 61. JJ213; III82-3. 62. 37. B153; K436; L211; V160; 63. III92. 64. 38. B153;L211. 65. 39. III92. 06. 40. B151; EE184; QQ11 ; 11191. G7. 41. B144; K438; P303; LI 185. 42. B152-3; III92. C8. 43. B144-5; B152-3; O328; 69. III85-6 ; III92 ; YYY179. 70. 44. B145; III86. 71. 45. B149; K434; III87. 72. 46. B149; III89. 73. 47. B150; III90-1. 74. 48. B150; III91. 75. 49. A198; C133; R156; W196: 76. CC21; DD42; GG198; HH47; JJ438; BBB21; 77. DDD204; JJJ241; 78. OOO151. 79. 50. B76-8; B138-41; F48; V150; III80-1; ZZZ181. 80. 51. Q25; JJ423. 52. AA48. 025; AA48-9; JJ423. Z42; AA49; JJ437. B145-6. B334; F180-1; J136; L195; P299 ; VV167. B335; L207; III97-8. 1279; J118; K407; P294; HH45; SS106; 00019. G302; L196. L196. B334; G221; K407. G303; L207; JJ223-4; III96. B335-6; G312; K408; AA47. L196; JJ302; III96. L208. K408; L196; III95. A194; A375; B15; G303; K379; R167. 1280; JJ224. K426; GG211. K408; JJ302. P550; DD57; III292. K426; III292. K426. I35G; K426-7; P198; III306. C133. DD42; GG320; BBB21 ; DDD209. Q42. SS106. EE220; JJ330; LL19; 11194; SSS186. B462; D47: F53; G301 ; DD56; BBB25; DDD41 ; RRR100. REFERENCES FOR CHAPTER XIII 1. E165; CC399; DDD250; ZZZ194. 2. E167; R56-7; RR8S. 3. F118; G35. 4. F117-8; R57; GG12; 118. 5. F117; V126; GG12; HH115; 118; RR88-91. 6. G172. 7. G175. 8. A54-5; G175; I Inn. 9. 1191. 10. A55; G175; 1190. 11. A55; II90-1. 12. C193; J341. 13. A338; U104. 14. A338-9; C156. 15. U104-5; AA90; FF294. 16. A151; AA174-5. REFERENCES FOR CHAPTERS 361 17. C156; 029; FF294. 57. 18. U105. 19. A301. 58. 20. A301; U106. 21. A301. 59. 22. D147; FF234. 23. A151-2. 24. C91; L310; R70; DD21; 60. RR381; T5BB17; DDD102. 25. A56. 26. A56. 61. 27. A315; C150. 28. P91; RR343. 62. 29. A301. 63. 30. A303. 64. 31. C152-3. 65. 32. RR344. 66. 33. RR344. 67. 34. C261. 68. 35. FF94; XX403; QQQ182. 69. 36. XX403. 70. 37. DDDDD74. 71. 38. EEEEE12. 72. 39. R68; RR343. 73. 40. A210; A214-5; A332; K403; 74. V130; AA172; III36; 75. VVVV401. 41. V130; AA172. 76. 42. A332; C71-2; D102-3; K403; 77. RR343; VVVV401. 78. 43. RR382. 44. V128; RR341. 79. 45. K530. 46. R214; V128; RR341. 80. 47. L49; M298; R68; W167; 81. RR341; QQQ178. 48. F217; L52; NN142. 82. 49. RR141; JJJ99. 83. 50. RR425. 84. 51. RR141. 85. 52. M298; R68; L49; 032; 86. RR482; QQQ180. 87. 53. RR483. 88. 54. RR483. 89. 55. L50; M298; R214; RR484; 90. QQQ181. 56. R67-8; KK112. J173; J181; Y28; EE278; ZZZ206. A455; W213; EE278; DDD99. A455; L66; W213; RR65-6; DDD99; ITT396; WWWW190. Flll-2; C2G; K230; R67; V57; W124-5; CC296; NN297. K230; F112; W124-5; CC296; NN2P7. K230; NN297; VV142. K230. C26; K230. D104-5; K230. W204-5. J213; WW217. WW19L 146; XX418. K230. C149; V127; W201-2. F92; J213; VV85; WW194. L55. RR243; VV87; WW192. F92; J213; L70; FF180; XX417. A357. C70;L71; WW193. A456-7; C70; LI 72; 0119; 1189; SS181. F88; WWII; III307; NNNN174. C172; G252. 1324; J172; RR243; VV142; WW217; XX289; JJJ49. E88; N71. GG54; PPP97. C189. HH56-7. W201. L69; V126; VV142; XX289. L71-2. JJJ226. 1324; V126; W201; 1145; RR243; VV142; WW217; XX289; JJJ49. 362 C. P. A. ACCOUNTING 91. W202. 92. 1324; W205; RR243; VV142; WW217; XX289; JJJ49. 93. U106-7. 94. A360; C173. 95. DIGS; K353-4. 90. CC315. 97. CC315. 98. G34; CC398; VV53; DDD249; ZZZ190. 99. DUO; G171; K240; U108. 100. D109; E171; F116; G171-2; K238-9; U108; GG180-1; DDD245. 101. A395; U108; W120; GG181; DDD98. 102. A395; DUO; U108. 103. DUO. 104. A88; C25; CC290; DD20; GG331; 1148; BBB11; DDD101. 105. A88; C25; Z37; CC290; DD17; FF228; GG50; IllfiO; JJ430; BBB11; DDD101; PPP10; LLLL356. 106. A88; C25; L308; Q41 ; Z37; CC290; DD20; GK3318; 1148; BBR11; DDD101; PPP10; LLLL350. 107. A88-9; C25: L308; Q41 ; Z37: CC290; DD20; GG318; 1148; BBH11 : DDDim ; PPP10; LLLL356. 108. A89; C25; C36; CC291; DD20; FF228; GG181; II155: BBB11; DDD102. 109. A89; C20; CC291-2; DD21; FF227; 11155; BBB12; DDD102; PPP65. 110. A89; C26; CC292; DD21 : FF227; 1149; III 60; BBB12; DDD102. 111. A89-90; C26; CC292; T)D21 BBB12; DDD102. 112. A90; C27; Z37; CC292; DD22; JJ430; BBB13; DDD103. 113. A90; C27; CC292; DD22; BBB13; DDD103. 114. A91; C27; C36; DD17; 1149; II155; JJ430; BBB13; DDD103; 000138; PPP10; XXXX236. 115. A91; C27; CC292; GG331; 1148; II155. 116. A91; C26-7; CC292-3; DD21; FF227; GG318; 1149; II160; BBB12; DDD103. 117. A91; C28; CC293; DD23; FF228; BBB13; DDD104. 118. A84 ; A99 ; C27 ; U110 ; DD22 ; GG50; II154; VV53; BBB12; DDD103; PPP65. 119. C32-3; L156-7; W124. 120. GG191; HHH205; III272-3. 121. J327; R72; GG63; HH165; 000146. 122. CC302; HH231. 123. E155; V134; RR299; ZZZ205. 124. A227; L51; AA189; CC296; DDD82; PPP28. 125. H288; L50; W202; DD56; LL97. 12(5. W207;LL97. 127. A 325-6; DDD83. 128. Y135-6. 129. V134-5; AA59. 130. I>72; S35; GG231; KK113; LL12; VV142; WW217; AAA157; EEE272; RRR123. 131. B348; E436; F59; G250; 1325; J172; L62; R242; U186; W230; CC19; DD57; KK87; QQ6; RR255; UU386; XX289; ZZ113; III308; JJJ49; NNN314; SSS55; TTT225; WWW181; YYYY70. 132. Y135. 13']. J172; P72; GG232; 1145; KK113;LL12; VY142; WW217; AAA157. REFERENCES FOR CHAPTERS 363 134. B367; EE197; HH12; RRR124. 135. B348; E43G; F59; G250; 1342; R242; U186; W232; CC18;DD57;RR255; UU386; XX289; ZZ114; III308; JJJ49; NNN314; SSS55; TTT225; WWW185; YYYY70; CCCCC148. 136. A317. 137. A317-8. 138. P654; JJ289-90; NN342; SS144-6. 139. RR308-9. 140. P654. 141. K414-5; WWW231. 142. C116; R176. 143. F135; DD54; KK46; SS388; BBB25; DDD40; III288; WWW231; DDDDD224. 144. JJJ240. 145. CC260; RRR276. 146. SS388. 147. F136; AA189. REFERENCES FOR CHAPTER XIV 1. A363;L78; W263; RR117. 25. 2. E309; F128; K571; W155-6; W264-5. 3. A363; E309-10; W155-6; W265. 26. 4. K580; QQQQ465. 27. 5. C60; W264; VV95. 28. 6. C60; F129; 1311; W264; 29. WW124; XX372; QQQ344. 7. C60; 1311; W264; WW125; 30. XX373. 8. C60. 9. H259; P308; R178-9; 31. KK161; EEEE198. 10. R179; W268; XXXX475. 11. H260; XXXX475. 12. P309; R179. 32. 13. L223-4; R192; W186; KK161. 33. 1 4. C50-1 ; C62 ; U46 ; CC265 ; 34. II322-3. 35. 15. C50-1; C61. 36. 16. C51; DD31; BBB16. 37. 17. C61-2; CC266;II322. 38. 18. A362; DD48. 39. 19. C61; Q41; GG318. 20. CC266; II322. 40. 21. K575; U132; W266-7. 41. 22. K575. 42. 23. K576. 13. 24. K578. 44. K579; NN93; III273; JJJ195; WWW253; QQQQ466; AAAAA229; CCCCC311. K579. 1263; K579; JJJ195. K579. R72; G-O63; HH165; 000146. W262; CC312; GG184-5; FFF14; JJJ118; RRRR150; VVVV229. CC312; GG184-5; FFF14; JJJ118; RRRR150; UUUU298; VVVV229; YYYY154. RRRR150; UUUU298; VVVV231 ; YYYY154. S164; NNN277. W269. A163-4. AAA178; TTT30. C98. A161 ; C98. A75; DD17; BBB9; DDD84-5. A354; J313; U66. El 05; F202; J313. A354; F202. V141-2. E104. >64 C. P. A. ACCOUNTING 45. A 359; 01 68. 46. FF228; 11161; ZZZZ143. 47. 0166. 48. A354. 49. 0167; II161. 50. C170; GG318. 51. A 359-60; GG318. 52. 020; Z40; II162; XXXX220. 53. C314; F129; S76; PD57; GO 231; JJ356: KK45: NN278; 0026; PP17; QQ14;RR255; VV201; YVAY276; AAA177; EEE269; NNN233-5; TTT20;UUU111. 54. B348; E436; G231; W235; CC339; HH40; SSS55; YVAYW1S4-5. 55. CCCCC23. 56. PP524; XXN256; AAAAA230. 57. 58. (Hi. 61. (2. 63. 64. 65. 66. 67. 68. (il'i. 70. 71. 72. 73. 74. 75. YYYY71; AAAAA 0313; CC1S; ZZ16; ,1,1,1106; XXX XI 74. KHK132. COCCC74. 1341; ^Y23^l; XX41o; XXX314; A\AY \Y1S1. A A 63. CC361. A102; A364. C316; YV224. YYYY71; ZZZZ225. KIM 09. J.17: 1T36-7: ZZ3H. J176-8; SS243; RRK122-3. 1326-8; KK23^7. AVW 156-7. RR234; WAY 67. RK234. PPP8. REFERENCES FOR CHAPTEB XY 1. K114; R127-8; AY236; CC218; HH43; SS297; DDD143; CCCC101. 2. G346; H121; MM62; UU319. 3. K113; MM61; SS298. 4. K115; MM63. 5. G347; K137; CC218; JJ295; MM124; NN209; AYAYAY224; DDDDD315. ti. DD30. 7. A404; E371; G350; K121; CC220-1; QQ47; SS305-6; IT319; AAA136; DDD146; AYAYAY223; TTTT165-6. S. K121; SS306. 9. K123; MM2!>. 10. K124; EE69. 11. G352; K125. 12. P106; Y65; EE(>J). 13. A225; K372. 14. A 25: 0352; TTTT150. 15. K129. 16. K311. 17. G183. 18. K104. 19. K115: MM 63. 20. MM63-4. 21. G349; R117; MM25; HHH326. 22. R118. 23. 11126; 00218; KE74; I1II43; AAA138-9; DDD151-2; PPP119. 24. K187; N90; R176; DD30: AAA13S-9; DDD151. 25. E408; HH232. 26. B359; L191; W2S9; OC260; HH284; LL134; OO325; SS233; FFF69; RRR100: SSS56. KKI'KKKNTKS FOR CHAPTKKS I ',:!!); (M4(i; HI 20 -7; 134; IL'IS; 014:i; KL'50; ( | i; EK75; FF1<>7; G22i; 11111:5; nu:n; SS::HS ; rr:ol of Business Administration University of California Los Angeles 24, California SOUTHERN UNIVERSITY OF CALIFORNIA LIBRARY, flLOS ANGELES. CALIF.