tet Atak, ye eee - iw he OY Pgh tovthe te Veteielbatake ne taken ee tee ate hsaeae en ee eee aay, seteh caste ert Beee yahopnieg sre berthed. beta Py theber eine h es ‘ : mis . te OM hes) paphinr ti td é » ‘ : : 2 | = = Eamets Lede Fn lah ary ; i viet : vice =e ? " : rT. - oie é she ° Sos etbctiete bates 4 ; : : Pet f ts aan “ ‘ of ard i" a i] tl Mecehchazens - setae wattage : a ics ~ eta re rheiereyete IRS 4g deka Spiel Sy, ; ’ } } ' ; F t | v - ‘ ' ‘ i t- i > 2 my ~~ } “ i 4 Sy ‘ > vi ‘ is ; » : Au. , ed i a Litas f a \ z ‘ ‘ : 1 ) ‘ ‘ 5 Y. et, ¥ ote | Ls aa Any tat > 5 JAGIODH THEORY AND PRACTICE OF ACCOUNTS APPLIED ECONOMICS AND ORGANIZATION BY TOMER ST. CLAIR: PACE, Cy P. A. (N.Y.) LECTURE I S¥ THE FOUNDATION Wealth Articles that cost an effort to produce and that satisfy the needs or desires of mankind are known as wealth. For example, wild fruit that is gathered and made available for food costs an effort and satisfies a need, and is an article of wealth. The locomotive, a machine that aids in the transportation of things ‘and persons, is a more complicated instance. Its manufacture involves ' the gathering of natural products, the mental effort of the inventor, the _ physical labor of the workman and mechanic, and the work of the trader in making the various exchanges. Air, on the other hand, while supplying the most urgent of necesst- ties, is common to all without effort. It has, therefore, under usual con- ditions no economic value, and is not wealth. The articles that constitute wealth vary in their character from those that satisfy the primary needs of food, clothing and shelter to those that satisfy the desire for adornment or other luxury, without regard to actual needs. The Right of Property The ownership of the articles of wealth, it is believed, was first held é in common by the members of the family or tribe. Community owner- ship early gave way to individual ownership. With the latter there crime - into existence the right of property, which is the right of one individual to the possession, use and enjoyment of something, in nearly all cases an article of wealth, to the total exclusion of every other person. Copyright, 1914, by Homer St. Clair Pace, Z Inasmuch as the use of certain articles of wealth is essential to exist- ence, and the possession of others conduces to comfort and pleasure, the determination of the respective property rights of individuals is a matter of interest and consequence. Units of Measurement The exercise of exclusive rights over property presupposes an interest in the extent of the ownership. The savage who claimed the ownership of his weapons undoubtedly preferred as many as he could conveniently use to a less number, insufficient for his needs. One of the chief incentives for an enumeration, or count, is thus found, and it is supplied by the method: of numbering—one, two, three, etc.—that is used to some extent by all races, civilized or uncivilized. In this way, an idea of the number or extent of things is expressed. Many articles in their nature lend themselves conveniently to meas- urement in mere numbers. Thus, it may be said that there are forty cars in the train, and that there are ten trains a day for six days of the week. Numbers are divided into convenient groupings, as for example, gross or score, and by custom the terms are applied to certain things, as a dozen of eggs or a gross of pens. Another common grouping is into ten, or mul- tiples thereof. | Other things are measured more conveniently by a special unit. Thus, wheat is measured by the bushel, fluids by the gallon, coal by the ton and cloth by the yard. Numbers are relied upon, however, to convey an idea of the extent of the units, and thus it is said that ten tons of coal will supply fuel for a house, or that forty bushels of wheat are contained in the load. It is obviously inconvenient to state an aggregate ownership of the articles of wealth in the various units of measurement, for it would be necessary to state it in bushels, yards, gallons, etc. It was done in this way at one time, however, and there are records in existence that show that taxes in ancient governments were levied and paid in terms of quan- tity measurement, such as measures of grain. For the aggregate measurement a common denominator is required, in which all property rights may be stated. Such a unit has been in use for thousands of years, and is known as money. It is a medium by which wealth, and the effort expended to produce wealth, may be measured. Money is itself divided into convenient units, known variously as dollars, pounds, francs, etc., and they are expressed in numbers, which are essential to all enumerations or counts. Oe - SS —— ———— 3 Each article of wealth has a worth, known as value, that may be expressed in the required number of units of money. Thus, four bushels of wheat may be valued at one dollar a bushel, or four dollars, while a cord of wood may be valued at three dollars. The owner of both ‘pos- sesses values to the extent of seven dollars. It is obvious that the articles have been reduced to a common basis, comparable with all other articles of value. Money serves another purpose in that it is a token of effort expended,) ” exchangeable for the products of other effort. By its use, the producer may sell his product, taking an agreed value in money, which can be held in convenient form until he finds a seller of those things which he desires. A new exchange is then made, the seller taking his pay in money, which he in turn can convert into goods, and so on. Prerequisites The foregoing, that is to say, wealth, the right of property and a unit of measurement, are necessary prerequisites to the development and use of a scientific method of stating the extent of property rights, and determining their increase and decrease. | Wealth supplies the subject matter, or articles, the value of which is to be stated. The right of property, by which one individual has exclusive rights in the things that are essential to his existence and that satisfy his tastes, is accompanied by a desire for a knowledge of the extent of the owner- ship, and its fluctuations. The unit of measurement, money, as applied to the value or worth of property rights, provides a common measure that is essential to the comprehension of the extent of ownership. Definitions and Distinctions Accounting is the science of recording and stating facts in relation to the acquisition, production, conservation and transfer of property rights or values. Accounting has a theory, or body of underlying principles, upon which is based a practice, involving the construction and use of all records, statements and devices needed to record and state values and their transfer. Auditing is the verification of the accounting record that, presum- ably, is made in accordance with the theory and practice of accounting. Law, so far as accounting is concerned, supplies all necessary rules and regulations in relation to the acquisition and disposition of property values, and all transactions incident thereto. . 4 ) Accountancy is a profession, the practice of which involves a general academic education and a special or technical training in Accounting, Auditing and Law. The members of the profession of Accountancy, known as account- ants, offer their services to the public in the construction, installation and operation of accounting systems, the presentation of accounting facts, the verification of accounting records, and in such other matters as their special training may justify. The object of these lectures is to present the theory and practice of Accounting, as above defined, in its fundamental aspects. The lectures provide the basic technical training for the practice of Accountancy and for private employment upon accounting records. Accounting Objects The science of accounting has two principal and well defined objects, namely: 1. The determination, at any desired time, of the financial position of an individual or enterprise, that is, the possession of values and the liability for values. 2. The determination, for any period of elapsed time, of the increase or decrease of values of an individual or enterprise. Accounting Essentials Three essentials must be met in an accounting record in order that the objects of accounting may be fully secured, namely: 1. Original Position. The financial position of the individual or enterprise, that is, the possession of values and the liability for values, at the beginning of the accounting period, must be determined and recorded. This meets, for that moment of time, the first object of accounting, and provides a statement against which comparisons may be made with subsequent financial statements. 2. Chronological Record. A record of the financial transactions subsequent to the time of starting, in the order of dates, must be made. This provides a record of the acquisition and transfer of values that affect the original position, and supplies material for achieving the second object of accounting. 3. Rest. There must be a rest, or time at which the accounting record momentarily ceases, for the determination of the financial position. This provides a statement that may be compared with the statement showing the original position, and, if the second essential is properly Se ee . = _ ee 5 met, the two positions may be reconciled by a tracing of the transactions affecting values. The time, usually a year, that elapses between the two financial positions and during which the chronological record is made, is known as the accounting period. The calendar year, that is, the period from January 1st to December 3ist, inclusive, is the ordinary accounting period. A fiscal year may be any consecutive twelve-months’ period, such as the twelve-months’ period from July ist to June 30th, inclusive, that constitutes the business year adopted by railroads. The accounting period is usually the same as the fiscal year, irrespec- tive of whether the latter is for the calendar year or some other twelve- months’ business period. Bookkeeping The systematic and chronological recording of facts as to the owner- ship and transfer of values is known as bookkeeping, and is the medium through which accounting results are obtained. The term accounting is more comprehensive than the term book- keeping, as there are several systematic records for recording financial facts, any of which may be called bookkeeping. The term accounting embraces all methods of bookkeeping. The two methods in common use are known as Double Entry and Single Entry. The system of Double Entry bookkeeping, so far as can be traced. appeared in Venice and Genoa in the fourteenth century, and was known as the Method of Venice. More than a century later, in 1494, a monk, Luca Paciola, published the first treatise upon Double Entry bookkeeping. The first English work upon the subject, by Hugh Oldcastle, a school- master, was published in London in 1543. Several fairly complete works appeared in England and America early in the nineteenth century. The system that Paciola set forth is now the recognized standard of bookkeeping. It remains unchanged in principle, and it has been changed in practice only to save labor and to meet the different condi- tions under which business is now transacted. The term Single Entry has a restricted meaning, as will be explained in a subsequent lecture, although under Single Entry bookkeeping may be grouped all the methods and devices, other than Double Entry book- keeping, by which the attempt is made to record values and the transfer of values. Single Entry has gradually given way to Double Entry until now it is rarely used except in small retail undertakings. 6 Double Entry Theory The system of Double Entry has become the standard of bookkeeping because, by its use, the objects of accounting are accomplished with the least effort. | Double Entry bookkeeping is based upon the theory of a natural law of compensation or balance. In nature there are many instances of a division of things into two parts, effecting a balance or equilibrium. For example, there are two poles, north and south, there is an east and a west, day and night, male and female, etc. : This natural law of balance or equilibrium supplies the fundamental principle of Double Entry bookkeeping. Considering the first object of accounting, that is, the statement of the ownership of values, it will be seen that the theory of balance, or equilibrium, can be applied, for the total of such net values must equal the worth of the owner. Thus, in the case of an individual possessing values to the extent of ten thousand dollars, the values and the worth of the owner constitute a balance or equilibrium, as follows: Vales. (a . $10,000 Worth of Owner... $10,000 The application of the principal to transactions subsequent to the statement of the initial ownership will be considered later. Double Entry Definitions In accounting, things of value owned, and the right to receive val- ues, are known as assets, They may be classified for the purpose of accounting as follows: 1. Real property, that is, land and all buildings and fixtures that are permanently attached to the land; 2. Personal property, including all things of value other than real property, such as merchandise, money, and the right to receive values, such as accounts receivable, or amounts due from others known as debtors. The debts due to others, known as creditors, in accounting are termed liabilities. Liabilities present an element the inverse, or oppo- site, of assets. The net worth of an individual is the amount of his assets, less the amount of his liabilities, and is known in accounting as capital. It is the amount by which the assets exceed the liabilities. In the economic sense, an individual’s capital is the total, or gross amount of assets he possesses. Thus, if the total assets in a business 7 amount to $25,000, the economic capital is $25,000, although there may be $10,000 of liabilities. In such a case, however, the accounting capital would be only $15,000. Throughout all accounting, unless otherwise specified, the term cap- ital is used in the latter sense, and means the excess of asset values over liabilities. | The assets of a trader, or merchant, to illustrate the definitions given, are $20,000 and his liabilities are $10,000. The accounting capital, therefore, $10,000, is the amount of the excess of assets over liabilities. It is obvious that assets — liabilities + capital. The condition may be displayed in a form similar to the one previously given, as follows: [OC Re Oe $20,000 Liabilities........ $10,000 Capital (to balance) ~ ake: 10,000 $20,000 $20,000 The initial balance, or equilibrium, necessary to open double entry books of account when the assets exceed the liabilities, can always be established in this manner. No matter into how many items the assets and liabilities may be divided, the excess of the total amount of the assets over the total amount of the liabilities is the capital, and the amount necessary to establish a balance. Original Position In opening double entry books of account it is necessary to determine the first essential of accounting, or original position. The assets and liabilities are inventoried and displayed in opposition, in the manner before indicated. Assets are carried to the left side of the statement, and this position to the left, or debit, side is maintained for assets throughout all double entry. The liabilities are carried to the right, or credit, side, and always thereafter appear on the credit side. The capital, while not a liability in the sense that it is an amount due a creditor, is an amount showing the accountability of the business to the owner, subject to the payment of the liabilities. It must appear with a credit balance to effect a balance or equilibrium. The initial statement is variously known as a Statement of Assets and Liabilities, Statement of Affairs, and Balance Sheet. The two latter terms are perhaps best reserved for other statements, to be described later. In the construction of such a statement, let it be assumed that John Doe started in business January 2, 1902, with $5,000 in cash and 8 $9,000 in merchandise values, with no liabilities. The condition would be displayed as follows: JOHN DOE. STATEMENT OF ASSETS AND LIABILITIES AS AT JANUARY 2, 1902. ASSETS. CAPITAL. Cash Gs cipeek Ais eet see t $5,000 John Doe, Capital...... $14,000 Merchandise........... 9,000 $14,000 $14,000 As an illustration of a more complicated case, Richard Roe started in business July 1, 1902, with $1,000 in cash, $2,500 in accounts receiv- able, real estate valued at $15,000, upon which there was a bond and mortgage (liability) for $8,000. There was six months’ interest at six per cent. due on the mortgage. The procedure is to list the assets and liabilities and carry in Capital to balance, thus: RICHARD ROE. STATEMENT OF ASSETS AND LIABILITIES AS AT JULY 1, 1902. ASSETS. LIABILITIES. Sah eee eee ee eee es Po Bond & Mortgage ..... . $8,000 Accounts Receivable (as Accrued Interest........ 240 per Schedule)........ 2,500 Reali Rstatete sc eae iO ‘(otal Assets iii ae $18,500 Total Liabilities.... $8,240 Capital. occ epee 10,260 $18,500 $18,500 The principle is the same in all cases. The object is to find the net capital or investment by listing all assets and all liabilities as they stand on the day the statement is dated. Interest that is accrued, but not due, is as much a liability as the bond itself, for the bond may not be due to be paid for several years. Therefore, accrued interest and all similar items, whether assets or liabil- ities, must be taken into the statement. In the rare case of an excess of liabilities over assets, the amount necessary to effect a balance must be carried to the left side, as a deficit or deficiency. It constitutes an element the inverse of capital, or an accountability for values beyond those owned. 9 The Journal The position of the individual or undertaking having been thus ascer- tained and a statement constructed on the double entry principle of making the total debit items equal the total credit items, the actual opening of the books of account, by the transfer of facts, is in order. In double entry bookkeeping, the Journal, in one form or another, is the book in which the original record of the business is kept from day to day, including the statement of the original assets, liabilities and capital. The most common form of Journal is a bound book, ruled, beginning at the left, with columns for date, a wide column for names of accounts, a narrow column for ledger page or folio (abbreviated L. F.) to which posting is made, and two money columns, one for debits and one for credits. The ordinary ruling is, therefore, substantially as follows: (Debit (Credit (Month) (Day) (Names of Accounts) 1 oA Se Money Money a 3 Column) Column) In transferring the facts from the Statement of Assets and Liabil- ities the same relative positions are maintained in the money columns, the assets being carried to the left, or debit, column, and the liabilities and capital to the right, or credit, column. Upon the basis of the first Statement of Assets and Liabilities of John Doe, and following the rule stated, the opening Journal entry would be as follows: 10 New York, January, 1902. 2 CASH osc o eek ih okt tek eee $5,000 MERCHANDISE, ¢.35) Hake Be 9,000 To JOHN DOE, Capital........... $14,000 For assets (no liabilities) of John Doe, who this day engages in the business Ofc TOUe ote ets eee wea Meee once 6. > 66 21 S.e ere @ @ & piles bie be ce. rele 26,6 Bo 0e It is obvious that it is a reproduction of the Statement of Assets and Liabilities, except that the money columns are adjoining. The above entry means that Cash is debtor for $5,000, that is, Cash is debited with it. The meaning of this is clearer when one thinks of the cash as turned over to the cashier or placed in a drawer, in which case the cashier or the drawer is accountable, or debtor, for the amount and should be charged with it. The entry also means that Merchandise is likewise chargeable with $9,000 of value and must account therefor. The entry means further that John Doe is to be credited with $14,000, for, considering the business as a thing apart from himself, he should receive credit for the capital he contributes. The credit indicates the accountability of the business to the proprietor. The old way of expressing the entry would be Cash, Dr., Merchan- dise, Dr., To John Doe, Cr. The Dr. and Cr. abbreviations are now dispensed with, but the To remains in use, so that the usual form is as given above. The best method is to place the name of the city or town in which the business is located, with the month and year, at the head of the Journal page, and the day of the month in the center immediately above the entry, as shown in the foregoing illustration. This obviates the necessity of using the column to the left of the page for date, which can be utilized for some other purpose. | Considering the more complicated condition shown in the second example, the opening entry would be as follows: 11 New York, July, 1902. GASH: stra Abas: Jaan dae ise $1,000 ACCOUNTS RECEIVABLE........ 2,500 REA IESPATE 20) O00 eT ai 15,000 To BOND & MORTGAGE....... $8,000 “ ACCRUED INTEREST...... 240 “ RICHARD ROE, CAPITAL.. 10,260 For assets, liabilities and capital of Richard Roe, who this day engages ty the: fusiness Ofs 0) ey 4 ee w Ee er 6 16 10 Oe isn ea i 8 a ee eee) bike rw) ee ie el Sie: ee! 6 In the foregoing, Cash, Accounts Receivable and Real Estate are accountable for the respective amounts with which they are debited. An account would be opened with each debtor, but here, in the absence of details, Accounts Receivable are treated as one account. The liabilities, Bond & Mortgage, and Accrued Interest, are credited with the respective amounts to show the liability of the business on account of each. The Capital Account is treated as in the foregoing illustration. The form will become impressed with subsequent work. It is here important to understand that assets are carried to the debit column, and liabilities and capital to the credit column. In Journal illustrations hereafter given, no rulings will be shown, but merely the accounts affected, which will be sufficient to show the principles of debit and credit. In each entry the total placed in the debit column must equal the total placed in the credit column, to preserve the equilibrium of the work. The Ledger Not only the opening entries, but also every subsequent transaction, might be recorded in the Journal, and a complete record of the business kept in this way, as will be seen as the system is unfolded. It is easily seen, however, that it would be necessary to classify or index the record in such a way that all entries bearing upon a particular 12 subject, as, for instance, Cash, could be ascertained, viewed and con- sidered as a whole. Thus, if the amounts for which Cash is accountable, are recorded by debits, a summation of such debits is necessary to dis- close the total accountability. Without such an arrangement of items, the Journal record would give little or no idea of the facts of the business. This classification of facts is made by carrying or posting the Journal entries to accounts, in a book called the Ledger, each account having a debit and credit side. Journal debits are posted to the debit of Ledger accounts, and Journal credits are posted to the credit of Ledger accounts. A Ledger account is a collection, under a distinctive caption, in a book called a Ledger, of the debits and credits pertaining to a particular person or subject. The Ledger ruling resembles the Journal ruling in that there are debit and credit money columns, although the arrangement, in the ordi- nary Ledger ruling, is different, and more nearly resembles the form shown for the Statement of Assets and Liabilities. Starting from the extreme left of the page, the ruling is, columns for month and day of month, column for explanations, column for Journal folio, that is, page of Journal from which amount is carried, and money column for debit items. This consumes the left half of the page, and the right half is ruled in a similar manner, the money column being for credit items, thus: (Debit (Credit (Month) | (Day) | (Explanations) | F. | Money ||(Month) | (Day) | (Explanations) | F. | Money Column) Column) The Ledger is the book in which the principal facts recorded in the Journal are collected in accounts, each account with the caption, and the debits and credits appertaining to that account, as determined and shown in the original record in the Journal. The total debit of each Journal entry being the same as the total credit, it follows that if the entries are correctly posted to the Ledger 13 accounts, the total debits of the Ledger accounts will always equal the total credits. By ascertaining whether the debits and credits of the Ledger ac- counts are in balance, a valuable check is provided upon the accuracy of the postings. In the first example of Journal entries given, three accounts would have to be opened in the Ledger, and after posting, they would appear _as follows: CASH. 1902 Jan. 2 To John Doe, Capital..... 1 | $5,000 MERCHANDISE. 1902 Jan. 74 To John Doe, Capital..... 1 | $9,000 JOHN DOE, CAPITAL. 1902 Jan. 2 By Sundries..| 1 | $14,000 The explanation in the Cash Account To John Doe, Capital, means that Cash was debtor To John Doe, Capital, credit. It names the ac- count that received the credit, so that, by glancing down the debit col- umn of the Cash Account, the accounts that received the various credits can be determined, without reference to the Journal. The same explana- tion applies to the Merchandise Account. 14 The By Sundries in John Doe, Capital Account, means that more than one item (Cash and Merchandise) was debtor to that amount. In case one account only were debited, it would be named, but if more than one account is debited, it is customary to use the term Sundries. The date and folio column in the illustrative Ledger accouats are self-explanatory. The Basic Books The Journal and Ledger are the two essential books in double entry bookkeeping. By their use, every necessary record and classification can be made. A complete record may, in fact, be maintained in either alone, but on account of lack of classification, as explained, the Journal without the Ledger is inadequate. On the other hand, debits and credits may be made directly to Ledger accounts in the first instance, without passing through a Journal. Such a procedure, however, does not afford a record that may be considered in — chronological order; it burdens the Ledger accounts with a mass of detail not needed in the classification of transactions, and, in general, opens the way to omissions and errors. Practically, both Journal and Ledger are necessary for successful work in double entry bookkeeping. As all other books are but forms of the Journal and Ledger, a thor- ough mastery of the principles of these books will materially simplify the further consideration of the double entry bookkeeping fabric, which rests upon the few principles and three essentials that have been outlined. THEORY AND PRACTICE OF ACCOUNTS Reece APPLIED ECONOMICS AND ORGANIZATION _ By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) LECTURE II _ THE RECORD OF TRANSACTIONS i GENERAL View. coc. uc). AON Se ea On Ue eae cue, 45 REAL, PERSONAL AND NominaL Accounts............° 19 Pe PURCHASES 0S) 02. a ety SSN ok ee re ae 19 ae ena Are ae 20 -- RETURNED PuRCHASES AND RETURNED SALES.......¢.. 20 ie i WIVISION OF MERCHANDISE’ ACCOUNT..../i.04 Obs eos 21 ee: . - Prorir et Sti ge R a pit hers Se we ee as 21 poe _ Diviston op EXPENSES INTO ACGOUNTAL Lc) Samer te ee i RCC U Ni Ale etre he a a: 23 a ee RECEIVABLE AND BILLS PAYABLE. Baa heh UL Bot ey Da Distinctions BETWEEN EXPENDITURES......5.0 005.0. sel COPYRIGHT, 1914, BY HOMER ST. CLAIR PACE. tek PACE & PACE — : in o PACE STANDARDIZED COURSES IN ACCOUNTANCY, BUSINESS ADMINISTRATION, vie ‘AND ENGLISH, IN RESIDENCE AND BY EXTENSION : os 30 CHURCH STREET, | a 0k NEW WORK CITY THEORY AND PRAcTICE OF ACCOUNTS APPLIED ECONOMICS AND: ORGANIZATION By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) LECTURE II THE RECORD OF TRANSACTIONS General View The object of the commercial undertaking, under ordinary circum- stances, is to make a profit. In a trading concern the effort to secure such profit takes the form of buying at one price and selling at a higher price, the difference in the buying and selling prices, or Gross Profit, as it is usually termed, being large enough, presumably, to cover all the expenses of the undertaking and to leave a balance, which is known as Net Profit. In the illustrative Statements of Assets and Liabilities that have been considered, the Capital Account measures the net asset value, or net worth, of the undertaking. Especially in the first example, in which there are no outside liabili- ties, but merely assets on the left side, balanced by the Capital Account on the opposite side, it is apparent that the Capital Account is but a measurement of the values that exist contra, or opposite. This is always the function of the Capital Account—it indicates to the proprietor the amount of his net investment in the business, or, as some choose to express it, it shows the liability or accountability of the business to the proprietor. If profits are earned by exchanging assets for assets of greater value, and the profit is not withdrawn from the business, there must be an in- crease in the capital or investment to the extent of such profit. If expenses are incurred in making such turnover, they must be deducted from the Gross Profit in order to arrive at the net increase in the investment or capital. Copyright, 1914, by Homer St. Clair Pace. 16 Stating the proposition arithmetically, if the initial Cap- ital was... SS QORY Po SE haa Pee Cr coe $900.00 and the GrossiProfitasicwics 6 Ae eae. eee $200.00 by deducting the expenses incurred in securing such Gross Profits: coer gear eas ins 5 URE R enn Re, > emma 75.00 we arrive,at the Net |Profitac ys area. . ae 125.00 which, if left in the business, would increase the Capital to $1,025.00 Stating the same proposition from the Double Entry accounting viewpoint, bv raising a Capital Account, it is as follows: CAPITAL ACCOUNT. To Expensesi = simone bey wes peed $75.00 By Balance, >. .0. 7p cnn ee eee $900.00 RL BOLGNCE GOWN oe ck i oho nena 1,025.00 “ Gross ‘Profit. - 2.622: 224 200.00 $1,100.00 $1,100.00 By Balance). .:.s004 «5 8 eee $1,025.00 It thus appears that, if losses and expenses are charged to Capital Account, and profits are credited to Capital Account, and there are no withdrawals by the proprietor, the balance of the Capital Account will be larger or smaller just as the business makes a net profit or loss. Instead of making such charges and credits directly to the Capital Account, it 1s customary to raise intermediate, or temporary, accounts, that hold the items of expense and profit in suspense until the close of the interval of time, usually one year, which is known as the accounting period. Scrutinizing more closely the items of expense and loss, it is found that they are either paid by turning over an asset as where rent is paid by cash, or they are taken into the accounts by setting up a liability, as where rent is due to another and is credited to an account opened in his name. It follows that such expenses and losses must be debited, either to take the place of the asset which is surrendered and therefore credited, or to balance the liability which is credited, as will be more fully illus- trated later. 17 Profits, on the other hand, consist of increased assets and are meas- ured by credit balances. Thus, if the business has. $500 of merchandise, the Merchandise Ac- count will be debited with that amount, and if it should be sold for cash for $600, Cash Account would be debited with the $600 received and Merchandise Account would be credited, leaving Merchandise Account with a credit balance of $100.’ That is, a profit of $100 has been earned, which consists of cash, and it is measured by the credit balance of the Merchandise Account. Assets and expenses (including losses) being debited, and liabilities, capital and profits being credited, it follows that an account with a debit balance is either an asset or an expense, or a combination of the two, and that an account with a credit balance is either a liability, capital or a profit or some combination of these elements. By the method of raising intermediate accounts, instead of carrying items of profit and loss directly to Capital, all the items of a certain kind are brought together in an account. For example, all payments on ac- count of salaries are charged to Salaries Account. This classification of expenses and profits is of use in the conduct of the business during the accounting period through comparisons which can be made with similar classifications of former periods, and it is of value in the preparation of analytical statements at the close of the ac- counting period. At the completion of the period the balances of the Nominal accounts, as they are termed, carrying profit and loss elements, are brought together, usually by Journal entries, in a ledger account called a Profit & Loss Account. It is necessary to bring all losses and expenses to the Profit & Loss Account by charging the latter and crediting the particular expense account, thus: jg ald pul Bos wl bs pee ei rane ie peek ea ug eee ai Shay Sid D7 Red MOBS SR Lah 7 AOE ie RATE It is necessary to bring all profits to the Profit & Loss Account by crediting the latter and charging the particular profit account, thus: LH RE Sn (received ies eh bes eis Pata bin on MOsPROR UE x lLOSoeisenwe. js awa o ks vs The construction of a Profit & Loss Account is merely a gathering in one Ledger account of the items of profits and losses, offsetting them against each other. If the total of the profit items exceeds the total of the loss items, 18 the excess, being a credit balance and measuring increased asset value in the business, is carried to Capital Account, thus: BROPUTT ae hhOSS ite a, Oe 300) ab RAS a ee TOpGAPITA Ls 225 its Sate gee eae The foregoing entry balances the Profit & Loss Account, and clears the books, at that particular moment, of all Nominal accounts. If a loss is incurred, it is carried to Capital by a debit entry and Profit & Loss Account is credited to balance. If drawings had been made by the proprietor during the accounting period, they would have been charged, properly, to a Drawing Account or Personal Account opened in his name, the balance of the Profit & Loss Account would first have been taken to such account, and the bal- ance, measuring the net increase or decrease of investment in the business, would have been carried to the Capital Account. Instead of raising a separate Drawing Account and charging it with withdrawals, they are sometimes charged directly to Capital Account. The method of keeping withdrawals in a distinct account, and carrying the amount of the net increase or decrease of capital to the Capital Ac- count and thereby showing the net result without a multiplicity of items, is preferable. This view of the Profit & Loss Account is now given in order to show its relation to the Nominal accounts, and that it is merely a consolidation of such elements and the gateway through which they find their way to the Capital Account. It is important that the general plan be grasped by the student in order that the goal to be attained, and the general means of reaching it, may be clearly in mind before, as well as during, the consideration of the details which is about to be undertaken. Therefore, to reiterate, the books are opened with the assets on the debit side, and the liabilities and Capital on the credit side, effecting an equilibrium, or balance. During the transaction of the business for the period, Nominal, or temporary, accounts are raised, to which expenses are charged and to which profits are credited, and at the end of the period these accounts are closed into one, and the net profit or loss is offset against drawings in the Drawing Account, and the balance is carried to Capital Account, and marks the increase ar decrease of net asset value in the business as the result of the transactions for the fiscal period. After the Nominal accounts are closed out, the books, so far as the nature of the accounts is concerned, are in the same condition as when 19 opened—assets appearing as debits to accounts, and liabilities and Cap- ital as credits to accounts. Real, Personal and Nominal Accounts The temporary accounts, raised in the course of the accounting period, to be offset and closed out, are known as Nominal accounts, and their nature has already been sufficiently noted. As distinguished from Nominal accounts, those accounts represent- ing real facts as to the ownership of values, such as Cash, Real Estate, Machinery, Plant, etc., and the liability for values, such as Accounts Payable, are known as Real accounts. Accounts with persons, either with debtors, those indebted to the business, or with creditors, those to whom the business is indebted, are also known as Personal accounts. Personal accounts are, in fact, Real accounts, although they are often given the distinctive classification. Another classification of accounts is into Personal and Impersonal, the former being those with persons, and the latter all other accounts. This classification seems to be illogical, because the Impersonal accounts include those representing asset values, such as Real Estate, and those representing nominal elements, such as Rent, thus associating elements of entirely dissimilar character. The most logical division would seem to be into Real accounts, sub- divided into accounts with persons and accounts with things, and Nom- inal accounts. Upon the opening of a set of books only Real accounts ordinarily appear, but upon the transaction of business Nominal accounts are raised, and remain until closed out at the end of the accounting period. Purchases The business of a trading concern provides transactions that illustrate the principles of accounting, and although a comprehensive theoretical view of the transactions of an accounting period has been given, it will now be reinforced by entries covering specific transactions. The first procedure in a trading business, is to buy stock. It may be bought for cash, in which case Merchandise would be charged and Cash credited, the following Journal entry covering the principles of debit and credit: tive SRM Oue Vou OS OST Op es CES ee Oar eae PROM Cy Eda Set, Gideon Shee covet tie as That is, the transaction is merely an exchange of an asset of one kind for an asset of another kind, and so it appears in the books as raising 20 i an asset by a charge to Merchandise, and the cutting down of another asset by a credit of an equal amount to Cash. If the purchase is made upon credit, Merchandise would be debited and the person or concern from whom the purchase is made would be credited, as follows: MES CIAMN DIDE.. cucu satetan ou ene eee Oe Too WEELTAM JONES, cue. steerer cee That is, the transaction amounts to obtaining an asset by incurring a . liability of an equal amount, and it is carried out in the books by charging the assets and crediting the person or concern to whom the business is indebted for the asset. In either event, whether one asset be raised and another cut down by a like amount, or whether an asset be obtained and a liability of a like amount be incurred, the net condition of capital is not changed. Sales Sales, in the natural order of things, follow purchases. Like pur- chases, they may be for cash or on time. If for cash, Cash is charged and merchandise credited, with the amount of the sale, thus: for Cash should be charged, that is, it is accountable for all cash received, and Merchandise, having been charged with the cost of goods, should be credited with the amount received for goods which have been sold and which have passed out of stock. If the sale is on credit, the person to whom the goods are sold should be charged in an account opened in his name, and a credit should be made to Merchandise the same as in the foregoing illustration, thus: for the business now has an asset in the account receivable. Returned Purchases and Returned Sales Goods are sometimes returned to the one from whom they were bought and are then known as Returned Purchases. The one to whom the return is made should be charged, and Merchandise credited, thus: WILLIAM JONES: 23 552 pee eee ce TO MERCHANDISE. 2 aa Ateneo for, to the extent of the return, it is the extinction of a liability by the turning over of an asset. 21 In like manner, customers of the business may return goods, and such returns are known as Returned Sales. In such cases Merchandise is charged and the customer credited with the amount, thus: for, to the extent of the return, it reduces an asset and restores the Mer- chandise Account to its former position. Division of Merchandise Account In the accounts of traders, a Merchandise Account is usually maintained, to which purchases are charged, sales credited, returned purchases credited and returned sales charged, in the manner which has been set forth. A better and more modern method is to divide the Merchandise Account into two ledger accounts, viz., Purchases, to which purchases are charged and returned purchases credited; and Sales, to which sales are credited and returned sales charged, the Purchases Account showing the net purchases, and the Sales Account the net sales. Or, if the volume of business justifies it, a further division may be made by opening a Returned Purchases Account and a Returned Sales Account. The Merchandise Account is a consolidation of these various ele- ments, and while it theoretically gives the same result as the division into separate accounts, practically the amount of net sales and net pur- chases cannot be determined, from time to time, as readily; the com- parison of purchases and sales with previous periods is difficult; the Merchandise Account in practice frequently becomes the resting place of many items which are not otherwise easily disposed of; and, in short, it falls short of giving the satisfaction that is obtained by making the division into distinct Purchases and Sales accounts. Profit If the selling price differs from the purchase price, the new element of profit or loss enters into the accounts, for in that case the selling is not exchanging one asset for another of equal value, but for one of a greater or less value. Ordinarily, of course, the exchange is for an asset of a greater value, and a profit is made. If the accounts are opened with Purchases and Sales accounts, and all the goods on hand are sold, there will be on the books a Purchases Account, debited with the cost of the goods, and a Sales Account, credited 22 with the selling price of the goods. It is a simple case of cost, as shown in the Purchases Account, as against proceeds, as shown in the Sales Account. The excess of the proceeds over the cost is the Gross Profit made in the trading transactions. If no expenses were incurred in these transactions, and no drawings made by the proprietor, the excess of the Sales Account over the Pur- chases Account would be the net increase of assets on account of the trading operations, to be finally taken into the Capital Account. In practice there would be expense items to be charged against the Gross Profit, but this does not change the principle in the least. Practically, it seldom happens that the goods are completely sold out, for the purchases and sales go on continually. But if the goods on hand are inventoried at cost prices, and the amount deducted from the cost of the goods as shown by the Purchases Account, it is evident that the balance will be the cost of the goods sold. To express it tersely, cost of goods bought, less cost of goods on hand, equals cost of goods which have passed out of stock. This being true, it is easy to arrive at cost against selling price, as was done in the theoretical case where the goods were all sold. The exact method of doing this will be considered in the next lecture. Division of Expenses into Accounts The Nominal accounts raised in the course of the business have to do principally with the items of expense, and just how many accounts shall be raised is a matter dependent upon the particular business and the requirements of its management. ) In any event, the principal items of expense, such as wages, rent, insurance, freight, cartage, etc., are collected in distinct accounts. When such expenses are paid in cash, the proper account is charged and Cash credited, and if not paid in cash, the proper account is charged and the party to whom the undertaking is liable for the amount receives the credit. Thus, if it is a cash payment for rent, the entry is: for an expense is incurred, which should be charged, and it is met by cutting down the asset of cash, which, therefore, should be reduced by the credit. If it happens that the rent is due, and through shortage of cash, or otherwise, it is not paid in cash, the condition can be shown by charging ZS the expense account, Rent, as before, and crediting the person or con- cern to whom the rent is payable, thus: On) EV Ee ICV INGE. ce cca. for an expense is incurred which has not been met, and for which a cor- responding liability should be shown. If, later, David Brown is paid in cash the amount due him, the entry would be: 3 PTE) ic ES SCD IN hae hee eee ce Yo RS On Acres Cite Chie Meee ES EGP whee for the liability, as shown in the account payable, is extinguished by the turning over of an asset. The final net result of the David Brown rent transaction is a charge to Rent and a credit to Cash, as in the first illustration. Discount Discount is the abatement of a portion of a sum due or to become due. Many classes of merchandise are sold on credit, that is, without cash payment, to persons with established financial standing, the time usually allowed being ten, thirty or sometimes sixty days. In such cases it is customary to allow a discount, or deduction, from the selling price in order to induce cash payments. For example, if a bill of merchandise is bought for $1,000, terms net thirty days or one per cent. discount for cash, it can be settled by a cash payment of $990. -The term discount is also applied to the rate per cent. deducted from the face value of a negotiable instrument, and is in the nature of interest. It is a common practice for business concerns to issue their notes, generally for short periods of thirty, sixty or ninety days, without interest, and discount them at their banks, that is, sell them for what they will bring, the proceeds being the face of the note less the discount. Another method of securing cash is to endorse and discount bills or notes which have been received from customers, the discounting bank collecting the face value when due. Discount deducted from such promissory notes, bills of exchange, etc., is computed by the method known as Bank Discount, that is, simple interest at the agreed rate of discount on the face of the bill for the time it has to run between the date of discount and maturity, counting the actual days. 24 Thus, the discount at 6 per cent. on a note for $1,000, maturing in thirty days, would be $5, and the proceeds or net cash to the one who dis- counts the note would be $995. If the note bears interest, the discount is computed on the total of principal and interest due on the note at maturity. Bank Discount is the method in common use, and the courts have held that the term discount in an ordinary commercial document means a rebate of interest and not true or mathematical discount. True Discount is “‘that interest on a certain principal for the term and at the rate which, when added to its principal, gives the face of the note or bill discounted.’’ Thus, in the example given, the true discount would have been $4.9751, and the Present Worth the difference between $1,000 and $4.9751, or $995.0249. That is, the sum of $995.0249 and interest thereon at 6 per cent. for one month will amount to $1,000. True Discount is found by dividing the amount of the obligation by the amount of $1 for a given time and rate (in the above case $1.005); the result will be the present Worth. The difference between the Present Worth and amount of the obligation is True Discount. It will be seen that Cash Discount may be in favor of the business, as where a liability is settled before it is due, or it may be against the business, as where it is allowed to a customer for payment of an account before it is due; or it may be allowed to a bank for discounting a bill receivable or a bill payable. Thus, discount may be an expense or a profit, and the Discount Account usually contains both elements, the balance of the account show- ing the net result of the total Discount transactions. | The same principles are involved in Interest, or the compensation for the use of money, when it is paid or received, and the items are fre- quently, although not necessarily, carried in one account under the cap- tion Interest & Discount Account. In determining the entry to be made for an item of Discount, the question is, Is it a profit or a loss? If it is a loss, it should be charged to Discount, because losses are charged and appear as debit balances of accounts; and the person in whose favor it is allowed should be credited. If it is a profit it should be credited to Discount, and the person from whom it is received should be charged. Items of interest received are similarly credited. Trade Discount is a deduction from a list price, it being the custom in certain lines of business to keep a fixed list of prices, the fluctuations in the market prices being provided for by discounts from the list prices. Thus, if an article is listed at $8 a dozen, the price might be 10, 5 and 2 aS off, that is, 10 per cent. off $8, leaving $7.20, 5 per cent. off $7.20, leaving $6.84, and 2 per cent. off $6.84, leaving $6.70, as the actual price. Prices sometimes depend upon the amount of business transacted with the particular customer, such differences in price being provided for by the discounts allowed from list prices. | Trade Discount is ordinarily not taken into the accounts, as it forms no part of the real price. Allowances may be for prompt payment, adjustment of prices or overcharges, etc., and are deductions usually made to secure cash settle- ments. They are ordinarily treated in the same manner as Discounts. Bills Receivable and Bills Payable Promissory notes, bills of exchange and checks, are ordinarily termed negotiable instruments. Under the New York statute the essentials of a negotiable instrument are as follows: 1. It must be in writing, and signed by the maker or drawer; 2. Must contain an unconditional promise or order to pay a sum certain in money; 3. Must be payable on demand, or at a fixed or determinable future time; 4. Must be payable to order or to bearer; and 5. Where the instrument is addressed to a drawee, he must be named or otherwise indicated therein with reasonable certainty. A negotiable promissory note is a written promise to pay to bearer or to order, for value received, a certain sum of money at a determinable future date. A bill of exchange, ordinarily called bill, is a written order of a person, called the drawer, upon a second person, called the drawee, to pay to bearer, or to the order of a third person called the payee, a certain sum of money at sight or at a determinable future date. In Accounting, notes and bills, when they are due to the undertaking, are known as bills receivable, and when payable by the undertaking, are known as bills payable. Checks, while they are negotiable instruments, are ordinarily treated as cash. Settlement of liabilities is usually made by cash or by giving notes or bills. If settlement is made by cash, the creditor is debited and Cash credited. If settlement is made by bill, the creditor is debited and an account called Bills Payable is credited. If the settlement is by cash, it is the extinction of a liability by turn- ing over an asset of equal value, and hence, the liability is charged and 26 the asset credited. If a bill is given for the liability, it is but a change of the form of the liability from an open account to a formal written obli- gation to pay, and hence takes the form of extinguishing one liability by a charge and raising another liability account to take its place. Bills Payable Account, being a liability, appears with a credit balance. If a bill is issued with a view of obtaining cash, instead of the settle- ment of an open account, the ordinary method is to make a note for a certain amount, due at a future date, without interest. Such notes are usually discounted by a bank, the amount of cash received being debited, and the amount of discount, which is in the nature of interest paid in advance, is debited, and Bills Payable credited to balance, thus: When the bill is paid, Bills Payable Account is debited, and Cash is credited, for it is the extinction of a lability by turning over an asset. If the bill is not paid, but renewed by a new bill, Bills Payable is debited, and Bills Payable is credited, so that the settlement of the prior note and the issue of the new one will appear in the Bills Payable Account. Discount is charged and Cash credited for amount of discount on new note. In the same manner, customers of the undertaking may make a settlement of their accounts in cash or by bill, and the procedure is to debit cash or Bills Receivable, as the case may be, and credit the account of the customer. Even when the sale to a customer, and the receipt of the bill receivable from him, are simultaneous, it is the best practice first to debit his account with the amount of sale, crediting Merchandise, and then pass another entry charging Bills Receivable and crediting the customer. In this way the ledger account with the customer discloses all of the transactions with him. Bills Receivable Account, being an asset, appears in the accounts with a debit balance. The bills are held in the Bills Receivable account until paid, when Cash is debited and Bills Receivable credited; or, until the bills are dis- counted, that is, the right to collect the face of the bill at maturity sold to the bank for whatever price in cash such right will bring. In case the note is discounted, Cash is charged with the proceeds, and the amount of discount is charged to Discount Account, crediting Bills Receivable Account. If a bill receivable is discounted and afterwards is dishonored, that is, not paid by the maker when due, it will come back to the business 27 for payment, inasmuch as it would under ordinary circumstances be endorsed. When such dishonored note is taken up Cash should be cred- ited, if paid in cash, and the party from whom it was originally received is charged with the amount. Dishonored bills should not be held in the Bills Receivable Account, but should be charged back to the party from whom they were received. Distinctions Between Expenditures An expenditure for rent represents nothing but loss at the end of an accounting period, if no payments have been made in advance. An expenditure upon office furniture would represent, at the end of the ac- counting period, value nearly equal to the expenditure. The rent, being a necessary expense incurred in obtaining the gross . profit for the period, should, in determining the net profit for the period, be closed out against such gross profit. If the office furniture is worth less to the business, by reason of use or otherwise, than its cost, such depreciation, being a loss incurred in making the gross profit, is chargeable against it the same as a direct expense. It is necessary that these distinctions be kept in mind in distributing charges between Real and Nominal accounts, as the soundness of the accounting conclusions as to profit and loss are dependent upon distin- guishing and charging against gross profit all the losses incurred in making such profit. hy aia ’ i cow a) F ‘ sn iL? an FT, y s ' ‘ Sd . = ‘ _ : Ld am * tft ryan Ma ” ‘ j 5 a « ” o i 4 PA Re Na th ha Ree Sey fy ASN oy ts Dee LS PALMER RARPMRAD ph! het) byt) if at ig atta con ; Prat! Nye bat "a hi eo TPE RGD GARI ICN ancineneren Bis, by F < ai 4 ir ; x ; Pa ae aT Pid . AA» ein a SR VA” Ae Seer iy Te) tl i a. ‘ « 5 ty ’ f s é Lt } .% e) i pat) tgs van ° . +) (~ y ad Pk 33 t at ig *4 1 ' f , a? 4 +” P? r { x b= 2 . tr Sau i . . ‘2 « + 2 es ve 7 + iv? . s * > ' . , ‘ “ 4 * CP) ij rd : ; ie * ‘ , f st s ry : 7 - 7 iTS { i 2 . ee 1 ss Lil : i , r t- > + f ‘ oe at yf 1 bie rivews’. a4 pO + ‘ona 4 t i rf abe ’ 4 > "4: Lie +a rey Be . © 4 Ls ¥ ' , , i we ‘ Pua iN" As CY ; f bax¢ 5 \ ¥ ' 4 A i be ot 7h But 4 ' oh St io 3 ; eg’ yale Ne ‘ : fr A 7 au ) ey vibes aL RAL! ‘ +" ’ ; o} tow “* begs ihuerleeyre ay ¥ , ie hig Pity 2 TA’ 7 Re ‘ i shine sate Cans be irae scone Bee a ele aie Pan nea iu "a o.* x ie : a yi _ THEORY AND PRACTICE OF ACCOUNTS ie. ie APPLIED ECONOMICS AND ORGANIZATION (By TOMER ST. CLAIR PACE, -C. PA. (N.¥.) LECTURE III CLOSING THE BOOKS Pree se itech any CC Mr aman SO UN selias | 28 PURTAL, BALANCE. 3 yc ceh PE ROR SAO ncmn Ot eR UR OT ae 28 Pid Botner Books ee a ee 30 =CLOSING THE NOMINAL ACCOUNTS... 065.8) 31 TE DRAWALS SS an ON oct: ft Ca a: 34 ASSET AND: LIABILITY ELEMENTS IN NOMINAL Be COOU MES COD mehr nc lal aie plea as aint ete eels 34 Olin, Usn or NOMINAL. ACCOUNTS ons Se 35 Post-CLosING Tee RANCH oe No ets So Barance SHEET...... Tee eke A Gee gs! eh ie Oy 36 TRADING ACCOUNT. e254. UE eee tian are pie Ty tree Ned 38 Prorit & Loss ACCOUNT FOR SUBMISSION WITH RL ERN CES OHDET Oo OR hee Sy Oe Ree S 40 COPYRIGHT, 1915, BY HOMER ST. CLAIR PACE eo PACES PACE PACE STANDARDIZED COURSES IN AGCOUNTANCY, BUSINESS ADMINISTRATION, AND ENGLISH, IN RESIDENCE AND BY EXTENSION 30 CHURCH STREET, | | NEW YORK CITY "TuHeory AND Practice or ACCOUNTS APPLIED ECONOMICS AND ORGANIZATION PemoNv eR ST CUATR PACE. CP. A. .(N. Y.) LECTURE III CLOSING THE BOOKS Rests Among the fundamental requirements of an adequate accounting system as stated in Lecture I, there must be rests, or times at which the accounting record momentarily ceases. At such time of rest the financial position of the undertaking is ascertained and compared with former posi- tions, and the intervening record is analyzed and studied with a view of increasing desirable and decreasing or eliminating undesirable results. At the close of the accounting period, in order to attain the desired results, the process known as closing the books is carried out, although the expression, in its ordinary sense, does not mean a literal closing of all accounts in the books, but only a closing of the Nominal accounts that have been raised during the transactions of the period. It was formerly the practice actually to close out all accounts at the time of such rest, but this is no longer done, at least not by American and British accountants. The process is a closing of the Nominal accounts into an account which is raised in the Ledger under the caption of Profit & Loss, and which is designed to show on the one hand, credit, the profits for the period, and on the other hand, debit, the expenses and losses for the period, the difference between the two, or balance, being the net profit or loss. | Trial Balance The initial step in closing the books is to test the accuracy of the postings and obtain a comprehensive view of the Ledger accounts. This is accomplished by the preparation of a Trial Balance. Copyright, 1915, by Homer St. Clair Pace. 29 A Trial Balance is a schedule of the Ledger accounts, showing the debit or credit balance of each account, the balances being arranged in parallel debit and credit columns and effecting an equilibrium. If the double entry principle is followed throughout in the entries and postings, and the balances of all the accounts are correctly abstracted and carried into the Trial Balance, the footings of the debit and credit columns will be the same, that is, they will balance. Hence, the name, Trial Balance, meaning a trial of the accounts to ascertain if they are in balance. A Ledger folio column is usually placed to the extreme left of the Trial Balance sheet to facilitate reference to the Ledger accounts. The following is an illustrative Trial Balance of the accounts of a sole trader, taken at the close of an accounting period as a preliminary to closing the books: JOHN SMITH Trial ._Balanc® as 304. Li: Dr. Cr 1 Real Estates: fy paaciics «oss Ss dle. och yh UA eee ee ee $10,000 3 Purniture Co Pietures ;.is ses G ciccg da ome tps eee oe eee 1,100 10 CASI rs tee ae. PERE ee Sea ee 970 12:4 Bond Ba Mortyages. ¢s59 5) cai-inmicd anal s Gah ge eee ee ea $2,000 12...) Jorn omirth, Capital 20: pci ssn gies aee Fike ae 14,590 100 ot. Jahr P.cfones: 05-25 weld Pa Se ER ee Bh bls Lae ae eee ee 580 105 Wr. Halles. Fee 2605 aire ao uae 2 cao eskd cae a ee ee 2,410 210-9 AS Brady 2. 56 eG Ha WeR RAL as tee We he Ace ee eee 1,840 200 5 4 K7 South 8 (0.23 ce ia hn patents hee sie a ee eee eee 375 208 “WrAper Bros: Sicibeiec ered. 5 korea htes esheets een ee eee 900 212 WEA tC handler seal tes Gam poy season week Ge Oana eaten ne ee 1,340 SUD MICTONANOISE) oe vice chy St vs a hk ede kee etna a ee eee 8,000 320 Revit § SEs Age be uks,..8 nik Wicgs eA be Se lke & Peale 500 Dek ATIBUTANICE Nocesg hed eye p+ pps dod Kae IRIS Oke k & hie chee in ale 55 324 Wartame ra iG Ces EOE WS AA als Bc SPC bts eis ok Ge ee en 100 326 elie gl Pee pa 4 we A Ee aR rn pyeee TULARC PT 5,000 BOUT KMS Geis CL va ceca» + i> sgn be widenele oy tiie ee ee eee 4,900 OAD Hi ATICTOGE pb ck oy Sc wisveti-s so 3 9 a OKA 6 RR DCLOae ope ee hee ee 50 342 PRSCOUMES Sieh Se wik le Rs sess ok wate RR RES A We eae ne ee 200 $27,455 $27,455 Instead of the balances of the accounts, the totals of the debits and credits of each account are sometimes carried into the debit and credit columns respectively of the Trial Balance, and if the work is correct, the columns will balance as in the method of taking the differences, or bal- ances. The first method is now the more usual, and has the advantage of showing, in each case, the net condition of the account, rather than the total of each side. | A Trial Balance is usually taken once a month in addition to the Trial Balance taken at the close of the period. By this means errors may 30 be discovered and corrected while fresh, and the corrective work distrib- uted over the period instead of accumulating to be performed at the busy time of closing the books. In addition, the monthly Trial Balance affords a view of Ledger accounts which is useful in the management of the business. The Trial Balance is valuable as a test of the accuracy of the work in posting Journal entries. If the balance cannot be effected, it is evi- dence of error, which must be corrected in order to bring the books to a balance. Errors are, perhaps, most likely to occur in the preparation of the Trial Balance itself, through mistakes in addition and in abstracting the balances, or in omitting one or more Ledger accounts. If there is no error in this work, the postings are open to suspicion as a likely place for errors to have occurred, and if it transpires that they are correct, it may be due to the Journal entries themselves not being in equilibrium. While the attainment of a Trial Balance is not conclusive evidence that there are no errors, it is nevertheless strong evidence that the post- ings are correct, and that the balances have been properly abstracted. One of the rare things that may occur is a compensating error, that is, an error on one side that exactly offsets an error on the other side. Such an error, as well as one by which an item is posted to the wrong account, without affecting the equilibrium of the books, will remain un- detected so far as the balancing principle of the Trial Balance is con- cerned. However, the accuracy made possible by the Trial Balance check, characteristic as it is of Double Entry bookkeeping, quite compensates by its usefulness for the extra labor involved in making the entry with its twofold effect. The other function of the Trial Balance is to afford a comprehensive view of the accounts as they exist in the Ledger, not only at the time of closing the books, but from time to time as the trial balances are taken during the business period. At the time of closing the books, the Nominal accounts, brought to their proper amounts by adjustment entries after a careful survey of the business, are presented in the Trial Balance for scrutiny, and from it the information is obtained to formulate the Journal entries necessary to close the Nominal accounts into the Profit & Loss Account. Trial Balance Book In order to preserve the Trial Balances a Trial Balance Book is ordi- narily kept, ruled with numerous debit and credit columns so that the 31 balances may be inserted without rewriting the names of the accounts for each trial balance. The ruling is as follows: JAN. FEB. Mar. APR. L. F.| NAmeEs oF ACCOUNTS wn The book is opened flat and the ruling extends over the two pages, affording columns for at least six months, and if an insert sheet is used between the pages, narrow enough not to obscure the names of accounts, columns for the entire year can be provided. The names of new accounts opened, ordinarily Personal accounts, can be added at the bottom of the list. Closing the Nominal Accounts As a preliminary step, an inventory or schedule of the goods on hand is made. It is merely a detailed list of the merchandise on hand, with values carried out, ordinarily, at cost prices. If a Merchandise Account has been maintained it will, presumably, stand charged with the amount of the purchases, and credited with the amount of the sales. If we deduct from the amount of purchases the cost of the goods on hand, the difference will be the cost of goods that have passed out of stock. Stating the proposition arithmetically with illustrative figures from the accounts of John Smith, the purchases amount LOS SAV STE IS. 58s Lied a A RE PS te cae $60,000 The inventory of goods on hand, at cost, amounts to.......... 6,000 Leaving cost of goods that have passed out of stock.......... $54,000 {i the ‘sales amount: to, Say. i. -(%. ares oie Beant aie = eae eee 68,000 The excess of selling over cost price, or Gross Profit, is........ $14,000 32 In Double Entry bookkeeping, the deduction of the amount of inven- tory from the cost of merchandise purchased is accomplished by crediting the Merchandise Account with the amount of Inventory. By the same entry a New Merchandise Account, or Inventory Account, is opened and charged with the amount of inventory, being at the moment a pure Real account, stating an asset value. The entry would be as follows: INVENTORY AS AT———........ $6,000 Poe MER GEAND DSH iia Uris $6,000 At this stage the Merchandise Account stands credited with the erly AI he en aed a eh Bs nde BU hae ty $68,000 Beeman rie amount of inventory...) 6... alse ce eee bee 6,000 Ee A RCTCL Se ee ce ete a ue es $74,000 and it stands charged with the amount of purchases.......... 60,000 the difference between the debit and credit sides of the Account TTT (wie OP ig Ti. 8). Agate wis Mas ead Caen 2 ae 4s, $14,000 which is a credit balance, and the amount of Gross Profit that was ascer- tained by the former solution. The balance of the Merchandise Account at this time is purely Nomi- nal, measuring the Gross Profit. It should be transferred to Profit & Loss Account, closing the Merchandise Account, by a Journal entry, as follows: Riis Ce AON EE tat cs eb eth 3" 5 win ce pie! 2 $14,000 Or eNO Sma WOSS ia. 2.5050 2% $14,000 After the foregoing entries, the Merchandise Account, stating the pur- chases and sales in summary form, will appear as follows: MERCHANDISE ACCOUNT ME eCASCS 2) oss cee te ee ees POULOMMI TI] | bot aIGS asks 8 ira Tar cbc gs; $68,000 “ Profit & Loss (Gross Profit) ... 14,000 PCRITVENLOLY LCL eer se teeta bg 6,000 $74,000 $74,000 The balance of the Inventory Account, or New Merchandise Account, representing cost of merchandise on hand at the beginning of the succeed- ing accounting period, should be charged against the Merchandise Account of such period. The various expenses and losses standing to the debit of Nominal accounts will then be debited to Profit & Loss Account and the respective 33 accounts credited to balance, as has been explained in Lecture II. This can usually be done by one consolidated entry, thus: PROFIT & LOSS To SUNDRIES.. $10,555 IOPUIN Goes. ss chee wes Sine a een ee $500 TNS URINE eres atone 55 RSAC eae etn aan 100 DALARIES chia cee ate ee eee 5,000 EXPENSE es ce sheen ose ee 4,900 The profits, other than the principal trading profit which has already been considered, are then credited to Profit & Loss Account and the re- spective Nominal accounts debited to balance. thus: SUNDRIES To PROFIT & LOSS.. $250 INTEREST ces use peetmeeetoe cies $50 DISCOUNT (eh seen ieee 200 It is assumed in the illustrative figures that Interest and Discount accounts show a profit, but this, of course, is not always the case. After the foregoing entries have been made and posted, the Ledger Profit & Loss Account will appear as follows: PROFIT & LOSS ACCOUNT Ta Rentce oe ct er cke eran “.... $500 || By Merchandise (Gross Profit). ... ee § TA LTISEIICE Fotos ik 5 cance eek ee orale ee eae ee TLMTQEESUL Ls aka ha « Deke ane Py \GATEARE 7c cies te ee ere 100 © LNSODUTE no a:aans ain Sav a 200 S. WALATIOS. coer td sigh + ope nese hee 5,000 MUR DEDIEG (5 ied. ties inane dierme aan 4,900 “ Balance down (Net Profit)..... 3,695 ; $14,250 $14,250 By Balance... . «cist ne eine $3,695 It is a desirable thing, in posting to the Ledger Profit & Loss Account, ~ to show the items of profit and loss, instead of the To Sundries and By Sundries, which in themselves mean but little. Thus, instead of posting in a lump sum the total amount of expenses and losses, the amount trans- ferred from each account, such as Rent, Insurance, Salaries, etc., is shown, and an inspection of the Ledger account will disclose the facts without recourse to the Journal. The closing of the books is sometimes effected by direct transfers of the balances of Nominal accounts to the Profit & Loss Account, without the use of Journal entries. Thus, Rent Account would receive a direct 34 credit for the amount chargeable against the accounting period, and a debit for that amount would be made in the Profit & Loss Account. The use of the Journal entries is the better practice. Withdrawals Drawings are ordinarily made by the proprietor from time to time, and should be charged to a Drawing Account or Personal Account. The drawings form no part of the profit and loss transactions, and therefore should not be taken into the Ledger Profit & Loss Account. ‘The balance, net profit or loss, of the Profit & Loss Account, as was explained in Lec- ture II, should be carried to the Drawing Account. The balance of the Drawing Account will then represent the net increase or decrease of Capital for the period, taking into account all the profits or losses and drawings, and should be transferred to the Capital Account, increasing or decreasing that Account just as the net investment is increased or decreased. In the illustrative case under consideration, there being no drawings by the proprietor, the Net Profit is carried directly to the Capital Account, by an entry as follows: PCat lr Cee le C2, see tee oid dene tie eo $3,695 TO CAe ia ACCOUNT So. .', $3,695 The books will then disclose, as at the time of opening, assets to the debit of accounts and liabilities and Capital to the credit of accounts. Asset and Liability Elements in Nominal Accounts Great care should be exercised in closing Nominal accounts, as it is evident that, in order to arrive at the true profit, only the expenses which belong to the accounting period should be charged and only the profits which belong to the accounting period should be credited. The expense accounts appearing in the ante-closing Trial Balance . may show more or less charged than rightfully belongs to the period, so that a careful scrutiny and adjustment are necessary. If insurance, for instance, is paid during the period for a three-years’ term, the entire amount will doubtless appear charged to the Insurance Account, although at the time of closing the books only that part which is paid for insurance for the current accounting period should be charged as an expense of that period. The balance, being insurance paid in advance, at this time should be treated as an asset of the business, and not as an expense. The simplest way to treat such an account is to charge Profit & Loss Account with the amount chargeable for the period and credit the amount a to Insurance Account, bringing down the balance of the Insurance Account, as a debit which would remain in the accounts. The opposite condition would exist in the case of rent which was accrued but not paid, and possibly not due. In such a case Profit & Loss Account should be charged with the full amount of rent chargeable against the profits of the period, and Rent Account credited. The latter would then show a credit balance, measuring the liability on account of rent. The account should then be ruled off and the balance brought down. There are other methods of treating such accounts. One is to close the old account entirely and bring down the balance in a new account, as, for instance, Insurance, New Account, and allow it to remain as a balance. This is practically the same as the first method outlined. Another plan is to open an account called Suspense Account and carry to it the debit and credit items, the balance being the net asset or liability. Upon entering the next accounting period the items are dis- tributed to their proper accounts and the Suspense Account closed, by entries directly the inverse of those by which the account was created. A Suspense Account is one raised to hold temporarily that which properly belongs to another account, so it will be seen that the use of a Sus- pense Account in this case conforms to the general use of such an account. The method used is not so important, so long as the principle of charging to an accounting period all the expenses and crediting to it all the profits which properly belong to it, is rigidly followed. It is not sufficient, in actual work, to rely upon the accounts that appear in the Ledger, but a critical survey of the business itself must be made to ascertain whether there are any outstanding assets, liabilities expenses, losses or profits which should be brought into the accounts to arrive at the real results. In the illustrative accounts of John Smith, it is assumed that: the accounts as presented in the Trial Balance stand at their proper amounts. The Use of Nominal Accounts It should be recalled at this time that the same result, or effect upon Capital, would have been produced by charging every expense and draw- ing and crediting every profit, directly to Capital Account, and that the whole system of Nominal accounts is raised for the purpose of classifying expenses and profits so that the relation of each class to the ultimate result may be appreciated. Post-Closing Trial Balance. A new Trial Balance should be taken after the final result is carried to Capital Account, to test the accuracy of the closing entries and postings, 36 and to display Ledger facts in such a way that they will be available for the preparation of later statements. It will appear from such post-closing Trial Balance that the Ledger accounts present practically the same elements as the original statement upon which the books were opened, viz., assets appearing as debits, lia- bilities appearing as credits, and Capital Account, with a credit balance, to balance. Although the actual items of assets and liabilities may vary from the original figures and the Capital Account show a different balance, as will undoubtedly be the case, the elements will be the same. In the accounts of John Smith, heretofore considered, the Post- Closing Trial Balance is as follows: JOHN SMITH Post-Closing Trial Balance as at........ L. F Dr. Cr 1 LS, CLEA RR Serie SSE nD LEE ARO REO AE, xo MERE ees RM dy ee $10,000 | | aa OM De® qb kyon RAM Se 6 FpRi aA AMA is 2, AAR ark ik 1a a Ae eae ,100 UMMM ESION Rb hee. SOS Jugs. ida: Lapbeaiels oh staal dels oo 4 970 12 Pond RP ALINESADE CARA EN ae ta st pn Carers wre ve! dee eee $2,000 PPO a Cl Camital io) yec cs 55 Wes wee Wem eines stile mae ea ee 18,285 100 | John F. Jones ee gas Nei ac Fai gig ORO ED ene PAA ALE TA Tog 580 ee MERE CEL ALE oS eee eA ee Pie's alc). e vv Sold wa gic Mecca's 6 Sue 2,410 110 A. scores Pere ch eh at ela ase Dl sheds me Fatianlaie wiley) Escace © 1,840 NITE ERP EALY We tC AUR Ect, RRS abies hice ok sie «a ao ais pik wie su 6 rsalece 375 DERE UIC R Soon, andres sa abe heats fs ptkis bes ale! Ses Aad ics he ge ole da 900 EE CRC LSTICICE Gir Urea Tun tos eicd a ee pierces hc eis oaie dq 88 1,340 SOM OLOTY fe At Wires os es hla sae ed PUT OR ae 6,000 $22,900 $22,900 _ Upon the figures of the post-closing Trial Balance is based what is probably the most important statement in accounting—the Balance Sheet. Balance Sheet The Balance Sheet, to define it in accordance with the generally accepted idea among accountants, is a statement of the assets, liabilities and capital of an undertaking as at a certain time, prepared from facts recorded in double entry books of account. The Balance Sheet is the statement by which the financial condition of the business, that is, the amount and kind of its assets and liabilities, as recorded in the Ledger, is made comprehensible to the proprietor and others. It is, in short, the connecting link between the books, on the one hand, and the proprietor, and his bankers or others to whom he may desire to communicate the financial condition of his business, on the other hand. 37 The Balance Sheet, as the most important statement that can be pre- pared from double entry books of account, is worthy of the most careful consideration, but in this elementary Lecture it is impracticable to do more than call attention to its most important characteristics. The terms Financial Statement, Business Statement, Statement of Resources and Liabilities, Statement of Assets and Liabilities, etc., are sometimes used instead of the term Balance Sheet. None is so short as Balance Sheet, and as the term is in good standing among English- speaking accountants the world over, and is used by railroads, banks and large business institutions, no deviation from the accepted practice should be made by the Accountancy student. The term Statement of Assets and Liabilities is generally reserved by accountants for the statement of assets and liabilities prepared from single entry books, or from sources other than double entry books. A Balance Sheet should be headed with the name or style of the undertaking, and with the date at which it is made. In the accepted American and Continental-European form, the assets appear on the left side of the Balance Sheet, under the caption Assets, and the liabilities, including Capital, on the right side, under the caption Liabilities. The Balance Sheet being but a rearrangement of the post-closing Trial Balance, and not an account, the abbreviations Dr. and Cr., and the introductory words To and By should not be used thereon. In a single proprietorship or partnership it is customary to state the assets and liabilities in the order of their probable quickness in realiza- tion and liquidation respectively. In corporation Balance Sheets this order is ordinarily reversed, the quickest assets and liabilities appearing at the bottom. The English practice is to reverse the sides of the Balance Sheet, placing the liabilities on the left side and the assets on the right side. This practice has doubtless grown out of the Companies Act of 1862, which provided for this illogical form. The reason for the English form is not clear. The theory advanced in support of it is that, the statement being an account rendered to the proprietors, headed by the name of the undertaking, the undertaking should be credited with its assets and charged with its liabilities. As a matter of fact the Balance Sheet is not an account, but merely a re- arrangement of the post-closing Trial Balance. The Balance Sheet of John Smith, prepared upon the basis of the Post-closing Trial Balance which has been given, is as follows. : pa eam agin ” 38 JOHN SMITH Balance. Sheet as at........ Assets Inabilities a Pl a ei $970 || Bond & Mortgage.. “net a ae $2,000 Accounts Receivable, as per Accounts Payable, as per 0 wa Spgs Seite Ab Mei a EC no 4,830 Schedule. . Can ALE 2,615 OE SS Tae ea 6,000 || John Smith, Capital. . Re: 18,285 Poruiture & Fixtures... 0000.0... 1,100 AMS 1 2S aia ee a 10,000 $22,900 $22,900 For the sake of simplicity, no provision has been made in the fore- going illustrations for losses that may be incurred in the realization of the accounts receivable, either through bad debts or discounts, nor for depre- ciation. Such provision could be made by charging Profit & Loss Account with the estimated amounts, and in each case setting up, with a credit balance, a reserve. Thus, a Reserve for Bad Debts could be created, to which uncollectable accounts could be charged. Instead of creating , a reserve for depreciation it is sometimes written directly off the asset account by a credit entry, reducing by the amount of such entry the amount at which the asset is carried in the books. In case reserves are created they should appear on the Balance Sheet as a deduction from the value of the particular asset for which they are created, and not as a balance on the liability side. Trading Account Instead of using a Merchandise Account throughout the accounting period, the better and more modern method is to charge purchases to a Purchases Account, crediting returned purchases to the same account, the balance showing at all times the amount of net purchases; and to credit sales to a Sales Account, charging returned sales to the same account, the balance showing at all times the amount of net sales. It is necessary when closing the books .at the end of the period to bring together the elements of opening inventory, if any, purchases, sales ‘and closing inventory, in order to determine the gross profit which has been made, and which, under’the method of using a Merchandise Account, is shown by the credit balance of that account. This is accomplished by raising on the books, at the time of closing, a Trading Account, to which the inventory at the commencement of the U. OF ii. LB, 39 accounting period, if any, is charged, and to which the subsequent pur- chases are charged, the opening inventory account and the Purchases Account being credited to balance, thus: and by crediting the amount of Sales and closing inventory, closing the Sales Account by a charge to balance, and setting up the inventory at closing, thus: At this stage the Trading Account will contain, in summarized form, all of the elements of a properly kept Merchandise Account, including a credit on account of closing inventory, and will show the Gross Profit which may have been made, by a credit balance. The balance of the Trading Account, showing Gross Profit, is trans- ferred to Profit & Loss Account, thus: TRADING ACCOUNT Siler tie oe eer nee To -PROBTTALOSS.25 i: Bae eee and the subsequent procedure of collecting in the Profit & Loss Account the items of profit and loss which are necessary to determine Net Profit is the same as if the balance of Gross Profit had been transferred from a Merchandise Account. If the business is large enough to justify it, a special account may be kept for returned purchases, instead of crediting them to the Purchases Account; and likewise a special account may be kept for returned sales instead of debiting them to the Sales Account. Where these divisions are made, the balance of the Returned Purchases Account is brought into the Trading Account, thus: RETURNED PURCHASES ACCOUNT.. To TRADING ACCOUNT sec eeanees and the balance of the Returned Sales Account is brought into the Trad- ing Account, thus: RAD INGUACCOUN TT cigar ier teeeerens. To RETURNED SALES ACCOUNT.. thus bringing iato the account the same elements as in the illustration where the division into special returns accounts was not made. 40 It is important to remember that the Trading Account is not main- tained throughout the accounting period, but is raised only at the time of closing to collect the elements which are necessary to determine the Gross Profit, and to show by the balance of the account the amount of such Gross Profit, and that it is immediately closed by a transfer of its balance to the Profit & Loss Account. Profit and Loss Account for Submission with Balance Sheet The two main purposes for which accounts are kept being the deter- mination of assets and liabilities, and the determination of profits and losses, it is necessary that there should be statements prepared from the books of account which disclose these facts, for the information of the proprietors or others in interest. The Balance Sheet, which has been described, displaying the assets, liabilities and capital as at a particular time, meets the first requirement. The Profit & Loss Account, as transcribed from the Ledger Profit & Loss Account, including explanatory detail, showing the Gross Profit made for a certain period of time, with the expenses and losses charge- able against such Gross Profit, and the resultant Net Profit, meets the second requirement. It is therefore apparent that a Profit & Loss Account may be either the Ledger Account raised under that caption, or the transcript of such account which is prepared for submission with the Balance Sheet, and which may vary somewhat in detail from the Ledger Account. If a Merchandise Account is used in the accounts, the balance, show- ing Gross Profit, appears as a credit to the Profit & Loss Account. If the division into Purchases and Sales Accounts is made in the accounts it is necessary to set up in the Ledger a Trading Account to determine Gross Profit. In preparing a Profit & Loss Account for submission with the Balance Sheet, if the Merchandise Account is used, the Gross Profit appears as a credit balance. If a Trading Account is used, it is usual to submit it with the Profit & Loss Account proper, to show the items which go to make up the Gross Profit. In some cases it is included as a first division in a state- ment called Profit & Loss Account, or Trading and Profit & Loss Account, the balance, Gross Profit, being brought down to the second division of the Account. The usual condition of a Gross Profit has been assumed throughout; although a loss upon trading is a possibility. It would not affect the handling of the Trading Account in any way. 41 In displaying such a Trading Account for submission with the Balance Sheet, it is the practice of American accountants to deduct the Inventory from the Purchases, by subtraction on the left side of the statement, instead of making the deduction by a credit entry as is done in the Ledger account. This is done in order to show, without a calculation on the part of the reader, the cost price, and to display such cost price in com- parison with the selling price. The Profit & Loss Account discloses the transactions that have led up to, and resulted in, the condition of assets and liabilities as shown in the Balance Sheet. In connection with drawings and contributions, if any, it connects the position as to capital disclosed in the Balance Sheet, with the position as to capital disclosed in the preceding Balance Sheet. It is this general idea of the purpose and use of the Profit & Loss Account which the student should acquire at this stage, leaving the details until later. oy ey ] _ THEORY AND PRACTICE OF ACCOUNTS. | APPLIED ECONOMICS AND ORGANIZATION. By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) LECTURE IV, THE CASH BOOK. SCOPE OF THE JOURNAL AND THE LEDGER.............. 42 Direct Enrry to Lepcer Casu Account.........5... 42 Pere AGH OOK ne es ln) hay are a ar 43 COCUMNAR LDIEVELOPMENT. 0008.5. dew Getik bee cate AS PEPOOUN Tae Cutt ea ONCE Sie Wa ierane a Sey 8 46 ILLUSTRATIVE Case Book Eero HPO RAUIACE Nc Rav ite Pun Re Alaa 48 LABOR-GAVING PRINCIPLES) 2.0 C2 Ok Ae Daou ae pene LEDGER SuMMarRY CASH ACCOUNT......0. 00.000 00004 49 - Perty Cages: 00s De Mae OSS a 50 PMpansT OVSTEM Ou hie he yee ee ok 50 - Bank ACCOUNTS AND RECONCILIATION OF CasH........ S| aN “STATEMENT OF RECEIPTS AND PAYMENTS.........--5- Yee e _ STATEMENT OF INCOME AND EXPENDITURE........2....-. 52 « COPYRIGHT, 1914, BY HoMER ST. CLAIR PACE. PACE '& PACE - PACE STANDARDIZED COURSES IN ACCOUNTANCY, BUSINESS ADMINISTRATION, AND ENGLISH, IN RESIDENCE AND. BY EXTENSION aut 30 CHURCH STREEET, ark : : AS NEW YORK CITY THEORY AND. PRACTICE OF ACCOUNTS APPLIED ECONOMICS AND ORGANIZATION Doerr ern 5 be CLALRY BACH] CurPiaAs (Ni Y2) LECTURE IV. THE CASH BOOK. Scope of the Journal and the Ledger. The student no doubt has observed that complete double entry books may be maintained by the use of the Journal and the Ledger; that ac- counts may be opened, maintained for a business period, and closed for the determination of profit and loss, with no other books than Journal and Ledger necessary to record every transaction. The Journal and the Ledger are the essential books of double entry bookkeeping. It is true, however, that many other books are in common use.~ Such books, upon investigation, are found to be but forms of the two basic books, calculated to economize effort in the recording of trans- actions, while retaining the accuracy and other desirable features of double entry. Direct Entry to Ledger Cash Account. It will be recalled that, in Lecture I, it was stated that a complete record of business transactions could be maintained on the Double Entry basis in the Ledger alone, but, for reasons given, that such a method would be impracticable. Consider, for the moment, that such an abbreviated procedure is used for cash transactions, entries being made directly in the Cash Account in the Ledger, without the use of a Journal. It is evident that the debits, on account of cash receipts, may be entered directly in the Cash Account, and that the customary Ledger explanation, giving the name of the account receiving credit, may be utilized as a guide to the proper account to be credited. On the other hand, cash disbursements may be entered from the stub of the check book directly to the credit of the Cash Account, and Copyright, 1914, by Homer St. Clair Pace. 43 the balancing charges made to the proper Ledger accounts from such credit Cash Account entries. The procedure will be apparent from the illustration which follows: LEDGER CASH ACCOUNT. 1902 1902 Jan. | 2 | To John Smith, Cap- Jans: 2 1 By. Expense. 4.3. aces $50 ital Acct {ies $1,000 2... $84 Purchases: 25 300 3 | “ A.B. Childs & Co. 200 4.) *" Jones’ © Cova 100 It must be borne in mind, in such an assumed case, that entries would first be made in the Ledger Cash Account, balancing postings being made therefrom in accordance with the explanatory detail. Thus, to balance the initial debit entry of $1,000, that amount is credited to John Smith, Capital Account. Such a procedure amounts to an elimination of the Journal so far as Cash transactions are concerned. The chronological order is preserved, however, so that the Cash transactions may be viewed in the order of their occurrence. The foregoing method of direct entry in a Ledger Cash Account is rare in practice, and it is given in order to make clear the development and principles of the Cash Book. The Cash Book. The ordinary Ledger ruling does not afford space for sufficient ex- planatory detail, and for this reason, and for other reasons which will appear later, the Cash Account is taken bodily out of the Ledger and bound into a separate book; and instead of a single page containing debit and credit columns, a page is given to debits, and a page to credits, the pages being placed in opposition. Such a Cash Account, bound in a separate book, in which cash trans- actions are recorded directly and postings are made to Ledger accounts to balance, is known as a Cash Book. Find the Cash Book where you may, it amounts in principle, whether in.its simplest form, or with intricate columnar rulings, to the same thing— 44 a transposed Cash Account, given the dignity of a distinct binding, in which Cash transactions are entered in the first place, and from which balancing postings are made to maintain the double entry principle. The following ruling illustrates the simplest form of Cash Book: Dr. CASH. | January, 1902. Date. Accounts to be Credited. Explanatory Detail. |L.F.| Amounts. 1902 Jan. | 2 | To John Smith, Capital Account........ Tavestinent: nites lh ok $1,000 Peer ert hhds Or (0.48 eh Bs plain pees Gi doeG 5 eee ie 75 200 $1,200 CASH. January, 1902. Cr. Date. Accounts to be Debited. Explanatory Detail. {L.F.| Amounts. 1902 Nene EY Expenses oe. Le Ve cee: Dries tae os eee oe 40 $50 PRE ULC TAGS o-oo ie ala) SY sic terecalley oe 10 bbls. X @ $30....... 30 300 Seem OPS Ge CO 8 2 red © peed pos OMACCE eae ke cs van ae 90 100 REELS OCG AOTOOTG 22 1s ie dhe ods eBid pet oe aga ety ey BOW es ho e 750 $1,200 The pages are thus seen to be opposite to each other. The Dr., or receipts, page discloses the total cash receipts; and the Cr., or payments, page discloses the total payments, the excess of receipts over payments being the balance of cash on hand. The initial debit entry is posted to the credit of John Smith, Capital Account, the ledger folio being inserted in the column provided for that purpose. The amount of the second entry is credited to the account of A. B. Childs & Co. On the credit page the inverse procedure is followed for the various accounts indicated are debited. It will be seen from the foregoing explanation that the procedure, in theory, is the same as in the case of direct entry in the Ledger Cash Ac- count, and that the Cash Book amounts merely to an amplified Ledger Cash Account, in which the original entries are made. 45 When either the Dr. or the Cr. page is written full, the balance, usually a debit excess, is determined. In case of a debit excess, the amount is entered in red ink as Balance Forward on the credit page, and the pages are thus brought to an exact balance, which permits ruling off. On the new Dr. page the balance is shown as Balance Forward in black ink. Another procedure is to carry forward total receipts and total pay- ments, instead of the balance. This method has the advantage of dis- closing, by column totals, the total cash receipts, including opening cash balance, and the total cash payments, from the beginning of the month to any later date in the month. If balances were carried forward, to obtain this information it would be necessary to add the totals of the pages. In the rare case of excess of payments over receipts, which may occur through an overdraft on a bank account, the balance will be a credit excess, and will constitute a lability instead of an asset. Columnar Development. The saving of effort accomplished by the use of the Cash Book as outlined, lies principally in the elimination of the Journal by making debits and credits directly in the Cash Book. There is another avenue open for the economizing of effort—by the use of the principle which is expressed tersely in the axiom the whole equals the sum of the parts. In the use of the Cash Book in practice it will be noticed that there are recurring items of disbursements, such as rent, salaries, postage, tele- graph tolls, etc., which may all, or nearly all, be charged to an Expense Account. To economize effort in posting, an inner column is provided on the credit side of the Cash Book, to which the Expense items are carried during the month; and at the end of the month the column is totaled and carried into the regular outside column, from which it is posted to the debit of Expense Account. | Thus, the labor involved in posting to an account that would ordi- narily have more charges than any other account is reduced to the post- ing of one entry a month. On the debit side of the Cash Book, the receipts on account of cash sales are apt to be numerous, and may be collected advantageously in a separate column of the Cash Book of the ordinary mercantile business. The cash purchases, which appear on the credit side of the Cash Book, ordinarily, on account of their rarity, do not call for a separate column. 46 A column, therefore, is provided for Cash Sales on the inside of the regular debit column; and at the end of the month the total is carried to the regular debit column, and from it is posted to the credit of Mer- chandise Account, or, if one is maintained, Sales Account. It may be argued that an inspection of the Expense Account, or of the Sales Account, at any time other than at the close of the month’s business, would not disclose the true condition of the account. This is true, but the condition of these accounts is rarely a matter of interest more frequently than once a month. If it is desirable to deter- mine the exact condition of either account the proper procedure to fol- low is to add the total of the unposted amount in the Cash Book to the balance at the beginning of the month. The Cash Book is capable of indefinite expansion in this direction. It is practicable and desirable, in some cases, to divide the item of Expense into as many as ten subdivisions, with a column for each subdivision. For the successful carrying out of this method, there should be pro- vided on both debit and credit pages a Net Cash column, in which the net receipts and the net payments respectively are entered, and from which, by ascertaining the excess of receipts over payments, the cash balance may be determined. The use of the Expense and Cash Sales columns, as well as the Net Cash columns, will be illustrated after a consideration of the treatment of cash discounts. Discount. The question of discount frequently enters into the receipt and the payment of cash, not as a cash transaction, but as a concomitant, or a coinciding, transaction. Thus, if a business receives $99 in settlement of a $100 account, payable under 1 per cent. discount, the discount, while no part of the cash transaction, is naturally associated with the cash receipt, and requires accounting consideration at the same time. If no Cash Book were maintained, the Journal entry would be to debit Cash $99, debit Discount $1, and credit Debtor’s Account $100. If the Cash Book heretofore outlined were in use, the $99 would be carried into the debit side of the Cash Book, and the $1, discount would be charged by a Journal entry, the Debtor’s Account being credited with $99 from the Cash book and $1 from the Journal entry. This procedure would necessitate the use of two books of original entry to cover the transaction. Items of discount flow from, and are associated with, cash transac- tions. For convenience of reference and economy of effort, it is desirable to record such items in proximity to the cash transactions from which 47 they flow. Columns, therefore, are ordinarily provided in the Cash Book for that purpose. Thus, in the illustration given, the receipt of the $99 is recorded in the Net Cash column on the debit side of the Cash Book; the $1 discount is recorded in the adjoining Discount column; and the total, $100, is carried to a Total column. The item of $100, being the amount which the cash payment of $99 liquidates, is posted to the credit of the one who makes the payment. Cash is charged with the $99 by the act of entering it in the debit side of the Cash Book; and it remains to charge the $1, representing the expense or loss in securing the cash settlement, to Discount. It is a rule to carry postings from the debit side of the Cash Book to the credit of Ledger accounts, but it is evident that the effect of dis- playing the discount in proximity to the cash received, has been to in- troduce an element into the debit side of the Cash Book which must be placed to the debit of a Ledger account, for discount given, being an ex- pense, or a loss, cannot under any circumstances be credited to Discount. This inconsistency is allowed to remain during the progress of the month’s business, and the total is then carried to the credit side of the Cash Book in the Discount column. From there it is posted, as are all other items on the credit side (with the exception of discounts received), to the debit of the proper Ledger accounts. The discounts received, which present a similar inconsistency, are allowed to remain in the Discount column on the credit side of the Cash Book during the progress of the month’s business, and the total is then carried to the Discount column on the debit side of the Cash Book, and then posted, as are all other items on the debit side (with the exception of discounts given), to the credit of the proper Ledger accounts. The carrying over is a simple matter. An entry to Discount is made with the explanation, Discounts given, (or received) per contra. After this, the postings are made as for any other Cash Book entry, as has been indicated. This procedure, which brings the postings from the Cash Book within the rule that Cash Book debits must be posted to the credit of Ledger accounts, and that Cash Book credits must be posted to the debit of Ledger accounts, permits of a neat balancing of the Discount columns. There are other methods of handling discount in the Cash Book, notably in the case of the use of Summary Entries in the Journal at month- ends. This matter will be considered fully in a later Lecture. It is well to note that Discount forms the exception to the rule that nothing but actual cash transactions shall be recorded in the Cash Book. 48 Illustrative Cash Book. The following illustration of an eight-column Cash Book makes clear the use of the columns which have been described: 1902 Jan. Net Cash. Dis- Cash count.| Sales. | Total. es ee | ee | — | $2,858 Dis- $750 100 $500 500 300 100 120 200 200 100 1,220 20 $2,890 Cr. Ex- count.} pense.| Total. | | | CASH. January, 1902. Accounts to be Explanatory Credited. Detail. Tak: LP ese e MOL WALGL. ih 1. tc clad s. ctalchastece atake ee ep LIN: « o4..\otlotiee< 15 Ge ee Ae. 78 eC el Salt... coke nk 10 CoG Sout. sabe PA st Mnlg Ge GAY, Peal) CIA. Ow. 75 URE RSELNCSALOLE ico kb 4 + ANG $60) ot x Wena to: Balance...) 0)... $3,500 AEE rt an hice be Paes Ben a Ee eR ee $4,440 Wee lance sath et 940 $4,440 $4,440 1g02 Jan. 13 By Balance (profit)... $940 CONSIGNMENTS. IQOI ' Dec. 26 By Shipment No. 10.. $3,500 Ig02 Jan. 13 ToShipment No. 10.. $4,440 Assuming that the books were closed at December 31, 1901, the debit balance to Shipment No. 10, $3,500, being the cost value of goods shipped upon consignment, would be treated as an asset. On the Balance Sheet, it would be stated as inventory upon consignment. Had expendi- tures such as freight and cartage been incurred in placing the goods upon consignment, it would be allowable to charge them to the Shipment Account and treat the combined amount of inventory value and such expenditures as asset value. The balance to the Consignments Account, being an amount withheld from the credit side of the Merchandise Account, or the Purchase Account, for the reasons stated, may be credited to either, or to a trading account. That this is correct in principle may be seen from the fact that in the case given, it is merely inventory, and that this is, in effect, the same as is done with the inventory of merchandise not placed on consignment. 104 That it would be correct, in case the goods have been sold, to credit it likewise, may be seen from the fact that it represents cost of goods sold, withheld for the time being from the Merchandise Account or Sales Account. In connection with profit or loss, to be transferred from the shipment account, it would give the element of sales. Thus, the entire amount standing to the credit of Consignments Account at the end of the accounting period, representing cost of goods sold on consignment and cost of inventory on consignment, may be credited to Merchandise Account or Trading Account, whichever is used. An analysis between the two elements may be made if desirable, and the cost of goods sold may be combined with the results transferred from the shipment accounts to determine the net selling price of goods sold on consignment, if such course is desirable. In any event, merchandise consigned must not be treated as sales at least until actual sales are made and it passes from the consignment status. Alternative Method. An alternative method is based upon the theory that a shipment of merchandise upon consignment amounts merely to a transfer of stock from warehouse to the possession of the consignee, and requires no entry other than a memorandum record of such transfer until financial trans- actions actually take place. For the purpose of making the memorandum record, a Shipments Book is maintained, in which a record is made of the lots of merchandise sent out upon shipment, giving a distinctive number to each shipment and details of goods shipped. In case many shipments are made to one consignee, it is sometimes desirable to allot a special page in the Shipments Book to such consignee. As the shipments are sold and account sales received, they are checked from the Shipments Book, so that an inspection of this book, if properly kept, will disclose the stock out on shipment. Especial care is necessary in keeping such a book, for inthe absence of the necessity of making it prove with other records, the entries may be carelessly made. It answers its purpose well enough if properly kept. In the case that shipments are so rare that a special Shipments Book is not justified, a memorandum Journal entry may be made in the same manner as was suggested to record the receipt of con- signments inward. Upon receipt of an account sales covering a shipment, entries are passed, charging the consignee with the net proceeds, and crediting the amount to a Sales Account, or to Merchandise Account if the latter is kept. It would be practicable to credit such amounts to a Shipment sales Account, to be transferred to the Trading Account at the end of 105 \ the period, if it were desirable to make the segregation between sales on shipments and sales on the ordinary basis. If charges were prepaid on shipments, they could be charged to a general account called Freight and Shipments. At the end of the accounting period, this account would be analyzed, and- the charges on outstanding shipments would be retained as a deferred charge or asset to be added to the amount of the merchandise on shipment, and the nomi- nal portion would be carried as a charge to the Sales Account, or to the Shipment Sales Account if the latter is maintained. It will be noted that in this procedure, for the sake of brevity, the distinctive principle of a ledger account for each shipment is omitted. Reliance is had upon the account sales and other detached papers for information as to the outcome of the particular shipment. For inventory purposes the unchecked items in the Shipments Book disclose the goods on shipment to be taken into stock. The amount would be charged to Inventory on Shipments, and credited to the Trading Ac- count or Merchandise Account if the latter is maintained, the same as other inventory. On the Balance Sheet of the consignor, it would ap- pear as Inventory upon Shipment. The successful use of this alternative method depends almost en- tirely upon the correct handling of the memorandum records covering the shipments. The method first given would probably give the better results under ordinary circumstances. Accounts Current. Credit transactions involve, for the purpose of verification and agree ment, the exchange of written documents or statements, of which the invoice, bill, statement, and account sales, that have been sufficiently described in this and previous lectures, are types. Another common form heretofore referred to, and one that may be described conveniently at this juncture, is known as an Account Current. An Account Current is usually a transcript of a ledger account, dis- closing the charges that have been made to an individual, firm or corpora- tion, for a certain period of time, and the credits that are proper offsets to such charges. The account is usually brought to a balance, which if a debit, measures the amount receivable on the account, and if a credit, the amount payable on the account. The term open account is often used as synonymous with account current, either describing a statement that discloses a series of charges and credits between two parties, that is still continuing. An Account Stated is an account rendered to which the parties have expressly or impliedly agreed. To maintain an action upon an account stated, it has been held that it must appear that the account has been 106 balanced and rendered, with an assent on the part of the defendant, either express or impled, to the balance. The acceptance of an account ren- dered, without objection within a reasonable time, will render it an account stated, and it will not be necessary to prove the items that result in the balance. In the case of fraud or mistake, such an account may be im- peached, but not otherwise. It will be seen from the foregoing that an account current, when it is agreed upon, becomes an account stated. This may come through lapse of time, without objection on the part of the one to whom the account is rendered, although the better and more usual course is to accept the account and thus make it an account stated beyond question. In the absence of interest charges or allowances upon the items of an open account, the rendering of an Account Current amounts to nothing more than transcribing the debit and credit amounts and bringing down the resultant balance. In many lines of business, however, by express agreement or trade custom, the equities of the parties are conserved by the calculation of interest upon the debit and credit items that enter into an account current. Thus, if a factor, credited the account of his prin- cipal with the proceeds of the sales of various lots of merchandise during the month, but did not remit for the same until a subsequent date, the principal might be compensated. for the loss of the use of the proceeds by interest calculated upon the various amounts from their respective dates to the subsequent date of settlement. If a payment were made on account during the interval thus covered, the interest upon such payment, from its date to the subsequent time of settlement, would be deducted from the interest upon the credits to the account of the principal, to arrive at the net interest charge that should be made against the factor. There are several ways in which the interest may be calculated. The method that has been indicated is to compute interest at the agreed rate upon each debit item from its date until the desired subsequent date, and upon each credit item from its date until the desired subsequent date. If the interest on the credit items is greater than the interest on the debit items, such excess is the net amount of interest to be credited to the account; if the interest on the debit items exceeds the interest on the credit items, such excess is the net amount of interest to be charged to the account. In rendering the account, it is usual to provide two extra columns on the debit side, one to contain the number of days for which interest is to be calculated for the particular item, and the other to contain the amount of such interest. #For the same purpose, two columns are added on the credit side. 107 The difference between the interest columns will indicate a net credit or charge on account of interest as the excess may be a credit or debit ba’ance. The difference is carried to the interest column contra to bal- ance, and is also carried to the regular debit money column, if a charge, or to the regular credit money column, if a credit. This is the method used in many lines of business, including stock brokerage. The method will be readily apparent from the following illustration: HENRY SMITH in account with Dr. July, 1902. CARLING & CO., Factors. Cri Date Item Amount | Time|Interest|} Date Item Amount | Time|Interest (d’ys)| (6 %) (d’ys)| (6 %) 1902 1902 aves SU OLCASH 2. arsis csc ces $2,000.00] 8 $2.67]! July 1|/By Account Sales ...| $1,000.00} 30 $5.00 ies CUM et... ss) acl F,000.00| x E27 Miwa eek |e a fee tel 215O00.00|—) 12k 8.75 uly ati io interest, 6%, conira|.........|..... 14.41 Sor siles “ aye 500.00] 18 I.50 SEan|OMbGLINCe GOWN... .| 1,814.41]. .06 |. cee oss Pe tTEO| tone a: ce BO 800.00] 15 2.00 ‘** 31] ‘* Interest, net credit COMUTA ci seesnem ss). EACA Ee apart: $4,814.41 $17.25 $4,814.41 $17.25 - 1902 | Aug. s\ By. Balance: (2 -; 255), $1,814.41 Another method of arriving at the net charge or credit on account of interest is to determine the balance of the account from day to day, and calculate the actual interest upon such balance for the time that it exists. This is particularly useful where the balance is a matter of continual in- terest, and is likely to remain either a debit or credit balance steadily. It makes no difference in the result, of course, whether interest be calculated on the total debit and credit items, and the difference taken, or whether the difference between the debits and credits be determined and the in- terest calculated thereon. The procedure will be clear from the treatment according to this method of the facts before given. It is as follows: HENRY SMITH in account with July, 1902 CARLING & CO., Factors. Date Item Dr Cr. Balance | Days | Interest 6 % 1902 Cr. Cr. Jaiernemy Account Sales... ........ $1,000.00] $1,000.00 9 $1.50 Wek FEOV as vs Pee osrhe ear a bl as Diese aioe Ser ala: sl 2,500.00 3,500.00 3 1.75 Cort St Cae rt ROUGE vie ei yas aka ees 500.00 4,000.00 3 2.00 aia yo hy . Pe OAs ie Cara eaks (mar tet iin, sane 800.00 4,800.00 7 5.60 ene Se WESC TASTES sai a's nies ww cee ws $2, 000100ls- a meee: 2,800.00 7 3.26 MME UPI MRS TGs: he oie eso. 9 ee ees © TOOO0O le Re eetnae 1,800.00 I .30 ST IB VELMECTCS., O57. oc cave cr os Eiye tieee Pac AP ite ase ha dPdiveat oc 5 $14.41 (EEN) SETS 11st a a a EOS EAL AEP er ten eee tesa hy AT tu cn 2 chile Sex ty $4, SIA ATI OA rObAtA Tier et awe ers ee $14.41 RRR TS AS AIATIO®, Con irie Gig yy state copie S ew Ret ee Ss SRSA ANGE OLAAT Soak sil S poe ge 108 The rulings in bank ledgers proceed upon the plan of the last state- ment, in order that the balance of the account, which is a matter of vital interest, may be disclosed from day to day. In case of the allowance of interest upon a depositor’s balance, the interest, in ordinary practice is not credited from day to day, but is calculated periodically, say once a month or once a quarter. Referring to the illustration, interest on $1,000 for 9 days would equal interest on $9,000 for one day. Multiplying by the number of days, the following is obtained: 9 x $1,000 =e $9,000 2 * 3,500 — 10, 500 3 x 4,000 <= 12,000 7 “8 4,800 = 33,600 7 x 2,800 = 19,600 I x 1,800 a 1,800 LOtaL. ..-bapmale eee ahs $86, 500 This is the amount, $86,500, wpon which interest must be calculated for one day. Pointing off two places gives $865, interest at 6 per cent. for 60 days, and dividing by 60, to obtain interest for one day, gives the same result as obtained in the illustration, viz.: $14.41. In practice the banks calculate on the even hundreds. This would take two places off each product, and off the total, so that the total could be divided by 60, or, still shorter, disregard the cipher on the 60, point off one place, and divide by 6. Taking the figures above, leaving off the two places, gives 865; pointing off one place, gives 86.5, and dividing by 6, gives result, $14.41. In case the balances change frequently, the multiplication may be avoided by carrying out the balance for each day and adding to obtain the amount on which to calculate interest for one day. If the balance for g days is $1,000, the same result is obtained by carrying out the $1,000 nine times and adding, as by multiplying $1,000 by 9. This is the more usual course in case the balances are subject to frequent changes. REY) Se He OST phe } isd ¢\ Ea} #3E 05 ees aMbaes Wy. id tage * THEORY AND PRACTICE OF ACCOUNTS. : | APPLIED ECONOMICS AND ORGANIZATION. By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) LECTURE? LX: THE LEDGER AND CONTROLLING ACCOUNTS. Popes a vecOnmner. 3k Oca anor eo ae ce 109 Po emaiatiinns AGCOUNTS. ore viele et eee AEE: Customers’ CONTROLLING ACCOUNT..... 00. 0c ccs ceeeseenes Weta. 111 _. CrEpITorRs’ CONmROLLING ACCOUNT: 3 kee s ace ne dA dl3 ee MeO Ks) rte Sea MIN rh aR cS a 116 THE ADVANTAGES...... Pde UA He RUN PENN See me I ON LE ew od 118 Bee anos Vnocers eo Oe wes 119 Pe EIGER se aR Nee UR UE APE Goi cael 120 a RAMSACIONS JIURING ACCOUNTING PERIOD.) Osh ol ode ese Roos 122 Seen TRING se? FT Is OF CLOSING BOOKS. MeO ye ree 122 COPYRIGHT, 1914, BY Homer St. Craik Pace. > : ey! Pmt : ‘ THEORY AND PRACTICE OF ACCOUNTS. APPLIED ECONOMICS AND ORGANIZATION. By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) _ LECTURE IX, THE LEDGER AND CONTROLLING ACCOUNTS. Ledger Development. The use of a single Ledger would, under usual conditions, be clumsy and unsatisfactory in a business large enough to justify the use of the modern columnar books of original entry that have been described in previous lectures. Therefore, it is necessary to consider more particu- larly the Ledger, its development, and its adaptation to the requirements of modern accounting in an undertaking of considerable size. In a small business, where the accounts may be conveniently carried and handled in a single Ledger, it is usual and satisfactory to group the accounts in the Ledger into three divisions according to their nature, viz., Real Accounts, Nominal Accounts and Personal Accounts. Thus pages from 1 to 100 might be allotted to Real Accounts, from 101 to 200 to Nominal Accounts, and from 201 to 500 to Personal Accounts. The Personal Accounts should be subdivided into Accounts Receivable and Accounts Payable. The classification is often, deviated from and the Cap- ital and Drawing accounts of the proprietor, or partners, stated first, and the location of Nominal Accounts and Personal Accounts may be reversed. The classification indicated is useful in posting and in referring to the accounts, as the nature of the account indicates approximately its location in the Ledger. It also permits of a convenient grouping of the accounts in the trial balance that is useful in studying the condition of the accounts, and in the preparation of statements. When the volume of business is so large that the one Ledger is inade- quate, additional ledgers are added, but the division of accounts as between the different ledgers does not ordinarily follow, as in the single Ledger, the classes of Ledger accounts. In the first stage of development beyond the single Ledger a division is made into three ledgers, as follows: 1. Customers’ Ledger, or, as it is often called, Sales Ledger, designed to contain the accounts of those who are indebted to the under- taking, including, it may be, Bills Receivable. Copyright, 1914, by Homer St. Clair Pace. 110 2. Creditors’ Ledger, or, as it is often called, Purchase Ledger, designed to contain the accounts of those to whom the undertaking is indebted, including, it may be, Bills Payable. 3. General Ledger, designed to contain all of the accounts pertain- ing to the undertaking that do not fall within the scope of the Customers’ Ledger or the Creditors’ Ledger. If the volume of business justifies it, there may be a still further division of the Customers’ Ledger or the Creditors’ Ledger, either alpha- betically or geographically. Thus, the accounts receivable may be divided into two ledgers, one containing those accounts beginning with the let- ters from A to M, and the other those from N to Z; or, geographically, one ledger may contain accounts with city customers, the other, accounts with out-of-town customers. It is often desirable that the financial position and earning capacity of the undertaking may not be common knowledge among the office em- ployees, and to guard against such a contingency the General Ledger may be divided into a Private Ledger, containing the Real Accounts, Capital Account and the Profit & Loss Account, and a General Ledger, contain- ing the other ledger accounts. The Private Ledger is usually in charge of the proprietor, a partner, a confidential clerk, or the firm’s accoun- tant. Instead of thus dividing the General Ledger, some firms prefer to treat the General Ledger itself as a private book, to be kept by one in the confidence of the management. The use of the Private Ledger will be more fully considered later. While there may thus be three or more ledgers, it is evident that each contains but a part of the accounts which, to obtain a Trial Balance, must be considered as a whole, and which, in the small undertaking, are contained in a single Ledger. The location of an error, in an attempt to arrive at a trial balance from the books of a business so small that the accounts can be handled conveniently in one ledger, is not a serious matter, but considerable labor is involved in checking over accounts numerous enough to justify the use of three or more ledgers. The work is further complicated by the fact that, in the larger under- takings, several bookkeepers are employed on the accounts. Without special provision in the methods used, the error cannot be localized, in advance, to a particular ledger and assigned to the bookkeeper in charge thereof, but a general checking of the ledgers must be instituted. To secure this localization of error in advance, and for other import- ant reasons that will appear, Controlling Accounts, sometimes called Adjustment Accounts or Summary Accounts, have been devised. 111 Controlling Accounts. In a system of accounts that embraces Controlling accounts, there is one Ledger, usually the General Ledger, that has within it all of the elements necessary to effect a Trial Balance. ; Within it are not only the ordinary detailed accounts that fall within its scope, but in addition controlling or summary accounts that disclose, in summary form, by reason of monthly postings, the transactions that are posted in detail from day to day in subsidiary ledgers. Thus, there may be a Customers’ Controlling Account that discloses, by its balance, the total amount due from customers. The individual accounts with customers are kept in a Customers’, or Sales, Ledger, and the debit balances in that ledger, in the aggregate, exactly equal the debit balance of the Customers’ Controlling Account in the General Ledger. Likewise, there may be a Creditors’ Controlling Account, the credit balance of which exactly equals the total credits of the individual ac- counts with creditors in the Creditors’, or Purchase, Ledger. - The manner of bringing this about is worthy of careful study, for the principle is one of great importance in the modern development of accounting. The principle will be illustrated with customers’ and cred- itors’ controlling accounts, although its application may be extended to the control of factory accounts by the general financial books, the control of the receipt and issue of stores, the control of departments and tax levies in municipal accounts, and, in fact, to innumerable conditions throughout accounting. aay 4 Customer’s Controlling Account. To open a Customers’ Controlling Account in the General Ledger, after a trial balance is effected to insure accuracy, the sum of the debit balances of individual customers’ accounts is charged to it, and the indi- vidual accounts are credited and thus closed out. This may be done by a Journal entry. The individual accounts are then opened in the Customers’ Ledger, the Journal entry supplying the information in proved and convenient form. If it were the original opening of the books, the credit would be to Capital. An illustrative skeleton Journal entry is as follows: CUSTOMERS’ CONTROLLING ACCOUNT To SUNDRIES For opening of controlling account, and closing of individual customers’ accounts, as under: cy (Stig Cd a Ube ORR Or RO ek SSO Re Saha ea reve Stem imme OVO Sete he! AS SO AS IO. PEA Se, MOO ses 6 Fe) 876 Oe LS en elle) eo 8. ee 6 a & a een 6 6. 6a we 112 The controlling account is usually brought to its true state by sum- mary entries at month-ends, preferably passed through the Journal. The sales, for example, are recorded from day to day in the Sales Book, and the charges are made to the individual customers’ accounts in the Customers’ Ledger, so that, in connection with entries posted from other books of original entry, the state of a customer’s account may be determined at any time. The total sales for the month, as disclosed by the summation of the Total column in the Sales Book, is charged by Journal entry to Customers’ Controlling Account, and credited to Sales Account, the credit being the same as would take place were no control- ling account used. It will be clear that this amounts, in the General Ledger, to posting the total charges in one amount to a controlling, or summary, account, the individual debits having been made in a sub- sidiary ledger. An illustrative entry is as follows: CUSTOMERS’ CONTROLLING ACCOUNT........ Ta. SALES: 3h See Gai Re Se In case of returned sales, the procedure would be the inverse of that carried out to record the sale of the goods. In the Cash Book, provision is made on the debit side for a Net Cash column, a Discount column, and a Customers’ column, the latter, in case of a payment under discount, containing the total of the first two. Thus, upon receipt of $99 from a customer in payment of an account of $100 under one per cent. discount, the $99 is entered in the Net Cash column, the $1 in the Discount column, and the $100 in the Customers’ column. ~The customer is immediately credited in his account in the Customers’ Ledger with the $100. The totals of the Cash and Discount columns are available at the month-end for summary entries, Cash and Discount being charged and Customers’ Controlling Account being credited. An entry to illustrate the principle is as follows: SUNDRIES To CUSTOMERS’ CONTROLLING ACCOUNT DISCOUNT sic cc ashe ec 0 9 eign se 0 it re ls If a Bills Receivable Book is kept, the bills will be entered from day to day, and the accounts of the respective customers, from whom the bills are received, will be credited in the Customers’ Ledger. At the end of the month, a summary entry is passed, charging Bills Receivable Account, kept in the General Ledger, and crediting Customers’ Controlling Account, with the total of the notes received from customers during the month. In case a Bills Receivable Book is not kept, the bills will be entered in the Journal. Bills Receivable account will be debited, and the cus- 113 tomer’s account, kept in the Customers’ Ledger, will be credited for each transaction. Therefore, for the summary entry at the end of the month, it will be necessary to determine the total amount of such entries from the Journal, and debit Bills Receivable account with it. The amount is ticked off without posting, it being noted that the entries have already been posted in detail to Bills Receivable Account. Customers’ Control- ling Account is credited to balance the amount of the debit. The entry would be: Peeler OL V ADL, ) >) eee tees ee ele ews To CUSTOMERS’ CONTROLLING ACCOUNT The Customers’ Controlling Account would then disclose the trans- actions with customers in summary form. Assuming figures for the pur- pose of illustration, the procedure will be made clear from the following form of account: Dr. CUSTOMERS’ CONTROLLING ACCOUNT. Ce 1902 1902 Jan. 1 To Balance (total due Jan. 31 By Cash & Discount from customers)....... $20,750 (total for month)...... $17,100 2/31 *To’ Sales (total for “31 By Bills Receivable (to- Sremittiae. SoS er Se 24,125 tal for month)......... 900 SO Slo By Balance. As. Sa 26,875 $44,875 $44,875 Feb. 1 To Balance (total due from Customers)...... $26,875 It will be apparent that, if the Customers’ Ledger is properly opened, so that, at January 1, 1902, the debit balances of the accounts equal the balance shown in the Controlling Account, and the totals have been prop- erly taken off, entered and posted, the combined balances of the custom- ers’ accounts must be brought to an absolute agreement with the Con- trolling Account. If an error, therefore, has been made in posting to a customers’ account it is immediately localized by the failure of the Cus- tomers’ Ledger to prove, and the searching of the remainder of the ac- counts for the error is avoided. Creditors’ Controlling Account. The Creditors’ Controlling Account is opened by a credit to it of the total amount due to creditors, as disclosed by the books when their accuracy is determined by a trial balance, and the individual creditors’ accounts in the General Ledger are debited to close them. The individual accounts with the creditors are then opened in the Creditors’ Ledger. 114 The information for this latter procedure may be obtained from the Journal entry if a Journal entry is used as, in many cases, is preferable. The following entry illustrates the principle: SUNDRIES To CREDITORS’ CONTROLLING ACCOUNT For opening of controlling account and closing of individual creditors’ accounts, as under: DAVIS Fe CO or re a iia ae ae 2 ae or cig pape JAMES BROS. eo. ocelot bye oe 6 On Geek oe B.) .G.. SEARLE) 633 c2b.00 4s CGE BG 2S - oe ET C5 TCs 2s feisapd » appcegset uneleh lcets bok? © « Wiela pile It wili be seen that this amounts to a consolidation of the accounts payable into one account in the General Ledger, and the opening of a subsidiary ledger for the individual accounts. As in the case of the accounts with customers, if the total credits and the total debits thereafter entered in the individual accounts are carried to the respective credit and debit side of the Creditors’ Control- ling Account, its balance will equal the combined balances of the sub- sidiary ledger. A record of the purchases will be kept in a Purchases Book, or similar record, from day to day, and from it the creditors will be credited with their respective amounts in the individual accounts maintained in the Creditors’ Ledger. From the Purchases Book the total purchases for the month may be ascertained at the month-end, and a summary entry passed in the Journal, charging Purchases, Plant, Expense, or such other accounts as may be indicated by the columnar arrangement of the Purchases Book, and credit- ing Creditors’ Controlling Account. The following entry illustrates the principle: SUNDRIES To CREDITORS’ CONTROLLING ACCOUNT For purchases, etc., for month of.......... as under: PURCHASES coi v oe ae te bc crcels areie 4a ype oe EX PENS Be ois cis aces bu gy eee a EEL OE aha inl cas fae On the credit side of the Cash Book columns are provided for Net Cash, Discount, and Creditors, so that in case of a settlement of a claim for $200 under two per cent. discount, $196 is entered in the Net Cash column, $4 in the Discount column, and the $200, being the amount charge- able to the creditor in his account, is entered in the Creditors’ column: The totals of these columns are available for a summary entry at the month- end, Creditors’ Controlling Account being charged with the total charged he to the various creditors’ accounts, as shown by the Creditors’ column, and Cash Account and Discount Account being credited to balance, thus: CREDITORS’ CONTROLLING ACCOUNT To SUNDRIES PSCOUNT Ir? 88 Oo “igictdl Bee mucins) Bah prorins wee OL 6 Ole 161.6) 8 60 618 OP 6 6 8 Re 6. CAO ESS Om ©). 6) 04 6) 6) 8 ek & 61 28 6 87,846) @ OY 6 If settlements were made with creditors by giving them Bills Payable, and such Bills Payable were debited to the proper creditors’ accounts in the Creditors’ Ledger, and credited to Bills Payable Account in the General Ledger, by Journal entries, it would be necessary at the month- end to pass a summary Journal entry, debiting Creditors’ Controlling Account and crediting Bills Payable (noting that the latter had already been posted), with the amount, posting only the former. If a Bills Pay- able book were maintained, the total credit on account of bills issued would be ascertained from this book, and would not have been posted during the month, as would be the case were the Journal method used. The entry would be: Pm lORS’ CONTROLLING ACCOUNT. ws. ute os EDT DIST RIA", Wo 4 Of ser ge roe Rea a are aR eee pee A The amount of Returned Purchases would be debited, by a summary Journal entry, to Creditors’ Controlling Account, and Purchases would be credited, thus: CREDITORS’ CONTROLLING ACCOUNT................. RACER GETA SEG, MOET TORE RN ork? OY SITCIIOO In short, the procedure in the case of creditors’ accounts is the in- verse of that adopted in the case of customers’ accounts. The procedure will be more easily understood, perhaps, by a study of the following illustration, which is drawn up to conform to the prin- ciples and practice set forth: Dr. CREDITORS’ CONTROLLING ACCOUNT. Cr 1902 1902 Jan. 31 To Cash & Discount (to- Jan. 1 By Balance (total due tal for month).....2... $11,500 th @reditors) 2ic5. 4a ese $10,800 “31 To Bills Payable (total “31 By Purchases (total for fo nonth aioe hi, 800 MONCH es te ee ee “31 To Returned Purchases (total for month)...... 250 alee Lo balance)... 20).5. \. 10,250 $22,800 $22,800 Feb. 1 By Balance (total due Creditors) seuss Fah. $10,250 116 The monthly entries may be made by postings direct to the Ledger accounts from the books of original entry, as is done by many bookkeepers, although there is more likelihood of errors, due to omissions, than in the case where the transactions are brought to an exact balance by Journal entries. It will also be found in many cases that a bookkeeper, who would be unable to understand and operate controlling accounts if it were neces- sary to pick up the entries in such a way, can carry out the procedure successfully if he is required to follow our pro forma entries, such as have been outlined. In addition, the summary Journal entry is theoretically sound, because it restores to the Journal its function of a complete, although summary, record of the transactions. Practically, it is satisfactory to bring into the books a summary of the month’s business that can be understood and grasped as a whole. It is not only useful to the accounting staff, but con- veys a great deal of information to a proprietor first hand from the books, even without a technical knowledge on his part. It is found in many cases that this method of securing information appeals more to a pro- prietor than the inspection of prepared statements. The Cash Book. A thorough understanding of the Cash Book ruling that is necessary in the use of Controlling accounts, is essential at this juncture. The ruling on the debit page of the Cash Book, beginning with the money column to the left and proceeding to the right, may be Net Cash, Discount, Customers, Creditors, Cash Sales, and General Ledger, thus: Dr. CASH. — Date Item ) Pee oe Net Dis- | Custom-| Credit- | Cash | General Cash count ers ors Sales | Ledger The initial cash balance and all cash receipts are entered in the Net Cash column. In case of the settlement of an account by a customer by payment of cash under discount, the amount of cash is entered in the Net Cash col- umn, the amount of discount in the Discount column, and the sum of the 117 two, which is the amount to be credited to the customer, is entered in the Customers’ column. The Creditors’ column is provided to take care of the possible receipt of cash from a creditor, which might come about by the return of goods, or otherwise, and while the ruling should be provided, its_use is compar- atively infrequent. For the sake of simplicity no transactions of this kind were included in the illustrative Controlling Account before given. The procedure is to carry the amount of cash into the Net Cash column and extend the amount to the Creditors’ column. In the case of cash sales the amount is carried into the Net Cash column and extended to the Cash Sales column. In the case of a cash receipt affecting a General Ledger account, as, for instance, the sale of Real Estate, the amount would be carried into the Net Cash column and extended to the General Ledger column. The opening cash balance being carried to the General Ledger column, a proof of the accuracy of the distribution in the columns is effected by determining if the summation of the totals of the Net Cash and Discount columns equals the summation of the totals of the other columns. Bearing in mind the various columns that have been indicated, the summary Journal entry covering the transactions, would be as follows: SUNDRIES To SUNDRIES For summary of cash receipts, for month of........ as under: CASH. For receipts (other than opening balance)....... Poben AUN bdsesa: Sac ites “ule atria). azarae. 6 CUSTOMERS’ CONTROLLING ACCOUNT........ CREDITORS’ CONTROLLING ACCOUNT........ GENERAL LEDGER ACCOUNTS (posted in detail). The initial cash balance would have to be deducted from the total of the Net Cash column and the total of the General Ledger column, in order to arrive at the figures for the foregoing entry. It will of course be understood that the General Ledger items will be posted from time to time, and that in the summary entry at the end of the month they are included to complete the entry, but are ticked off as being already posted. On the credit side of the Cash Book the ruling, beginning with the money column to the left and proceeding to the right, providing that only 118 one column is required for Expense disbursements, may be Net Cash, — Discount, Creditors, Customers, Expense, and General Ledger, thus: CASH. Cr. Date Item Lick se SINEe Dis- | Credit- | Custom- | Ex- | General Cash count ors ers pense | Ledger a a eee | | | | SS | | ee = | The procedure is the inverse of the debit page, and the pro forma Journal entry to cover the credit side of the Cash Book, is as follows: SUNDRIES To SUNDRIES For summary of cash payments for month of...... as under: GENERAL LEDGER ACCOUNTS (posted in detail). CASH.” ‘For payments: >. ss... css «tau. se DISCOUNT | i... one cn tle sue mee by et en The Customers’ column is to take care of any possible payments of cash to customers through the return of merchandise, or otherwise. The General Ledger total postings are included merely to complete the entry, the postings having been made from the Cash Book. It will be noted that the difference between the Net Cash columns discloses the cash balance, or the overdraft, at any time, an essential of a_satisfactory Cash Book. The foregoing entries presuppose the keeping of a Ledger cash account, opened by the initial cash balance, and which, under the method shown, will disclose the cash receipts and payments by monthly summary entries. The Advantages. Assuming that there are but three ledgers in the books under con- sideration, General Ledger, Customers’ Ledger, and Creditors’ Ledger, it is evident that every element necessary to a Trial Balance is embraced within the General Ledger. 119 If the correct totals have been determined in the books of original entry, and correctly transferred to the Journal and posted to the Con- trolling accounts, and the balancing of the General Ledger effected there- by, the accuracy of the totals shown to be due from customers, and due to creditors, by the Controlling accounts, is fairly assured. If the total amount due from customers, as shown by the schedule of accounts from the Customers’ Ledger, does not agree with the Controlling Account balance, there is evidently an error in posting, abstracting bal- ances, or in the preparation of the schedule. The same applies to the accounts in the Creditors’ Ledger. Therefore, the error, or errors, if there be more than one, are local- ized, or limited, to a known ledger or ledgers, and no time is lost in going over a large part of the work that is accurate. The localization of error is the great labor-saving principle of the Controlling Account. It will be apparent that the person in charge of the accounts will have in his possession a key or check by which he may require subordi- nates to achieve a certain result. Another advantage is that the General Ledger may be written up quickly, and statements, in rough, showing profit and loss and financial position, prepared, without waiting for the posting and balancing of the Customers’ and Creditors’ Ledgers. However, there is a chance of error in writing up the Controlling accounts, as for instance, wrong additions, or the placing of amounts in the wrong columns in the Cash Book, so that the work cannot be considered as proved until the subsidiary ledgers are in agreement with the Controlling Accounts. Self-Balancing Ledgers. If it is desired to make each ledger self-balancing, that is, to embrace within itself the elements necessary to a complete balance, it will be neces- sary to open in each subsidiary ledger a General Ledger Controlling Ac- count, which will be a summary account in inverse form to the Control- ling Account of the subsidiary ledger in the General Ledger. Thus, in the Customers’ Ledger, the General Ledger Controlling Ac- count would be credited with the total sales, debited with cash payments and discounts, and debited with returned sales and bills receivable. Likewise, in the Creditors’ Ledger a General Ledger Controlling Ac- count would be established, charging it with the total purchases, and crediting it with cash payments, discounts, bills payable, and returned purchases. This arrangement, carried out in the subsidiary ledgers, will provide the elements in each that are essential to a trial balance. This is some- 120 times desirable as a source of satisfaction to the ledger clerk, although, inasmuch as the chief bookkeeper has in the General Ledger a controlling account that supplies all the facts that would be contained in the con- trolling account in the subsidiary ledger, all of the advantages are secured, even if each subsidiary ledger is not made self-balancing. In the case of the division of the General Ledger into Private Ledger and General Office Ledger, it is sometimes desirable to have in the Gen- eral Ledger a Private Ledger Controlling Account, the mere balance of which will mean but little to the clerk in charge, but which will enable him to test the accuracy of the ledger by taking a trial balance, as will be explained later. Private Ledger. The Private Ledger, as has been pointed out, is a ledger in which. are kept the accounts necessary to determine the financial position and earning capacity of an enterprise, and it is usually kept by someone in the confidence of the management in order that such information may not become the common knowledge of the office employees. A Private Journal is preferably used with the Private Ledger and is kept by the same person. The accounts will include, as the book is often kept, the assets of the business, with the exception of accounts receivable and cash, and the liabilities of the business, with the exception of accounts payable. The items that are excepted are taken into the Private Ledger by means of a controlling account that measures the difference between such assets. and liabilities. This difference is usually a debit, measuring the excess in amount of the cash and accounts receivable over the accounts payable. By means of this controlling account, in conjunction with the other assets and liabilities, the correct capital of the undertaking is shown in the Pri- vate Ledger. The Private Ledger is opened by an entry in the Private Journal debiting in specific asset accounts the items of assets that would appear in the Private Ledger, such as Real Estate, Machinery, etc., and crediting in specific liability accounts the liabilities other than accounts Payable, for example, Mortgage Bonds Payable. In addition, the net debit or credit excess by reason of the difference between cash and accounts receivable on the one hand, and accounts payable, on the other, is carried into the entry. Thus, the entry necessary to open the Private Ledger might be as follows: 121 SUNDRIES To SUNDRIES For assets and liabilities of Doe & Roe as at January 1, 1902, as under: Bote ls Ey Le rd. toe ee een een et FOE | Be RCEL leven te, 2, et tener eer a eee GENERAL LEDGER CONTROLLING ACCOUNT. MORTGAGE BONDS PAYABLE.............. ret ACCOUIN yo ae ies tro ela oo The General Ledger Controlling Account balance in the above is the difference between the assets and liabili- ties carried into the General Ledger, as under: Accounts Receivable: :)o01 2. c.mimath eneigous $ ETE SINEAD TE SO TR CRE ORE 5) UEP UN et aD THEA OE ee ee ee ee an eee $ Less: In the General office books, an entry is passed in the Journal debiting the Accounts Receivable and Cash, and Crediting Accounts Payable and Private Ledger Controlling Account, thus: SUNDRIES To SUNDRIES For assets and liabilities carried in Private Ledger by Controlling Account, as under: ACCOUNTS RECEIVABLE (in detail).............. ee NCL ye AN AD Ee oe a Mee ts a os woe vig oto) PRIVATE LEDGER CONTROLLING ACCOUNT The General Ledger being opened on the above basis, the balance of the Private Ledger Controlling Account in the General Ledger will equal the balance of the General Ledger Controlling Account in the Private Ledger, and the two ledgers are thus articulated by the controlling ac- count expedient. It will be observed that there is a ledger account main- tained for each asset and liability, although each ledger contains but a part of such accounts. 122 If the business is large enough to justify it, a subsidiary ledger is opened for Accounts Receivable, and a subsidiary ledger for Accounts Payable, a controlling account being opened for each in the General Ledger along the lines that have heretofore been set forth. It will aid in a clear understanding of the plan of the ledgers if the Private Ledger is considered as the real ledger, embracing in detail or summary form all of the accounts and controlling the General Ledger, which, in turn, controls subsidiary ledgers containing the accounts of customers and creditors. In case of the installation of this method in a going business, the General Ledger previously used should be closed completely, and entirely new ledgers opened, in order that there will be no trace of the accounts that are to be treated as private. Transactions During Accounting Period. Transactions may take place during the accounting period, after the installation of the Private Ledger, that affect accounts in both the General Ledger and the Private Ledger. For example, real estate may be sold for cash, the treatment of which illustrates the procedure. This would be recorded in the general books by an entry debiting Cash, and crediting Private Ledger Controlling Account, and in the private books by an entry debiting General Ledger Controlling Account and crediting Real Estate. Entries of this nature would be comparatively rare, and could be taken into the private books by entries in the Private Journal at the end of each month. As purchases are made, they are recorded in the usual way in the general office books, an account being opened in the General Ledger and charged with their amount. Sales are also handled in the General Ledger, an account being opened and credited with the amount thereof. In case a Merchandise account is used the charges for purchases and credits for sales will be made to it instead of to the separate Purchase and Sales accounts. Nominal accounts are raised in the General Ledger to record the various classifications of expense, such as Wages, Salaries, Rent and Expense, and to record any item of profit that may be secured, and, under ordinary circumstances, the Private Ledger would not be affected thereby during the accounting period. Entries at Time of Closing Books. The first procedure at the time of closing the books is to have a trial balance of the General Ledger taken. The nominal accounts appearing 123 thereon are closed into the Private Ledger Controlling Account, prefer- ably by a Journal entry. Thus, the amounts standing to the debit of such accounts as Purchases, Wages, Salaries, Rent and Expense, are charged to the Private Ledger Controlling Account, and the accounts are credited to balance. The accounts with credit balances measuring nominal ele- ments, including sales, are closed by debit entries and their amount cred- ited to the Private Ledger Controlling Account. This will bring the General Ledger to its original position, as far as classes of accounts are concerned, disclosing Accounts Receivable and Cash, on the one hand, and Accounts Payable on the other, the Private Ledger Controlling Account establish- ing the equilibrium. A Trial Balance should then be taken to prove the -accuracy of the work. The Trial Balance taken before the transfer of the nominal balances, and the one taken afterward, are supplied to the person in charge of the private books. The inventory of stock is ascertained, preferably by some one other than the clerk in charge of the General Ledger, if it is desirable to withhold from him the result as to profit and loss. Any other informa- ‘ tion necessary to the determination of profit and loss is obtained, and the closing of the books is carried out in the private books. At this juncture it should be recalled that the Private Ledger contains all of the assets and liabilities in specific accounts, with the exception of the assets and liabilities carried in the General Ledger. It contains the net effect of the latter in a controlling account that, at the beginning of the accounting period, represented the true position. So far as entries con- cerning accounts carried in both ledgers are concerned, their effect has been carried in from month to month. But the effect of the nominal account in increasing and decreasing assets and liabilities in the General Ledger will not have been carried into the Private Ledger. Thus, if Sales amounted to $100,000, and Purchases and Expenses to $95,000, the effect upon the net asset value recorded in the General Ledger would be an increase of $5,000. It is, therefore, necessary at the end of the accounting period as a preliminary to the closing entries, to bring the nominal accounts into the Private Ledger, setting them up in ordinary ledger accounts, and to carry their difference, or net effect, to the General Ledger Controlling Account. This is accomplished, preferably, by an entry in the Private Journal, thus: 124 SUNDRIES To SUNDRIES For the raising of nominal accounts and adjustment of General Ledger Controlling Account, as under: PURCHASES: J .:5..dawooek. sectional he a EXPENSEsi0.s 52638). a 2eb ee ene, ee GENERAL LEDGER CONTROLLING ACCOUNT. From this point, the Private Ledger having been brought to an agree- ment with the General Ledger, and containing all of the nominal elements for the accounting period, the procedure is the same as in closing a set of books under ordinary conditions. The entries are passed through the Private Journal. A Trading Account is raised, to which the opening inventory, and the purchases, are charged, the latter being credited to balance. The sales and closing inventory are credited to the Trading Account, the Sales Account being debited to balance it, and the new inven- tory being set up by a charge to Inventory. The balance, measuring ordi- narily a gross profit, is transferred to the Profit & Loss Account, and the Trading Account is closed. The nominal elements appearing in the nominal account are then closed into the Profit & Loss Account, the amount of the expenses being charged and the amount of the profits being credited thereto, the nominal accounts being closed. The balance of the Profit & Loss Account, measuring the net profit or net loss for the period, is car- ried to the withdrawal accounts, if any, and the balances of the latter are carried to Capital, and measure the net increment or decrement of capital. The Private Ledger, at this stage, will, as in the beginning, disclose all of the assets and liabilities, and the capital, of the enterprise, although the net asset value recorded in the General Ledger will appear only by the balance of the General Ledger Controlling Account. If the foregoing method is carried out, the object of the Private Ledger will be fulfilled. Even the bookkeeper in charge of the General Ledger, if the opening and closing inventories are withheld from him, cannot determine the outcome as to profit and loss. The bookkeeper in charge of the General Ledger, however, is usually more or less in the confidence of the management and, in fact, often has charge of both the General Ledger and the Private Ledger. Where this is true, the object of keeping the 125 Private Ledger is that the clerks other than the bookkeeper in charge of the General Ledger, who may have occasion or opportunity to consult the General Ledger, may not ascertain the confidential matters. There are many variations of the method given. In case the confi- dential clerk has charge of both the General Ledger and the Private Ledger, the desired results may be obtained by keeping a Private Ledger with only such accounts as would readily disclose confidential information, such as the Capital, Profit & Loss and Withdrawal accounts. From the principles and full procedure given any of the other methods may be worked out, and, in fact, are but variations thereof, more or less com- plete, as the particular case requires. nek al . | A” a oa ae ot ee ae et ) & ee, = eee L 7s id iS SS) Ads \ . tH ‘, 1 = r) +) at erate By re) 7 3 } =. ( i = =i s ‘ LY en RY. i a Lae 4 - rr i kG i ‘ iy A 197 ay 1 die t : Aisa Tete orien eR NARA OPS vas a a RRS Le HONRAIS apna rink one seth fhieshinee Ok IAP IHeR VO, Ne act eetd to AOA TAY goad § eae ae SBOVIQ, 2x ceed. shh. Htod: to sagen ott ae L. Sete ritad "ube, Leen trnonl vil. beninido: O& Vart @ atiras: Dott Pil kieyys. ait atces0o3A al MEISE Fe Berge role TREO ONGOs 3 ait witbae | Sh reve PRT PEE SKE ET iy”? rite aucr} ya +A) m ‘ ‘tats ehouisaHe taritor acl * vite, a vigs wT wi d » shod Jota). enorariive due sie 43 t ne ss : * BTID OT. BAO parts image < oti ‘a bes ate it ee) iret « f 4 ar ” i | a ee ‘ Tk i 4 : ‘ 1? re ki + yw de? | j F iy i" ‘hi 7 pe “a ‘ \ 4 p Z ; -, an q a E ‘ ware at i eT SS NEN Pee 3 ‘ Wig ; ‘ 4 i vi ny . : Vier aed aes Sa AB se A et Bares: ©, Ls ‘ ‘ | I , is f >. ie A Paks ce ul al) oe th wee ne a AG i ~% : ee & are 4 ae J Crane tok ac i ee a’ roe dens tS A Mi _ THEORY AND PRACTICE OF ACCOUNTS. APPLIED ECONOMICS AND ORGANIZATION. _ By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) LECTURE X. ARITHMETICAL EXPEDIENTS., PVE AGH LIU WH OATES Voc l es eg Goo cree es WON yh tr See Ua des 126 PV BRACING ACCOUNTS 6.0 ho Se ea ei ow ee 130 DETERMINATION OF TIME IN CALCULATING INTEREST ... 132 rr Ay, Metro oe a ae 134 COPYRIGHT, 1914, BY HoMER St. CLAIR PACE. PACE & PACE wy PACE STANDARDIZED COURSES IN ACCOUNTANCY, BUSINESS ADMINISTRATION, AND ENGLISH, IN RESIDENCE AND BY EXTENSION Ba 90 CHURCH STREET, - NEW YORK CITY THEORY AND PRACTICE OF ACCOUNTS. APPLIED ECONOMICS AND ORGANIZATION. PaO MVMIGRE SI. CEATR, PAGE ;..€. PA.’ (N.-Y¥.) LECTURE X. ARITHMETICAL EXPEDIENTS. Average Due Date. It is often necessary, in the case of amounts falling due at various dates, to determine a date at which settlement can be made of the total, without prejudice, in the matter of the use of money, to the respective parties. Such a date is known as the average due date, or equated time of payment. The common interest procedure, which does not give in itself the equated time of payment, is the calculation of interest upon each item at the agreed rate to some common date. Thus, A advances to B the sum of $4,000, on dates and in amounts as under: 1902 Tee ou Gn sem tera ey, GEM Tn. $1,000 ‘Lota SER ae 4 Cie) OF TC fe 7 ye fe 2,000 Bee eh aia es asides, on xe en dk a gb wid si Be es caste) 1,000 TEM Me OY eae AN Ai RI Rs $4,000 It might be desirable on the succeeding 15th day of July to determine the amount then due A, allowing 6 per cent. interest upon his advances. The calculation may be made as follows: Amount on which Time in days to calculate in- Date Amount to July 15th terest for one day 1902 June 1 $1,000 x 44 _ $44,000 June 15 2,000 x 30 == 60,000 June 30 1,000 x 15 =a 15,000 $4,000 $119,000 Copyright, 1914, by Homer St. Clair Pace. 127 The total, 119,000, represents an amount of dollars upon which interest should be figured for one day. Pointing off two places gives the interest at the agreed rate, 6 per cent., for 60 days, $1,190. Dividing 1,190 by 60 (cutting off the cipher in each case and dividing by 6) gives a result of $19.83. Adding the $19.83 to the $4,000 advanced, gives $4,019.83, the total due A on July 15th. It might, however, be desirable for B to give A a note for the sum of the advances, $4,000, with interest at the agreed rate, dated upon the average due date, in order to give the correct interest return to A. For the purpose of determining such a date, reference should be made to the table before given, in which the proposition is reduced to the calcu- lation of interest for one day upon $119,000. This proposition may be stated inversely; viz., that one day’s interest upon $119,000 is the same as interest upon $1.00 for 119,000 days. In order to give effect to the varying amounts and the time that each has to run, interest may be cal- culated upon $1.00 for 119,000 days. If $1.00 would run 119,000 days, $4,000 would run for as many days as 4,000 is contained in 119,000. The quotient is 293, or, say, 30, the number of days for which the interest runs on the whole amount of $4,000 previous to July 15th, or from June 15th, the average due date. To prove the average due date, interest upon $4,000 for 30 days at 6 per cent. is $20.00, or, to be exact, using 293 days, $19.83, the same as was determined by the calculations upon the separate amounts. Aside from the calculations and their proof that have been given, the equated date of payment is obviously June 15th, inasmuch as the first and the last amounts are the same, and are equally distant in time © from the intervening amount. Charging interest upon the first advance, $1,000, for the month, would obviously produce the same result as charg- ing interest upon the sum of the first and last advances, $2,000, for the half month beginning with June 15th. In practice, it is necessary, owing to the more complicated conditions likely to exist, to determine, as shown, the required date by an arith- metical process that will give due weight to the various amounts that enter into the total, and to the time that each amount has to run. It is always necessary to select arbitrarily a date to which, or from which, the time in days is calculated in respect to each item. The variations will give the weight as to the time that each has to run; and the weight as to amounts is obtained by multiplying the number of days in each case by the amount of each item. It is found convenient to select as a basic date one of the dates in the series, to save a calculation, preferably the first or the last of the dates 128 given. If the proposition is worked on this basis, and if June 1st is selected, the results are as follows: Date Amount Days from June lst Products 1902 June 1 $1,000 ~ 0 = | 0 June 15 2,000 x 14 _ 28,000 June 30 1,000 x 29 = 29,000 $4,000 57,000 Dividing 57,000 by 4,000 gives a quotient of approximately 14. In this case, if a prior date is selected, the number must be added to the basic date, instead of subtracted. If 14 days are added to June (st, the same result as before, June 15th, is obtained. Another and more complicated example will be given, the dates and amounts being as under: 1902 Stay SAS oc PEL RORY EAS APO ORO LTS Pe eat $650 TLS US Ie epee OLY ere a ea 500 OTe RU vcd eee eer nie Mk ac. Aa Ayman Lee Oe ge 250 IO nee rine eRe ig eae as oes ee 300 aapesl aC 0 NEC 8s OL ae a de $1,700 Required, average due date. The last date is used as the basic date, to show the procedure when the last date is selected; and the days and products are: Date Amount Days to November Ist Products 1902 Sept. 9 $650 x 53 _ 34,450 Cy. 0 500 x 26 —— 13,000 Oct 9 250 x 23 =e 5,750 Nov. 1 300 x 0 = 0 $1,700 53,200 If 53,200 is divided by 1,700, the result is approximately 31, and 31 days previous to November ist, the basic date, would be October 1st, the average due date. This result may be proved by calculating interest to any desired date, upon the various items for the time each item has to run, and upon the entire amount from the average due date. For the proof, interest will be calculated at 6 per cent., to November 1st, upon each item, thus: 129 $650 53 days @ 6% =a $5.74 500 26 days @ 6% oa: 2 sit 250 23 days @ 6% — .96 300 0 days @ 6% — 0 $1,700 $8.87 $1,700 311 days (adding 4 necessary to give absolute check) $8 .87 If one of the dates other than the first or the last date is chosen, the difference. between the products previous to the date, and subsequent to the date chosen, must be used as the dividend, and the days calculated toward the greater weight of products. Thus, in the calculation, if the third date, October 9th, had been chosen as the basic date, the results would have been as under: $650 ~*~ 30 ane 19,500 500 ek 3 een 1,500 250 +4 Vi ee DTotal ores. dscns re ee oe 21,000 300 x 23 — 6,900 $1,700 | 14,100 If the difference of the products is divided—14,100 by 1,700—the result is approximately 8. As the greater weight of products is previous to that date, it is necessary to count backward eight days from October 9th to find the average due date, which, as before, is found to be October Ist. Illustrations have now been given in which a first, a last, and an intervening date, and a date entirely outside of the dates of the money items, have been used as a basis; and the average due date obtained has been proved in each case by interest calculations. There are other methods based upon interest calculations, of calcu- lating the equated time of payment, but the method given is sufficiently brief, and is easily understood and applied. A method that is found convenient when the account extends over a long period, and when months intervene between the items, is based upon calculations of interest at the rate of one per cent. per month. This rate is selected because of the convenience in calculation—any other rate would give the same mathematical result. The interest on each amount is calculated from a convenient date, say the first of the month in which the first amount appears, to the date of the respective item, 130 at the rate of one per cent. per month. The total of such interest is then found. The items of principal are then totaled, and one per cent., or a month’s interest, is determined by pointing off two places. Dividing this amount by 30 gives the interest on the total amount for one day. If the amount arrived at from interest calculations be divided by the amount that represents the interest on the total of principal for one day, the quo- tient will be a number that will indicate the number of days between the basic date and the due date. Applying this principle to the foregoing example, the following result is obtained: Time from Date Amount September 1 Interest PME OUR. ic ok cl $650 8 days $1.73 oS See ate 500 1 month 5 days 3.83 rey eit ken hes. 250 1 month 8 days Sed Sh aaa cane 300 2 months 1 day 6.10 $1,700 $16.83 Placing the point in the 1,700 gives a result of $17.00, interest for one month at one per cent. on the total amount. Dividing this amount by 30, the number of days in the month, gives approximately .57, the amount of interest on the total amount of principal for one day. Divid- ing the interest as above, $16.83, by the foregoing quotient, .57, gives a quotient of 30. Calculating 30 from the basic date selected, September 1, gives the average due date as October 1, the same as was obtained by the other method. Averaging Accounts. In a previous Lecture, an Account Current was given which is re- produced here in running form, as under: HENRY SMITH IN ACCOUNT WITH July, 1902. CARLING & CO., Factors. Dr. Time Interest Date Item Amount (days) 6% 1902 en OA dg oy oy Sue sas $2,000.00 8 $9.67 eM LO 1,000.00 1 a waived) §=~LO interest, 0%, contra......... 0 7, 14.41 Maro re palarice Gown ee 1,814.41 i 0 $4,814.41 ret $17.25 131 Cr. Time Interest Date Item Amount (days) 6% 1902 jalyrd By Aocount Sales. sat). Meee $1,000.00 30 $5 .00 aL SOR Vita Coount pales | oa) peeas hos 2,500.00 fh S.L5 ive ID YeACCOUN Dales tc lol Perouse 500.00 18 TS Juby716" (By Actount Sales... cans see ae 800.00 i 2.00 July 31 By Interest, net credit contra..... 14.41 ae. 0 $4,814.41 Ps $17.25 1902 Apt sRy Balance rye vk. ci eens $1,814.41 Assuming that the amounts to the credit of Henry Smith were pay- able at the dates named, and that the debits were proper offsets at their respective date, the date is required at which it would be equitable for Carling & Co. to date their note, bearing interest, in settlement of the balance of the principal of the account, $1,800, instead of reaching a set- tlement on the basis of the Account Current. It is necessary to determine the products of the sides from or to a common date, the same as if the average due date of each side were being determined. If we proceed in this way to the last date named, July 30, the results are: Credits: $1,000 x 29 — 29,000 2,500 x 20 = 50,000 500 x 17 ae 8,500 800 x 14 = 11,200 98,700 Debits: $2,000 x 7 —— 14,000 1,000 x 0 = 0 14,000 Excess of creqdits...; Seas eee) ee) eee eee 84,700 Dividing the excess of products, 84,700 by the balance of the account, 1,800, gives, as a result, 47. That is, analyzing the process, Henry Smith is entitled to the use of $1.00 for 98,700 days; and, as an offset, Carling & Co. is entitled to the use of $1.00 for 14,000 days, the excess in favor of Henry Smith being the use of $1.00 for 84,700 days. Inasmuch as $1,800 is due Henry Smith on account, he will be entitled to the use of $1,800 toe for as many days as 1,800 is contained in 84,700, or 47. The time must be calculated backward, so that it may be determined that 47 days pre- vious to July 30 is June 13 the date from which interest must be com- puted on $1,800. In the Account Current, interest is calculated to July 31; so, in com- puting interest as a check upon the accuracy of the due date, one day must be added to the 47 days, making 48 days. The calculation of inter- est at 6 per cent. upon $1,800 from June 13th to July 31st, 48 days, is made by pointing off two places to obtain interest for 60 days, $18, and by taking away one-fifth, for the 12 days by which 60 exceeds the actual 48 days, $3.60, leaving $14.40. This result is within one cent of the amount achieved in the Account Current by figuring the interest on the debit and credit items, and by deducting the interest upon debit items from the interest upon credit items. Other dates may be selected as a basis, but the method given, has, perhaps, the fewest complications. An understanding of the reason for the processes is much more essen- tial than memorizing a formula. The latter is likely to be forgotten, but a knowledge of the principle will remain and may be of use in a situation that the process does not cover. Determination of Time in Calculating Interest. A detailed consideration of the methods of calculating interest is not within the scope of this Lecture. It is thought desirable, however, to consider several phases of the subject, particularly in relation to the > computation of time. The ordinary commercial method of calculating time is to assume that there are 360 days in a year, that may be divided into 12 parts of 30 days each, corresponding, although not exactly, to the 12 calendar months of the year. The exact days are counted, and, for example, may be found to be 75. If 75 is divided by 30, a result of 24 is obtained. Thus the interest must be calculated for two months and 15 days. For this time 24 twelfths, or 5-24, of the yearly rate must be taken. This method answers well enough for short-time periods, although carried to its logical conclusion, by counting all the days for a year 365, and by dividing by 30, a result of 124 is obtained, so that in a year the inaccuracy amounts to 4 of a month, or five days. That is, 365-360 of the rate is charged, amounting to an excess of 5-360, or 1-72. It has been held that such excess, growing out of the method of cal- culating interest, when it brings the actual interest collected above the legal rate, does not constitute usury. 1535 In case an amount is payable in a month, the due date falls on the same date of the succeeding month, irrespective of the number of days elapsed. A note dated on January 31, payable in a month, would fall due on the last day of February. The calendar months are recognized in this way. In fact, it is not at all uncommon for interest to be calculated upon the basis of calendar months, each to take 1-12 of the rate; and the re- maining days are taken as their fractional part of a 360-day year. Thus, interest is to be calculated from June 10th to September 15th. The time from June 10th to September 10th is taken as three months, and for the time from September 10th to the 15th, there must be added 5 days, mak- ing the total time 3 months and 5 days. Had the first method been fol- lowed, the result would have been: Days in June, . oS 225° eae eee 20 Days an J tly. cio yc sua a clea eke ae ee ee 31 Days in August oss. hes eee re eee 31 Days in September...i.... / 5. See 15 Total); } ivi. ails abel 5 eee 97 Dividing the 97 by 30 would give 3 months, 7 days, a difference of 2 days. The two methods may thus work different results, depending upon the variations in the number of days in the calendar months. For long periods of time, approaching a full year, the last method gives more nearly the correct result. The discrepancies in each method, from the commer- cial viewpoint, are compensated by the ease of calculation obtained in the 360-day method. The time in obtaining exact interest is determined by taking the actual number of days, and by calculating the same proportion of the rate as the number of days bears to the 365 days of the year. Thus, in the case of interest running for 75 days, 75-365 of the rate, instead of 75-360, would be used. Thus the error of 1-72, as pointed out in the 360-day method could be avoided. This method, used by the Government, is known as the 365-day method, and is rarely used in business. In either method, in determining the number of days between two dates, one is included and one is excluded. In New York, the date from which the time runs is excluded, and gives the effect of the exclu- sion of one day. Thus, in the case of a loan running from June 15th and payable July 10th, the count could be made conveniently by deduct- ing 15 from 30, the number of days in June, which leaves 15. Deducting, in a month, one number from another, includes one of the numbers and excludes the other. To the 15 must be added the total number in July, 134 10, because the exclusion has been made in June. Thus 25 is given as the number of days for which interest should be calculated. Custom usually determines the method. It is incumbent upon the accountant to know the various methods of computing time, and the effect of each, although it is not often his province to insist upon a change in method that will produce a more nearly correct result when such a change is opposed to accepted commercial usage. Sixty-Day Method. There are many methods of calculating interest in use. One of the best for ordinary purposes is the 60-day method, which has been used in illustrative calculations. It proceeds upon the basis of the 360-day year and the six per cent. rate; that is, one-sixth of the rate, or 1 per cent., is applicable to one-sixth of the time, 60 days, or two months. Inasmuch as 1 per cent. may be found by pointing off two places in the principal sum, the interest on the amount in question for 60 days at 6 per cent. is obtained by placing a point. If the days are greater or less, an amount in proportion is respectively added or subtracted. The sum is then re- duced to the actual rate should it vary from 6 per cent.; that is, if the rate is 5 per cent., one-sixth of the amount is deducted. ‘e art rs isi sie % vat ig aise a it a wah ae : , mas Y + ‘ Lit aki O/C NR Og Set Sa a, midi ; enh Pie paps | Li, ie) Me ele) whee ‘eae ye Teh ca Vy ec ‘ Pe ¥ De Sune Ryn Fae aR ane Be ee ey mths Leads Wer 6 7211 tl a wera te |) pede bd . j a ae Meg fy’ iI ? 4 h ft , VER SR ak me > °A A af MW wy i VePoRe t \ ' ¥ Py Pi 1 j | F . . wf + t i | é t i : ¥ . } oe ol ’ ' ’ t J ' 7 j } a ‘ vy Dae Ye : & ba in ‘ $ + Pwgs > Aimee ey i aie toe ae nlihe THEORY AND PRACTICE OF AUDITING. - “ By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) LECTURE I, PRINCIPLES AND DEFINITIONS. WING BNE BATES CN ti oy oa iy, LCi eae hve trie Se ees dea ee ERRORS IN THE ACCOUNTING RECORD.. eae tore ra a Mulia hac 2 Tus NECESSITY FOR VERIFICATION OF THE AccoUNTING RECORD.... 3 “URUDITING. Wo. 2. ey OR PUL RS AIL ipo ane Wee te RTs UA | 4 Pee rors OF VERINIGATION Vi. ty 2 u St set ae Wee 5 ee eon REPORT OC eM oe tun pe eh vee 7 PAINCTIONG UT ERMO IK Mae a he aya a eke 9 P VERIFICATION e000): Be ee a een ey el weape WAU 10 COPYRIGHT, 1913, BY Homer St. CiatrR Pace, ee 4 ting mere : eee ar aad THEORY AND PRACTICE OF AUDITING. By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) LECTURE I. PRINCIPLES AND DEFINITIONS. In General. Accounting, in a broad sense, is the recording of facts as to the acqui- sition and disposition of values, and as to the incurrence and discharge of liability for values. In respect to the particular undertaking, the excess of the values possessed over values owed, at any moment of time, is the investment or accounting capital of the enterprise, and the financial position is displayed by setting forth the values possessed, or assets, in opposition to the values owed, or liabilities, in conjunction with the ac- counting capital. It is evident that the facts displayed in opposition will produce an equilibrium, which provides the necessary prerequisite to the future record of increases and decreases of value by the bookkeeping device known as double entry. It is essential to a satisfactory accounting record that this initial financial position be established. ' The subsequent record must disclose, in chronological form, the increase and decrease of assets and liabilities, classified in such a way as will be most convenient and informative in respect to the specific enterprise. In order to determine the increase or decrease of the accounting capital invested, it is necessary to determine, after the lapse of any desired period of time, the value of assets and amount of hability, the excess of the former being the capital. While the comparison of a known opening financial position with a known subsequent financial position will disclose the net difference in the accounting capital of the undertaking, it does not, in any way, dis- close the reasons for the net change, either in respect to particular values or in respect to the undertaking as a whole. Copyright, 1913, by Homer St. Clair Pace 2 The chronological record, connecting the original position with a subsequent position, is necessary in order that the business transactions may be recorded in such a way as to show the reasons for the change in investment. Information is thus obtained for the purpose of augment- ing results that have been beneficial, and for decreasing, or eliminating, results that have been detrimental. The accounting record is effected, preferably, through double entry bookkeeping, which constitutes the means by which the accounting results are obtained. Double Entry bookkeeping is accepted as the standard means of expressing accounting results, because it meets the essential requirements of an adequate accounting record while the other devices do not. However, unscientific devices are often employed, and the double entry method may be so improperly handled as to achieve but a small part of the desired results. The recorded initial financial position, the chronological record there- after, whether properly kept or not, and the subsequent financial position, cover the range of the accounting period. From the record and facts must be gained the knowledge of the assets and liabilities, and the profits and losses, of the particular undertaking, for which the accounting record is inaugurated and maintained. Errors in the Accounting Record. In the making of an accounting record, there is always the possibility of errors. The errors may arise unintentionally through an imperfect knowledge of accounting and bookkeeping: methods, and may consist of either of the following: 1. Errors of principle, affecting the statement of asset and liability elements or financial position, and the profit and loss or revenue trans- actions that lead to such statement of financial position. Thus, if the replacement of a capital asset, that is, one acquired for the permanent use of the enterprise, when worn out, is made out of funds contributed as capital, and not out of funds secured through the use of capital assets, an error of principle is committed, misstating the revenue-producing or profit capacity of the undertaking. The errors may be of omission, not appearing in the record, as well as those of commission. Thus, if an expense and resulting liability are omitted, the profit increment will be overstated. 2. Errors of technique, affecting the bookkeeping accuracy, such as a wrong posting or error in addition. Errors of this class may not affect the statement of assets and liabilities, and profit and loss, as in the case of a nominal element being carried by mistake to a rent account instead 3 of to a salary account. However, should a nominal element be carried to an asset account, through an error in posting, it would be a technical bookkeeping error, although achieving, if undiscovered, the same result as an error in principle. Errors of technique, too, may be of omission, as where an inventory item and the liability therefor, are not raised in the books, on the theory that, inasmuch as the entry does not change the net results, it need not be recorded. As distinguished from unintentional errors, there may be intentional errors, made: 1. For the purpose of misstating the financial position, or revenue- producing capacity, of the undertaking; 2. For the purpose of covering direct peculation or fraud on the part of the one entrusted with making the accounting record. In the first instance, the proprietor may cause the error to be made for the purpose of securing loans or credit, or to secure unduly favorable terms upon sale. The second class covers fraud and embezzlements, ordinarily carried out by the purloining of cash and the falsification of records to cover the theft. The Necessity for Verification of the Accounting Record. The simplest state of affairs that can be imagined in respect to the keeping of an accounting record, is the case of the person who personally knows every detail of the business involved, and who personally makes the accounting record. In such a case, the business would be so small that the owner could check the accounting record with his personal knowledge to such an extent that the errors would be trivial, except possible inten- tional errors on the part of the owner. The next step in the development of a complex organization is a small business in which the proprietor has so few assistants, and devotes so much of his personal attention to the transactions, that he knows from time to time, the amount of property he owns, and the financial obliga- tions to which he is subject, and what the approximate outcome should be in relation to the profit and loss of the undertaking. In a larger business, and increasing with the magnitude of transac- tions involved, the proprietor is dependent to a greater extent upon his employees, and especially upon the employees who maintain the account- ing record, to determine from time to time his financial position and the results of the business transactions. The greater the size of the business, the greater his dependence must be, and the more difficult it is to devise and verify an accounting system 4 by means of which those entrusted with large operations can keep in touch with the multitude of details which, in the aggregate, produce, or fail to produce, the results for which the undertaking is operated. The office manager, or bookkeeper, who maintains the accounting record, no matter what the size of the undertaking may be, is obviously not competent to certify to his employer as to the absence of errors of principle and technique, for it may be assumed that the bookkeeper, granting his honesty, will keep the accounting records as well as his knowledge and experience permit. Even to a greater extent, the book- keeper or office manager is not competent to testify to the absence of fraud, for, being an interested party, his evidence might be influenced by self-interest. However well the business man may be satisfied as to the adequacy of his accounting record, and the integrity and competency of the person in charge thereof, when, for the purpose of obtaining credit, he finds it necessary to submit financial or earning statements to his bankers or others, he labors under the same disadvantages in presenting the facts to such persons as does his own bookkeeper in presenting the facts to him. That is to say, the banker looks upon him as an interested party, apt to be prejudiced, and, other things being equal, places less faith in his statement than he would in a statement vouched for by one who is not directly interested. Auditing. Auditing is the verification of accounting records. The necessity for auditing arises from the lability of error, either intentional or unin- tentional, and either of commission or omission, and the business necessity of an independent determination of an accurate accounting record, both as to possession of values and liability for values, and as to revenue- producing capacity. Auditing, when properly performed by competent and disinterested professional auditors, guards against waste and incompetency of manage- ment, and against the evils that come to employer and employee through improper supervision of those entrusted with the handling of money. It provides the avenue for publicity, and is the means by which the investor may be assured of the integrity of his investment, and the competency of the men who are entrusted with the management thereof. Various though the manifestations of Auditing may be, whether an investigation covering special matters, or a detailed examination of the record of the financial transactions of an undertaking, it amounts, in the end, to the verification of accounting records. 5 The Scope of Verification. There are different kinds of audits, depending upon the nature of the verification that is required. The ideal audit is one that covers a complete verification of the accounting record from a prior authenticated financial position, up to the latest financial position, involving a considera- tion of the business with a view not only of verifying the record that has been made, but of safeguarding against the omission of transactions that are vital to proper statements. Thus, if an undertaking was originated on the first day of January, 1900, and its possession of values and liability for values, absolutely known and set forth at that date, an ideal audit would involve a tracing of the increases and decreases of assets and liabilities, resulting in a certain condition of assets and liabilities as at the end of the period which is being audited, say at December 31st, 1900. Such a verification reconciles, by the chronological record, the financial position of the undertaking as at the beginning and closing of the year 1goo. If, at December 31st, 1901, a complete detailed audit for that year were desired, the position being verified to December 31st, 1900, it would, of course, ordinarily be unnecessary to verify the work prior to such authenticated statement of assets and liabilities. Conditions may exist, however, that would render necessary a verification prior to the former financial statements. Therefore, it will be seen that the ideal and full detailed audit con- sists in the verification of an accounting record, from some authenticated prior position, whether at the beginning of the business, or at the begin- ning of some accounting period, down to the subsequent date at which it is desired to set forth the accurate financial position of the undertaking. The foregoing is known as a detailed audit, although a detailed audit may be made, and in fact generally is, without a checking of the complete accounting record, as will appear later. A completed audit is one in which the verification is made for a cer- tain period after the accounting record is complete, and it is made, so far as is possible, with the accounting records in possession of the accountant. The advantage of a completed audit is that, the entire record having been made, there is little chance of alterations in the books, particularly so when they are in the custody of the accountant. A continuous audit is one in which the work is performed from month to month during the accounting period. The advantage of the contin- uous audit, as compared with the completed audit, is that errors, either of principle or technique, are detected sooner than if the audit were made 6 after the end of the accounting period. In addition, the bookkeepers, not knowing the exact date when the audit will be made, are under the necessity of keeping their work well caught up. The disadvantage of the continuous audit is that there is a chance of alterations in the work, after it has been audited. Such alterations may cover fraud or affect the position at the end of the year, and are difficult to detect without re-auditing. A balance sheet audit, as distinguished from a detailed audit, is one in which the verification is made only to the extent necessary to certify that the correct financial position of an undertaking is set forth in its Balance Sheet. The amount and kind of work necessary for the accountant to per- form, in order to certify to the correctness of a Balance Sheet, is a matter of some dispute, although unquestionably it should be determined that the undertaking possesses assets at least to the amount stated in the Balance Sheet, valued in accordance with accepted accounting princi- ples, and that the liabilities are not in excess of the amount stated. It is sometimes contended that the work consists merely in certify- ing that the Balance Sheet is prepared in accordance with the books of account. This means nothing more than a transcript of book balances, correct or incorrect, as may happen to be the case, and permits of the use of the accountant’s name, without extending to him an opportunity to perform the work that would render his certificate of value. If, in an exceptional case, it should seem to be advisable for an ac- countant to make such a certificate, he should state plainly therein that he is certifying to nothing further than that the Balance Sheet is in ac- cordance with the books. Even this may lead to a misapprehension on the part of those who look upon the association of an accountant’s name with a statement as, in a measure at least, vouching for its substantial accuracy. It is hard for the layman to make the distinction, and it is much the better plan for the accountant to avoid such certifications. On the other hand, it is not considered necessary to make a detailed audit in order to make the certificate, although it is necessary to trace profit and loss transactions to a considerable extent, in order to see that proper provision has been made for probable losses upon realization of accounts receivable, for depreciation, etc. It is not intended to give, at this point, more detail than is sufficient to fix, in a general way, the scope of the audit. An investigation may relate to any particular phase of the account- ing record, or it may relate to part or all of the transactions over several accounting periods, or over the entire life of the undertaking. It may 7 be to determine its earning capacity for the purpose of sale, or the ad- mission of a partner; it may be a report upon the property and revenue- producing capacity of a corporation, in order to facilitate a sale of its bonds; it may be small in scope, but intensive as to detail, or it may be wide in scope, with but small reference to detail. Whatever the scope of an investigation may be, the accountant will, of course, safeguard himself by certifying only to the matters that he has actually investigated. Forms of Reports. The forms in which an accountant may set forth the results of his efforts at verification will vary from the mere certification of a Balance Sheet to a voluminous analytical report, and, within certain limits, may be made to reflect his ability to reduce to clear and concise language and statements the facts found to exist. | Theoretically, in the case of the certification of a Balance Sheet, it is prepared by the regular accounting staff and submitted to the accountant, who then verifies the items and certifies that it sets forth the true financial position of the concern. Practically, the accountant is more frequently called upon to prepare the Balance Sheet, as well as certify to it, and even though he is not, a recasting and revision are likely to be necessary. If the Balance Sheet, as originally made or recast, is in form satis- factory to the accountant and his client, the accountant will give an un= qualified certificate. A satisfactory form is as follows: THIS CERTIFIES, That the above Balance Sheet of the John Doe Company is a true statement of its assets, liabilities and capital as at the close of business December 31, rgot. RICHARD ROE, Certified Public Accountant. The form used in certifying to the Balance Sheet of the United States Steel Corporation, as published in its annual report, is as follows: “We have: audited the above Balance Sheet, and certify that in our Opinion it is properly drawn up so as to show the true financial position of the United States Steel Corporation and Subsidiary Companies on December 31, 1906.” If the client insists upon a Balance Sheet that the accountant cannot conscientiously certify, or if his investigation has not been full enough to justify an unqualified certificate, resort may be had to a qualified cer= tificate relieving the accountant from the responsibility of unqualifiedly 8 approving the statement. The qualified certificate may give the reasons for the qualification, or not, according to circumstances. The following is a form of qualified certificate: THIS CERTIFIES, That the above Balance Sheet of the John Doe Company discloses its true financial condition as at the close of business December 31, 1902, subject to the qualifications contained in my report of February 3, 1903. RICHARD ROE, Certified Public Accountant. The certificate may be made to include the revenue accounts of the concern, if they have been verified, or each may be certified separately. Instead of a certificate, the accountant may make a report, comment- ing upon the items of the statements, attaching the latter as exhibits to the report proper, and numbering or lettering them for identification. Thus, the Balance Sheet may be Exhibit A, the Trading and Profit and Loss Account Exhibit B, etc. This, in fact, is the usual form of report, and is capable of development sufficient for any report, whether of detailed or balance sheet audit, or of special investigation. It is customary, in addition to making such a report, to certify to a copy of the Balance Sheet so that it may be used for the purposes of the client. It is best to adopt, as nearly as may be, a standard form of report, using the same stationery, cover and binding, as well as a regular style of presentation of subject matter of report and supporting schedules. It frequently happens that several reports are made to a client in the course of an investigation, and in such a case the inconsistencies of differ- ing styles are most apparent. At this point, it is not intended to give more than the general principles that should govern in the matter of the preparation of reports. The working papers that accumulate during an audit should be care- fully made with pen and ink, on uniform paper. In handling numerous papers, a great economy of effort, and satisfaction in binding, are secured by the use of sheets as nearly the same size as possible. Analysis sheets should be provided with rulings sufficient for the construction of analytical statements. These papers are used as the basis of the report and should be arranged in order and filed carefully for future reference. The methods of preparing working papers vary with accountants, but hasty and careless work should not be permitted in any case. A report should usually be made in triplicate or quadruplicate, so that the client may be supplied with the original, signed copy, and one or two additional copies if desired, leaving one copy to be preserved by the accountant in a fire-proof file. 9 The legal responsibility of the accountant for certifications and rep- resentations contained in reports is not well settled in this country. He is unquestionably morally responsible for reasonable professional care in making such certifications, and, if the courts follow English precedents, will be held legally responsible as well. The accountant, in reporting upon any matter, should confine him- self to a presentation of the facts, and not express opinions unless they are specifically asked for, and then only with the greatest caution. Facts may be so presented as to leave but one conclusion possible, but as a general rule, it is better to allow the person to whom the facts are pre- sented to draw the conclusion. Distinctions in Terms. There is some confusion in the use of the terms accountant, auditor, accounting, auditing, and accountancy. The term accountant, or public accountant, is properly applied to the person who, having the requisite theoretical training and experience, offers his service to the public in the installation of accounts and systems, and in the making of appraisals, audits and reports. Under the Certified Public Accountant law of New York, the degree of Certified Public Accountant may be obtained by conforming to certain requirements, and other states have followed closely the New York legisla- tion, thus officially establishing the use of the term accountant. There is another use of the word accountant, describing a skilled bookkeeper engaged in private employment. To make a distinction, the word public is used in connection with the word accountant, giving the term public accountant, although with the growth of the profession, the single word accountant is coming to be accepted as descriptive of the professional accountant. In England and Scotland there are statutory provisions requiring that corporations, and certain other classes of undertakings, must have their accounts audited and certified by auditors, so that the term auditor is properly used in designating the person who performs such work. In this country the term accountant includes in its meaning the per- son who audits accounts. This is evidenced by the legislation providing for the degree of C. P. A., for the accountant will most frequently use his degree in certifying to facts determined through auditing work. There is a common acceptation of the term auditor as meaning one in charge of an accounting department, generally of a large corporation, such as a railroad company, but whose duties are private, and who cannot IO be called an auditor in the sense that a public accountant is sometimes called an auditor. The terms accounting and auditing apply to different branches of the accountant’s work, the former including the installation of accounts and systems, and the latter the making of audits and reports. The term accountancy is applied to the profession of the public ac- countant. The term accounting is sometimes used in this sense, but it is preferably used in referring to that part of the professional work of Accountancy that deals with the theory and practice of accounts. The name controller or comptroller, is often applied to the chief of the accounting staff of a large corporation, signifying, in many cases, a more responsible position than auditor. ras ; .. ’ r “a q,¢ ¥ ie ‘y yy , } x 7 A * ai j + 1 ww J : ; ‘ x : 4 ‘ U * ¥ i * , ; , . \ P ? 4 ; bu ve fe ee ; } ; hPa es j ’ 5 ? ‘ ‘ ‘ ~ rs . , ‘ ‘ z f } r . 1 f a ' Ato ’ A oe ee a a Fwy pt We ar eae THEORY AND PRACTICE OF AUDITING. By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) LECTURE. V: REPORTS. DB OINISIONG eos Ree yoy ey ae Seite e dahe FL o 38 “PRINCIPLES OF PRESENTATION... 0.00000 000004) CAO SSR ai leah he a a6 | Principtes Appriep TO RECEIPTS’ AND PAYMENTS.......10.-.0.-55 40 ECR MO A REPORT ft Coukt nr Mee ee ROR EY 46 CoPYRIGHT, 1913, BY HomMER St. CuatR Pace, THEORY AND PRacTICE OF AUDITING. De bnoOMER St CUAIK PACH Cl ry A. (Ni ¥.) LECTURE V. REPORTS. Definitions. A report is a statement or presentation of facts in respect to a par- ticular audit, examination, investigation, or subject. An opinion is a professional conclusion or judgment, to a considerable extent based upon known conditions or facts, but falling short of certainty. The distinction should be well understood, for the accountant, unless otherwise instructed, merely states the facts disclosed by his work in auditing, uncolored by his own opinions, conclusions, or judgment. In giving an opinion, when called upon for that purpose, the account- ant should proceed with the conservatism that will alike safeguard his own reputation and prevent ill-considered action upon the part of his client or others depending upon his judgment. The matters directly connected with the installation and operation of accounting systems and business organization are peculiarly within the province of the account- ant, and are fit subjects for opinions and recommendations. The accountant is often requested for an opinion as to future profit and loss outcome, based upon past results, probable production, markets, etc., to be used for the purpose of influencing investors and others. In such a case it is well for the accountant to content himself with a state- ment of facts as to past results, and allow others, if they choose, to deal in prophecies over their own names. The young accountant, in particular, before making estimates of future revenue, should first, for a period of years, note the percentage of cases in which, for unforeseen and unfore- seeable reasons, expected income fails to materialize. This Lecture is designed especially to state the principles involved in the presentation of accounting facts in reports. Copyright, 1913, by Homer St. Clair Pace. 39 Principles of Presentation. The presentation of a whole thought or idea, in the attempt to convey an understanding of facts, is better, even though it be in condensed form, than the presentation of a part of such thought at a time. This is especially true in accounting, owing to the difficulty of imparting a knowledge of conditions from figures. Thus, it may be said that a man has a capital, or worth, of $100,000. If it is stated that he has $50,000 of personal property and $50,000 of real property, making a total of $100,000, the information is amplified. Observe, however, that if the latter statement were made independently of the first, there would be steps in the conveyance of the whole idea. Thus, the statement “he has $50,000 of personal property,’ by itself imports but a part of the facts as to financial position. It may be that the personal property is divided into $25,000 of mer- chandise, $15,000 of accounts receivable, and $10,000 of cash, and that the real property is divided equally between country and city holdings. The main fact as to financial worth thus develops into detail without great effort on the part of the reader. Nevertheless, one who reads no further than the first paragraph, stating the worth to be $100,000, has a complete idea, although meagre in details. If the items were numerous, say 50 or 100, or more, the mind could not carry their relative weights, and, pending the achievement of a total, a confusion of ideas and facts would exist. The main fact and its amplification may be presented in a graphic way to show the development, thus: Merchandise....... $25,000 Personal Property $50,000} Accts. Receivable... 15,000 Cash. 73:2 Aa eee 10,000 Worth $100,000 Country) .):..) hee $25,000 Real Property... $sojoooiCity <3 5 yee eee 25,000 The presentation is complete at each stage, and the reader may pass on to details, or not, as he chooses. The analysis can be carried still further by a division of merchandise into classes, accounts receivable into desired groups, cash into different bank accounts, etc. This principle is applicable to the presentation of facts in English without figures. For example, it has been stated that— Accounting is the science of recording facts in relation to property rights. 40 Amplifying this basic statement, we may say that— Accounting is the science of recording and stating facts in relation to the acquisition of property rights or values. Still further amplifying the statement, we may say that— Accounting is the science of recording and stating facts in relation to the acquisition, production, conservation and transfer of property rights or values, known as assets. From this point, it may be shown that the recording has to do with the accounting records and the stating has to do with forms of statements to disclose results; and the various other essential words may be used as texts for detail extending, if desirable, into volumes. The method of stating a fact and developing it by supporting state- ments, and still further statements, is useful for many purposes. The “supporting statements are said to articulate or join into each other, although the word does not satisfactorily give the idea of an expansion of detail in statements arranged in a logical order of fact development. Principles Applied to Receipts and Payments. An audit, and the report thereon, may deal with a particular phase of the accounting record, and not cover a complete detailed verification. The most common illustration of this is known as a Cash audit, which is that part of an audit that has to do with the verification of receipts and payments of cash. The presentation of the results of such a special audit will now be undertaken for the purpose of illustrating the principles that have been stated. A Statement of Receipts and Payments, or as it is sometimes known, a Statement of Receipts and Disbursements, is merely a record of the incoming and outgoing of the asset cash, presented with such degree of detail as the particular case may demand. It may be assumed that a theatrical enterprise had four companies, A, B, C and D, presenting plays during the months of October, November and December, 1902. During the month of October, the receipts of A were $20,000, of C $10,000, and the other two companies had no receipts. During the month of November, the receipts of A were $11,000, B $10,000, C $2,000 and D nothing. During the month of December, the receipts of A were $4,000, of B $5,000, of C nothing, and of D $13,000. The total receipts were, therefore, $75,000. The payments for October were: A $21,000, C $5,000, and the other two companies nothing. The payments for November were A $5,000, B $10,000, C $2,000 and D nothing. The 41 payments for December were A $1,000, B $6,000, C nothing and D $11,000. The total payments, therefore, were $61,000. The cash on hand was the excess of receipts over payments, amounting to $14,000. It will be assumed that the foregoing facts have been verified, and that it is desired to state them in form convenient for ready understanding by one without accounting knowledge. It is obvious that the figures must be recast, in order to afford an intelligible idea. First of all, following the principles before stated, the summary of receipts and payments, with the resulting cash balance, should be shown to convey an idea of the transactions as a whole. It may seem to the lay mind illogical to present a summary, or summing up, before the facts wpon which it is based are presented, but it naturally results from an acceptance of the principles stated. The summary, like the porch to a house, provides the entrance, but it is the last to be constructed. The summary results from a recapitulation and condensation of the various schedules and statements. There is nothing to prevent a reference to the summary after a consideration of the details, in case it is needed for a review of the situation. In the attempt to analyze the receipts in the case given, it is found that they may be analyzed either by companies or by months. Inasmuch as there was not a complete operation of each company for each month, and also in view of the fact that comparisons with months of other years are not required or possible under the conditions, a statement of receipts and payments by companies is the first step in amplifying the summary. The next step in the analysis is to show the receipts of each com- pany by months. By this method, the mind is gradually carried from a condition that is comprehended to statements involving more detail. The arrangement is such that one may leave off consideration of the statements at the end of any one, with a complete idea to that point. The statements, especially arranged to illustrate the application of the principle, follow: 42 BLANK THEATRICAL COMPANY. STATEMENT OF RECEIPTS AND PAYMENTS FOR THREE MONTHS ENDING DECEMBER 31, 1902. Summary. Bee ED Ss As DOT ALLAOUCC sei. ue a eat atta Ce sols ya's $75,000 MeO UN DS a5 Nel ALLACUOd Lc. se eyed ere ac at ey sie se tie tie 61,000 Pe enICon CASEY OLIaNty oot Sin gieGnne et etiee ccs etal e tole tees $14,000 Statement by Compantes. RECEIPTS: EG eee Ould slau a Ree ea ef eru aa $35,000 UD acta A) PARDEE NE og leg ts FR RC eR aay 15,000 1 GLE pleco pia: ani tar ear oO Oe ae nm ar ead 12,000 EOE ele: AW URE ot ard Bas, eae ins Bap ace I 3,000 iy Sh are Gah CRT TS Re eee See ge am RRR $75,000 PAYMENTS: oye phe ts Bog 2 RAMEE DUE Los hs ae Poe ee $27,000 SNE eS ee I te a Neate e hae 16,000 Oe BOE EAR gle ine CONES Bian rors 7,000 ree Faherty UN ey Gute sieuh eevee alee fe 11,000 Pheveo. Pile Serena nn CGR saint ti le Ui pea Siwy oka ava Sande dian Veh an gle « 61,000 Balance, Cash on hand, as per Summary........ $14,000 43 Statement of Companies and Months. RECEIPTS: om OChObaricas ese heen wre k cece $20,000 Novembercoiine.. oi. SS 11,000 December veins bete aee 4,000 a $35,000 po. OCTODEE Sc nce Us he Gee fe) November: .......55c50sss5un $10,000 December... i.. os eee 5,000 ——___— 15,000 Cee October s.:...c ise dole en eeeeoe $10,000 Novemiber:.: os 0s uu easels 2,000 December); oss chou verb eee O 12,000 pee October... 2o. Sate eee fe) November :.¢ i eciissees ie eee Oo December’. J.Gay

__ | — | Total (Dr.) (Cr) Regular| Prepay- | Streets | Buildings ment a The deductions (allowances) on account of bills and sales are com- paratively infrequent and are entered in one debit column. This would have to be analyzed periodically and the deductions made from the re- spective columns. Or, in the case of numerous deductions a debit column could be provided for each class of sales, either at the extreme left, or the debit and credit columns for each classification could be adjacent, with the total debit and credit columns to the extreme right. It is not intended to consider fully gas accounts at this time, but merely to illustrate the principle of ledger account development. Advantages of Columnar Ledger Accounts. Columnar development of ledger accounts, so far as classification of transactions is concerned, has many uses, although like many other expedients in accounting, it is not desirable in all cases. In the accounts of small undertakings, with the total number of accounts within reasonable limits, there is little use for it. In case a compiled analytic statement of certain phases of the busi- ness is often needed, the columnar ledger account offers a ready and reliable means of meeting the condition. Columnar classification, as compared to classification by separate ledger accounts, requires addi- 6 tional work at the time of posting, because the usual debit is made, as well as an entry in one or more distribution columns. It should be borne in mind, however, that there is compensation in that it is necessary to turn up but one account, instead of several; that the distribution into columns and the proof thereof safeguard, to some extent, against error; that there are fewer accounts to handle in the trial balance; and that an analytic statement of the subject is available at all times. There may be columnar development of the ledger account of a some- what different nature. Thus, in addition to the usual debit and credit columns, a third may be provided, into which is carried the balance of the account after each entry, so that the net state of the account appears, In such a case, it is usual to place the debit, credit and balance columns at the extreme right, in the order stated. This ruling is sometimes used in customers’ accounts, and in other cases, as will be shown later. The Ledger, however, in a broad sense, is but a classification of the accounting record, and all devices that are employed therein are useful only to the extent that they make available the facts essential to an in- telligent understanding and management of the affairs of the concern. Classification in Books of Original Entry. The classification secured by the columnar ledger, while useful in many cases, requires, when it merely supplements and analyzes the record made in the books of original entry, practically a duplication of the labor required in such original entry work. It is true that the columnar ledger may, in certain cases, be used profitably as a book of original entry and ledger combined. At the moment, however, the use of the columnar ledger as an adjunct to customary books of original entry, is in mind, the defect of which, for undertakings of considerable size, is that the results are secured without proper economy of effort. It is obvious that the most economical procedure, if practicable, would be to arrange the original record in such a way that each fact could be placed under its proper classification upon its original entry. This, if completely carried out, would do away with the idea of a distinct Journal and Ledger record. In practice, this rarely happens, for there is a cer- tain value in maintaining the distinction, as will more fully appear, but for the purpose of illustrating the fact that such a record is possible, and in some cases practicable, the case of a combined Journal and Ledger for household accounts may be cited. The ruling is as follows: ‘uor}eoytsse]o Aressooou oyy ATddns ‘jfosqt ut ‘Aeur p1ooor [eUIBIIO oy} JY} JOR} OY} Jo VOTyeIISNIT Ue se [nJosn AYeyd st SulNI oy, “popesdtt oq p[nom spioser oatsuoyoidutod orour ‘uos1ad 9U0 jo oul} 911jU9 94} postnbor Sut -daaxpfooq oy} ft pue ‘oun, ev ye yIOM plnoo uossod ouo ATUO yoryM uO proser o[durts wv st JI ‘“UOL}BOYISSe[D VATSUD}X 9 JO poo OU ST o10Y} PUB MOF OB SUOIPORSUIT OY} YOIYM Ul S}UNODDe 0} POU] st SutoSer1oy oy} Jo osn oY], ‘ULIOF SuLUUNI ATeUIPIO oY UL JO Pea}SUT 4YYSII 0} 39] Woy posure suotydes Jospa] YIM ‘OoULTe [II JO WIIO} & JOS} St pr0d01 oY YSnoyyye ‘out, Aue ye Udyxe} 9q P[Noo souvled [e} Y “yunoooy [eydey 0} paLojsuvsy 0q Udy} P[noo owOoUT UMVIPUN OYJ, “JUNODDY sUTOOUT 0} s}UNODIe esuddxo oY} WOT} JOONp ope oq P[Noo si1ojsuvs} Aressooou 9y} “IQ “BUISOTD Jo ou, oy} 72 YULTG Joey, UUINjOD oy} UI JUNOIOWY SSO’T 29 JOLd & UL PopoTJOO Oq PTO sol1jUs [eUIMION “SUTSO[D JO 9UIT} oy} [JUN o8ed 0} o8ed WO, preMIO] poles oq p[hom suurnfoo [Te Jo s[e}o} oy, ‘sesuodxy ployssnoyy Joy poptaord uurnjoo Iq oy} Ul yqop ev pue yYseD Jo} poptaoid uurnjoo Id oY} Ul Wpoto ve omMbor pynom sosuodxe pjoyssnoy 107 quowAed ysvo e ‘gidurexo Ioq “4rporo pue qiqep 0} sev UOrOUl{sIp Onp YPM porlojJUe o1B SUOTJOVsUeIy JUONbesqng ‘soUR[eq [[IM YOIyA Jo sytpeio pue syqep OY} ‘SUUINTOD oAT}odsor oY} UL porous ore Teydvo pue sorqyiqer ‘sjosse [erytut oY} ‘PIodar oy} Jo uorzeIEdo oy} UT TARR, nares ead Soon: aerial to rear ae) (= see ad Serene Cmca sl (mem cal (scree | a fee er nie HI Seren | CUES Fel Pea Se Sf (UR Mies ESS |e ene ee > tes Sete EL ig ekg BS eae ae Ta rs ee ee fg Ure al Die fg ne 0 erg pcr eg FO ACh lee. [eaces iQ f 2c] [ero [euos ploy , -U94) -19q -9sno}] syreqoq oyeq aUIOD [ey SIO ony ; -UT -dey -yIpoig | Sloyqoq | -tuing yseg osuodx ee eS Se ea ee ee ee eee ee eee, ‘dwOoUa ONILNNOOOV GTIOHASNOH 8 Classification in Cash Records. In the simple household accounts heretofore considered, it was shown that a classification, inclusive of all transactions, could be made in a single record. It would cover Journal, Cash Book, and Ledger functions, with all necessary display of essential facts, on a single page. In large undertakings this would be impracticable, owing to the number of transactions and the desirability of a more minute classifi- cation. The original record in larger enterprises is likely. to provide for the grouping of related transactions, such as cash receipts and payments, sales, purchases, etc., and the attempt at classification is directed to one or more of such records. The Cash Book affords a conspicuous example of the grouping of similar transactions, and it is often developed by columnar classification. As has already been shown, the Cash Book is, in principle, a Ledger ac- count in which direct entry of cash receipts and payments is made. A saving of effort is effected through the addition of columns to hold items to be posted in totals periodically. In a simple form of Cash Book, this development extends to the use of a column for items of expense, on the credit side, and for cash sales, on the debit side, with additional columns for discounts if such associated items are recorded in the Cash Book. The columns provided usually cover the greater number of transactions, but they effect only a few Ledger accounts. Many postings will be made, however, from the general column, affecting a large number of ledger accounts. The fuller application of the columnar principle to the credit side of the Cash Book would provide for a classification of all transactions asso- ciated with money payments. It would include all costs or expenses, and all property, paid for in cash. The success of the Cash Book distribution depends upon the main- tenance of a cash basis, or a condition that approaches closely thereto. Otherwise, liabilities would be incurred on account of costs and property, and the entry and distribution of the latter would be postponed until cash settlements were made. Entry and distribution could, of course be made in the Journal, which could also be used to carry in unsettled and accrued items at the time of closing the books. On the debit side of the Cash Book, the receipts, if from cash sales or returns, could be distributed under suitable captions, but the entry of sales or returns that pass through accounts recording transactions with customers could not be postponed until date of settlement, because the state of the specific account could not, in the meantime, be ascer- tained from the books. 9 It is obvious that the Cash Book classification is dependent upon the flow of cash in and out, a matter that is not in many cases imme- diately associated with the acquisition of assets and the incurrence of costs, and which, therefore is not well adapted to the control of the accounting record. The nearer the business approaches a cash basis, the more satis- factory such a distribution will be, and there are many cases in which the method produces satisfactory accounting results. Its use is largely confined to small water, gas and electric light companies, where collec- tions and payments are upon practically a cash basis, to the accounts of fire insurance companies which approach a cash basis, and to the con- ditions found in clubs, associations and other undertakings where the state of affairs is substantially as outlined. In the form of. record devised for household accounts, no separate ledger is needed, for the record, complete in itself, serves every ledger function. When the record is divided, however, the various parts must be brought together to provide a view of the accounts as a whole and to give the characteristic double-entry proof of accuracy. Therefore, the ledger resumes its place as an essential record, and the classification, as made in the separate parts of the original record, is carried to the ledger, either in an account for each classification, or to a summary or controlling account that controls several such classifications. It may be accepted as a principle, that the Ledger is a necessary record in systems of modern columnar books in which classification 1s largely made in the books of original entry. It is necessary to establish the periodical proof of the double-entry accuracy of the records, and to afford a view of the accounts as a whole. For the purpose of illustrating the principles that have been pre- sented, the credit side of a Cash Book, ruled to show total cash payments, distribution into three property accounts, five expense accounts, and a miscellaneous column for items not coming within the distribution col- umns, is given as under: H Oo 3 G ed ° n va q a 5 P| 3% ee ete Ad he oC 4) n}|%&}m |g] s = olf a laRl slew lead ol hl al 81 8) ype o AD | sea | Pr Woe Ud et 4 bed ae ra La Ye ¥ ; : itt | . Ae ae ae ae we Ore is BEI Ras me ace ered wt ae ay , r 7 oe , Ay ot be aa we 3 ' 44 ij M » 8 ley R ‘| ’ y 4 ou ; 4 A h fin . } , : ‘4 i 7 ‘ ast ube Podge & i i, 134 . & > ee Seige 6 77§ The ey a - y aetery3 ty on, reed dearth Jeera i j . ; 4. fit TPB fh hen: st é - ‘ i. t P ; , Vy > > t ey * . S| ¢ . la ah > \h ae TAR Pie ‘ mr ay Ch i/eah @ . ‘ y : aS ee Ri oe re Ce ane ~ we 4 p. i. TEES UI ORES ohoe Bte bat ad iv ay. 2 a ' ft. yee ou) iy P| : Bt 5a f Ty en A) vie) ay Chen :) ' ' ie ion ( a8 2s BR a : 4 Lt ee De iy sd if ay r 2 hah RY Ot ; t 14 n ie ra) ' TREN DIRS By ie INTERMEDIATE THEORY AND PRACTICE OF ACCOUNTS. By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) LECTURE IL. —_—~—-- CONSTRUCTIVE ACCOUNTING. USACE 6 OTR CE aig ao seag ELCs as ean Nise a Trew TEaea ter ah ame Seb enT e gc 15 PPO ePROACCOUNT RULINGS (i a Ah aun at Meee a RE Vo 15 Boston, OR TABULAR, LEDGER...... Dee CS Vi ur a Fy oy 17 : DEPostrors’“LEnGer’..). serene Big gee HON aM ne es AU ew eleteer ct ge 19 ~ TABULAR LEDGER FOR dh BRIOMCAL OH ARGHS ia iity or ahecsiain Ripe oie an 21 Se MIOMSTRNOT VE VP RINGIPLES: 6 gts uc bok Vig Ce he hac Uk wee tales 23 Pe oen Lae AN CARD DEVICHS oul ee er ee ow ote ele rea 24 COPYRIGHT, 1913, BY HoMER St. CLAIR PACE. Nd Mounts ni *< yeh if 4) Se hcraees INTERMEDIATE THEORY AND PRACTICE OF ACCOUNTS. By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) ERECT URES LE CONSTRUCTIVE ACCOUNTING. In General. The need for classification is present throughout all accounting, and there are innumerable rulings and devices by which it is accomplished. In the previous Lecture, the subject of classification was treated in its fundamental aspects, and rulings and forms were given to illustrate the principles presented. A further consideration will now be undertaken, dealing with still other practical rulings and devices. The student, in this way, will obtain a working knowledge of many of the expedients common to different phases of accounting. Ledger Account Rulings. _ The prime essential in the ruling of a Ledger account is that there shall be a debit and a credit money column, or at least that there shall be provision for making the distinction between debit and credit items, which, in their nature, are opposed to each other. A common departure from the standard ledger ruling is the sub- stitution of a Journal ruling, in which the debit and credit money columns are placed in apposition at the right. This form is often used for customers’ accounts, where the debits are likely to exceed greatly in number the credits, and where the balance of the account is a matter of frequent interest. The ruling results in a saving of the major part of the space that is allowed for explanations on the credit side. On account of this saving, two, or even three, accounts may be placed in the width of a Ledger page. The ruling is as follows: Copyright, 1913, by Homer St. Clair Pace. 16 JOURNAL-RULED LEDGER ACCOUNT Explanation As a variation of this ruling, a third column, to contain the balance of the account, may be placed to the extreme right. This is used for customers’ accounts, and it is also used in the ruling of a stock, or shares, ledger in a corporation in order that the total number of shares belonging to a stockholder may be shown at all times; and, in general, it is useful where it is desirable or necessary to show regularly the balance of the account. The following ruling is given in illustration of the Journal- ruled Ledger account with a balance column added: JOURNAL-RULED LEDGER ACCOUNT, WITH BALANCE COLUMN Explanation : ; Balance A condition might arise where it would be desirable to have the debit and credit columns in juxtaposition, while preserving the usual amount of space for explanations in regard to both debit and credit items. To meet this condition, the following ruling is often used: i] SPECIAL RULED LEDGER ACCOUNT Explanation Explanation — | ——_ |{ ——— | | —_———— | — — _ [ _ The foregoing ruling is well adapted for the display of statistical information. The money columns are contiguous, as in the Journal- ruled form, but the usual explanation columns are maintained, so that the detail in regard to the money entries may be entered and classified. In the Journal-ruled account, the explanations for both debit and credit entries are entered in one column. In case the detail consists of quan- tities of articles, such as stores or shares, the intermingling prevents their summation. The last ruling may advantageously be used for loans secured by collateral, as the collateral may be shown as it is received and surrendered. In material or stores accounts, too, it may be desirable to keep a record of quantities as well as of values, and this can be done in the space pro- vided for explanations. Other rulings may be used for this purpose, but the one given answers well under conditions in which there is an advantage in having the money columns in apposition and space for detail classified between debit and credit. There might be cases in which there would be an advantage in having the statistical, rather than the money columns contiguous, and the ruling could be modified to meet the conditions. A variation of the foregoing ruling is the addition of a balance column, which may be placed between the debit and the credit columns, at the center of the ruling. Boston, or Tabular Ledger. The so-called Boston, or Tabular, ledger is a development of the Journal-ruled account that has been shown. The important accounting feature in each is that provision is made for the regular presentation of 18 the balance of the account, usually, but not always, in a column provided for that purpose. The tabular ledger, however, arranges the accounts in statement form, with the caption of the accounts to the left and a series of distinct rulings to the right. One complete ruling, with debit and credit columns, and perhaps a balance column, is provided for a certain fiscal period, which may be a day, a week, a month, a quarter-year, or a year, as is needed. These rulings follow one another from left to right across the page, opposite the caption or name of the account. If there should be no more than one debit and one credit for each fiscal period, one line across the page would be enough for an account, as is shown by the following: 1902 January February March Client Dr. Cr. | Balance| Dr. Cr. | Balance} Dr. Cr. | Balance Jonn Doe. s5 500 200 300 200 300 200 Richard Roe... 1000 fe) I000 I000 ° iT Olais fee ccrs 1500 200 1300 200| 1300 200 The balance in the second period is determined by deducting from the total of the debit and the previous balance, the credit, thus establishing the state of the account as a basis for the next period. With certain modifications, the foregoing ruling would provide in a professional office for the ledger record with clients. The state of account, and its relation to the other accounts, is dis- closed by an inspection of the book. The summation of the columns gives total charges, total credits and total balance, thus establishing an effective control of the entire tabular ledger. In case the debits and credits were more numerous, as would be likely to happen in practice, several lines would be given to each account. There is a limit, however, to the vertical space that can be thus given, because the tabular form is dependent upon associating a number of accounts on a page. Otherwise, assuming that an account took a whole ak] page, there would be nothing secured beyond that which is available in an ordinary ledger account, with the balance of the account brought down periodically. In order to secure proof by totals, the balances would have to be abstracted the same as for a trial balance. The practical limit is a maximum of six or eight separate entries, during the business period, although if a summary were made elsewhere, the result of numerous transactions could be entered in the tabular ledger. Thus, twenty charges made in a month might be made and summarized in another record, and the total entered in the tabular ledger as one amount, and a similar procedure could be used in respect to credits. Depositor’s Ledger. A typical application of the tabular method is found in the treat- ment of accounts with depositors in bank accounting. The balance of the account is of vital importance. It establishes a basis for credit, its amount must be known to make certifications of checks, and it must never be overdrawn, that is, a debit balance is not permissible. There- fore, it is necessary to require by the accounting procedure that the bal- ance be determined and displayed for the smallest possible fiscal period, that is, for each business day. In bank accounting, too, owing to the fact that money, the quickest and most convertible of all assets, is handled in large quantities, there is a need for daily proof of the accuracy of the accounting record. The tabular form, which approximates a continuing statement, supplies such internal check with the minimum of effort. The form that was originally used, and that is still used by many banking institutions, is as follows: 20 Aue YIM 10440804 ‘UUINTOD JIPeID 9Y} UL poioque pure sdijs psodop oy} WoIJ Te}0 UT YYSnoIq are syisodep sy, “yIpeo e se oouRleq oY} YIM poqyreys st Aep oy} pue ‘Avp yovo Jo} popraoid st uUIN[OO jIpeio Be pue Jiqep Y ‘“suUIN[OO 4Ipesto puv jIqep Jo solos wv ATOIOW YIM SUI[NI e& OUT podaoAd ‘soTJoeId Ut ‘soouRysUT AUP UL sey SUL[NI SuLoso1oy oy, ‘o1oymesyo Ivodde [IM sv ‘suljunooe yueq Ut sinpsosoid oy} jo zed we ST yey} yooyo [eUIO]UL 944 IO [NJosn st [ej0} oy, ‘esed 03 osed WO pIeMIOJ polled Teyo 94} pue poppe ST UUINOO souL[eq oy, ‘posuryoun jo] st yUNOoWe oy} ‘SsUOTJOvSUBIy OU OTe o104} JT “Aep 0} Aep WIJ JNO porLsied st sInposooid styy, ‘souv[vq MoU oY} S8uTEq ‘sesreyo Joyo puv pred syooyo 94} JoAO ‘oouRTeqG pue sjisodep yons Jo [e}0} 94} JO ssdoxo oy} ‘Avp Sutpooeid oy} Woy soURTeq 94} 0} poppe oe Aep oY} Ioj sytsodap oy4 ‘pIVMIOJ PoLLIVd oq 0} VoUL[eG OY} SUTUIINj9p OJ, “no porsieo st oInpoooid sures oy} Ap SUTP99dONS oY], “pozzWO u9}JO SI UUINTOO sty} YSsnoyye ‘s[reyep 10} UWN]OO oy} ur poyst]T oq AvW syOoyo oyeivdes oy], “UUINOD soURTeq 9q4 0} poLivd st yUNODDe oY} JO soURTeG IY ‘sysodep oy} 04 Yosyo ue o1e yey} sedsreYyo JoyjyO Io syeyd Jo syuowAed p10091 0} UUINOO 4IGep [e}0J B ST 9194} O[IYM ‘UUINTOD yIpoto oY} UI porous ore syisodep oy} yey} poyou oq []IM 4 "OV “99 EOS EC eat ECO CIOL Stu OO'T Allie H picsrietia, AGradcade, “ais anja souof uyof sreqoy | sTtey sjeqoy | s[rez STeJOL sitet goue | sytsod -9q | s0ue | spsod -9q sour sjisod -3q [eg -2q 9 |———| -Ied -3q | -—-—_—_ -[eg -9q SS ropsodaq syooy) syooyg S904) 1£ 19q039Q of 19q0100 fas Hs I 1940399 mes Aepsoupo Aepsony, Aepuoy] sropisodacy ONITNY TINY ‘Aasaay] NoLsog 2t other possible credit, such as interest. The total of checks paid, checks certified and collection charges, are entered as a debit from the original records, and the excess of the credit column is the amount to be carried forward as a credit to the next day. The balance standing to the credit of depositors being known as at the close of the preceding day’s business can be proved against the general ledger controlling account. The ruling is as follows: Boston LEDGER, SKELETON RULING _ Depositors’ Ledger Date Date Date Dr. Cr, er Ce Dr Cr: WOuu Jones. .... Harry Loomis... 1G, Etc, The ruling, in bank accounting, is subject to many modifications, depending upon the volume of business and the amount of internal check that is considered necessary. The forms given are illustrative, although they are both common in practice. The use of the tabular ruling for depositors’ accounts is made practic- able by the summation of items deposited, and of charge items, in the original records, and the entry of the totals only in the ledger. Tabular Ledger for Periodical Charges. The business period for which the ruling is made may be short or long, as the case may require. Illustrations have been given of the use of the ruling for daily rests and monthly rests, and one for a longer period will now be given. In many undertakings, notably those supplying water, gas and elec- tricity, charges, payable in cash, are made at regular intervals to cus- tomers or consumers. In such cases the amounts are practically all paid shortly after the charge is made. This is often brought about by the grant of a rebate for prompt payment or the imposition of a penalty for delay. For charges thus made and paid, the tabular ledger becomes a mere register, showing offsetting debits and credits. The unpaid items constitute the accounts receivable, and are comparatively few in number Especially in water companies, where charges may not be made more often than quarterly or half-yearly, the ruling is in common use, and is known as a Consumers’ Register. To show its operation the following ruling is given: 22 poseq ore sosieyo oyy, ‘spotsod Surposd0ns IO} Us94}IIMOI oq JOU poosuU ‘asuUeYO OU ST d10Y} jt ‘Tleyop o}er yORszUOS oy], ‘uurnjoo Aouour ysy oy} Aq UMOYS oq [JIM SIOWIOJsND WOI] ONp [e}0} oY} ported ay} Jo SutuUTseq 94} IV ‘o1oyMos]O poure[dxo AT[N} o10ur oq []IM se ‘sjoo13s Aq SJUNODOV oY} SUISUVIIV UL sosejUvApPe IIe OIOY, “JouUeUT quotusAtoo Aue ut JO ‘sjoorys Aq posuviie oq AvUI SIOUINSUOD JO SOWIvU 9Y} ‘UWIIOJ BULOSIIOF 9Y} JO 9SN oY} UT ‘PIVMIO} PoLlIed st oUCTe soURTeq e pu syes]yO ATosr1e] ‘10yrenb e Io Avp ouo ‘porsod & IOj ssouIsnq 9Y4} 4eY} UT ‘OAOMOY ‘OpIOUIOD SUOT}IpuOCD OMY OY ‘syUNOUTe 9[qQvys Aye} Ut opeur ole sosieyo orporsod yorum Ul UOT}IpUOCD & ST oJOy} ‘a9oURJJOduTT AreUIId Jo SI s0URTeq 9}eIpOMIUT OY} Yorum UI suOT}ORSURIy ATIep JO PeoysUT ‘“SUTJUNODDe Yueq UT dsoy} Wor; ATOPIM JOYIP VY} SUOTJIPUOD YOU 0} POUSISEp ST qnq ‘Iospey woysog oy} jo sofdroutsd oy} sorpoqure yt yey} ut AYZIOMEJOU SI 4 ‘JoSpe] [e1oues wv Ul solijue ATewUINsS Aq poorjzuce ‘UIIOF Ie[Nqe} Ul popni ‘1os8peyT AreIpIsqns we UL UOTJBOYISse[O vB ‘JOoYO Ul ‘SI P1ODII BUIOSIIO} OYJ, oe 7) Yet Se. i a B=: ees fe ead pa voy preyory jovi fe) op zi | of -idy | o S Oz S +h eee EBOCTORMOL ted 12941S uyof co61 = = zoor a g ‘rs An{ |] @ | seoue P09 P,99X oyey, «| ‘1 [Udy = ond nah -MOTTY | JUHowy | 23eq 2 ea Ma ok qoeizuog | ond youmsuo) = eS souryeg || iy = oourleg 3 ae ; ° a = 6 . (stoyzenb Surposdons IO} SUI[NI oures) zo6r1 ‘of ounf sutpuq Jozren?) 23 upon inspectors’ reports, and may, in some instances, be based upon meter readings. The date of payment is stamped, or written, in the column provided for that purpose, and indicates settlement. Provision is made for allowances by a special column. The balance due, deter- mined by deducting from the summation of balance due at beginning of period and all charges, the total payments and allowances, is carried in detail to the balance due column in the succeeding ruling. | The use of the totals of the columns will be readily understood. The total charges will be posted to a controlling account for consumers and sales or rates credited. The total payments and allowances will be charged to Cash and Allowances respectively, and the Consumers’ Controlling ac- count will be credited. The balance of the latter should prove with the total of the balance column in the Register at the beginning of the period. The ruling is largely illustrative and wou!d be modified in practice to suit the specific conditions. Constructive Principles. The principles governing the display of accounting facts in ledger accounts, together with numerous illustrative rulings, have been given in this and the preceding lecture. Many more examples might be given, but sufficient have been presented, it is hoped, to make clear the salient principles, which will now be recapitulated. Ledger accounts are created to collect, for convenient reference, facts in relation to transactions in property, transactions with individuals, and the increases and decreases in accounting capital that result from such transactions. Each account, for identification purposes, is given a name or caption. The prime essential, in the construction of a ledger account, is that provision shall be made for a distinction between accounting debits and credits, usually first indicated, although not necessarily so, in another accounting record. £ The rulings may be arranged in the way that will most conveniently display the distinction between the debits and credits, the detail necessary to their understanding, and the difference, or accounting balance, that results from the offsetting of such debits and credits. | The debit or credit entry may be a summary, with the detail analyzed in columns provided in the account for that purpose, resulting in the columnar form of ledger account. The accounts may be arranged in statement or tabular form, so that a continuing statement, in form convenient for the determination of totals and the proof of accuracy, is secured. 24 The common ledger ruling is the most satisfactory for the great majority of the smaller enterprises. In very large undertakings, the ledger, as such, is reduced to but little more than a check upon the double entry principle by a few accounts, largely summary or controlling in their nature. Finally, and most important of all, no form of ruling should be blindly accepted, but the conditions existing in the particular case should be studied, and the ruling devised and adopted that will insure the proper classification with the least effort. Loose-Leaf and Card Devices. In the consideration of the ruling of the ledger account, no particular attention had been paid to the manner in which the accounts should be bound or collected for their classification use. In the usual form of ledger, which has been assumed, the rulings are printed upon pages, either one or more to a page, as the size of the ruling and page and the needs of the particular business require, and the pages are bound into permanent book form. With such a binding, in case of error or fraud, a page cannot be removed from the binding or a page cannot be substituted for another, without a mutilation of the book. There is, therefore, a considerable safety and satisfaction in having a record that contains the entire classi- fication and in which the relation of each account to the others may be studied as to transfers, dates, etc., with the knowledge that the entire record is in hand. nu In the development of the ledger, one book is found inadequate for the accounts of a concern with a considerable business, so that the ledger is divided, as has been shown elsewhere, into several distinct books. Thus, there may be a general ledger, a private ledger, a creditors’ ledger and one or more ledgers for the accounts with customers, which may be divided alphabetically or geographically. By this division of the accounts into different books, records of a convenient size are secured, and a division is made that renders possible the employment of several bookkeepers in the work. Each unit, or separate book, however, is used in its bound form under certain mechanical limitations, among which may be mentioned the fol- lowing : 1. The inclusion of accounts that are closed, and, therefore, of rare interest. These accounts must be handled continually in referring to the accounts that are open and active, thus increasing the bulk to be handled and the difficulty of access. 2. The loss of space incident to the grouping of accounts. It is = often useful to arrange ledger accounts in alphabetical or other grouping, and to insure this blank space sufficient for the maximum probable needs of each division must be provided. This will always result in an amount of unused ledger space, which must be handled continually and a part of which will eventually be lost. 3. The inability to divide the record. The bound book prevents the division of the record in case statements are to be prepared, or lists made, or any work performed in which it is desirable to have more than one person work upon the material contained in a single book. 4. The aggregation of work incident to opening a new ledger. The transfer of accounts to a new ledger, when a ledger becomes so nearly filled as to render its further use impracticable, necessitates a large amount of work to be performed within a limited time. Further disadvantages in the use of bound books may come to mind, although it is believed that, in principle at least, they are covered in the foregoing. In a general way, the disadvantages of the bound form lies in that it cannot be kept free from inactive records and it cannot be divided for the purposes of classification and work. The limitations are in the binding, for without it the accounts appear upon loose leaves, which, providing that a sheet is given to each account, may be sorted and re-sorted into any desired groupings. An account may be removed when it is closed, and a sheet is added when a new ac- count is opened. In this way all of the disadvantages of the bound vol- ume are overcome. New difficulties arise, however, chiefly in regard to safeguarding the record against accidental loss of a part thereof and fraudulent substitu- tions and abstractions. Before considering the methods employed to overcome or minimize such dangers, attention may be called to the fact that a ledger account is not usually an original record, but a mere classification of that which is first recorded elsewhere. For this reason, as a general proposition, the objections to the loose leaf method have less weight in regard to the ledger than to the books of original entry. A new ledger can be constructed from books of original entry, but new books of original entry cannot be constructed from a ledger. The loose-leaf devices fall into two classes, viz., loose-leaves and cards. The loose leaves are used in a binder that retains the form of the bound book, into which loose leaves may be placed. They are retained by a clamp or a lock. In the case of a lock, a key is provided, so that its pos- session is a prerequisite to the insertion or abstraction of leaves without mutilation. The arrangement is governed by leaves or tags that give an 26 alphabetical or other desired grouping. The sheets of paper, in some cases, are water-marked and numbered by the manufacturer and this, under proper restrictions, constitutes a further safeguard. An example of the use of loose-leaf ledgers is furnished by one of the largest industrial corporations, which keeps its stock ledgers, showing the ownership of the shares into which its capital is divided, on the loose-leaf basis. The cards are cut from bristol board or stiff paper in any desired shape and size and are kept in trays or boxes. They are bound, if at all, by a rod or other device that secures them in their place. They are more convenient for sorting and distribution than leaves from a loose-leaf ledger and their use is indicated whenever such sorting is frequent. The danger of accidental loss of cards is greater than is the case with ledger pages although, in well conducted offices, the chance of the loss of cards is slight. Card ledgers are used by some savings banks, where the depos- itors’ accounts are kept on cards, but such use is not yet general. The use of cards is principally confined to statistical records. The tabular ledger ruling is not conveniently handled on cards, but otherwise any of the ledger rulings can be used with the loose-leaf devices. There are many important uses for these expedients to be considered later. The attitude of the accountant should be the same as it is toward other devices and expedients. He should thoroughly understand the uses and limitations of each and in his constructive work select and adopt that which, in his judgment, will best serve the interests of his client. Just as no one remedy in medicine is a panacea, so no one expedient in accounting meets all conditions. Were it otherwise, there could be no profession of Accountancy. ; INTERMEDIATE TH EORY AND Sree ee OF ACCOUNTS. APPLIED ECONOMICS AND ORGANIZATION. By TOMER. Sie CUAER (PACH SCBA: LECTURE IIL. CONSTRUCTIVE ACCOUNTING. 2 Wr IRS ATG acer in eH sk INU a eG ORV Gu ely vos weighs awe 27 eas vo CRENTTORS Sse ei es wera 20 BrANcH. Accounts, 0.0.0.0... Pee Pete Mine. Cie hada tay fanaa Be 33 Weer ANAT YSIS C0 as en Oe eee aha No aes EO ADPAGCOUNT: CLASSIFICATION (ira cee Sew Y aeck Na opin toatl 39 COPYRIGHT, 1912, BY Homer Sr. Cuair Pac. pk a tee CHS RRL i fi bees ALiy. } e,. als INTERMEDIATE IT HEORY AND PRACTICE OF ACCOUNTS. APPLIED ECONOMICS AND ORGANIZATION. Eve LG buh yk COL ACL Rano et eC ag C7 Ee LECTURE III: CONSTRUCTIVE ACCOUNTING. In General. In the accounts of merchants, engaged either in wholesale or retail trade, the greater part of the accounting detail arises from sales and pur- chases of merchandise, and the settlements made with customers and creditors. The basis may be cash or credit, or, most often, a combination of the two. Asa general rule, retail merchandising more nearly approaches a cash basis than wholesale trading. Many devices have been evolved to economize effort in making the accounting record of these transactions, some of which will be considered in this lecture. Recording Sales. It is customary for the vendor to render the vendee, or customer, an itemized bill of goods sold. The name of the customer, the date, the details of goods sold and the charge will appear thereon. The bill, there- fore, includes all information that is likely to be required for the pur- pose of future reference, and all that would appear in an original record, from which, in fact, the bill is often copied. If the same facts are recorded in the original record, say a sales book, there would thus be the work of twice writing the same facts. The principal labor-saving that can be effected in recording sales is to avoid one of the processes, by making a duplicate that will save one writing. This may be done by means of a carbon paper or by letter press copying. The carbon or copy serves as the original accounting record, from which the posting of the charge may be made to the cus- tomer’s account. In this way, one writing is saved. Copyright, 1912, by Homer St. Clair Pace. 28 Instead of loose forms, to be made in duplicate or copied, the original and duplicate bills may be bound in a book, with perforations that make possible the removal of the original bills. The remaining duplicate bills become the sales book, from which postings are made. The bills, owing to the bound form of the book, are written with a special pen or pencil, and the duplicate is secured through the insertion of a carbon sheet. A more practical method is the use of unbound bills which are pre- pared in duplicate upon the typewriter. The duplicate is in a form con- venient for use in a loose-leaf binder, into which all duplicates are placed, and which becomes the Sales Book. In this may be seen the operation of the loose-leaf principle in the original record, by which great economies in effort are secured. The chief difficulty that develops in the use of duplicate bills as a sales record is that the form of the record prevents proper classification on the record itself. Thus, if five different classes of merchandise are sold, a subsidiary columnar record is necessary to make the classification. This is easily accomplished when sales are recorded in a regular sales book by the use of the columns, but the duplicate bills, in the method under discussion, are large, and cannot be classified in a manner convenient for summation. This is overcome by the use of a subsidiary sales record, into which the amounts are posted under any desired classifications. The accounts of a concern that produces and trades in certain builders’ supplies will illustrate one way in which the sales may be treated. The bills are made in duplicate on the typewriter. The original is sent to the customer and the duplicate is pasted into a book kept for the pur- pose, although a loose-leaf binder would in most cases be preferable. From this book the postings are made to the customers’ accounts and the amount is carried to a sales register and placed in a total column and in its proper distribution column. If the bill covers more than one class of merchandise, this is indicated so that the distribution can be made to columns, provided in the sales register for the various classes. In this concern, the name of the customer and date of bill are also entered in sales register, because it is desirable to display the names of the customers in a form that will give an idea of who is buying and the classes of goods bought by each. The duplicate bills cannot be viewed as a whole in the same manner as a compact sales register. In fact, inasmuch as there are but two bills on a page in the duplicate bill book, it is difficult to obtain therefrom such information. The inclusion of names and dates is not always necessary, and if not, a mere columnar analysis of sales will answer, and a greater saving of effort is made. The sales register affords totals from which, at the end of the month, 29 the customers’ controlling account is charged and the various sales ac- counts are credited. The customers’ accounts are posted from the dupli- cate bills, so that the agreement of the customers’ controlling account and the customers’ ledger proves the work. In conjunction with the foregoing, a voucher record, in the ordinary form, is used, and a cash book, thus completing the system. The saving in the method is the use of the carbon copy for a record of the detail of goods sold, inasmuch as the name, date and amount are entered in a record that is substantially a sales book. The system is not given as a model, although in the particular business it works well. There are cases in which the original bill is made by the salesman, as is the case in many retail establishments. The duplicate serves sub- stantially the same purpose as the ordinary duplicate. A posting is made to the customer’s account, in case of a credit sale, and the sale is carried to the proper classification in a register provided for that purpose. There would, in such a case, be a monthly recapitulation of the charges ren- dered to the customer, which, in the case of a retail establishment, usually contains full detail. The principles are capable of much ingenious amplification, to meet the needs of the particular enterprise, but they will be found to be sub- stantially the same in all trading accounts. Payments to Creditors. The practice of securing a receipt, release or acknowledgment of payment at the time of liquidating a claim, has existed from time imme- morial, and in the case of payments in actual money is of great importance. Nearly all payments are made in modern commerce by checks that must be endorsed by the payee before collection, so that evidence is secured, without special effort, of the receipt by the creditor of a certain amount of money. Nevertheless, an ordinary paid check is not an entirely satisfactory form of receipt, for it does not specify on its face the items it settles, and may be applied in the absence of instructions, as the payee elects. It is the custom, therefore, to return with the check the bills covered thereby, in order that they may be receipted. In many cases, they are attached to a voucher heretofore described, and the latter is receipted. In either case, considerable effort is required in following up the receipts and vouchers and in filing them. So great is this, that it is not uncommon to hear of a concern that takes no receipts, a practice that is not usually approved by accountants. The obvious remedy, and the one adopted by many firms, is a com- bination voucher and check, the use of which is a receipt for the items specified on its face. 30 The use of varying and clumsy styles of voucher checks led to the appointment of joint committees by the American Bankers’ Association, The Society of Railway Financial Officers, The Association of Railway Accounting Officers, and The American Association of Public Accountants, for the purpose of recommending forms that would meet the various requirements of the voucher check, with a minimum of undesirable fea- tures. For the guidance of students, who will later be engaged in devising accounting systems, it has seemed advisable to quote from the report of the joint committees as follows: ‘“A voucher check or a draft voucher is used when it is intended to convey more information and detail than a single check. It furnishes accurate statements of account coupled to receipts therefor and proof of settlement through a bank. “Tt should contain nothing that may affect its negotiability. It should throw upon the payor bank the responsibility for only the follow- ing items: “(a) Its genuine and correct signature. ‘““(b) The ascertaining of the sufficiency of funds to meet it. ‘“(c) Alterations in the check portion. ‘“‘(d) Correctness of the endorsement. “For many years, bankers, merchants, manufacturers and railroads have been burdened with crude and cumbersome forms of voucher checks which were devised for the purpose of combining a detailed receipt for payment with an order to pay. The vouchers oftentimes have not been in negotiable form, have been covered with advertising, have consumed much unnecessary time in scrutinizing, have compelled anyone handling to unfold and refold and, altogether, have been about as objectionable and awkward for the service they pretended to give as can well be im- agined.”’ In substance, the following resolutions were adopted: That the voucher check be made in negotiable form; That a voucher check should be in the form of a straight check or draft, and endorsement of the payee thereon be accepted as the only receipt required; That a voucher check should be of the standard check size and in the standard draft form, with the number, date, account and signature at the right and in the order named, and the name of the payor (Bank or Treasurer of Company) in the lower left hand corner, and that where a folded voucher is considered necessary by railroad companies, it should fold to standard check size, the check or draft to be at the bottom; That when a detachable check is used it should be in the standard form described above; ————— 31 That the number, the date, the amount and the signature should all be in evidence on the right hand side of the check; That the paper of the original should be of good quality and that the paper of the copy should be of a different color to distinguish it easily and the copy may be of inferior quality; That no advertising or business cards should be placed upon the check form which may tend to confuse or blind the party handling the check or cause important details of the check to be obscured. The size of the check or draft form should be from 5 inches to 34 inches wide by 84 inches long, and folded vouchers of whatever size should readily fold to the same dimensions and thus adapt themselves to all ordinary check files. Checks narrower, wider, or longer than these dimensions are objectionable. Four of the most useful forms have been selected from the ones given, as follows: Newry orks Grty eeu mie me Ser Ge rns COG Var a NI Ge Wy es American Bankers Bank 100 Wall Street BEM Cycler oe ate nae Che US ON ht Qa xb ula KOHN Dollars for The above form is a common check form, with a single line indicating the distribution of the account settled. Voucher No.____ New? Y orkusteoue st bat ne oh On Noe eee ad _ TREASURER ; Chairman Che American Bankers Association Committee FIDELITY TRUST COMPANY, TACOMA, WASH. Countersigned and Approved Pay to the Order of Secretary Dollars $ President, First Vice-President, Chairman Executive Council ITEMS in full payment of Voucher No. THE AMERICAN BANKERS ASSOCIATION PAYABLE AT NATIONAL BANK OF COMMERCE IN NEW YORK FECL Ba hh ESS A ER a NEW YORK, N. Y. (23-A Secretary The above is an excellent form for single voucher requiring the approval of several officials. In use by the American Bankers’ Association. 32 FORM VOUCHER STATEMENT OF ACCOUNT SERIES NUMBER JOHN DOE & CO. DUPLICATE 999 BEEKMAN STREET NEW YORK ADVERTISING OR DISPLAY MATTER asain tiie 7 cst CHECK BELOW TO BE DETACHED BY PAYEE CHECK NO. VOUCHER NEW YORK SERIES NUMBER Pay To THE ORDER OF $ DOLLARS IN FULL PAYMENT OF ACCOUNT STATED IN VOUCHER OF CORRESPONDING NUMBER, DUPLICATE OF WHICH IS RENDERED HRREWITH TO THE JOHN DOE & COMPANY AMERICAN BANKERS BANK NEW YORK By The above voucher check is correct in form for the use of any corporation or individual where considerable detail is required. It possesses the following advantages: Negotiability. A complete statement of account and settlement therefor, for the payee. A complete copy of such statement and settlement, together with a distribution record, for the drawer. 4. A simple, yet fully identified, check or order upon the bank which is easily detached from the voucher proper. Each party to the settlement receives all the information he needs and the whole voucher does admirably what it undertakes to do. A carbon sheet should be used for tracing the copy; thus an absolute copy is obtained. Whe CORRECT AUTHORIZED AND APPROVED Chicago, Til. pnosuchtbsecsstnnesrneccineastutet ei pul ys oun Pay 10 the.order of 2 eee 7 ORT TT ah ae Address 4-0 Tree ere ene AUDITED Biche ete Pe TT ome ib. | meee 26,333,44 Good=will}< 3 isa serie ee 7,000 $50,500 $50,500.00 In comparison with the foregoing, the Balance Sheet, under the actual conditions, would have shown: Balance Sheet of A & Bas at.......... Réal Estate... ..55425 5035 $25,000. -A, Capttali..ii. 0870 $25,000 Cash" xtc ewan 18,500 -By/ Capitals. Pliio2 see 25,000 Good-wilh?t So Viter: ii: 6,500 $50,000 $50,000 Under the agreement, therefore, the better the results of realization, above the amount guaranteed by B, the less he receives, nominally, for his Good-will, although the substitution of cash for Good-will undoubt- edly strengthens the financial position of the firm and his own interest. The actual value of the Good-will is not lessened in the slightest by suc- cess in collections. The division of the $500 as a profit would have been better for B, had it been possible. The balances of the capital accounts measure the respective proportionate interests of the partners in the partnership assets, and, while in the second balance sheet the interests are shown to be equal, in the first balance sheet B’s interest is shown to be slightly in excess of A’s, due to his preference in the division of profits. It is necessary, in cases of this kind, to handle the contributed ac- counts receivable in such a way that a distinction may be made between 59 realization and trading transactions, For this purpose a separate ledger may be used for the accounts taken over, care being taken to see that receipts from customers are properly applied. The discussion of further illustrations of opening entries and adjust- ments would lead to but one conclusion, namely, that the difficulty lies in the interpretation of the partnership agreement. In seeking for a reasonable interpretation the accountant should carry through the possible accounting processes, in order to study their respective effects. By the exclusion of interpretations that bring about improbable or absurd results, the field is narrowed and the reasonable accounting intent gathered. Dissolution Adjustments. The accountant is most often called upon to determine accounting facts at the time of dissolution. A typical example of the complications that may arise in the settlement of a small partnership is supplied by a proposition given in an examination. The facts, fortunately, were not in dispute and are clearly stated. The proposition follows: S and T began business August 1, 1899, S investing $8,000 and T $5,000, gains and losses to be shared equally and no interest allowed on investments or charged on withdrawals. The firm was dissolved May 1, 1900. The books had been kept in a haphazard fashion but the part- ners agreed to the following statement which was submitted for settle- ment: net debit of S $2,100; net credit of T $3,500; cash on hand, $3,400; to shares bank stock (market value $1,100); expense debit $5,100; profit and loss debit $3,000; credit $500. The bank holds the firm’s note for $2,000 on which there is accrued interest $60. Prepare a statement show- ing the settlement of the partnership affairs of the firm. Inasmuch as the assets, liabilities and relative capital interests of the partners are known, a balancing statement may be produced, as a basis upon which to work, by the use of whatever nominal amount is necessary to effect the balance. Thus, if X contributes $100 and Y $200 and the profits and losses are to be shared equally, and there remains only $100 of assets, a balanc- ing statement can be made that states the facts, as follows: RS Rte oS e-gsacc) a alas odio oe $100 eee ee gi 8 SS oo oka ae; $100 eats ements? ois th eh AR Seas AVE es 200 $100 $300 SOTIGE LOSS alc. yw ste dD vo eee Oe Oe 200 $300 $300 60 The loss carried one-half ($100) against each partner would exactly offset X’s capital and leave the books thus: Assets iiaets ecceebaiee $100 TYE ge SO OS Ee $100 Upon the withdrawal of the assets in settlement of Y’s interest, his account would be closed by a charge and assets would be credited to balance. Again, had X and Y brought their accounts to a position where X had overdrawn by say $100 and Y had a credit balance of $400, and the condition as to assets and liabilities was that the concern possessed $100 and had no liabilities, a balancing statement could be prepared thus: Assets ic: aka a bya aud aati e fiends GPa $100 PaSe PEET CCN, TR REE aed Pee, Peep 100 i See I RE PR a be me PDS POS Fee $400 $200 $400 Balance (10S8)\. «tee ee ere eet ae 200 $400 $400 The loss, carried one-half to each, produces a debit to X of $200 and a credit to Y of $300. Y would be entitled to take the $100 and to collect $200 from X, who evidently drew out the $100 he contributed and $100 in addition, and who is also chargeable with one-half of the losses. Y evidently increased his contributions to $400, and after deducting his share of the losses, he is still entitled to the return of $300, as stated. Therefore, the relative weight of capital contributions or deficien- cies being established, and the assets and liabilities being known, a bal- ancing statement may be prepared by carrying in assets and capital deficiencies as debits, and liabilities and capital contributions as credits, and a nominal amount to balance. In case a portion of the nominal elements are known, but not all, such as are known are carried in and a nominal account is set up for whatever balance is necessary to secure the equilibrium. Thus, in the S & T proposition, a balancing statement can be pro- duced, as follows: CSU SER AR aA. a AP dei $2,100 d bere anemia ey Geigte tc pa ae eee ee $3,500 HE RRC Es OL TNT EN RCN ee eaeRa ony Wem 3,400 Bac LOG ieee ante oo gk Ui |, 1,100 LEXDCTISO ener ee. Lee PANG 5,100 ONE QR an runt rr 100 eo fe 3,000 500 Eiicel ue iovmmem mati: (cet deat rs. 2,000 PCOrueds Interesure an Tek ohh yee 60 $14,700 $6,060 BAsHeeretTOub Oc LOSS ayes .. 77g $3,500 “Bank: Sh0gk 2 SP et 1,100 .~~ Profit & Loss-35 ee 520 $2,440 . sBalance; 3 fa.ee wee eee 1,580 $4,020 $4,020 By Balance! ° : ieee $1,580 The proposition can be worked on a single entry basis, although the double entry basis is to be preferred. However, to corroborate the solution and to present the resource and liability view of it, the single entry solution will be given. Total S i Capital ‘Contribertions: .8 5 $F, 22) SPUR eae $13,000 $8,000 $5,000 Withdrawals.2) o. Pai APs ae ee 11,600 10,100 T,500 $1,400 —$2,100 $3,500 Remaining Capital: Cash): .’.4.4 Woes) enna at nee $3,400 Bank Stock... .+., sunenien aaa 1,100 $4,500 Less. Laabilities. yc) 8 Se eee 2,060 2,440 Net Profit, half toveach seo. eee $1,040 520 520 — $1,580 $4,020 OF) ee SPE poise lh See $1,340 DANK SLOCK 200. se. eee 1,100 2,440 — $1,580 $1,580 63 The foregoing may be the “statement” the examiner had in mind. The only added information in this solution is afforded by the items of withdrawals, and this can not be accepted for anything more definite than the net results, as aggregate contributions and withdrawals would not necessarily show. Distribution of Capital Losses. In the distribution of profits and losses, no distinction is made be- tween those that arise through trading and those that result from the realization of capital assets. A partner’s capital may be extinguished from either trading or cap- ital losses and a deficit created that is made good from a copartner’s con- tributions, although, as in the case of S and T, before given, the deficit may arise from excessive drawings. After a full realization and liquidation, as an example, the following condition may be found to exist: Doe & Roe, Balance Sheet as at.......... i ee BE BOE NOG tod arbi al osm io ‘arnt capil $8,000 Me ky Sale (a CANS a a a ap toner ge 2,000 $10,000 $10,000 In case the losses are divided equally, $2,600 would be chargeable to each of the partners, and this would bring about a condition as follows: Doe & Roe, Balance sheet as at.......... em LA St Se, GiSo6 © Dees Soe ET $5,400 TP A a a Cae ae 600 $5,400 $5,400 The situation is that losses which were divisible equally have been incurred to an extent more than sufficient to extinguish Roe’s capital contribution and they overlap upon the capital contribution of Doe. Therefore, Doe would be entitled to receive the remaining cash, $4,800, and to collect from Roe the balance of $600 necessary to return to Doe his capital as shown to exist after the adjustment of the losses. A still more complicated condition would be the case of three part- ners, one capital account showing a deficit and the other two showing credits, and in which nothing could be collected from the partner with the deficit. The deficit, so far as the two responsible partners are con- cerned, is a loss, and should be borne in the proportion in which the profits 64 and losses were to be shared as between such partners. Thus, in the case of X, Y and Z, sharing profits and losses equally, the following con- dition existed: Gashouls Jn »sadoe ot » SPTGQOO. TDR, VS a $4,000 Lie ere ake Ca ae BIOOO Nhe cir ace ait oth tee ee 6,200 $10,200 $10,200 Distributing the deficit of Z, which was uncollectible, equally be- tween X and Y, the following statement results: X, Y & Z, Balance Sheet as at.......... Cash 4. tial eee eee ate ce, $7200. ee eda $2,500 AO Rr 4,700 $7,200 $7,200 The capital accounts, as adjusted above, disclose the proportions in which the remaining cash would be divided between the partners, X and Y. The adjustments of partnership interests under complicated conditions of this kind have given rise to many disputes and there are conflicting decisions. The foregoing, however, is the commonly accepted account- ing view. Interest. The capital contributions of partners are often unequal in amount. Therefore, the partnership agreement may provide for an adjustment to be made upon an interest basis, so that, before the division of the profits in the agreed proportions, an equalization is made that overcomes the inequalities of varying capital contributions. Such an adjustment, as commonly carried out, has no bearing what- ever upon the matter of profit or loss, but is merely an adjustment of the capital interests. | Thus, A, B and C contributed respectively $10,000, $5,000 and $5,000, to a business. The profits and losses were to be shared equally and each partner was to be credited with 6 per cent. interest upon his capital. Irrespective of profit or loss, to carry into effect the interest provision, it would be necessary to credit each partner with 6 per cent. interest upon his capital and to divide among the partners the aggregate interest in the proportion in which profits and losses would have to be divided. From this it will be seen that if capital is contributed in the same proportions as the profits or losses are to be shared, there would be no 65 need for a provision for interest upon capital. Thus, if the profits and losses in the case given were divisible respectively one-half to A, and one- fourth each to B and C, the interest procedure carried out and divided as to the debit in the proportion of one-half, one-fourth and one-fourth, respectively, the same result would be obtained. That is to say, the partnership interests would be exactly the same as though no calculation had been made. In the actual case, however, in which the profits and losses are divis- ible one-third to each partner, A receives 6 per cent. upon $10,000, amount- ing to $600 and is chargeable with only two-thirds thereof, so that his capital is increased $200 by the operation and the capital accounts of B and C are each decreased by $100. In this way, an adjustment is made that compensates A for his extra contribution of capital. The capital accounts would appear as under: Dr. A. Cr. Pre FOnt-te LOSS, 66... .>- SoG By Ganitalie edocs Waa $10,000 MI cde ah stot «ane 10,200 “ Interest on Capital, 6%. 600 $10,600 $10,600 By Balanceyiiy) Js ves $10,200 Dr B. Cr. Peer rou, eo LOSS. 666... PAOOMU AY ATIC La de ties e $5,000 SenIanCe. 666 et 4,900 “ Interest on Capital, 6%. 300 $5,300 $5,300 Dy alatloc ec tenes ere tat ete $4,900 Dr. C. Cr. memeeront & Loss......%... $4007 eBy Cantal amreersie soc. $5,000 ee ANCE ee 4,900 ‘“ Interest on Capital, 6%. 300 $5,300 $5,300 BY A DAlAR Cera riick a dus sx $4,900 In the ordinary case of profit earned, the matter of crediting interest takes the form of an appropriation of profit prior to the ordinary profit division, but inasmuch as the adjustment would take place irrespective of the securement of a profit, it is apparent that, after all, the procedure amounts to a mere adjustment and re-statement of capital interests to 66 carry into effect the provision to compensate, upon an interest basis, for unequal contributions of capital. In order to give full effect to equalization upon an interest basis it is necessary that interest should be charged upon drawings, so that the partner receives credit for the amount of capital that actually stands to his credit from time to time in the business. The interest may be cal- culated only upon an excess capital or charged upon a deficit. Thus, the agreement might provide that $10,000 of capital is to be contributed by each of two partners and that 6 per cent. interest is to be allowed on any excess capital or to be charged upon any deficit, that occurs. The credit or debit is carried to the capital account affected and the balancing portion of the entry is carried to an adjustment account or through the profit and loss account, to be divided as are profits and losses. The provisions that may be made for adjusting unequal contributions of capital or effort, either by the provision of so-called salaries, commis- sions, division of profit, etc., are innumerable, but they will be found to fall under the principles given. It will be plain to the student at this stage that the accounting prin- ciples involved are of general application, and the difficulties that are likely to be found in partnership accounting arise in the interpretation of the partnership agreements. vt, i* Ni ea > AAat i eh ne ‘ade as we an e 4 ¥ 5 a i ah ie ee ee - = = — on = Le a ae ~ : ADVANCED THEORY AND PRACTICE OF ACCOUNTS. ORGANIZATION AND FINANCE By HOMER ST.CLAIR PACE, C. P. A. CORPORATIONS—LECTURE I. CORPORATE RECORDS. Dae ROMIREEPTORSHIP Se oe ugha UNL RN lal Seek: Faille ECL GN. I eG M ey ORME Re aN 2 ORGANIZATION... .-.). ors eee uae EU Ms Ge cM ERA ALN GAM 3 ee OME OU ech eee amet). Cake uP IU. ae Aw SOS As ale as Se rOa ce Aga 4 OCR GAN BRCORDS O16 SU a twists tee Ser ee PONS papier 5 Phang AND PRANGFERS OF STOCK 2105 os ye 6 | Srock Boor. Ll Se GO MeN ay ee eg ELC RTA VG ea ore 1206 DN Ey OO ar aha s 2 ed oes EAS ON ean a aa ei | 9 : TRANSFER RECORDSIN LARGE CORPORATIONS O3k ae ee hn gare es II “Listinc Stock UPON STOCK PES OMAN Gu yOu ce i ond Ve es meet Peiiaee Or OTOCRHOLDERS Mio A Se os pee eis eee gL Ae 12 COPYRIGHT, 1012, BY HomeErR St. Cratr Pace, Ey at » Ky pM tas a ADVANCED THEORY AND PRACTICE OF | ACCOUNTS. ORGANIZATION AND FINANCE By HOMER ST. CLAIR PACE, C, P. A, CORPORATIONS—LECTURE I. CORPORATE RECORDS. Proprietorship. Three distinct forms of proprietorship are employed in the invest- ment of capital and the organization and conduct of enterprises, viz.: 1. Single Proprietorship, in which an individual, known as a sole trader, invests part or all of his capital and controls the undertaking; 2. Partnership, the relation created by the association of two or more legally competent persons to carry on a lawful undertaking, in which they combine capital, skill or time, one or more of them, to achieve the purposes of the association; 3. Corporate Proprietorship, the abtilrenects of capital by the crea- tion of an artificial being, as will be more fully explained later. The form of single proprietorship is the simplest and the one to which recourse is ordinarily first had in the natural development of an enterprise. The form of partnership is the outgrowth of the first form, through the economic desirability of combining capital and skill in the attainment of a mutual object. Thus, if the common object of A and B is to make a profit, to be attained through an undertaking in which both capital and skill can be advantageously employed, and A has skill but no capital, and B has capital but no skill, they can, by combining, produce more profit in the aggregate than would be possible if they should proceed independently. A partnership labors under the necessity for a dissolution of the form of organization in the case of the death of a partner, which may jeopard the business and capital invested.’ Further, individual liability for all the obligations of the undertaking attaches to each partner, thus placing his capital not invested in the particular enterprise subject to its vicissi- tudes. These conditions apply equally to a sole trader, and render desir- able the third form of proprietorship. Corporate proprietorship permits of the aggregation of capital, in many cases without further liability than the capital contributed, thus Copyright, 1912, by Homer St. Clair Pace. 2 enabling persons with small amounts of capital to contribute with limited liability and without actively assuming the responsibilities of manage- ment. It insures a continuity of the enterprise that is in nearly all cases desirable, and in some cases, as in a railroad, indispensable. The method is, therefore, from an economic viewpoint, the natural development of the partnership form, as the latter was of the single proprietorship form. The nature of the corporate form will be more fully apparent from the definitions and explanations to follow, although it is not intended, in this Lecture upon Theory of Accounts, to cover fully the legal prin- ciples involved. Definitions. A corporation may be defined as an artificial being created by law for certain specified purposes, composed of individuals united under a common name, the corporation being distinct from such individuals, so that it continues to exist notwithstanding changes in the individual mem- bers through death or otherwise. A corporation, for practically all pur- poses, is considered as a natural person. For accounting purposes, corporations may be considered in two general classes, viz.: 1. Public corporations, organized for the purpose of government, such as a county or municipality. 2. Private corporations, comprising (a) Stock corporations, or those organized for the purpose of profit, such as a mercantile, manufacturing, banking or railway corporation; (b) Non-stock corporations, organized for purposes other than profit, such as a cemetery, library or religious corporation. A stock corporation is defined to be a corporation having a capital stock divided into shares, and authorized by law to distribute to the holders thereof dividends or shares of the surplus profits of the corporation. There are certain distinctions to be observed in stock corporations. They may be divided into: 1. Public Service corporations, or those rendering a public service for a private profit, with special powers or privileges, such as the right to condemn property, for the grant of which certain rights of supervision and control are reserved to the creating power. They are usually organ- ized under a general law, applying especially to the organization of such corporations and are subject to special restrictions. 2. Business corporations, being the remainder of the stock corpora- tions. These are subject to a further division in some states. For example, in New York, financial institutions, such as banks and trust companies, are incorporated under a law applying especially to them. 3 The great majority of the stock corporations, however, consist of those organized for the purpose of carrying on trading and manufac- turing enterprises. Organization. The incorporation is usually effected under a state law, by the asso- ciation of natural persons, known as incorporators, who execute a certifi- cate of incorporation, in some states termed articles of incorporation, setting forth the name and object of the proposed corporation, its dura- tion, principal place of business, names of its first directors, the amount of its capital stock and its division into equal parts, known as shares, and such other matters as may be desirable or as may be required by statute, the incorporators specifying opposite their signatures the number of shares for which they respectively subscribe. When the certificate of incorporation is filed and accepted, and all the formalities have been complied with, the corporation is fully organized. The capital stock is divided into equal parts, known as shares, for the purpose of dividing the ownership of the capital. In New York, the shares cannot be less than $5, nor more than $100, each. Thus, if a corpora- tion has an authorized and issued capital of $100,000 divided into shares of $100 each, there would be 1,000 shares of stock, issued in the names of the various proprietors, known as stockholders, according to their ownership. Upon payment to the corporation of the par value of the shares sub- scribed by the original incorporators, certificates of stock are issued to the respective persons, certifying that the holder is the owner of a certain num- ber of shares of the capital stock of the corporation. The stock certificates are signed by the proper officers of the corporation, and, in New York, must be sealed with the corporate seal. The ordinary form of stock certificate is as follows: Incorporated under the Laws of the State of New York THE JOHN F. HOWARD COMPANY Capital Stock, $100,000 RINE GLASER CESS) LILI ip ila n,m sale ie Lape wl ein ros loa vw sea lim Sua lee eb sies ihe is the owner of PUMReOy HUME WLU TIC ahs Sie Me ibeiale eh see Shares of the Capital Stock of THE JOHN F. HOWARD COMPANY, full paid and non-assessable, transferable only on the books of the Corporation by the holder hereof in person or by Attorney, upon surrender of this Certificate properly endorsed. (SEAL) IN WITNESS WHEREOF, the said Corporation has caused this Certificate to be signed by its duly authorized officers and to be mash with the Seal of the Corporation this...... Ce uOE eal Gia a's Jag BMT ge he Secretary. President. Shares $10 Each. 4 The following is an ordinary form of the stub bound in the stock certificate book against the certificate forms: Certificate NOW Gow aeccs bE ay a eR eh MIRA TRE ec BY Shares Tsetredfori. Wie ele oe eae DO BGET Je ic Aaleyal iets tatehon 1g Tsstied GO a ageieu lela Bias ierens Addressee y Cody SEN tee (Form of Certificate) The certificates may be sold and transferred, and for that purpose it is customary to print a blank power of attorney upon the back of the certificate. When this is properly signed by the stockholder in whose name the certificate is issued, the one to whom the stock is to be trans- ferred may personally, or by his attorney, transfer the stock to his name upon the books of the corporation. That is, he may surrender the old certificate for cancelation and receive in lieu thereof a new certificate issued in his name, thereby becoming a stockholder of record in lieu of the former stockholder. The following is an ordinary form of the assignment and power of attorney that appears on the back of a stock certificate: Sec eve rervieg€Cg€ ve bo ea Cee epee siesvwveenewVeseeh een es 02 ve 4 6 wv 2 6 + tb © % 6 0 @ 8 © SS Bie 8) Se eee eee Shares of the Capital Stock represented by the within Certificate, and do hereby irrevocably constitute and appoints.) 0.6 .ije 2 se oes ais wie + at piles » 5p » En nls brid ib un ale ARUP RAN Te eee ees aL my true and lawful attorney to transfer the said Stock on the books of the within named Corporation, with full power of substitution in the premises. Dated 2 toes eae ee ae ale 10. she In presence of: oS 0 0. eel bso se 2b 6)» eS.» 2 ales, b Bre seek ee mee te oo? 28 CA Peele ae GPS et aoe eCeevwes pee &@ oe o's © © 215 8 Oe eee Notice. The signature of this assignment must correspond with the name as written upon the face of the certificate, in every particular, without alteration or enlargement, or any change whatever. Control. The stockholders control the corporation through action taken at annual or special meetings. At such meetings a stockholder is ordinarily entitled to cast one vote for each share of stock standing in his name. 5 The immediate control is vested in the Board of Directors, the members of which are elected by the stockholders at the annual meeting of stockholders. The stockholders, or the directors when authorized by the stock- holders, adopt by-laws, which are rules providing for the calling of regular and special meetings of stockholders and directors, election of officers, duties of officers, and such other matters as may be desirable. The Board of Directors elects officers to manage the affairs of the corporation when the Board is not in session. The officers are subject to the Board of Directors in all matters, and their duties are prescribed in the by-laws. The officers, as ordinarily provided for, and their duties, are: President. The president is the chief executive officer of the corpora- tion, presiding at the meetings of stockholders and directors, and having general supervision of all its affairs. Vice=President. The vice-president performs the duties of the presi- dent in case of the latter’s inability to act, and such other duties as may be provided for in the by-laws. | Secretary. The secretary records the proceedings of the stockholders _ and directors at their meetings, has the custody of the seal of the corpora- tion, which he attests by his signature on certificates of stock, contracts, etc., and performs such other duties as may be required. Treasurer. The treasurer has charge of the receipt and disburse- ment of moneys, and in many cases it is his duty to keep the accounting records. There may be other officers, but in any event they will be elected and their compensation fixed by the Board of Directors, to which they are accountable. Books and Records. The books and records that are essential in the conduct of a corpora- tion, may be divided for convenience, into two general classes, viz.: 1. Corporate Records. Under this will be grouped all books and records that are peculiar to the corporate form of organization, such as the Minute Book or Record Book, Stock Book or Stock Ledger, Stock Cer= tificate Book, and the Transfer Book. 2. Financial Records. These records are intended to embrace the bookkeeping record of the financial transactions of the corporation, pre- ferably kept on the double-entry basis, which records do not necessarily differ from the accounting records kept in the other forms of proprietor- ship. They would consist of the Journal, Cash Book, Ledger, and similar books, and the books and records supplementary thereto. The first division is to receive particular attention in this Lecture, the detailed consideration of the second class being left for attention later. 6 Issues and Transfers of Stock. In close corporations, that is, ones in which the stock is held by a few persons, where the transfers of stock are apt to be rare, the original entry of the issue of a stock certificate usually consists of the entry on the stub, or counterfoil as it is sometimes called, of the stock certificate, the stubs and certificates ordinarily being bound in.a book. The stub is filled in with the number of the certificate, the date of issue, name of stockholder and number of shares, and the stockholder, upon receiving his certificate, receipts for it at the bottom of the stub. If the certificate is returned to the corporation for transfer to another, the assignment on the back is filled out with the name and address of the one to whom it is to be transferred and with the name of the attorney who will make the transfer on the books, and duly signed, the certificate is can- celed, generally by punching the signatures of the officers who signed it, and pasted back against the stub from which it was issued, and a new certificate is issued in lieu thereof, in accordance with the assignment, the new stockholder receipting for the new certificate on its stub. Thus, the stub and canceled certificate supply every detail essential to the record and for the posting to the Stock Book. Stock Book. In a stock corporation, the par value of the stock that has been issued is shown in the financial records in a single Ledger account known as a Capital Stock Account, no attempt being made to show the ownership of shares, this being done in a book or ledger known as a Stock Book or Stock Ledger. The New York law requires that a Stock Book shall be kept, setting forth in alphabetical order the names of the various stockholders, with their respective addresses, number of shares standing in the name of each, when they respectively became the owners thereof, and the amount paid thereon. The law requires that this book shall be open to the stockholders and judgment creditors of the corporation at least three hours of each business day. The Stock Book will, therefore, contain accounts in which are recorded the details of ownership of shares, equalling in the aggregate of par value the amount of the capital stock issued, as it is carried in a total sum in the Ledger belonging to the Financial Records. It is usual to keep the Stock Book as a double entry ledger, showing the total amount of shares of stock issued and outstanding in a single © account, which may be called Capital Stock Account, either as a debit or credit, it matters not which. This will show a balance of shares that 7 will equal, in par value, the balance of the Capital Stock Account in the Financial Ledger. On the contra side of the Stock Ledger, in proper accounts, appear the stock-holdings of the various stockholders, in shares, a separate account being given to each stockholder, the sum of the ac- counts equalling the total of the Capital Stock Account, thus establishing the valuable double entry check upon the accuracy of the book. It is more usual in the Stock Book to debit the various stockholders and run the Capital Stock Account with a credit balance. Although less usual, it seems more natural to credit each stockholder with his shares, keeping the Capital Stock Account with a debit balance, merely as a bal- ancing account, as it is more usual to think of a capital account, whether of shares or of an interest in a partnership, as a credit amount. It is quite immaterial, however, which form is adopted. The law requires that the number of shares, not dollars, shall be shown. This is better, regardless of the law, for the amounts are round, and keeping the record in shares saves many useless figures. The ruling of a Stock Ledger differs from that of the ordinary (ecioe On the extreme left of the page are columns for the month and day of the month, then a column for numbers of certificates issued, followed by a column for numbers of certificates canceled, although these two columns are sometimes combined and only one used. To the extreme right are three columns, one for debits, one for credits, and the third for carrying out the balance of the account, so that the requirement of the law that the number of shares outstanding in the name of each shall be shown, may ibe met, | To illustrate the use of the ruling, it will be assumed that J. W. Jones, of Tuxedo, N. Y., acquired 100 shares of stock of a corporation, and on January 2, 1902, certificate No. 115 was issued to him therefor. Later on February 8, 1902, he sold 50 shares of his stock to W. H. Lane, of White Plains, N. Y., and presented certificate No. 115 with the power of attorney on the back thereof duly made out, transferring 50 shares to W. H. Lane and the other 50 shares to be reissued to himself. In the first place, to record the acquisition of J. W. Jones of the 100 shares of stock, an account would be opened in his name, and credited with the number of shares. If it were an original issue of stock, the bal- ancing Capital Stock Account would be debited; if it were a transfer, the account of the transfer would be debited. Upon surrender of certificate No. 115, it would be canceled by destroying the signatures by punching or otherwise, and would be pasted back against its stub in the stock certifi- cate book, and new certificates for 50 shares each would be issued in the names of J. W. Jones and W. H. Lane. In the account of J. W. Jones, 8 the cancelation of the entire certificate No. 115 must be shown, balanc- ing the account, and the new certificate, No. 125 for 50 shares, would be credited. An account is opened for W. H. Lane, as was done in the first instance for J. W. Jones. It is apparent that transfers do not affect the Capital Stock Account, which will be undisturbed, except in case of original issues of stock or reduction of outstanding stock, the latter being of rare occurrence. The procedure will be seen from the following illustration: J. W. JONES, Tuxedo, N. Y. Amount Date Gs rik Ott: Dr. Cr; Balance Paid Issued Canceled (shares) (dollars) I go 2 Jan. 2 IIS I0o 100 Full Paid. Feb. 8 II5 100 ° ii 8 125 50 50 W. H. LANE, White Plains, N. Y. Amount Date tf. Cté. Dr Cr. Balance | Paid Issued Canceled (shares) (dollars) 1902 Feb. 8 126 50 50 Full Paid. In addition to the columns shown in the foregoing rulings, columns are sometimes provided in which to enter the name of the transferee or 9 transferor, as the case may be. Thus, a column “from whom transferred”’ in the account of W. H. Lane would show from whom his stock was trans- ferred. This information however could be obtained from the stock certificate stub with small labor, were it required. In case of stock being only partly paid, it is necessary to provide a column to show the amounts actually paid in thereon from time to time. It may be placed to the extreme left of the page, or as shown in the foregoing. In case of fully paid stock it is not usual to enter the dollars in each case, a notation that it is fully paid being sufficient. It will be seen that the Stock Book ruling is not unlike the Journal ruling, except that an additional column is provided to show the balance of the account. This is not an unusual ruling in financial books, and is used by savings banks to show the balance of the customer’s account from day to day, or as often as there may be changes, and it is sometimes used as a ruling for the Customers’ Ledger in a mercantile business. Minute Book. It is necessary to keep a Minute Book, or Record Book, in which the proceedings of the meetings of the stockholders and directors are recorded. This record, in common with all other purely corporate records, is kept by the Secretary. If properly kept, the Minute Book furnishes a complete chronological record of the more important affairs of the corporation, including the election of directors, with their terms of office and compensation, if any, the by-laws as they are adopted and amended, the amount of capital stock authorized and issued, and the purposes to which its proceeds are devoted, the issuance of other securities, the adoption of contracts, elec- tion of officers and their terms and salaries, and the innumerable matters that are necessarily brought before the stockholders and directors for their formal approval. In recording the minutes of a meeting of the Board of Directors, the place and date of the meeting should be first stated, that the meet- ing was duly called in accordance with the by-laws, who presided at the meeting, and the names of the directors present, in order to show that a quorum, that is, the number necessary to transact business, was present. The by-laws usually specify how notice of meetings shall be given, but, as a general rule, it is better to state that the meeting was “duly called,’ than to attempt to specify the steps by which it was called If the latter is attempted, it must be done with great exactitude, or the record will itself show a defect. In the former case, in absence of proof to the contrary, it will be assumed that the meeting was properly called. Io Following the statement that the meeting was duly called is, ordi- narily, a statement that the minutes of the preceding meeting were read and approved. The business is generally transacted in the form of resolutions. A resolution covering a particular matter is presented by a director with a motion that it be adopted. The motion is supported by another director, and then presented by the presiding officer for discussion and vote. It is customary in the minutes to state the name of the director who presents, and the one who seconds, the motion, the resolution in full, and the fact of its adoption or rejection. In this way, the business transacted by the Board of Directors is recorded in the Minute Book. The record is ordi- narily signed by the Secretary and approved and countersigned by the President after its approval by the Board of Directors at a subsequent meeting, although in many corporations the Secretary alone signs the minutes. The same order of record is used for meetings of stockholders, which are ordinarily recorded in the same Minute Book, the records of the stock- holders’ and directors’ meetings appearing in the order in which they are held. The name of each stockholder in attendance at a stockholders meeting is recorded, with the number of shares of stock standing in each name, as well as a statement of the shares represented and voted by prox- ies, that is, persons authorized by power of attorney to vote stock stand- ing in the names of others. The Minute Book furnishes the best, and practically the only, record of the regularity of stock and bond issues, approval of contracts, and other important matters, and it is therefore highly important that it be properly kept. To the accountant, the Minute Book furnishes evidence of the correctness of many items of the Balance Sheet, and of salary and other expense items. An index of the Minute Book should be kept, in order that ready reference may be had to the resolutions. Whatever may be the merits of loose-leaf devices for certain lines of work, they should never be employed in any form for a Minute Book. The book should be substantially bound, preferably in full leather, and the minutes should be written in with a pen or with a book typewriter. Reliance in many cases must be placed on the record, and its form should be one that will, as nearly as possible, prove its authenticity on its face. Many cases are known, where the practice of writing minutes on a type- writer and binding them into a loose-leaf binder has been in vogue, in which the minutes of a meeting were taken out and destroyed in lieu of holding a meeting to rescind resolutions. This undesirable action would not occur were a proper form of Minute Book used. II Transfer Records in Large Corporations. In large corporations, where the stock is widely held and dealt in on the stock exchanges, a more elaborate system than heretofore described is necessary in order in insure accuracy in transferring stock and to facili- tate the tracing of particular transfers. | In addition to the Stock Ledger and Stock Certificate Book, a Trans- fer Journal is maintained. The book is opened flat and both pages are used for a transfer. On the left hand page are recorded the date, number of the transfer, name of the person from whom stock is received, number of certificate and number of shares, the latter appearing in a column to the extreme right of the left hand page. On the opposite, or right hand page, against the entry already out- lined, is recorded the name of the new stockholder, together with his address, the number of the new certificate and number of shares, the latter equalling the number received as per the entry opposite. If the stock is received from a number of holders to be transferred to one name, it is run under one transfer number; if, on the other hand, it is the stock of one person to be transferred into the names of several new holders, it is likewise covered by one entry. It will be noted that such a Transfer Journal merely arranges, in chronological order, the facts contained in the stubs and canceled certificates, and, in addition, gives to each transfer a distinctive number by which it may be traced. The number of the transfer, date, numbers of old and new certificates, number of shares, etc., are posted to the Stock Book or Ledger. In the case of an additional issue of stock by the corporation, it is entered on the left hand page as an original issue, to be posted to the balancing Capital Stock Account in the Stock Book, and on the right hand page the names of the new holders, numbers of certificates, etc., will be entered. In the case of different classes of stock, a separate ledger and transfer journal are usually kept for each class. Listing Stock upon Stock Exchange. Only such stocks and bonds as have been added to an official list kept by the Committee on Stock List are dealt in on the New York Stock Exchange. The Committee on Stock List requires that, before the securi- ties of a corporation are listed, it shall make a formal application, con- taining a statement of the organization and purpose of the corporation, its capitalization, the object of the new issue, and a balance sheet and statement of earnings, to be accompanied with copies of the charter or articles of incorporation, by-laws, stockholders’ and directors’ resolutions covering the issue, with any contracts or leases affecting the issue, all I2 to be certified by an officer of the corporation. In this way an attempt is made to bar from the list questionable issues of securities. Certain rules have been adopted by the Stock Exchange as to what constitutes a “good delivery’’ of stock, that is, as to when the formalities of assignment, etc., have been met so that the purchaser must accept the certificate. These rules largely govern the action of the transfer offices of the large corporations in accepting stock for transfer. The Stock Exchange requires that bonds and certificates of stock must be printed from steel plates made by an engraving firm which they approve, so that no printed or lithographed certificates or bonds can be dealt in on the Exchange. | Lists of Stockholders. It is necessary to make lists of stockholders from the Stock Ledger for use at stockholders’ meetings and for dividend paying-purposes. In a small and closely held corporation this is a simple matter, but in the larger corporations, where the number of stockholders runs into the thou- sands, it is more difficult to prepare such lists at frequent intervals from large and clumsy ledgers. . It is not unusual for a corporation to have two or more classes of stock, and in making up a list it is difficult to sort out duplicates caused by the holding by the same person of more than one class of stock. It is, of course, desirable, in case of mailing notices of meeting, sending out annual reports, etc., to have a list of the actual holders of stock, without such duplication of names. The difficulty is obviated, and the labor involved in making a list for any purpose is reduced, by keeping a supplemental list of the stockholders on cards, each card giving the name of a shareholder, his address and the total number of shares, in lead pencil, of each class of stock standing in his name. These lead pencil totals are corrected from time to time as trans- fers are made, so that a list may be made at any time with the names of the stockholders in alphabetical order, with their respective addresses and holdings of stock, or envelopes may be addressed by running through the cards. The list, when completed, may then be checked against the Stock Ledgers. In fact, the entire record is sometimes kept in a card ledger without the use of the ordinary bound Stock Ledger, but this practice is the excep- tion rather than the rule. The use of loose-leaf ledgers has been found advantageous in the case of some of the largest corporations, the heavy labor incident to opening new ledgers thereby being avoided. a A ae Sa ens Oe Ma ~ ADVANCED THEORY AND PRACTICE OF ACCOUNTS. | ORGANIZATION AND FINANCE By HOMER ST. CLAIR PACE, C. P. A. CORPORATIONS—LECTURE II. OPENING OF FINANCIAL RECORDS. ee eae RY tN lola kala, 33 CONSIDERATION FOR Issur or STOCK.......... Ee ES ae Saceeeey Issuz or Stock ror Monry ONLY... .......0.0.., ee Gen Weenies r4 Issup OF Parr OF AUTHORIZED STOCK FOR MONEY . PCRS AGS fee ater an an Desa OW PARTLY: PAID STOCK FOR MONEY: i ared oc 0 LENG hae 18 MT INCORPORATORS.. 650s he cy ee ee i aa at IssuE OF STOcK FoR Property, Lazor DoNE AND MONEY........:. 21 | ACQUISITION OP PuOvueniee 10 oi Se ee Le 24 Corrective OPENING ENTRIES......... Fe DOU ROR IT ee ae eat 26 COPYRIGHT, 1912, BY Homer’ St. CLAIR Pace. ADVANCED THEORY AND PRACTICE OF ACCOUNTS. ORGANIZATION AND FINANCE By TONE RST CATR PAC BH GP AY CORPORATIONS—LECTURE II. OPENING OF FINANCIAL RECORDS. In General. The principles of Double Entry bookkeeping are applicable to the accounting of any undertaking, irrespective of its form of organization. Double Entry has, in the past, found its most usual expression in single proprietorship and partnership accounting, and from this, perhaps, has arisen the erroneous idea that corporation accounting, as it is called, is a thing apart from bookkeeping and accounting in general, capable of being taught and practiced independently. It is a fact, however, that the accounting which has grown up with the general incorporation of business undertakings is but the development and adaptation of the double entry bookkeeping that answers so well the requirements of the other forms of business organization. It is, therefore, the study of the development and adaptation of Double Entry to the corporate form of organization that confronts the student, rather than the study of a subject involving new principles. The financial books themselves, so far as their names and general purposes are concerned, do not differ from those of a single proprietor- ship or a partnership. The Journal, Cash Book and Ledger are the three principal books. If a trading business is transacted, and the volume of transactions justifies, a Sales Book and Purchases Book, and, perhaps, a Returned Sales Book and a Returned Purchases Book are provided; the Cash Book will be amplified by additional columns, and the Ledger will be divided into a Customers’ Ledger, Creditors’ Ledger and General Ledger, and the first two ledgers will, perhaps, be further sub-divided. Bills Receivable and Bills Payable books may be used, and controlling accounts may be instituted to facilitate the taking of trial balances and to obtain the other benefits that come from their use. In other lines of enterprise, the books will present no unusual features on account of the corporate form of organization. Copyright, 1912, by Homer St. Clair Pace. 14 It will thus be seen that the financial books themselves present no unusual features, and the peculiarities of corporation accounting must be looked for in the method of recording certain transactions, particularly those relating to the contribution of capital and the payment of profits to stockholders, known as dividends. Consideration for Issue of Stock. The opening of corporation books is dependent to such an extent upon rules of law, that, although this is a Lecture upon Theory of Accounts rather than upon Law, it is necessary to quote, in full, Section 42 of the Stock Corporation Law of New York, which is a counterpart of the New Jersey law, and which states substantially the provisions of the law in many other states. It is as follows: ‘“* Consideration for issue of stocks and bond.—No corpora- tion shall issue either stock or bonds except for money, labor done or property actually received for the use and lawful pur- poses of such corporation. Any corporation may purchase any property authorized by its certificate of incorporation, or necessary for the use and lawful purposes of such corporation, and may issue stock to the amount of the value thereof in pay- ment therefor, and the stock so issued shall be full paid stock and not liable to any further call, neither shall the holder thereof be liable for any further payment under any of the provisions of this act; and in the absence of fraud in the transaction the judg- ment of the directors as to the value of the property purchased shall be conclusive; and in all statements and reports of the cor- poration, by law required to be published or filed, this stock shall not be stated or reported as being issued for cash paid to the corpo- ration, but shall be reported as issued for property purchased.”’ It will be noted that the foregoing amounts, in effect, to a rule that the stock of a corporation cannot be sold at a discount, but must be ex- changed for cash at par, or for property or services that shall be worth, in the judgment of the directors, the par value of the stock issued therefor. The stock of a corporation may, therefore, be issued for one, or more, of the following items: 1. Money; 2. Labor done; 3. Property. Issue of Stock for Money Only. The most simple state of affairs that could exist in the opening of corporation books of account would be the issuance of the total authorized capital stock for an amount of cash equal to its par value. a5 The first actual bookkeeping record in such a case is made in the Corporate Records, heretofore described. Stock certificates are issued in the names of the incorporators for the shares for which they have respectively subscribed, upon payment to the corporation of their par value in cash. A Stock Ledger, or Stock Book, as the law terms it, is then opened, and from the detail contained in the stubs of the stock certificates, an account is opened with each stockholder, showing the number of shares issued in his name. A Capital Stock Account is opened to balance the individual accounts, which serves the double purpose of showing at any time the total amount of stock issued, and of providing the double entry check upon the accuracy of the Stock Ledger. The financial books proper are opened by a Journal entry, that should set forth, as a preliminary to the actual financial record, the name of the corporation, its object, capitalization, shares, with any other desired gen- eral information, and with the names of the incorporators and their respec- tive subscriptions for capital stock. A pro forma explanatory opening, with financial entry, to open the books of a corporation with an authorized capital stock of $100,000, all subscribed and paid for in cash, is as follows: THE JOHN F. HOWARD COMPANY A corporation organized under the laws of the State of New York, with an authorized Capital Stock of One Hundred Thousand Dollars —$100,000.00 divided into One Thousand (1,000) shares of the par value of One Hundred Dollars ($100) each, with express and implied powers necessary to carry on the business of manufacturing a commercial substitute for ivory, said stock being subscribed as follows: Or Oe ELOW ATL. oa \l ss icla/ saa aya an 500 shares Porn es Howardy: [ros ye ae 200 VV Mia RC TTAANE YS 0g a rudd sie tales FOO Mn ahs Pea PTA OOMAGES fs staly oe cite oth inne LOGI ine NAVE Ta Beart oe os cade naa Maat LOG? Cat watety, yes eyenatyale sa eee 1000 shares eS RAL ES CEOS oe a Ae Ss Wh alte bc Stn ae Sal eke eat PRN Pay $100,000 ‘ye Ge ALES TE el Oo OT CIE ge OR VN Bi $100 ,000 For cash received in payment of stock subscribed as above, certifi- cates being issued, as under: MENTE RPOUTL EU ELOWALG 6s hloc yale od ow eselg wake eee 500 shares Cerro Wen oity Ler ER OWATC TEC) 34d) oleh adeect fal ate 200 SEPM Otte WRC ASITINIGY a0 5 ee sin sis eae we es alm Wea san Sole lt bite PEN Ck Ae ALY FN MOUMETE A tealatutt ils whiels) ebluy diviacditace 100 f CPOE COS CONV pte VERE ate Gree, seh rsasasheh en vin aide Mayers Toc has ARS ATRIA EAU sO TONS Bec oT EO ME ORR AND | AYR rh 1ooo shares 16 If a Cash Book is to be maintained, the amount of cash is carried to the debit of the Cash Book; or, as is sometimes the case, the original entry for shares issued for cash may be passed through the Cash Book exclusively, although it is at all times satisfactory to have a complete record of the opening entries in the Journal. If there is no Cash Book, an unusual case, a Cash account is opened in the Ledger, to which the amount is posted from the Journal. Even though a Cash Book is maintained, a Ledger Cash account may be opened, and cash receipts and payments posted in summary form monthly. For the balancing posting, an account, under the caption of Capital Stock, is opened, to which is posted, in dollars, the amount of stock issued, thus completing the posting of the opening entry. No attempt is made, in the General Ledger, to show the distribution of the stock among stockholders as this is accomplished in the Stock - Ledger. The conversion of the cash, thus brought into the corporation, into the various assets necessary for the conduct of the business, is recorded along the usual lines of double entry bookkeeping. The Capital Stock, in some cases, is divided into classes. For example, there may be Preferred Stock, that, through a provision in the certificate of incorporation, may have a preference in dividends, that is, in the dis- tribution of profits, or a preference in the return of capital, upon dissolu- tion, or both, as well as Common Stock. Without an express provision, Preferred Stock will not have a preference in the return of capital in case of the liquidation, or winding up, of the corporation. In the case of there being more than one class of stock, an account will be opened in the General Ledger for each class, for example, Preferred Stock Account, to which the par value of all Preferred Stock issued is credited, and a Common Stock Account, to which the par value of all Common Stock issued is credited. In the event of there being only one class of stock, the term Capital Stock, and not Common Stock, is ordinarily used. It is Common Stock, of course, but the particular designation is not essential. Issue of Part of Authorized Stock for Money. There are two complicating contingencies that may occur in the opening of corporation books, even in a corporation in which it is not intended to issue stock except for cash, viz.: 1. Issue of only a part of the authorized capital; 2. Issue of partly paid stock. T7 The first contingency is contemplated in Section 5 of the Business Corporations Law of New York, which is typical of the provision of many other states on this subject. It is as follows: “Payment of Capital Stock.—One-half of the capital stock of every such corporation shall be paid in within one year from its incorporation, or the corporation shall be dissolved, and the directors, within thirty days after such payment shall make a certificate of the fact of such payment, which shall be signed and acknowledged by a majority of the directors, and verified by the president or vice-president and secretary or treasurer, and filed in the offices where the certificates of incorporation are filed. The dissolution of any such corporation for any cause shall not take away or impair any remedy against it, its stockholders or officers, for any liabilities incurred previous to its dissolution.’ It will be seen from the statute quoted that a corporation may have an amount of authorized, but unissued, capital stock. It is not considered the best practice, text-book theories to the contrary notwithstanding, to carry into the financial books the amount of such authorized, but un- issued, stock. To illustrate, a corporation is organized with a total authorized cap- ital stock of $100,000, of which only $75,000 is issued, and for which the corporation receives $75,000 in cash. The remaining $25,000 is, therefore; authorized, but unissued, capital stock. To record properly the foregoing transactions an entry should be made, omitting the explanatory opening and entry explanation for brevity, as follows: DNS SA CAN Sel EA BW BLAS MB) C0) Gna nips SS AA abl He $75,000 So far as the record of the $25,000 of authorized, but unissued, stock is concerned, this may be ascertained at any time from the Minute Book, as it will show the original capitalization and the issues of stock from time to time. In addition, the preliminary to the opening entry in the financial books, as already explained, will state the amount of authorized capital stock, and subsequent issues will appear in the financial books. The erroneous text-book method, to which reference has been made, is to debit Cash with $75,000, debit an account called Treasury Stock with $25,000, and credit Capital Stock with $100,000. This brings the unissued stock into the financial books, and encumbers the books with a useless $25,000 on each side of the accounts. If the additional $25,000 of stock is ever issued, it will then be quite time enough to carry it into the financial books. 18 In England, it may be said, there is a provision of law that requires a corporation to show, in its published Balance Sheet, its total authorized capital. There is no such requirement in New York, and probably not in this country. Treasury Stock, properly so called, can only be created by the return to the corporation, through purchase or donation, of Capital Stock of the corporation that has theretofore been issued. In such cases a. Treasury Stock Account may be raised and charged with its value, actual or par, as the particular instance may require. It is apparent, therefore, that authorized, but unissued, capital stock, can not be treated as Treasury Stock. Issue of Partly Paid Stock for Money. The second complicating contingency arises from the practice of issuing partly paid stock. In New York, which will again furnish a typical example of the ordinary statute upon this subject. this is made possible by Section 62 of the Stock Corporation Law, as follows: ** Partly paid Stock.—The original or the amended certificate of incorporation of any stock corporation may contain a pro- vision expressly authorizing the issue of the whole or any part of the capital stock as partly paid stock, subject to calls thereon until the whole thereof shall have been paid in. In such case, if in or upon the certificate issued to represent such stock, the amount paid thereon shall be specified, the holder thereof shall not be subject to any liability except for the payment to the corpora- . tion of the amount remaining unpaid upon such stock, and for the payment of indebtedness to employes pursuant to sections fifty- four and fifty-five of this chapter; and in any such case, the cor- poration may declare and may pay dividends upon the basis of the amount actually paid upon the respective shares of stock instead of upon the par value thereof.”’ This enables a corporation, by express provision in its certificate of incorporation, to issue partly paid stock. This privilege is subject to the provision of Section 5, of the Business Corporations Law, which has been quoted, that one-half of the capital stock shall be paid into the corporation within one year. In case of the issuance of such partly paid stock, the certificates are issued as usual, except that they should indicate upon their face that the stock is not fully paid. The vital point in accounting is that the corporation receives a cer- tain percentage of the capital, and the right to call for enough additional capital to equal, with the original amount paid in, the par value of the stock. When the difference is paid in, the corporation is bound to issue its fully paid certificates of stock. 19 Upon the basis of receiving cash and promises to pay in exchange for stock issued, the initial entry, whether carried out in the Journal, or partly in the Journal and partly in the Cash Book, in the case of a capital- ization of $100,000, payable 50 per cent. upon subscribing and the balance in monthly instalments of 10 per cent., would cover the following prin- ciples of debit and credit, viz.: oA SIR G2) ae OA Wate ar enue evoN et $50,000 STOCKHOLDERS’ SUBSCRIPTION ACCOUNT _ 50,000 POO PL DAN Dae LOC Kiaiex yan unen i gol lel Nib Ho $100,000 To this entry should be added a suitable explanation, setting forth the names of the stockholders liable for further payments, with the respec- tive amounts. It more frequently happens, however, that the stock is not issued until it is fully paid, and in such cases the entry would be as follows: 1ST a AS RURAL inet A nes $50,000 STOCKHOLDERS’ SUBSCRIPTION ACCOUNT _ 50,000 To SUBSCRIPTIONS TO CAPITAL STOCK $100,000 As the payments are made, Cash would be debited and Stockholders’ Subscription Account credited. As the subscriptions are paid in full, stock would be issued, Subscriptions to Capital Stock being debited and Capital Stock credited. When all instalments are received and the stock issued, the Stockholders’ Subscription Account and Subscriptions to Capital Stock Account are closed out and Capital Stock Account stands credited with the entire issue of $100,000. The following entries illustrate the principles: To STOCKHOLDERS’ SUBSCRIPTION ACCOUNT......... See Mie PONS TO VWCAPTPAT pO NS a aaa hilar tede Veh (Mie 23 4 A IS @ WO aC a ape ssh ANU UT Rigs UOTE LR mPa Stet A? The only practical difficulty is that it is undesirable to maintain an account in the General Ledger with each stockholder, if such accounts are very numerous. They are of a temporary nature, and are no part of the trading operations of the undertaking, and yet it may become neces- sary at any time to know the exact amount due from an individual. Further, despite the fact that it may become necessary at any time to determine the status of an individual’s account, it is perhaps desirable to know the aggregate amount due more frequently than the status of particular accounts. . 20 In small corporations, individual ledger accounts are sometimes opened in the General Ledger, in lieu of a summary account, or perhaps more often, as outlined in the form of entry above, a summary account is opened under the caption of Stockholders’ Subscription Account, or other suitable name. Where the individual accounts are thus dispensed with, the amount due from any particular individual is arrived at from the explanations contained in the entries, or from the ledger account, if this information is carried, as it may be, to the detail columns of the ledger account. Where it is the intention to call in the balance due in instalments, the total amount may be divided into Instalment No. 1, Instalment No. 2, etc., and a ledger account opened for each instalment. The names of the subscribers may be entered in the explanation column on the debit side, filling in on the credit side opposite the names of the particular sub- scribers the payments as made. The names of those in default will thus not be credited and are easily ascertainable. The most satisfactory plan, especially where the stockholders are numerous, is to maintain the Stockholders’ Subscription Account in the General Ledger as a summary account, to which the total to be called is posted as a debit, and to which credits are made in periodical totals as amounts are paid in. A subsidiary ledger is opened, somewhat on the lines of a stock ledger, in which accounts are opened for the various stockholders, as per the explanation in the Journal entry, and a balancing account opened which corresponds to the summary account in the General Ledger. As pay- ments are made, they are entered in the Cash Book in a special column. The individual subscribers’ accounts are credited from day to day from the Cash Book, and at intervals, the Stockholders’ Subscription Account in the General Ledger is credited with total cash received, and the balancing account in the subsidiary ledger debited with the same total. Thus, from the subsidiary ledger, the state of any individual’s account may be deter- mined, and from the General Ledger, the total amount due may be ascer- tained when it is posted up to date. } This subsidiary account is sometimes maintained in the Stock Ledger, by providing in each stockholder’s account debit and credit money col- umns, charging the total amount, and crediting all payments made. The Stock Book must, in any event, show the amount paid by each stock- holder upon his subscription for stock, and combining the two economizes in effort. A still further amplification of the procedure in large corporations is to maintain a special cash register for recording receipts on account 2I of stock subscriptions, carrying the receipts to the Cash Book in totals only, and posting directly to the individual accounts affected from the Cash Register. << Dummy 4 Incorporators. It is sometimes desirable to have the incorporation effected by per- sons who are not the real parties in interest, known as “dummy’’ incor- porators. It is usual in such cases to have the certificate of incorpora- tion signed by the men selected, not less than three, usually for shares of the par value of $500, and it is customary for such incorporators to be named in the certificate as directors. The payments for the stock subscribed should actually be made, some corporation lawyers insisting that the payments be made by checks deposited in the bank by the corporation. The certificates are then issued to the incorporators, who assign them in blank and turn them over to the real parties in interest, who reimburse them for the cash paid in, if it was not, in fact, advanced in the first instance. If the incorporators are not to serve as directors, they will present their resignations and directors will be elected to fill the vacancies, and the stock assigned by them will be transferred to the real owners. If they are to act as directors, and the holding of stock is a necessary qualifi- cation, the assigned certificates will be held assigned in blank, so that the directors will be stockholders of record, although they will not, as a matter of fact, own any stock. So far as the accounting is concerned, it must be ascertained that the corporation received value equal, in the judgment of the Board of Directors, to the par of the stock subscribed, and that the certificates were actually issued. Cases are frequently found in which the stock is subscribed by “dummies’’ but issued in the first instance to the parties in interest, with no assignment. This is a serious defect that must be remedied by counsel, and is a condition that the accountant should not display in the books. Issue of Stock for Property, Labor Done and Money. In the organization of a corporation, even where the bulk of the stock is to be issued in exchange for property, it is quite usual for a few shares to be subscribed and paid in cash, say five shares of $100 each, although it is not an essential that any part of the capital be paid in cash. The organization may be thus effected so long as the capital with which the corporation begins business is not less than $500, and so long as one- half of the authorized capital is paid in within one year. 22 Stock is also sometimes issued to pay for legal and other. expenses incurred in promoting and organizing the corporation. It will, therefore, happen that, except in the case where the shares are paid in cash only, the corporation will receive two, and sometimes three, of the items that may be received in exchange for stock. To illustrate, a corporation may be organized with an authorized capital of $10,000, of which ten shares of $100 each, $1,000 par value, are to be issued for cash, and 70 shares, $7,000 par value, are to be issued for the property of a partnership which is fairly worth, at market prices, the $7,000 thus to be paid for it. The opening entry, if passed entirely through the Journal, and the issue of stock for Cash and for Plant and Sundry Assets is simultaneous, might properly be as follows: OFT BARR ar nen Arie Way RRNA eR bol TARE. ors! $1,000 PLANT & SUNDRY sASSETS iicpatace ee on cl 7,000 To CAPITAL STOGE ay ie Oa es eas $8,000 The item of Plant & Sundry Assets might be divided into the dif- ferent asset accounts, such as Plant, Merchandise, and Accounts Receivable, in the initial entry, as is the custom with English accountants. In Amer- ican practice, however, it is usually entered in the first instance by a charge to Plant & Sundry Assets, to be distributed later to appropriate property accounts under captions and values authorized by the Board of Directors of the corporation. In this way the responsibility for fixing the values is placed where it belongs, and the opening may be carried out without delay. No account is taken in the financial books of the amount of author- ized, but unissued, stock, being 20 shares, $2,000 par value, for the rea- sons given in considering a similar case in the disposition of stock for cash only. It need hardly be stated that the above entry should be preceded by a resumé of the principal facts of capitalization, business, etc., embodied in the certificate of incorporation, as was suggested in the first example of opening corporation books. It will hereafter be taken for granted that the student understands that the entry should be preceded by such an explanation; that the authorized, but unissued, stock is not to be carried into the financial books; and that the cash part of the entry may be made in the Journal, to be posted to the Cash Book, or passed through the Cash Book exclusively. Continuing the illustration just given, it will be assumed that the same state of facts exists with the exception that the vendors require that $8,500, in stock, shall be paid for the property that is to be turned a over, instead of the amount $7,000, which would equal the market value of the tangible assets. The vendors may base their claim for this larger amount on the ground that there is good-will to be taken into consideration, or that the stock which they are to receive is not readily marketable, and would have to be sold, if at all, under a discount. At any rate, vendors usually require, in exchange for the property and good-will of a going concern, an amount of stock the par value of which considerably exceeds the mar- ket value of the net assets. It will be further assumed that $500 of stock is issued on account of labor and services in organizing the corporation. These various items will necessitate the issue of the entire authorized capital stock, as appears from the following entry: ePIC UI ls Ab $1,000 Beit cr OUN DRY “ASSHT Saheim, line 8,500 Sra NIZATION HXPENOH Sie fe vene sak 500 OD G IN E L AL, io LOG Keane ea as 28 Veen Yoko $10,000 In practice, the acquisition of Cash and of Plant & Sundry Assets, and the incurrence of Organization Expenses, might not be simultaneous; in which case a single entry would not include the entire transactions, each transaction being recorded as it occurred. In the illustrations, for the sake of brevity in setting forth principles, they are treated as one transaction. s Later, when values have been placed upon the different assets by the board of directors, the necessary asset accounts are raised and charged, including, if necessary, a Good-Will account, and the Plant & Sundry Assets account is closed. Assuming that the Plant was valued at $5,000, Stock on hand $1,000, Accounts Receivable $1,000 and Good-Will $1,500, such an entry would be as follows: Rr Mere eet er Sy ka SAY PR Stan nya giars are $5,000 MME IN TAIL ee lg acc og St aaltehababe tet die Crane tare 1,000 POU NM bo CE LV A BiB oie isan camera a T,000 Pe VV RE, Daim MOh SUDA SUE TAR et I, 500 TOM AN Desa SUNDRY) ASSE DON Oee Sunn $8, 500 Organization Expenses Account is frequently allowed to stand, to be written off out of profits during the first few years, say three, of the under- taking, instead of charging the entire amount against the profits of the 24 first year. A less conservative practice is to charge the amount to the cost of property. . The above problem may be solved in a slightly different way, by charging Plant & Sundry Assets in a separate entry with the $8,500 and crediting the Vendor. Later, when stock is issued to the Vendor in settle- ment, his account is closed by a charge, and Capital Stock Account is credited for the amount issued. This method is especially advantageous when the taking over of the assets and issuing stock therefor are not simultaneous, and in cases where liabilities are assumed as well as assets taken over. Thus, in a case where the assets are carried on the books of the vendor at $9,000, and the liabilities assumed amount to $2,000, and the agree- ment is that the vendor shall receive $8,500 in stock for this net equity of $7,000, the entry would be as follows: PLANT: & SUNDRY (ASSETS) enim Wuiaay $10, 500 To' SUNDRY. LIABILITIES MGR eo | $2,000 To BLANKS) Vendors. ta ae ee ee 8,500 The Plant & Sundry Assets Account, and Sundry Liabilities Account, would later be distributed into specific accounts in pursuance of the action and direction of the Board of Directors. A slightly different way to record this transaction would be as follows: PLANT (@ SUNDRY ASSETS tea one $10,500 To (BILAN Ks) Vendor ( 2Oo0pe eee i eae | $10, 500 BLANK: "Venton Soe ee a see 2,000 lo SUNDRY LIABILIDT ES aeons eee 2,000 It will be seen that this is practically the same as the preceding method, although it may be contended that there was never a moment of time at which the real liability to the vendor was $10,500, as shown momentarily by the first entry. The distribution into the particular asset and liability accounts would be made later. Acquisition of Properties. In the case of the purchase of a going concern, the contract of pur- chase will specify a date at which the transfer is deemed to have taken place, or a date at which it is to take place. This date becomes the account- ing dividing line between profits, those accruing before that date belonging to the vendor, and those accruing subsequently belonging to the vendee. 25 ) The line of demarcation must be sharply drawn and care exercised to make the apportionment in accordance with the principle stated. If the vendor continues to hold and operate the property, he does so for the account of the vendee, and must turn over to the vendee the profits earned, although entitled to compensation, no doubt, for services rendered. | If a period of time elapses between the date agreed upon as the time at which an enterprise is to be turned over, and the actual organization of the buying corporation, any profits earned should be treated as a diminution of the purchase price. Likewise, expenses incurred may be capitalized and added to the cost of the property. Otherwise, the cor- poration would be in the untenable position of earning a revenue or in- curring a loss before its existence and starting operation with a balance of profit or loss. The corporation can not make a contract before it is organized, but the contract of purchase is often made by the promotors of the corpora- _tion, who assign the contract and all equities thereunder, in consideration of a certain amount of the stock or other securities of the new corpora- tion. The net asset value acquired under the contract is the amount that must be set up in offset to the securities issued in payment, and technical profits, earned before actual possession is acquired, must be merged in such net asset value. For example, the business of a partnership with a capital of $100,000 was to be taken over as at January 2, 1902, in consideration of an issue of $100,000 of the stock of a corporation, and the business was not actually taken over until January 23, 1902. During the three weeks the capital increased, after paying all expenses and charges, to the extent of $1,750, through profits secured. The $1,750 can not be carried into the accounts of the corporation as a profit, but must be merged in the cost of the prop- erties acquired, the net asset value of which must be stated at $100,000 and not at $101,750. The amount would preferably first be applied to writing down such intangible assets as good-will or patents, and then to such assets as plant and machinery. If it were not advisable to write the assets down, a special reserve for depreciation or loss could be credited so long as it is clearly shown that it is not a profit. An asset should be taken into the accounts at its cost, and if a profit should be shown in such a case, it would be taken in at an amount in excess of its cost. Inversely, if a mortgage were made and bonds issued thereunder dur- ing the process of acquiring the properties, any interest thereon before actual trading or operations began would be a charge against the cost of property, because it is a necessary incident to such acquisition. That 26 is, such interest charge is not incurred as a part of the cost of securing profits through operation, but as a part of the cost of securing the neces- sary equipment with which to operate. Were it otherwise, the corpora- tion would begin to operate with a loss upon its books. If, as a matter ' of conservative business policy, it is decided not to capitalize, that is carry to the cost of the property, such interest, a charge therefor may be made against the first year’s profits, when secured, in such a way that the results of operation or trading will not be obscured, and the property written down with the amount. Corrective Opening Entries. It is not unusual to find instances in which corporate accounts have been imperfectly opened, or not opened at all. The corrective work necessary will depend upon the circumstances of the specific case. In the case of a corporation organized to originate a business, it is not infrequent to find that the amount of cash actually received is charged to a Cash account and the amount credited to an account called Stock Receipts account, or some similar name. In other cases, it may happen that no method of accounting is attempted further than the keeping of a Minute Book, a Check Book, and an account with the bank. In still other cases, especially where the corporation is organized to take over the business of a partnership, the attempt may be made to maintain an account with each stockholder, showing the amount of stock in his name, somewhat after the manner of keeping capital accounts in a partnership. The most chaotic condition that is likely to be found is an absence of a knowledge of the assets owned and liabilities incurred, and the absence of an adequate record from which such facts may be ascertained. -No matter in how imperfect a condition the accounts may be found, there are certain points that must be established in order to bring the books to a condition where they will disclose the facts as to financial posi- tion. The process, in case no accounts have been kept, is to prepare a financial statement, along the lines of a balance sheet, carrying the assets to the left, and the liabilities and capital stock to the right, in opposition thereto. | To begin with, the amount of the capital stock issued and outstand- ing, if regularly authorized, can be ascertained from an inspection of the Minute Book, care being taken that no greater amount of stock is issued than is authorized by the certificate of incorporation and the reso- lutions of the stockholders and directors. The authority for stock issues being established in the Minute Book, an inspection of the Stock Certifi- cate Book, if it has been properly kept, will disclose the certificates that 27 have been issued, the names of the holders thereof, and the number of shares for which each is drawn. The par value of the stock that is found to be authorized, issued and outstanding, should be carried to the right side of the financial statement, and provides the starting point in the construction of a statement to display the financial position of the corpo- ration. At this stage it should be determined that a Stock Book has been kept, containing, in alphabetical order, accounts showing the stock holdings, in accordance with the statutory provision that has been cited in a previous Lecture. The liabilities, with the aid of the creditors, may often be determined without difficulty, and should be listed and displayed on the right side of the statement in conjunction with the capital stock. The amounts of capital stock and liabilities are determined first on account of the ease with which they may, in the majority of cases, be established. The assets should be inventoried, and such items as Real Estate, Plant, Machinery, and other permanent assets, carried into the left side of the statement, in opposition to the capital stock and liabilities, at their cost, if such cost can be ascertained; if not, at an appraised value to be obtained from the best authority available. If any of the assets were acquired in exchange for issues of stock, the transaction will, in all prob- ability, be disclosed by an inspection of the Minute Book, and the assets should be stated at their cost in par value of the stock issued therefor, irrespective of market, or other, values. Care should be taken that all assets are inventoried and brought into the statement. After all of the issued and outstanding capital stock, and all of the liabilities, of the undertaking, have been displayed on the right side of the statement, and all of the asset values have been carried into the state- ment on the opposite, or left, side, the statement should be brought to a balance by a Profit and Loss Account. If the assets exceed the combined amount of capital stock and liabilities, a profit exists in the business, and should be displayed by a Profit and Loss Account credit balance. If, on the other hand, the combined capital and liabilities exceed the amount of the total assets displayed, a loss exists, that should be displayed by a Profit and Loss Account debit balance. Provided that all of the assets, capital stock and liabilities have been taken into the statement, the Profit and Loss Account will invariably show the correct result as to profit or loss. This is true, because, in the first instance, the asset value received by the corporation will exactly — equal the amount of capital stock issued. If, aside from the original con- tribution of capital, assets and liabilities were acquired and incurred that exactly equaled each other, there would be no profit or loss; but, if the 28 assets acquired exceeded the amount of the liabilities incurred, a profit would exist. Inversely, if the liabilities incurred exceeded the amount of assets acquired, a loss would exist, and in either case the balance would be effected, and the true condition shown, by bringing the Profit and Loss Account into the Statement. With the statement prepared, as a basis, a Journal entry is passed debiting the assets and crediting the liabilities and Capital Stock, accounts in the Ledger are opened to conform, and the postings are made. The books being thus opened, the succeeding transactions are recorded in due course. In case the record has been kept as in a partnership, or some other systematic attempt at a complete record, the books of the corporation may be opened by a Journal entry stating the original position as to assets acquired, liabilities incurred, if any, and stock issued. The subsequent transactions may be brought into the accounts by a summary entry, carrying in the balances of the nominal accounts, as well as amounts suf- ficient to adjust the other accounts to their proper amounts as shown by the trial balance of the books kept on the partnership or other basis. ADVANCED THEORY AND PRACTICE OF ACCOUNTS. ORGANIZATION AND FINANCE. By HOMER Sr. CLAIR PACE, C. P. A. (N. Y.) CORPORATIONS—LECTURE III. CLASSIFICATION OF ASSETS AND LIABILITIES. CAPITAL ASSETS AND CURRENT ASSETS.........0.50200 2 bese eee eee 29 CaPpiTAL LIABILITIES AND CURRENT LIABILITIES...........-.25.-4--. 31 RRR ice Oe? ase ee ea 8 SB a OR oe Poe ne oe ae 34 MMIIEIRS WADITAN. ho po fois a8 ER Gales Botte ie sae te A al 8 35 a EMPATION 20 rN) RNs SS e Ns SE tk ty een OE ee ga 37 SeeecTPATiVe DALANCE SHER. . 43200 o-5.5 2 ee a he ees oe See 38 COPYRIGHT, I912, BY Homer St. Crair Pace. eR ahr ae wes » Pech hy Oe ey ay 4 PeAEB. ¢ ADVANCED THEORY AND PRACTICE OF ACCOUNTS. ORGANIZATION AND FINANCE Be ROME Ras CLAIR PACH. CP. AU (N. Y.) CORPORATIONS—LECTURE III. CLASSIFICATION OF ASSETS AND LIABILITIES. Capital Assets and Current Assets. A part of the capital of an organization, corporate or otherwise, in the ordinary course, will be required for investment in assets that will be held for the permanent use of the enterprise, such as lands, buildings, machinery, and fixtures. The remainder of the capital will be required to finance the current operations by the purchase of such items as mer- chandise, raw materials and supplies, and the payment of salaries and wages, pending the returns of the business. Thus, in a manufacturing corporation, organized with a paid-in cash capital of $100,000, the permanent plant might require the expendi- ture of $80,000 of the capital, leaving a balance of cash, not expended on the permanent plant, of $20,000. It will be obvious that some amount of cash should be left over, after the purchase of the real estate, plant and other equipment necessary to carry on the manufacturing operations, for such a plant cannot be run without the purchase of raw materials and supplies, and the payment of labor, the returns for which will be delayed through the time consumed in manufacturing the product, mar- keting it, and collecting therefor. The assets thus invested,,or sunk, permanently in the undertaking are known as Capital Assets, sometimes called Permanent Assets or Fixed Assets. In the construction of a Balance Sheet to display the financial condition of a corporation, or of any organization of considerable size, it is customary to group such assets under the caption of Capital Assets, as a first division on the asset side of the Balance Sheet, listing the assets and carrying out the total. Copyright, 1912, by Homer St. Clair Pace. 30 In addition to permanent investments in land, buildings, machinery and similar assets, investments may be made in the securities of other companies engaged in similar lines of business. When it is the intent to invest the capital permanently in such securities, it is convenient to state them as Investments in Other Companies, as a division of the Capital Assets. It is often expedient, however, to make a separate classification of such assets, not including them in the Capital Assets, but stating them as a distinct classification immediately after the Capital Assets. If minority interests only are owned in such companies, the shares may be considered a temporary, rather than a permanent, investment of the capital, and, in addition, a company may be liquidated and the investment returned without the power on the part of the owner of the minority shares to prevent such action. In the case of companies controlled by the owner- ship of all, or a majority, of the shares of stock outstanding, the best method is to present the actual assets and liabilities of the companies in a Consolidated Balance Sheet, with the stockholdings eliminated, as will be explained later. As distinguished from the Capital Assets, those that are held in realized form, such as cash, or are held merely for the purpose of realization, such as raw material, inventory, bills receivable and accounts receivable, are known as Current Assets, sometimes called Quick Assets, Floating Assets, or Liquid Assets. The term Cash Assets, sometimes used to designate Current Assets, is apt to be misleading, and is therefore a less desirable term. The Current Assets are listed under that caption below the Capital Assets, and the total is carried out under the total amount of the Capital Assets. The Current Assets, strictly, are those in realized form or those held only for realization. In the case of amounts that stand to the debit of ledger accounts that represent a transient benefit or favorable effect upon the business, to be received in a future period, such as advertising paid for in a period before its effect is enjoyed, a deferred charge to profit and loss exists, although it stands, for the moment, as a nominal asset upon the books. Evidently, such Deferred Charges are not Capital Assets, and, not being held for realization, are not Current Assets, even though some value might be recovered, as in the case of prepaid insurance. It is best to segregate such items from the Current Assets, and list them under the caption of Deferred Charges in a final division on the asset side of the Balance Sheet. An accrued asset is one that has accrued, but is not due, such as interest that has accumulated upon a bond, but that does not become collectible until a subsequent date. Accrued assets are, in the accounts ar of some corporations, classed as Deferred Assets, on the theory, appar- ently, that they constitute a distinct class. This is not justified by the facts, because the amount of a note due to be paid to the company in three months, classed as a Current Asset, is analogous to an amount of accrued interest that will likewise be due to be paid in three months. Such an asset should, therefore, be classed as a Current Asset. A wasting asset is one that is consumed with the progress of the busi- ness or the effluxion of time. For example, a mine contains an aggre- gate amount of mineral, and every ton taken out during the progress of the work diminishes to that extent the amount available. Its wast- ing does not depend upon the effluxion of time, but upon the actual mining operations. When the mine is entirely worked out, its value is extin- guished, and even the machinery and appliances, in such a case, would have little or no residual value. If it is desired to keep the capital of the corporation intact, that part of the proceeds of each ton that repre- sents the capital cost must be retained and not distributed in dividends. It is quite usual, however, to distribute the capital invested in the mine with the profits, mining companies forming the exception to the rule that capital cannot be returned to the stockholders in the guise of divi- dends. An example of a wasting asset that depreciates with the effluxion of time, regardless of use, is a prepaid lease of land for a term of years. In fact, any asset that wastes through use or the effluxion of time may be said to be a wasting asset, and is properly classified as a Capital Asset. It should be carried at the amount of the value remaining, estimated conservatively on the basis of the best data obtainable. Assets enter mains are defined to be assets in hand, such as the prop- erty that comes into the possession of an executor or trustee for the purpose of meeting the immediate claims against the estate in his charge. The use of the term is rare except in the transactions of executors or trustees. In law, the term legal assets denotes those that constitute a fund for the payment of debts accrued at their legal maturity, and equitable assets are those that can be obtained only through an action in an equity court. These terms are not used in the Balance Sheet classifications. Capital Liabilities and Current Liabilities. In the conduct of an enterprise, it may be desirable or necessary to incur financial liabilities through the purchase of merchandise, materials and other property on credit, by the borrowing of money upon promissory note or bond, or through one of the many other channels that present themselves in the regular course of trading or operating. 32 The financial liabilities thus incurred are classified, as a general rule, according to the length of time for which they run. The long-time lia- bilities, such as an issue of bonds secured by mortgage upon real estate and plant, and the other liabilities the maturity of which extends beyond a certain length of time, are known as Capital Liabilities, sometimes called. Permanent Liabilities or Fixed Liabilities. In addition to the long-time liabilities, it is customary, in the case of a corporation, to include Capital Stock in the Capital Liabilities. Cap- ital stock is not a liability, and does not fall due to be paid at any time or in any amount. It represents ownership merely, divided into share units, and, plus any credit for profit or surplus undisturbed, or less any loss incurred, it measures the book value of the investment to the owners. Its inclusion, therefore, with Capital Liabilities, however, customary asso- ciates unrelated elements. The total, however, is an amount of capital that, under usual conditions, will remain in the business, and need not be met from current assets. The Capital Liabilities are listed and stated as the first group on the right side of the Balance Sheet, the total amount being carried out. The Capital Liabilities are thus displayed in opposition to the Capital Assets, although there is not necessarily any close relation as to amount. The classifications are as to character of assets and liabilities, and the character of both changes as business expediency requires their change from one to another. The short-time lhabilities, such as accounts payable, and bills and notes that fall due within a certain time limit, are known as Current Lia= bilities, sometimes called Quick Liabilities or Floating Liabilities. Current Liabilities are listed on the Balance Sheet under the caption Current Liabilities, and the total amount carried out under the total amount of Capital Liabilities. This displays the Current Liabilities in opposi- tion to the Current Assets, and a comparison of the respective totals affords one of the most valuable guides as to ability of the undertaking to meet its immediate liabilities. The distinction between Capital Liabilities and Current Liabilities rests solely upon time of maturity. A fifty-year bond, or even a ten- year bond, will be classed immediately as a Capital Liability, and a sixty- day note as a Current Liability. Between the two lies the line of demarca- tion, and its exact location will depend upon the nature of the business. It may be, in many instances, that all liabilities that fall due within the period of time for which banks discount commercial paper should be classed as Current, and those that extend beyond that period as Capital. 33 If a Capital Liability, by the effluxion of time, comes within the limit, it is truly a Current Liability, although it might be unusual so to class it, for it must be paid or renewed. This is obvious when it is remem- bered that the object of the classification of Current Liabilities is to state for ready reference the liabilities that must be paid or renewed within a certain time. A Capital Liability that cannot be renewed becomes as much a Current Liability as a short-time note that is due and cannot be renewed, and merely because Capital Liabilities most frequently dre renewed does not change the theoretical classification. The attempt is sometimes made to classify the liabilities on the basis of the use of their proceeds, the theory being advanced that Capital Lia- bilities produce Capital Assets. The error of this is plain in the case of a corporation, with a paid-in capital of $100,000, invested in plant, that finds it necessary to mortgage its plant to secure $25,000 of funds for the purchase of Current Assets, or for the liquidation of liabilities incurred through the purchase of such assets. The liability would be classed, if it secured a long-time loan, as a Capital Liability notwithstanding the fact that the proceeds were used to provide Current Assets. The fact is, the conversion of assets from one form to another is a matter of busi- ness expediency, and, subject to mortgage conditions, is made regardless of form or time of liabilities. The proceeds might even be lost, in whole or in part, without changing the nature or the amount of the obligation. The payment of Capital Liabilities is usually secured in some formal way, as by mortgage on real estate and other property. The aggregate of such liabilities is known as Funded Debt, from the custom of funding short-time obligations into long-time bonds or notes, secured by mortgage or other indenture. The interest, definite in amount, and recurring regu- larly, is known as Fixed Charges. In railroad accounting, rentals under long-time leases of property, and sometimes taxes, are included in Fixed Charges. An accrued liability is one that has accumulated, but is not due to» be paid. Such a liability is properly classified as a Current Liability. The distinct classification of Deferred Liabilities is undesirable for the reason | given for excluding Accrued Assets from the classification of Deferred Assets. A contingent liability, as the term indicates, is one that may, or may not, become an actual liability, definite in amount. A contingent liability arises in the endorsement of a note or bill discounted, unless liability is specifically avoided by the form of endorsement. Another example is the possible liability upon suit for damages for personal injuries, or otherwise. Contingent Liabilities are shown in memorandum form on 34 the Balance Sheet as a distinct classification, usually following the Current Liabilities, but without definite figures carried out. The maximum amount of each class of contingent liability, when it can be ascertained, should be stated in the memorandum. Surplus. If the total amount of asset value, correctly stated, exceeds the com- bined amount of capital stock and liabilities, a surplus exists. Surplus appears on the credit side of the accounts, either in one account, or in two or more accounts, such as Surplus, Undivided Profits or Profit & Loss. Dividends declared should appear in a Dividends Payable Account, and, being an account payable, the collection of which can be enforced by the stockholders, should be classified with the Current Liabilities. The real book investment in the corporation is the sum of the capital stock and the surplus, and, in contemplation of a dissolution of the cor- poration, the two merge, for each stockholder would be entitled to his pro rata share of the assets after liquidation of the liabilities, whether the amount was more or less than the par of his stock. From the viewpoint of the corporation as a going concern, however, there is a distinction between capital stock and surplus, in that the latter may be paid to the stockholders in dividends, while the capital stock may not be returned except upon formal dissolution. A useful purpose may, therefore, be achieved by stating the facts so that the distinction is apparent. The surplus is displayed as a final division on the right side of the Balance Sheet, divided into as many items as may be desirable, the total being carried out to the amount column. If a departure can safely be made from the established custom, the capital stock may be displayed in conjunction with the surplus, the total carried out disclosing the entire capital investment of the undertaking. It is far more usual, however, to carry the Capital Stock into the Capital Liabilities. In the case of a deficit, that is, an amount by which the combined capital stock and liabilities exceeds the amount of assets, correctly stated, there will be no surplus and the deficit appears as a debit balance. It is displayed as a final amount on the left side of the Balance Sheet, the Deferred Charges, in such a case, immediately preceding it. If it were desirable to show the real capital investment, the deficit might be de- ducted from the amount of capital stock on the right side, although this is unusual. In case a Balance Sheet has been prepared and published in one form for years, or in case the established custom requires a certain form, 30 as is apt to be the case in public service corporations, the accountant is frequently under the necessity of yielding, after presenting his own views as to display, to such established usage. So long as the essential facts are disclosed, the accountant is justified in sacrificing, to some extent, his views on matters of technique. It is not intended, at this point, to consider fully the principles under- lying the valuation of assets, but it must be borne in mind that the amount of invested capital, as disclosed by the capital stock account and the surplus or deficit account, is dependent upon such valuations; and that values fixed on the basis of a going concern differ from those fixed on the assumption of a realization. It follows that, as a practical matter, capital stock furnishes little beyond units of ownership as a basis for the distri- bution of whatever profit there may be available for dividends, and as a basis for the distribution, upon dissolution, of whatever is left after liquidation of liabilities. Working Capital. The excess in the amount of the Current Assets over the amount of the Current Liabilities is the Working Capital of the enterprise, being the net amount of asset value available for carrying on the current opera- tions of the undertaking. In the example of the manufacturing corpo- ration before given, with a capital stock of $100,000 and an investment of $80,000 in permanent plant, the Current Assets consist entirely of cash, $20,000, and there being no Current Liabilities, the Working Capital of the corporation is $20,o00. Working Capital does not appear as an account with a balance, but its amount is determined from classifying the Current Assets and the Current Liabilities, and determining the excess of the former over the latter. _ The proportion of Working Capital to the entire amount of capital invested varies with the different lines of business, and even with the individual undertakings in the same line of business, according to pros- perity and the views of different managements. In the case of collec- tion of money in advance for goods sold or services rendered, little or no Working Capital is required, because the necessary funds for carry- ing on the operations are advanced by the persons to whom the product is sold, or for whom the services are rendered. Thus, in the case of a railroad, a small percentage of Working Capital is required for the reason that a large part of the tolls for the services rendered, both in transporting property and persons, is collected in advance by the railroad company. In addition to the payment in advance thus secured, a railroad company often pays its employees monthly, and some- 36 times not until the roth or 15th of the month succeeding the one in which the services are rendered; and, through its financial responsibility, it is able to secure a longer period of credit for its supplies than would other- wise be possible. In these respects it occupies a peculiarly fortunate position in regard to the necessity for Working Capital, collecting largely in advance and taking advantage of long-time credit. As contrasted with this, a concern that sells on long time, for ex- ample, an undertaking that manufactures sewing machines that are sold directly to the consumer on time extending from one to two years, to be paid in instalments, must have a very large proportion of its capital free for financing the current operations. An initial Working Capital, unless of liberal proportions, would soon be converted into accounts receiv- able, the collection of which would extend over long periods of time. The loss of interest thus incurred must, of course, be compensated by a larger selling price of the product than would otherwise be necessary. In examining the Balance Sheet of a business for the purpose of extending credit or otherwise, the first consideration, as a rule, is to determine whether the Working Capital is sufficient for the needs of the particular business. If the condition is unfavorable in this respect, the negotiation of a short-time loan, or an advance, does not change the situa- tion so far as the Working Capital is concerned, for the reason that while the Current Assets increase to the extent of the amount of the loan, there must be set up a Current Liability for the same amount. The only effect of such a procedure is to provide funds to pay the most pressing of the Current liabilities, at the expense of setting up others to come due a little later. If sufficient Working Capital does not exist, the situation can be relieved permanently only by the direct contribution of additional capital by the proprietors, or by the indirect contribution through earn- ings that are not withdrawn but left in the enterprise for the purpose of providing the necessary additional capital. The case often happens that sufficient Working Capital will be in the undertaking at the commencement, but through the need for increas- ing the plant, the Working Capital is sunk in the permanent plant, thus creating an unfavorable condition as to the Working Capital available for the enterprise. Thus, in the case first cited, in which $20,000 of Work- ing Capital was available in the first instance, if the legitimate additions to the plant should cost $25,000, making a total charge to that account of $105,000, and no additional capital had been contributed, or allowed to remain in the undertaking from profits secured, there would have been an excess of Current Liabilities over Current Assets of $5,000, instead of a Working Capital of $20,000. If a mortgage, securing a long-time oY. loan, that could fairly be classed as Capital Liability, had been placed upon the permanent plant, it would have relieved the situation to the extent of the funds, and for the time of the loan, thus secured. If a re- newal of the loan could be made at its expiration, upon the same security, the Current Assets would not be needed to meet the liability, and the Working Capital would remain intact. The only unfavorable effect as to the current operations from such a procedure would be the interest charge on the loan, that would have to be made from earnings. Capitalization. In determining the capitalization of an enterprise, no better general rule can be laid down than it should have as capital the amount of funds with which the business can be most economically conducted. Thus, if a corporation is organized with a capital of $100,000, which is suffi- cient for its needs eleven months of the year, but during the twelfth month it needs an additional $50,000, it might be more economical for the cor- poration to borrow the $50,000 for the month than to carry permanently a capital of $150,000, a third of which would be idle or invested at a low rate of interest for eleven months of the year. In such a case, granting that the loan of $50,000 could be effected beyond reasonable doubt, the capital of the corporation should doubtless be $100,000. In the case of the incorporation of an enterprise with a capital of $100,000, in which $150,000 of capital was permanently needed, the funds might be obtained by placing a mortgage for $50,000 upon the permanent property of the undertaking. Assuming that such a loan could be renewed upon its expiration by repledging the same assets, the funds secured by the loan would be available for the purposes of the corporation, without recourse to the current assets. It is obvious, however, that such financing is not as conservative, aside from the fixed interest charge involved, as where the entire amount of capital needed is supplied by the proprietors by stock issues. In the latter case, there is a liberal borrowing capacity available in the times of financial necessity that are reasonably sure to come to every enterprise, no matter how well managed. In industrial corporations, the difficulty of renewing capital habilities is apt to be great in times of commercial depression. In public service corporations, it is more usual to find the permanent plant mortgaged heavily, because in the nature of such corporations the enterprise continues indefinitely, and under ordinary business conditions, the renewal of such loans can be made without difficulty. Granting sufficient capital in the first instance to provide the neces- sary permanent plant, and a reasonable amount of working capital, it 38 may be found necessary, through increased business, to increase the per- manent plant, and this is frequently accomplished by the sale of long- time securities, such as bonds secured by a mortgage on the property. The work of improvement may be well under way, and a part of the securi- ties sold to defray the cost thereof, and then difficulty may be encountered in disposing of the remainder of the bonds. In such a case, it not infre- quently happens that the work of improvement cannot be altogether stopped and is carried on out of funds secured by short time loans, the intention being to convert such short-time loans into a bond issue as soon as the market conditions permit. This condition becomes dangerous in the event of a depression, for the short-time loans may have to be paid without an opportunity to convert them into the long-time issue. The corporation may thus be forced into insolvency and a receivership. Insolvency may result from the lack of sufficient cash funds to meet maturing obligations, even though the enterprise may technically have a surplus of assets over liabilities, or even a surplus of assets over com- bined liabilities and capital stock. The mere possession of a credit to the Profit & Loss Account or Surplus Account does not necessarily indicate that funds are available to meet maturing obligations, for the profits may be invested in the permanent plant, or tied up in current operations in such a way that they cannot be realized upon for the purpose of meeting obligations. In the same way, and for the same reason, a corporation may have a profit and still be unable to pay a dividend, through lack of cash with which to make the payment. Illustrative Balance Sheet. For the purpose of illustrating the distinctions that have been made, the accounts of the manufacturing corporation, with a paid-in capital of $100,000, heretofore mentioned, will be used. The post-closing Trial Balance at the close of the second year’s business was as follows: 39 THE AMERICAN MACHINE CoO. Post-CLosinG TRIAL BALANCE AS AT DECEMBER 31, 1904. RR SOO ars) Ce LIER NES ARE CLA UAC RN ON DU Be le le Ay $100 ,000 Ser MOTt race 2O-NGarvBonds oon) sees eek ie Pe a 25,000 NEUE TORRE URAL ATS, oot USE UA aR A RR A RL eilas Antale lee far poy $10,000 OEE Te MS 4 iia ces ee ROA RN OLA UC 30,000 TEES Te ee OPED |e 6) ede! oid dk 96 aa es MDs aed alae idl Bales 55,000 Reserve for Depreciation of Buildings... .. MER, SU TEL Rea aC 1,500 Reserve tor Depreciation of Machinery . ...). 5. s4 4 seis viecaeume seid Pt Ae, Reserve for Losses on Accounts Receivable..............20ce00es 425 Orvanization’ Expense (4 written Off) (o.oo i sinid cb el ddige a vee June I ,000 RIE TES ECOIVADI@ re hes eb in 4s sick a4 oh beard hla aie a tials eek 42,500 Bills Receivable......... Keim er sh wid al eet ata) anal lnt elkl laa eal MeL COP AW RAEN el ad Tie RN I2,000 ate halhy) 5's eng Se alg mM doh a Wick Cie hada e ete digie adalat 5,500 Minemuaryenstotes and Labor. ii ii. Se BO 7,500 Memetmer Pimiened otock: (Cosk) 35's «iia 's cls yak deal le tleie dare oiled pall 9,000 RR Ey LOSE ET TE Ne Viparere emit ole lee Meiers eae. a tenua 19,500 CT OE NESTE ATTN at ATOR LO le TE I QP OD EY A 15,000 ci le GE SEALS) (ed IE WR Pik ds Toh a ae TRL AULD A UE a I 4,000 SG CO Oe BRD Ce nS a Be OSS CME MOLD Aid oe AVaes $172,500 $172,500 The simplest rule in Balance Sheet construction, in corporations, is to display the assets in the order of their probable realization, beginning with the slowest, and the liabilities in the order of their probable liqui- dation, beginning with those maturing last. Following this rule, the facts would be displayed as under: THE AMERICAN MACHINE CoO. BALANCE SHEET AS AT DECEMBER 31, 1904. _ (Deficient in Technique) Assets. Liabtlities. Organization Expense........... $1,000 CAD ILAL SeOC HI! oie «ole wink aay tala ten $100,000 oe, ARTETA een 10 ,000 First Mortgage 20-Year Bonds... 25,000 RMSE EM tees. a\cil sls ai dave 30,000 Accounts) Payable Aiea 19,500 EL es a) Sky 4 as ni/etaye, os 55,000 Bills HAVA Ble an, tales ta atl iat) games 15,000 Inventory of Stores and Labor... 7,500 Dividend Payable, Jan. 2, 1905... 4,000 Inventory of Finished Stock..... 9,000 Reserve for Depreciation of Build- Accounts Receivable............. 42,500 pha tLe MI (Re ANG LAP PCN ME teas fe I,500 Patent @CEIVADIO 2 2 oasis» etevn 514 12,000 Reserve for Depreciation of Machi- MEP IMME RTE tet) 250 i's: shal yk lay ol iare ecb 5,500 TOL e id cv tviaiuea. a Grelaaenee 2,750 Reserve for Losses on Accounts Recétvableose se ee a 425 Undivided! Profits i) un acme 4,325 $172,500 $172,500 The above Balance Sheet falls short of technical perfection in that the net amount at which the Buildings, Machinery and Accounts Receiv- able are taken into the Balance Sheet can be determined only by an arithmetical deduction of the respective reserves, a process that should be carried out in the construction of the Balance Sheet. It is technically defective in that the investment in plant and machinery is not shown in total, so that its relation to the Capital Stock and the current assets may be grasped. 40 It is technically defective in that the current assets and current liabilities are not shown in their respective total amounts, so that their relation to each other, and its effect upon the business, cannot be ascer- tained without additions. | | | It is technically defective in that under the caption Liabilities appear items that cannot properly be so classified. Gikty ih It is technically defective in that the amount of capital that may reasonably be expected to remain in the enterprise cannot be determined without an arithmetical calculation. + In short, it amounts to little more than a post-closing trial balance, and does not fulfill the accounting requirement that, in the Balance Sheet, the facts of the post-closing trial balance must be rearranged, classified, condensed, and set forth in a way that will convey the greatest amount of information. The technical defects may be overcome by recasting the Balance Sheet in the form generally adopted by accountants, as follows: 4I Szg‘Lorg Celt r Sree rome A ee ae eet ee eee es et OOS J PoplAlpuy) OOO'r *sn)G4nG SLofol 00S ‘gf eco ate Sle ‘cb @ Vers, 6 be ele 5 6 © “SorpIqery quoting [210 ooo'r Us 5 OV bes 0 8 a0 ote es Soot ‘zs ‘uel ‘giqeAeg puoprlaiq ooo! Cr e e660 6206-0 v6. 6 0 O. S00 6+ 6 Bie Spel eles oe ew ee eters ne aqeAeg SIT ooS ‘61¢ wee) ol 8 a. 6 fete» Py ewe ar ele e ie bw pe ‘aiqeAeg syUNnoo0y ‘SOUMIGDYT WMa4ang o$L‘ 064 o$z2‘2S 000‘ Szr¢ Be ee ee ee ee SATIN EET JUpId es) [eqOL 00S ‘gz 000'Sz 0 Es Ra Ae PRE ee eae eee spuog 19x -0z 983710] SILT ooo! oorg CP CD Ce > SS ew SO SG Peele va. arwus) 6 ov ow, oY. 6 ene Crs © 3904S jeqideg ooo! org ‘sauyrqnyy wouddD ‘voor ‘1 aaaWaOAG LV SV LAGHS AONVIVYG Szg ‘Lord Pm a ak OR ee OA 2 . ‘(yo 1194)TIM §) ssuedx 7 UOlyezIUeSIO “SaBADYD) pasdf{aq sjassy JUOIIND [e10], 00S ‘ ¢ oe eee eee eee eee eee see ee o eee e eee sees eeeoeees yseg ooo en ee age” ora ees Eee woe Seem ose ee ee BIGVAIIID yy STIG SLotzv Szv "4555 + S9sso’T IO] DAIOSOY SSo’T ooS ‘ zoe ee IIGVATIIO YY syUNO.Yy oo$ ‘g1g¢ —————— 000! 6 a ee 3904S peystury 00S ‘ Le Se a Sx Cee iat bet at Pet Ioqe’] pue So101S : SOLIOJWIAUT "SJOSSY JUALIN) oe Sve 6 ure sie. 6 6G 0 o% 6. 8 @ ee 8.6 08 a spossy Teqideg [e1OL aS See ok ied eR RE OL BL uorze1oeidaq 10} 9AIOSOyY SSo’T coo! SS¢ A et at Te a eG ay is CK Fe ee at ALOUTyOR elt hee bane Og Ee A Ma Ss uorzyelerdeq IO} DAIOSOYy Sso’T 000 ‘ of o- 0 0 @ (© 0.0 6 6 6 6 6 8 6 8 6 8 0 6 Ue © 6 6 Care © 6 6 678 6 eH em ssuIp[Ing ie Pe ae Te Pett e teen eee neces eee epterT ‘sjassy jondny (anbruysa J, sutjunodoy Areurojsng) ‘(OO UNIHOVIW NVOISHNV AHL 42 It can be seen at a glance from the above statement that the funds supplied from stock issue and mortgage bonds amount to $125,000, out of ‘which $90,750 is sunk in the plant, leaving $34,250 as working capital from this source. Adding the surplus, amounting to $3,325 after deducting the deferred charge, gives an aggregate working capital of $37,575. A more direct way to obtain the same information is to deduct from the total amount of current assets, $76,075, the amount of current liabilities, $38,500, leaving the same amount as achieved before, $37,575. It is obvious that the current assets, out of which current liabilities must be met, are about as 2 to 1, although about one-half of the excess is in inventories, the slowest of the current assets, and that $4,000 of the $5,500 cash is needed immediately for dividend purposes. It may be claimed that the inclusion of Capital Stock under the cap- tion Capital Liabilities is technically incorrect, but the customary technique is adopted for reasons heretofore given. There can be no better rule of technique than that accounting state- ments should be constructed in such a way that the maximum amount of information may be gained by the layman with the least expenditure of effort. V | Ai h - C : iy : th We rh) : 9, AML AT \ nev ‘i i os At ks ex , yh ve ay V us H \ \ - G} Ve \ sa iy AGS Vi he ke fA | 4 P ey CONUS da eye! wae ‘ 04 1 Mody ty ES NEL 7 BRAWL NY Piicey kd ’ Ja Asal vy Se a bees ae, . i : in L. Uh | ‘ Ala i) yA hye , u vies ‘ s Pera os ‘ ’ ) ; Ms 1 4 4 a te Ae ee i M ye ee’ | oY : Y , : Cuber \e rv. ‘ . *} \ ty § . ? 2 Wer \e * ae ; ’ . ‘ ie in ’ » ai a) . aha i ry ‘ 1 : ‘ ) i Fe . r W , i 1 i f | i - i 4 i iy x ' ' ‘ »~ ‘ { . st a ° i ; : * oS -. La 1 1 f i * . 7 it . ’ 4 4 4 , , ' J ff . 4 ty >t ' ‘ A f us ? x f ; ie , A ; Pru onl ' |! eS te) A} é a ‘ i AE Bi _ the 4 q : teh ve a , rf , ve ‘ a 5} > Ta ! inal rg ' Z aa v ai) WD as. 2 ADVANCED mT EEORY AND PRACTICE ~ OF ACCOUNTS. ORGANIZATION AND FINANCE. By HOMER ST. CLAIR PACE, ©. P. A. CORPORATIONS—LECTURE IV. REVENUE OR INCOME. Perea (NOMINAL. TISTINCTIONS 2. cae a hag PROT Ree tee a 44 EXPENDITURE. BaP EC Maley Sea, oan Cle Ree ule gene gee 46 PRINCIPLES OF VALUATION. Re on indae eg rites cul ae cael tcd Wika idenoue Diane 46 FEULEMENTS OF INCOME. 12.20 eile Me Lat cae, ie ie ena CAS - ILLUSTRATIVE Tyee hocdoNTe. ee Oa eee, 49 | eo COPYRIGHT, 19012, BY HomeER St. Cuatr Pace. ee vee VERGE eat ADVANCED THEORY AND PRACTICE OF ACCOUNTS. ORGANIZATION AND FINANCE. BY OOMER Sta CLAIR PACE. C..P. A. CORPORATIONS—LECTURE IV. ———$———- REVENUE OR INCOME. In General. The term revenue has two commonly accepted uses. It is used, first, to designate the income of a government, or a division of a govern- ment, arising from the imposition and collection of taxes, duties, etc. Hence, the use of the term revenues to describe the total of such income. The term may also, but not necessarily, in the case of a government, include the proceeds of the sale of stocks, lands or other property. The term revenue is used, secondly, to designate the income of organ- izations other than governmental bodies. It is a generic term, embracing all profits, returns, rents, interest, issues, earnings and income, received, or the right to which has accrued or been gained, irrespective of the desig- nation that may be applied to such element in the specific undertaking. Thus, in a mercantile concern, the excess of what is obtained over the cost of obtaining it is known as profit. In case the excess of the selling price over the cost price of the goods sold is called gross profit, the balance that is left, after deducting all other costs incurred, is known as net profit. It will be obvious that profit and net profit are the same, the latter term being used in contradistinction to gross profit. In the business of the transportation of property and persons, the aggregate received for the services rendered is known as gross earnings. After deducting therefrom the direct costs of operation, but excluding rentals, interest, and, in scme cases, taxes, the balance is known as net earnings. After deducting the rentals, interest and other charges not before taken into account, a balance, known as net income, available for distribution as profit, is obtained. Copyright, 1912, by Homer St. Clair Pace. 44 In the case of organizations maintained for purposes other than profit, as, for example, a club, the dues and collections applicable to the pay- ment of -running expenses and the maintenance of property, are known as revenue or income. Inasmuch as the term revenue may originally have implied a return or rent, instead or an assessment, its application to non-profit organizations, that collect from their members the amounts necessary for their purposes, may be questioned. However, the idea of a return does not enter into its common use to denote governmental income, and its use to designate the income of non-profit undertakings should hardly be barred on this account. In the accounts of an estate, the returns from the use of the property are known as income. The illustrations could be multiplied, but enough have been given to indicate that various terms and distinctions develop and are used in different classes of undertakings. The term revenue is broad enough to embrace all. It should be noted, however, that the term income has a common use as a generic term, covering everything that is embraced in the term revenue. It is probably a fact that income is more frequently used by legal writers and courts, while revenue is more commonly employed by accountants and corporation officials. So far as published definitions are concerned, it would appear that the term revenue is used chiefly to describe the income of a government, while the term income is most fre- quently applied to the revenue of private concerns. Enough has been said to indicate the interchangeability of the two terms. In this Lecture it is intended to consider, in detail, the subject of revenue or income as it applies to organizations other than governmen- tal bodies. Real and Nominal Distinctions. In conducting an enterprise under ordinary conditions, a portion ef the capital will be invested in capital assets, held for the permanent needs of the concern. The remainder, whether held in cash, or partly or wholly converted into assets that are to be turned over, will constitute the current assets. There may be liabilities, classified, according to their time of maturity, into capital liabilities and current liabilities. There will be a capital account or accounts, disclosing the amount of investment or ownership. In the assets and liabilities will be included the personal accounts, with which the capital account, showing accountability to the owners, is classified. All of the elements enumerated may be classified as real. 45 As distinguished from the foregoing, the accounts that are raised to record revenue, embracing all returns, profits and income, and the expenditures or charges that are properly offset to such gross revenue, may be said to contain nominal elements, or those that exist in name only, raised for the purpose of measuring, for a definite period, increases and decreases of assets and liabilities. Their nominal nature may. be seen from the fact that, having served their statistical purpose, the elements may be canceled against each other and permanently closed. Exception may be taken to the inclusion of the capital, or owner- ship, account as a real element, on the ground that it only measures a net asset value, and is not itself that value. However, it measures a real fact as to proprietorship, while a true nominal element may be offset and closed from the books. The balance that remains after the nominal accounts have been offset becomes, in the case of a profit, a real element of accountability to the owners. An ordinary liability is a sufficiently real element, although it but measures an amount that, theoretically, must be satisfied from the assets contra. The distinction between the real and nominal elements is important in determining net revenue or income, because the cost of an expense, charged to an asset account and allowed to remain therein, overstates the net revenue to its extent, and charging the cost of an asset, the value for which remains, to revenue, results in an understatement, to its amount, of the net revenue. ; An illustration of a distinction between capital and revenue expen- diture is furnished in the case of a railroad company that is renewing 75-pound steel rail with 1oo-pound rail. The original steel, and the track, should be maintained by charges to revenue. Therefore, only the excess weight of 25 pounds is a proper charge to capital. The charge to revenue for the 75-pound renewal, would be reduced by a credit for the residual value in the steel removed. The curious condition of such resid- ual value being in excess of the cost, so that the renewal is made at a profit, has been known to occur through fluctuations in the values of steel. An instance of an incorrect distinction may arise, for example, in the case of the salary of an engineer, whose time is divided equally between maintenance work and new construction, but which is charged to capital. It would properly be divided one-half to each. Such an erroneous dis- tribution would overstate net revenue to its amount, and load capital assets with an operating expense. 46 Expenditure. An expenditure is an amount paid, or to be paid, and may result in the acquisition of an asset, in which case it is a capital expenditure, a capital outlay, or, as it is sometimes called, merely outlay; or an expen= diture may result in a cost or expense, chargeable against revenue, in which case it is called a revenue expenditure. The use of the word expenditure in the term Statement of Revenue and Expenditure, or Statement of Income and Expenditure, obviously refers to amounts paid, or to be paid, that are a charge against gross revenue or income. Expenditure, like the term expense, may apply to an actual payment or disbursement of cash, or to a liability incurred, to be paid later. Unlike expense, however, it may apply to capital as well as to revenue. While a capital expenditure, strictly, is one for which asset value to the extent of its amount remains, in practice the terms outlay, capital outlay, or capital expenditure, are used only to denote an expenditure made for the betterment of the permanent assets with a view to increasing the earning capacity. The strict definition would include, therefore, the purchase of merchandise, or similar current assets, to be used in the revenue end of the business. The latter, in accepted practice, despite the strict definition, would be classed as a revenue expenditure in the same way as insurance paid in advance. The unused values would be con- sidered more in the nature of deferred charges to a revenue or income account of a later period. Principles of Valuation. In view of the well-settled principle in accounting that the profit shall be stated as the net amount earned, and inasmuch as its determination depends, after the deduction fram revenue or income of the direct expenses, upon the proper valuation of assets and upon proper estimates of the shrink in realization upon those that are held for realization, a full con- sideration of these subjects is desirable. The income itself is credited, if, during the period, it is earned, accrued or gained, irrespective of its actual receipt in money or its equivalent. ? The direct expenses, such as wages, salaries, rents and insurance, the benefit of which applies to the period for which the gross income is taken into account, whether actually paid in cash during the period or not, are deducted from, or charged against, such gross income. So far as the assets of an enterprise are concerned, they will consist, as has been pointed out, partly of capital assets, or those that are more or 47 less permanent in their character, by the use of which the business is carried on, but which are not acquired or held for the purpose of realization. Thus, land may be acquired and a building erected thereon for the use of an enterprise. If the asset is one that depreciates, that is, becomes of less value through use or the effluxion of time, as would be the case with the building mentioned, such depreciation, being an inevitable accom- paniment of the returns or profits made through the use of the building, would be a deduction therefrom. The principle is that the capital assets should be kept intact out of revenue. This means not merely that the asset, be it machinery, buildings, or other asset subject to depreciation, shall be kept in condition for use \ by repairs, but that there shall be an amount withheld from the returns that will be sufficient ultimately to replace the asset when it has become obsolete through changed conditions, inventions, or otherwise. Subject to being kept intact out of revenue, the capital assets should be valued at their cost. Their realizable value, in view of the fact that they are not purchased or held for realization, should not be considered. Thus, in the case of the land mentioned, the fact that similar tracts are selling for more or less should not affect the profit-making capacity and showing of the concern using the land. The land was, presumably, worth, as a part of the necessary equipment, its cost, and not being subject to depreciation, its value may ordinarily stand at its cost. In special cases, appraisements and revaluation are necessary in order to bring the state of the accounts more nearly into accordance with conditions, but in such cases the fluctuations should not be allowed to obscure the trading or operating results. There is a distinction between the valuation of assets upon the basis of a going concern, that is, one that is to continue in business, and one that is to be realized and liquidated. An asset may be worth its full cost to a concern for its particular business, and still have a realizable value of only part of such cost. So long as the intention and ability to continue business exist, the cost, subject to proper allowances for repairs and depreciation, is the proper basis of valuation. In the case of the realization of a capital asset, the profit or loss is treated as any other profit or loss, except that care should be taken to avoid confusing it with trading or operating results. Pending realization, appreciation may better, in the majority of cases, be disregarded. Current assets, unlike capital assets, are held for realization only. Their worth consists not in their peculiar adaptation to the undertaking, but in what they will produce upon realization. Thus, accounts receiv- able are carried as assets at their estimated collection value, the estimated 48 loss being provided for by a reserve account, to which the losses, as made, are charged. Inventories of material are stated at cost, or market price, whichever is lower. Throughout, conservative action is required in order to avoid_an overstatement of profit, a much more unfortunate occurrence, from an accounting viewpoint, than an understatement. Losses or expenses that must be charged against revenue on account of adjustment of asset values, may be designated as indirect charges. They are as properly chargeable as the direct expenses, but present the distinction that their amount is dependent, to a large extent, upon judg- ment. They, therefore, present to the accountant the opportunity for the exercise of ability of a higher order than is called for in the determina- tion and deduction of the items of direct expense. Elements of Income. The Statement of Revenue & Expenditure that would be constructed upon the principles given would present elements as under, although the technical arrangement, in practice, would be different: BLANK & BLANK STATEMENT OF REVENUE (OR INCOME) & EXPENDITURES FOR YEAR ENDING DECEMBER 31, 1904. REVENUE (OR INCOME). Gross Revenue (or Income) including all increment through trading or operating, whether actually received in cash (OT NOU 0... 47s. peeetee eee $ fo) EXPENDITURES. Direct Expenditures, whether actually paidin cashornot. $ ° Indirect Expenditures, including adjustments upon realiz- able assets and provision for maintenance of capital ASSETS 6 6a SI ey eae etn $ o § 6) Balance, Net Revenue, Income or Profit ...... | $ fe) Extraordinary Income or Expenditure........ $ ° EJ ©, ct rab) — ie 27 O 49 Illustrative Income Accounts. For the purpose of placing before the student, for study, the income accounts of large corporations, three selections have been made, all of which have been prepared and published in the report, or running form. It is not intended to approve or disapprove the form in any of the cases, but the object is to reproduce, from practice, statements in which the attempt has been made to meet the various essentials of an income account. GUANAJUATO CONSOLIDATED MINING AND MILLING COMPANY STATEMENT OF PROCEEDS AND EXPENSES January 1 to December 31, 1907 Bullion, Concentrates and Shipping Ore.................. $673,341.52 Bocmom ining, .Milline. and Cyaniding....... 0. ene. 385,919.61 $287,421.91 Treatment Charges on Concentrates and ene C Cane ee eel, Ue eae eee $59,116.69 Bullion Expense, including State and Federal NM eee ad vie,8 x 4 yinltia ex gd oie 20, 628.96 79,745-05 RE MOET ern ie NL ho utah ga aig CAR oc Ve WAR RE $207,676.26 PreerseL tcl WUNeT OOUICES . sce oa oe hee fi 1,686.97 VETOED Sec R ae Ae aie eco es Pe Be ee $200, 363.23 Taxes on Minor Properties, Legal Expense, Transfer, Regis- trar, Salaries, Maintenance of West Virginia Office, etc.... 19,433.42 MMO TELCO CALIIOO 7 oe ts. a ol tale acta © eee ens $189,929.81 Bree ONG, Interest, paid Out. 2.6. os dees eee} 20,156.69 GE OES LAM pie Bs a ee EN $169,773.12 50 CORN PRODUCTS REFINING COMPANY INCOME ACCOUNT Year Ending February 28, 1910 Profits from Operation. 9 finc.:.5 6) ae $3,437, 317-81 Interest on Loans, Deposits and Overdue Accounts....... 74,842.55 Interest and Dividends on Securities Owned............. 52,022 .5e Rentals from Real Estate—Not Used in Operation....... 10,297.23 Total. Income. » «S.J ee ee $3,574,480.92 Deduct: Interest on Bonded Debt................ $374,302.90 Interest on Borrowed Capital............ 22,095.13 TAX@S . os ts eke ee 102,878.70 Instirarice: sx 5.2. eo yee aa 103,145.30 Miscellaneous Expenses................. 22,575.48 Reserve for Profit-sharing............... 175,000.00 Depreciation. on Properties:.3 7s. eee 382,547.14 Discounts'on Bontis Sold) 200 ce or 250,000.00 Reserve for General, State and Corporate Taxes . . Gut.S0h Fee ce es ee 70,000.00 Total. Deductions ~ 3.0: diskette ot ae ee I,502,544.65 Net Income for Year cai - ilo Sins ce eee $2,071,936.27 51 UNITED STATES STEEL CORPORATION AND SUBSIDIARY COMPANIES CONDENSED GENERAL PROFIT AND Loss ACCOUNT For Year Ending December 31, 1909 ieroes Receipts—Gross Sales and Earnings. 4... 6.6 3625'4 doe yo50 se vas Operating Charges, viz.: Manufacturing and Producing Cost and Operating Expenses, including ordinary maintenance and repairs and provisional charges for depreciation. . Administrative, Selling and General Expenses, and Employees’ Bonus Funds (not including general expenses of transportation companies).......... Taxes (including allowance for corporation excise Less, Amount included in above charges for pro- visional reserves for depreciation now deducted for purpose of showing the same in separate item MPIME Or aS SCC DOIOW bi ee cee cee alee as women RCT em ee ey ay come Fer te a yo, a tek he ee Se UG Sh) eg han, tee Sundry Net Manufacturing and Operating Gains and Losses, including Idle Plant Expenses, Royalties received, Adjustments in inventory valuations, etc.. Meneais received... ...2..... Py Clie sl dss be Carat naarate $507,136,156. 15,460,613. 8,704,193. 3,621,652. $5 34,922,576. I7710,453" $2,424,787. 960,594. 39 12 63 Total Net Manufacturing, Producing and Operating Income before deducting provisional charges for depreciation....... OTHER INCOME Net Profits of Properties owned, but whose operations (gross revenue, cost of product, expenses, etc.) are foerernided im this statement. ..... 2... cee nine Income from Sundry Investments and Interest on I CRE Sk ag pile Ue cio aie a ve ee bg oe wes ec mes ester iat ae et oe ed ba ag aE be OREO Be eee $672,646. 2,759,970. 55 08 $646,382,251.29 511,204,262 .50 $135,177,988.79 3,385,382 .24 $1 38,563,371 .03 3,432,616.63 $1 41,995,987 .66 * Includes charges for ordinary maintenance and repairs, approximately $35,000,000. Total;-brought forwards ay. bay «saa nk eine eee an eee nee INTEREST CHARGES Interest on Bonds and Mortgages of the Subsidiary Companies i tissis cui suis Stele stars Majo) sta acetate pier $7,728,822 .79 Interest on Purchase Money Obligations and Special Deposits or Loans of the Subsidiary Companies.... 158,355.39 Balance, being the aggregate earnings of the several companies for the year before deducting provisional charges for depreciation. . Less Net Balance of Profits earned by subsidiary companies on sales made and service rendered account of materials on hand at close of year in purchasing companies’ inventories, and which profits have not yet been realizedjin cash from the standpoint of a combined statement ofthe business of the U. S. Steel Corporation and subsidiary companies....... Earnings for the Year 1909, per Income Account............... Less Allowances for various Depreciation Funds.............. Net ‘Earnings in the Year 1900... 4c. seteee ede he ASSETS LIABILITIES Sundry Rights and Franchises. $75,000 Capital Stocks. i... $100,000 Rr ces oP euaae a". « « 25,000 $100,000 $100,000 The Balance Sheet evidently discloses the true state of affairs, for the corporation has, in fact, acquired two items of assets in exchange for its stock issue, viz.; Cash, to the extent of $25,000, and Sundry Rights 73 & Franchises, which is fairly chargeable with the difference, $75,000. It should be noted that the facts are recorded at each stage of the procedure. While, for the sake of clearness in explaining the most important points in the foregoing problem, round amounts have been used, in practice it would necessarily happen that there would be at least three incorporators to whom stock would be issued, and this would have to be shown in the opening entries. It is customary in such cases to issue at least five shares of stock at par for cash, although it is not necessary that the shares be paid for in cash. A method that is used to a considerable extent is carried out by making no entry whatever when the stock is returned to the treasury. When it is sold, an entry is passed debiting cash and crediting the property account, or possibly an account under the caption of Proceeds of Donated Stock, this latter to be credited to the property account at a later date. The objection to this procedure is that no record is made in. the financial books when the stock is returned to the Company. This objection is overcome to some extent, however, by the fact that the donation is usually made a matter of record in the Minute Book. An erroneous procedure is sometimes carried out by which a Surplus, or Working Capital, account is set up when the stock is donated to the Treasury and credited, Treasury Stock being debited. Against this so-called Surplus, or Working Capital, account, the discount on stock sold is charged. If this method had been adopted in the problem under consideration, the Balance Sheet would have been as follows: Incorrect Solution THE BLANK CORPORATION. Balance Sheetiae ar. eee ASSETS LIABILITIES Sundry Rights & Franchises.. $100,000 Capital Stock (48 $100,000 Cash (Ob 2 22.0 ink Ge ga 25,000 Surplus (or Working Capital) ieee 25,000 $125,000 $125,000 This procedure is supported on the ground that, if the Sundry Rights & Franchises are really worth $100,000, there is an increase in capital to the extent of the amount of stock donated, and that against this should 74 be charged any discount, resulting in a net amount of Surplus or Working Capital. The objection to this procedure is that there is no profit out of which to create Surplus. The whole operation is undertaken to place the stock in the treasury in such shape that it may be sold at a discount, and the creation of a nominal profit or capital out of the transaction is, in nearly all cases, likely to create wrong impressions as to the financial condition of the corporation. The consideration of Donated Stock has been necessary owing to the frequency with which it arises in practice. It is a transaction open to some legal doubt, and the accountant should proceed with the approval of the counsel of the corporation. Illustrative Balance Sheet and Profit and Loss Account The Balance Sheet of the Anaconda Copper Mining Company, as at December 31, 1909, and the Profit and Loss Account of the same company for the year ending December 31, 1909, are appended, for the purpose of placing before the student examples for study. 75 ———OCOoOoOoOoOoOCOC_—== 16° 16S°616'9E$ 60°91'6L9'F 60°9T2‘6L0°L$ bo ELL'VELS C8'Chh hr6 F$ 68°SLE OPS‘ 00°000‘009 80°SPE"L bL0E0'EE9 TS 00°000‘000‘0E$ 00°000‘00h‘Z 9€ “SE ‘VE “SON SpuspIAId PNped gies la a poxouue JUNODDY sso’T pue yo1g Jed ‘6061 ‘TE Jequis00q suipud9 JIevaA 94} JOJ WoOid ppy oe ae SO6T ‘TE Joquiedeq, sourleg -SNTdaNS ‘61 Arenuef ajqeAed ‘7¢ ‘ON pueprlAIq "+ *peqzuesoid JOU sJURLIeAA PUSPIAIC, baat Eicon er poeniooe sexe, surpnyo -ul ‘ajqeAeg saseM pure sjuNoODDy INaWND "* “yore 0O'EZ$ JO sereYS 000‘00Z'T ‘penss] puke pezioyyny ‘Yo01sS [eyIdeg :TVLIdVA SHILIVIAVI'T ‘6061 ‘IE YHAWHOAC LAAHS AONVIVA 16° 16S‘616°9E$ €6°886'SLP'OT L8°899'T81'% IL 786190 'F2$ 9E'ZOP'PEG'E 18°96 '986'S EL'cc9' vss $ OF OES'8EL'Z LV'8EL EP $ oe 880'PES PP'888'LZ0'E SE"LS6'669'02$ “ANVdNOO}]ONININ WAddOO VAONOOVNV pue s[qeAlsey sJUNODDW pure suLO'T ere er or ve ee ee ot ee ee ea sosuodxo SUI][9S IO} BDUBMOT[e SSo] ‘JoyIeW 7e ploy pure JsATIS ‘ys09 ye 1sddop —pury uo ploy pure JaATig ‘1eddop A Ne BS rae gles JO} pfey eIpueyoJs]Ay > LNaaaAD S850 6) Okeke Bw ka, ae © emt suor}etedo ainyny ul asn Joy} sayddng pue s[eLoeje/[ iia ichuahacnicieaaand postdxouy souemsuy MeKRRiCRC(@| ***sgtueduiod AIpUNS UT S}USU}S9AUT Pe eee ee eee 938 ‘SYIOMIOIE MA ‘solipuno, ‘sijiwMmes ‘Arsuyoy ‘soulpy ye Aroutyoep pue ssurpiing rn oe Aysodoid oyIsuMOL, Sut -pnpur “o}a ‘ST[TUIMeS ‘Seyoyid ‘ssupley, ‘SyIOAA UOTjONpay OJ spue] pue sjyshRy JoyeM ‘Soulyy jeosz ‘sume[Q sutulyy pue souly[ :CaxIyy SLUSSV 76 0G ELL ‘VEL ‘S$ LS 0€3‘FZ1 Pee CE Oe STs ee CECT SG Sw Seb oe ee OS wie eee One eL8 S9.19}U] 29°26 ‘600‘Z$ eee eke 6 eC ee ok aS USES +, ee tere ete Cues UMOp yYys8no1q sourleg 9b°780'000‘8T$ P3°£96‘986'S Cretan bLU TCLS (es bbe) ® n.i6\'e 6 so1id Sur]]as you ye ploy pue T9ATIS :4S09 ye JIaddoy—pusa }e puey UO pos pue JaATIS ‘toddog IP’ ET8‘08Z See ete ee flere ene ote Ue Ew, ob a Shee Cee e ‘yuowdmby pue Sjur[g jo uonepedaq pue spue’y] JoquILy, pue [vod jo uorjadaq suljonpep Jeye‘syuswyiedaq AIeIpIsqnS Jo WOIg JON O8'ZEL‘T I Ce OS ap CLG eS Mae u's te Kehegioh eal, GiB T One Ter aes S}d19904J SNOOUP]IIISTPAI 00°000‘0S Ser iviger& JoN Yaw eis 16" 6./6 "86, 'e) 9s" (ai eye) © \6)67 8) 94) 8-05 STyshy J3}eM jo jeqUuaYy Cr’ IPT vis Wher erede, % e's 4) 6 vie fs) ee 086 6 @ @ 6 eee SJUSUI]SIAUT uo SpueplAIq OP Z8S‘OF Be ee ere re here le We we Hie 6 Sw ge SaTeS soveydneig pue Sor] eAOY AiG ee ee eee ee CEES s19w0}sn7J 0} SaIaATEq ‘a ‘I—pjoy pue JsayIS ‘1addog jo sajes OL PPS‘ T6S'TT$ bZ'ELLPET C$ VS ELL ‘PEI A SS SSG OO SS SE SU ee ae eS Cee eS Ss ee 6s S es eee ee on ee ee oe 94S souRleg SUIOZaI0} 0} poled 4YyoIg Buleq ‘sourleg 9¢'F80‘000‘8T$ L9°ZF6‘600'Z C2 6g 1G EURO ee ey Sa a 6 a See «oe ee ee ee eee ‘uMOp petites ‘}SoJoJUT «YM Buyeeap asiojaq ‘WWorg Buleq ‘soueleg TE°9ZE‘09 OP0) CCPC ob 1 Sl ee Se Se 68 Ue) wane. wee) are) ee sesuedxy uoljel}stUIWpYy 02'90€‘E9L‘T Be (0 8. 6 SS) Cel ee, See eis Ore, O06. emer USS ears eS sosusdxy BUTT[IS pue SuIUyaYy ‘SPY 0} JSAM WoO sey JO uorNezOdsuery POLE tari ene cee aus i eh ore ke uoneIo -aideq SuIpnpoul ‘epuooeuy ye sesuadxq uonNonpoy " S¥JOM UOTONpayY 0} souTP, Woy 219 Jo uoNR}Io0dsues a is as tah UOsI9Y} Sesusdxy Surseyoing pue uol -eyiodsueiy, surpnyour ‘saseyoing 1addog deg pue 319 TREES RMR RR RET ENS e Cr ars. qu] UO uONeTD -aideq pue juswidojaasq surpnput ‘sosuedxq Sururpy ies pak "“a0Ld ZUT][aS Jou 72 POD puke IBATIS {4809 ye Joddoj—sutuulseq je puey uo pjoy pure JaATIS ‘1addo5 0S°1Z0'618% 67° CE6 OST DL’ 68h‘SOL ST0¢8‘TIS‘S 06'FF269T ‘9$ ‘6061 ‘Tg YAANAOAC ONIGNY AVAA AHL YOA LNNODOY SSO] GNV LIdOug ANVdWOO ONINIW YHddOO VAONOOVNV ‘panunuoy—juNoddV sso'T pure IoIg pue yooyg sourreg oanesysnyyy] F - Fr @& Pn sy : os : ; FPS VE PP SANS rg Oe SIT SU BAO ot ok - : : art —~> , 7 4 —e we , « “ . 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ADVANCED THEORY AND PRACTICE .. “OF ACCOUNTS. ORGANIZATION AND FINANCE. By HOMER ST, CLAIR PACE, C. P. A. - CORPORATIONS—LECTURE VIL. FUNDS AND RESERVES. DEFINITIONS AND DISTINCTIONS...... egal Rar kat oO eg arth 9 SUS 77 aR GOUT es ais oe OM ee i a ee SE et 70 PE ey Nu A us aah IRL OAL Woy ate Fiat 79 Ree aay FOR Osshe ote er oe a ye 80 eee BCPA V ES oe TSU Re ay Do pice aunt We piace Si - Sinkine Funps.......... UE Rear on ed Ras WR CU Ree soial a NS Saas DNS 81 BryeInG FUND ENTRIES Solo oh een. Se ane eg or eae Sinkinc Funp ILLusTRATION....... Ore Ne i ean dea et Nace! 84 Marein, Rest, Dt a CAE OU CONE Rai ea Can ge NA TRS RN a neat 86 Peerntne UPON LIISSOLAITION Vie chy civ vue eid ee ea kie s caalinks, pte 87 CoPYRIGHT, 1912, BY Homer St, Clark Pace, \, A y We Bi?) te + CPR ER, Meter eran Lo ay tethers ra a dies & A ate ADVANCED THEORY AND PRACTICE OF ACCOUNTS, ORGANIZATION AND FINANCE. By HOMER ST. CLAIR PACH, C., P. A. CORPORATIONS—LECTURE VII. FUNDS AND RESERVES. Definitions and Distinctions. The use of the term fund is common and proper whenever it is neces- sary to distinguish certain assets, associated for a purpose, from all other assets. Hence, a fund may be defined as a stock or accumulation of assets, either money or convertible wealth, brought together for a par- ticular purpose. The property and property rights belonging to an individual, or to an organization formed for the production or conservation of values, constitute a fund, the assets of which are segregated from all other assets and distinguished as belonging to the particular fund. Without thus providing for the identification of the assets the rights of creditors and proprietors could not be defined and safeguarded. The assets of a corporation constitute the corporate fund and are used in carrying out the objects of the corporation. A portion of the assets may be contributed as capital by the stockholders, while in many cases a considerable portion of the entire fund is loaned or advanced by creditors. The fund is the entire stock of assets, whether invested as capital or advanced as loans, and it may be subdivided in various ways. For example, certain assets may be segregated and held for the purpose of liquidating a financial obligation, or for the purpose of making a certain improvement to the permanent plant. In this way assets are associated within the corporation for particular purposes and funds created. Copyright, 1912, by Homer St. Clair Pace. 78 In order to make clear the relation of a special corporate fund to the general fund, the following form of balance sheet, arranged especially to present the condition, is submitted: ASSETS. CAPITAL AND LIABILITIES. Assets (general fund)..... $175,000 Capital Stock... 157s $100,000 Assets (fund for payment SNIPEIMSS sue cL ee eee 50,000 of liabilities) sae es 25,000 Liabilities. ; 4a 50,000 $200,000 $200,000 The entire corporate fund is $200,000, although the intention is evident to hold $25,000 of assets in a special fund, available for the pay- ment of liabilities. The sources of the funds are shown on the right side. The use of the term fund, as has been indicated, is not limited to corporation practice. It may as well be applied to any stock or accu- mulation of assets, irrespective of the form of business organization hold- ing title thereto. Thus, the contribution of money and articles of value without formal organization for the use of an indigent family, constitutes a fund that may be designated as a relief fund. | A fund may be temporary in its nature, as in the case of a building fund, which ceases upon the completion of the building for which it is created; or it may be permanent in its nature, as in the case of a main= tenance fund, created for the upkeep of a building after its completion. The latter may be divided into principal, or the part that constitutes the body of the fund, and income, the part that is derived from the use of the principal, and that may be expended without impairing the fund proper. The fund may be a trust fund, that is, a fund held by one, known as a trustee, for the benefit of another, known as a cestui que trust, or beneficiary. The fund may be gradually built up by setting aside principal sums and by the accumulation of interest thereon, in which case it may be known as a sinking fund. Hence, a sinking fund is defined to be a gradual accumulation of assets, by a governmental body or private enter- prise, for a particular purpose, most frequently the payment of a loan upen its maturity. The creation of funds is essential to the production and conservation of values, and their treatment, therefore, will be necessary throughout all accounting. . 79 In this lecture, it is proposed to consider in particular funds common to the corporate form of business organization. Fund Accounts. An account is a collection, under a distinctive caption, of the debits and credits pertaining to a particular person or subject. Thus, it may be a ledger record of the debits and credits relating to a person, to an asset, or to some phase of a business, or it may be a document apart from books of account, formally setting forth, for a period of time, a series of financial demands or claims, with their offsets, of one person against another. All financial transactions of an enterprise are recorded in accounts. The establishment of a fund is a transaction, or a series of tran- sactions, having to do with asset value. Funds always consist of assets and can, in no instance, be dissociated therefrom. Inasmuch as assets appear, throughout all accounting upon the double entry basis, as debit balances, it follows that funds, likewise, must appear with debit balances. Capital consists of assets, but in double entry accounting the credit balance that is designated Capital, merely measures the asset value contra. In corporate practice, the accounting capital would be the amount of capital stock issued and outstanding, plus any undistributed profit or surplus, or less any deficit. In the case of a surplus, the intent to with- hold a portion thereof from distribution and to accumulate assets in some particular form to the extent of the amount of such withheld profit, might be evidenced by a transfer from the surplus account to a special account. The amount thus set aside in a special account would not be a fund, but it might show the intention to create a fund. The fund when created would appear in an account with a debit balance, measuring the actual assets associated for the purpose of the fund. Reserves. A reserve is something held back for the present. The term is ap- plied, in Accounting, most frequently to the withholding of some part of the credit balances that represent profit. Thus, when there is an intention expressed by the directors to withhold from distribution any part of the undistributed net profit, such action may be shown by an account under a caption that indicates the facts in the particular case. The subject of income has been treated at length in preceding lec- tures, and it will be taken for granted that the student has in mind the classes of expenses and losses, direct and indirect, that are properly charge- able against income before arriving at the net income or surplus out of which lawful dividends may be declared and paid. 80 The element of surplus, when not distributed in dividends, may be left in a Surplus or similar account without definite action by the board of directors, or it may be formally appropriated. In case a reserve of profit is made, not for a definite purpose, but merely to indicate the inten- tion to withhold surplus from distribution for the general good of the cor- poration, the term Reserve may be used as a caption for the account to which the amount is transferred. It differs from surplus only in the ex- pression of intention as to distribution. The appropriation may be for a particular purpose. Thus, it may be made for the betterment of assets, as a conservative and precautionary measure, even though full allowance has already been made for depre- ciation. The account to record the amount thus set aside may be called Reserve for Betterments. It must, in the first place, be thoroughly understood and appreciated that the credit balance to surplus, or other profit account, is not, in itself, a profit. The real profits exist in the assets on the other side of the accounts, the amount of which is measured by such credit balance. Therefore, in transferring an amount from Surplus to Reserve for Betterments, no fund, in the sense that a fund is a collection of assets collected or set aside for a specific purpose, is created. All of the assets are, in a general way, a fund for the purposes of the corporation, but from the general fund no specific fund is created for betterments by the transfer from Surplus. A fund for betterments could be created only by setting aside and ear-marking specific assets. However, the appropriation and transfer from Surplus to Reserve for Betterments is a formal withholding of profit from distribution, and may be taken as an evidence of intent to expend upon betterments an amount equal to such appropriation. In fact, such action is often taken after the net income or surplus has been expended in betterments and additions, in order to confirm such expenditures. It would be improper, for the reasons given, to designate such a transfer from Surplus as a fund, and the reasoning applies to all similar appropriations and transfers. The fund, if created, exists on the asset side of the accounts. Reserves for Losses. The term reserve is often used in a different sense. It will be recalled that such indirect expenses as depreciation on fixed assets, and estimated losses on the realization of current assets, are proper charges before the determination of netincome. In order to retain cost values in the accounts, and for other reasons, the fixed asset is not written down by the amount of the allowance for depreciation, but a Reserve for Depreciation is set up. So also, in the case of provision for estimated losses in the collection =) of accounts receivable, the custom is to charge the Profit & Loss, or In-. come, Account and credit an account called Reserve for Bad Debts. The reason for the creation of such an account is that the accounts in which the losses will occur are at the time unknown, and it is necessary to set aside, or reserve, a portion of the credits equal in amount to such expected loss, in order that the element may be held available to write down the asset account when the exact amount and location thereof are known. The cases cited are not true reserves, but are merely offsets to losses that exist or that are expected to become actual, but which it is not yet practicable to write off. 50 an estimated part of income (not net income), is held available to meet such losses when it becomes feasible to write them off. If the estimate is too large, then to the extent of the overestimate a real reserve, or profit, exists that may later be transferred to Surplus. If the more unfortunate situation of an underestimate exists, it will have to be made good from later periods, or from Surplus. y To avoid confusion, such accounts should, in their caption, state the exact purposes for which they are created. In the Balance Sheet they should be deducted from the respective assets for which they are created, and should not be carried to the liability side. In particular, such accounts should not in any way be confused with true reserve or surplus. Secret Reserves. In some instances, corporations, particularly financial institutions, understate asset values, thus creating a so-called secret reserve. One of the purposes of this is to render uniform the earnings or profits, by drawing upon such secret reserves in times of business depression, leay- ing the Reserve or Surplus, formally set aside, intact. This practice is wrong in theory, as there is no more justification for understating asset values than for overstating them. It is, perhaps, needless to point out that the accountant is more frequently under the necessity of protesting against the latter than the former practice. It is the custom of some institutions to omit the value of their bank- ing house and fixtures from the Balance Sheet, stating, however, the name of the asset and carrying to,the money column the word nil. This is doubtless better than omitting it altogether, as it serves notice that asset values exist that have not been taken into account. Sinking Funds. A sinking fund may be created by the gradual conversion of assets into the form adopted for the particular fund without reference to the profits of the corporation. If this were done and the sinking fund created 82 for the purpose of meeting an obligation at its maturity, it could be used for that purpose and the procedure would merely be the extinction of a liability by assets gradually accumulated and held for that particular purpose. A sinking fund may be created from assets appropriated for that purpose from profits. Inasmuch as a liability, theoretically, is payable out of assets other than those secured as profits, there is no accounting reason why net income or profits should be withheld from distribution for the purpose of providing a fund to meet the liability at its maturity. It is obvious, however, that if, in addition to the general assets of the undertaking, a part of which are secured through the incurrence of the liability, further assets are accumulated through the retention of profits, there is added financial strength and greater protection to the creditors. In case an obligation is secured specifically by mortgage upon a wasting property, as might be the case in a mining company where the capital assets are reduced by the extraction and sale of the mineral, the sinking fund plan may be used to accumulate from the income an amount sufficient to render certain the payment of the liability at maturity. This, strictly, is not the accumulation of a fund from withheld profits, but the accumulation of a fund from returns to keep intact the assets and to prevent the distribution of capital in the guise of dividends. Thus, if the payment of a debt were secured by a mortgage upon coal lands, a pro- vision might be necessary that required a certain amount, equal at least to the cost value of the coal, to be retained from the income received from sales of coal, and placed in a fund for the benefit of creditors. The creation of a fund, for which assets are ear-marked and set aside, whether out of profits or not, does not necessarily, without the creation of a specific lien thereon, insure the payment of an obligation. So long as the assets are under the control of the undertaking, and subject to its vicissitudes, losses in other assets will eliminate the reserve for sinking fund, and possibly necessitate the use of the sinking fund assets for the general purposes of the concern. Hence, when the sinking fund is created for the protection of a creditor, and not merely as a convenience for the one creating it, it is ordinarily required that the sinking fund be in the hands of a trustee, most often a trust company. In this way it is pledged for a particular purpose, and is removed from the fund that is available for the payment of unsecured creditors. It is important to bear in mind that all appropriations or reserves from profit depend, for their integrity, unless the assets represented ~) Q re) ~ Xu thereby are taken out of the control of the corporation, upon the accounts as a whole, and losses that bring the assets, fairly valued, to a point where they do not exceed the combined amount of the liabilities and capital stock, eliminate every such appropriation from Surplus. Therefore, from the viewpoint of the interested creditor, the only satis- factory sinking fund is the one beyond the control of the debtor, pledged for the benefit of his claim. | Sinking Fund Entries. In case a sinking fund is created by the mere conversion of assets from one form to another form, without reference to profits, the entries would provide for charging the sinking fund account, or accounts, with the assets belonging to the fund and crediting the accounts from which such assets were transferred. If the sinking fund assets were augmented by interest accretions received on such assets, the income would be merged in the ordinary income account, for the reason that the accumulation of the fund bears no relation to profits. In case the fund is created out of profit assets, it would be necessary in the first instance to transfer the amount to be set aside from net income or surplus to an account created to show the appropriation of profit. Inas- much as it is profit held back for a time, for sinking fund purposes, the account may properly be called Reserve for Sinking Fund. This account will then measure the amount to be withheld from profit for the purpose of the sinking fund, and in a statement to disclose the financial condition, it would be stated in an indent column as a distinct item, but merged with unappropriated surplus in the total column to show the entire amount of surplus in the corporation. The creation of the fund proper will then proceed by the conversion of assets to the form required in the sinking fund, in the same manner as before stated. If the sinking fund is in the hands of a trustee, the ordinary procedure is to pay the trustee an amount of cash equal to the appropriation from net income or surplus. If the sinking fund is brought to the proper amount, it will equal the Reserve for Sinking Fund shown with a credit balance. If it is less than the appropriation, there will still remain an amount of assets to be converted to the sinking fund basis. Interest accretions, whether collected by the corporation or the trustee, would increase the amount of the fund, and could be credited either to the Reserve for Sinking Fund or to a special sinking fund income account, later to be transferred, after deducting any possible costs or charges, to the Reserve for Sinking Fund Account. 84 Sinking Fund Illustrations. A bond, as will be explained more fully in subsequent lectures, is a written agreement to pay to bearer, or to some person, or order, a certain sum of money at some future determinable time, the payment of which is, in most cases, secured by a mortgage or trust deed upon real property, and, in some cases, upon personal property as well. The interest is payable according to the terms of the bond, usually quar- terly or semi-annually. In case of failure to pay the interest or the prin- cipal of the bond at maturity, a trustee, designated in the mortgage secur- ing the bonds, is empowered and obligated to foreclose the mortgage or trust deed and dispose of the property for the benefit of the claims of the holders of the bonds. The mortgage or trust deed, in many cases, provides that the com pany issuing the bonds shall, as additional security, withhold each year from its net profits a certain amount, which shall be turned over to the trustee, to be held, with or without interest accretions, for the payment of the bonds. In some cases, a certain proportion of the bonds are drawn each year by lot and are retired out of the funds thus in the hands of the trustee, or, the funds may be held, with interest accretions, until the maturity of the bonds, when the entire issue is redeemed. A case may be assumed in which, by the provisions of a trust deed, a company must pay, for a period of twenty years, the sum of $25,000 from profits each year, to a trustee, which is to be invested in securities of the class authorized by law for savings bank investments. The interest received on such securities to is be added to the fund, and together with the principal of the fund, is to be used in the payment of the bonds at maturity. In some cases the securities purchased under the provisions of the agreement were bonds bought at a premium, that is, an amount in excess of face value. Inasmuch as the bonds would be payable at maturity at par, the value of the bonds would have to be written down proportionately each year against the nominal interest return that was received therefrom. The entries necessary to cover the foregoing transactions for a term which involved the setting aside of $25,000 for the fund, the purchase of securities, receipt of interest, etc., would be as follows: SURPLUS. ae ack oe Au ee Dee oe a oe To RESERVE FOR’ SINKING FUND. ..: 0. eee This entry is necessary to indicate in the books of the company the formal reservation from distribution, for a certain period, of the sum which is agreed to be turned into the fund out of profits. 85 This entry is necessary to record the actual payment of money to the trustee as required under the agreement. The amount is thus placed in the hands of a third party, which safeguards it against losses that the company might incur in other directions. SINKING FUND SECURITIES WITH TRUSTEE...... For bonds purchased at par. paovwluUM ON SINKING FUND BONDS..........04.% For premium on bonds purchased. To SINKING FUND TRUSTEE, Cash Account...... If, in the books of the company, it were desirable, as it no doubt would be, to keep an exact record of the transactions of the trustee, it would be necessary on receipt of information from the trustee, to pass entries setting up the securities purchased for the purpose of the fund, either in a general account or in separate accounts. Inasmuch as the pre- mium would be written off, either at once or gradually, against the income, it is taken into a distinct account. Pee ING PUND TRUSTEE, Cash Account............. Peel Gre AN) IRE VIEN UE og oe ele ee eet The above entry would be passed, upon information received from the trustee, to record the receipts on account of interest on securities held for the fund. The cash would augment the cash received from the corporation on account of the yearly payment, and would be available for the purchase of further securities. Be taNGOEUND REVENUE 2!) soleleny SEY, To PREMIUM ON SINKING FUND BONDG...... The foregoing entry would be necessary to charge off against the revenue account the proportionate amount of the premium. A still more conservative measure would be to write off immediately from the revenue any such premium, although in theory such charges should be distributed over the life of the bond. A change in the procedure might be the purchase of the bonds of the corporation for which the sinking fund is created, instead of other securi- ties. This is a matter that would be governed by the agreement in the particular case and does not affect in any way the principles involved. Finally, in the case assumed, before the retirement of the bonds for which the sinking fund is created, the securities in the hands of the trustee 86 would be reduced to cash, and if sufficient to retire the bonds, an entry would be passed as follows: BLANK .MORTGAGE BONDS... .:....2.). 4.04 seen To SINKING FUND TRUSTEE, Cash Account..... If the funds were not sufficient, the balance would have to be made up by the corporation. The net effect of the whole transaction is to give an added security for the payment of the bonds through a certain amount of profit being withheld from distribution among stockholders, which is rendered particu- larly effective by its withdrawal from the general fund of the corporate assets and its deposit in the custody of a trustee. During the sinking fund operations, the two credit balances arising would be stated as Reserve for Sinking Fund and Sinking Fund Revenue. These amounts would represent surplus if they were properly created out of net profit, but would differ from ordinary surplus if there is an agreement that provides that, to the extent of the balances of these accounts, profit shall not be distributed. There is therefore, justifi- cation for displaying these facts in the accounts stated, although the two should be added to the total of unappropriated net profit or surplus to obtain the grand total that discloses the undistributed profit. The credit balances of profit held from distribution during the sinking fund agreement are released by the payment of the bonds, and, being an element of surplus or undistributed profit, the accounts should be closed by a charge to each and a credit to surplus. A better procedure, perhaps, would be to transfer it back to Profit & Loss, or Income, from whence it came, and then to transfer the amount to Surplus. During the operation of the sinking fund, the sinking fund accounts proper with debit balances, consisting of securities, cash, etc., should equal in amount the accounts with credit balances, and their display in opposition would be effective in balance sheet construction. They would then show on the right side the sources of the fund and on the left side the state of the fund as to the character of its assets. Margin, Rest, Etc. The element of surplus may be recorded in the accounts under many names. Thus, the words margin and rest are used in this connection. Enough has been said to enable the student to determine the element and to treat it according to accounting principles. Funds may be stated under various captions. Thus, assets are often accumulated in a Redemption Fund for the retirement of a liability, 87 which does not differ essentially from a sinking fund. Likewise, the term Investment Fund is sometimes found in use, to denote an aggregation of assets held for investment purposes. Entries upon Dissolution. Upon the dissolution of a corporation, the legal formalities having been complied with, it is first necessary to liquidate the liabilities. The remaining assets are distributed pro rata among the stockholders of record. Capital Stock Account remains a fixed amount throughout the life of a corporation, and it is not permissible to carry thereto any profits or losses. Inasmuch as in the realization and liquidation of a corpo- ration there is almost certain to be a surplus or a deficit, it is considered best, for the purpose of the retirement of the Capital Stock, to merge such surplus or deficit, and the amount of the stock to be canceled and retired, in a distinct account. This account may be given a suitable caption, as for example, Stockholders’ Distribution Account. The liabilities are liquidated, the accounts being debited to balance. The assets are realized and the respective accounts credited with the sums produced. Capital Stock Account is closed by a charge to balance. and a Stockholders’ Distribution Account is raised and credited with the amount. The debit and credit balances existing in the realized asset accounts, and any surplus or deficit, are carried to the Stockholders’ Distribution Account. Then, upon surrender of stock certificates for cancellation, each stockholder receives his pro rata share of the assets, whether cash, securities, or other assets, and the Stockholders’ Distribution Account is charged and the asset accounts credited. As the distribution progresses, the balance of the distribution account measures the assets undistributed. Thus, the balance sheet of a corporation about to be dissolved might be as follows: BLANK CORPORATION, BALANCE SHEET AS AT........ Assets Capital and Liabilities CM oe ak ee OSS OOO gs CADItAI LOCK: oe ane rates $100,000 Seri. Par... 2... 5. 50,000 | Accounts. Payable....... 30,000 [0s Oe 25,000 $I 30,000 $1 30,000 88 It is assumed that the stock is held in equal amounts by A, B, C and D; that the liabilities are paid and the remaining assets distributed. The following entries would be necessary to close the books: ACCOUNTS (PAYABLE ta) sere eters ne vino $30,000 To. CASH Utrera eer. pee $30,000 CAPITAL SOC Kor tie, tit ia er nas eee Cees aes 100,000 To STOCKHOLDERS’ DISTRIBUTION ACCOUNT atk ve et ot aha eee 100,000 STOCKHOLDERS’ DISTRIBUTION AC- GW LOE Us Mase Bere peal FR Cad cages oy Spa 25,000 boyd BN 0) 1 Ht barnes esd pede! aye ty peday - 25,000 STOCKHOLDERS’ DISTRIBUTION AC- OUND ye cues sacra erates ee eee 75,000 TO “CASH Are washer a Ree eee 25,000 ee ia 0, Oi ds O) ie, GaN Reis wn lige h 50,000 For assets turned over to stockholders for stock surrendered and canceled, being 75 per cent upon its par value, as follows: Stock- | Par of PaIpD holder |. Stock. |>-————— Canceled} Cash Stock | Total | | | | Je $25,000] $6,250} $12,500) $18,750 Bi. So a8 G00 6,250} 12,500] 18,750 hua 25,000 6,250} 12,500] 18,750 D Athi igieg 25,000 6,250} 12,500] 18,750 $100,000] $25,000} $50,000] $75,000 ADVANCED THEORY AND eke ies OF ACCOUNTS ORGANIZATION AND FINANCE - By HOMER ST. CLAIR PACE, C. P. A. (N. ¥.) “CORPORATIONS—LECTURE VIII LONG-TIME NOTES AND BONDS DePO ON RR i er fe rf ces Pes Ge phere ols hcejook a Tle elles 89 POPE INOMES Oe ee ea OA oda ek ee ate 90 Coupon-BEARER INCE HS anita yee ee koe Cay 93 Pee) re A ee ae ur eet ahs 94 We PON DONDS ih Wa pio ae ites ay ae 96 PRESERVATION OF PAID UCOUPONS W060 wos Se 98 UGISDERED BONDS. il i hy oe Re ee ily ae 99 Bonps REGISTERED AS TO PRINCIPAL............-0.- 99 ~ Ciasses or Bonps....... Se a ee a 100 CopyricutT, 1915, By HoMER ST. CLAIR PACE “PACE & PACE PACE STANDARDIZED COURSES IN ACCOUNTANCY, BUSINESS ADMINISTRATION, AND ENGLISH, IN RESIDENCE AND BY EXTENSION a 30 CHURCH STREET, NEW YORK CITY Bey Gh \ “Ww th ie: Sa St seep) Ng tbe Yay. es ne Dest oy Nak SOx Ae) ye gent St, GR ed & Pea ss ee fi AI Ne by ADVANCED THEORY AND PRACTICE OF ACCOUNTS ORGANIZATION AND FINANCE By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) CORPORATIONS—LECTURE VIII LONG-TIME NOTES AND BONDS In General The capital of a corporation, at the outset, is derived from the pay- ment into the corporation of assets equal or greater in value to the par of the stock issued. This fund constitutes the accounting capital, that is, the excess of asset value possessed over the amount of liabilities owed. If profits are made and not withdrawn the accounting capital is increased by the amount thereof. In another sense, however, the capital is the aggregate wealth or property held and used by the enterprise, irrespective of the method by which it is added to the general fund. Thus, in case money or prop- erty is advanced to the corporation as a loan, instead of being contributed as a capital investment, its amount increases the fund of assets in hand and thereby the available asset capital. The accounting capital would not be increased by such a procedure, inasmuch as a liability is set up equal in amount to the asset value borrowed. The funds thus secured by loans may be divided, in a general way, between those obtained by long-time, or capital, loans, and those ob- tained by short-time, or current, loans. In the case of the former, it is quite usual to renew the loans upon maturity. When this is practicable and reasonably certain, and it is within the plans of the management of the corporation, the amount of such long-time, or capital, labilities, may be considered a permanent fund. Although it constitutes a liability, falling due to be paid at a certain time for a definite amount, and is not an element of proprietorship, the amount of such renewable capital liabilities may be added to the amount of issued capital stock to determine the amount of capital available for the permanent uses of the enterprise. Copyright, 1915, by Homer St. Clair Pace. 90 The assets secured by short-time loans are not acquired for per- manent use, but for current needs. Such loans rank as current liabili- ties and are payable out of current assets. Thus, it will be seen that corporate funds come, in the first place, through the proprietors, by the payment of stock or the accumulation of profits; and, in the second place, through advances by persons who thereby become creditors. The latter, for the repayment of their loans, have general and special rights in the assets of the corporation that are prior to those possessed by the proprietors. A current liability is most often an indebtedness for merchandise, material, labor, or money advanced, and stands as an open account or in the form of an unsecured promissory note. This form of liability re- quires no special consideration at this time. It is the purpose of this Lecture to consider the formal evidences of indebtedness issued on account of long-time advances or loans, usually classed as capital liabilities, and the procedures necessary to their proper treatment in accounts. Registered Notes There is no prescribed form of note or security necessary to be used in the borrowing of capital. The loan may be negotiated without the issuance of a note, or it may be upon the ordinary form of promissory note, or it may be upon a more formal, and secured, instrument. The procurement of loan capital in large amounts involves borrow- ings from a number of persons, or, to state it in more usual terms, it neces- sitates the sale of securities to such persons. Therefore, even though the object is effected through unsecured notes, it is usual to adopt a form of note that will be attractive to investors. For this purpose a registered note may be used. A clause is inserted in the face of the note providing for its registration, on the books of the company, in the name of the payee, and for the issuance of a new note to any designated transferee, upon the surrender of the old note with the power of attorney on the back thereof properly filled out. The notes are usually of some fixed denomination, say $500 or $1,000 each. For the purpose of identification, the notes may be issued in series, as Series A, Series B, etc., or they may be identified by a title including the year in which they mature, as 5% Registered Gold Notes of 1910, 5% Regis- tered Gold Notes of 1911, etc. The interest upon registered notes is paid, at the prescribed dates, to the holders of record, by check, or otherwise, as is convenient. In case of the loss or destruction of a registered note, the registered holder may obtain a new note upon proving his loss and filing a bond 91 of indemnity, usually for double the amount of the note, safeguarding the company against possible claims or loss. The registration in this way provides a satisfactory protection against loss. The notes should be printed with stubs, and bound in the same man- ner as a stock certificate book. The stub of each issued note is filled out with the name of the payee, date, and such other information as may be useful. A note ledger should be provided, and an account opened with each note-holder, showing address and the date and number of each note registered in his name. In case of transfers, the surrendered notes can be pasted back against their respective stubs, and the entry made direct therefrom to the note ledger. In case there are many transfers, the work may be facilitated by the use of a transfer journal. For interest- paying purposes, a list of the note-holders is prepared from the note ledger, and the total proved against the general ledger. The use of cards for the note ledger is often desirable on account of the convenience of the cards in addressing envelopes and preparing interest-paying lists. So far as the general books are concerned Cash, or other asset received, is charged and the note issue credited thus: LESSER ORE S010 OS ba ae $100,000 TO 5% REGISTERED GOLD NOTES Gy EA oe ON CP ager ae a a ae $100,000 For sale at par of notes Nos. 1 to 100 in- clusive, registered as follows: * * * ** * The general note account shows the total liability on account of the notes issued in this class, while the note ledger discloses the names and holdings of the individuals. The following is a form of a five-year registered note, the direct obligation of the company, without special security, as used in railway financing: 3, $5,000. THE BLANK RAILWAY COMPANY FIVE PER CENT. FIVE-YEAR NOTE REGISTERED New York, N. Y., U. 5. A., August 1, 1904. On the first day of August, 1909, for value received, THz BLanKk RaILway Company (a corporation organized and existing under the laws of the State of Illinois) hereby promises to pay to ee eer a Ol 8, Oe Ole ele Oey ara 2 a Om a Vee abe Or) 6 6. 16) ely Oech se Lear 6 Fe OL RO Oey Om Oi eh ol BL eer efié e Gf fo te se 6 ee ee 8 em el Le 8 92 the sum of Five THousanp Do .tars ($5,000) in gold coin of the United States of America, of the present standard of weight and fineness, at its agency in the City of New York, and to pay interest thereon, at the rate of five per cent. per annum, in like gold coin, semi-annually on the first days of August and February in each year, from the .......... day of The registered holder of this note may, at his option, transfer the Same in person or by attorney duly authorized, upon the books of the Railway Company in the City of New York, or may exchange the same for a coupon note for the like principal sum with coupons attached matur- ing on and after the date when the next semi-annual instalment of interest would have been payable on such surrendered registered note. All payments on this note, either of principal or interest, shall be with- out deduction for any taxes which the said Railway Company may, be required to pay thereon or retain therefrom, under or by reason of any present or future law of the United States or of any State, County or Municipality therein. The Blank Railway Company reserves the right to redeem this Note on any interest day prior to maturity on 30 days’ notice at the rate of $101 per $100, and interest. THE BLANK RAILWAY COMPANY, ATTEST: Vice-President, Assistant Secretary Form of Stub: No. THE BLANK RaILway Co. $5,000 5% 5-YEAR NOTE REGISTERED Issued to Date? of Issue voor. a4 ees cee ee Tnterest: frome ot ea ieee eae eo .)-@ ©. 2s) 0°" 2S be "Ee Ole ise 8) ee On Ore ee ee eee Pe 93 Form of Power of Attorney: Me MU Te BCRIVED S50... 200 1. fh ce deute hereby sell, assign and iene a ant he Ns £8 Sa) Se PAU sas the within Note of the Blank Railway RELY 3 and do hereby irrevocably constitute ne a sl eA a Re i i Vk bold Attorney to transfer said Note on the Books of the Railway Company in the City of New York, with full power of substitution in the premises. @ O. & 46 1a eo OL OC. © 6 oF 8) oO 6 O @ © Ce oe) OB Oy Oh ae The provisions of the last three paragraphs in the above form of note are no essential part of the form of registered note, but were inserted to meet the requirements of this particular note issue. | Coupon-Bearer Notes In the above form of registered note, provision is made for its con- version, at the option of the holder, into a coupon note. A coupon, or coupon-bearer, note, is one payable to bearer, and it therefore passes from hand to hand without the formality attaching to the transfer of registered notes. Instead of the interest being paid to registered holders at the regular interest period, coupons are attached to the note, one for each amount of interest falling due throughout the life of the note. In the coupon form of the registered note given, the interest is payable semi-annually, and each payment amounts to 23 per cent. upon $5,000, or $125. Therefore, if the note is dated August 1, 1904, Coupon No. 1 for $125 falls due on February 1, 1905, Coupon No. 2 for $125, being interest for the second six-months’ period, falls due August 1, 1905, and so on until the maturity of the note. This being a five-year note, there would be ten coupons attached. As the coupons mature they are detached, or clipped, as it is called, and are paid to bearer. It is customary to deposit coupons for collection by one’s bank in the same manner asacheck. The issuing company, upon payment of the coupon, cancels it. This canceled coupon should be filed as evidence of the payment of the interest. 94 The following is a form of the coupon: Coupon No. 1. $125.00. On February 1, 1905, Tot BLranxk RaILway ComPANY will pay the bearer at its agency in New York, One Hundred Twenty-five Dollars, in gold coin, being six months’ interest then due on its Five per cent. Five Year Note No. 1001. JoHN Dog, Treasurer. The form of the note is substantially the same as the registered note, except that it provides for payment to bearer, payment of interest by coupons, and conversion, at option of holder, into the registered form. In issuing a coupon-bearer note in exchange for a registered note, past due interest coupons are detached. No attempt is made to keep a record of the holders of the coupon- bearer notes by the issuing company. As conversions are often made from one form to the other, it is convenient to maintain an account in the note ledger for Coupon-Bearer Notes, treating the total of such notes as though held by one person. This brings all the notes issued into the one record, and its total can be proved against the general ledger account. The notes may be secured by the deposit of collateral with a trustee, in which case they may be known as Collateral Trust Notes. In fact, the provisions that may attach to such an issue are too numerous to specify, and little more than the general principles and procedures can be given. Bonds A bond is an obligation in writing and under seal. A fuller definition is that a bond is an instrument under seal whereby one acknowledges himself indebted to another in a specified sum, generally but not neces- sarily conditioned for the performance of some act. A single bond is one by which the obligor agrees to pay a certain sum of money to another at a determinable date. A conditional bond is one by which the obliga- tion becomes void upon the performance by the obligor of some act, other- Wise remaining in full force. It is not the present purpose to consider all classes of bonds and the legal principles and distinctions that are applicable thereto, but merely to discuss that type, classified as a single bond, by which the obligor pledges himself and, if a natural person, his heirs, executors and administrators, or, if a corporation, its successors, to pay to another a certain sum of money at a future determinable date. The bonds that represent, to a large extent, the capital liabilities of corporations, belong to this class. 95 The most important difference between the notes that have already been described, and the common form of bond, is that a lien attaches by mortgage to certain property as security for the payment of the prin- cipal and interest of the bond. The distinction between the bond and the mortgage securing its payment, is important, and to aid in making the distinction, the various forms of mortgage-secured debt will be con- sidered briefly. The simplest and most readily understood procedure for the secur- ing of debt by mortgage, and the one still in use in many of the states, is carried out by the borrower of money giving his promissory note there- for in the usual form. ‘To secure the payment of the note, when due, a mortgage, or conditional transfer of certain property, usually real estate, is made to the payee named in the note. In case the maker of the note fails to perform the conditions of the note, then the payee may, in accord- ance with the provisions of the mortgage and of the statutes in relation thereto, proceed to advertise and sell the property mortgaged for his benefit, and apply the proceeds thereof towards the payment of the amount of principal and interest, due him upon the note, and his proper costs. As a variation of this method of securing the payment of a loan, in New York and in other states, a bond and mortgage is given instead of a note secured by a mortgage. This type of bond is of the conditional class. The amount of the bond is usually for double the principal sum to be paid, the former being known as the penal sum. In case the obligor in the bond fails to meet his obligation, the property mortgaged as security to the bond can be sold, subject to the contract and statutory provisions, and the proceeds thereof applied to the payment of the principal sum, interest, costs, etc., the balance, if any, to be paid to the obligor. The penal amount of the bond is formal, and nothing beyond the actual amount due for the principal, interest and proper costs, can be collected. Originally the full amount of the bond could be collected, but the present rule is as stated. This is the procedure largely used in negotiating real estate loans. The methods of borrowing money upon note and mortgage, or bond and mortgage, that have been described, answer the purpose well enough in small undertakings and in many real estate transactions, but where large amounts of capital are to be raised upon a security of this kind, especially when the nature of the undertaking is for a long term of years or perpetual, as in the case of public service corporations, it is found to be much more economical and satisfactory to issue the obligation in some denomination convenient for transfer and trading, and secure the pay- ment of all of such obligations by the execution of one mortgage running to a trustee, whose right and duty it is to enforce the provisions of the 96 mortgage for the benefit of all of the holders of such bonds in case of a default in the payment of the agreed rate of interest or in the repayment of the principal. The ordinary type of corporate bond is issued under the provisions of such a trust deed or mortgage. The bond is a written undertaking, under seal, to pay to bearer, or to the order of another, a certain sum of money at some future determinable date. As in the case of the issue of notes, it is convenient to issue bonds of some fixed denomination, as for example, $1,000 each. Although for convenience in selling and trad- ing, the bonds are issued in certain denominations, in the general accounts of the corporation all of the bonds of a certain class are included and stated in one account. The amount of the outstanding bonds of an issue rank, under usual conditions, as a capital liability, the cash, or other property received, being set up as an asset. Authorized, but unissued, bonds are not carried into the accounts. If signed and sealed, although not actually delivered, they may be set up as Treasury Bonds, in order to charge the proper officer with their custody. Coupon Bonds The coupon, or coupon-bearer, form of mortgage bond is most acceptable to American investors. Like the coupon-bearer note, it passes from hand to hand without any formalities of transfer, and the interest is payable according to the tenor of interest coupons, alike payable to bearer, that are attached. A form of coupon-bearer bond issued by a railroad is as follows: No. UNITED STATES OF AMERICA STATE OF MINNESOTA THE BLANK RAILROAD COMPANY $1,000 | $1,000 First Mortcace Gotp Bonp © The Blank Railroad Company, a corporation organized and existing under the laws of the State of Minnesota, promises to pay to the bearer One Thousand Dollars ($1,000), in gold coin of the United States of, or equal to, the present standard of weight and fineness, at its office in the City of New York on the first day of October, one thousand nine hundred 97 and fifty, and on presentation and surrender of the annexed coupons as they shall severally become due, to pay interest, in like gold coin, on such principal sum at the rate of four per cent. (4%) per annum from the first day of October, in the year one thousand nine hundred, until such principal sum shall be paid, such interest being payable on the first day of April and October in each year at its office or agency in the City of New York. This bond, with others of like tenor and date, is secured by a first mortgage bearing date the first day of October, A. D. 1900, to The Mer- cantile Trust Company, a corporation of the State of New York, as Trus- tee, conveying to said Trustee ninety-five and seventy one-hundredths (95.70) miles of completed railway, and a lease-hold estate in thirty-two miles of completed railway, against which the Railroad Company is au- thorized to issue, and the Trustee is directed to certify, Two Million Dollars ($2,000,000) of said bonds upon the execution and delivery of the mortgage. | The mortgage also provides that in case The Blank Railroad Com- pany shall hereafter buy additional rolling stock, or build or otherwise acquire an extension of said ninety-five and seventy one-hundredths (95.70) miles of railroad, or build or otherwise acquire branches, and shall convey said rolling stock or extensions or branches to the Trustee to be held subject to the terms of said mortgage, additional bonds may be issued in respect to said rolling stock to an amount not exceeding the actual cost, and in no event to exceed Two Thousand Dollars ($2,000) per mile of completed road then owned by the Railroad Company and in respect to extensions and branches at the rate of Twenty Thousand Dollars ($20,000) per mile, and for the purpose of procuring additional ground and terminal facilities in the cities of Red Wing and Mankato, an additional amount not exceeding the actual expenditures and not exceeding One Hundred and Fifty Thousand Dollars ($150,000). If default shall be made in the payment of interest which shall accrue upon any of the bonds secured by said mortgage, the principal thereof may be made due and payable as provided in said mortgage. This bond shall not be valid until the certificate endorsed hereon shall have been duly executed by the Trustee. IN WITNESS WHEREOF, The said Blank Railroad Company has caused the signatures of its President and Secretary to be affixed hereto this first day of October A. D. 1900. 98 The mortgage or deed of trust securing this bond has been duly stamped according to law. THE BLANK RAILROAD COMPANY, by Attest: e.0 @ ¢ © @ @ « © 66 @ ¢ © 8° 2 Oe is) Bewe ene eee ESTER CRUDE ERS ZIRE HO PSUe Sen ede President. secretary. Attached to the foregoing bond were 100 interest coupons, cover- ing the semi-annual interest payments for the fifty years of the life of the bond. The following is the form of the coupon: The Blank Railroad Company will on the first day | Coupon of April, A. D. 1901, pay to the Bearer at its officein the | No. 1 City of New York, Twenty Dollars ($20) in gold coin of the United States, being six months’ interest then due on its First Mortgage Gold Bond No..... $20 The coupon usually bears the engraved signature of the Treasurer, As is usual in such cases, the bond does not come under the pro- tection of the trust deed or mortgage unless it is authenticated by the trustee. For this purpose a trustee’s certificate is provided, to be signed by the trustee, the form, in this case, being as follows: TRUSTEE’S CERTIFICATE The Mercantile Trust Company, a corporation of the State of New York, hereby certifies that this is one of the Bonds de- scribed in a certain mortgage or deed of trust, executed by The Blank Railroad Company to the undersigned as Trustee, bearing date the first day of October, 1900. THE MERCANTILE TRuST Company, Trustee, by Vice-President. Preservation of Paid Coupons The paid coupons should be canceled as paid, and preserved in order that they may be presented to the Trustee, with the paid bonds, at the time of the retirement of the bonds. In case of the loss or destruction of any such bonds or coupons, the Trustee will require a bond, indem- nifying it against loss through possible claims upon it for payment, usually for double the amount of the par of such bonds and coupons, before it 99 will execute a release of the trust deed or mortgage. This matter may be raised long before the maturity of the bond through consolidations or reorganizations that render the retirement of the issue desirable. For the purpose of preserving such paid and canceled coupons, in case the issue is large, a book may be provided for each maturing coupon, in which spaces are given numbers to correspond with the numbers of the bonds. Thus, upon the maturity of the first coupon a book marked Coupon No. 1 would be provided, with a space for coupon from bond 1, bond 2, bond 3, etc., the number being printed in the space, and each coupon as paid and canceled would be pasted in its respective place. Upon the maturity of the second coupon a book for Coupon No. 2 would be provided, and so on. An inspection of the books would readily disclose the bonds for which coupons had not been paid. In some cases the paid coupons are burned in the presence of repre- sentatives of the interested parties and an affidavit, known as a cremation certificate, is made of the fact, and this certificate is accepted by the ELUSTEE. Registered Bonds A purchaser of a negotiable instrument, in good faith, for value, acquires title thereto, although the vendor may have acquired the instru- ment by fraud and possessed no title. This has been held to apply to bonds, and there is thus constituted a danger in case the bonds fall into dishonest hands. To overcome this, it may be provided that the coupon-bearer bonds can be converted into registered bonds. The conditions are similar to those stated in the case of registered notes, and the accounting records necessary are substantially the same. ‘The interest is paid to the regis- tered holder, usually by check. It is not considered necessary to include a form of registered bond. Bonds Registered as to Principal In lieu of a clause in the trust deed for full registry, provision may be made for the registry of the principal of the coupon-bearer bond. For this purpose, space is provided on the reverse of the bond in which the name of the owner may be recorded by the company, or its transfer agent, the ownership being recorded in the books of the company. ‘Thereafter no new owner will be recognized except upon formal transfer by the registered owner. The bond may be assigned in blank, thereby reverting to its bearer form, or it may be assigned or transferred to another registered holder, whose name, in turn is entered on the bond and in the books of the company. 100 The interest is payable by bearer coupon and is not registered. The chance of loss, however, is reduced by this method to small proportions. Classes of Bonds Bonds have been classified, so far as their form is concerned, into coupon-bearer, registered, and registered as to principal. Aside from the foregoing, they may be classified as to their nature, and bonds thus classified may take any one of the three forms stated. Thus, a first mortgage bond is one that is secured by a first lien on a particular property, although it may be in coupon-bearer, registered, or registered-as-to-principal form. A second mortgage bond is one secured by a mortgage subject to a prior first lien, and, similarly, there may be a third mortgage bond, subject to two prior liens, although this is not so common. A collateral trust bond is one secured, under the terms of a trust deed or contract, by the deposit of collateral securities. These may be mortgage bonds of other companies, which, in some cases, provide an interest return more than sufficient to pay the interest on the bonds secured. In such a case the surplus may be used to create a sinking fund to apply towards the payment of the bonds secured. A consolidated bond is usually one secured by a mortgage on a prop- erty formed by the consolidation of several properties, and may be subject to prior liens on the various properties. In contradistinction, a divisional bond is one secured on a part of the property, as a branch railroad line. A convertible bond is one that may be converted into some other security, usually capital stock, upon certain contingencies. Such a bond, from its convertibility, has more speculative possibilities, as a rule, than other forms of bonds. An income bond is one providing for the payment of interest out of income, if earned. Thus, an income bond issued in 1903 provided that the payment of interest for the seven years ending 1910 should depend upon the earnings, and after 1910 the interest charge became absolute. A debenture has been defined to be ‘“‘an instrument in writing, generally under seal, creating a definite charge on a definite or indefinite fund or subject of property, payable to a given person, etc., and usually constituting one of a series of similar instruments.’’ The term is applied to both stocks and bonds. There are many titles given to bonds, words being chosen to convey briefly the essential characteristic of the security. The most common have been described. ay ORGANIZATION ‘AND FINANCE. CORPORATIONS. By HOMER ST. CLAIR PACE, GC. P’ A, LECTURE IX. _ LONG-TIME NOTES AND BONDS--.Continued. STATUTORY PROVISIONS...... (BONDS SOLD at a Discount ey... 20... > Save oF Bonps aT A PREMIUM. .<-... 0.2... PS Scithi ROR GROPERTY cca eh ay och ae eeu ee SALE OF STOCK AT A PREMIUM..... ee ae POUR a a ae i) PURCHASE AND. SALE OF BONDs.... Pe MIM ON-DONDG PURCHASED is Ue SS uae ita ~- Discount oN Bonps PuRcCHASED. . : ' PaYMENT OF COUPONS........ MURPLUS CREATED BY REDUCTION OF STOCK. 200 Peis.) ooo P CONSALIDATED, BALANCE SHEET 220. 0540 os Se seria CoNDENSED GENERAL BALANCE SHEET OF UNITED STaTESs STEEL PAPO ORATION foe ia ie Cale eile een Gl whew a's SO ASV asstek Wont seep COPYRIGHT, I912, BY Homer St. CLair Pace: _ ADVANCED THEORY OF ACCOUNTS. IOo.t 102 103 104 104 105 106. 106 107 108 store) ADVANCED THEORY OF ACCOUNTS. ORGANIZATION AND FINANCE. CORPORATIONS. PreconL hoo bo CLAIR PACK, CPA. LECTURE IX. LONG-TIME NOTES AND BONDS—Continued. Statutory Provisions. It is provided by the New York Stock Corporations Law that, in addition to the powers conferred by the General Corporation Law, every stock corporation shall have the power to borrow money and contract debts when necessary for the transaction of its business or for the exercise of its corporate rights, privileges or franchises, or for any other lawful purpose of its incorporation; and it may issue and dispose of its obliga- tions for any amount so borrowed, and may mortgage its property and franchises to secure the payment of such obligations, or of any debt con- tracted for said purposes. Every such mortgage, except purchase-money mortgages, and mortgages authorized by contracts made prior to May 1, 1891, shall be consented to by the holders of not less than two-thirds of the capital stock of the corporation, which consent shall be given either in writing or by vote at a special meeting of stockholders called for that purpose. When authorized by like consent, the directors may confer upon the holder of any debt or obligation, whether secured or unsecured, evidenced by bonds of the corporation, the right to convert the principal thereof, after two and not more than twelve years after the date of such bonds, into stock of the corporation. There is a special provision in the Railway Law applicable to the issue of bonds by railroad companies, which it is not necessary to con- sider at this time. The provision of the New York Law that no corporation shall issue stock or bonds except for money, labor done or property actually received Copyright, 1912, by Homer St. Clair Pace. 102 for the use and lawful purposes of the corporation, states that property purchased may be paid for in stock to the amount of the value thereof, but it does not provide that the money, labor done or property received for bonds shall equal in value the par value of such bonds. Thus, while stock may not be issued for less than the par value, there is apparently no such limitation in the statute upon the issue of bonds. Under the New York law, the owner or holder of any corporate or municipal bond or obligation (except such as are designated to circulate as money, payable to bearer), heretofore and hereafter issued in, and payable in, New York, but not registered in pursuance of any State law, may make such bond or obligation, or the interest coupon appending to the same, non-negotiable by subscribing his name to a statement endorsed thereon that such bond or obligation or coupon, is his property, and there- after the principal sum therein mentioned is payable only to such owner or holder, or his legal representatives or assigns, unless such bond, obliga- tion or coupon be transferred by endorsement in blank, or payable to bearer, or to order, with the addition of the assignor’s place of residence. Bonds Sold at a Discount. In case a bond is sold at exactly the amount of its par, an asset is received equal in amount to the liability set up, and the interest that is properly a charge on account thereof is the rate named in the obliga- tion itself. It is not unusual, however, for bonds to be sold at a discount, or premium, depending upon the security of the obligation and the pre- vailing rates of interest in the money market. Thus, a bond that bears a nominal interest rate of 4 per cent. say, in case the ruling rate for money loaned on obligations of equal security is 5 per cent., would not sell except at a discount, say, to illustrate, at 90. The 10 per cent. discount is the penalty exacted because the nominal rate named in the bond is not suf- ficient to give the current return upon the investment. It is an addition to the nominal interest rate, which, instead of being paid in money from time to time as the interest periods mature, is settled with the holder of the security in the first instance by the purchaser’s receiving a bond, part of which is issued to make good an insufficient nominal interest consideration. In the case of the sale of one hundred bonds of the par value of $1,000 each, amounting to $100,000, bearing interest at 4 per cent., at a price of 90, Cash would be charged with the proceeds, $90,000, Discount on Bonds with the amount of discount, $10,000, and Mortgage Bonds would be credited with the total, $100,000, the latter to record the liability. 103 The practice of capitalizing, or carrying to the cost of property, such discount on bonds is not infrequently met in practice, and is theoretically incorrect because it does not represent asset value, but an amount that should be a charge against profits on account of interest, distributed over the life of the bond. It being assumed that the term of the $100,000 of bonds is ten years, and the questions of compound interest necessary to determine the exact amount chargeable against profits each year being disregarded, it may be approximated that, inasmuch as the bonds are for ten years one- tenth of the discount should be charged against profits each year in addition to the nominal interest charge, giving a net charge on account of interest of five per cent. a year. This procedure would be carried out by setting up, in the first instance, the entire amount of the dis- count, and holding it upon the books as a deferred charge, debiting, at the time of closing the books each year, the proportionate amount for that year, against Profit & Loss. The nominal interest, being the amount actually paid in cash, is also charged to Profit & Loss, the latter thus receiving as a debit the full amount chargeable on account of interest. The Discount Account, standing as a deferred charge, will be reduced year by year by the credits until, at the time of the maturity of the bonds, it will have disappeared from the books, It is interesting to trace this procedure a step further, in order to fix the principle clearly in mind. It will be recalled that, in the first place, a liability of $100,000 was set up, for which assets, amounting to only $90,000, were received. It is necessary to accumulate in the business during the life of the bond, an additional $10,000 of assets, so that there may be available, in conjunction with the $90,000 of assets, an amount sufficient to equal the amount of the maturing bonds. The accounting procedure that has been outlined merely provides for this by withholding from profit during the life of the bond $10,000, representing asset value to that amount on the debit side of the accounts. It is not intended to convey the impression that the assets thus accumulated are specifically ear-marked, or accumulated in a sinking fund, but merely that general asset value is withheld from profit distribution in order to keep the accounts in accordance with sound accounting principles, Sale of Bonds at a Premium. The condition may be found of a sale of bonds at a premium, that is, at a price in excess of the par value, and such excess should be credited to a distinct account that may be called Premium on Bonds Sold Account or Bond Premium Account. The incorrect practice of treating such a 104 premium as a profit or surplus is sometimes carried out. However, the principles governing the sale of bonds at a discount apply here, except that the opposite condition is found. The nominal interest rate specified in the bond itself is so high, in conjunction with the security afforded, that the bonds sell for a price in excess of par, and the premium so received is an amount paid in advance by the purchaser for the privilege of collecting the nominal rate specified in the bonds during successive interest periods. So far as the corporation is concerned, it is an amount received against an amount later to be paid as interest, and should be used as a reduc- tion of the nominal interest charge. Thus, if an issue of bonds is sold at 110, say, $100,000 of bonds at $110,000, bearing six per cent. interest, maturing in twenty years, the annual interest charge thereon would be $6,000. Disregarding questions of compound interest, at the end of the first year, assuming that the interest were paid annually, a proportionate amount of the premium should be transferred from the Premium Account to Profit & Loss, say one-twentieth, or $500. The nominal interest, $6,000, is then charged against Profit & Loss, and the correct net effect of a charge of $5,500, on account of interest is secured. The Premium Account will then stand credited with $9,500, being the amount applicable to the reduction of the nominal interest during the remaining nineteen years of the life of the bond. The same result may be achieved by other methods, but the principle is as stated. If, instead of this procedure, the Premium Account were held at its full amount, and the nominal interest were charged against each Profit & Loss period, the amount of such Premium Account would be a true surplus at the time of the maturity of the bond, growing out of the fact that Profit & Loss had been overcharged during each Profit & Loss period by the failure to take into account the proportionate amount of the premium. Bonds Issued for Property. In case of the receipt of property for an issue of bonds, instead of the receipt of money, the same principles apply in case the value of the prop- erty, determined in the best manner possible, varies from the par of the bonds. The appraisement of the property is a matter to be considered upon the merits of each individual case, although ordinarily the asset. would be set up at the amount of the liability incurred on account thereof. Sale of Stock at a Premium. The sale of stock at an amount above its par is not uncommon, and the amount of such excess constitutes a surplus that, in ordinary con- 105 servative practice, is held for the uses of the corporation. Such a surplus, however, may be distributed as profit. The surplus created by the issue of stock at a premium should not be confused with the premium received on account of an issue of bonds, for the reason that stock is not a liability, and does not come due at any time nor in any amount. The return‘upon stock is in the nature of a dividend, or a sharing of profits, and is not interest that can be accrued from day to day. Therefore, the whole theory of payment for the use of money involved in an issue of bonds bearing interest does not apply to stock. The amount of the premium received on an issue of stock should not be confused with the profit derived from trading or operation, but should be carried into Profit & Loss or Income in a division created for such extraordinary items. Purchase and Sale of Bonds. It is now the rule upon the New York Stock Exchange to quote the prices on bonds without interest, the amount of the accrued interest being added to the price of the bond. Thus if a bond is sold at go, the price is calculated as go per cent. of the par, less the broker’s commission, and plus the amount of interest that has accrued to the date of delivery. In the case of the sale at go of a four per cent. bond of the par value of $1,000, interest payable on the first days of October and April in each year, sold for delivery on November 13, the price will be calculated as 90 per cent. of $1,000, or $900, less the broker’s commission of one-eighth of one per cent. of the par value of the bond, $1.25, and plus interest at four per cent on the par value of the bond, for one month and twelve days, $4.66, amounting to $903.41. A security, whether a bond or otherwise, is recorded in the accounts at its cost, irrespective of its par value. Thus, in the illustration given the purchaser will add to the price of 90 the commission, giving the pur- chase price of the bond proper as $901.25. The accrued interest may be best charged to an Accrued Interest Account, which will be credited to balance the charge upon the collection of the interest. The commission of a stock broker is always calculated upon the par of the security, whether a stock or bond, and is figured at one-eighth of one per cent. It is deducted from the proceeds of securities sold, and is added to the cost of securities purchased, making the net price one-eighth of one per cent. less or more than the quoted price, as the case may be. It is often found useful, notwithstanding the fact that securities are recorded at cost instead of par, to record the par of the security in 106 the explanation column on the debit side of the ledger as purchases are made, and to record the par of the security in the explanation column on the credit side of the ledger as sales are made, so that, by obtaining the difference between the par, recorded in such explanatory columns, the par value of the securities on hand may be determined. This does not affect in any way the regular money columns. The procedure is useful in determining the par value of any security on hand and in check- ing against securities held in a vault. The shares may be used instead of par value in the case of stocks. Premium on Bonds Purchased. In the case of the purchase of bonds tor investment purposes at a premium, that is, at a price in excess of the par value, such premium is an amount paid for the privilege of collecting the nominal interest rate specified in the bond, and in order to determine the net interest return, it is necessary to charge against the nominal return for each interest period a proportionate amount of the premium thus paid. Thus, in the case of the purchase of a bond of $1,000 par value, maturing in ten years, at a premium of to per cent., bearing a nominal interest rate of 4 per cent. per annum, the bond will fall due to be paid upon maturity, not at the cost thereof, $1,100, but at the par value thereof, $1,000. There- fore, the amount of this premium must be withheld from the nominal interest collected, in order not to overstate net profits or income. In order to record the purchase of the bond, the entire amount, ex- cluding the accrued interest at the time of the purchase, but including the excess amount paid over the par value of the bond, may be charged to a bond account under a suitable caption. At the time of the receipt of the nominal interest, Cash is charged and Interest is credited for the full amount thereof less the proportionate amount necessary to reduce the premium. This proportionate amount is credited to the bond account. This procedure being carried out for each interest period, the bond account, during the life of the bond, will be written down to its par value. There are several accounting procedures by which this result may be accom- plished, but the one given illustrates fully the principles. Discount on Bonds Purchased. In case of the purchase of a bond at less than par, inasmuch as an obligation is held that will mature and be collectible at an amount in excess of its cost, in theory the amount of such excess is an addition to the nominal interest received. The omission of such increment results in nothing more than the omission of an unrealized profit. 107 Payment of Coupons. The payment of coupons is usually made by establishing, with a bank or other financial institution, a fund equal to the amount of the maturing coupons. This is set aside by the bank from other accounts and funds and is held especially for the purpose of paying the coupons as they are presented. Through the absence of holders of bonds, or through the loss or destruction of bonds or coupons, it often happens that there is a balance left with the bank or other agent on account of coupons, payment for which has not been demanded. The amount thus left belongs, in the absence of claimants, to the corporation, and it is therefore desir- able to have a record of the amount on the books of the corporation. Were the corporation, in its accounts, to charge off to Interest Account the full amount of the coupons, no record would exist. The better practice is to charge Interest and credit Coupons Payable, for the full amount of the maturing coupon. At the end of each month, a statement of cou- pons paid is received from the bank, or other disbursing agent, and the amount thereof is charged to Coupons Payable, and the special fund, which before has been set up as a charge to the bank, is credited. There will thus exist at the end of each month, after the accounts are written up, a net charge to the bank or other agent for the amount of funds not disbursed, and on the other side of the accounts a balance to Coupons Payable, measuring the liability for coupons due, but not presented. There usually is a provision in a mortgage to the effect that the cor- poration or its agent shall pay the coupons as they mature, and the selec- tion of such an agent is a matter entirely within the power of the corpora- tion. Therefore, any balance of funds on hand with an agent is merely held for the purpose of meeting the payment of the coupons whenever presented. In the absence of presentation of coupons the fund would belong to the corporation, and it is desirable and necessary not to eliminate the amount thereof from the corporate records. In case a bank or trust company is allowing interest upon cash bal- ances, the interest upon funds set aside for the purpose of paying coupons ceases from the time of such transfer from the general fund. While a large percentage of coupons would be presented on the date of maturity, there are many that do not come in for weeks and months, and in some cases even years, after the due date. Bankers not infrequently do not make a special charge for the payment of coupons, especially when the amounts are large, receiving their compensation therefor by thus setting aside the fund and receiving the benefit of the use of the portions not immediately called for payment. 108 Surplus Created by Reduction of Stock. The distinction between operating surplus, available for dividend purposes, and surplus created by the reduction of capital, may become important when the question of dividends upon preferred stock arises. In the case of Roberts vs. Roberts-Wicks Company, 184 New York 257, this question was discussed at length and decided, as will appear from the following extracts: ‘The capital had become impaired to the extent of upwards of $90,000 and no dividends had been declared to its stock- holders. “In the charter and in the certificates issued to the pre- ferred stockholders, it was stated what was to be the nature of the preference which was accorded to that class (preferred) of stockholders; namely, to be paid ‘out of the surplus profits arising from the business of the corporation’ a dividend equal to 6 per cent. per annum on the preferred stock before any divi- dend shall be paid on the common stock; such dividend on the preferred stock shall be cumulative. “Each class of stock was part of the whole capital stock and both classes were made by the charter alike in all respects, except in the one respect that the preferred stock was entitled to have ‘the surplus profits arising from the business’ appro- priated, in first order, to the payment of 6 per cent. dividends, cumulatively. “When * * * directors met to act upon the question of dividends, their duty was, in dividing the surplus profits, to apply them, in first order, to the satisfaction of the debt to the preferred stockholders for arrears of dividends. “For the purpose of such a dividend, however, only such surplus as represented the profits from the business could, legally, be availed of, and this brings us to consider the question of the disposition of the surplus of capital, left upon the reduction of capital stock, which the appellant claims to be equivalent to sur- plus profits and, hence, to be applicable upon the company’s debt to the preferred stockholders on account of arrears of dividends. * * * As stated, the capital had become impaired to the extent of $90,861.85, and this necessitated the reduction as then effected. The reduction to $200,000 thus left $9,138.15, which was an excess, or surplus, of capital. We may assume that the directors could have converted it into cash and have distributed it by way of dividends; but the preferential right of the preferred stock- holders did not reach to a distribution of that which was capital, nor create any charge upon capital. That which constitutes the capital stock of a corporation belongs to all of its stockholders, proportionately to their holdings. Upon dissolution, or in liquidation, it entitles him to share ratably in the assets. If the 109 directors had undertaken to divide this surplus of capital, it was apportionable, only, among all the stockholders ratably. The statute contemplated nothing else than that. “The statute reads: ‘If the capital stock is reduced, the amount of capital over and above the amount of reduced capital shall, if the meeting so determine, be returned to the stock- holders pro rata. ; ‘“ Assuming that the directors were empowered to distribute this surplus of capital, the preferred stockholders would have no legal, or equitable, claim upon it in satisfaction of past due dividends. Their only right would be to share in such a dis- tribution ratably with the common stockholders. “It must be borne in mind that the $9,138.15 remained in the corporate accounts, after the reduction of capital stock, as a portion of the former capital, and was, in no sense, like an excess of property which had been accumulated in the conduct of the business beyond the fixed capital. It did not represent ‘surplus profits arising from the business.’ ‘“T have, therefore, reached the conclusion as to this sur- plus of capital, left on hand after the reduction of the capital stock from $300,000 to $200,000, that it was not applicable to the claim of the preferred stockholders for the arrears of unpaid dividends.”’ Consolidated Balance Sheet. Corporations in many cases are authorized to acquire and hold the capital stock of other corporations. In practice, the holdings may vary from a few shares purchased for investment, or speculation, to a con- dition where practically all of the stock of another corporation is held. In fact, the corporation may be a holding corporation, organized merely to hold the stock of other corporations, all of the actual activities being carried on by the corporations whose stock is held and controlled. In the case of the control of a corporation resting in another corpo- ration, the controlled corporation is known as a subsidiary corporation and the corporation owning the stock is known as a holding, or parent, cor- poration, although the term holding is applied most often to corporations that do not themselves conduct activities but merely hold the stocks of operating companies. Aside from the legal complications that arise in such circumstances, there are many important matters to be considered from an accounting point of view. The balance sheet of each corporation will, if properly prepared, disclose its financial position, but it is difficult to obtain, from a study of the separate statements of parent and subsidiary corporations an idea of the condition of the enterprise as a whole. This is desirable, in view IIo of the fact that, so far as actual ownership is concerned, the activities practically constitute a single enterprise. In order that the situation may be readily grasped an illustration will be given. Corporation A is capitalized at $1,000,000 and has a surplus, that is, an excess of asset value over the combined amount of liabilities and capital stock, of $200,000. It owns 90 per cent. of the stock of Corporation B, capitalized at $100,000, which it acquired and charged in its accounts at par. Corporation A also owns all of the stock of Corporation C, capitalized at $50,000, which it acquired and charged at 95 cents on the dollar. The balance sheets of the respective corporations may be stated, for the purpose of illustration, as under: BALANCE SHEET OF CORPORATION A DECEMBER 31, 1902 Assets Liabilities Capital Assets $950,000 || Capital Stock. ...... $1,000,000 Stock of subsidiary cor- Capital Liabilities.... 100,000 porations: Current Liabilities... 35,000 Corporation B at par Q0;000 "| "pirpitis. oer 200,000 Corporation C at 95.. 47,500 Current Assets........ 247,500 $1,335,000 $1,335,000 BALANCE SHEET OF CORPORATION B DECEMBER 31, 1902 Assets Liabilities Capital Assets $230,000 || Capital Stock....... $100,000 Current Assets......... 70,000 || Current Liabilities. .. 125,000 2 Sn heiee 75,000 $300,000 LAG BALANCE SHEET OF CORPORATION C DECEMBER 31, 1902 Assets Liabilities eital Assets... . 6.2. $50,000 || Capital Stock....... $50,000 Surrent Assets.....5... 95,000 || Capital Liabilities... 40,000 (OULU aa a 25,000 || Current Liabilities... 80,000 $170,000 $170,000 The book value of the stock of a corporation is the amount by which the assets, correctly valued, exceed the liabilities. Stated in another way, it is the amount of capital stock plus the surplus or less the deficit. Thus, the book value of the Capital Stock of Corporation B above is $175,000, or $175 to each $100 of stock. The book value in such a case would be stated as 175. Inasmuch as the stocks of Corporations B and C are carried in the Balance Sheet of Corporation A, at cost, the full effect of the values that exist in the subsidiary corporations is not disclosed. This effect may be shown by adjusting the value of the subsidiary stocks as carried in A’s books to book value. In the case of the stock of B 75 per cent. would have to be added to the $90,000, or $67,500, making the total value $157,500, and the $67,500 would be credited to surplus. In the case of the stock of C, the book value is only 50, or $25,000, so the shrink, $22,500, must be charged to Surplus and credited to Stock of Corporation C. Surplus, after these adjustments, would stand with a credit balance of $245,000. This expedient, while disclosing in the Balance Sheet of Corporation A the net condition in accordance with the best values obtainable, would not disclose the full facts as to the assets and liabilities of the respective subsidiary corporations, and it would be clumsy to carry through such adjustments as the book values of the stocks of the subsidiary corpora- tions fluctuated. Instead of the foregoing, a better accounting procedure is to prepare a statement known as a Consolidated Balance Sheet, in which all of the assets and outstanding liabilities, and the stock issued and in the hands of outside parties, are shown. This is prepared without the necessity for adjustment entries, by a consolidation of the items in the various financial statements. It is obvious that the use of the actual assets and liabilities in such a statement, with the elimination of the stock owner- II2 ship, will give the same net effect upon Surplus as the use of the net in- creases and decreases of book value. Thus, the Capital assets would be shown in the consolidated state- ment as $1,230,000, made up as follows: A odin bose Wate 6) Riou whe nla OU aU epee ang NOt re ain Boy 5 olen kchiantits eS AE ae a ee ce 230,000 OM ea errs ce ee ee 50,000 $1,230,000 In the same manner other items would be consolidated, but the ownership of the subsidiary companies’ stock appearing in the parent corporation as a debit balance, and its issue appearing in the subsidiary corporations as credit balances, would be eliminated. The Consolidated Balance Sheet when thus prepared would appear as follows: CONSOLIDATED BALANCE SHEET OF CORPORATIONS A, B AND C AS AT DECEMBER 31, 1902 Assets Laabilities Capital Assets.ioees oer $1,230,000 || Capital Stock A....... $1,000,000 Current Assets.......... 412,500 || Capital Stock B $10,000 Surplus...... 7,500 17,500 Capital Liabilities..... 140,000 Current Liabilities... .. 240,000 Slirplig. SY Sere 245,000 $1,642,500 | $1,642,500 The same surplus, $245,000, is achieved as in the case of the adjust- ment entries. Instead, however, of the net asset value of A’s holdings in each subsidiary corporation being shown, the entire assets and the entire liabilities are shown, presenting a much fuller financial statement. In case a portion of the stock of a subsidiary corporation is held by outside interests, the theoretical treatment is to apportion to it its share of the surplus or deficit, and show the net effect in the Consolidated Balance Sheet. In the case of the $10,000 of B stock outstanding, the surplus applicable thereto on the basis of values shown, $7,500, is added to the amount of the stock, to show the estimated interest of the holders Dist of such stock in case of a realization and liquidation on the basis shown. In practice, when the outstanding stock is small in amount, it is often carried into the statement at par. The liabilities rank against the assets of the corporation for which they are incurred, and not against the assets as a whole. This however, does not affect the showing of the financial condition of the entire enter- prise, and reference may be had to the subsidiary balance sheets, which should always support the consolidated statement, for information as to the liabilities of the respective corporations. The Consolidated Balance Sheet is one of the accounting devices that has come with the tendency to consolidate corporate interests. It is principally useful where practically the entire ownership of subsidiary concerns rests in a holding corporation. Condensed General Balance Sheet of United States Steel Corporation. For the purpose of illustrating the principles of the consolidated balance sheet, the financial statement of the United States Steel Corpora- tion as at December 31, 1906, as published, is presented herewith asa complicated example, and it is believed that a careful study thereof will well repay the student. It will be noted, in the first place, that the term Condensed General Balance Sheet is used instead of Consolidated Balance Sheet, although it embraces the assets and liabilities of subsidiary corporations as well as of the parent corporation. Either designation will answer, although some confusion might result from the fact that the term Condensed Balance Sheet is often used, especially in railway practice, to describe a balance sheet that does not include the assets and liabilities of subsidiary corpo- rations, but is merely a condensation of the ordinary balance sheet of the parent company. In the statement under review the idea of the con- solidation may be gathered from the word General, which is used with the word Condensed. Under the caption Liabilities are included the stocks of subsidiary companies not held by the United States Steel Corporation, which are stated at par value. It has already been pointed out that when the amounts of stock thus outstanding. are inconsiderable, they are usually taken into the statement at par. Incidentally, the treatment of deferred charges to operations, sink- ing and reserve funds, and surplus, will be of interest to the student. 114 CONDENSED GENERAL BALANCE ASSETS. PROPERTY ACCOUNT: PROPERTIES OWNED AND OPERATED BY THE SEVERAL COMPANIES: Balance of this account as of December 31, 1905;.. 1... « shee 4-5 Bie Adjustments during 1906 in foregoing balance... ....4:-,.0,:....:-. Expended for Additional Property and Construction in 1906........ Less: Charged off to the following accounts, viz.: To Bond: Sinking Piunds o. 0.0 7s ee eee eee $1,406,500.00 To Depreciation and Extinguishment Funds.... 2,063,052.54 To Funds provided from Surplus Net Income for payment of capital expenditures............ 30,615,844.26 Expenditures for Stripping and Development at Mines, viz.: Balance at December. 31;°19052% < o-fasioslcns man cae « $4,016,985.45 Net Increase during the year ‘1906. .............. 1,705,355.16 DEFERRED CHARGES TO OPERATIONS: Payments for Advanced Mining Royalties, Exploration Expenses and Miscellaneous charges, chargeable to future operations of the properties: 27256. SWE aia. Shen to ein Wik et pet NEN Dhs iad Oana ay Sane Less: Fund reserved from Surplus to cover possible failure to realize: Advanced .Mining Royalties: tit! se.in <<. «sus INVESTMENTS: Outside Real Estate and. Other Property, ......5.5<.- «245.04 eave aes SINKING AND RESERVE FUND ASSETS: Cash held by Trustees account of Bond Sinking Funds.............. ($24,767,500 par value of Redeemed Bonds held by Trustees, not treated as an asset.) Contingent Fund and. Miscellaneous Assets. .. 0... 0.0 nnsrnunncseseon Insurance Fund. Assets (at Cost) ¢ 2s cis ops ps sian oe Rees Le Depreciation and Extinguishment Fund Assets (at cost)............. Investments (at cost) for Special Construction Fund for Gary Plant... CURRENT ASSETS: INVENTOTICS® . 5 oc avS ci oe ae OW Wal Saeed aa bee eee Bills Recetvable, Gustomers.i\.. > .kou vs op css ai es eee Agents’) Balances 3 (o's ei ws. NDE S «Poe 3 Falls ee ae sundry. Marketable: Bonds and Stocks ..:. ..<«4:-0is-0 4 bee ee Loans On Collateral. ow 2 iden cw pee ole y Pere ie ene ee Cash, viz. In hand and on deposit with Banks, Bankers and Trust Companies subject to cheque............. $62,812,418.49 Deposits loaned:on call, a..c:-ii9 24 > oe ee eee 2,824,390.35 Time Certificates of Deposity. .. 25 i vues eae ora 2,000,000.00 * Inventory valuations include profits accrued to subsidiary com- panies on materials and products sold to other subsidiary companies and undisposed of by the latter—see contra specific surplus account for these profits. The total of all inventories is, however, below the actual current market prices, 3 UNITED STATES $1, 380,031,032.25 84,823.16 32,155,146.46 $1,412,271,001.87 34,085,396.80 $1,378,185,605.07 5,722,340.61 $4,272,621.94 2,500,000.00 $397,287.89 1,542,398.24 3,649,979-74 11,708,499.14 10,145,788.59 $119,897,466.73 58,836,772.50 4,203,933.30 672,576.16 7:720,348.35 7,600,000.00 67,636,808.84 $1,383 907,045.68 1,772,621.94 1,617,351.29 27 443,944.60 266,567 ,905.88 $1,681 ,309,769.39 ‘TEEL CORPORATION ‘EET, DECEMBER 31, 1906. LIABILITIES. APITAL STOCKS OF SUBSIDIARY COMPANIES NOT HELD BY Mae st CORPORATION. (Par Value)... .. 2.0. cece cic cceneone j “ONDED AND DEBENTURE DEBT: United States Steel Corporation 50 Year 5% Bonds... $303,957,000.00 » United States Steel Corporation 10-60 Year 5% Bonds 170,000,000.00 $4.73,957,000.00 Less: Redeemed and held by Trustees of Sink’g Funds 18,956,500.00 A TS EC gS A i a a Subsidiary Cos.’ Bds. (Grtd. by U. S. Steel Corp’n).... $48,624,000.00 Subsidiary Cos.’ Bds. (Not grtd. by U.S. Steel Corp’n). 64,307,680.41 $112,931,680.41 Less: Redeemed and held by Trustees of Sink’g Funds — 5,81 1,000.00 EERE ERII O05 Ay cc o)'e) coe! clan dio ee isis e is nie wisi her ew os Se 8 Weepenture scrip, Illinois Steel Company...............c cee eee sence SAPITAL OBLIGATIONS AUTHORIZED OR CREATED FOR CAP- | ITAL EXPENDITURES MADE (HELD IN THE TREASURY SUBJECT TO SALE, BUT NOT INCLUDED IN ASSETS): faa). 9. Steel Corporation 10-60 Year 5% Bonds..........0. esc eee eee ECTS S700 oe Total, not included in General Balance Sheet Assets or Liabilities. . MORTGAGES AND PURCHASE MONEY OBLIGATIONS OF SUB- SIDIARY COMPANIES: RS en | EIEN COPS HOATIONS op ictar rec bis Jaleo cee dhs bee ee eee vee pe’e SURRENT LIABILITIES: Mupentoncount nyvyanlie and Pay Rolls... ke ee cee ee Special Deposits or Loans due employes and others................. EES a VCE oe rae mumricielsteress and Unpresented Coupons.............-c ence nteee Preferred Stock Dividend No. 23, Payable February 28, 1907......... Common Stock Dividend No. 13, Payable March 30, 1907............ Seemann Current Liabilities... 2... ec cle een ctw eecswwes SINKING AND RESERVE FUNDS: sinking, Depreciation and Replacement Funds...................%. General Construction Fund for authorized appropriations............ Special Construction Fund for account Gary, Ind., Plant............ Contingent and Miscellaneous Operating Funds..................... TNE tne oo ts es ie ks Sic la aniie wb aa g eras e's che o be cia wales meND SINKING FUNDS WITH ACCRETIONS..................... $508,302,500.00 360,281,100.00 Oe € Ce Ss ee CS ewe $45 5,000,500.00 I107,120,680.41 35,069.18 $30,000,000.00 10,320,000.00 $40,320,000.00 $2,514,626.37 I,717,500.00 23,853,579.40 T,077,292,29 2,728,361.61 7,166,344.29 6,304,919.25 2,541,512.50 $38,665,489.73 3,957,959-15 26,867,797.89 7,424,705.80 3,741,829.28 6 (6s) 2 Oem Bee 8 ame Represented by Cash (and by redeemed bonds not treated as assets—See Contra). JNDIVIDED SURPLUS OF U.S. STEEL CORPORATION AND SUB- SIDIARY COMPANIES: Meters provided in Organization. 2.1... si oe ee eels oe ales Balance of Surplus accumulated by all companies from April 1, rgo1, MENISCAL OO a. Pee wh wig have o/s avin dining aed elias aie Total Surplus exclusive of Subsidiary Companies’ Inter-Company Un OU UBT QUEEN ah 9 Coke i Wee lees Me SoG or ganas eRe Undivided Surplus of Subsidiary Companies, representing Profits ac- crued on sale of materials and products to other Subsidiary Com- Senne etiesicpert? factet,s IN VEnNtOries wc asc circ es ee eps oro Oe we he $25,000,000.00 54,556,654.01 $79,556,654.01 18,164,060.34 $868 ,583 ,600.00 23 400.00 562,156,249.59 4,232,120.37 43 672,009.34 $1,478,667 ,385.30 79,750,881.85 25,164,787.89 975720,714.35 $1 ,681,309,769.39 mH ¥ > thee +3 ee ee ’ . Ser ist? Bt Gn GT Masse a ¢e ed ‘ oh , ye se swe + . . ‘ » ‘ a 2 roel ‘abtuang ‘Si bee See wi hineeeict” erg? ait % $ Spey e bs eat Bas 3; 4 a petal ye Seta? A ee Alp) uh elas St ER. ret Se ter teg wey. CO Dy { WY Saullo ve eM bare G3 oe aie’ . .! ADVANCED THEORY AND PRACTICE | Yo OF ACCOUNTSs. ORGANIZATION AND FINANCE. CORPORATIONS. ie By HOMER ST. CLAIR PACE, C. P. A. (N. Y.) SSE ECTURE: X:; SYNDICATES. : In GENERAL hye Fie ote a, Cee Gee cen aro eee 117 : Form OF SYNDICATE AGRERMENT, [0008600 a Ree A 118 a RatLway BUILDING SYNDICATE......... a ee PURE RS at ei SRN a 118 | : AccounTING PRINCIPLES AND PROCEDURE... Sy On ave Un 123 . Bond SYNDICATES. COPYRIGHT, I914, BY - Homspr St. Crain Pacs, ADVANCED THEORY AND PRACTICE OF ACCOUNTS. ORGANIZATION AND FINANCE. CORPORATIONS. Pero VERS TT “CLAIR PACE, GP. A. (N. Y.) LECTURE X. SYNDICATES. In General. A syndicate is an association of persons, formed for the furtherance of some object, usually one involving the contribution, temporarily, of large amounts of capital, or the agreement so to contribute. A syndicate is not in the nature of a corporation, although ordinarily used as an aid to corporate activities. It more nearly approaches a special partnership, organized for carrying out a particular undertaking. The attempt is usually made, in the agreement constituting the syndicate, to relieve the members thereof, inter se, of partnership responsibilities. As distinguished from a syndicate, the term promoters is usually applied to the persons who assist in organizing joint stock companies or corporations. Thus, promoters are those that have to do more par- ticularly with the steps preliminary to the organization of a corporation. A syndicate is rarely organized for such a purpose. The usual form of organization is an agreement between a syndicate manager or managers, and certain persons known as subscribers or par- ticipants, reduced to writing, and subscribed by the parties thereto, setting forth the name and object of the syndicate, and stating the mutual agree- ments, undertakings and responsibilities of the managers and participants. The syndicate agreement, in order to facilitate its execution by a large number of subscribers, may be made in many copies, and each, by the terms of the contract, may be deemed an original, with full force and effect. The agreement usually provides that the syndicate shall become binding upon the subscribers when subscriptions have been received for a certain specified amount of capital. Copyright, t914, by Homer St. Clair Pace. 118 The name and object of the syndicate, and the duties, powers, respon- sibilities and compensation of the managers are usually set forth in detail. The compensation of the managers is usually fixed as a percentage upon the capital of the syndicate. A syndicate secretary may be provided, although the appointment of a secretary, and such agents and employees as may be necessary for the purposes of the syndicate, usually falls within the powers of the syndicate managers. There are no requirements in this country, at least, that a syndicate shall file reports or disclose the nature of its business or operations. For this reason, the syndicate method has advantages in certain classes of undertakings. For example, in case a railroad company desires to acquire real estate for the purpose of making an improvement, as, for example, the building of a station, the entry of the railroad company into the market for the real estate would have a tendency to advance prices. Such an operation could be better carried out either by individuals, or by an asso- ciation of individuals in the form of a syndicate. The method of organization by which managers have full power, without the action of a board of directors, to carry out the objects of a syndicate, while not suited to the needs of permanent business, lends itself well, when not abused, to the successful accomplishment of the purposes for which syndicates are organized. Syndicate enterprises are. often highly speculative, and unsuited, for that reason, for permanent organization in the corporate form. For the reasons given, and others that may exist, resort is often had to the syndicate method of pooling capital, and the treatment of the accounts that arise in connection therewith becomes of importance to the Accountancy student. Form of Syndicate Agreement. In order that the student may study the organization of a syndicate, and obtain an idea of the powers and responsibilities of the parties thereto, and the accounting contingencies likely to arise, it is deemed expedient to reproduce herewith a typical syndicate agreement. The one given is for a construction syndicate, although, with the objects changed, it would answer for any undertaking. It is as follows: Railway Building Syndicate. THis AGREEMENT, Dated this first day of February, 1900, by and between John Doe, hereinafter called the ‘‘ Syndicate Manager,” party of the first part, and the syndicate subscribers hereto, severally parties of the second part, of whom each is hereinafter termed the ‘‘ Syndicate dA Subscriber,’’ and all of whom, together with said John Doe, constitute the syndicate, to be known as the “‘ Railway Building Syndicate.’ WHEREAS, It is proposed by the Syndicate Manager to complete certain negotiations now in progress for the purchase provided he can do so upon reasonable terms, of the Indiana Railroad, a line of railroad miun to0 miles of main track, extending from...... 0.2... 0c.c4 eae eens to 8 a with certain coal lands, and having completed the purchase of said railroad, but not otherwise, to extend said line of rail- MM A, orcs ccc sy, wien) eco gered COR CMa tet i as, “sam aiat Abe, a distance of about fifty (50) miles, and to purchase rolling stock, if found necessary or desirable in the opinion of the Syndicate Manager; and WHEREAS, For the purpose of providing the necessary money for the purchase and construction of said properties for the purposes herein set forth, said Syndicate Manager and the Subscribers hereto wish to form a syndicate to advance the necessary money; not exceeding in amount $3,500,000; Now THIS AGREEMENT WITNESSETH, That, in consideration of the premises, and of their mutual agreements, the Syndicate Manager and the Syndicate Subscribers hereto severally agree with each other, as follows: 1. The parties hereto form a Syndicate for the purpose of purchas- ing and acquiring the Indiana Railroad, hereinbefore described, and having purchased said railroad, but not otherwise, of constructing the lines hereinbefore described, and to make such additions and improve- ments as the Syndicate Manager may deem desirable, and having acquired the same, merging, operating, controlling and disposing of the same as may be determined by the Syndicate Manager to be for the benefit of such Syndicate. 2. Each Subscriber hereto, and to any counterpart hereof, shall set opposite his name the amount of his subscription to the Syndicate, and shall be called upon to pay, or to be liable only for such amount, as shall bear to the obligations of the Syndicate, not exceeding $3,500,000, the same ratio or proportion as his subscription bears to said maximum obli- gation. In the event that more than the aggregate amount of $3,500,000 is subscribed, the Syndicate Manager may reduce any or all subscriptions hereto in such an amount, in his discretion, as shall make the aggregate subscription $3,500,000, and in case any such reduction shall be made, the Syndicate Manager shall notify the Subscribers whose subscriptions have been reduced, of the amount of such reduction. The funds of the Syndi- cate shall be applied, used and disbursed by the Syndicate Manager. 3. The Syndicate Manager agrees to proceed with reasonable dili- gence to purchase said Railroad, at such prices and upon such terms of 120 payment as shall, in his judgment, be reasonable and the best obtainable in the circumstances, and having made such purchase, said Syndicate Manager shall deposit with a Trust Company to be selected by him, the contract or evidence of such purchase, showing the terms and conditions thereof, and thereafter proceed with the construction of the new lines above described. 4. The Syndicate Subscribers irrevocably name and appoint the Syndicate Manager their agent and attorney with full power and authority to do any and all acts, and enter into and execute any and all agreements or other instruments necessary or proper, or by the Syndicate Manager deemed expedient in the premises, to carry out and perform the said agreement for the purchase of the said Indiana Railroad, and the con- struction of the new lines hereinbefore described, and to that end abso- lutely to control the property so purchased and constructed as fully in all respects as if he were the absolute owner thereof, with power to borrow money thereon and pledge the property or any portion thereof as security therefor, and to sell and dispose of the same upon such terms as may be in his discretion for the interest of this Syndicate, and with like power to hold, manage, control and dispose of, in his discretion, any and all stocks and securities acquired on any sale or disposal of said property, or any part thereof; also, in his discretion, to organize a railway company to hold the title of the lines purchased and constructed, in pursuance of this contract, and to cause such company to issue such securities as it may deem for the interest of this Syndicate, and when issued, to control and dispose of, in his discretion any and all securities thus issued. 5. This Syndicate agreement shall continue in force and operation until the first day of February, 1902, unless sooner terminated by the Syndicate Manager, in his discretion, and upon notice to the Syndicate Subscribers. 6. The Syndicate Subscribers will, from time to time, and at any time, on call of the Syndicate Manager, and to the amount of such call or calls, make cash payments on account of their respective subscrip- tions hereunder, upon ten days’ written notice by mail from the Syndicate Manager. All payments hereunder from time to time by the Syndicate Sub- scribers shall be made to the Trust Company, designated in such call, for the account of the Syndicate Manager. Each Subscriber shall, at the time of making each of the payments called hereunder, receive a certificate issued by the said Trust Company, certifying to the amount of such payment, and the interest of such Sub- scriber in said Syndicate, subject to the terms and conditions of this 121 agreement. Such certificates shall be in assignable form, and be trans- ferable only on the books of said Trust Company by assignment and sur- render of such certificate, and, upon such assignment and surrender, a new certificate shall be issued in the name of the Transferee. _ 7. The Syndicate Manager shall have the sole direction, manage- ment, and the entire conduct of the Syndicate, and the enumeration of particular or specific powers in this agreement shall not be considered as in any way limiting or abridging the general power or discretion intended to be conferred upon and reserved to the Syndicate Manager in order to authorize him to do any and all things proper, necessary or expedient in his discretion to carry out the purposes of this agreement; neither shall he be liable under any of the provisions of this agreement, or in or for any matter connected therewith, except for want of good faith and the failure to exercise reasonable diligence. 8. The Syndicate Manager shall be entitled to a commission of two per centum on the amount of the subscriptions hereto, without any obli- gation to share the same with any Subscriber, or to account therefor to the Syndicate or to any Subscriber, which shall be the full compensation of the Syndicate Manager in managing the Syndicate and supervising the construction of the new lines. All other expenses of the Syndicate Manager, including counsel fees, brokers’ commissions, and all other disbursements and expenses made by him in connection with the carrying out of the purposes of this agree- ment shall be a charge to the Syndicate, and all profits and losses of the Syndicate shall be divided and borne pro rata. The Syndicate Manager is to be a Subscriber to the Syndicate, and, to the extent of any such subscription or reservation by it, he is to participate in the profits and losses to the same extent as other Subscribers. Should the Syndicate Manager, in the carrying out of this agree- ment, sell and dispose of said railroad properties, or stocks and securities received therefor, the net proceeds of such sale shall be distributed pro rata to the Subscribers from time to time in the discretion of the Syndicate Manager. Should said properties not be sold, but be capitalized by the formation of a new company or companies, of which companies the Syndi- cate Manager acquires the securities issued, or should said properties or any part thereof be disposed of for stocks and securities which are not sold by the Syndicate Manager, then, after payment of all expenses and commissions accruing under this agreement to said Syndicate Manager, and upon the termination of the Syndicate, such securities so acquired shall be distributed pro rata to the subscribers hereto or their assigns, as provided herein. 122 9. Each Syndicate Subscriber hereby ratifies, assents to and agrees to be bound by any action of the Syndicate Manager taken under this agreement, and agrees to perform all of his undertakings hereunder, from time to time, on call of the Syndicate Manager, to the full extent of the amount set opposite his name or allotted to him, but he shall be liable hereunder solely to the Syndicate Manager or his assigns, and only to the extent of his individual participation in the Syndicate. Each and every party hereto will, upon reasonable request, execute and deliver all further writings which may be necessary or proper to carry this agreement into effect. The failure of any Syndicate Subscriber to perform any of his under- takings hereunder shall not release or affect any other Syndicate Sub- scriber. The Syndicate Manager may, in his discretion, by written consent, release any Syndicate Subscriber. In case any Syndicate Subscriber shall fail to perform any of his undertakings hereunder or be released by the Syndicate Manager, other Subscribers may be received by the Syndicate Manager and take the share of the Subscriber so failing to perform his undertakings or so released. Upon failure of any Syndicate Subscriber to perform any of his undertakings hereunder, the Syndicate Manager shall have the right, at his option, to exclude such Syndicate Subscriber from further interest and participation in the Syndicate, and to hold him liable for all damages caused by his failure. Nothing contained in this agreement or otherwise, shall constitute the Syndicate Subscribers partners with the Syndicate Manager or with one another, or render them liable to contribute more than their ratable amount as aforesaid, or entitle them to any participation in the results or profits of said Syndicate other than as specified in this agreement. 10. This agreement shall bind and benefit ratably, according to the amount of the several subscriptions, not only the parties hereto, but their respective successors, survivors, assigns and personal representa- tives. An original hereof is to be signed by the Syndicate Manager and deposited with the Trust Company so to be designated by him, and counterparts may be signed by the Syndicate Subscribers and retained by the Syndicate Manager, and all shall be taken and deemed one original instrument. 11. All notices issued by the Syndicate Manager hereunder shall be mailed to the addresses of Subscribers as given below opposite their respective names. The holding of certificates issued by said Trust Company, shall con- stitute such holders parties to this agreement, as fully to all intents and purposes as if signing the same. 123 In Wi1tTNEss WHEREOF, The Syndicate Manager, party of the first part, has signed an original hereof, and the Syndicate Subscribers, parties of the second part, have subscribed said original, or counterparts hereof, as of the day and year first above written. NAME ADDRESS AMOUNT Accounting Principles and Procedure. In the case of a construction syndicate, or in the case of any syndicate with large capital and numerous participants, it is best to open a distinct and complete set of syndicate books. In the Journal, as a basis, it is often desirable to make a complete copy of the syndicate agreement, showing the subscribers and the res- pective amounts subscribed by each. This preserves and makes available in the books themselves, the agreement upon which the accounting must rest. The accounts may be opened by an entry debiting the respective syndicate subscribers and crediting the syndicate Capital Account. As the money is paid in upon calls, Cash is debited and the respective sub- scribers are credited. The entries, in such a case, would be: Syndicate Agreement, copied in full, as memorandum. Do La CS LG 8 geet Od 8 Bd SONS Sara kale nea a Beg Mery er ee CADCPUUING Lay wong eniit io hc te whe elie be For syndicate subscriptions (account opened for each sub- scriber in general or subsidiary ledger). MAMIE IST 5, fae Lame chew ew ttuee aie Mek Te ete SW ACS oh ONT Pope inti co UW. DoCRIBER Sic. 22k Ooi eee oes For payment of call number....of....per cent. If, as is sometimes the case, all the money is not called in, there will be an overstatement of capital on one side, and an authorized but uncalled 124 amount of subscriptions on the other. For this and other reasons it is preferable in many cases to charge Subscriptions Called as the calls are made, and credit Capital Account, the latter showing at all times the amount of subscriptions called for payment. Cash is charged and Subscriptions Called is credited as payments are received upon the call. The detailed account with the subscriber may be operated in a subsidiary ledger, card or otherwise, so that the unpaid calls in such record would prove against the balance of the Subscriptions Called Account. The entries, in such alternative procedure, would be: It is immaterial which method is used although the latter keeps the financial records clear of accounts that may never actually enter into the accounting record proper. In order to keep a proper record of transfers from the data which is supplied by the bank or trust company, it is necessary to operate a book similar to a stock ledger, giving the name of each subscriber, address, amount of subscription, payments thereon, etc. Inasmuch as it is often necessary to send out notices, prepare lists of subscribers, etc., a card ledger, the units of which can be sorted and handled conveniently, is preferable to a bound book or loose-leaf ledger. This is especially true where the subscribers are numerous. The object of the syndicate is usually effected by the acquisition of securities, or the construction of property, paid for by the cash which has been received. The treatment of such assets is no different from that accorded in other accounts. | Thus, the property acquired would be charged at cost, and the entries, in principle, would be: For amounts paid. gl te To. CREDITORS .i32ies oe a For amounts owed. 125 The assets are ordinarily turned over to the corporation for which the property is being acquired or constructed, and paid for in corporate securities. The entry, in effect, would be: TNS ET DST 09 Sg CE ee e BEE eNO ett oy TELLIER eR DINED WAR 9260150 MIEN) ORs US DUO ond wines coe uls. « bshediiecalance a ube For sale of properties, for which securities were received, as follows: * * * * * * * If the securities received from the corporation exceed the value of the assets as they appear upon the syndicate’s books, and it is desired to carry such securities at their par value on the books of the syndicate, it is necessary to set up an account to receive the excess credit, to be called a Bonus Account, or some other name, as the case may require. Discounts upon the sales of the securities eventually find their way as a charge or offset against this account. The liabilities being paid, and the assets reduced to cash, or to some other desired basis for distribution, the nominal elements are collected in a Profit & Loss Account. The balance of this account is transferred to a Subscribers’ Distribution Account, to which has been transferred, as a credit, the amount of the syndicate capital. As each subscriber pre- sents his certificate for cancellation, he receives his pro rata share of the assets, and the Subscribers’ Distribution Account is charged and the assets credited with the amount thereof. This is substantially the same procedure as obtains in the dissolution of a corporation. The expenses, other than the direct cost of properties, is often trans- ferred to Cost of Property before the sale of the properties, and are elimi- nated in that way. But if there are any nominal debit elements that remain on the books, they are a charge against Profit & Loss Account. Thus, the entries would be, after determination of the profit, in principle, as under: 126 PROFITA& GOSS ees eeces ae eete he ee oe eee ee CAPITFALG: ACCOUNT ee a ee To SUBSCRIBERS’ DISTRIBUTION ACCOUNT.. For transfer. SUBSCRIBERS’ DISTRIBUTION ACCOUNT. we To ASSETSis Of A ee For pro rata distribution upon presentation of syndicate cer- tificates. There may be many contingencies, such as payment to subscribers in instalments, the distribution of securities, or the distribution of part securities and part cash, but the general principles that apply have been sufficiently illustrated. Bond Syndicates. As indicated by the definition, a syndicate is useful when it is desir- able to pledge, for temporary purposes, large amounts of capital. This is true in the common form of bond syndicate, known as an underwriting, in which a banker bids upon an issue of bonds which he believes can be bought and resold to investors at a profit. In many cases the banker would not care to undertake, unaided, to buy and market the issue. To meet the situation, a few of the banker’s clients who may be interested in such a venture, are approached with a syndicate agreement, by the terms of which the syndicate agrees to take the bonds from the banker at cost, or such other price as may be agreed upon, each subscriber binding himself to pay in the amount of his subscription and to take his pro rata share of bonds. The banker, however, is constituted syndicate manager, with power to sell the securities, and usually receives a commission, regard- less of results. Under the power to sell, the syndicate manager will offer the bonds for public subscription at a price above the cost to the syndicate. It may be that the manager will call in only a part of the subscriptions, loaning the balance to the syndicate on the security of the bonds held, or negotiate a loan for the syndicate on such security; or he may, in fact, advance all the money, and make no call whatever, although this is unusual. If the bonds are sold, the manager deducts all expenses and his com- mission, pays all loans and distributes the proceeds. The subscribers may thus secure a substantial profit with the advance of but a small amount of capital. 227 On the other hand, in case the bonds cannot be sold at a profit, the syndicate may be extended in the hope of a more favorable market. If this is not done, or the market does not materialize, the remaining amount due upon subscriptions, or such amount as is necessary, is called in, all expenses and loans are paid, and the bonds are distributed pro rata. The private bankers control the investment market to such an extent, that those engaged in financing enterprises recognize, in the majority of cases, the futility of attempting to float large issues of securities with- out the aid of the banker, and the method indicated is the one commonly employed. In times of prosperity, when securities sell readily, syndicates are profitable, and participation in those formed by successful bankers is much sought. In times of market stagnation, the syndicate members become loaded with securities through the failure of the public to buy. So far as the accounting procedure is concerned, if there are but few participations, the banker may open an account with each, crediting amounts paid in, and charging advances and the cost of securities bought for each. The securities are apportioned, and the proceeds applicable to each account are credited. When all charges, including expenses, are made, and all credits have been entered, the results will show an amount due from or to the subscriber. The par of the securities acquired and sold for each account may be shown as a memorandum. Thus, A, B, and C, as subscribers, and D, as syndicate manager, organized a syndicate of $300,000 for the purpose of buying $300,000 of bonds, to which each of the subscribers agreed to contribute $100,000, subject to the call of the manager. A call of 25 per cent. was made upon the subscribers, and in response, A, B, and C each paid to D, $25,000. The bonds were bought for $270,000, the manager, as a banker, loaning to the syndicate the amount necessary, in conjunction with the cash already paid in, to pay for the bonds. The bonds, and the syndicate agreements to pay in the remaining calls, were held as security to the loan. The bonds were sold at a profit sufficient to pay all expenses and to return the subscriptions paid in, with a 20 per cent. profit, or $30,000 net to each subscriber. The banker, who was the syndicate manager, could open an account in his books with each subscriber, crediting the amount of subscription paid in. To each account could be charged the proper proportion of the cost of the bonds and expenses. The par of the bonds held as security to the advance could be shown in the explanation column of the account. As sales were made, the pro rata amounts could be credited to the respec- 128 tive accounts, the final credit disclosing the amount to be paid to the subscriber. This procedure is useful in syndicates with few subscribers, and involves proportioning all transactions as they occur. In the majority of cases it would be better to open a distinct set of books to cover the syndicate transactions. pet 4 rey eee oS - mr A Pe %. eit ni Ph ee TC 2 11486605 SREP VESTS.