SMill! lit 2fem ^atk hate diallegt of AgricuUutc At OfarncU InlweraitH 3tl)ata. Sf. f . JItbrarg Cornell University Library HF 5625.S76 The philosophy of accounts, 3 1924 013 824 267 The original of tiiis book is in tine Cornell University Library. There are no known copyright restrictions in the United States on the use of the text. http://www.archive.org/details/cu31924013824267 THE PHILOSOPHY OF ACCOUNTS BY CHARLES E. SPRAGUE, A.M., Ph.D., C.P.A. Author of " The Accountancy of Investment" AND "Extended Bond 1 abides" FOURTH EDITION NEW YORK THE RONALD PRESS COMPANY 1920 Copyright, 1907, by Charles E. Sprague Copyright, 1908, by Charles E. Sprague PREFACE It is not within the province of this treatise to teach the Art of Bookkeeping. Skill in that art is attained by practice, either in recording actual transactions in the counting room or those, simulating actuality, which are prepared for practice in the school or in the many excellent manuals of instruction. But facility in the processes of an establisht system will not satisfy the inquiring mind of one who has gone thus far; he will desire at a proper stage of his development to know the scientific basis of all sys- tems, the wherefore as well as the how. When the subject is taken up at the collegiate or university stage, it is especially fitting that the science of accounts be unfolded concurrently with thoro drill in the art which depends upon it. As a branch of mathematical and classificatory science, the principles of accountancy may be determined by a priori reason- ing, and do not depend upon the customs and traditions which surround the art. I have endeavored to set forth these principles simply and naturally without resorting to fictitious modes of presentation, but adhering to the fundamental equations and their sub-equations. I hope that my work may be of some utility to the profession of puoiic accountants in the training of their assistants, as, even in routine-matters, the best work is done by those who under- stand the theory and the reason of what they are doing. To business managers who have not been practical bookkeepers, it may be that I may throw some light on the methods in use and perhaps point out where they may be made more eflfectiv. I had at one time intended to extend the book by adding to the twenty-one chapters here given relating to Accounts in General, a Part II on Accounts in Particular, in which should be taken up all the principal forms of account with various sug- gestions as to handling them. I found, however, that the task would reach encyclopedic proportions if I treated each type of account with the degree of thoroness which has been given to Cost Accounts by several authors and to Investment Accounts in my work on "The Accountancy of Investment." I have there- fore contented myself with an Appendix, containing some Mono- graphs on a few very essential accounts. I am conscious that the work will deserve and receive severe scrutiny as it is the product of over thirty years' handling of accounts in all grades of service and of six years' teaching the subject in the School of Commerce, Finance and Accounts of New York University. Charles E. Sprague. 54 West 32d Street, New York. September, 1907. PUBLISHER'S PREFACE In the present reprint of "The Philosophy of Accounts" the publishers have retained the reformed spelling used by Professor Sprague in the earlier printings. This is done as a matter of respect to Professor Sprague's memory as it is not the spelling used in other publications of this Company. The Ronald Press Company. January 2, 1917, CONTENTS CHAPTER I Nature of the Account pase What is an Account?.— Definition of an Account of Value — Increase and Decrease — An Informai, Account — Intro- duction OF Totals CHAPTER II Form of the Account Principles of Arrangement — The Standard Form — The Journal Form — The Three Column Balance Form — Money Columns Between 5 CHAPTER III Construction of the Account Cash Account as Model — Meaning of Each Side — Exemplifica- tion — Resultant — Equation of the Cash Account Without Negativ Quantities — Accounts of Indebtedness — Account OF "ME." ic CHAPTER IV The Transaction Equation of the Balance Sheet — Equation of the Transaction — Six Occurrences, op which Every Transaction Must Contain At Least Two — Examples of Each — Analysis of Transactions 19 CHAPTER V The Bai^ance Sheet fTs Importance — Its Constituents — How Constructed — By In- ventory — By Derivation — Adjustments — Minuteness and Comprehensivness To be Reconciled — Group Accounts — A Specimen Balance Sheet — Extended meaning of " debtor " and " Creditor " — The Reverse Method of Presentation — Equation of the Balance-sheet — Its Limitations — Order OF Arrangement — Partnership Balai^ ce-sheet — Corporate Balance-sheet — One-sided Form — Business without Bal- ance-sheet — Municipal Accounts 26 vi The Philosophy of Accounts CHAPTER VI Phases op the Assets page Things and Rights — Intbrconvertible — Uncompleted Contracts — Embodiment of Services Given — Storage of Services TO BE Received — Capital — Investment '. 39 CHAPTER VII Phases of Inabilities Negativ Assets — Postponed Decrease op Assets — Rights of Others — Uncompleted Contracts — Loan Capital — Assets Corresponding to Certain Liabilities — Some Seeming Liabilities, Actually Offsets — Liabilities do not Shrink. 43 CHAPTER VIII Proprietorship Phases of Proprietorship — As Rights — Distinction Between Liabilities and Proprietorship — As Service — As Capital ; Own-Capital — Fictitious Methods of Presentation of Assets, Liabilities and Proprietorship — Cash Theory — " The Business " Theory 46 CHAPTER IX Offsets and Adjuncts Supplementary Accounts ; their Purpose — Offsets Against Assets — Adjuncts to Assets — Adjunct to Proprietorship — Offset to Proprietorship Seldom Revealed 51 CHAPTER X Insolvency Converse of Proprietorship — Possibility of Continuing in Spite of Insolvency — Four Cases 54 CHAPTER XI The Period Equal Intervals — Minor Unit, the Day — Major Unit, the Year — Intermediate Unit, the Month ; Sometimes Week, Quar- ter, Hai^Fyear, 55 Contents vii CHAPTER XII Economic Accounts pagb Object op thb BnsiNEss-sTRUGGi,B — Economic Accounts Subor- dinate TO Proprietorship — Their Purpose, Anai,ysis — Outside and Inside Account — Must be Limited to Period UNDER Consideration — Outlay Dependent on Consumption, not on The Receipt of Supplies nor on the payment for them — Exemplified as to Interest 59 CHAPTER XIII The Economic Summary Account Intermediate to the Economic and the Proprietary Accounts — Various Names for this Account — Examples of Profit and Loss, Trading and Distribution Accounts — Statement in Untechnical Form — Tabular Form 69 CHAPTER XIV The Trial Balance Test of Equilibrium — Order of Arrangement — Accountant's Rough Statement from Trial-balance 78 CHAPTER XV The Journal A Preliminary Book — Formerly Considered Indispensable and THE Only Source of Posting — Analysis of Transactions — Form of Journal Entries — Balance- entries Thru Journal — Certain Entries for which the Journal is Advantageous — Gradual Disappearance of the Journal — Auxiliary Books — Monthly Journalization of Auxiliary Books — Posting Delayed — Downfall of the Complete Journal 82 CHAPTER XVI Posting Mediums Auxiliary Books Become Subdivisions of the Journal — Sphere OF Journal Now Limited — Disappearance of Daybook — Predigestion of Material — Columnization — Columnar Journal — Side-posting — Loose-leaf Journal — Cash-book Used as Journal — Cash Sales 91 viii The Philosophy of Accounts CHAPTER XVII Posting from Tickets page Documentary Record — Ticket-posting A Modern Method — Vai,ue OF VODCHERS — ADVANTAGES OF TiCKET-POSTING — SUPPRHSSION OF Details ^9 CHAPTER XVIII The Ledger An Organized System — Incomplete Ledger — Sometimes Incom- pleteness ONLY Apparent — Grades of Accounts — Subord- inate Ledgers — Controlling Account — General and Subordinate Ledger in the Same Loose-LEaf Book — Private Ledger — Tabular I,edger ''°3 CHAPTER XIX Precautions Against Error Causes of Error — Comparison — Checking off — Calling off — Reconstructiv Methods — Check Ledgers — The Bank Balance Ledger — Reverse Posting — Application to Sav- ings Banks — Sectionizing — The Coupon Method — Proving THE Balance — Double Balance Method — Balance Posting, OR Proving by Difference ii° CHAPTER XX The Detection of Errors Classification of Errors — Selection of Procedure — Trans- position Indicated by 9's — Correction of Error — Narrow- ing The Field — Tabulation of Ledger 122 CHAPTER XXI Fiduciary Accounts Accountancy of Administration, without Proprietorship — Name OF Fiduciaries — Purpose of Accounting — Functions op the Fiduciary — Equation of Fiduciary Accounts — Executors' Accountings — Liabilities Omitted from Inventory — Accounts Transformed into Schedules — Savings Banks Really Fiduciaries 130 Contents "x MONOGRAPH A The Cash Account page Definition and Extension op "Cash" — Sub-Division of Cash — Variations of Cash AcconNT — Bank Account Superseded by Check-stub — Check-Book as Posting-Medium — Complex CASH-BOOK — COLUMNIZATION TWO PRINCIPLES — CONCOMITANTS — Discounts, as Example — Journalization Thru Cash — Check Register — Alternate Pad System — Strip System — Balancing Cash — Auditor's Duty as to Verifying Cash Balance — Verification of Bank Account 139 MONOGRAPH B The Merchandise Account Specific and Economic Values in the Same Account — Neither Predominant — The Merchandise Account in the Old Mixt Form — Different Views — Difficulties in Both Views — Example op The Old Form — How To Close it — Modern Form Exemplified 155 THE PHILOSOPHY OF ACCOUNTS. CHAPTER I Naturb of the Account What is an Account? — Definition op an Account of Value — Increase and Decrease — An Informai, Account — Intro« DucTioN of Totai^. 1. The word " account," used in its broadest and loosest sense, means not merely a narration, or a statement of facts, but some- thing systematic or orderly. A rambling tale narrated by a gossip would not be an account because it is not systematic. An account must be a systematic statement of facts ; but this is not all, it must tend or point to some conclusion. An account, as distinguisht from a mere narration, is intended to establish some conclusion, to prove or disprove some proposition, and its parts, the facts of which it is composed, must bear upon this conclusion and must either favor or oppose it. Hence these facts or elements of the account may either be all of one tendency or some of them may be of an opposit tendency to the others. 2. But the accounts of which we are trying to discover the philosophy are of one class; the original class which gave the name to all the others, namely, accounts of value or financial ac- counts and for these we may, summing up the foregoing require- ments, adopt as our definition: An account is a systematic statement of financial facts of the same or opposit tendency leading to a conclusion. 2 The Philosophy of Accounts 3. As increase and decrease are the two opposing tendencies in financial facts, an account must in its form provide for dis- criminating between these tendencies, distinguishing increase from decrease, positivs from negativs, -j- from — . 4. A very primitiv, yet logical and effectiv, form for an account might be one in which space was reserved for only one column of figures and where a conclusion was reacht after every entry, the distinction between increase and decrease being exprest in the text alongside. Thus let it be supposed that I require to keep an account of my deposits with a certain bank. The conclusion sought for is, how much have I in the bank? The positiv, or plus, or. additi" or increase elements of the account are the moneys which I de- posit; the negativ, or minus, or subtractiv, or decrease elements are the sums which I draw out. If then the facts were that I de- posited $2,000 and also $500 and that I drew $300 and $600 suc- cessivly and again deposited $1,000, an account might be con- structed as follows: Figure i. Deposited $2,000 Deposited 500 $2,500 Drew 300 $2,200 Drew 600 $1,600 Deposited 1,000 $2,600 5. This is certainly an account, and it accounts for the con- clusion, which is that the amount now in bank is $2,600. It is not in the ordinary form of an account, it is not in the moet effectiv form for many purposes, and it is lacking in details which give incidental information; yet it conforms to the essentials of an account and not only leads to a conclusion but expresses it. 6. Elaborated into an account giving greater information, yet retaining its simple form, this might read: Naturb of TB.n Account Figure 2. MY ACCOUNT WITH THE FIRST NATIONAL BANK. 1906 Jan. •t 2 7 I 4 24 Opened my account by depositing check of Wm. Jones for Deposited currency received from sale of cattle Balance in bank Drew by check No. i to the order of John Smith for 6 months interest at 6% $2,000 ,500 Feb. $2,500 300 Balance in bank Drew by check No 2 to the order of Peter Menken for a loan to him .. $2,200 600 Balance in bank Deposited checks of Wm. Jones Balance in bank el $1,600 1,000 $2,600 7. Here we have given many details of the transactions w^hich will serve to identify them and enable us to prove them if neces- sary, thus furnishing information and protection. As every transaction has a date and an amount, we have ruled vertical lines to contain those particulars. This is on the principle of tabulation, that is, of allotting a separate column to any series of related facts which occur with regularity. 8. Simple and unconventional as this method is, it is used in substance by many good bookkeepers on the back of the check- stubs where they keep account of the bank balance by alternate additions and subtractions. Strange to say, these bookkeepers and some excellent accountants would be horrified to see a ledger account which was not adorned with a " Dr." and " Cr." over the top and with repetitions of the prepositions " To " and " By " on every line, thus doubly emphasizing the fact that the left hand side is the left hand side. They would defend the simplicity of the stub-account by saying that it was not an account, which is a very easy, but not very satisfying way of disposing of the difficulty. 4 The Philosophy of Accounts We must insist, however, that the statement given above is in essence an account. 9. The principle of tabulation, or columnizing, may be applied to this account by providing two money-columns instead of one, and in the additional column placing the subtractiv entries. Figure 3. FIRST NATIONAL BANK. In account with [Me] Date Deposits Checks 1906 Jan. 2 7 $2,000 500 Feb. I 4 21 1,000 $300 600 We do not need to label the several entries as " Deposit " and " Check " ; by allocating each to its proper column we indicate this more clearly, and we have the further advantage of readily ascer- taining even in a much more extensiv example, the answers to these questions : How much are the Total Deposits? How much is the Total Drawn? These are very valuable pieces of information, next in importance to the prime conclusion, What is the Balance? 10, It is therefore the custom, and wisely so, to separate the positiv and the negativ elements and to sum each by itself. There are occasional exceptions to this and rightly so if anything is to be gained thereby. With this understanding, then, that the two tendencies are to be treated apart we will next consider the form of the account. CHAPTER rr foRM OP THE AcCOUNf Principles of Arrangembnt — The Standard Form — Thb JournaS Form — Thk Three Coi,dmn Balance Form — Money Columns Between * 11. We will now consider what arrangement of space is best suited to the purposes of the account, the positiv and the negativ elements to be kept separate so that each may be totaled when desired. 12. The information which is required is the following: How Much Value? How? When? Why? and With Whom? as to each transaction. Supposing we are at present providing for one kind or tendency only, it is evident that the figures representing the amounts involved, should be free and clear of the context which explains them and that there is no better method of exhibit- ing these figures than to place them in a vertical column. As they are frequently the result of a calculation embodied in the context, it is appropriate that they should follow the context and this brings the money-column to the right of the text. 13. As the date when the transaction took place is the identify- ing clew which we use in looking for information, it should also have a free and clear space, allowing the eye to pass rapidly from one date to another, and this space should not interfere or be con- fused with the other explanatory matter; hence it will be advan- tageous to place the date-column on the left. The remaining explanatory text will occupy the central space and will seldom need subdivision. Its various details. With Whom, Why and How, should, however, follow a uniform and unvarying order of sequence to facilitate reference. (Figure 4.) 14. This is a frame into which may be fitted all items of the same kind or tendency; we have next to provide for those of the opposit tendency. The most obvious way of doing this is by re- The Phuosophy of Accounts FiGURB 4- [Date] [Specification] o X S o ^ peating or duplicating the whole of the above scheme. This was anciently done on two pages but it is now customary, and gen- erally more convenient, to use but one. (Figure 5.) The narrow columns at the left of the money-columns markt a are for the purpose of indicating in some brief way the exact source of, or authority for, the entries. 15. This standard, or traditional form of the account is used in almost every set of books. There is no law, however, requiring it to be used and there is no harm in deviating from it when any- thing is to be gained thereby. 16. There is one feature in the standard form which should be noticed. There being separate date columns on the two sides, it does not present a chronological view of all the transactions. If this is desirable, it can be attained by adding merely another money column to the form in Figure 4, interweaving the dates and specifications of both columns and separating the amounts only. This is often called the Journal Form, from the book of that name. (Figure 6.) Form of the Account Figure 5. THE STANDARD FORM OP ACCOUNT. Date $ Date Figure 6. ACCOUNT IN JOURNAL FORM. 17. A variation of this form provides a third column in which may be entered the balance, or resultant of the two other columns ; as at c. (Figure 7.) The Philosophy of Accounts Figure 7. THREE COLUMN BALANCE FORM. Figure 8. MONEY COLUMNS BETWEEN. Date $ s Date 18. These are the principal variants, but minor variations occur from the exigencies of certain businesses. For example, if it is very desirable to compare the corresponding amounts on the Form of thb Account 9 two sides the standard form may be changed so as to bring the two money columns together. (Figure 8.) In this example the money columns are not exactly in the centre, on the supposition that the right-hand entries require briefer specification than those on the left hand. 19. The form of the account is a matter of convenience, rather than of prescription. While custom should not be deviated from without cause, it has no claim superior to utility. lo Thb Philosophy of Accounts CHAPTER III Construction op the Account Cash Account as Modei, — Meaning of Each Side — Exemplifica- tion — Resultant — Equation of the Cash Account Without Nkgativ Quantities — accounts of indebtedness — Account of "Me." 20. We have now given to the account a frame or mold to hold its contents; we must next consider what is to be placed in the frame and how arranged. 21. An account representing some form of wealth or property will be the simplest to begin with, and we select money because it is the easiest form of wealth to value. Such an account repre- senting money (or any of the substitutes for money) is called a cash account from an Italian word meaning box; it is the money- box account. 22. Recurring to the definition of an account, we ask: What are the facts of opposing tendencies to be recorded in a cash account? Evidently increase and decrease of the stock of money in possession. What is the conclusion ? The amount of that stock of money at the time of inquiry. 23. The facts may be designated by many pairs of names, as : PosiTivs. Negativs. Receipts. Payments. Into the box. Out of the box. Plus. Minus. More. Less. Increase Decrease. The conclusion is known as : POSITIV. Stock of Cash. Cash on hand. Cash Balance. Balance. Construction of thb Account 24. Let the following be the facts which it is desired to record, constituting the " items " of the account. ( 1 ) Having no money, I borrowed from A. B., $100 on January i. (2) Received my salary on January 31, $50. (3) February 2 I repaid to A. B. $75. (4) On the same day I paid expenses $49. (5) On February 15, I loaned to C. D. $35. (6) Received my salary, $50, February 28. (7) Repaid to A. B. on March 3, $13. (8) March 5, loaned to C. D. $12. (3) Received salary on March 31, $50. (10) Collected on April 10 from C. D. $10. (11) Paid various expenses on April 14, $27. (12) Collected from C. D. on April is, $20. 25. Using the Standard form of account (Figure 5) and de- ciding arbitrarily that the positiv or receipt items shall occupy the left-hand portion, we record the facts as follows : Figure 9. CASH ACCOUNT. 19 — 19— Jan. I Borrowed Feb. 2 Repaid to A. B. «7S from A. B. $100 " " Paid Expense 49 " 31 Rec'd Salary SO Mar. I Loaned to CD. 3S Feb. 28 Rec'd Salary 5° " 3 Repaid to A.B. 13 Mar. 31 Rec'd Salary SO s Loaned to CD. 12 Apl. 10 Collected from C. D. 10 Apl. 1 4 Paid Expense 27 " IS Collected from C. D. 20 • 26. We have now complied with the definition of an account in so far that we have made a systematic statement of these twelve financial facts, six of which are of like tendency and six of the opposit tendency. As the total of the receipts is $280 and the total of the payments $211, it is evident that the balance is, at the beginning of April 16, $69, which is the conclusion sought. 27. The account in its present form is a current account. It follows the course of time and gives a history of the cash. The conclusion, or resultant of all the facts, is necessarily made up at some certain moment, and, for reasons which will appear later, the same moment is usually chosen for recording all these resultants in a group of accounts. 12 The Philosophy of Accounts Figure io. CASH ACCOUNT. $IOO $75 so 49 5° 3S 5° 13 IO 12 20 27 $280 $211 Balance 69 28. The most obvious way of recording the resultant, or balance, would be to sum up each side and set down the result under the greater sum, as shown in Figure 10. As we are now concerned with values only we omit the words. 29. This, however, is not the most usual way of expressing a resultant. The double lines drawji under both sides usually denote equality, like the sign =, and if they are not equal they must be equalized. The amount necessary to equalize the two sides of this account is the balance $69, which we have inserted in italics (sug- gesting the use of red ink) to designate something which is not a current transaction but an instantaneous result, not an occurrence but an inference. Figure ii. CASH ACCOUNT. $100 50 50 5° 10 S75 49 35 13 12 20 Balance 27 $211 69 $280 $280 Here is a true equation. All the receipts exactly equal all the payments plus the balance. The preponderance of receipts is added to the opposit side to make equalitjr just as, in weighing Construction of the Account 13 butter, if the scales are out of balance, you do not take off some butter but you add on a weight. 30. In mathematics the normal way of asserting a truth is by means of an equation. The account in its current form (Figure 9) merely gave the facts; it now asserts the conclusion. As sub- traction in accounts (see Figure i) may lead to confusion, the same effect is produced by adding to the other side. 280 — 211 =69 is transposed to read 280 = 211 +69. 31. This principle of compensation or adding to the weaker side so as to produce equality is a very important one in accounts, as v,'iH be seen when we come to treat of proprietary accounts. 32. The equation of the cash account may be read in several ways. Receipts = Payments + Cash on hand 280 ^211+69 In = Out -|- Remainder 33. In this last form any account representing a property may be read. The increase, by acquirement or otherwise, is recorded on the left-hand side ; on the right-hand side are two things quite at variance, in fact, antagonistic ; one, the decrease of property or of value, the other the resultant or value in possession. 34. Taking the right-hand side of the above equations, we see that the two terms are contrary : 211 is what has been paid out. 69 is what has not been paid out. 280 is all that has come in. Yet the 211 and the 69 are both on the same side. It is neces- sary to discriminate carefully between these two kinds of terms and not to assume that because they are on the same side, they must be congruous. 35. To illustrate another class of accounts, those representing indebtedness, let us select from the twelve items in Figure 9, sonic which imply indebtedness. Such are Nos. i, 3, 5, 7, 8, 10 and 12. I, 3 and 7 relate to the dealings with A. B., to whom the subject of t'ne narratiy becomes indebted and discharges the debt. 5, 8. 14 Thb Philosophy of Accounts lo and 12 represent the converse relation with C. D. who borrows and repays. As this loan to C. D. is very similar to a piece of property, we will place the positiv elements, the moneys loaned, on the left-hand side and the repayments on the right. (Figure 12) Notice that this is exactly the opposit side to the one on which each transaction is found in the Cash account. This phase will re- appear hereafter. Figure 12. ACCOUNT OF THE INDEBTEDNESS OP C." D. TO ME. Feb. IS March 5 Loaned him Loaned him S3S 12 Apl. 10 " IS Collected Collected $10 20 36. C. D. is called our Debtor, and we are his Creditor. When he discharges the debt in whole or in part, he is also called creditor, by an extension of language ; really he does not become creditor, but merely extinguishes debt. Hence we can make a useful shortening of the heading by merely writing the name of the debtor with the abbreviations Dr. and Cr. With this change the balanced account appears as follows : Figure 13. Dr. C. D. Cr. Feb. IS Mar. 5 Loaned him Loaned him S3S 12 Apr. 10 " IS " 16 Collected Collected Balance $10 20 ■f7 $47 $47 Construction of the Account 15 Again we have the equation Indebtedness Incurred = Discharge of Indebtedness -\- Balance owing or Present Debt or again Indebtedness Incurred = Indebtedness Discharged ■j- Indebtedness not Discharged. 37. The separate items on the two sides are called debits and credits; hence we have another form of the equation Total Debits = Total Credits + Net Debt. 38. These words debit and credit are often applied by analogy to accounts where there is no idea of indebtedness, all entries on the left side being called debits and all on the right credits. 39. The transactions with A. B. are the opposit of those with C. D. ; the subject gets in debt to A. B. and gets out again. As indebtedness to us is entered on the debit side, it would seem that indebtedness by us should appear on the credit side, and as A. B. is truly a creditor, this is quite correct. Discharges of his claim are treated also as debits and thus we can use the same form as in the account of C. D., the difference being that C. D.'s account has the larger total on the credit side and the balance on the debit. Dr. Figure 14. A. B. Cr. Feb. 2 Mar. 3 Apl. 16 Repaid him Repaid him Balance S7S 13 12 $100 Jan. Loaned by him $100 40. As another way of looking at accounts of personal in- debtedness it may be noted that in both accounts, A. B.'s and C. D.'s, the left or debit side is unfavorable to the person named in the heading and the right side is favorable, so that instead of i6 Thb Philosophy of Accounts Debtor and Creditor we might have entitled the sides Against and For Adverse and Favorable To the Bad and To the Good 41. These terms refer to A. B. and C. D. respectivly and to any other debtors and creditors. But as regards the proprietor of the cash account these terms must be reversed and what is favor- able to the person with whom he deals is unfavorable to the pro- prietor and vice versa. So that he would be entitled to write " Against Him " For Him [but for Me]" [but against Me]" 42. In the case of Cash, which is inanimate and cannot owe nor be owed he can still designate the two sides as "[For Me]" " [Against Me]." 43. Seven of the original transactions have now been doubly entered, once in the Cash account and once in some other ac- count; each being in one place " for me " (debits) and in another place "against me" (credits). As the effect upon "Me" is neutralized in each pair, it is unnecessary to keep any account with " Me," as far as they are concerned. 44. But there are five remaining entries which appear to con- cern " Me " alone; Nos. 2, 4, 6, 9 and 11. We may open an ac- count with " Me " and, following the precedent already establisht, place these five transactions each on the opposit side to where they appear in Cash account. " My " account may be headed " Against " and " For " just as if " I " were a stranger. We shall see by trial how this will turn out. Against Figure 15. ME For Feb. 2 Feb. 14 ApL 16 Expense Expense Balance $49 27 74 Jan. 31 Feb. 28 Mar. 31 Salary Salary Salary $50 S° S° $150 $150 45. " My " account shows a balance of $74 of preponderant in favor. Construction op thb Account 17 This balance is different from that of any of the other ac- counts. It does not represent property, nor indebtedness, but pro- prietorship. It shows the increase in wealth caused by income being greater than outlay, which has resulted in a present status of $74 net worth. 46. This is strikingly corroborated by an independent opera- tion. Extracting the balances of all the other accounts, we make up this statement : Cash on hand $69 Due from CD 17 $86 Less due to A. B 12 Net worth of " Me " $74 Thus by two different processes we obtain the same result : one by an historical account, tracing the growth of wealth by excess of earnings over expense, the accumulation of net surplus ; the other not by a current account but an instantaneous one, which at a given moment inventories the concrete results of the same struggle. 47. The summary of balances which was given above is usually presented in account form. On the left are the assets con- sisting of property and claims upon property. On the right are first, all claims against the assets, designated as the liabilities: second, the remainder unclaimed, or the net assets free from lia- bility, variously known as proprietorship, capital, stock or simply by the name of the proprietor. This statement is known as a balance sheet. Figure 16. BALANCE SHEET. Assets Cash on hand . Due from C D. Liabilities Due to A B . Proprietorship. , $12 74 $86 1 8 The Philosophy of Accounts 48. I can see no benefit in lumping the $12 and the $74 to- gether and calling them all liabilities. Those who use this ex- pression often contradict themselves by saying that the pro- prietary account is the excess of assets over liabilities ; but if the proprietary account is one of the liabilities there cannot be any excess. 49. This miniature specimen shows the relation and inter- dependence of accounts. They are not isolated but each is con- nected with others. When they form a system which provides for the recording of all occurrences within a given sphere of pro- prietorship they constitute a ledger, the embodiment of whose results is the balance sheet. 19 CHAPTER IV The Transaction Equation op the Bai,ance Sheet — Equation of the Transaction — Six Occurrences, op which Every Transaction Must Contain At I,east Two — Exampi,es of Each — Anai£ proprietorship are credits and decreases are debits. The Transaction 21 58. We have therefore the six possible occurrences distributed as follows under debits and credits. Debits. Credits. Entries on left side. Entries on right side. Increase of Assets. Decrease of Assets. Decrease of Liabilities. Increase of Liabilities. Decrease of Proprietorship. Increase of Proprietorship. 59. We have now to show that in every transaction at least two of the occurrences must appear and that they must be on opposit sides of the above list. This may be done by going thru the list and taking up each of the six. ( 1 ) Increase of Assets. Suppose cash to be received ; unless some other asset is given in exchange, or some liability discharged, our total worth must have increased by that much. Thatjs^ to say, (debit) Increase of assets must either correspond ~ •?.'>- ( to decrease of assets, (credit)-; to increase of liability, or I to increase of proprietorship. We cannot get something for nothing ; but the sopiet^iing given in the third case is not a material something but a service &i< some kind. '^Lh}!^ Increase of proprietorship by giving service is called earnings or income. (2) Decrease of Assets. If we part with any of our assets, unless we either receive in return some other asset of equal value or cancel some liability thereby, we have to the same extent diminished our net wealth or proprietorship. (credit) Decrease of assets must either correspond ( to increase of assets, or (debit) J to decrease of liability, or I to decrease of proprietorship. In the third event we have parted with something of value without any tangible return. This is called outlay. There is a true return but it is in service received ; as services are not listed in our assets, any more than our bodies, our minds and our skill, we must consider that the result is a simple subtraction from our net wealth. 22 The Philosophy of Accounts (3) Increase of Liabilities. If we run into debt, unless we get something for it, or, what is just as good, get out of another debt, we must so far as our tangible wealth is concerned have lost proprietorship. As increase of liability is of exactly the same effect as decrease of assets, we have a series similar to the second one. ^credit) Increase of liability must be attended either ( by increase of assets, or ^^DEBIT) } by decrease of liability, or I by decrease of proprietorship. 4. Decrease of Liability. The payment of debt may be efifected by parting with some asset, or by incurring a new debt; or if by neither of these means, but by giving services, then the net wealth is augmented, just as in increase of assets. (debit) Decrease of liability involves either i' decrease or assets, or (credit) -| increase of liability, or I increase of proprietorship. (5) Increase of proprietorship. We may increase our wealth in the form of more assets or of less liability, both of which are debits. (credit) Increase of proprietorship corresponds to increase of assets, or decrease of liability. It may possibly correspond to a decrease of proprietorship, but this would be an ideal shifting or transfer entry. Thus, a sawmill being one of our assets, and it being desired to keep the earnings of sawing separate, we consider that the real estate, if let to a tenant, would bring a certain rent : we credit that rent as earnings of real estate but debit it as outlay on behalf of the saw- ing enterprise. (6) Decrease of Proprietorship. This is precisely the con- verse of the preceding and requires no further argument. (debit) Decrease of proprietorship is either . f decrease of assets, or ^"^ ' / increase of liabilities. (debit) J The Transaction 23 It is thus establisht that any entry to the debit, or left side, calls for a like amount on the credit side, and vice versa. 60. A few examples may serve to indicate how transactions may be analysed into the debits and credits of which they are composed. ( I ) I purchase merchandise for cash. There is an increase of assets in the department of merchandise. There must therefore be a corresponding decrease of assets, or an increase either of liability or of proprietorship, one of the three occurrences on the credit side. Evidently the first of the three is the true one and the entry is of the form Dr. Increase of Assets Cr. Decrease of Assets In the abbreviated wording ordinarily used this would read. Assets Dr. to Assets But usually we specify more minutely what particular depart- ment of the assets, and consequently what account, is affected, i. e. : Merchandise Dr. to Cash This is still further shortened to Mdse to Cash or Mdse/Cash It is understood that without special designation the account on the left is the one debited and the one on the right is credited. The view might very rationally be taken that as the proprietor- ship was increast by acquiring the merchandise and was decreast ■ by parting with the money, therefore the two changes of pro- prietorship should have appeared in the account, giving the following entries: Mdse/Proprietor Proprietor/Cash But it seems useless to record in the proprietor's account ex- changes which do not either increase or decrease his net wealth. This is attempted in the system of logismography, but its utility is doubtful. (2). I purchase merchandise from John Jones on credit. As the acquisition of merchandise is a debit, we must select from the three kinds of credit and get the result : Dr. Increase of Assets Cr. Increase of Liability Assets Dr. to Liabilities Mdse/John Jones 24 The Philosophy of Accounts (3) Received cash for salary. As cash is received, the debit must be an increase of assets. What is the credit? No asset figuring in the balance sheet has been diminisht; no indebtedness has been incurred. The result is a clear increase of proprietor- ship, earned by the rendering of service. Dr. Increase of Assets Cr. Increase of Proprietorship Cash/Proprietor But it is seldom that the account of the proprietor receives im- mediate credit for an earning. Greater benefit is derived by pro- viding a number of temporary accounts which are credited with earnings on a plan of classification, during a certain period, so that a comprehensiv view of the progress of the proprietor dur- ing that period is afforded. This transaction would doubtless be credited to Salary account. Cash/Salary (4) We hold a mortgage which is not yet due for several years. The interest is due every half year. One month has elapsed since the last maturity and collection of interest. Wish- ing to bring our accounts down to date, how shall we represent the fact that this one month's interest has been earned ? It might be claimed that there has been no income because the payment of interest has not yet become due. But by the same reasoning it might be proved that there is no mortgage debt, for that is not yet due. There is in fact an indebtedness from the mortgage debtor to us. It grows from day to day, tho it may not be convenient to register it every day. It is an asset which has been acquired during the month, not by exchange for some other asset, but by rendering service. The service rendered is the use of our capital. Tho the indebtedness from the mortgagor to us is a personal debt, yet it does not rest solely upon his credit, but upon the security of the real estate. It is for several reasons advantageous to consider it as a special kind of asset and not class it with other debts receivable. The increase of proprietorship caused by ser- vices given of this particular kind may also have an account by itself. Thus we analyze the transaction as follows : Debit. We increase our assets by acquiring a claim for this accrued interest in addition to the principal debt. Thb Transaction 2.5 Credit. We do not diminish any asset nor incur any liability by doing so ; therefore we have an increase of proprietorship thru the giving of service : Accrued Interest/Interest. or Interest Earnings. (5). We receive in payment of a debt partly cash and partly a note, or written promise to pay. Suppose that the debt is $200, the cash $50 and the note $150. Two kinds of assets are acquired, and one kind is parted with. We may consider this as two transactions or as one : Cash/John Jones Bills Receivable/John Jones or Cash/ Bills Receivable/John Jones or in the old phraseology. Sundries Dr. to John Jones 200 Cash 50 Bills Receivable 150 61. It is not difficult to analyse a transaction into its debits and credits, if we recall the six possible phases, three of debit and three of credit. $50 50 150 ISO 50 150 200 26 The Philosophy oh Accounts CHAPTER V The Bai^ance Sheet Its Importancb — its Constituents — How Constructed — By Ik- VKNTORY — By Derivation — Adjustments — Minuteness and comprehensivness to be reconciled — group accounts — a Specimen Bai^ance Sheet — Extended Meaning of " Debtor " AND " Creditor " — The Reverse Method op Presentation — Equation of the Bai,ance-sheet — Its Limitations — Order OF Arrangement — Partnership Bai,ance-sheet — Corporate Bai,ance-sheet — One-sided Form — Business without Bai<- ance-sheet — Municipal Accounts 62. The Balance Sheet may be considered as the groundwork of all accountancy, the origin and the terminus of every account. 63. The balance sheet of proprietorship is a summing-up at some particular time of all the elements which constitute the wealth of some person or collection of persons. It must comprise : (i) The values of assets, consisting of property and claims, to which the person, or collection of persons, has title ; (2) The values of the claims existing against the assets and which m.ust be satisfied from them ; and (3) The value of the residue after subtracting (2) from (i) and the respectiv proprietary interests in that value. (i) = the sum of (2) and (3), and it is customary to place (2) and (3) together on the same side of an account. (2) and (3) instead of being of the same nature (as is sug- gested when (3) is reckoned among the " liabilities ") are sharply antagonistic. 64. The total value of the assets (not the assets themselves) is divided into two portions : The portion subject . , , . „, . , , • i to outside claims. The portion not subject The Bai^ance Sheet 27 65. There are two ways of constructing the balance sheet. (a) By actual investigation of quantities and prices of assets, and of extent of liabilities ; also of distribution of proprietorship. In inaugurating a system of accountancy for a concern which has had no suitable accounts this is the only way. It may be called the inventory method. (b) By tracing the changes of values from the preceding balance sheet thru the accounts, and collecting the resulting balances. This may be called the method by derivation. The former method is entirely independent of the books of account, the latter is entirely dependent on them and on their supporting vouchers. 66. If the books could be perfectly kept, the results would be the same by either method ; just as the location of a ship by dead reckoning should theoretically coincide with that obtained by observation of the sun. We know that practically they always vary; and practically no system of accounts is so minutely accurate or so presciently devised as to take account of all changes and contingencies. 6y. In practice, the two methods of constructing the balance sheet must cooperate. The results derived from the current ac- counts must be subjected to the scrutiny of valuation and even if they are purely matter of account like indebtedness, they should be verified by evidence from the negotiant whose interest in the balance is adverse to ours, or from an impartial source. 68. In the current work of accounts many records are pro- visional and intended to be subject to adjustment later. As the work must go on without interruption, there is necessarily a de- gree of roughness which can be corrected in the following balance sheet and which until that time does no harm. Hence to make the balance sheet as nearly perfect as possible adjustment must be made. 69. The question now arises, should these adjustments be effected by supplementary entries in the current accounts or should they be ignored in the regular books and only appear thru their influence on the balance sheet? 70. I should decidedly prefer the former course as making the results of valuation and derivation coincide ; at least for a balance 28 The Philosophy of Accounts sheet which is intended for the information of the proprietors. Where a balance sheet or report is required by some outside authority, it may be that the point of view required is so alien to that assumed in the accounts themselves that no adjustment is practicable; they are constructed on a diiferent basis. Never- theless, even in this case the specially made adjustments should be left on record so that every figure in the report may be traced, if need be, to some figures of the books. 71. While every account is tributary to the balance sheet, yet it is very seldom that each account is represented by a separate balance. . The balance sheet is almost always condenst by group- ing into a single item many balances of similar nature. Thus, if the proprietorship has among its assets claims against various debtois, they are not set down at length in the balance sheet AB $ CD EF etc. but are condenst into a single line Sundry Debtors $ 72. This gives a more comprehensive view of the business at the moment, but a less minute one. The minuteness is attained by means of a separate list, or schedule, giving in as full detail as may be required the facts of each individual account, and showing that the aggregate balances equal the single item recorded in the balance sheet. 73. All thru accountancy runs the demand for minuteness and the contrary demand for comprehensiveness. They are generally satisfied by a double presentation. In organizing this, it is most satisfactory to make the condenst balance sheet very condenst so as to give a bird's-eye view of the general character of the busi- ness and to go to the other extreme in the expanded lists, giving all details that can be required. 74. In order to furnish both grades of information, to supply the broad results of the condenst balance sheet and the exact details of the individual accounts, two different grades of ledger may be kept. In the higher or more condenst ledger, accounts are kept with whole groups of assets or liabilities considered as a Thb Balance Sheet 25 whole. For example, if there are among the assets numerous investments on mortgage, there is a single account entitled " Mortgages " in the general ledger while each separate mort- gage has a separate account in a special ledger called the MORTGAGE LEDGER. The balances of the Mortgage Ledger always equal, when aggregated at any given time, the balance of the Mortgage Account in the General Ledger, provided this latter is fully posted. This proviso is necessary because, while the Mort- gage Ledger should always be kept posted to date, the General Ledger may be further condenst by having its debits and credits entered monthly in a lump. 75. These group accounts are artificial. The members have no concert of action and no joint interests. The account exists solely for the convenience of the proprietor. 76. We now give a condenst balance sheet of the affairs of one James Jones in the form ordinarily used in this country, Scotland and Continental Europe : Dr. Figure 19. BALANCE SHEET OF JAMES JONES. Cash $3,506.74 Merchandise 22,166.73 Personal Debtors 15,972.15 Real Estate 10,000,00 ;i,645.62 Mortgage $4,000.00 James Jones 47,645.62 $51,645.62 We have placed the abbreviations " Dr." and '' Cr." over the two sides which is the customary, tho not invariable, rule, and we must interpret those expressions. ^7. Looking at the left hand side, we see that it consists of three kinds of property, and a collection of debtors. The property does not owe Mr. Jones anything; it belongs to him. Yet the balances of property are on what we agreed to call the debit side ; there is a close analogy between property actually in possession 30 The Philosophy of Accounts and that which someone is bound to deliver to you; sometimes, as in case of a bank-balance, it may be considered either property or debt receivable, at will. Let us, therefore, extend the mean- ing of the word debtor so that it means, when speaking of prop- erty, " belonging to," " the property of." To be consistent, the meaning of " creditor " must be extended correspondingly so that it means " owner of," as well as " owing to." 78. With these extended meanings, we may re-write the balance sheet with interpretations. Figure 20. BALANCE SHEET OF JAMES JONES. [Relations of Persons and Property to Him.] Dr. Cr. [Debtors owing him or property belonging to him.] [Creditors claiming from him or his actual ownership.] Cash [belonging to him $3,506.74 Merchandise 22,166.73 Personal Debtors [owing him] 15,972.15 Real Estate [belonging to him] 10,000.00 $51,645.62 Mortgage [owed by him] $4,000,00 James Jones [what he is ■worth free and clear'] . . .^^,6^^.62 $51,645.62 79. Another form of presenting the affairs of Jones is just the reverse of the above. Instead of being the account of everybody else in relation to Jones it represents Jones as he stands in relation to others ; exhibiting him as creditor for what he owns as well as for what is due him, and on the other side what he owes as well as the resultant or that amount which he does not owe. (Fig. 21.) 80. This manner of presentation is mostly used in England — liabilities and ownership on the left, assets on the right. 81. When we say " in account with " between two names, we mean that the former is the debtor on the Dr. side and creditor on the Cr. side. Thus, A in account with B, means that the left hand side of the account is contra A and the right side is pro A, while B in account with A reverses the sides. Thb Balance Shbbt 31 Figure 21. JAMES JONES. [His Relations to Persons and Property.] Dr. Cr. [Showing how he is indebted and [Showing how he is creditor what he is worth.] or owner.] Mortgage [he owes] $4,000.00 [Balance or] Net Capital , 47,64s 62 ;i,64s.62 Cash [he owns] $3,506.74 Merchandise [he owns] . 22,166.73 Personal Debtors [he being the creditor] . . 15,972,15 Real Estate [he owns] . 10,000.00 ;i, 645.62 82. With these interpretations, we may describe these two modes as follows : The American mode represents : THE UNIVERSE IN ACCOUNT WITH JONES. The English mode represents : JONES IN ACCOUNT WITH THE UNIVERSE. It seems to me that the American mode is preferable, for the following reason : " Jones in account with the Universe " has already an account, like the one in Fig. 14, which is a current account, not an instantaneous one; one which does not give a snapshot of his status but the history of how he arrives at that status. It seems to me that to have the instantaneous account and the historic account both from the same point of view is less logical than to assemble the accounts of the universe including that of Jones and show that the result is true. 83. But the mode, or order, is comparativly unimportant ; the really vital thing is that we have an equation weighing assets on the one side against liabilities and proprietorship on the other. Jones expresses the same facts whether he chooses to say " What Belongs to me + what is Owing to me = what is Claimed from me -|- what is Unclaimed." or " what I Owe + vvhat I am Worth = what I Have + what I Claim " ; whether he writes in the third person or in the first. 32 The Philosophy of Accounts 84. The balance sheet has limitations. The personality of the proprietor, his skill, his experience, tho important elements of his capital, can never be brought into his balance sheets. They cannot be bought nor sold and they only make themselves manifest thru the services which he does sell. 85. The assets of the balance sheet consist solely of material factors outside of the proprietor, or of rights over others ; in other words, of material things now in possession and of material things which shall be in possession. 86. The " Me " account, which almost invariably occurs, re- ceives various names, and these indicate a feeling of difference between this account and the others. There is in fact a profound difference as between soul and body; between any man's Ego and Aliquis. The most usual title for a sole proprietor's account is probably JAMES JONES, CAPITAL ACCOUNT. Another form is simply CAPITAL [account]. The objection to this is that all, or nearly all of the assets are capital in the economic sense ; the man or the group of men use both loan-capital and their own capital for their profit. If we are careful to discriminate between the bookkeeper's " Capital " account, and the economist's " Capital," no harm is done. If " James Jones' Capital " account is spoken of, this con- fusion is avoided. So it is if we borrow from the economist the terms, capital-balance or net capital. 87. Stock is an old-fashioned word for the same meaning, but is now seldom used except as to corporations. 88. James Jones, proprietor or James Jones, proprietary, would seem appropriate forms of speech for this purpose, tho not much used. 89. The arrangement of the items in the balance sheet is of some importance especially if the list is voluminous. There should be some governing principle applied thruout if possible. In our example the order of availability has been followed, or, as it might be termed, the order of liquidation. Those assets are given first which are most readily convertible into cash. On the other side, those liabilities should first be stated which must first The Balance Sheet 33 be met, and lastly the proprietary interests which are entitled to no fixt sum but to " what is left." 90. It is not certain in any particular case that this order of presentation would be the best to follow. In an industrial enter- prise where it was thought that productivity or earning power was more important than readiness in debt-paying, it might be that the fixt plant was entitled to the first place among the assets and that the cash on hand would be placed at the end as the least productiv of assets. But, at any rate, some principle of arrangement is better than haphazard. 91. Let us now assume that James Jones whose balance sheet we have exhibited associates with himself William Smith as a partner under the firm name of Jones & Smith ; also that Smith contributes a net proprietary interest of $23,822.80, viz., the following assets: Cash $5,082.34 Merchandise 17,082,65 Personal Debtors 8,123.17 Bills Receivable 7,000.00 $37,288.16 subject to the following liabilities : Bills Payable $8,000,00 Personal Creditors S.46S-3S $13,465.35 92. The firm of Jones & Smith is a unit in mercantile affairs. The assets belong now to both jointly; the debts have been as- sumed by both and both are responsible for their payment. A new business entity has been created distinct from Jones and from Smith ; it is a collectiv unity but a real one. Prof. Irwin Fisher in his " Nature of Capital and Income " says that it is a " fictitious person holding certain assets and owing them all out again to real persons." In this I think he has been misled by the lazy habit of bookkeepers in calling all the credit balances liabili- ties, altho they know that some of those balances are not liabilities. Even admitting that there is a fictitious entity it owes nothing to the real owners. It merely is a composit ownership which again is owned in various shares by real owners, and has nothing to do with debt. 34 Thb Philosophy of Accounts 93. The copartnership of Jones & Smith has a status at this moment ; it therefore has a balance sheet. In this, the proprietor- ship may be represented jointly or distributivly, as may be pre- ferred. The former would be preferable for an outward balance sheet, such as to a mercantile agency, or in applying for credit; the latter for information of the partners. (Figures 22 and 23.) Figure 22. BALANCE SHEET OF JONES & SMITH. Cash Merchandise Bills Receivable Personal Debtors Real Estate $8,589.08 39,249.38 7,000.00 24,095.32 10,000.00 $88,933.78 Bills Payable $8,000.00 Personal Creditors S. 465-35 Mortgage Payable 4,000.00 Jones & Smith (the firm's capital) . . .71,468.43 $88,933.78 Figure 23. BALANCE SHEET OF JONES & SMITH. Cash Merchandise Bills Receivable Personal Debtors Real Estate $ 8,589.08 39,249.38 7,000.00 24.095-32 10,000.00 $88,933.78 Bills Payable Personal Creditors Mortgage Payable James Jones William Smith $0,000.00 5.465.35 4,000.00 47.645-62 23,822.81 $88,933.78 94. Let it be supposed that Messrs. Jones & Smith, instead of a partnership, had preferred to form a company, named the Jones Mercantile Company. They ronsider that, as the actual value of their joint proprietorship is over $71,000 it would be quite proper to capitalize it at $60,000, in 600 shares, of $100 each. Nevertheless, there is a total proprietorship of $71,468.43, as before, all of which must be represented in some form. In order to represent both the amount of the capitalization and the true proprietary value, we divide the total proprietorship into two parts : — Capital: par, or face value of shares $60,000.00 Surplus: excess of real value over par 11,468.43 Their sum is the real proprietorship The resulting balance sheet would be: — $71,468.43 Thb Balance Shebt 35 Figure 24. BALANCE SHEET OF THE JONES MERCANTILE CO. Cash $8,589.08 Merchandise 39,249.38 Bills Receivable 7,000.00 Personal Debtors 24,095.32 Real Estate 10,000.00 $88,933.78 Capital Stock $60,000.00 Surplus 11,468.43 Bills Payable 8,000.00 Personal Creditors .... 5.465-35 Mortgage Payable 4,000.00 $88,933.78 95. The anomaly, not infrequently occurring, of ranking the capital and surplus before the liabilities may originate in the fact that a new corporation begins with capital stock and assets before contracting liabilities. It would seem more rational to place the proprietary accounts after the Habilities. 96. Another kind of business entity is now introduced, a coiiectiv body but still personal and real. The fictitious feature is the nominal or par value of shares. Jones holds 400 shares out of 600 ; this does not express the value of the shares but merely the proportion which they bear to the entire proprietorship. The true value of Jones' shares is not -^22. of $60,000, but -^^ of the ■^ 600 r } ) (jQQ entire $71,468.43 or whatever the true value may turn out to be. The book value of each share would be $119.11405 and this would vary with the ups and downs of business. 97. A distinguisht publicist, Edward M. Shepard, has recently argued that it would be better if no nominal value at all were attacht to shares of stock, if each merely represented the -^ or the ~ part of the entire proprietorship. There could then be no such thing as watering, or its opposit. "■?,. As it is, however, the true net value of the concern is artificially split into two parts in order to exhibit the nominal capitalization. This is convenient for several reasons. The law generally strives to make the nominal capitalization conform to the cash originally invested. The nominal value of the share is a convenient basis for stating dividends by percentage. In some kinifi of corporations, also, as insurance companies, the value is required to be kept up to at least the par of capitalization. In others, as national banks, shareholders are guarantors of solvency up to the par value of their shares, after those shares have fallen tc ?ero. 36 Thb Philosophy of Accounts 99. The selling value of the shares should be, apparently, the book value of the assets minus the liabilities. Yet, no matter how accurately the assets may be valued and the liabilities ascertained, it is very seldom that the selling price corresponds to the book value. The reason may be that while the assets are sufficient for liquidation at the book value, they are not handled with the success which will earn the average rate of dividend. This may be from lack of skill, from unfortunate location or some other disadvantage. But the purchaser is trying to buy future income, and will not invest unless he sees a prospect of getting it. On the other hand, the management of the business may be so successful that its earning power is greater than the average per dollar and if this is appreciated it will command a premium greater than the surplus. 100. The two sided, debit and credit form is not invariably the best for the balance sheet. To place the assets, liabilities and net proprietorship one below the other is a very clear way of pre- sentation, and admits of various orders of sequence, and of any process of summation. Figure 25. Net worth of investment $71,468.43 Liabilities 17,465.35 Total Assets $88,933.78 Detailed Baiance Sheet. Capital Stock, 600 shares of $100 $60,000.00 Surplus 11,468.43 Net value of investment $71,468.43 Assets: Cash $8,589.08 Merchandise 39,249.38 Bills Receivable 7,000.00 Personal Debtors 24,095.32 Real Estate 10,000.00 Total assets $88,933./^ Liabilities : Bills Payable $8,000.00 Personal Creditors S.465.35 Mortgage Payable 4,000.00 I'otal Liabilities $17,465.35 Thb Balance Sheet 37 lOi. We have said that there are certain assets, such as skill and experience which, in practice, never appear in the balance sheet. As a consequence there may be persons or business entities which have no balance sheet. An individual receiving a salary for his skill in some particular function and expending it exactly as fast as it is received, needs no balance sheet. His skill is a non-ledger asset, and he accumulates nothing concrete. If he does " get ahead " or " get behind " to a slight extent he will have assets and liabilities which will give rise to a balance sheet; but this will be insignificant in comparison with the non-ledger assets of personality + skill. Nevertheless he requires outlay and in- come accounts, for he receives and gives services emanating from these non-balance-sheet assets. 102. A municipal corporation is in a similar position. Its principal asset is its power of confiscating the property of its mem- bers and others within its limits, thru taxation, to an extent which can not be valued, but which is measured by the needs, as legally ascertained, of its members. In theory it is merely an agent for converting property into service. It has assets and some of them can be valued ; but the most important ones, like highways, yield public and non-measurable service. It has liabilities also; but no balance can be struck between its assets and its liabilities which will define its status to any instructiv purpose. Lists of its assets so far as ascertainable are valuable ; lists of its liabilities are even more so; but its proprietorship cannot be reduced to dollars and cents and hence its balance sheet is non-existent. The highest function of municipal bookkeeping is the coordination of revenue and expenditure, of sacrifice and service. (See Maclnnes, on Municipal Balance Sheets.) 103. Having thus establisht the foundation of the balance sheet, we will proceed to the analysis of its components, Assets, Liabilities and Proprietorship, all three of which are usually but not invariably present. Of these the most concrete and tangible are the properties and rights constituting the assets ; next are the deductions or reservations therefrom known as liabilities, and finally, existing only as a relation, is the still more abstract conception of proprietorship. 38 The Philosophy of Accounts 104. The credit side gives the distribution, not of the actual assets, but of their value, while the debit side divides them accord- ing to their nature. No one asset need correspond to any par- ticular liability. The assets and liabilities taken together, the former being tangible and the latter definit, constitute the specific values which are the subject of the specific accounts. 39 CHAPTER VI Phases of the Assets Things and Rights — Intbrconvertible — Uncompleted Contracts — Embodiment op Services Given — Storage of Services TO BE Received — Capital — Investment. 105. The specific values on the asset side of the balance sheet are of two classes : 1. Things. 2. Rights. Or we may say Or again, 1. Things belonging to us. 2. Debts owing to us. 1. Possessions. 2. Expectations. We shall see upon examination that these classes imperceptibly blend into each other and that every asset may be lookt upon either as a " thing " or as a " right." Possession of a thing is merely the right to use it and control it. Therefore all our " things " may be lookt upon as merely rights of dominion. We look upon our cash as a thing and as one of our most concrete assets. Yet the greater part of it is usually in bank deposits, which are merely the right to receive money on demand or to transfer such right to any one who will accept it instead of money. But excluding bank deposits as not being money, we may hold bank-notes or greenbacks. These are nothing but printed agreements conferring the right to re- ceive money, which is seldom called for. Finally, the coin, even if of the standard metal, is value in possession. Yet, unless we are jewelers, we do not use it. We prize it simply because we have the right under the law to satisfy contracts by parting with it. 40 The Philosophy of Accounts 1 06. Thus things convert themselves into rights, and the re- verse is true: rights are convertible into things. Rights are but the future tense of things. Not only this but they are almost always secured by things. The personal indebtedness which we list in our assets is generally based upon the goods which wert ours but which we have sold. We feel that they are still in existence as morally ours until paid for. We have trusted the purchaser for the reason that he owns these and other goods which will more than satisfy our claim. Thus all rights rest ultimately upon things, either present or expected. 107. But rights are sometimes materialized into a kind of artificial things, especially when they are evidenced by some ma- terial thing, such as a written document. A mere debt is seldom thought of as a thing in possession, while a note, which is a written acknowledgment of the same debt, is lookt upon as some- thing valuable in itself, because it can be toucht and handled. Especially is this true of bonds, mortgages, etc., formal docu- ments, usually transferable, which create the illusion that they are actual property, not merely the symbol of a debt. On the other hand, things are sometimes personified into personal debtors, and the whole system of assets and liabilities is converted into a set of debts either receivable or payable. It is feigned that the cash account is the account of the cashier ; he is indebted for all the receipts and credited for all the payments. Similarly the warehouseman is regarded as owing for all the merchandise, the land agent for all the real estate; regardless of the fact that there is no actual indebtedness, since these cus- todians take no title to the things. Neither the shepherd nor his dog is in debt for the sheep. 108. These extremists, who have tried on the one hand to convert all assets into things, and on the other hand to reduce all things to personal debts, have had long discussions, especially in Italy, dividing themselves into the two camps of the materialists and the personalists. Apparently it has not occurred to these controversiahsts that in truth some of the assets are of the one and some of the other nature, and that many may be lookt at in either phase ; furthermore that so long as the nature of the asset and its form of account are understood, it is needless to twist it Phases op the Assets 41 into the shape of some other asset. To seek the truth and follow the facts is safer than to compress everything into the mould of a " theory." 109. Rights always arise from uncompleted contracts. No man owes you unless there has been a contract, tacit or exprest, oral or written, for him to give you something and for you to give him something. If one of you has fulfilled his part of the contract, that one has acquired a right and the other has incurred an obligation. The contract may be a mere understanding with- out words, or it may be duly signed, sealed and witnest. no. In another aspect all assets are the embodiment of ser- vices previously given ; and in still another they are a storage of services to be received. Some one must have given labor in order to produce any wealth ; but if it will not in the future command the services of labor, or save the expenditure of labor, or of its embodied results, it is worthless and not wealth at all. 111. Yet the values resulting from these two aspects are only approximately equal. On the one hand, the services which were given may have been sold for more or less than a just price as settled by competition ; consequently the assets received for the services may be less or more than the future services receivable. The whole economic struggle (reducing everything to terms of service) is to sell one's own services high and buy the services of others cheap. On the other hand, a disservice (to use Prof. Fisher's word) may have occurred thru various causes, so that the services once anticipated appear impossible of entire realiza- tion. It must be observed that the aspect of assets as the present worth of future services is entirely based upon opinion, while the aspect which regards them as the resultant of services given is based upon facts. 112. Capital is defined by economists as that portion of wealth which is set aside for the production of additional wealth. In the balance sheet of a business concern, frequently, all the assets are capital, being employed as tools for its operations. There may be other assets, called investments, where the actual hand- ling of the tools is turned over to some one else and the value receivable for the services is returned in cash or other assets. This is exemplified in the ownership, by corporations of the shares or bonds of other corporations. The physical assets 42 The Philosophy of Accounts underlying these securities are used as tools by the corporation issuing them, rather than by the one owning them. Yet in a remoter sense such vicarious assets may be considered as capital ; for example, their possession may be a safeguard against some contingency or a reserve of strength. Hence it is easy to accept the view of Prof. Irvin Fisher, that all assets are capital.* 113. To summarize this chapter, the assets comprising the debit side of a balance sheet may be considered in one or more of the following ways : (i) As things possest, directly or indirectly, or physical assets. (2) As rights over things and persons, for use, for services, or for exchange. (3) As incomplete contracts, whereof our part has been per- formed in whole or in part; or contractual assets; (4) As the result of services previously given, or cost; (5) As the present worth of expected services to be received; (6) As capital for the conduct of business operations ; or (7) As investment in the hands of another who uses it as capital. 114. The special case in which certain assets are devoted to the payment of certain liabilities will be treated under liabilities in the next chapter. *ln the "summation of capital," Professor Fisher eliminates, by cancellation, the se- curities of one concern held by another, as they cannot furnish capital to both; which approximates to the distinction in the text. 43 CHAPTER VII Phases of Liabilitiks Nbgativ Assbts — Postponed Dkcreasb oe Assets — Rights ob Others — Uncompleted Contracts — Loan Capital — Assets Corresponding to Certain Liabilities — Some Seeming Liabilities, Actually Offsets — Liabilities do not Shrink. 115. As we pass from the asset side of the balance sheet we seem to leave the actual and concern ourselves with the ideal, the objectiv gives place to the subjectiv. While the asset side contains concrete actualities, the other side deals with the distri- bution of these actualities among those who have the title to them and those who hold claims against them, the liabilities. 116. In algebraic language we may say that liabilities are negativ assets and that proprietorship is measured by the alge- braic sum of all the assets positiv and negativ. Another way of expressing this phase is that the liabilities are postponed decreases of the assets ; a future diminution having the same effect on the net proprietorship as a present diminution. 117. The liabilities may to some extent be lookt upon in aspects corresponding to those stated for the assets, altho they never represent concrete property. As rights, they are the rights of others against us and our property, just as the assets are our right against others. Considered as uncompleted contracts, they are those in which our part of the contract is the part unfulfilled. As capital, they represent that portion of the total capital which has been furnisht by others, or loan-capital. 118. Ordinarily there is no designation of certain assets as destined to meet certain liabilities, but any or all of the assets may, upon default, be expropriated to a sufficient extent to pay any liability. The word assets, meaning enough or sufficient, suggests this view of their nature from the point of view of the creditor. There are cases, however, where definit assets are 44 Thb Philosophy of Accounts paired off against definit liabilities, in such a way that these par- ticular assets cannot be parted with unless the liability (which is said to be secured) has first been paid. A familiar example is the mortgage on real estate. The title is in the owner ; the real estate stands in his balance sheet as an asset; he has full dominion over it ; he can collect the rent from it and can even sell the prop- erty subject to the paramount rights, or Hen, of the mortgage. The status of the property would be as follows, for example : Value of Real Estate . . . . . $10,000 Equity 6,000 $10,000 $10,000 The true proprietorship in the real estate is the " equity " in the above balance sheet, and this is all that the owner can really sell. Hence, instead of calling the entire $10,000 an asset and the $6,000 a liability he sometimes prefers to eliminate the liability and treat the equity as a net asset. Equity in real Estate. Value $10,000, Mortgage $4,000 The word equity in the balance sheet is taken in the pro- prietary sense ; here, in the sense of an asset. 119. Similarly, other assets are pledged to the satisfaction of liabilities and usually some steps are taken to prevent the owner from alienating the asset to the detriment of the pledgee. The United States Government takes from national banks their bonds as security for the redemption of circulating notes guaranteed by the Government. Assets. U. S. Bonds to secure Cir- culation Liabilities. Circulation (Notes out- standing) The ordinary loan on collateral is another example of an asset paired against a liability. Phases of Liabhitibs 45 120. While there is this correlation between assets and lia- bilities taken in pairs, there is seldom exact identity of value. The asset is always taken, or intended to be taken, larger than the liability, for prudential reasons; so that there is a residue above the liability such as the equity in the mortgaged property or the margin in the loan on collateral. 121. Many seeming liabilities are more properly defined as deductions from certain correlated assets; of this we shall speak more fully under the head of offsets. 122. While assets may shrink in value, that shrinkage affects the proprietorship, never the liabilities, which must be regarded as rigid and inelastic. 46 The Philosophy of Accounts CHAPTER VIII Proprietorship Phases oif Proprietorship — As Rights — Distinction Between Liabilities and Proprietorship — As Service — As Capital ; Own-Capital — Fictitious Methods of Presentation oe ASSETS, Liabilities and Proprietorship — Cash Theory — "The Business" Theory. 123. The proprietorship may, like the liabiHties, be viewed in the same phases as the assets, all excepting that of " things." Where there are any liabiHties, no list of things can be drawn up which represent the proprietorship because the liabilities may be canceled by disposing of whatever assets are chosen for dis- posal by the proprietor. But if there are no liabilities whatever, the sum of the assets is the total proprietorship. Let us agree in the balance sheet at Figure 18, that the mortgage shall be stricken out and the value of the equity alone be carried as an asset. There being then no liabilities, the proprietorship is simply the sum of the assets and the balance sheet needs but one side. Cash $3,506.74 Merchandise 22,166.73 Personal Debtors 15,972.15 Equity in Real Estate 6,000.00 Capital $47,645.62 The last line is proprietorship ; it is capital in both senses, the bookkeeping sense and the economic sense. 124. As " rights," however, the proprietorship may be viewed. The assets being regarded as composed of rights against others and the liabilities as others' rights against us, the excess of rights in our favor is the proprietorship. 125. Thus the right-hand side of the balance sheet is entirely composed of claims against or rights over the left-hand side. " Is it not then true," it will be askt, " that the right-hand side is entirely composed of liabilities? " The answer to this is that the PROPEIETORSHIJP 47 rights of others, or the liabilities, differ materially from the rights of the proprietor, in the following respects. (i) The rights of the proprietor involve dominion over the assets and power to use them as he pleases even to alienating them ; while the creditor cannot interfere with him or them except in extraordinary circumstances. (2) The right of the creditor is limited to a definit sum which does not shrink when the assets shrink, while that of the proprietor is of an elastic value. (3) Losses, expenses and shrinkage fall upon the pro- prietor alone, and profits, revenue and increase of value benefit him alone, not his creditors. For these reasons the proprietary interest cannot be treated like the liabilities and the two branches of the right-hand side of the balance sheet require distinctly treatment. 126. Considered as the effect of service, the proprietorship is the expression of how much more service has been given than received. Considered as the embodiment of future service it represents the net value of the service which the proprietor has a right to expect without giving any further service of his own. 127. Considering all the assets as capital, the proprietorship is that portion (in value) of the capital, which the proprietor furnishes as distinguisht from the portion which he induces others to place in his hands for utilization, or the liabilities. 128. Before collecting the various phases of the assets, lia- bilities and proprietorship into a systematic whole, it may be well to mention two somewhat fictitious methods of presentation, each introducing an intermediary element which disappears by cancellation. 129. In the cash theory, every transaction is supposed to pass thru the phase of cash. There is no direct exchange of any asset for another asset, but it is assumed that cash is received for the former and at once paid for the latter. Thus a sale of mer- chandise on credit is represented as a sale for cash accompanied by a loan of the cash to the purchaser. Purchaser/Mdse becomes Cash/Mdse Purchaser/Cash. 48 The Philosophy of Accounts 130. A very large number of the transactions are genuinely cash, and it is evident that the others may be separated into two each, one involving a receipt of cash and the other an expendi- ture. Without at present dwelHng on this, we may conclude that any asset, except cash itself, may be considered to have cost money, and that any liability or proprietorship may be considered as having procured money or as being sources of money. The debit side of the balance sheet is transformed into a statement of cash paid, and the credit side into a statement of cash received —a reversed cash statement. * 131. Taking the figures of Figure 23 we thus transform them into the following: Figure 26. BALANCE SHEET OF JONES & SMITH. Proceeds of Cash Paid. For Merchandise $39,249.38 " Bills Receivable .. . 7,000.00 " Personal Debtors . . 24,095.32 Real Estate 10,000.00 " Balance unpaid 8,589.08 $88,933.78 Sources of Cash Received. From James Jones. . . . $47,645.62 " William Smith. . 23,822.81 " Bills Payable. . . . 8,000.00 " Personal Credit- ors 5.465.35 " Mortgage Pay- able 4,000.00 $88,933.78 Jones and Smith are supposed to have paid in to the firm's treasury the sums which each was worth, and the firm to have also borrowed the sums of $8,000, $5,465.35 and $4,000, as stated. The firm then bought with the cash thus acquired the assets of each partner, which restored to each enough to replace in his private treasury the cash he had contributed and also to pay the individual debts, which are now replaced by the firm's indebted- ness. There also remains unexpended a cash balance of $8,589.08. 132. The application of the cash theory to the corporate balance sheet (Figure 24) may serve to explain several things: The facts for which this offers a plausible explanation are the following : *For a special study of the cash account, see Appendix, Monograph A. Propeistorship Figure 27. JONES MERCANTILE COMPANY. 49 Capital and Liabilities. [Cash received from] Capital Stock $60,000.00 Surplus 11,468.43 Bills Payable 8,000.00 Personal Creditors 5.465.35 Mortgage Payable 4,000.00 $88,933.78 Assets. [Cash paid ior] Merchandise $39,249.38 Bills Receivable 7,000.00 Personal Debtors 24,095.32 Real Estate 10,000.00 Cash Balance 8,589.08 $88,933.78 (i) That the Enghsh accountants usually place the assets (cash paid) on the right-hand side and vice versa; this being the natural form of a cash statement. (2) That, as remarkt in Chapter IV, the proprietary ac- counts usually come before the liabilities ; companies being formed by first paying in cash for shares, in form at least. Often this is effected by the giving of checks which offset each other or are endorsed back, but the form is generally observed. (3) That the cash stands last in the list of assets, it being regarded as a balance unexpended. 133. The other theory adopts as its intermediary a supposed entity " The Business." All assets are regarded as " owing " to The Business and The Business is regarded as owing all the " liabilities " in which are included the proprietary claims. This is a favorit theory in this country, and it has this merit that it recognizes that the proprietor or proprietors may have many other investments and do not in the accounts presented reveal anything more than their worth as to The Business. But I can- not see that it justifies the inclusion of proprietorship among the liabilities. Surely The Business does not stand in the same re- lation to its proprietors or its capitalists as to its " other " lia- bilities. It would seem more appropriate to say that it is " owned by " than " owes " the proprietors. 134. On the following page are shown the phases, which the three parts of the balance sheet assume from different standpoints. 50 The Philosophy of Accounts o a Ah 0) L rt^ V S w S « S ui :3 »> CO p "o ^' ,- ^ t3 p (t> g " •" o OJ .& ^ o SS £ +^ < 5 cj (U o is <« 2 bo MJ3 ■•^ £ a ° T C/3 3 S •g c ^ 'Si a. o 01 O OJ ja ^ ;3 o w 3 P3 '3) ' -iJ +J ut-l O bjj ^ o ■+J TJ ^- ^ O o ni ^ > .-ti .a '3 Oh J3 O rt te (DO 3 rt ^ -3 ^ H S O Q 51 CHAPTER IX Offsets and Adjuncts Suppi,EMBNTARY Accounts ; their Purpose — Offsets Against Assets — Adjuncts to Assets — Adjunct to Proprietorship — Offset to Proprietorship Sei,dom Reveai^ba-f > o AfeSj o o I n « o o 6- Z w z M D (K W 94 T^B Philosophy of Accounts columns had been provided in the columnar journal and entitled (say) "Accounts Receivable, Dr.," and "Accounts Receivable, Cr.," the aggregate might be ascertained at any time from the totals of these columns by balancing; the items being also posted to the individual accounts, as noted in the folio columns. 268. To obtain the aggregate balance at the end of each month the balance at the beginning would be placed under the total of the debit column and then the balance struck: Accounts Receivable. Dr. Accounts Receivable. Cr. [Total for month] Balance carried forward [Total for month] Balance brought forward By bringing the previous balance under the column instead of bringing it to the top, wc preserve the monthly total clear and distinct. The same device is also useful in other than columnar books. 269. More usually, however, the monthly totals are posted to a formal general-ledger account as will be explained hereafter. 270. There is danger of overdoing the principle of column- ization. If we attempt to carry too many columns, the necessity of adding them up after a very few entries in each introduces a great many useless figures. In a great number of columns ex- tending a long distance across the page there is danger also of inserting the amount in the wrong column. 271. In a multi-columnar journal there is great waste of space; for with ten columns nine-tenths of each column, on an average, must be vacant. If we get rid of the idea that each Posting Mediums 95 amount must necessarily come exactly in line with its descriptiv entry, we can carry a large number of accounts by the process of side-posting. 272. Suppose an ordinary journal with two money columns only, but occupying the left-hand pages alone, the right-hand pages being devoted to the side-posting or analysis. There are, say, thirty lines to the page. Let the right-hand page be ruled in four columns, two for the analysis of debits and two for the analysis of credits. There will then be sixty lines in which to enter the thirty possible debits, and sixty lines for the thirty possible credits, so that there will be ample room, allowing for names of accounts and for totals brought and carried forward. But the side posting must be done one account at a time, and only when the journal page is complete. Suppose, for example, that we begin with debits to cash. We write at the top in red the amount brought from the previous page; then passing down the journal we post every debit to cash until we have exhausted them, checking each as we do so. When the last has been posted, we either add these debits together in red or leave a line for doing so later. Next we take up another account, say Expense, and pick out all the debits relating to that account. We shall finally have the entire contents of the journal classified into columns, but these will be solid, compact columns, not the straggling ones produced by the ordinary columnization. (See Figure 48.) 273. The loose-leaf principle may also be utilized to classify the journal while retaining its time-honored form. Each fre- quently recurring type of entry may be assigned to a separate page and additional pages inserted as these fill up, so that on the last day of the month it is only necessary to complete the entries by addition, they having already been posted in detail. If, for example, the charging of interest on personal accounts is one of the normal entries regularly occurring, a loose-leaf journal page is headed: " Sundries Dr. to Interest " and each charge of that nature is entered thereon as it occurs, with uniform specifications which may be columnized to suit the requirements. The posting of the debits is kept up day by day. 96 The Phii,osophy of Accounts O <; a < X H K a l5 H M o W Q n o < Pu a z ■< W h H 1-1 PI < (A £^ N O ^>^ « «1 ■* O N 'J- ^*- 0\ 6 00 r^ ^; vo O M H ^ N tOMVO Si, «9 qSBO 1 Qsuadxg CJ ft Posting Mediums 97 As the pages fill up, others are inserted and the additions made continuous to the end of the month when the compound entry is completed. 274. In this way, we have the same results as in monthly journalization, without the delay incident to that plan (Arts. 258, 259). But in the rigidly bound book, this would have been impracticable as the space required for each class of entry could not be predetermined ; if too much space were allowed, there would be waste ; if too little, confusion and intermingling. There is an elasticity which is of great advantage in the modern method of first preparing the sheets and then binding them into books, rather than binding first and then accommodating the writings to them. 275. Recurring to the direct posting mediums, or partial journals, such as cash-book and sales-book, it may be observed that in many kinds of business the cash-book may be made to contain all the entries for which the journal has been kept open, as stated in Art. 251, thus completely abolishing the journal. The cash-book is eligible for this office, since it is a complete ac- count, having both sides. A fictitious receipt of money is entered on the one side and is compensated by a fictitious payment on the other side. Thus, in a bank, which pays interest on deposits, the usual formula is Interest/Depositors. But this may, instead of a journal entry, be two cash-book entries Interest/Cash Cash/Depositors as if the bank had paid the amounts of interest to the depositors and they had re-deposited the same. In fact, many banks do actually draw checks for the interest and send them to each de- positor; if the depositor (as oftenest happens) sends back the check endorst for deposit the fact in these banks coincides with the fiction in the former class. Objection may be made to this journalization by means of a pair of cash-entries, that it inflates both sides of the cash-account by the same amount. This how- ever, is not considered a very great evil. Those who are very punctilious as to keeping the cash " pure " may place the amounts of such entries outside of the cash-column to exclude them from gS The Philosophy of Accounts its total, or may write them in colored ink with the same purpose. 276. Where several posting mediums are used, it will happen that there are entries which affect two of the posting mediums. For example, sales for cash, where there is no known person to be charged for the sale and to be credited for the cash. This seems to have presented a difficulty for some writers on bookkeep- ing, and they have set forth two remedies. The one is not to make any entry in the sales^book at all, but to post cash-sales direct to the sales account in the ledger. This makes the sales-book an incomplete record of sales, and destroys the unity of the total sales entry in the ledger. The other way is to establish an ac- count representing the purchasers for cash, entitled, perhaps, '' Cash Sales." This is debited in the usual coursfe from the sales- book and credited from the cash-book. But it seems to me that these devices are entirely useless and that no posting is needed. If we look upon the cash-book as a cash account, the debit to cash is already made; if we look upon the sales-book as a segment of the sales account, that credit is effected. All that is necessary is to mark the cash entry and the sales entry each as the posting of the other. 277. Any " auxiliary " book may almost invariably be treated, not merely as a posting-medium, but as an actual account, or half-account in detail, altho there may be a more condenst account in the ledger. Especially is this view requisit when we consider postings as made from the original papers which represent transactions. QQ CHAPTER XVIT Posting from Tickets Documentary Record — Ticket-posting A Modern Method — Value OP Vouchers — Advantages of Ticket-posting — Suppression OF Details 278. As I have already said, in modern business the primary record of any normal transaction is made on a paper of some kind. These papers for the most part have an evidential value: they are proof of some fact and constitute vouchers between the concern and its subordinates or those outsiders who do business with it — the co-negotiants. The latter are the more valuable, but the highest degree of value in a voucher is attained when it embodies admissions, adverse to themselves, on the part of the co-negotiant in the transaction and of every subordinate who has to do with it; when everyone who is charged with value admits his responsibility, and everyone claiming value defines the extent of his claim in writing. The subject of the voucher is a most important one, especially to the auditor and is con- stantly assuming greater importance. A large part of the busi- ness world is at the stage where the only vouchers recognized are those for cash paid. It is beginning, however, to be gen- erally seen that when cash is received, some other value is given and that an acknowledgment of this other value is desirable ; hence the voucher with cash is coming to be exacted as well as the voucher for cash. For example, a bank files the deposit-slip which is a voucher with cash, as well as the checks, which are a voucher for cash. 279. But this is not the place for the treatment of busines^s papers as vouchers; it Is solely their use as posting-tickets, irre- spectiv of serving as evidence, with which we are now concerned. The use of the ticket as a posting source is a modern develop- ment Forty years ago, altho the ticket existed, it was used only once; it was "written up" in the day-book, or in the journ.il, or in the auxihary, as the case might be, but thereafter it was 100 The Philosophy of Accounts dead. No posting was considered legitimate unless it was from book to book. Even the banks, having written up deposit-slips, remittance letters, checks and drafts in books called " debit-cash " and " credit-cash," posted the depositors' accounts from these clumsy books and not from the easily handled tickets, as is now universally done. 280. The thoro application of the voucher principle results, in a paper for every transaction which occurs, even those known as journal entries. If the auditor finds such a complete set of vouchers, conveniently arranged, he can make himself independent of the books; he can arrive at results which will verify, or dis- prove, the results of the books far more effectually than the old plan of " ticking off " and may readily introduce a different and instructiv point of view by re-classification. 281. In a thoro-going ticket system, the distinction between " writing-up " and posting vanishes and every ticket is simply entered in every place where it should be, at least twice, often more times. The state of the books is just the same as if one of the entries had been made thru a posting medium. It cannot always be told afterwards which process was actually employed. 282. The ticket, or voucher, should have appropriate places for noting the fact of the postings having been made, either by a reference number or letter, or by a check-mark. All tickets of a certain form may in some cases be provided with a serial number so as to determin the order of occurrence if necessary ; or again, when made up from outside, such order of rotation may be denoted by a numbering or dating mechanism, to be applied as they come in. 283. The practical advantages of posting from ticket to book over posting from book to book are as follows : (i) The ticket is brought with the left hand close to the point where the entry is made so that there is no need to rely on memory even for the brief space of time it takes to pass from the page of a book to the page of another book. This brief time is sufficient to cause many errors, from the prototype and the copy not being under the eye at the same moment. Posting prom Tickets toi (2) The tickets may and should be assorted into an order which will go straight thru the ledger without wan- dering back and forth. A great part of the bookkeeper's time is wasted in the physical exercise of turning leaves. This advantage attends also the loose-leaf systems of accounts where a regular consecution can be maintained. (3) As only one of the tickets at a time is exposed to view, the eye does not so easily lead to error by falling upon a wrong amount. (4) Tickets can be distributed and several bookkeepers work on them at the same time; whereas with a bound book one must wait for another. 284. The keeping of the tickets after use requires considera- tion and it is important to instal a good filing system. The simplest is to file by date, and this will do where reference is seldom required. It may be in packages, in envelops, in scrap- books or vertically in drawers or boxes, tickets of the same model being of course kept together. Either of these plans may also be used when the assorting is done by accounts. An in- genious combination of posting and filing is where the account is kept, instead of a card, on an envelop in which are filed the vouchers, these being of the kind which are returned to the debtor on payment. This plan is used in clubs, where the mem- bers' tickets for supplies go inside the envelop and the account on the outside. When the bill is rendered, nothing more goes in or on that envelop. When paid, it is yeturned, with contents, to the member, a new one being started. 285. When the vouchers are filed by dates in a monthly bundle, a cover, or jacket, may be used, having on its outside a summary or a journalization of the contents, making a posting' ticket for the general ledger. Inside may be a detailed Hst of the vouchers for the use of any auditing authority. 286. Some vouchers, used as posting-tickets, have ultimately to be past on as vouchers to some one else, like the club-tickets mentioned above. In this case a duplicate is often retained for permanent record and reference; and if this can be in facsimile, as by the carbon or copying press methods, it is all the better. 102 Thk Philosophy of Accounts 287. The preserving of the original or duplicate tickets often renders it unnecessary to make any detailed entry in the books, but simply the amount. Thus, it was formerly customary to copy each bill of goods sent out into the sales-book; but the more modern practice is to enter there and in the purchaser's account merely the total sold, without specification of items or prices. Again, the totaling of the sales themselves is rapidly performed by listing them on one of the modern adding machines, which give an automatic total. If the machine has the additional feature of combining with the adder a typewriter for the names, the basic accounts (those represented by posting-mediums) are, in the loose-leaf methods, entirely posted by machine^ I03 CHAPTER XVIII The lyEDGER An Organized System — Incomplete; Ledger — Sometimes Incom- pi,ETENESS ONLY Apparent — Grades of Accounts — Subord- inate Ledgers — Controlling Account — General and Subordinate Ledger in the Same Loose-Leap Book — Private Ledger — Tabular Ledger. 288. Having treated of the nature of accounts, their construc- tion, classification, relation and interdependence, it remains to speak of them as an organized system or ledger, which when com- plete is capable of recording all the occurrences within a given sphere of proprietorship. 289. The ledger is sometimes incomplete, and is then fre- quently known as a " single entry ledger." This means that a part of the accounts are omitted or neglected, so that many entries are only half posted. Usually it is the proprietary and economic accounts, or some of them, which are supprest. The missing accounts are implied in the transactions, and when an accountant examins such a system he invariably constructs the lacking ac- counts as the easiest way out; which rather indicates that their omission did not save any labor in the end. 290. We must not hastily assume that a ledger is incomplete, because the missing accounts do not appear between the same covers as the others. It is very probably the case that in some other book or on some sheet of paper, perhaps in untechnical form, these accounts lie hidden, for they certainly exist implicitly if not explicitly. It is not the insertion of the words, " Dr. to " and " Cr. by " which makes the account ; and it is not the bind- ing which limits the ledger ; a ledger may be contained in a dozen volumes, or a dozen ledgers may be contained in one volume ; or there may be no binding at all, as in the card-ledger; or there may be a removable binding as in the loose-leaf ledger. The re- lation of the accounts to each other, or to some other account to which they refer, is what determines the extent of the ledger. I04 The Philosophy of Accounts 291. The accounts which appear in the balance-sheet may be group-accounts (Art. 74), in which case there are necessarily accounts of a lower grade for each member of a certain group; or, in a limited sphere, without the use of any group-accounts, each account may enter directly into the balance sheet. The dif- ference between these two modes of presentation is analogous to the difference between a town-meeting where each voter partici- pates, and a representative assembly. The case where the ac- counts are all of one grade, may be called a simple ledger. This is frequent in small business spheres, but infrequent in the large ones. 292. When there are several grades of accounts, there are a Principal Ledger and Subordinate Ledgers; or as often called, a General Ledger and Special Ledgers. The former is always complete, but the latter may or may not be complete, or self- balancing. Taking for example a Mortgage Ledger, such as described in Art. 74, all its balances are on the debit side and it would seem impossible to make a trial balance. It is true that the trial balance is one-sided, but the figures with which this should agree are elsewhere; they are the balance of the group account " Mortgages " in the general ledger. 293. In order to make the debits and credits of the Special Ledger equal, there is sometimes introduced into it what is called a "controlling account," which is usually entitled " General Ledger." It is exactly the reverse of the " Mortgages " account in the general ledger; what is debited there is credited here and vice versa. It certainly puts the mortgage ledger " in balance " if that is considered desirable. 294. It might be urged that this controlling account is illogical, inasmuch as increase of the asset " Mortgages " must invariably be represented by a debit. But when we look more closely we see that the controlling account is proprietary in its nature; that it represents one section of the proprietorship. It might be headed " The Proprietor in account with Mortgage Debtors." From this point of view it is correct in theory and its balance ought to appear, as it does, to the credit. 295. The controlling account is not, however, so much a necessity as a convenience. It is quite easy to dispense with it and to check the total of the mortgage-ledger by the balance of The 1,edger 105 the group-account in the general ledger. It is not necessary that a trial-balance or a balance-sheet should always be two-sided when, as in this case and the case cited in Art. 123, there are no negativ or subtractiv values. 296. The choice between incorporating a controlling account into the subordinate ledger, and considering it controlled by the corresponding account in the general ledger, depends in each system upon the answer to this question : Is it preferable to give the keeper of the subordinate ledger a chance to prove his own accuracy or to have him report his total to the keeper of the general ledger for verification? The decision will depend on personal and administrativ considerations having no relation to the theory of accounts ; theoretically either procedure is correct. 297. In a system of accounts of moderate extent, a general ledger and subordinate ledgers may be kept in the same volume by the use of one of the loose-leaf plans, thus avoiding expense and the appearance of complexity. 298. It is simply a question of using two colors of paper in providing the ledger-sheets. For example, if the detailed ac- counts are in blue paper, let a smaller supply of sheets of exactly the same ruling be in buff. Buff will then indicate the general ledger accounts, that is those which are directly tributary to the balance-sheet either because they represent units which need no subdivision or because they represent groups. The blue pages represent the members of groups ; just before each group of blue pages comes a buff page which summarizes the figures of the blue pages. The little balance-sheet of Jones & Smith (Art. 93) when ex- panded into a ledger combining both general and subordinate accounts, might be contained in the following leaves : A buff leaf for a summary account of cash. Blue leaves as required for details of cash transactions; cash book. A buff leaf for a merchandise (asset) account. Blue leaves constituting invoice book. A buff leaf for a sales account. Blue leaves constituting sales book. A buff leaf for a group account for bills receivable. Blue leaves constituting bill-book for receivables. A buff leaf for a group account for customers. Blue leaves containing individual accounts, with customers alphabetically arranged; the customers' ledger. io6 Thb Philosophy of Accounts A buff leaf for the real estate account (a single piece). A buff leaf for bills payable account. Blue leaves constituting bill-book. A buff leaf for a group account for creditors. Blue leaves of individual creditors, alphabetically arranged; " the bought ledger.'" A buff leaf for account of the mortgage. A buff leaf for capital account. Blue leaves for partners' accounts. A buff leaf for profit and loss. Blue leaves for various economic accounts. 299. Thus nearly all the records of a moderate business may be contained in a single binder and a transfer holder of precisely the same arrangement, with the advantages of two grades of ledger, general and subordinate, giving both comprehensiv and minute information. Blue leaves are inserted as needed, and re- moved when filled. Buff leaves may be kept separately when re- moved, forming a condenst history of the business. 300. If the accounts are sufficiently numerous to divide into two or more volumes, the personal accounts, debtor and creditor, should be in a different volume from that containing the accounts used as posting mediums (Chapter XVI) as, in posting from book to book, both books should be open. With the ticket system (Chapter XVII.) this precaution is unnecessary. Even if a single volume is used, the leaves of posting mediums may be tempo- rarily detacht while posting. 301. Probably the most adaptable ruling for a combination ledger is the three-column or balance ledger (Fig 7). If a part of the leaves be delivered without ruled down-lines, special rul- ings may be made by hand to suit special forms of account. This would be almost impracticable with a bound book. 302. Postings to the general ledger consist of the totals, usu- ally monthly, of the basic accounts, such as cash, purchases and sales. The trial balance of the general ledger should be first veri- fied, which, from the small number of its accounts, is easily done. Then each subordinate ledger has its own trial-balance, verified by its controlling account or by the balance of the corresponding general-ledger account. 303. The ledger may be considered as the book of account; all others are tributary to it or derived from it, or are sections of it, kept apart for convenience. The modern tendency in ac- ThB IrEDGER 107 counting practice is that the complete cycle of accounts as em- bodied periodically in the balance-sheet or equation of status shall be the basis of all records ; that there be no auxiliary books independent of the ledger accounts but that each shall definitly and regularly prepare materials for those accounts. 304. Such of the accounts as are confidential and not intended to be accessible to the office force are sometimes kept in a Private Ledger. These accounts are most frequently, in firms, those of the partners and of such investments as it is unnecessary to have appear in the current accounts, the scope of the private ledger being governed by circumstances. If it is intended to conceal the amount of capital it is desirable to keep in the private ledger, be- sides the proprietary accounts, some specific ones. For example, in the accounts of Jones & Smith (Fig. 23) it may be thouglit best to keep confidential the valuation of the real estate, the amount of the mortgage, and the capital of each partner. The private ledger would then contain the following accounts : Real Estate $10,000.00 Mortgage Payable $4,000.00 Jones 47,645.62 Smith 23,822.81 Balance of Private Ledger 65,468.43 $75,468.43 $75,468.43 This balance, $65,468.43, would need to be furnisht to the general-ledger bookkeeper before he could verify his trial-balance, which would take this form: Cash $8,589.08 Merchandise 39,249.38 Bills Receivable 7,000.00 Personal Debtors 24,095.32 Personal Creditors $5,465.35 Bills Payable. ... 1 8,000.00 Private Ledger 65,468.43 $78,933.78 $78,933.78 305. Where the number of accounts in the general ledger is small and the transactions are of a few types, the ledger may take the tabular form, which is self-proving because the additions and subtractions operate both transversely and vertically. 306. The modes in which the ledger may be tabulated are so various that it is difficult to give a typical illustration ; but Figure 49 may be suggestiv. io8 The Philosophy of Accounts Pi a o Q M i-I s o '^ o Pi < o o ° § - o o w O tn loco O M lO Tj- O *^ 0\ r- CO rooo r- ►-t -i- c>co O to t^ V) O CO r^ m O o "O ■^ M Tl-vO O O M . y x^ U rOO o Os o O M M {) IH C) .H f> t-^ *+ C) lO C) CO O o 1- M o CO Ti- a O CO >OCO O ■-« r^ -* O O O O !>. CO CO O CO -^ ^ N o c o -) O "O (M 0\ 1 1-.*^ Vh 1J ctj IH d Ph P^ iXl (JH hi^ ,o^^^ O 00 « -1 u M O\00 1 o cor^ On 1 o lO On w r^ w M *^ o O ^O O 0\ lO o O M O M CO o O W lOlO « IJ O lO lo r^ CO () O M O on M CO CO CO ^ ¥if The Ledger log 307. Taking the same list of accounts shown in Art. 303, a ledger is to be constructed which shall show each month all the transactions of the month, with the results at the close. Entries bearing the same letter form a complete transaction as will be seen by collating them. The economic accounts are kept in a separate table and are not balanced but aggregated from month to month. Their resultant, however, is carried into the table of the special accounts. The private ledger plan is also illustrated. For any incidental transaction of a type not comprised in the key, a letter is assigned and the explanation given in manuscript. no The Philosophy of Accounts CHAPTER XIX Precautions Against Error Causes of Error — Comparison — Checking off — Calling off — Rbconstructiv Methods — Check Ledgers — The Bank Balance Ledger — Reverse Posting — Application to Sav- ings Banks — ■ Sectionizing — The Coupon Method — Proving THE Balance — Double Balance Method — Balance Posting, OR Proving by Difference. 308. Experience shows that the intellect, even in so mechan- ical a process as posting, cannot be absolutely relied on to be free from error. Error or omission will occur in a small percentage of the work and is usually caused by inattention. This is either temperamental, or else accidental, resulting from interruption, disturbance, fatigue from too long continued work or illness. The errors thus caused would be found by the next trial-balance ; but in the meantime the inaccuracy of the account might bring about a loss. To avoid such loss and also to minimize the labor of the trial-balance, various plans are in use for a daily check on the current work. 309. This check will be the more efficacious according as it is independent of, and different from, the original work. If we take exactly the same road as before we are most likely to strike the same pitfalls. The same aberration of the intellect which caused an error will be apt to produce the like again. 310. Different minds find different means the best in this respect, and each should seek the check which he himself finds efficacious. The quantity of work to be gone over is also a determinant, as a long-continued series of postings has a benumb- ing effect so that a very simple test may fail, from that proneness to assent which everyone feels in greater or less degree. 311. Misposting will hardly ever pass unnoticed if before leaving each posting, by a conscious effort of will, one wakes himself up to the real meaning of what he is recording and, Precautions Against Error. in shutting out all other thoughts, asks himself "Is this true?" This habit is a valuable one to form. 312. The simplest check is to go over all the postings a second time, comparing with the original. To show, in case of interrup- tion, how far the process has gone, a check-mark ^ is placed opposit each item after it is found correct. These ticks should not be too large, but contained within the ruled lines ; an untickt line is a danger-signal which may be obscured by a large tick. If an item has been posted to the wrong account, the true account will be blank; the posting must be supplied and tickt. If the item had been altogether omitted, the matter is at an end ; if it had been posted in a wrong place, there is somewhere in the books a line without a tick, which when observed must be instantly investigated. 313. If another person, not the original poster, conducts the comparison and ticking there is some additional security, for the new man comes with a fresh eye to the work. 314. When assistance is available, it is quite usual to work in a team of two, in the process called " calling back," " calling off," or " calling over." One person reads off the name or num- ber of an account and the other, turning to the proper page, responds with the figures. I am aware that this method is used by many public accountants in auditing, probably to save time, the bound-book system not allowing of any other division of labor. Yet I believe that two persons working separately will accom- plish more, and more surely, than in the " calling-off " process. The ear is less reliable than the eye and more easily deceived. The tasks of the two men are not precisely equal : the one being com- parativly inactiv, and therefore a large part of his time being wasted, while his mind becomes torpid thru inaction and when, after hundreds of correct postings, an incorrect one is called off, he fails to observe it. If it is possible to subdivide the work so that each can check a separate part by eye, I think it will be found that the two will accomplish more and better, separately, than together. 315. Quite a different class of check systems is composed of those where we reconstruct the accounts anew from the original sources, or by the converse process reconstruct the posting- sources anew from the accounts. The resulting lists are com- 112 The Phii,osoi>hy op AccoukTS pared in total with their prototypes, hence the final test embraces but few figures and the chance of " assenting " to an error is greatly lessened ; while the relation of the figures is altered into new combinations. 316. A check-ledger or balance-ledger is in effect a duplicate ledger kept in some simpler and briefer, perhaps rougher way, because it is not needed for precise information but for the pur- pose of a check on the ordinary ledger. For this reason, it may be kept in pencil ; dates may be omitted and all descriptiv matter ; a large number of accounts may appear at one opening ; or it may carry balances only and not transactions. This may be a very good plan in a mercantil business where balances are not very often called for except monthly. It serves mainly as a correctiv of the monthly trial balance, all final balances being compared before totaling. 317. In a banking business of any kind, the correct keeping of depositors' accounts is a matter of the greatest importance. The balance should be at all times ascertainable and reliable to avoid the risk of overpayment. The balance-ledger was therefore intro- duced as a check on the ordinary ledger. Its peculiarity is that each account runs horizontally, occupying a line across the page. The first column in the page contains the initial balances, usually in red, of thirty or forty accounts, a name on each line. When totaled and aggregated this column is a trial-balance of the deposit system. The next column contains all the credits for the day on each account, a third column all the debits, and the fourth the resulting balances of the next day. It is evident that the totals may be proved, forming the equation: Old Balance-f-Crcdits — Debits=New Balance. Figure 50. THE BANK BALANCE LEDGER. Names Balances Jan. IS Credits Debits Balances Jan. 16 Credits Debits AB B B CB 1734.16 2000.00 2217.65 223,19 300.00 500.00 100.00 463-17 1857-35 1836.83 2717.65 Totals S95I-SI 1023 19 563-17 6411.83 Precautions Against Error 113 318. This is the general principle on which it is workt, omit- ting a number of details and variations in practise such as pro- viding for debits in detail ; writing the daily credits in the same column as the balances but in different ink ; placing inactiv accounts by themselves; providing for overdrafts (debit bal- ances) ; making part of the pages narrower so that the names do not have to be rewritten. 319. The convenience and advantages of the balance-ledger are so great that in most banks it has become the principal ledger, and the " vertical " accounts have been disused altogether. The check on it is the monthly statement which is written up day by day with a facsimile copy, and which gives debits and credits in detail. In this point of view the balance-ledger might properly have been treated in a later chapter. 320. Directly contrary to the methods which duplicate the ledger are those processes which are known under the title of " reverse posting." I think I was the originator of this name, at least, tho the process itself was doubtless thought out by others before me. 321. The essential feature of reverse posting is to reconstruct from the ledger itself the sources of the ledger, or if the posting is from tickets to reconstruct a few of the accounts from tho many. These few which are to be rebuilt are those which enter into the majority of all the regular transactions — those which would be selected for the basis of posting mediums if ticket- posting were not employed. Figure 51. REVERSE POSTING SHEET 19... Dr. Cash 17 96 58 Sales Interest Sundries 114 The Philosophy of Accounts 322. Supposing that the debits were normally for Cash, Sales, and Interest and that the credits were usually for Cash, Pur- chases, Discounts, and Expense, a small sheet is ruled with a column for each of these basic accounts and an extra one for " sundries " or miscellaneous. REVERSE POSTING SHEET 19.. Cr. Cash Purchases Discount Expense Sundries 323. These forms may be on a single page, or on opposit pages of the same leaf, or on separate leaves. 324. The columns are to be filled strictly by copying what is found in the account and the proof is made by adding each column. Each column will correspond in its total to the total of the transactions of one of the posting mediums or one of the basic accounts. The two " sundries " columns will be equal in aggregate. 325. It might be recommended (tho I have not seen this in practise) to make the totals continuous during the month, carry- ing forward the totals from the bottom of one sheet to the top of the next. The totals of the posting-medium added in pencil to the same point would always be proved. The same result might be attained by recapitulating the daily totals of columns on a monthly sheet, and aggregating these day by day. 326. An important question in the use of reverse posting is : When shall the sheet be filled? at the time of posting, or as a distinct process? It is easier to insert the posting in the reverse- sheet while the page lies open before you. Many do this, keeping Precautions Against Error 115 the sheet alongside and as soon as each entry is made in the ledger transcribing it on the sheet. The entire efficacy of the reverse posting process depends on the contents of the sheet being a tran- script from the ledger, right or wrong, and from nowhere else. I should myself be afraid that, with the memory and sight of the original so freshly before me, I might revert to it and write it mstead of the erroneous ledger-sum which I ought to copy, and which I should thus fail to detect. 327. The alternativ method is, first to go thru with all the posting ; when the last entry is posted, and not before, to take up the reverse-sheet and fill it from the ledger. This again has two alternativs : a. To examin every account in the ledger for transactions of this date ; h. To leave, on posting, some indication or trail by which the accounts affected may alone be considered and all those which are untoucht may be disregarded. 328. Plan a would be a very thoro one where the accounts are few but activ, so that the majority of them had some change each day. It would eliminate some classes of errors such as posting the same item in two different places. 329. Plan b may be carried out in either of several different ways. One is to use strips of paper at the time of posting, insert- ing them so that they project above the page where the posting occurs. Then in the reverse process these are used as markers, and only those pages are referred to where a marker is found. There is a modification consisting in a variation in the color of the strip, using, for example, red strips for debits and black strips for credits. I think this dangerous, because it suggests too much. Perhaps a debit has been erroneously posted to the credit side, but the red strip suggests a debit and the reverse posting is made to the debit-sheet ; then the error is concealed instead of being revealed. I should decidedly prefer a strip which would merely indicate the page and leave the reverse-poster to do his work without suggestion. There is an objection to this slip plan, that a posting to the wrong page might be undiscovered. In the card ledger no strips need be used, but each card to which post- ing has been made left a little higher than the others or a little ^^ one side. ii6 The Philosophy of Accounts 330. Another way of " blazing the trail " is to prepare the reverse posting sheet by writing in each column in advance the numbers of the pages affected, taking these numbers from the original sources. In Figure 52 in the cash column I have indi- cated the place of these numbers. This would discover such an error as alluded to in the previous paragraph unless the original source were improperly folioed. 331. As an extension of the method in Article 330, the names as well as the folios may be included in the proof of the posting. It is recommended that only a few letters of the name be written in the preparatory work and that, at the time of the reverse post- ing, the remaining letters be filled in. This compels the attention to be fixt upon the name, which might otherwise be overlookt. 332. When tickets are used for posting, or for making up the posting mediums, a most advantageous way of preparing the sheets is to assort all the tickets in a single series, alphabetically or numerically, so as to bring them into the same order as the pages of the ledger and to avoid the waste of time thru turning back and forward. To give the fullest effect to the verification the number or name of the account should be in the middle of the sheet and the columns to the left and right. 333. The highest degree of certitude is reacht when the veri- fication or reverse posting is done not by the original poster, but by another, who has no prepossessions as to the transaction. He turns to the account and transcribes literally what is found there. He is compelled to look at the name, the amount, which side it is on, and what its source ; none of these facts are suggested to him. If, then, after he has reverst every posting the columns of his sheet exactly agree in total with the total given elsewhere, the evidence is very strong that all the posting is correct. 334. In a savings bank, where the accounts are very numer- ous and the current entries are all cash, this method with various modifications is used extensivly and effectually. In the larger institutions of the kind it is further found advisable to " section- ize" the ledgers; that is, to divide the whole mass of accounts into large blocks, say of 2,000 or 3,000 accounts bearing consecutiv numbers. This feature is carried into the daily work by making a b-^eak -n the list gt the end of each section or block. This presupposes that each teller has made a list, either by Precautions Against Error 117 H W W W t/J . y, i-H 3 be CL, Ph w c/l ei w > w « § w s u f*3 M 1 00 M 1 s d M M (/I 1 CO 1 ii8 The Philosophy of Accounts mechanism or with a pen, of the tickets, the total agreeing with the state of the cash and forming the standard to which the reverse posting must conform, if correct. 335. An account must he kept with each of the blocks of accounts constituting a section. This makes an intermediate sys- tem between the General Ledger account of Depositors, and the individual account of each depositor. This will give information at the time of the trial-balance as to how much the balances of each section ought to produce. If some of them are found cor- rect, the attention is concentrated upon those which show differ- ences. This principle of sectionizing is of great value in all cases where there is a large number of accounts to be handled — so large that the search for an error is very laborious, like the hunting for needles in a haystack. If we divide the haystack into a number of smaller stacks, in many of which it is apparent that there is no needle, the search is much facilitated. 336. Returning to the reverse-sheet for testing transactions in savings banks, we have assumed that a consecutiv list of trans- actions has been prepared at the teller's desk, by which he proves his cash and to which the bookkeeper's sheet must finally con- form, the latter being numerically arranged and broken into sec- tioniv. These two lists are sometimes combined in what is known as the Coupon Method. This consists in keeping at the teller's desk a set of sheets, one for each section and entering on these, preferably from the pass book, each transaction which has been made. The transactions thus assort themselves instead of being assorted afterwards. The sheets are in a peculiar form, there being two money-columns with a perforation between, with spaces for number and name. The first of the money columns is left blank by the teller, who uses only the outer one. He balances his cash by this outer column, aggregating all the sheets, tears off the strip or coupon and retains it. The remainder goes to the bookkeeping depart- ment as a reverse-sheet. It is not quite so convenient for that purpose as a consecutiv list in numeric order for the accounts in a heavy section have to be pickt out of a mass, or else there is much turning of leaves. On the other hand, if the section fails to prove, it is very easy to discover the error by laying the coupon in the place where it originally was and comparing the amounts as thev Precautions Against Error 119 Figure 53. PROVING SHEET. COUPON. ' 12 Apr.1907 Section 23 460,001 — 465,000 23 No, Name Deposits 12 Apr. 07. 462,749 460,979 463,652 464,998 460,723 Smith Jones Robinson Murphy Becker &c. 100 25 63 17 3 stand side by side. There is no exact chronological list and no exact numeric list. 337. Where the "three-column" ledger (debits, credits and balance) is used, it is very important to have the balance column verified; more important, in fact, than the debit and credit columns, for the balance-column is relied upon as a guide for instant payments. There are two ways of insuring the accuracy of the balances, which may be termed the double-balance and the balancei posting methods. The former requires the addition to the sheets (Fig. 52 or 53) of two columns for "old balance" and "new balance." Figure 53 would then be arranged as follows: Name. Smith Old Balance. 2769.13 New Balance. 2869.13 Deposits. 100.00 Deposits. 100.00 No. 462,749 The teller has inserted only 462,749 Smi 100.00 and the testing clerk has added Ih 2769.13 2869.13 100.00 all copied from the ledger. Thus an error in balancing would be as certain of detection as an error in posting; for the difference I20 The Philosophy of Accounts between the totals of the "old balance" column and of the "new balance" column must be equal to the totals of the deposits (or drafts). "Balance posting" equally insures correctness of balances with much less labor. Its essential feature is working backward from the balance (which is first to be entered) to the transaction which is inferred from the increase or decrease exhibited in the balance column. No change is made in the sheets, whether of Form 52 or 53, but the variation is in the order of posting the ledger. Thus if the ledger account of John Smith stands as follows : 462,749. JOHN SMITH. Date Dr. Cr. Balance 1907. Brought forward 2769.13 and it is desired to post a deposit of $100, the posting and proving are done in the following stages. 1st Operation. Taking the deposit ticket, the bookkeeper writes the date and then, instead of entering the $100 to the credit, he enters in the balance column 2869.13 and nothing else. Continuing this process until all the accounts having transactions have been re-balanced, he turns over the tickets to the head book- keeper. Smith's account then reads 1907. Brought forward 2769.13 April 12. 2869 13 2d Operation. Another bookkeeper having no intimation of the transaction infers from the increast balance that it was a deposit of $100, and inserts that sum in the credit column of the ledger. 1907. Brought forward 2769.13 April 12. 100.00 2869.13 This is exactly the same entry as would appear if the entry had been made first and the re-balancing done afterward ; but there is this important difference, that an error in striking the balance would cause the $100 to vary from the original ticket and lead tc detection. Precautions Against Error 121 3d Operation. The $100, which, if the balancing has been correctly done, represents the correct transaction, is copied into the sheet opposite the proper number and name, and the sheets deHvered to the head bookkeeper. 4th Operation. The tickets and the sheets, reaching the Iiead bookkeeper by different channels, are compared by him. If he finds that they agree in all respects, he is assured not only that the debits and credits are correct and on the right sides but, what is still more important, the balances are reliable. He may, however, have overlookt some discrepancy, or some transaction may have been omitted altogether; hence a still further proof is made. Sth Operation. The columns of debits and credits are added up by sheets and sections and aggregated ; and if the totals agree exactly with those of the actual cash received and paid, there is the highest degree of assurance that all the work, including the balancing, has been correctly done. Experience shows that it is almost impossible for an error to evade the process. 338. There is another class of precautionary methods, which consist in transcribing, not the figures themselves, but a so-called " check number " derived from the digits of the amount of the transaction thru the properties of 9 or some other number. I shall not discuss these, as they are somewhat outside of the province of accountancy. 122 The Philosophy of Accounts CHAPTER XX The Detection of Errors cl J3 5 Old Balance Cr. < a "^ W w New Balance Cr. 6 m Q 1—1 W 43 s Old Balance Dr. < P c =1 u u 5^ Thb Detection of Errors 127 The left-hand side of this equation is represented by the left- hand page of a book ruled in a number of columns, and the right- hand side by its right-hand page. The debit entries occupy a number of columns according to their sources in the various posting-mediums or the basic accounts, exactly as in the reverse- posting sheet, Art. 301, Fig. 50; and the credit entries are classified in the same way. 347. The arrangement of the tabulation might be as in Fig. 54, it being supposed that the debit postings are all from a Cash Book, a Sales Book, and a Journal, and the credits from Cash Book, Invoice Book, and Journal. 348. Having provided these columns, it is obvious that the contents of any account may be " strung out " across the page and that, including the initial and final balances, exactly the same total will appear on each line. Thus, suppose that a customer, John Smith, owed at the previous trial balance $279.43 .' that he purchast several bills, posted from the sales-book, amounting to $265.67; that he was charged by journal-entry with a sum of 24.38; that he was credited " by cash " $200 ; and that therefore he owes at this balancing-time a balance of $369.48. Entries would then appear in columns i, 2, 4, 5, 8, and 11, as follows: Column I John Smith [or folio] 2 Old Balance Dr., $27943 4 Debits from Sales, 265.67 5 Debits from Journal, 24.38 $569.48 8 Credits from Cash, $200.00 II New Balance Dr., 369.48 $569.48 Only two of the balance-columns can possibly be required in any given account. 349. Having entered these figures, they should be immediately added across on each page, and as the total of each is 569.48, the conclusion is that the account is correctly balanced, tho nothing is yelt known as to the correctness of the postings. Consistency with itself, not conformity to its prototypes, is all that is demon- strated of the ledger. But frequently the entire error is dis- 128 The Philosophy of Accounts covered during the process, not having been caused by erroneous posting, but by erroneous combination of correct entries (class i, Art. 319). At the bottom of the page each column is added and it is evident that as every line was in equation, so the aggregates must also obey the law : Old debit balances + debits from Cash + debits from Sales + debits from Journal + new credit balances = old credit balances + credits from Cash + credits from Invoices + credits from Journal + new debit balances. If this does not hold good, something is wrong either with the total of some column or with the balancing of some line and this must be discovered before passing to the next page. In an obstinate case, an intermediate footing may be made about half- way down the page and this again tested by the equation. If this aggregate stands the test, the error is in the lower part of the page; if it fails, the error is above it. Thus by subdivision the error must ultimately be located, and corrected. It is recommended that the totals of each page be carried forward to the next, insuring that no unbalanced line or page has been left behind. 350. It may be thought best not to group all the entries of a certain kind into a single line, but set them down in detail, using as many lines as necessary. In the example in Art. 328, the debits from sales, $265.67, may be 4 items; $82.65, $25.33, $91-25, and $66.44. Then the account as tabulated will occupy four lines in depth instead of one. Column I 245 John Smith 279-43 82.65 24.38 25-33 Tobias Smollett etc. 91-25 66.44 8 II 200 369.48 This makes the cross-addition a little more difficult, but, as fewer accounts can be entered on a page, the cross-addition of each line may be omitted till the bottom and then the entire page be proved as a whole. 351. Accounts like Cash and Merchandise, or what we have been calling basic accounts, must be left to the last. Everything The Detection of Errors 129 else is added up and probably without going any further the error will stand revealed. Column 3 should tally with the total of Cash paid, or there is error there ; column 4 with the total of sales, column 8 with the total of cash received, column 9 with the total of purchases, and a discrepancy in either of these totals must be traced by checking of the department in fault. 352. To complete the tabulation the accounts of Cash and Merchandise (or the basic accounts whatever they are) must be transcribed into linear form, commencing with the old balances and ending with the new. The debit and credit entries will undergo a kind of reversal : in the Cash account the receipts will be entered below the payments in column 3, the payments under the receipts in column 8 ; the purchases under the Sales in column 4, the sales under the Purchases in column 9. But the line of Cash and that of Merchandise will be in balance and the entire ledger will be tabulated. The columns will then correspond in pairs, as follows : The totals will be equal, of columns 2 and 7, 3 and 8, 4 and 9, 5 and 10, 6 and 11. Columns 2 and 7 having been compared with the totals of the old trial balance, so that nothing may be omitted, columns 6 and II will constitute the new trial -balance. 353. It has even been thought worth while, in case the trial balance is taken at long intervals, to go first thru the operation of tabulating instead of starting with the simple trial balance, columns 6 and 11 constituting the complete and only proof of accuracy. This is a laborious, but very thoro and satisfactory mode of proof. 1.30 The Philosophy of Accounts CHAPTER XXI Fiduciary Accounts Accountancy ov Administration, without Proprietorship — Namb OF Fiduciaries — Purpose of Accounting — Functions of the Fiduciary — Equation of Fiduciary Accounts — Executors' Accountings — Liabii5oo C 300 $46,800 The arrangement of schedules is here precisely the same as that employed by Mr. Loomis in the paper cited in Art. 364. I have not constituted an account for Schedule J being " items in inventory uncollected," for the reason that I think these are better obtainable from the inventory account itself. The following would be the same account translated into the form of a surrogate's account, following the summary given by Mr. Loomis. Fiduciary Accounts 135 SUMMARY I charge myself with amount of Inventory $43,000 " " " Schedule A 2,000 B 1,500 " " C 300 Total charges $46,800 I credit myself with amount of schedule D $ 600 " " " " E 1200 F 8,300 G i.,400 " " " " H 2,150 " " " " J 6,000 Total credits 20,650 Leaving a balance of $26,150 By comparing this with Figure 55 it will be seen that the charges of the accounting are made up from the credit of the Estate accounu and the credits of the accounting from the debit side of the Estate account. 370. It IS not necessary to go as far into the details of fiduciary bookkeeping as we have with that of proprietary book- keeping, since most of the mechanism of the latter is applicable to the former, and those details are derivable from the excellent treatises of Hardcastle and Gottsberger. 371. It may be remarkt that the accounts of a savings bank (of the Eastern or mutual type) while usually treated on the proprietary basis are strictly speaking fiduciary. The legal cor- poration is the board of trustees, yet they have no equitable inter- est in the assets ; they merely administer a trust. The depositor is merely a creditor to the amount of his cash deposits and such interest or dividends as have been allotted him by the board; he has no legal title to the surplus, but has an equitable title, with his fellow depositors, to it. The surplus is a trust fund, for the benefit of the depositors at the time being, but not divisible except upon liquidation. 372. The failure to distinguish between proprietary and fiduciary accounts has led to some errors ; such as the creation of a fictitious intermediary " The Business " referred to in Article 133- MONOGRAPH A THE CASH ACCOUNT 139 MONOGRAPH A Thb Cash Account Definition and Extension op "Cash" — Sub-Division op Cash — Variations op Cash Account — Bank Account Superseded by Check-stub — Check-Book as Posting-Medium — Complex CaSH-BOOK — COI,UMNIZATION TWO PRINCIPLES — CONCOMITANTS — DISCOUNTS, AS Example — Journalization Thru Cash — Check Register — Alternate Pad System — Strip System — Balancing Cash ~ Auditor's Duty as To Verifying Cash Balance — Verification op Bank Account. 373. " Cash " taken as a concrete noun signifies in accounts that which is received and paid in settlement ; the medium of liquidation. This is a somewhat imperfect definition of some- thing which varji.s in the extent of its meaning. Some would restrict the term to the meaning of " money " alone, but even then it is difficult to fix the limitations of money itself, ohall we con- fine it to full legal-tender specie, or shall we include bank notes and treasury notes, which are really certificates of indebtedness? We find that those who endeavor to narrow the field of cash down to that which can be handled are inconsistent in so doing. They will consider the check of another as cash altho it merely conveys the power to receive an amount from some bank, not even constituting an assignment of the amount ; while on the other hand amounts due us by a bank which need no act to make them ours are excluded. The best usage, I think, recognizes as the subject of the cash account everything which can according to business custom, be used without question to extinguish lia- bilities or to acquire assets; in short, to carry out contracts. Whatever is acceptable on either side as the fulfilment of a con- tract calling for dollars (or pounds, francs, marks, etc.) is in a business sense " cash." In its potentialities it is the most versatil of assets, for it is .aq only one which has at command every existent form whatever of property or service. 374. The cash is usually separated into two parts ; Cash on hand, and Cash on deposit. The former is sometimes called offic^ 140 Thb Philosophy op Accounts cash and the latter subdivision is frequently styled.' Balance in Bank, or (in England) Cash at the Banker's. The latter phrase has been recently criticized by eminent British authority for fear lest it should be thought that it indicated the presence at the bank of sufficient coin or other tangible money specifically segregated and belonging to the account. But these fears are groundless; no one would make such a foolish mistake. 375. In modern times, cash " on hand" or in physical posses- sion is overshadowed by bank-cash, so that the payment of cash calls up the i9ea of writing checks rather than that of counting out money. The latter process is used only for the very insignifi- cant dealings, and is sometimes designated as " Petty Cash." 376. There is a sense in which the " Petty Cash " account is sometimes kept which I cannot help considering as improper and dangerous. It is when the money transferred to petty cash is considered as expended, as far as the regular books are con- cerned; petty cash becoming a sort of economic account, equiva- lent to " minor expenses." There is supposed to be a book in which the keeper of the petty cash records the expenditures, but as he calls for round sums whenever his appropriation is nearly exhausted there is nothing in the system which makes a verifica- tion of his record compulsory. A much better plan, the imprest system, will be explained hereafter. 377. Theie is almost invariably a book called the Cash Book which contains in detail all the transactions affecting the cash, sometimes with other information. The relation of this book to the ledger is subject to the following variations: 1. There is a cash account in the ledger, practically a sum- mary of the cash book in weekly or monthly aggregates derived either from the journal or from the totals of the cash book. 2. The cash book is itself the cash account just as if it were a part of the ledger placed for convenience in a separate binding. 378. The scope of the cash-book as to containing more or less branches of the cash gives rise to other variations. I. The balance of the cash-book may be considered as con- sisting of cash on hand, alone. All bank transactions are treated separately thru a bank account or accounts. Thb Cash Account 141 A. Deposits are usually treated as received into the office- cash and then paid over to the bank, even when they consist of items which must eventually be deposited. B^ Checks are treated in one of two ways. Bi. They are entered on both sides, as if the money were drawn from the bank and then paid over ; or B2. They may appear in the bank account only, debited to the payee and credited to the bank. II. The balance of the cash book may be considered as embracing both cash on hand and that on deposit. No distinction is made in the money-columns between sums paid by check and those paid from cash on hand ; nor between receipts remaining on hand and those deposited in bank, altho such distinction may easily be indicated in the text. At each occasion of balancing the cash, however, the components must be separately stated : so much in bank, so much on hand, total so much. III. By double columns on each side the cash on hand and that in bank are kept in the same book and yet distinct. Cross- entries affecting both columns represent transfers between the bank and the office. This would appear from the text-books to be the favorit method in Great Britain. IV. By the imprest system all transactions are forced ulti- mately to pass thru the bank. The imprest is a fixt sum, usually an even amount, which is held in the office for the payment of petty purchases. There may be several imprests in the hands of various subordinates. When any payment is made from the imprest-cash, the bill, receipt or voucher is counted temporarily as cash on hand thus keeping the balance intact. If the imprest consists of $100, this may be $7y of it in payments made and receipted for and $23 in actual money. But from time to time the imprest must be replenished and always from the bank, a check being drawn for the entire $yy exactly and entered to the debit of the appropriate accounts ; the check is casht and the proceeds placed in the imprest. By making all other payments by check and by depositing all cash received, without exception, the cash transactions are faithfully represented by the bank account, and the cash balance at any time is the bank-balance plus the fixt imprest. In this way the cash account is checkt from an independent source, the books of the bank. 142 The Philosophy of Accounts 379. The bank account to which the cash account is now reduced is sometimes kept in the ledger, but the most detailed account is always contained in what is known as the " stub " of the check-book. And there is no reason why, if this stub-account is carefully kept, it should not supersede the bank account altogether. 380. Instead of a wide stub from which the checks are torn, an interleaved check book may be used, a leaf of checks between two pages which contain the account of checks and deposits. In keeping this account, the totals should be carried forward from page to page, not balanced at the foot of the page as is frequently done where the contents of the check-book are to be transcribed into a cash-book. 381. The cash account is thus superseded by the check-book record, which would have to be kept anyhow, and the procedure is greatly simplified. The old way was to copy the contents of the check-book, together with the transactions of the office-cash into a cash-book; then to journalize this cash-book, repeating all its contents ; then to post from the journal to the ledger, which includes a cash account as the fourth version of the same history. 382. Fiduciary accounts (Chapter XXI) lend themselves par- ticularly well to this plan of making the check-book into a com- plete cash book. Trust funds should always be kept separate from individual cash and the proper way is for the fiduciary to open a bank account for and in the name of each trust which he may assume. His check-book, suitably kept, will serve as the chief, or the only, book of account and posting medium. By the use of side posting (Article 271) he may minimize the labor of posting to a ledger or may dispense with it altogether if his accountability is solely for cash as, for example, the treasurership of a society ; classification of receipts and expenditure being the only aim. 383. This plan of making the check-book the medium of all transactions will not, for various reasons, be always practicable. When there are several bank-accounts and several cashiers, it will often be simpler to unite their results in what may be called a complex cash-book. This may be in the columnar form and the columnization may be on either of two principles : the one divid- ing the receipts and payments according to the branch of the The Cash Account 143 cash to which they relate, the other according to the contra accounts involved in the transactions : the accounts credited when cash is debited, and debited when cash is credited ; credited " by Cash " and debited " to Cash." On the former plan, there will naturally be a pair of columns for each bank and a pair of columns for each cash-keeper and also a pair of columns for " the public." These last columns record those transactions which increase or decrease the total cash balance, as distinguisht from those which are transfers between branches or receptacles. The public columns exactly correspond to the entries of Mode II. Each transaction must necessarily, in this plan, enter into two columns, possibly into more. If it is an interior transaction, a shifting between depart- ments there must be a receipt in one and a payment in another. If it is an actual receipt or payment, from or to the outside world, it must affect " the public " column and also some department. 384. The arrangement of these columns may be somewhat as follows : Fig. 55- Received Paid From Teller A From Teller B From C Bark From D Bank From the Public To the Public To D Bank To C Bank To Teller B To Teller A Or perhaps these leading s would be pre ferable Disbursed by Tellers Drawn from Banks Received from the Public Parti- culars Paid to the Public Check List Deposited in Banks Received by Tellers Mr. A Mr. B C Natl. D Natl. D Natl. C Natl. Mr. B Mr. A The " check list " column is a convenience for summing up the items received and to be deposited. 385. The second mode of columnization does not concern itself with the components of the cash, but with the consideration which caused it to change hands, the equivalents which were received and given ; the wherefore, not the where. This is done for the purpose of forming totals which may be posted in mass, usually monthly, or, following the old conceptions, to make the cash-book self-journalizing. 144 The Philosophy of Accounts 386. Both kinds of cash-book may be kept concurrently in an extensiv business, where all cash transactions have their origin in tickets or vouchers. They will usually, then, be a daily cash- book of the first columnar plan and a monthly cash-book of the second, the former being balanced every day and the latter at the end of each month. 387. The monthly, or journalized cash-book, as well as the simple form 2, admit of columnizing some values which are not receipts nor payments, but are concomitants of those transactions ; and thus the keeping of a special posting-medium is avoided. As an example of this, we may take the subject of cash discounts. 388. Indebtedness for purchases is usually subject to a stipu- lation that the purchaser may settle at an earlier time than is required by the contract and in consideration of such prepayment shall be entitled to a discount stated in a percentage of the full, or gross, price. Thus it happens that many, or most, of the cash amounts paid or received in settlement of such indebtedness are less than the amount standing on the account as due ; and that it cannot be determined until the payment is actually made whether the discount-option will be utilized, or at what rate. In case of a debtor the settlement will be Cash Discount /Customer. The discount is a concomitant of the cash-entry and it will evidently be an advantage if the entries can be made concurrently without having to repeat the particulars. For this purpose two additional columns are provided, one for the gross amount of the bill, one for the amount of the discount, and the third for the actual cash received. Customers. Gross Discount Cash $2,934.62 $58.69 $2,875-93 The third column only is used for balancing the cash. The middle column in total is posted at the end of the month to the debit of Discount, an economic account, the aggregate of which Thb Cash Account 145 at the balancing period should be carried to the debit of Sales, or of the Trading account. The first column is equal to the sum of the other two if the subtractions of the discount have been cor- rectly made and this test should always be applied. 389. As to posting to the customer's account the simplest way is post the gross amount without distinguishing between cash and discount. It might be thought best to state these separately, in order to leave a record of whether the customer pays promptly or foregoes discount; but if this is not sufficiently indicated by the date, a memorandum of the rate of discount may be inserted in the posting ; as : Apl. 5 (—2%) $2,934.62 which would be far more expressiv than Apl. 5 By Cash $2,934.62 390. Another way of entering the discount without a con- comitant column is to represent that the entire amount has been received and the discount refunded. Received from Customer, $2,934.62 Expended for Discount, $58.69 This follows the fact less closely than the method by concomi- tant column, and it does not agree with the bank pass-book, which will record only $2,875.93 ^s deposited. This latter, more fictitious method by two cash entries is often used for discounting bills receivable, but even there I think the concomitant method will frequently be found preferable. 391. In Article 275 a device was explained by which the cash- book is made to perform the work of the journal by introducing two equal and opposit amounts. This would be objectionable in a check-book used as cash-book, for it would break up the corre- spondence between the account kept by the bank and that kept by the depositor. Nevertheless the shifting of debits and credits may be effected by drawing a check to your own order, and, instead of issuing it, depositing it to your own credit. For example, A is a customer who, besides buying of you, occasionally sells you some special article. As you prefer to keep your personal debtors and creditors separate, you have two accounts with A, one in each capacity. He owes you $270 on the one account and you owe him $30 on the other. He sends you the 146 The Philosophy of Accounts net amount $240, instead of sending $270 and waiting for you to return $30. To avoid a journal-entry transferring the $30 from one account to the other, you draw a check for the $30 not to his order but to your own, since he has already paid himself; this check you charge to him, but deposit it along with the $240, making up the $270 necessary to balance his account as a customer. 392. The reduction of the cash book, the cash account and the bank account to the one form of the check book is a great simpli- fication, but it has been found that the check book itself may be simplified. What is known as the check register is beginning to supplant it. Instead of containing only three, or at most six checks to a page, thirty to fifty may be described on a page, pro- vided we utterly abandon the idea of a stub from which the check is torn and enter the descriptiv matter on a single line. The checks are made up in pads and are numbered in advance, as are also the lines of the register. The rule must be inflexible that the entry on the register shall be made first and the check filled out from it; in fact, this ought to be the rule when the stub is used, for a check might be issued without record. The vacant stub is somewhat more of a reminder than the numbered line, yet it is thought better to forego this advantage rather than to lose so much time in adding up every four or five checks. This plan is mostly used by banks issuing drafts which are practically checks on other banks, and is then called a draft- register. Its introduction is facilitated by the fact that no contra account of deposits needs to be kept on the same page. Without the invention of blocks or pads of blanks, which keep the papers firmly in their proper order, this form of register would have been impracticable. 393. I propose a new method of handling the cash transac- tions, or rather a recurrence to the original plan of a ledger account, with the aid of the following comparatively modern devices : pads of blanks ; machine-numbering ; cards or loose leaves for accounts; ticket posting, and perhaps carbon- duplication. There should be a memorandum-blank of the same size as the check and bearing the same number, on which should be entered all the data of the check necessary to make it a posting ticket. The Cash Account 147 Fig. 56. Memorandum op Check Check No ■ 5(>93 on First National Bank $Soo. July -y. igo7 Payable to William Jones Charge to do Check No. 5693 New Yorl :, July ij, igo7 FIRST NATIONAL BANK Pay to the order of William Jones_ Five hundred —Dollars Smith Ssoo. John . The tickets and the checks should alternate in the same pad, the ticket always above its check, so that it would be impossible to " forget " to make the entry, and this plan would be at least as effectiv as the stub. 394. The bank account would be kept as part of the ledger on its own card or its own leaves. The check memorandum would be posted to the credit of the account and likewise to the debit of some other account and then filed. 395. This method is not always applicable, as there are cer- tain circumstances which seem to demand the existence of a check-book; but it seems to me to be very nearly the ultimatum of directness and simplicity. 148 The Philosophy of Accounts 396. A modification, using carbon duplication, may be used when numerous checks are drawn in succession and the typf writer is used for filling them in. The checks will be on a long strip with perforations between (instead of being padded) and a similar strip will be behind it with the carbon between. This strip, taking the place of the memorandum tickets, gives a fac- simile of all the filling. It may or may not have printed matter so as to interpret its contents. This plan has been used with great success for pay-roll checks drawn on a bank which is used for this sole purpose and where a deposit is made of the exact total of each set of checks, which total is obtained by adding the carbon strip. In this case, the strips are not torn off and used as posting tickets, since no indi- vidual accounts need to be kept with the payee ; the total is posted in bulk to the Labor account. 397. In whatever form the account of cash is kept, its veri- fication or " balancing the cash " cannot be neglected. Cash on hand should invariably be verified daily, because the difficulty of tracing an error increases with the lapse of time. With cash on deposit, which is less liquid, the error is generally in calculation only, and a daily proof, tho not so necessary as in cash on hand, is still desirable. 398. It is unnecessary, and generally undesirable, to break the columns of a cash account by the insertion and carrying for- ward of a balance. A memorandum in the margin, showing that the difference between the two totals is exactly accounted for by the values found, is just as eflfectiv for this purpose and the totals themselves generally have a certain utility. 399. The bank account as exhibited in the check-book should be made to tally with that rendered by the bank itself in the pass- book or the monthly statement. This is a most valuable cor- roboration as it is furnisht by a person outside of the concern. Hence in any suspected case of fraud, and even in any ordinary case, the accountant will seize upon the pass-book and check- book as among the most valuable bases for his examination. 400. In case of audit, it has been claimed by some that the verification of the cash balance is no part of the duty of the auditor. From a practical standpoint, I should be disposed to question this dictum, and an actual instance may be adduced to The Cash Account 149 the contrary. A trust company, as receiver of a hotel, employed a cashier and general bookkeeper, dishonest and afterwards a convict. The trust company retained a firm of public account- ants to make a monthly audit of the accounts, which they did, and passed them as correct. The actual cash balance, however, was very different from that shown in the books, which was fictitious. The cash on hand consisted, in addition to the real money needed, of a large amount of memorandums, worthless checks, etc. This would have made the balance on hand appear absurdly large, but the embezzler, to conceal this, overdrew the bank account constantly, but held back, unissued, checks to deal- ers in supplies, which had been regularly signed, and the amount charged to the dealer's accounts. The cash balance of, ^^y- $10,000 was composed of worthless paper $40,000 less overdraft at bank 30,000 $10,000 The auditors paid no attention to this on the ground that it was not their duty to verify the cash balance. How they could neglect the balance of the check-book does not appear, for it was the posting medium for the dealers' ledger. They contented themselves with the nominal net balance, without inquiring into its components ; they do not appear to have even inquired why the bookkeeper did not fill out a printed form appearing at the end of each month in the general cash-book which called for a detailed statement of the items composing the cash. It seems to me that an audit which does not probe the bank account is almost worthless. * 401. In the verification of the bank balance, it seldom happens that the same result is shown in our account and in the account rendered by the bank. The cause of this is that, as in other accounts of indebtedness, there is an interval of time between the payment on the one hand and the receipt on the other, so that the transaction is for a time in transit, and necessarily appears under one date in one account and under another in the other. *I have no intention to assert, nor do I believe, that any such view is usual among American certified public accountants; but I am emphasizing the point that this is poor iuditini;. Possibly the contract for auditing expressly excluded verification of cash; in thAt ca<=f the Trust Company was to blame. 150 Thb Philosophy of Accounts Where deposits are made by mail, this is often the case. Where checks are issued, they do not ordinarily reach the bank on the same day and frequently are " outstanding " for many days. It is therefore necessary to make a reconciliation between the two balances and this should be made a permanent record, so as to facilitate the next following reconciliation. 402. I would recommend that the balance of our account be first brought down and made the basis of the reconciliation, a total of the checks being inserted above the balance, as in Figure II. Next the deposit side is examined. This is composed of the previous balance which was adjusted and the deposits since made. If these are all in, the totals of the left-hand side should agree. Next, the checks actually canceled and returned should be compared with the list accompanying them, after which they should be reassorted by serial numbers into the order in which they were originally drawn. A list of the missing checks should then be made up. The total of this list should exactly equal the difference between the two aggregate of checks, as drawn and as paid. Having thus reconciled each side of the account, we are pre- pared to record the results. The general principle to be followed is that we must bring the balance on our books into conformity with the bank's statement for a moment, so that in the next recon- ciliation, if there is no variance, one side will be identical. It the variance is caused by delay only, and not by actual error on either side, we restore our account to its original status. 403. Suppose that there are 5 deposits and 5 checks, giving on our books the following result : Deposits Checks $633.34 No. I $200.CX) 522.19 2 400.00 300.00 3 19973 456.97 4 108.00 250.00 5 329.14 Total $1,236.87 , Balance 925.63 $2.162.50 $2,162.50 Balance $925.63 If all the deposits have reacht the bank and all the checks have been paid, the figures $2,162.50, $1,236.87, and $925.63 will coincide and no adjustment will be necessary. But we will noi« Thb Cash Account 151 suppose that checks No. 2 and No. 4 are outstanding; also that the last deposit, $250, had not yet been credited by the bank; therefore the balance as rendered by the bank is $1,183.63, the difference between $1,912.50 and $728.87. The checks outstand- ing- are re-entered on both sides of our account; the deposit in transit is subtracted from the balance, which then agrees on the debit side with the bank statement; but the deposit, as it will reach the bank before the next reconciliation, is restored to its place. Total Balance No. 2 .. $1,236.87 925-63 $2,162.50 Balance $925.63 + Checks outstanding . . 508.00 $2,162.50 $1,433-63 — Deposit in transit.. . . 250.00 Balance as per pass book $1,183.63 Deposit in transit. . 250.00 No. 4 108.00 404. An audit involving checks outstanding can only be regarded as provisional and is not complete until those checks have been paid and their amounts re-examined. 405. One of the most important points to be considered in the inauguration of a system of accounts is the method of handling the cash and its record in the cash account, whether kept in the ledger, in a cash-book, or in a check-book. MONOGRAPH B THE MERCHANDISE ACCOUNT »55 MONOGRAPH B The Merchandise Account Specific and Economic Values in the Same Account — Neither Predominant — The Merchandise Account in the Old MixT Form — Different Views — Difficulties in Both Views — Example of the Old Form — How to Close it — Modern Form Exemplified. 406. The reader has been cautioned (Article 200) against mixt accounts; that is, accounts partly specific and partly economic. These will, however, sometimes occur thru the imper- fections of current accounting: an account which is normally economic will prove to have a residue of the specific when it comes to the nicer adjustment of the balance sheet; and vice versa. This has been toucht upon in the cases of Coal (Article 174-181) and Interest (Article 185-194). 407. There are accounts, as sometimes kept, where it cannot be said that either the specific or economic character predomi- nates ; where each phase is important and essential, and where, if practicable, the course of wisdom would be to create two accounts, one representing the specific and the other the economic side of the transactions. 408. A good example of such an account is the Merchandise Account in the form still prevalent but gradually falling into disuse. It is not recommended for adoption, but its structure should be understood, in order that, when encountered in the course of examination of accounts, it may be readily disentangled. 409. Merchandise is something bought at a certain cost-price for the purpose of selling at a higher price. The latter price consists of two parts — one equal to the cost, which it repays, the other the Merchandise-Profit, which is earned by services in bringing the goods near the customer, in selecting them with reference to their desirable qualities, in providing a convenient place where they may be inspected and in holding enough in stock to meet all reasonable demands. 156 The Philosophy of Accounts 410. Viewed in this light, every sale is properly creditable to two accounts, one part to the asset Merchandise parted with, the other to the income account for the profit. 411. But it seems to be considered in retail business, even on a large scale, impracticable to separate each sale into its two elements, and to know at each transaction how much goes to replace the goods, and how much to repay the merchant for services, risk, and expense. One would suppose it feasible, and some merchants find it so, to record in a column of the sales- book the original cost of each article. But more usually tihe sale-price is undivided. 412. The Merchandise Account, therefore, becomes a mixt account. On the debit side, it contains entries at cost-price, and on the credit side at selling-price. No correlation is revealed between the two sets of values, any more than if one were in rupees and the other in reichsmarks. Hence some writers, in their zeal for classification, have con- sidered the Merchandise Account as purely an Outlay and Income account. The merchandise is considered not as property but rather as a mere form of cash expenditure to be recoupt ultimately by receipts of a greater amount, the resultant being profit. A difficulty arises when we reflect that the merchandise on hand is property of too great value to be ignored. The way to get over this difficulty is to consider the merchandise on hand as an adjustment — an offset to the purchases. 413. Other authors again would classify this account as strictly a specific account- — an asset. The difficulty here is that if we attempt to balance such an account we get a meaningless balance, corresponding to nothing. Hence the assumption is made that there is an increment of value to the extent of the profit; that the merchandise, so far as sold, has appreciated to that extent. 414. But whether the Merchandise Account be regarded as specific, or economic, or, as I contend, mixt, the calculation and the recording of the result are substantially the same. Let us take as an example, the following facts: The Merchandise Account Merchandise on hand Jan. i $5,643.75 Bought during January 2,644.18 Sold during January 3,219.74 Bought during February 1,845.17 Sold during February 2,454.62 Bought during March 1,929.44 Sold during March 1,728.96 From these data let tis construct an account : Fig. 57. MERCHANDISE. 157 Jan. I Balance ^S>''43.7S " Purchases 2,644.18 Feb. " 1,845.17 Mar. " 1,929.44 Jan. Sales $3,219.74 Feb. " 2,454.62 Mar. " 1,728.96 But from this we can draw no conclusion. The debit side amounts to $12,062.54 and the credit side to $7,403.32, but the difference, $4,65";. 22, is not an asset, for that would be assuming that we have sold at cost price ; and it cannot be a loss, for that would be assuming that there is no balance remaining. If we know the profit, we can ascertain the balance; if w^ know the balance, we can ascertain the profit. 415. The balance on hand, ascertained by inventory, is the key to the situation. Assume that it is $6,894.16. Then we compute the profit thus : Merchandise on hand Jan. I $£,643.75 Bought in January $2,644.18 " February 1,845.17 " March 1,929.44 Total bought 6,418.79 Total cost $12,062.54 But there remains unsold at cost 6,894.16 Therefore the goods sold must have cost $5,168.38 But thev produced in January ■ $3,219.74 February 2,454-62 March 1,728.96 Total proceeds 7,403-32 and the profit must be $2,234,94 416. We can now complete our account. 158 The Philosophy of Accounts Fig. $8. MERCHANDISE. Balance (Inv.).. $5,643 Purchases 2,644 1,845 „ '■ 1.929 Propt 2,^34 $14,297.48 Jan. Sales $3,219.74 Feb. " 2,454.62 Mar. " 1,728.96 Balance (Inv.) . . 6,Sg4 ■ 16 $14,297.48 $6,894.16 goes to the balance-sheet; $2,234.94 to the Profit and Loss Account. 417. This is the traditional form of the Merchandise Acconnt and suffices perfectly for " balancing the books." Its defect is that it nowhere presents a clearly contrasted statement of the same goods at the two prices — in and out — and consequently the average percentage of profit could not be obtained without effort. 418. When there are goods returned, whether purchases returned by us or sales returned to us, the confusion is still greater, for each side contains some values at cost-price and some at selling price. To illustrate this, let us vary the above figures slightly, the final results being the same. Balance January i, as per Inventory $5,643-75 We purchased in January 2,760.18 but returned 116.00 We sold in January 3,452.74 but had returned 233.00 We purchased in February 1,865.17 but returned 20.00 We sold in February 2,937.62 but had returned 48300 We purchased in March 1,947.44 but returned 18.00 We sold in March i,903-96 but had returned i7S-00 Balance March 31, as per inventory 6,894.16 419. It will be readily seen that the difficulty of obtaining intelligible information as to the comparativ values, in and out, is even greater than in Figure 58, and that to obtain such infor- mation the account would need to be taken to pieces and made over. The Mbrchandiss Account 159 Fig. 59. MERCHANDISE. Jan. I Balance $5,643.75 Purchases 2,760.18 " Returns 233.00 Feb. Purchases 1,865.17 " Returns 483.00 Mar. Purchases 1,947.44 " Returns 175.00 " 31 Profit 3,234.g4 $15,342.48 Jan. Returns $1 16.00 Sales 3.452-74 Feb. Returns 20.00 " Sales 2,937.62 Mar. Returns 18.00 Sales 1,903.96 " 31 Balance 6,8g4.z6 $15,342.48 420. An Account which Needs to be Made Over is One which Ought to have Been Made Differently at First. 421. The modern practice is to separate the Merchandise Account into three: Merchandise, Sales, and Purchases; or at least the former two. The above transactions would be posted as follows; Fig. 60. MERCHANDISE. Jan. I Balance $5,643-75 PURCHASES. Jan. Feb. Mar. Total bought. . . $2,760.18 1,865.17 1,947-44 Jan. Feb. Mar. Total ret'd by us $116.00 " 20.00 " " " " 18.00 SALES. Jan. Feb. Mar. Total ret'd to us $233.00 483.00 175.00 Jan. Feb. Mar. Total sold $3,452.74 2,937.62 " 1,903.96 Next close Purchases into Merchandise: i6o The Philosophy of Accounts PURCHASES. Tan. Feb. Mar. Total bought. . . $2,760.18 . 1,865.17 • 1.947-44 Jan. Total ret'd by us Feb. Mar. " " " " Net Purchases. . . . $116.00 20.00 18.00 $154.00 6,4t8.'jg $6,572.79 $6,572.79 MERCHANDISE. ^ an. _ an.- Balance Mar. Purchases. . . • $S.643-7S . 6,418.79 $12,062.54 In Sales Account bring down the balance. SALES. Jan. Total ret'd to us. Feb. ' . Mar. . Carried down. 55233.00 483.00 175.00 $891.00 $8,294.32 Jan. Total sold $3,452.74 Feb. " " 2,937.62 Mar. " " 1,903.96 .294-33 Net Sales $7,403.32 422. The cost of goods sold is now obtained by subtracting from the total of Merchandise, $12,062.54 the present balance, 6,894.16 cost of goods sold, $5,168.38 423. The only two accounts remaining open are Merchandise and Sales. Sales/Merchandise $5,168.38 Having posted this entry, the Merchandise, a pure asset account, is closed into the balance sheet ; the Sales account, a pure Outlay and Income account, shows the cost and the proceeds of the same goods, and the difference is carried to the economic summary. Thb Mb;rchandisb Account i6i Fig. 6i. MERCHANDISE. Jan. I Balance . . . . Jan.-Mar. Purchases. 85.643-75 6,418.79 $12,062.54 Jan.-Mar. Sales, at cost. $5,168.38 Mar. 31 Balance 6,8^4.16 $12,062.54 SALES. Jan Mar. Cost of goods sold $5,168.38 ProfX 2,^34 94 Jan.-Mar. Net proceeds. $7,403.32 87,403.32 $7,403.32