illi(IIK' HP 131 7 CORNELL UNIVERSITY LIBRARY . FROM Date Due ■WT^ 1948 J R 'm^^mrm Cornell University Library The original of this book is in the Cornell University Library. There are no known copyright restrictions in the United States on the use of the text. http://www.archive.org/cletails/cu31924032514113 ACCOUNTING THEORY AND PRACTICE A FIRST YEAR TEXT BY ROY B. KESTER, M.A., B.C.S. CERTIFIED PUBLIC ACCOUNTANT ; INSTRUCTOR, SCHOOL OF BUSINESS, COLUMBIA UNIVERSITY HF5625 .K42 "igt?"""' "■'"""' ^,.^ 3 1924 032 514 113 (Second Printing) NEW YORK THE RONALD PRESS COMPANY 1917 Copyright, 1917, by The Ronald Press Company William G. Hewitt Press. Brooklyn, Printera J. F. Tapley Co., New York, Binders Co JHp father anJi f^ot^tv An Appreciation of Their Steadfast Interest in My Work INTRODUCTION There are many things, in the writing of a book, which can be said only in the foreword. First, the "raison d'etre" of the book may require an explanatory word. Second, it may not be out of place to discuss some of the many points of academic controversy; such as the difference between bookkeeping and accounting; as to whether ac- counting is an art or a science; the various theories of debit and credit, etc. Finally, consideration may be given to the need of a knowledge of accounting on the part not only of those preparing for business but also of those expecting to enter any of the professions. With regard to the first point, it may be said that although there are available excellent treatises on account- ing, the author feels that the field is rather barren of text- books for the use of college students. This book is an effort to supply this need for students of first-year accounting. As to the second point, suffice it to say that the author does not know the difference between bookkeeping and accounting and doubts whether there is any except in popu- lar parlance. As to whether accounting is an art or a science, he believes that there is an art and also a science of accounting, the former resting upon the principles estab- lished by the latter. The necessary brevity of this intro- duction does not permit an adequate discussion of all the theories of debit and credit. As to the necessity for a knowledge of accounting on the part of both business and professional men, it should suffice to direct attention to the inclusion of accounting in the courses of all schools of business administration and to the tendency on the part of many professional schools vi , INTRODUCTION to offer in their curricula courses in general accounting. The author believes the time will come when a fundamental knowledge of accounting will be required of practically all candidates for a degree from a college or university. It is to be remembered that accounting instruction is not standardized; it is still in a formative stage. A period of three years of graded work has received fairly general recognition as the minimum requirement for professional study, but the content of the three years' work is not en- tirely uniform, nor are the order and the method established in which the subject matter should be presented, nor the amount to be offered in each of the three years. In some schools a knowledge of "bookkeeping" is a prerequisite to entrance upon the study of "accounting" ; in others the dry bones of theory are separated from their application in practice, although the tendency seems to be to treat the two, theory and practice, in the one course. Again, in some schools, an effort is made to cover in the one year all of the so-called accounting theory, while in other places there is a growing conviction that the subject matter is too broad for adequate presentation in the time usually allotted to the first year's work. In other places an attempt is made to differentiate between accounting as presented for the general student and accounting as offered to the one expecting to make it a vocation. It is being recognized, however, that both classes must have equal training in the essential fundamentals of the science. A diet of denatured accounting will deprive the general student of training that may seriously handicap him. Most students on entering college do not have a knowl- edge of bookkeeping nor should it be required of them. Those few who do have such a knowledge, for the most part, understand only a partial application of debit and credit and not the fundamental principles on which rests INTRODUCTION vii the whole structure of accounting. This book is designed to meet this existing condition and will be found equally adapted to either class of students. The subject is devel- oped in such a way that the student knowing something of bookkeeping has little or no advantage over the one without such knowledge. This book has been written for the use of students in our colleges and universities desiring a first course in accounting. The present volume gives the scope of the work in accounting offered in the first year of the School of Busi- ness of Columbia University, and is an effort to mark out and define the portion of the whole subject which can be handled effectively in one year's time. There is a real demand for a one-year course which will treat the subject in a general way and give a brief view of the entire field. The author believes, however, that accounting in its broadest sense is just beginning to receive the consideration which it deserves and that more and more is recognition being given to the necessity of a thorough knowledge of its principles and their application, for effec- tive work in all lines of business activity. Accordingly, the material in this first volume is not presented to meet the demand of the casual reader or of the student seeking a bird's-eye view of the entire field, since much of the sub- ject matter is reserved for presentation in a second volume which the author hopes to have ready in the course of another year. In that will be taken up a more detailed treatment of the balance sheet in connection with its prob- lem of valuation ; various aspects of the corporation and of the income statement, not adequately handled in this vol- ume; together with some miscellaneous topics, including forms of special statements, branch accounting, sinking funds, and other similar subjects. The method of approach as given in this volume is viii INTRODUCTION perhaps not orthodox but it has seemed that the student, given an understanding of the purpose which the account- ing records are to serve, will be able to make that record with real intelligence instead of by rule of thumb. Ac- cordingly, the balance sheet and the profit and loss state- ment are presented first, as the goal towards which all record-keeping looks. The student is taught to analyze business facts and conditions from the very beginning. He is then led, step by step, through the use of non-technical terms, into the ledger, where he sees the way in which the data which he has been using are summarized. The books of original entry are next explained and the method by which the information is classified as it is brought onto the books. Finally, the business papers and documents which constitute the source of all entries are described. It has been found that the student who has no knowl- edge of bookkeeping can thus acquire rapidly and intelli- gently a facility in its technique with no lost or wasted effort. Instead of laboring through many "simple" trans- actions and spending much duplicated effort, he is taught fundamental principles and their application right from the beginning, after which these principles are correlated and tied up in a complete whole. The process may be somewhat discouraging to the student at times and he may ask for a simpler diet, but in the end he has a surer and more fundamental grasp of the subject than could have been obtained otherwise in the same time. The first half of the book is devoted principally to the work outlined above. The second half gives a broader and more intensive development of many of the subjects treated but incidentally up to that point. Here the order of ar- rangement is not so important. The guiding thought has been to present first the principles needed by the student in his practice work, and then to deal with the more detailed INTRODUCTION ix applications of these principles regardless of the fact that this has at times necessitated a break in the continuity of treatment of some subjects. As to the general content of texts on accounting, it may be said that it is always necessary to include a treatment of many points of the law, of business organization, and of finance. This is so because accounting is so intimately connected with all business activities that the subject can- not be fully tmderstood and applied unless it is based on a fair knowledge of business practice. These subjects should be kept to a minimum and effort has been made to do so. A word of explanation may be in order with regard to the practice work for the student. The material for this is presented at the end of each chapter and is intended as an application of the principles developed in that chapter or in preceding chapters. The various "Problems" given present disconnected material and bear no relation to each other; the "Practice Data," on the other hand, contain connected matter for record in blank books and relate to a business whose record the student is keeping. One rather long set of practice data is included in the present volume because it is felt that in some quarters we have got away too far from the long set, the work having been cut up into such short periods that the student does not get adequate drill in the making of the record nor a proper perspective as to the volume of transactions during a fiscal period. Nor with these short sets does he get a realistic basis for the calculation of depreciation, bad debts, and other similar items. However, care has been exer- cised not to overburden the student with the drudgery of too much of this material, only enough being given to insure facility in the application of principles. For the use of those instructors who desire to offer additional practice work, or desire an opportunity to vary X INTRODUCTION the problems or substitute detached problem work for a portion of the formal sets, a collection of classified prob- lems is given in the second appendix. In gathering these problems together the author has drawn freely from many sources and desires here to acknowledge the kindness of David Friday and R. J. Bennett in permitting the use of problems prepared by them. There remains the pleasant part of the foreword — the acknowledgment of the kind helpfulness of many whose best thought and effort have been given without stint in the production of this book. Acknowledgment is here made of helpful criticism and service from H. T. Scovill, of the University of Illinois; R. A. Klahr, of Colorado College; I, G. Flocken, of the University of Pittsburg; F. H. Elwell, of the University of Wisconsin ; D. W. Mor- ton, of the University of Oregon; Ben Morris and C. W. Collins, of the University of Denver. J. E. Trelevan, of the University of Texas, and Earl A. Saliers, of Yale University, gave much help by their painstaking review and freely given suggestions. Particularly does the author acknowledge indebtedness to the Columbia staff of instruc- tors in first-year accounting, F. P. Baltz, H. F. Seward, R. T. Bickell, C. M. Neubauer, E. M. Barber, and K. L. Baker. During the period of preparation of this material, Pro- fessor R. H. Montgomery, in a life full of many activities, found time to lend a guiding hand and give ever-ready encouragement. Both for this and for valuable criticism on many points, and especially in fixing the emphasis of the book, the author takes this opportunity of publicly acknowledging his debt to him. R. B. Kester. New York City, May 12, 191 7. CONTENTS* CHAPTER PAGE I History and Development of Accounting . i Antiquity of Accounting Business Progress in Babylon Egyptian Records Accounting in Ancient Greece Roman Records The Medieval Retrogression Early English Accounting The Rise of Double Entry Ancient Double-Entry Bookkeeping Early Text Books Development of the Ledger Account Organizations of Accountants Organizations of Accountants in the United States II Proprietorship . . . . . .12 Relation of Accountancy to Economics Relation of Accountancy to Law The Fundamental Problem of Accountancy Definition of Terms The Proprietorship Equation Illustrated III Types of Business Organization . . .19 The Single Proprietorship The Partnership The Corporation The Showing of Proprietorship Under These Types IV The Financial Statement . . . .26 Its Purpose and Use Its Content and Subdivisions Its Titles, Principal and Group Principles Governing Fulness of Detail Illustration V Comparative Financial Statements . . 33 Comparison of Net Worths How a Gain or Loss May Be Evidenced The Comparative Financial Statement — Its Con- tent ana Method 'Illustrative Problems or Practice Data accompany each chapter except Chapter I. xi xii CONTENTS CHAPTER - PACE ' Vl The Economic or Profit and Loss Elements of I / a Business . 3^ " Fuller Information Needed The Two Kinds of Records Temporary Proprietorship Records ( VII^ The Profit and Loss Summary . . -43 \ / Titles for the Profit and Loss Summary ""^ The Fiscal Period Need for the Physical Inventory Principles Governing the Make-up of Profit and Loss Summary Content of the Statement Algebraic Content of the Profit and Loss State- ment The Disposition of the Net Profit Additional Information Sometimes Given The Two Methods of Determining Net Profit VIII Interrelation Between the Economic and the Financial Elements of a Business . . 51 Various Aspects of Temporary Proprietorship Records Relation Between Profit and Loss and Financial Elements Exchanges Within the Asset and Liability Groups Illustration IX The Account . . . . . . . 56 The Goal of Account Keeping The Ledger Account Defined The Account Title The Two Sections of the Account The Mechanism of the Account The Ledger and Its Content The Number of Accounts X The Account (Continued) . . . .61 The Balance of the Account The Account Title Indicative of Its Classification The Meaning of Account Balances The Business Transaction Defined Analyzing the Transaction as to Its Accounting Record The Use of Debit and Credit Fundamental Principle of Debit and Credit The Philosophy of Debit and Credit . . 67 Attempts to Reduce Debit and Credit to One Rule Origin of the Use of Debit and Credit Basis of Debit and Credit as Used Here CONTENTS xiii CHAPTER PAGE The Debit and Credit Schedule Debit and Credit Determination Illustrated Necessary Equilibrium of Debits and Credits Debit and Credit as Applied to Asset and Liability Accounts . . . . -73 Student's Use of Working Rules Accounts Receivable Accounts Payable Accounts with Media of Exchange Other Liability Accounts Accounts with Fixed Assets XIII Debit and Credit as Applied to Proprietorship Accounts ....... 8o Proprietorship Accounts Defined Customary Explanations of Debit and Credit of Temporary Proprietorship Accounts Fundamental Consideration of Proprietorship Debits and Credits Income Debits and Credits Expense Debits and Credits Vested Proprietorship Debits and Credits XIV Debit and Credit as Applied to Mixed Ac- counts ........ 87 Analysis of a Sale Transaction The Old Merchandise Account, Its Content and Significance Modern Practice in Showing Merchandising Transactions Accounts with Assets Subject to Depreciation Capital and Revenue Expenditures XV Periodic Work on the Ledger . . . -97 The Trial Balance Work Preliminary to the Trial Balance Balancing an Account Use of Red Ink Rulings Transferring Summarizing the Ledger Rulings and Entries in Personal and Note Ac- counts XVI Treatment of Inventories and Appraisals . 109 Why the Current Record of the Ledger Needs Adjustment Basis of Adjustment Entries Adjusting and Closing the Merchandise Records Handling Depreciation on Fixed Assets Handling Prepaid and Accrued Expenses and Income xiv CONTENTS CHAPTER PAGE XVII Sources of Data for the Ledger ... • 120 Insufficiency of the Ledger Record The Book of First Record Posting to the Ledger The Journal Characteristics of the Journal Equilibrium of the Journal Entry; Compound Entries Standard Form of Journal XVIII The Subdivision of the Journal . . . 126 Inadequacy of the Old Journal The Subsidiary Journal a Labor-Saving Device Basis of Subdivisions Customary Subdivisions XIX The Purchase Journal . . . . -13° Meaningless Distinction Between Book and Journal Expanded Use of the Purchase Journal Analysis of the Purchase Transaction The Purchase on Account The Cash Purchase Handling the Cash Purchase Posting the Purchase Journal Form and Method of Use of the Purchase Journal Departmental Analysis of Purchases XX The Sales Journal ...... 140 Kind of Transactions Recorded Here Analysis of the Sales Transaction and Method of Record Summarization of the Sales Journal Goods Sold to the Owner XXI The Cash Journals ...... 143 The Cash Book Analysis and Entry of a Cash Receipt Analysis and Entry of a Cash Disbursement Form of the Cash Journals Cash Book Taking the Place of the Cash Account Posting the Cash Book Balancing and Ruling the Cash Book The Cash Short and Over Account Analysis of Cash Receipts and Disbursements Cash Discounts Analyzed Handling Discounts in the Cash Book Illustration and Explanation of the Analytic Cash Receipts Journal Handling Cash Sales CONTENTS XV CHAPTER PACE Illustration and Explanation of the Analytic Cash Disbursements Journal Alternative Treatment for Cash Discounts XXII The Modern Journal ..... 159 Matter Left for Record in the Journal Kinds of Transactions Recorded in the Journal Journal Explanations Closing and Posting the Journal The Analytic Journal with Divided Columns Illustrations — Opening Entries Adjusting and Closing Entries Objection to the Direct Ledger Method of Adjusting and Closing the Books XXIII Business Papers 170 Definition The Invoice Handling the Purchase Invoice Handling the Sales Invoice Returned Goods Invoices XXIV . Business Papers (Continued) . . . . 175 Use of the Note Receivable Negotiable Instruments — Their Use and Requi- sites Negotiable Instruments — Kinds and Definitions The Draft The Accepted Draft Illustrative Entries Entries After Payment of the Draft Classification of Drafts Checks Other Negotiable Instruments Principles Governing the Writing of Commer- cial Paper Kinds of Indorsement XXV Business Methods 187 Shipping Goods — The Bill of Lading Freight Notice and Expense Bill C. O. D. Shipments Duties of the Traffic Department The Statement of Account XXVI Business Methods (Continued) . . . 194 Service of the Bank to the Community Opening an Account with the Bank The Deposit Ticket The Pass-Book The Check Book XVI CONTENTS CHAPTER PAGE Securing a Loan Through the Discount of a Note Principles to Be Observed in the Calculation ot Interest Short Methods of Interest Computation XXVII Methods of Posting 204 The Journal and Ledger Records Differentiated — Posting Time of Posting Methods of Posting Cross-Indexing the Entries ,.,'" ^\ Explanatory Matter in the Ledger XXVip' The Trial Balance and Methods of Locating ^^ Errors 210 The Trial Balance Errors in the Trial Balance Suggestions for Locating Errors Transpositions Transplacements Checking the Postings XXIX Adjustment Entries and Corrections . . 221 The Need for Adjustment Entries Inventory of Stock in Trade , Other Adjustment Entries Depreciation, and Loss on Doubtful Accounts Expense Paid in Advance Accrued Expense Items Prepaid Income Items Accrued Income Items Corrections XXX Closing the Books — Summary Statements . 231 Purpose of Summarizing Method of Closing Effect of Closing the Ledger Profit and Loss Not an Account for Current Entry Making the Closing Entries Closing the Books Illustrated The Profit and Loss Account Need for the Summary Statements The Financial Statement Financial Statement — Report Form Financial Statement — Account Form Balance Sheet and Financial Statement Differ- entiated T^o Forms for the Profit and Loss' Statement Profit and Loss Statement — Report Form Profit and Loss Statement — Account Form CONTENTS xvii CHAPTER PAGE XXXI The Classification of Accounts . . . 246 The Purpose and Method of Account-Keeping Classification of Accounts Early Classifications Recent Classifications Classification Used Here Fundamentals of a Good Classification Classifying Business Transactions Detailed Classifications Chart of Accounts XXXII The Two Basic Methods of Accounting and Some Applications ..... 258 Accounting, Its Field and Method Analysis and Synthesis Analysis and Synthesis Applied to Account Clas- sification The Ledger; an Example of Analysis and Syn- thesis 1. Rulings The Progressive Ruling 2. Bindings Method of Arranging Accounts in the Ledger XXXIII Partnership from the Business Viewpoint . 271 Partnership Defined Operating Feature and Working Organization Essential Characteristics of the Partnership The Partnership Contract Partnerships Classified The Joint-Stock Company Partners Classified XXXIV Partnership from the Accounting Viewpoint 279 Profit-Sharing in the Partnership Average Investment as a Basis for Profit- Sharing Interest on Partners' Investments Valuation and Correct Booking of Original In- vestments Distinction Between Buying Out an Interest and Making an Investment to Secure an Interest Final Considerations XXXV Handling the Cash ..... 289 General Considerations Principle of the Double Record Handling the Petty Cash The Petty Cash Book Keeping the Bank Account Entering Checks on the Cash Book Branch Cash — The Working Fund xviii CONTENTS CHAPTER PAGE XXXVI Discounts 298 Definition and Kinds The Method and Purpose of Trade Discount Methods of Calculation The Nature of Cash Discount— Its Basic Ele- ments Showing Cash Discount in the Trading Section Correct Method of Showing Cash Discount Account Titles for Cash Discounts Methods of Booking Cash Discount Securing Information as to Neglected Discounts Trade Acceptances and Cash Discounts XXXVII Notes Receivable and Payable . . • 3^3 Conditions Precedent to the Present Use of Notes and Bills The Titles "Notes" and "Bills" Relation of the Note to the Open Account Relative Liquidity of the Note and Open Account Method of Recording Notes The Note Journals Notes Entered at Face Value Always The Interest Accounts XXXVIII Problems Encountered in Recording Notes Re- ceivable and Payable ..... 322 Entries in the Account The Discounted Note The Dishonored Note The Classification of Notes Notes Receivable Out as Collateral Note Renewals and Partial Payments / XXXIX /Sales 335 \ / Importance of the Sales Department \ ,' Basis for Sales Classification ■-.,, ^ The Sales Analysis in Books of Original Entry Principles Governing Booking the Analysis Use of the Sales Ticket in Analysis Analyzing Sales Returns Purchases and Returned Purchases The Handling of Cash Sales Sales to Branches Consignment Sales Instalment Sales Sales for Future Delivery Department Store Sales C. O. D. Sales The Bill and Charge System Salesmen's Commissions and Efficiency Records CONTENTS xix CHAPTEK PAGE XL Capitalization of the Partnership . . 347 The Real Capital Original Contributions Adjustment of Capital Contributions Averaging Investments Accretions of Capital Through Profits Additional Contributions and Loans Borrowed Capital XLI Other Partnership Problems .... 357 Admission of a New Partner First Case ; Second Case I Third Case Consolidation of Partnerships Partners' Loans in Relation to Firm Credit XLII Partnership Profits ..... 368 Ambiguity of Definition of Profits Compensation for Time and Services Interest on Investment Partnership Profits Defined Profit and Loss for Comparative Purposes Allowance of Salaries Allowance of Interest Interest on Partners' Loans Closing Profits to Partners' Accounts Reserved Profits Distributing a Deficit Partners' Withdrawals Profits Determination Upon Admitting a New Partner XLIII Problems and Methods Connected with Sum- marizing THE Period's Results . . . 379 Introductory Adjustments Problems Connected with the Merchandise In- ventory Methods of Recording Deferred Expenses The Summary Accounts The Trading or Selling Account Posting the Closing Entries The Balance Sheet The Working Sheet XLIV Partnership Dissolution .... 392 Temporary Nature of Partnership Causes of Dissolution Problems Incident to Dissolution Partnership Provisions Covering Liquidation XX CONTENTS CHAPTER . P-*''^ Partners' Rights and Procedure During Liqui- dation Distribution of Proceeds Sharing Losses 1. Sharing Losses Equally 2. Capital Deficit 3. Personal Insolvency of One Partner Distribution by Instalments Treatment of Good-Will Upon Liquidation by Sale XLV Types of Accounting Records and Their De- velopment ....... 403 Evolution of Analytical Journals Principle to Be Followed in Securing Analysis Subdivision of the Ledgers Types of Sales Journals and Methods of Hand- ling The Sales Returns and Allowances Journal Posting the Sales Journal Development of the Purchase Journal Handling Expenses Through the Purchase Journal Note Journals Analysis in the Cash Book Analysis in the General Journal XLVI Controlling Accounts ..... 413 Introductory Advantage of a Controlling Account Controlling Account Necessitates Changed Idea of Ledger Equilibrium Debits to the Controlling Account Credits to the Controlling Account Proving the Customers Ledger Accounts Payable Account Basic Principle as to Postings to Controlling Accounts Making the Subsidiary Ledger Self-Balancing XLVII Handling Controlling Accounts . . . 422 Introduction of the Controlling Account Recording Withdrawals of Stock in Trade The Problem of the Sales Journal Summary The Problem of the Purchase Journal Summary Accounts Both Receivable and Payable The Problem of the Note Journals Summaries Summary Entries for Columnar Books The Sales Journal Summary The General Journal Summary The Cash Book Summaries Other Controlling Accounts Principle Governing Content of Subsidiary Ledgers CONTENTS xxi XLVIII The Corporation ...... 438 Definition Growth of the Corporate Form of Organization Advantages Disadvantages The Formation of a Corporation Certificate of Incorporation — New York State Filing the Certificate — New York State Organization Tax — New York State Initial Acts of Corporation State Control Working Organization and Management Annual Election of Directors Officers The Showing of Proprietorship The Subscription Book and Subscription Ledger The Stock Certificate Book and Stock Ledger The Stock Transfer Book The Minute Book Other Records XLIX Opening and Closing the Corporation Books . 450 Corporation Accounting Records Real Capital and Capital Stock Common and Preferred Stock Opening the Books of a Corporation — First Method Opening the Books of a Corporation — Second Method Opening the Books of a Corporation — Third Method Opening the Books of a Corporation — Fourth Method Premium or Discount on Stock Instalments Entries for Common and Preferred Stock Payment of Subscriptions by Property- Change from Partnership to Corporation Current Record on Corporation Books Dividends Ultimate Control of Stockholders Dividends Out of Profits Only Distribution of Profits Reserves Dividend Liability L Consignments ....... 465 Definition Legal Status The Broker The Factor Duties of the Factor Factor Must Protect Goods jyj-ii CONTENTS PACE CHAPTEK ^ T^ o Consignments to Be Kept Separate Expenses Charged Against Consignment Factor's Lien on Consigned Goods Account Sales Compensation of Factor "Del Credere" Agency Advantages of Consignments The Consignor's Entries Two Methods of Entering Sales on Consignor s Books Consignor's Inventory The Consignee's Entries— First Method The Consignee's Entries— Second Method Consignments Must Have Distinguishing Marks Factor's Books at Close of Fiscal Period Consignee's Inventory Illustrative Entries on Consignor's and Con- signee's Books LI Approval Sales and Adventure Accounts . 482 Approval Sales Accounting for Approval Sales Tickler File Method of Handling Approval Sales Adventure Transactions Single and Joint Ventures Relations Between Parties Accounting for the Joint Venture Interest Allowances and Charges Distribution of Profits Joint Venture Accounts Illustrated LII Accounts Current ...... 491 Definition Interest on Balances Joint Venture Accounts Partners' Accounts and the Account Current Adjusting the Current Account The Bank Account an Account Current Reconciliation of Bank Balance Other Reconciliation Factors Reconciliation Statement a Permanent Record Reconciling Other Accounts LIII Safeguarding Cash ; Instalment Sales ; Pro- portion ; Book Inventories .... 500 Safeguarding the Cash General Principles Internal Check Statement of Receipts and Disbursements Instalment Sales The Problem Involved Accounting for Instalment Sales CONTENTS xxiii CHAPTER PAGE Separation of Instalment from Regular Sales Records Delinquency Records Chief Considerations in Handling Instalment Sales Proportion Simple and Weighed Apportioning Freight Charges Book or Estimated, Inventories LIV Balancing Methods ..... 511 The "Fool-Proof" Trial Balance Ledger Analysis Procedure of Analysis The Analysis Sheet Use of Ledger Analysis The Slip or Reverse Posting System Check Figures in Posting Errors in Columnar Books and Controlling Ac- counts Trial Balance Adjustment Account LV Single or Simple Entry ..... 520 Different Systems of Bookkeeping Single Entry Books Required and Methods of Record — The Journal Cash Book Ledger Single Entry as Adapted to Modern Needs Debits and Credits The Proprietor's Account Proof of Posting Profit and Loss Inventory and Appraisal Liabilities Accrued and Deferred Items The Balance Sheet and the Determination of Profit LVI Illustration of Single Entry ..... 529 Single and Double Entry Compared Opening Entries Net Profits Change from Single to Double Entry LVII Some Phases of Interest ...... 543 The Nature of Interest Commercial Interest Simple and Compound Interest Equation of Payments Average Due Date xxiv CONTENTS CHAPTER PAGE The 100% Method Compound Equation The Cash Balance Interest on Partial Payments United States Rule Interest on Daily and Savings Bank Balances Bank and True Discount Appendix A — Review Questions . . . . -553 Appendix B — Problems ....... 572 Consignments Partnerships — Formation Partnerships — Closing the Books Partnerships — Dissolution Joint Venture Corporations — Opening the Books Corporations — Closing the Books Corporations — Miscellaneous Single Entry Inventory Adjustments Fire Loss Adjustments Notes, Drafts, etc. Cash Disbursements Accounting — Theory and Practice CHAPTER I HISTORY AND DEVELOPMENT OF ACCOUNTING Antiquity of Accounting Accounting or the keeping of records is undoubtedly as old as civilization itself. Wherever trade and credit were introduced, some method of keeping a record must have been employed. With the rise of powerful chiefs and or- ganized government, the necessity for keeping account of many and varied complex transactions must have provided the means of doing so. Little record has been left by ancient peoples whereby a very definite idea can be formed as to their methods, but sufficient data have been discovered to prove the existence of a highly organized trade and to point out some of the tools and means by which that trade was conducted. Business Progress in Babylon Three or four thousand years before our era, Babylonia was a flourishing state. The code of Hammurabi, a ruler of Babylonia, 2285 B. C. to 2242 B. C., shows that the partnership form was known ; also the relation of principal and agent; drafts and checks were common; legal decisions had been recorded covering contracts, conveyances by deed, bonds, receipts, inventories, sales, and accounts of all sorts ; customs and ferry dues were collected ; highway tolls I 2 ACCOUNTING— THEORY AND PRACTICE and water rates were imposed. The records of two banking and money-lending firms, the Sons of Egibi of Babylon and the Marashu Sons of Nippur, have come down to us. The method of keeping their records was by means of sun-baked tablets or slabs, one-half by three-quarters inches in size, written on the front, back, and sometimes on the edges; others were as large as nine by twelve inches. Also care- fully prepared registers for the state made record of the ownership of property as the basis of taxation. All these records, it seems, were kept by scribes, who were presumably the only ones who could make the record. Egyptian Records In Egypt, accounts were kept on papyrus. We find here very careful record of the revenues and disbursements of the state. Taxes were usually payable in kind, necessitating the building of granaries and depositaries of various kinds for- the storing of the receipts — treasure houses, as it were. The tax payer bringing his grain was stopped at the first entrance to give a record of his payment, and again at the point where formal delivery was made, where a second record of the amount was written down. This method of auditing by means of duplicate but distinct records cannot in some instances be improved upon even today. Concerning the methods of record-keeping by the Per- sians, Phoenicians, and Carthaginians, we know little definitely. Trading both by land and by water was active and some method of account-keeping was presumably em- ployed. Accounting in Ancient Greece In Greece a strict accounting was required of all public officials. The records were kept by treasurers, sub-treas- urers, clerks, and checking clerks, but even these seem to HISTORY OF ACCOUNTING 3 have been unable to prevent peculation and graft which were very prevalent although severely penalized. Each of- ficer upon giving up his office was required to render an accounting of the funds intrusted to him. Publicity was secured by engraving the accounting on stone and exposing it to public view. The Greeks borrowed much from the East. They developed a crude clearing-house system, made loans, discounted notes, etc. Roman Records In early Rome the father of a family kept records of his receipts and payments in a sort of blotter or memoran- dum record. Every month these were transferred to a more carefully kept register, entry in which, if made with the consent of a debtor, was sufficient basis for legal suit or civil obligation. The bankers used a similar register and seem to have made use of a third book in which ac- counts with customers were set up, on the one page that for which they were indebted to the banker and on the opposite page that with which they were credited. Periodically a balance was figured and might be demanded in cash by the customer or the account might be continued. Checks seem to have been used by the wealthy, though cash payments were usual. The system developed by the state in this early period introduced a new feature by means of which disbursements were safeguarded. The official intrusted with the funds had no authority for disbursing them. That was intrusted to a separate and distinct body which issued orders on the treasurer, providing him with a voucher, at an accounting time, for the disbursements made by him. Cicero holds up to scathing satire one Verres, a public official and grafter, for the meagerness of his accounting; and in another case criticizes one attempting to base an action on memoranda, 4 ACCOUNTING— THEORY AND PRACTICE mere scraps of papers, in contravention to established usage. Both these instances point to the keeping of very carefully prepared records of transactions between persons. In the early empire, under Augustus, a system of provincial and district treasuries was employed with a strict accounting to the central treasury. It seems that as a basis for the levy of taxes, a crude form of budget showing the needs of the imperial household, the army, etc., came into use. Under the later empire this district system of government, the levying and collection of taxes, became very highly or- ganized. Eight of the ten or twelve central offices or depart- ments of control were devoted to accounting. The Medieval Retrogression After the overthrow of Rome and before the building up of a new civilization almost from its foundations, for a time attention was centered on the future spiritual life rather than on the affairs of the material world, and this may account for the loss of these records of the Romans. However, the Pope as the head of a vast and growing or- ganization, required records of various sorts and Charle- magne had an elaborate system of accounting for income and expenditure and required detailed reports from all his subordinates. Early English Accounting In England the earliest system of accounting on record was that of the exchequer, established about the time of Henry I (1100-1135). The basis for this accounting was the Domesday Book which showed all taxable estates in the country. From this the treasurer's Great Roll — ^the Pipe Roll — was made up and each sheriff was intrusted with the collection of his portion. Twice every year he rendered an account. At the first accounting he received HISTORY OF ACCOUNTING 5 the half of a tally stick with notches showing the amounts. The other half of the tally stick with its corresponding notches was retained by the treasurer. Upon his next accounting, the sheriff's tally stick was turned in as evi- dence of the payments already made and must exactly fit into the half retained by the treasurer. The Rise of Double Entry In the revival of trade during the twelfth and thirteenth centuries, Italy played a leading part. Here was unques- tionably the beginning of double-entry bookkeeping. When, is not known with exactness. A Florentine banker in 121 1 kept accounts with clients and memoranda of other trans- actions, but there was no attempt to bind them together into a systematic whole. A French firm, Freres Bonis (1345-1359), used its books for the purpose of making up a list of debtors and creditors, thus showing its position as to persons. This evidences a systematic, though limited, use of books for showing position. At this time, some systems were quite voluminous and elaborate, one Italian firm opening in one year eleven books — ^five white, two black, and one each red, orange, green, yellow. In Genoa in 1340, a double-entry ledger was in use. It shows a "pepper" merchandise account debited with expenses and credited with receipts, the balance being transferred to "profit and loss." A similar system used in Venice and known as the Venetian method was very neatly and care- fully kept. In these early books Roman numerals were quite generally used, the courts requiring that only books using the Roman notation would be accepted as evidence. Books were not often balanced, one set showing a balance after nine years, another thirteen, and another only after twenty-six when the accounts were transferred to a new volume. 6 ACCOUNTING— THEORY AND PRACTICE Ancient Double-Entry Bookkeeping In 1494 at Venice a monk, Luca Paciolo, a celebrated mathematician, brought out a book entitled, "Everything about Arithmetic, Geometry and Proportion." A recent American translation with commentaries by J. B. Geijs- beek entitled "Ancient Double-Entry Bookkeeping" has been made. At the end of his treatise on arithmetic, Paciolo includes a dissertation on bookkeeping comprising thirty- six chapters called "Reckonings and Writings." He makes no claim to originality, stating that his work was a sum- mary of existing practice. Some of his statements and methods are interesting. He states the purpose of book- keeping to be the furnishing of information with regard to assets and liabihties. He bases his opening entries on a list or statement of assets and liabilities. The system de- scribed provides for the use of three books, a memorial, a journal, and a quaderno. The memorial is a day book or blotter, its use being necessitated by the chaotic condition of the currencies then in use. The actual moneys received and paid were entered here and later transferred, reduced to a common medium of values, to the journal where a formal debit and credit were given, from which in turn they were posted to the quaderno or ledger. In the journal the date was at the middle of the page on a line reserved for it, only one money column was used, and the posting folios for debit and credit were shown as a fraction. In the ledger, the folio index was always of the contra ledger account and never of the original journal entry. The merchandise transactions were usually of the single venture type, each transaction being charged with its expenses and credited with its in- come ; the balance was transferred to Profit and Loss which held a very prominent place. Methods of detecting errors were given. Paciolo's treatise gave very few illustrations. HISTORY OF ACCOUNTING 7 Early Text Books A book for teaching by means of examples was pub- lished in 1525 by one Giovanni Antonio Taglienti. In Eng- land, Hugh Oldcastle, a teacher of arithmetic and book- keeping, brought out a translation of Paciolo, with some omissions not applicable to English methods, in 1543. In 1635 Richard Dafforne, an accountant, published the "Mer- chant's Mirrour, or directions for the perfect ordering and keeping of his accounts; framed by way of Debitor and Creditor, after the (so termed) Italian manner." His book went through several editions, evidencing a demand for the work. Since then the literature has been rather profuse, written mostly by self-styled accountants, teachers, and writing experts. Some were quite ambitious, one by Robert Ham- ilton of Edinburgh, 1777, illustrating systems for shop- keepers, tradesmen, land stewards, and farmers. He classi- fies accounts as personal, real, and fictitious. His books he calls a waste book (i.e., a blotter), a journal, and a ledger. He shows the ledger closed by journal entry and a balance sheet with assets on the left and liabilities on the right, exactly counter to current English practice. In the ledger was an inner column for foreign moneys ; there were shown forms for a suspense book for bad debts; a cash book; charges of merchandise ; a petty cash book ; a postage ledger ; bill books ; and a balance ledger for customers. It remained, however, for one Edward Thomas Jones, of Bristol, to capitalize his selling as well as his accounting ability when he accepted prepaid subscriptions for a ten-column ledger system invented by himself but never used. Development of the Ledger Account The form of the ledger account was very slow in de- veloping. At first it was merely historical or narrative, a 8 ACCOUNTING— THEORY AND PRACTICE statement of transactions, receipts and payments, debits and credits, in chronological order, one underneath the other on the same page. It seems that the account as now stated was not known in ancient times. Egyptian accounts about lOO B. C. show some classification, receipts being grouped together followed by the disbursements, with the balance carried forward for the next day. The development of a separate money column was slow. An English royal house- hold account for 1299- 1300 shows a narrative of receipts and disbursements with a money total column on the right entirely free from narrative. The form of the account up to the seventeenth century was usually as above, the money column on the right, the first entry being the opening bal- ance, followed by the receipts, and these by the disburse- ments. During the latter part of the fifteenth century the charge- discharge form was used by the Lord High Treasurer of Scotland. The account opened, "I charge myself with :" followed by the itemized estate entrusted to him and all revenues. It closed with, "I discharge myself with," fol- lowed by a statement of the moneys lawfully expended and, at the end, the uncollected revenue. The several pages of this report were footed but not carried forward page by page. At the close a recapitulation was made arriving at the net moneys to be accounted for. The double form of account as now known must have come into use about the thirteenth century in Italy and reached England by way of Holland, as was usually the case with Italian business meth- ods. Roman numerals were used until 1673, at which time the Arabic came into use and a regular money column was introduced. In Italy the Arabic notation had come gradually into use considerably earlier. Before leaving the subject of the early accounts, it mav be interesting to note that often items in officials' ac- HISTORY OF ACCOUNTING g counts were not approved by the "awdytowris" appointed to pass on them. An early auditor's certificate reads : "Ap- proved the foresaid accompts in all the heads and articles thereof (errors and mistakes always excepted)" — a form which some today might like to employ. Organizations of Accountants Organizations of accountants have been in existence but little more than fifty years. Almost from the start there have been those who devoted their entire time to profes- sional accounting, if we can believe some of the titles which they were wont to assume. In England in 1721, an ac- countant made an investigation of the South Sea Company in connection with its exploitation and reported his findings. This seems to be the first report on record and it does not cast much credit on the fair-mindedness and disinterested- ness of the accountant, who evidently was in the employ of the men whose manipulations he was investigating. In 1799, Holden's triennial directory of London gives eleven names and firms as accountants. The nineteenth century, with its rapid expansion and extension of trade due to improved methods of manufacture and means of reaching markets by easy transportation and communication, created a demand for the services of scientifically trained men of the highest caliber and largest vision to account for the intricate and complex transactions involved and to establish the necessary control for the proper management of such vast undertakings. ' The first formal organization of ac- countants was in Edinborough in 1854 when the Society of Accountants was incorporated by royal charter ; in Glasgow in 1855; and in Aberdeen in 1867. The Institute of Ac- countants was formed in London in 1870 but was not char- tered till 1880 at which time it secured the exclusive right to use the letters F.C.A. or A.C.A., respectively Fellow lO ACCOUNTING— THEORY AND PRACTICE or Associate of the Institute of Chartered Accountants. In connection with this Institute a students' association was organized from which upon the passing of severe examina- tions members can enter the ranks of the Institute. On the Continent, while the art of bookkeeping has developed rapidly and attained a high proficiency, accountancy has not attained the standing and following which it has in England where certain statutes such as the Companies Clauses Consolidation Acts of 1845, the Companies Acts of 1862 and 1900 and various bankruptcy acts, have fos- tered accountancy and provided for the employment of ac- countants. In Ireland, The Netherlands, France, and Italy organizations have been established on a somewhat similar basis. Organizations of Accountants in the United States In the United States an organization was effected in New York in 1887 somewhat along the lines of the English societies under the name of the American Association of Public Accountants. The first legal impetus was given to the profession in 1896 when an act passed the legislature in Albany authorizing the regents of the state university to grant upon examination the privilege of using the letters C.P.A. Other states followed and in 1905 a federation of the various states was taken over into the American Association of Public Accountants which until recently was the national body. At the annual meeting of the American Association in New York, September, 19 16, it was deter- mined to give up their charter and go as a body into the American Institute of Accountants, a new society organized a short time previously under federal charter. The new so- ciety has direct control over its membership, which is di- vided into two classes, fellow and associate, and, just as in England, membership in it will be based upon examination^ HISTORY OF ACCOUNTING n ■Contrary to the history of accountancy in England, there has been Httle legislation here to foster the growth of the profession until somewhat recently. The corporation and income tax laws have increased the claims upon the accountants' professional services, and some state laws have tended in the same direction. The growing appreciation by the banks of the value of the certificate of the public accountant when attached to a borrower's statement of financial condition; the demand for skilled accountants in public utilities work; the value of the training to a public office-holder; the favorable attitude of the membership of the Federal Reserve Board and Federal Trade Commission in recognizing the v-alue of correct accounting methods ; and more and more the increasing opportunities for the exercise of abilities of the highest order in the private field — all these things make the profession one of the most attractive to the young man of today. CHAPTER II PROPRIETORSHIP Relation of Accountancy to Economics We sometimes define Economics as the science of wealth, meaning thereby that body of classified knowledge relating to wealth in the aggregate. Under our present-day political and social systems, the ownership of wealth is very largely private. Furthermore, the division of labor as industry is now organized has been carried to an extreme point. Be- cause of these facts, the present varied organizations for producing wealth to meet human needs and desires have given rise to an urgent need for some effective means of keeping record of all the activities involved in such human endeavor. The effort of every individual engaged in industry is to increase wealth. To secure that result, he labors to extract the raw materials from nature, to shape and pattern them in such fashion as to supply the wants of his fellowmen, and then to distribute them by means of markets and ex- changes so as to secure for himself the greatest possible returns for his effort. As competition along the various lines of human activities has become keener, the margin of this return per unit of product has lessened, and the producer has had to increase his volume of business to secure his customary gains. To become a producer it has been neces- sary for him to use the saved wealth of former periods to pay his expenses for materials, labor, management, etc., during the period of production. He must consume wealth in order to produce wealth. After his product has been finished he must seek the best market for its exchange. This 12 PROPRIETORSHIP 13 necessitates the use of a complex system of transportation facilities. Finally, during the whole process of production and exchange there has been constantly before him the distribution of the estimated returns from his effort among the several parties engaged in the production of his article. And more and more as it has been necessary to make this distribution on the basis of estimated returns, has the need, the absolute necessity, for an accurate record of the costs of the activities and processes all along the line become appar- ent to him. The record, then, of the value of the rights of the various parties to this product, is the special field of work assigned to accountancy. Relation of Accountancy to Law The determination of what are the rights of the several parties to the creation, exchange, and ultimate consumption of a product is the field of law, more particularly business law. The determination, by means of its records, of the value, the amount, or the size of that right is the province of accountancy. Thus is Accountancy inseparably related to Economics and Law. No one of them can progress far without the help of the others. All being related to, and arising out of, the manifold field of human endeavor, their progress, their development, is dependent upon, and limited only by, the progress of that endeavor. The Fundamental Problem of Accountancy The effort of each one, therefore, being the increase of wealth, the first problem of accountancy is the determination of how much wealth is invested in a given enterprise and what ownership or proprietorship exists at given periods of time, so that by comparison the increases and decreases may be known. When by this means accurate information is had, an intelligent plan of action may be adopted to remedy 14 ACCOUNTING— THEORY AND PRACTICE the ills of business that are shown, or to increase any phases of profitable activity. Accordingly, we say that proprietor- ship and its changing values are the basic problems of accountancy. Definition of Terms Before proceeding to a definition or determination of proprietorship, it will be necessary to understand what is meant by the terms "assets" and "liabiHties." The root idea of the word "assets" is sufficiency. Specifically, assets are the "entire property of all sorts, of a person, association, or corporation applicable or subject to the payment of debts." Similarly, liabilities are those things for which a person, firm, or corporation is bound; one's pecuniary obligations or debts. We define proprietorship, then, by the equation: Assets — Liabilities = Proprietorship Or as the balance sheet usually shows : Assets = Liabilities + Proprietorship Some writers, in an endeavor to simplify the state- ment, treat "assets" as positive goods, and "liabilities" as negative goods. Since, from an algebraic viewpoint, the combination by addition of positive and negative quantities results in a quantity which measures the excess of one kind over the other, the equation is sometimes stated alge- braically : Positive Goods + Negative Goods = Proprietorship, that is. Goods = Proprietorship. This though simple in appearance, may be confusing in content and must be under- stood only to mean that net goods (the excess of assets over liabilities) represent proprietorship. In this work we will use the equation as given in the first forms. PROPRIETORSHIP 15 The Proprietorship Equation Illustrated By way of illustration, take the following simple state- ment: On January i, 19 16, Jas. T. Runyon started business with an investment of $5,000 cash. Here the proprietorship equation becomes : Assets (Cash $5,000) = Proprietorship ($5,000), for Runyon has made himself liable to no one as yet. But after securing the materials and equipment needed for start- ing his business, he finds his status to be as follows: He has store furniture and fixtures purchased from Lowell Bros, for $500, of which he paid $250 in cash, the balance still owing. He bought a stock of groceries for $2,500 from Reid Murdock & Co. on ten days' time. So far, his proprietorship has not changed ; he is worth the same as before, though there is needed a more complex statement to show it — somewhat as follows : Assets — Liabilities = Proprietorship Cash $4,750 Lowell Bros. Furniture 500 claim $250 Merchandise ... 2,500 Reid Murdock claim 2,500 $7,750 — $2,750 = $5,000 After conducting his business for six months, Runyon finds that his activities have comprised the purchase of a delivery equipment for $300; sale of goods amounting to $6,000; the payment of $1,000 for rent, clerk hire, and advertising; and sundry purchases of stock in trade and other items as needed. He finds that, as a result' of the above, he has $1,000 cash now on hand; that customers owe him on account $3,000; that his stock of goods still on hand is worth $2,100; that he owes creditors $1,000 for l6 ACCOUNTING— THEORY AND PRACTICE goods bought and his clerks $50 for services rei:dered; and that he has no other liabihties. It is seen that as the number of assets and liabilities increases, the above method of showing them becomes awkward and cumbersome ; therefore, using the same funda- mental equation, we make the following tabulation to determine and show his proprietorship : Assets Cash $1,000.00 Customers 3,000.00 Merchandise 2,100.00 Furniture 500.00 Delivery Equipment 300.00 Total Assets $6,900.00 Liabilities Creditors for Merchandise $1,000.00 Clerks for Services 50.00 Total Liabilities 1,050.00 Proprietorship Net Worth $5,850.00 This method of showing the proprietorship equation is called a "Financial Statement" or "Balance Sheet." It may be interesting to note that further analysis of the above information will disclose also the amount of his purchases and how much he paid his creditors. Take the transactions involving cash and we find that he had $5,000 to start with and received $3,000 from sales, in all $8,000. He bought furniture and delivery equipment for $800, and paid expenses of $1,000, in all $1,800, leaving a balance of $6,200 to be accounted for. $1,000 cash is still on hand, PROPRIETORSHIP 17 so he must have paid creditors $5,200. Since he still owes creditors $1,000 for goods bought, his purchases must have been in all $6,200. Problems (Assignment for Chapter II) 1. On June 30, 1916, H. S. Homer has the following property: cash $1,675.29 ; merchandise $15,683.71 ; furniture and fixtures $1,275 ; delivery equipment $836; stocks and bonds bought for investment at $5,360; accounts owing him: Jno. Peterson $69.50; Pete Hewitt $125; Chas. Jackson $742.69; Earl Jones $147.31; J. T. Squires $790.42; I. M. Axman $63.74; and S. P. Palmer $75. He owes James Bros. $1,250.69, T. J. Stewart & Co. $965, T. Jennings Jinks $4,692.43 for merchandise purchased; and his 60-day note for $1,000 discounted at the bank at 6% is due today. What is his present interest in the business? 2. During the following 6 months he bought goods amounting to $20,000 paying $14,769.25 cash, the balance outstanding on December 31. He paid on account to James Bros. $1,000, T. J. Stewart & Co. $469.31, T. Jennings Jinks $4,500; for expenses of clerk hire $1,500; rent $7So; including heat, light, and water service ; advertising $60 ; delivery equipment for repairs $75; deliverymen $600; supplies $150; and gen- eral expense $250. He received on old accounts : from Jno. Peterson $50; Pete Hewitt $125; Chas. Jackson $143.72; Earl Jones $147.31; J. T. Squires $600; I. M. Axman $13.74; and he is notified that S. P. Palmer has gone into bankruptcy and that he will pay 33 1/3% of all claims. Cash sales have been $10,763.25 and sales on account to new customers $25,637.52 of which amount all has been collected in cash except $8,769.41 which is now outstanding. Goods now on hand are valued at $12,673.49. He received in dividends and interest from his investments $268. Reckoning wear and tear on furniture and fixtures at 10% per annum and on delivery, equipment at 12^%, what is his business worth on December 31, 1916? 3. A railway company has the following assets : cash $32,500 ; office furniture $975 ; franchise $300,000 ; U. S. bonds 6% $30,000 ; interest accrued on U. S. bonds $900; power house $200,000; construc- tion $502,625; motors and cars $275,000; car barns $18,000. Its l8 ACCOUNTING— THEORY AND PRACTICE liabilities are notes payable $35,000; accounts payable $12,500; first mortgage bonds $200,000; interest due on same $5,000; second mort- gage bonds $250,000; interest due on same $7,500. What is the net worth of the company? Instructions Make a careful determination of the assets and liabilities in each of the above problems, and then present solutions according to the form last illustrated in the text. In Problem 2, the information as to cash receipts and disburse- ments must be used to determine the present cash on hand and the condition of the old customers' and creditors' balances. Calculate the depreciation for the half-year on furniture and delivery equipment on the values given in Problem I, CHAPTER III TYPES OF BUSINESS ORGANIZATION Before proceeding with a further discussion of the showing of proprietorship by means of financial statements, the three general types of business organization will be treated briefly, because the manner of indicating proprietor- ship is dependent to a certain extent on the type of organiza- tion. These types are ( i ) the single or sole proprietorship, (2) the partnership, and (3) the corporation. The Single Proprietorship The simplest form of business enterprise is that con- ducted by a single proprietor. It is well adapted to busi- nesses where the capital necessary for efficient production is small, where the processes are simple and capable of being handled by the average individual, and where the risks are slight. Very few legal obstacles are placed in the way of the individual desiring to go into business for him- self, nor is a great deal required of him. In some cases registration and the securing of a license are necessary. The observance of the general laws as to payment of taxes and as to local regulations to protect society from disease and fire is all that is usually expected. Subject to the general restrictions which ordinary business acumen and foresight would place upon an individual, he can enter practically any field of enterprise, has entire freedom and privacy in the conduct of his business, and shares with none the results of his endeavor. On the other hand, these seem- ing advantages oftentimes prove to be marked disadvan- 19 20 ACCOUNTING— THEORY AND PRACTICE tages. As industry the country over is at present organized, many fields of activity, demanding large capital, and man)/ kinds of technical knowledge are closed to the single pro- prietor. Freedom of action carries with it sole responsibility, and oftentimes the counsel and advice of others would have prevented disasters which sometimes overtake him. The Partnership A partnership is "a contract of two or more legally competent persons to combine their money, property, skill, and labor, or some or all of them, for the prosecution of some lawful business and to divide the profits and bear the losses in certain proportions." The essence of the partner- ship from the viewpoint of a working organization is mutual agency, each partner being the agent of the others, but, within the limitations of the partnership agreement, capable of acting as a principal for the firm. Few restrictions are placed on the partnership other than those placed on the individual. In some localities it is necessary to file in a public office a brief statement of the firm name and the names of the members, in order to secure the right to sue and be sued in the firm name. The chief advantages of the partnership are obvious — larger capital and therefore access to fields closed to the individual ; the combining of the business wisdom, skill, and knowledge of several ; the subdivision of duties and there- fore the possibility of specialization. While in the view of the business community, the partnership is an entity, a business unit, in the sight of the law it is not so considered, each member of the firm being held liable to creditors for the entire debts of the partnership as if it were his sole business. Of course, if any one member has to pay any of the firm debts, he has a claim against his copartners for contribution. Some of the disadvantages of this type of TYPES OF BUSINESS ORGANIZATION 2I organization are the possibility of friction among the part- ners and consequent delay of action; the extension to the firm of credit based not on the firm property but rather on the total property of the members, and the consequent liability of each partner and his entire private fortune for the debts of the firm. It should be said before leaving the subject that the partnership agreement should be very carefully drawn to cover in detail the relations of the partners, their duties and their rights, particularly as to sharing in the profits or losses of the firm. The Corporation The corporate type of organization is distinguished from the other types discussed ( i ) by the freedom of each owner from the personal liability for the debts of the business to any greater extent than his stock interest in the business, though frequently in financial corporations, and in a few states for all corporations, his liability is double that stated ; (2) by the evidencing of the share of ownership by a formal document called a certificate of stock; (3) by the allowing to each owner a voice in the affairs of the business only to the extent of his stock ownership therein; (4) by the neces- sity of securing from the proper authorities permission to do business; and (5) by having to comply strictly with the terms of this permit and to submit to certain requirements such as the filing of annual reports, payment of special taxes, and the like. Owners, or stockholders as they are called, conduct their business through a board of directors elected for that purpose and subject periodically, usually annually, to a re- view of their management and a new election. In this way the stockholder exiercises indirectly an oversight of the busi- ness. This remoteness of personal interest and oversight 22 ACCOUNTING— THEORY AND PRACTICE has been somewhat overcome by electing to the board only those largely interested in the business, and by continuing on the board those whose past ability as managers has been tried and proven. Frequently the board delegates to others hired by it the active management of affairs. The corporate form of organization has become popular because of the limitation of liability of its owners, because it lends itself well to the accumulation of large funds of capital necessary for the promotion of present large-scale enterprises; and, because, though unwieldy in point of the number of its owners, it has developed a convenient and effective means of centralized control and management. The Showing of Proprietorship Under These Types The showing of proprietorship for these three types of organization differs somewhat. The title under which pro- prietorship is listed in the financial statement is "Capital." In a single proprietorship such title is preceded by the proprietor's name, as shown in the following illustration : Assets Cash $2,000.00 Accounts Receivable 5,000.00 Merchandise 3,000.00 Furniture and Fixtures SOO-OO Total Assets $10,500.00 Liabilities Accounts Payable $4,450.00 Due Clerk 50.00 4,500.00 Proprietorship James Runyon, Capital $6,000.00 TYPES OF BUSINESS ORGANIZATION 23 In a partnership the showing of capital is not made in one item, but each partner's interest is stated separately at its present value. Assets Cash $2,500.00 Accounts Receivable 10,250.00 Merchandise 8,750.00 Furniture and. Fixtures 625.00 Total Assets $22,125.00 Liabilities Accounts Payable $5,465.00 Notes Payable 1,660.00 Total Liabilities 7,125.00 Proprietorship $15,000.00 Represented by: James Runyon, Capital $8,000.00 Philip Adams, Capital 7,000.00 $15,000.00 In a corporation, proprietorship is shown in the aggre- gate of the outstanding shares of stock valued at par under the single title "Capital Stock," and, if there is more proprietorship than that indicated by the shares of stock, it is Hsted separately under the title "Surplus." This method of showing it is prescribed by law and is an effort to inform creditors or those who may be creditors that the corporation has observed the legal requirement not to distribute any of its original capital among the stockholders; hence, the original proprietorship of the corporation must be listed at a fixed figure all the time, and any changes taking place in the proprietorship during the life of the corporation are taken care of separately by the "Surplus" as was indicated above. 24 ACCOUNTING— THEORY AND PRACTICE Assets Cash $1,850.48 Notes Receivable 1,645.65 Accounts Receivable 15,285.35 Merchandise 10,045.94 Supplies 1,145-37 Furniture and Fixtures 1,636.97 Delivery Equipment 1,427.50 Buildings 8,000.00 Land 2,000.00 Total Assets.. , $43,037.26 Liabilities Accounts Payable $5,762.26 Notes Payable 4,250.00 Salaries Due but Unpaid 25.00 Mortgage on Land and Buildings 3,000.00 Total Liabilities 13,037.26 Proprietorship $30,000.00 Represented by: Capital Stock $25,000.00 Surplus 5,000.00 $30,000.00 Problems {Assignment for Chapter III) 1. Make up three problems, using your own data, to illustrate the three types of business organization. 2. The following shows the financial condition of James Shon- good on December 31, 1914: He owns a building costing $5,000; on land costing $1,000; in part payment for which he gave his note secured by mortgage for $3,000. He has machinery valued at $900 ; loose tools at $150; finished goods on hand $2,500; raw material and partly finished goods $8,325; models and patterns $350; shop furniture $275; TYPES OF BUSINESS ORGANIZATION 25 typewriter, safe, office desk, filing cabinet, chairs, etc., in all $150. His bank balance is $525; cash in safe $75; amounts due him from cus- tomers on open account $3,967.50, on notes $572.25. He owes creditors on open account $2,572.75, on accepted drafts $543-50; pay-roll earned but not due $150. Due to expansion of his market he needs more capital to take advantage of new opportunities. Accordingly he takes in a partner. Homer Goodwell, who invests cash equal to Shongood's interest in the business, $9,000 of which is used to purchase the plant of a competitor ($1,500 for the ground and $1,600 for the machinery, $250 for tools, $100 for patterns, $500 for shop furniture, and the balance for the building), $5,000 to pay for product on hand which was taken over ($2,000 for finished goods, the balance being for raw materials) ; and $2,000 for delivery equipment. Show a financial state- ment for Shongood and one for Shongood and Goodwell. Instructions In Problem i, present the data in the form of solutions according to the illustrations in the text. In Problem 2, combine with the old assets the values of the new assets acquired before showing them in the financial statement for Shongood and Goodwell. The group names for customers and creditors are "Accounts Receivable" and "Accounts Payable" respectively. Notes due from customers are "Notes Receivable." Notes and drafts due creditors are "Notes Payable." List "pay-roll earned" as "Accrued Pay-roll" with the liabilities. Calculate the cash balance. List the mortgage note as "Mortgage Payable." CHAPTER IV THE FINANCIAL STATEMENT Its Purpose and Use The financial statement is designed to show the financial condition of a particular business at a given time. As previously illustrated, it marshals the assets in one list or schedule and the liabilities in another. The difference be- tween the totals of the two schedules gives the present or net worth of the business. It is not sufficient in making a financial statement to give simply the figures of pro- prietorship or net worth, but schedules must be drawn up to show the items that make up that net worth. From the viewpoint of an investor, a prospective purchaser, a banker to whom application for a loan has been made, or a concern considering the advisability of extending credit on a bill of goods purchased from them, it makes all the difference in the world to know that a particular business having a net value of $10,000 has assets of $15,000 and liabilities of $5,000; or to know that its assets are $260,000 and its liabilities are $250,000. The ratio of total assets to total liabilities holds a large place in the determination of ques- tions raised above by the investor, purchaser, banker, or cred- itor. Furthermore, the character of the assets and of the liabilities has an important bearing. If the assets are in properties for which there is not a ready market and the liabilities are claims which mature soon and will have to be met, the situation is unfavorable. If there are large values invested in easily salable assets; if there is a large balance of cash on hand after meeting current claims and providing 26 THE FINANCIAL STATEMENT 27 for those which will soon mature; if other liabilities are of a more permanent nature, such as mortgages or long time notes not requiring immediate attention — the situation might show evidence of too large a capital, or of inefficiency in management as shown by the failure to invest some of the surplus cash in properties from which some return might be secured. Its Content and Subdivisions It will therefore be seen that the financial statement must serve a very definite purpose or purposes, and that to serve these purposes it must have a very particular content. Any statement which lists assets and liabilities and shows their difference as proprietorship is a financial statement. The form or the method of scheduling has nothing to do with the fact of its being a statement of financial condition, but the statement which, because of its form, gives the most information for the purpose for which it was drawn is, in comparison with all others which might be drawn, the best statement. Hence, keeping always in mind as a functioning or guiding principle the use to which the statement is to be put, the form, the method of showing and marshalling the items, is of great importance. For this purpose we shall classify assets and liabilities roughly into two groups, current and fixed, whose connotation has been sufficiently indicated on the basis of ease of convertibility into cash, or salability, for the assets, and relative urgency of meeting the claim for the liabilities. Therefore, in any presentation of financial facts, the data should be shown grouped into the two classes of current and fixed, both for the assets and for the liabilities, so as to render easy comparison possible. In this way a basis can be secured for judging of the efficiency of the management in making provision for meet- ing the claims against the business as they fall due and in 28 ACCOUNTING— THEORY AND PRACTICE having as nearly as possible a proper balance between the two groups. While there is not entire uniformity at present in the matter of precedence of either group, the weight of authority would indicate the placing of current assets first, followed by the fixed assets, and a similar marshalling of the liabilities. Its Titles, Principal and Group Various terms are in use to indicate the main groups of items in the financial statement and as names for the statement itself. "Balance Sheet," "Statement of Resources and Liabilities," "Statement of Assets and Liabilities," are frequently used instead of "Financial Statement." Within the statement itself, Resources is used as an alternative title with Assets ; and Net Worth, Present Worth, and Net Assets are used for Proprietorship. For the present the forms shown will be used with the substitution of the term Net Worth for Proprietorship. The title of a state- ment should be full ; it should include the name of the busi- ness enterprise and date, and would appear somewhat as follows: ShONGOOD & GOODWELL Financial Statement, December 31, 1916 This should be followed by the lists or schedules of Assets, Liabilities, and Net Worth as has been indicated. Since the statement is a formal one, due regard should be had for neatness and general appearance on the page. Further consideration of headings and titles will be taken up in Chapter XXX. Principles Governing Fulness of Detail Mention has been made of the importance of full infor- mation in the financial statement. The degree of fulness is THE FINANCIAL STATEMENT 29 determined first by the general purpose which the state- ment is to serve; secondly, by the likelihood of obscuring essential data through too great detail; and thirdly, by the general appearance. If it can be shown on the statement that the business makes a careful valuation of its assets by taking into account the wear and tear on certain of its properties and the loss apt to occur through failure to collect all debts due the business, that statement points towards a policy of conservatism and efficiency not indi- cated by one failing to give that information. If a manage- ment has paid some of its expense bill in advance, e.g., rent for January paid during December, in showing financial condition as at the end of December it is right and proper and necessary, in order to make an accurate showing, that all such prepaid expenses be listed as assets ; for had the prepayment not been made the cash would now be larger by the amount of the prepaid expenses. Similarly, if ex- penses have been incurred that properly belong to the pres- ent period but whose payment has been postponed to a later period, such as wages due but unpaid, those expenses should be listed among the liabilities, for the cash would be smaller by the amount of such postponed or accrued items had this claim been met during the current period. Hence, to take care of these prepaid and accrued items on the financial statement, we make a third group headed "Deferred Charges" for the assets, but usually show expense accruals under the head of Current Liabilities, listing under these heads by name the prepaid and accrued items. Illustration To illustrate the correct showing of the matters under discussion in this chapter, the following statement showing the financial condition of the partnership of Jackson & Edwards is given : 30 ACCOUNTING— THEORY AND PRACTICE Jackson & Edwards Financial Statement, June 30, 1917 Assets Current Assets : Cash $2,365.00 Accounts Receivable $8,500.00 Less — Reserve for Bad Debts 170.00 8,330.00 Merchandise 10,425.00 Supplies 80.00 Deferred Charges : License Fees Paid in Advance 17S.00 Unexpired Insurance 7S-00 Fixed Assets : Furniture and Fixtures $750.00 Less — Reserve for Depreciation . . . 7S.oo 675.00 Buildings $9,680.00 Less — Reserve for Depreciation... 242.00 9,438.00 Land 2,500.00 Total Assets $34,063.00 Liabilities Current Liabilities : Accounts Payable $6,750.00 Notes Payable 2,500.00 Wages Accrued 250.00 Interest Accrued - 75.00 Fixed Liabilities : Mortgage on Land and Buildings 2,500.00 Total Liabilities 12,075.00 Net Worth $21,988.00 Represented by: S. J. Jackson, Capital $10,267.00 P. R. Edwards, Capital 11,721.00 $21,988.00 THE FINANCIAL STATEMENT 31 To give the fullest information, an additional column to carry the totals of each group of assets and liabilities is frequently shown. This would make comparison of the groups somewhat easier and so make the statement more intelligible and valuable, although for a small business the information is easily obtained from the above showing. One or two items, perhaps, need additional explanation. Reference has been made to the detailed information which the financial statement may give. In the one shown above it will be noticed that the proprietors, although having out- standing claims against customers for $8,500, recognize that, as their past experience has shown, they will be unable to collect all of these claims. Their estimate of the uncol- lectible portion is 2%, or $170, which is shown deducted from the face value of the asset in order to show a conserva- tive realizable value. Similarly, it is estimated that furni- ture and fixtures, costing $750, have depreciated 10% in value and buildings 25^%. This statement, which shows the basis for valuing the assets, is more useful than one merely giving the net estimated values without showing how such values were obtained. The term "reserve" is used in the above in the sense of the estimated amount needed to make good the loss. Problems (Assignment for Chapter IV) I. After operating for two years during which time their interests are kept equal Shongood and Goodwell realize that, if they are to meet competition on a satisfactory basis, they must secure large scale pro- duction. Therefore a company is formed with $75,000 capital stock, which takes over the partnership valuing its fixed assets at the figures shown in Problem 2, Chapter III, after allowing for depreciation at 32 ACCOUNTING— THEORY AND PRACTICE the rate per year of 3% on buildings; 6J4% on machinery; 12% on office and 10% on shop furniture ; 20% on models and patterns ; 10% on delivery equipment. Small tools had been maintained at an even value for the two years. Assuming that no cash was turned over by the partnership and that all other assets and liabilities have the same values as shown in the previous problem, draw up a financial state- ment of the company, using the additional information that the balance of cash is $42,000 resulting from the sale of the stock and remaining after the purchase of the partnership assets mentioned above and of the good-will of the partnership for which $3,763 was paid. 2. The Blank Company is capitalized at $25,000. It has on De- cember 31, 1916, outstanding obligations on open account of $5,621.75 and on its notes of $8,341.37. It owns property as follows : merchan- dise $5,339.40; cash $3,100.45; notes receivable $2,500; First National Bank stock $2,000; machinery and tools $10,000; furniture and fix- tures $590; real estate $15,900; horse and wagon $500; accounts receiv- able $11,592.76. It is estimated that from the stated values machinery and tools have depreciated 12^%, furniture 10%, real estate 4% and horse and wagon 12^4%, and that 2% of the outstanding accounts cannot be collected. Accrued pay-roll amounts to $Soo, and unpaid taxes $250. Interest earned but not due amounts to $175. Make a financial statement of the company. Instrtictions Refer to Chapter III for the manner of showing the net worth of a corporation. In Problem i, good-will is treated as an asset because actually bought and paid for. List it with the fixed assets. CHAPTER V COMPARATIVE FINANCIAL STATEMENTS Comparison of Net Worths The aim of every business enterprise is to increase its net worth. If James Runyon at the beginning of the year is worth $5,000, and if at its close his net worth is $7,500, it is evident that he has increased his wealth by $2,500. Very little information is given him or any one else as to the manner of the increase except that it came in the ordinary course of business transactions. No criterion is given by which we may judge effort by results. An in- crease of $2,500 may or may not be commensurate with the labors expended therefor. However, since it is very unlikely for any business to remain stationary, and since some method of determining that fact has been in use from the beginning of business endeavor, there is a degree of satisfaction in knowing merely how much that change is. The taking of an inventory and the appraising of one's properties from time to time and the setting over against them of one's liabilities for the same dates, give a basis for determining the increase or decrease, the gain or the loss for those periods for which records of net worth have been kept. A further analysis of the individual items, a com- parison of each asset at the beginning of the period under review with its value at the end of that period, shows the increase or decrease in that item of wealth. In like manner a comparison of each liability item, at the beginning and end of a period, would bring out the increase or decrease in the amount. 33 34 ACCOUNTING— THEORY AND PRACTICE How a Gain or Loss May Be Evidenced During a period a gain or increase in net worth may be evidenced in any one of four ways, (i) If the assets remain the same but the HabiHties are decreased; (2) if the HabiHties remain the same but the assets are increased ; (3) if assets decrease but HabiHties suffer a greater de- crease ; or (4) if assets increase but HabiHties suffer a lesser increase, provided no more money has been invested in the business, nor any been withdrawn, then there has been an increase in net worth, a profit. If the above relationships are reversed, then there has been a decrease in net worth, a loss. The following statements illustrate the points discussed above : Aaron Conners Financial Statement, June 30, 1916 Assets Cash $1,000.00 Notes Receivable 250.00 Accounts Receivable 5,250.00 Merchandise 8,500.00 Store Fixtures 525.00 Total Assets $15,525.00 Liabilities Accounts Payable $5,365.00 Notes Payable 1,250.00 Total Liabilities g 615.00 Net Worth Aaron Conners, Capital Sg gjQ qq One year later Conners' financial condition is shown to be: COMPARATIVE FINANCIAL STATEMENTS 35 Aaron Conners Financial Statement, June 30, 1917 Assets Cash $850.00 Notes Receivable 100.00 Accounts Receivable 6,425.00 Merchandise 10,260.00 Store Fixtures 472.50 Delivery Equipment 350.00 Total Assets $18,457.50 Liabilities Accounts Payable $6,192.75 Notes Payable 9So.oo Accrued Salaries S0.50 Total Liabilities 7,193-25 Net Worth Aaron Conners, Capital $1 1,264.25 The Comparative Financial Statement— Its Content and Method The showing for the second year evidences an increase of net worth of $2,354.25, the difference between the net worths for the two periods. It shows also that this profit is accounted for by an increase of $2,932.50 in the assets of 1917 over those of 1916, but this is offset somewhat by an increase in the liabilities of $578.25, leaving a net in- crease of $2,354.25 as shown above. A comparison of individual items might be made, but the two statements as shown do not lend themselves easily to that purpose. Ac- cordingly, a method of showing, known as the "Compara- tive Statement" form, is made use of — a form, which brings all of the data into juxtaposition and so is easily read. 36 ACCOUNTING— THEORY AND PRACTICE On (J pf o U o o o o m O O IT) O fl o mo 01 NO t-^ m CJ • 3 : c; ^t : E .9* ■s « rt c C rt 3 -a W U Iz; < § tJ5 Q 8 NO no" 8 8 IT) d in t-T in O o i-N. o in r:sK O o 0\ u^ in M 0\ & -^ ^ o H 2 " ■-a j= . •e* rt dJ (H ^ ^3 ^ ■" fLi -d 3 eo 3 o a> u O O o < ;z; <; lU In o N^ COMPARATIVE FINANCIAL STATEMENTS 37 This form locates definitely the changes in the asset and liability items, summarizes those changes, and shows the net profit, but it fails to show what forces at work within the business organization brought about the changes shown ; it shows effect or result but not cause. A supplementary, or rather a complementary, statement is needed for that purpose, and is discussed in the following two chapters. Problems (Assignment for Chapter V) 1. A. Howard at the beginning of 1916 had the following assets : real estate $2,500; furniture and fixtures $400; cash $1,550; accounts receivable $3,290; merchandise $5,710; and unexpired insurance for one year $50. His liabilities were : mortgage on real estate $500 ; accounts payable $3,000. At the end of 1916 he had assets and liabilities as follows: cash $1,000; accounts receivable $4,390; notes receivable $525; school district bonds $1,000; furniture and fixtures $360 ; real estate $2,425 ; merchandise $6,000 ; accrued expense items $125 ; notes payable $250 ; accounts payable $3,300. Determine Howard's profit or loss. 2. Make an analytical statement to show the effect on the business, i.e., the changes, of such profit or loss. 3. Can you tell how the change in proprietorship came about? Instructions Separate solutions for Problems I and 2 are not necessary. The comparative balance sheet set up for Problem 2 will serve also as a solution for Problem i. CHAPTER VI THE ECONOMIC OR PROFIT AND LOSS ELEMENTS OF A BUSINESS Fuller Information Needed As was indicated in Chapter V, it is not usually sufficient to know merely that net worth has changed and how much the change has been, nor is the whole story told when it is known exactly wherein these changes have occurred, which of the properties are worth more and which less at the end of the period than at its beginning. Another kind of information is necessary to give a full knowledge of the conditions bringing about the changes shown by the comparative balance sheet. The proprietor who knows simply that his cash is $i,ooo less now than it was at the corresponding time last period, has not the kind of control over his business that his competitor has who knows that the $i,ooo was ex- pended for an increased stock of goods, or the one who knows that an outstanding liability of that amount has been settled, or the one who knows that his expenses for the period have been larger by $i,ooo than for the former period. For, even this last competitor, though he may be worse o£f than the first proprietor, has at least this advan- tage — that he knows the reason for it. He has made a correct diagnosis, he knows the pulse beat of his business and is in a position to heal its ills or secure aid for them. If not, he can have the satisfaction of giving it a respectable burial and there will be no need for an autopsy. Simply, he failed to take advantage of his information until too late. 38 ECONOMIC ELEMENTS 39 However, the point should be clearly held in mind that the proprietor who knows exactly what is happening in his business is in a position to exercise a definite and sure control over it. Hence, it should be the aim of the account- ing department of every business, in order to justify its chief reason for existence, to give full information as to what is happening all the time within the business and what will be the result of such happenings in its financial life. Only in this way can the accounting department become one of the major departments of any business and so serve as a means of control. The Two Kinds of Records Accounting must therefore keep two kinds of records; not a double or duplicate record of every business dealing, but a record which looks at every transaction from two viewpoints, viz., what effect it may have on the assets and liabilities and what its efifect may be upon the proprietor- ship. Only thus by recording the changes in proprietorship as they occur can a somewhat certain knowledge of the trend of affairs as to losses or gains, as to the sickness or health of the business, be indicated previous to the time of taking actual valuations of all assets and liabilities. These records of changes in proprietorship are sometimes kept in great detail, depending upon the degree of minuteness of the information needed or desired by a proprietor to give him adequate control. They comprise items or headings de- signed to indicate the sources of all earnings, such as sales, interest receipts, discounts received, rent income, and the like, and the causes of all outgo, such as clerk hire, office expenses, salaries, repair items, interest charges, and ex- penses of all kinds, grouped under separate heads, if such classes of information are vital to the conduct of the business. 40 ACCOUNTING— THEORY AND PRACTICE Temporary Proprietorship Records These proprietorship records or sources of information are kept until the close of the period, when they are sum- marized and the net result is determined. Hence, they are called temporary, being kept for the purpose of recording the changes in proprietorship as they occur from day to day, and then closed or transferred to the summarized record called the "Profit and Loss Summary." Referring now to the case of Aaron Conners discussed in Chapter V, the accounting department furnishes the following additional information from its records : During the year from July i, 19 16 to June 30, 191 7, Conners bought $22,362.50 worth of goods; his sales amounted to $28,465.20; he paid for help $3,050.50; other expenses were $2,405.45 ; and he estimated the wear and tear on furniture at 10% or $52.50. As shown in his state- ment for 1917, he had $10,260 worth of merchandise on hand on June 30, 19 17. Analysis of this information develops an explanation of the changes which occurred in his net worth during the year. The goods he started with plus those purchased during the year give the total goods to be accounted for. This gives $30,862.50 ($8,50O+$22,362.5O=$3o,862.5o). These goods are accounted for by his having sold some and by having the rest on hand. Knowing how much is on hand June 30, 1917, viz., $10,260, he determines that the goods sold must have been the difference or $20,602.50 ($30,862.50 — $10,260 = $20,602.50). The price which he received for these goods sold was $28,465.20; hence, his profits from sales were $7,862.70, the difference between selling price and cost. We find, also, that certain expenses were incurred in selling his goods and conducting his business. These ex- penses were $3,050.50 for clerk hire, office help, delivery ECONOMIC ELEMENTS 41 boys, etc. ; and other expenses, such as rent, taxes, repairs, delivery up-keep, supplies, heat, light, and the like, amounted to $2,405.45. He estimates that his store fixtures have depreciated in value $52.50. All these items, representing costs of doing business, amount to $5,508.45 ($3,050.50 + $2,405.45 + $52.50 = $5,508.45) which subtracted from his profits from sales, $7,862.70, gives him a net gain of $2,354.25 ($7,862.70 — $5,508.45 = $2,354.25). This accounts for the increased proprietorship of that amount shown by the financial statement of June 30, 191 7. Without regard to a form which would be technically correct, the data of the preceding paragraph may be shown as follows : Goods on hand at the beginning, June 30, 1916 $8,500.00 Goods bought during the year 22,362.50 Total goods to be accounted for $30,862.50 Goods accounted for, now on hand 10,260.00 Goods accounted for, by being sold $20,602.50 Selling price of goods sold , $28,465.20 Cost price of goods sold, as above 20,602.50 Profit from sales $7,862.70 Expenses of doing business: Clerk hire $3,050.50 Other expenses 2,405.45 Depreciation 52.50 Total expenses 5,508.4s Net profit, or increase in net worth $2,354.25 The technical form of the summary of the temporary proprietorship elements will be presented in the next chapter. 42 ACCOUNTING— THEORY AND PRACTICE Problems (Assignment for Chapter VI) 1. Referring to Problem i, Chapter V, from the following data show the cause of Howard's changed proprietorship: depreciation on real estate $75 ; on furniture $40 ; interest paid on mortgage $35 ; rent and wages now due amounting to $125, as indicated ; purchases for the year $19,790; sales $25,000; other expenses, including insurance, $3,200. 2. As proprietor of a business, you started the year with $20,000 worth of merchandise, you bought $100,000 more during the year, and have on hand at the end $25,000. If your gross profit on sales was $40,000, what was the amount of your sales? Selling expenses were $15,000 and general administrative expenses were $10,000. Make up a statement showing the profit for the year. 3. Alex. Tuttle, your branch representative at Duluth, reported to you his year's sales as $92,350, his purchases $75,790, gross profit of $12,630. Referring to previous records you find he had on hand at the beginning of the year $21,070 worth of goods and that the average cost of goods sold for the past five years has been 78.4% of the sales. What conclusion would you draw therefrom and what explanation would you ask Tuttle to make? Instructions In Problem i the information as to goods on hand at the begin- ning and at the close of the year must be secured from Howard's comparative balance sheet required by Problems i and 2, Chapter V. CHAPTER VII THE PROFIT AND LOSS SUMMARY Titles for the Profit and Loss Summary The profit and. loss summary is known usually as the "Profit and Loss Statement," though other titles such as Loss and Gain, Income, Income and Expense, and Business Statement are frequently used. Showing as it does, the manner in which the net worth has been changed, it ampli- fies, it fills out the record shown by the financial statement. It is a supplementary record because it gives additional information, and is complementary to the financial state- ment because it rounds out and completes the story of business life thfere recorded. The Fiscal Period Because of the work involved and the frequent incom- pleteness of the records at the close of each day, a daily statement of condition is very seldom made up. Business experience for each particular enterprise determines the frequency of preparation of these statements. Whatever the period may be between statements, be it a month, three months, a half-year, or a year, it is called the fiscal period, i.e., it is the period at the end of which records are sum- marized and results obtained. For purposes of comparison with preceding and following fiscal periods, under similar conditions, the fiscal period should be, and usually is, a period of regular length, the half-year or year being perhaps the most common. In large enterprises and in many small enterprises monthly statements are customary. 43 44 ACCOUNTING— THEORY AND PRACTICE Need for the Physical Inventory Again, because of the work involved, especially where the product dealt in is small in value and sales are numerous, as in stores dealing in clothing, food, and the like, no record of the cost of each article is kept as it is sold, only the sale price being recorded. It is not possible, therefore, to determine from the records as usually kept, the cost of the goods on hand at a given time. The records are kept in this way not because systems of accounting cannot be de- vised to make both records, but because the results obtained by such systems are not justified by their cost, when other and less expensive means can be used with almost as satis- factory results. The customary method of finding the cost of goods sold was indicated in Chapter VI. Summarized briefly, it requires that, from the sum of goods on hand at the beginning and those purchased since, there be sub- tracted the goods on hand and unsold at the close of the period. This last item, the goods on hand' and unsold, is secured by making an actual count and valuation of such goods at the close of the fiscal period. So the device of physical inventory-taking is brought in as an adjunct or aid to the accounting records, but this is done only in the inter- ests of economy. Principles Governing the Make-up of Profit and Loss Summary The profit and loss statement, as the complement of the financial statement, is just as formal in character and the same general principles govern its make-up, viz., (i) the general purpose which it is to serve, (2) the likelihood of obscuring essential facts through too great detail, and (3) the general appearance as to legibility, clearness of form and expression, and arrangement on the page. Its heading is also similar to that of the financial statement: THE PROFIT AND LOSS SUMMARY 45 ShONGOOD & GOODWELL Profit and Loss Statement^* December 31, 1916 Content of the Statement The information given first in this statement is the earnings or income from sales, the order of the showing being determined by the method of arriving at the net gain figure, viz., that of subtraction of expenses from income. Just as assets are normally larger than liabilities, so are income items larger than expenses, and they are therefore given first. Set over against the sales income is the cost of goods sold, resulting, by subtraction, in a showing of profit called "Gross Trading Profit." Next are given those expenses directly connected with the making of sales, such as store rent, clerks' or salesmen's salaries, advertising, delivery expenses, and the like. These portions of the statement comprise the "Trading" section because they are concerned only with sales and direct expenses of sales. The important groups or items shown in this section are Sales, Cost of Goods Sold, Gross Trading Profit, and Selling Expenses. The next section or portion, called the "General Ad- ministrative," handles all other items of expense incurred in the management and general conduct of the business. The total of the two groups of Selling Expenses and General Administrative Expenses subtracted from the Gross Trad- ing Profit gives the Net Profit for the period, unless there be other sources or items of income, which must then be added before obtaining the net profit for the period. Thus the profit and loss statement is very simple in its general make-up and method of showing, following the lines of reasoning of every merchant when summarizing his results for the period. *"Statement of Profit and Loss" is an alternative form. 46 ACCOUNTING— THEORY AND PRACTICE It should be noted that the above paragraphs outline a simple statement of profit and loss for a commercial or trading business as distinguished from an industrial or manufacturing enterprise, the statement for which is some- what more complex even in its general outlines. Algebraic Content of the Profit and Loss Statement An algebraic presentation of the statement described above is oftentimes valuable. The cost-of-goods-sold por- tion becomes : (i) Initial Inventory + Purchases — Final Inventory = Cost of Goods Sold (2) Sales — Cost of Goods Sold = Gross Trading Profit The rest of the statement is covered by the following equation : (3) Gross Trading Profit — (Selling Expenses -f- General Administrative Expenses) + Other Income = Net Profit The Disposition of the Net Profit The net profit for the period belongs to the proprietor and constitutes an increase in his previous proprietorship or investment, unless he has already drawn out some of these profits as they accrued throughout the period. In this case, his drawings must be subtracted from the net profit indicated, before showing the increment to his net worth. Accordingly, the final section of the profit and loss statement gives the disposition of the net profit and its ap- propriation or addition to the previous net worth or pro- prietorship item. This section is known as the "Appropria- tion" section. If the business is a partnership, this section should show in detail the distribution of net profit among the several partners according to the agreement among THE PROFIT AND LOSS SUMMARY 47 them as to the proportions in which they are to share gains or losses. If a corporation, it should give the disposition made of the net profit in the way of dividends to the stock- holders, and any other appropriation made of these profits, including transfer to surplus. To illustrate some of the features of the profit and loss statement, two illustrations are given, the first presenting a correct statement for Aaron Conners, using the data of Chapter VI, and the second showing a more complex statement. Illustration i Aaron Conners Profit and Loss Statement, June 30, 1917 Sales for the year $28,465.20 Goods on Hand June 30, 1916 $8,500.00 Purchases during the year 22,362.50 $30,862.50 Goods on Hand June 30, 1917 10,260.00 Cost of Goods Sold $20,602.50 Gross Trading Profit $7,862.70 Clerk Hire $3,050.50 General Expenses $2,405.45 Depreciation 52.50 2,457.95 5,So8.45 Net Profit for the year $2,354-25 Illustration 2 Jackson & Edwards Statement of Profit and Loss, June 30, 191 7 Sales for the period $42,560.25 48 ACCOUNTING— THEORY AND PRACTICE Deduct : Goods on Hand June 30, 1916 $8,567.50 Goods Purchased during year 35,293-75 $43,861.25 Less— Goods on Hand June 30, 1917 10,425.00 Cost of Goods Sold 33,436.25 Gross Profit on Sales* $9,124.00 Selling Expenses : Salesmen's Salaries. $2,500.00 Advertising 1,250.00 Delivery Expenses 567.50 $4,3i7.SO General Administrative Expenses: Supplies $125.60 Office Help 900.00 Legal Advice 25.00 Light and Heat 93.6o Insurance 125.00 Interest 32.50 Miscellaneous Expenses 87.25 Depreciation on Buildings 75-00 Depreciation on Furniture and Fix- tures 242.00 1,705.95 6,023.4s Net Profit for the year $3,100.55 Appropriation of Net Profit: S. J. Jackson, Ys share $1,240.22 P. R. Edwards, J^ share 1,860.33 $3,100:55 Note: Frequently the totals of each expense section are labeled under their respective heads, as "Total Selling Expenses" and "Total General Administrative Expenses." Additional Information Sometimes Given It often happens that goods sold and goods bought do not prove satisfactory and are returned. When it is de- sired to give this information in the profit and loss state- •This term is used sometimes instead of "Gross Trading Profit." THE PROFIT AND LOSS SUMMARY ^g ment, the item "Sales for the Period," is extended short and the return sales deducted, only the "Net Sales" being full-extended. For example : Sales for the period $50,000.00 Less — Returned Sales 3,500.00 Net Sales $46,500.00 Similarly, from the goods purchased during the year, ex- tended short, the Returned Purchases are deducted and the "Net" extended. If there is other income, such as Interest, Rent, Discount on Purchases, and the like, the title "Net Profit for the year" is omitted, only the amount showing. An additional group or section heading, "Other Income," is next inserted, followed by a detailed statement of the income items, just as in the other sections. The total of this section added, as indicated in equation (3) on page 46, gives the "Net Profit for the year." It should be added, perhaps, that the above illustrative forms are not intended to be all-inclusive. At this stage, they are merely guides for the making of simple statements. The Two Methods of Determining Net Profit By reference to illustration i, it should be noted that, of course, the profit shown by the profit and loss statement must be the same as that developed by the comparative financial statement, since both cover the same period and constitute merely two ways of developing the same result. For this reason they are valuable in proving the correctness of results, acting as checks against each other. The account- ing department keeps both classes of records, viz., the asset and liability records and the temporary proprietorship records, not because both are needed to develop the amount 50 ACCOUNTING— THEORY AND PRACTICE of net profit — either class would do this — but because both are needed for the additional information given by them. Problems (Assignment for Chapter VII) 1. During the year 1916, Edmunds and Hansen made sales amounting to $150,000, of which, however, $10,000 were returned as being unsatisfactory. Their purchases, including freight, were $89,000; the cost of goods sold was 60% of the net sales ; and final inventory was $30,000. Expenses were : sales salaries $14,760 ; advertising $15,000; delivery expense $2,350; office salaries $5,000; rent $2,400; insurance $500; depreciation $1,000; office supplies $600; salaries of stenographers and bookkeepers $3,000; and general expense $2,150. Draw up a pro forma statement of profit and loss as on December 31, 1916. 2. Without any change in the other values shown in Problem i, Chapter V, assume that the unexpired insurance there listed as $50 for the year is only for six months, at the end of which time a new two-year policy is purchased for $225. Assume further that by the end of 1916 interest has accrued on notes receivable amounting to $15; on notes payable $10; and on school bonds for nine months at 6%. Using the information given in Problem i, Chapter V, and Problem I, Chapter VI, and the additional data just given, determine, by the two methods referred to in the text, the amount of the net profit for the year. InstrUrCtions In Problem i "pro forma" means correct as to form. Study care- fully the forms given in the text so as to become perfectly familiar with them. In Problem 2, it should be noted that the changes from the data given before concerning Howard's business are not supposed to affect any of the values there shown. The effect will be, however, to add values for unexpired insurance and interest to the assets and liabilities. The change in the statement of profit and loss will be reflected in the interest items and in the item of "other expenses" which will be reduced by the amount of the unexpired insurance. CHAPTER VIII INTERRELATION BETWEEN THE ECONOMIC AND THE FINANCIAL ELEMENTS OF A BUSINESS Various Aspects of the Temporary Proprietorship Records The profit and loss statement has been explained as a summary of the temporary proprietorship records kept for the purpose of registering the changes in net worth as they occur from day to day, and also for the purpose of noting the source or cause of the changes in assets and liabilities. The temporary proprietorship records may be regarded as the chronicle or history of the economic life of a business. The efforts of the business to produce income with the least possible outgo in the form of costs or expenses may be viewed as the work of forces or agencies striving towards that end. Every effort is offset by the cost of that endeavor, and, unless the prime result of the effort be more than its cost, its aim, viz., the increase of net worth, is not accom- plished. Relation Between Profit and Loss and Financial Elements These income-producing efforts are the agencies that bring about the changes in the values of assets and liabili- ties. All expenses and costs of the business are incurred for the purpose of securing the best possible results in the way of income. Every expense or cost that is settled causes a diminution of business assets, usually of the asset cash. If not settled, it causes an increase in the liabilities, usually the accounts payable, for the business becomes bound by or liable for it. Both of these conditions result in a decrease 51 52 ACCOUNTING— THEORY AND PRACTICE in the net worth. On the other hand, every item of income is reflected by an increase in assets or a decrease in liabili- ties, as when a sale of goods is made. The result of every sale is usually an increase in the cash or in the claims against persons, the accounts receivable. It may sometimes result in a lessening of liabilities through the cancellation of in- come against others' claims on the business. So there is constantly this direct interrelation between the financial and the profit and loss elements of every business. Exchanges Within the Asset and Liability Groups All changes in individual assets and liabilities are not always, however, the result of business or economic forces. There may be an even exchange of one asset for another asset, as when we purchase a delivery equipment for cash. The asset, delivery equipment, is increased by the same amount as the asset, cash, is diminished. Or a bill of goods may be purchased on credit, and in this case an increase of assets is effected, exactly offset by an increase in liabilities. These changes are well illustrated by the second example in Chapter II, showing Runyon's proprietorship. Accord- ingly, therefore, the changes in individual assets and liabili- ties are not so certain an index of changes in proprietor- ship as those registered by the temporary proprietorship records. The vital history of a business is its profit and loss record, its economic life. As a means of control this is of first importance because it chronicles the causes of all changes in financial condition. The statement of financial condition may be looked upon as the framework, the skeleton of the business personality, upon which is superimposed its economic structure. When both the financial framework and the profit and loss summary are given, it is possible with reasonable accuracy to tell the whole history of the business activities for the period covered. ECONOMIC AND FINANCIAL ELEMENTS 53 Illustration By referring to the illustration of Aaron Conners given in Chapters V and VII, "Comparative Financial State- ment" and "Profit and Loss Summary," respectively, it may be seen, with a fair regard for realities, just what took place in his business during the year. Giving summaries only, the story of his year's business reads somewhat as follows, numerous variations being probable, with net results re- maining, however, the same : He made sales of $28,465.20 to customers who paid in during the year $27,290.20. He purchased $22,362.50 worth of goods, making payments to creditors of $21,534.75. The net result of his notes receivable was the receipt of $150, and of his notes payable the payment of $300. He paid for clerk hire $3,000, still owing $50.50 at the end of the year; for general expenses he paid $2,405.45; and for a delivery equipment $350. He estimated depreciation on store fixtures at 10% or $52.50. His inventory showed merchandise on hand at the close of the year, amounting to $10,260. An analysis of the cash shows the interworking of most of the transactions : Cash Received On Hand at start $1,000.00 From Custom- ers $27,290.20 Notes Receiv- able 150.00 Current Receipts 27,440.20 Total Cash $28,440.20 Disbursements 27,590.20 Balance on Hand at end $850.00 Cash Paid Out To Creditors $21,534.75 Notes Payable 300.00 Clerk Hire 3,000.00 General Expenses 2,405.45 Delivery Equipment.... 350.00 Current Disbursements $27,590.20 54 ACCOUNTING— THEORY AND PRACTICE An analysis of the accounts receivable shows : Due from Customers at start of year $5,250.00 Sales to Customers during year 28,465.20 $33,715-20 Received Cash from Customers 27,290.20 Balance Due from Customers at end of year $6,425.00 An analysis of the other items will show similarly the interrelation between the economic and the financial elements of a business. Problems (Assignment for Chapter VIII) 1. On November 26, your stock of goods is destroyed by fire but your records are saved. They shovir that you started the year with $14,575.20 worth of goods, that you purchased during the year $73,974.75 worth, and your sales up to the time of the fire amounted to $97,534.69. Records for the past ten years showed an average gross profit on sales of 41.68%. What, approximately, was the value of the goods de- stroyed? Make a statement to show your claim. 2. From the following data concerning the Rawnser Goods Com- pany, prepare pro forma financial and profit and loss statements : Goods on hand from previous year $12,000; purchases $70,000; sales $84,000; general expenses $2,000; salesmen's salaries $6,400; cash on hand $20; cash in bank $2,130; manager's salary $1,250; rent $900; freight-in $250 ; returned sales $750 ; returned purchases $400 ; busi- ness plant $11,000; accounts receivable $8,000; notes receivable $2,000; accounts payable $6,100; notes payable $850; interest received on de- posits $100 ; office furniture cost $600 ; repairs to business plant $50 ; advertising $1,500; gain carried forward from last year $2,400; goods on hand now $14,600 ; advertising prepaid $50 ; office salaries now due but unpaid $200; rent unpaid $100. Allow 4% for depreciation on business plant; 10% on office furniture; and 5% for estimated bad debts. The capital stock is $25,000. ECONOMIC AND FINANCIAL ELEMENTS 55 Instructions Problem I. It is quite customary, although not theoretically cor- rect, to calculate percentages of profit, expenses, etc., on the basis of the net sales figure. Problem 2. Carefully differentiate between the balance sheet and the profit and loss items. In the case of "prepaid advertising" an adjustment must be made, resulting in an advertising cost of $1,450 for the current period. Adjustments must be made for the unpaid items also. The profit for the current year added to that carried over from last year will give the figure for "surplus" to be used in the balance sheet CHAPTER IX THE ACCOUNT The Goal of Account Keeping Throughout the preceding chapters constant reference has been made to records or data of the business furnished by the accounting department; Knowing the use made of those data in the compilation of financial and profit and loss summaries, knowing the goal, the purpose in the gathering of complete information about the business, we will trace the progress of that information, in exactly re- verse order; first, through the ledger, where it is grouped and summarized and made ready for the preparation of statements; then into the books of first entry, where the information is sorted and classified with a view always to fit it ultimately into the final statements of financial and business condition; and finally, to the transaction itself which gives rise to the business papers, the basis or first source of all accounting records. The Ledger Account Defined We come first, then, to the ledger account. An account may be defined as a record of one or more items, either similar or dissimilar, relating to the same person or thing, kept under an appropriate heading or title. Accounts are kept both with persons, as the accounts receivable and pay- able already mentioned, and with things such as land, build- ings, machinery, merchandise, cash, and the like. They are usually composed of both similar and dissimilar items; e.g., the cash account is composed of both cash received and cash paid out items ; the accounts receivable record both the items for which the person is in debt to the business and those 56 THE ACCOUNT 57 which show the cancellation or settlement of the debt, in pari or fully; and the accounts payable record the items for which the business is in debt to the person and those which show its cancellation or settlement by the business. Ac- counts may comprise only similar items, as where we record all sales of merchandise under one head or account and all purchases under another account. The Account Title The title given the account is important. It should indi- cate clearly the content of the account. Exact truth is a basic principle in accounting. Correct titles are therefore essential. A title which does not clearly and truthfully indicate the nature of the account, or one which is chosen so that under it may be recorded items of various and doubtful kinds, gives prima facie evidence of an imperfect knowledge of accounting principles or of a desire to hide data which will not bear close scrutiny. Therefore, great care should be exercised in the selection of titles. The Two Sections of the Account To make a separation of similar from dissimilar items, the account is divided into two sections, a left and a right as we shall call them for the present, and is shown some- what as in the standard form on page 58. The account head or title is placed in the center over the division line. At the extreme left of each section are the date columns — year, month, and day. Note particularly where the "year" is shown. The next space is for ex- planatory matter; the next column, left blank in the illus- tration, is a reference column whose use will be explained later; and the last in each section is the money column, where the dollar subsection column is further divided into columns for each decimal of the amount, and care must be 58 ACCOUNTING— THEORY AND PRACTICE i ■i-^ ■S ^ >o _ 1^ •^ ^ o s PERIODIC WORK ON THE LEDGER 107 account. As notes are issued they may be numbered, and when a particular note is paid by us, the entry covering this pa)TTient should show the number of that note. These remarks apply also to notes receivable. If full payment is made on each note as it comes due, entry of the payment may be made on the same line on which its issuance was recorded. This may result in the entries to the account appearing out of chronological order, but it assists in an easy determination of the outstanding notes. Numbering, or preferably lettering, the entries in an account may be applied with advantage also to personal accounts as it aids in locat- ing unpaid items, especially where payments cannot be re- corded in the order in which the items to be settled were entered. The method of ruling cancelling items as explained above is usually limited to notes and accounts receivable and pay- able. On the other hand, it is advisable that the method of showing balances for use in the trial balance be applied to all accounts. Problems {Assignment for CItapter XV) 1. Set up the ledger account called for in Chapter XIII, Problem 3, and show the account closed and the new accounts called for in Chapter XIII, Problem 4, properly set up. (Be sure to make cross reference to pages and show the transfers between the several ac- counts.) 2. Allowing five lines for each account and for the necessary depreciation reserve accounts which should follow immediately their particular assets, under date of December 31, 1916, set up the following accounts on the ledger, in proper form and under correct titles, and take a trial balance. T. C. Counts, investment $11,635; withdrawals Io8 ACCOUNTING— THEORY AND PRACTICE $900; purchases $12,300; sales $11,850; cash $1,040; furniture $2,100; notes receivable $1,300; notes payable, Dr. $590, Cr. $2,400; accounts receivable $3,210; horses and wagons $1,940; freight and drayage-in $128 ; insurance and taxes $205 ; interest and discount, Dr. $42 ; ex- penses $850; wages $1,280. Prepare financial and profit and loss statements using these in- ventories and appraisals : merchandise $7,500 ; furniture $2,000 ; horses and wagons $1,700; insurance unexpired $45 ; and expense supplies $170. Instriictions Problem i. Follow the forms and instructions for transferring given in the text. Problem 2. Be sure to enter the amounts on the correct sides of the accounts. Record the trial balance on a piece of journal paper. CHAPTER XVI TREATMENT OF INVENTORIES AND APPRAISALS Why the Current Record of the Ledger Needs Adjustment At the end of the fiscal period the record on the ledger is not a true record of financial condition, because no record has been kept of the cost of goods sold and no current record has been made of depreciation nor of certain other items of expense and income as they accrue from day to day. For this reason the ledger must be adjusted to bring it into accord with actual conditions. The entries required for this purpose are called adjustment entries. Whether the merchandise items are kept in one or in several accounts, these do not show the amount of stock on hand at any given time during a fiscal period. Similarly, expenses are not usually entered on the books until paid, nor do income items appear before their receipt. It may be that the services paid for during this period, as shown by the various expense accounts, have not been entirely used up, as where there remains on hand a supply of coal for heating purposes, or as in the case of insurance paid in advance for a given period of time, a part of which ex- tends beyond the close of the current fiscal period. In these and similar cases, the items actually paid must be separated into their two component elements, one part belonging to the current period, and the other part deferred until used in a later period. Similarly, income is some- times received in advance to cover services which have not yet Deen rendered or which have been rendered only in 109 no ACCOUNTING— THEORY AND PRACTICE part, as where rent is received in advance covering a given number of months, some of which belong to the next fiscal period. Consequently, only a part of this income applies to the current period, while the balance must be deferred to later periods. Basis of Adjustment Entries These items, then, comprising merchandise, deprecia- tion of assets, and prepaid and accrued expenses and in- come, form the basis for the adjustment entries. We take an inventory to find the value of the stock in trade; we make an appraisal of depreciating assets and thereby deter- mine the amount of depreciation for the current period; and we prorate on an equitable basis the prepaid and accrued income and expense items to determine the portions applicable to the period under review. The following illus- trations covering each class of adjustment entries separately, will help to clarify the above discussion. The detail of the account will not be shown, but only the totals as given in the trial balance. Adjusting and Closing the Merchandise Records The first illustration will cover the case where the transactions affecting merchandise are kept under the separate accounts with Merchandise Inventory, Purchases, Freight In, Returned Purchases, Purchases Rebates and Allowances, Sales, Returned Sales, and Sales Rebates and Allowances. The inventory taken June 30 showed merchan- dise then on hand, $11,267.40. Merchandise Inventory 1916 Jan. I $10,125.67 June 30 (E) 11,267.40 1916 June 30 Purchases (B) $10,125.67 INVENTORIES AND APPRAISALS Purchases III 1916 June 30 (Total pur- chases) $47,897.42 Freight In (A) 560.25 Mdse. In- ventory, Jan. I.. . (B) 10,125.67 $58,583.34 1916 June 30 Returned Purchases (C) $2,125.40 Pur. Rebates and Allow. (D) 267.92 Inventory, June 30.. (E) 11,267.40 Profit and Loss (F) 44,922.62 $58,583.34 Freight In 1-916 yune30 (Total). $560.25 1916 June 30 Purchases.. ... (A) $560.25 Returned Purchases 1916 June 30 Purchases.. (C) $2,125.40 1916 June 30 (Total). $2,125.40 Purchases Rebates and Allowances 1916 June 30 Purchases (D) $267.92 1916 June 30 (Total) $267.92 Sales 1916 June 30 Returned Sales ....(G) $3,924-83 Sales Re- bates and Allow.... (H) 392.48 Profit and Loss /I) 60,965.90 $65,283.21 1916 June 30 (Total) . $65,283.21 $65,283.21 112 ACCOUNTING— THEORY AND PRACTICE Returned Sales 1916 June 30 (Total) $3,924-83 1916 June 30 Sales (G) $3,924.83 Sales Rebates and Allowances 1916 June 30 (Total) $392.48 1916 June 30 Sales (H) $392.48 Profit and Loss 1916 June 30 Purchases. (F) $44,922.62 1916 June 30 Sales (I) $60,965.90 In order to understand the entries, note that the first debit entries in the Merchandise Inventory, Purchases, Freight In, Returned Sales, and Sales Rebates and Allow- ances, and the first credit entries in Returned Purchases, . Purchases Rebates and Allowances, and Sales accounts, are trial balance totals. All other entries are adjustment or clos- ing entries. In the illustration, a given letter is used for the purpose of indicating corresponding entries. To show the total cost of goods bought during the period, the Freight In of $560.25 is transferred or closed into Purchases. To show the "gross cost of goods to be accounted for," amounting to $58,583.34, the inventory of January i of $10,125.67 is closed into the debit side of Purchases account. To show the net cost of goods to be accounted for, the Returned Purchases and Allowances must be deducted from this gross cost and are therefore transferred to the credit side of Purchases. The balance of Purchases account at this point, viz., $58,583.34 minus $2,393.32, or $56,190.02, would indicate the net cost of INVENTORIES AND APPRAISALS 113 goods to be accounted for. This item of $56,190.02 is not indicated in the account, however, but given here in order to make the discussion intelligible. Part of this $56,190.02 (net cost of goods to be accounted for), amounting to $11,267.40, is the cost value of the unsold goods according tD the inventory of June 30, and the balance of $44,922.62 ($56,190.02 minus $11,267.40) therefore constitutes the cost of the goods sold. This final inventory is also shown as an asset on the debit side of Alerchandise Inventory. Put in a somewhat different form, we may say that the cost of goods sold is found by subtracting from the gross cost of goods to be accounted for, $58,583.34, the returns and the rebates, $2,393.32, and by further subtracting from it the amount of the closing inventory of June 30, $11,267.40; leaving a balance of $44,922.62, which repre- sents the cost of goods sold. This balance is now trans- ferred to the debit of Profit and Loss account. It would be equally effective, however, to transfer this balance to the debit of Sales, but since the Profit and Loss shows all other costs of the business, it seems more logical to show also therein the cost of goods sold. All of the transfer entries given above have their debits and credits determined as explained in Chapter XV. The Sales account is debited with the balances of the Returned Sales and Sales Rebates and Allowances, thus indicating a balance of net income from sales which is transferred to the credit of Profit and Loss. This account then shows net income from sales on the credit side, and cost of goods sold on the debit side, the balance being gross profit on sales. If, as is sometimes done, the cost of goods sold were transferred from the Purchases account to the Sales account, instead of to Profit and Loss, the balance of the Sales account would show gross profit on sales and should be transferred to the credit of Profit and Loss. All 114 ACCOUNTING— THEORY AND PRACTICE of the merchandise accounts, except the Inventory account, are thus balanced, and should be ruled off. The second illustration will cover the case where the stock-in-trade record is kept in one mixed account called Merchandise. Using the same data as before, that account will show as follows : Merchandise 1916 Jan. I Inventory $10,125.67 June 30 Purchases 47,897.42 Returned Sales. 3.924-83 Sales Rebates and Allow 392.48 Freight In 560.25 Profit and Loss 16,043.28 $78,943.93 June 30 Inventory $11,267.40 IC16 June 30 Sales $65,283.21 Returned P u r - chases 2,125.40 Purchases R e - bates and Al- low 267.92 Inventory, June 30 11,267.40 $78,943.93 When the merchandise is kept under separate accounts, the Freight In is transferred to the debit of the Purchases account, but when a single mixed account is kept, it is usually entered directly to the debit of that account. For adjusting the account when kept in this manner, the new inventory is entered to the credit of Merchandise. The balance of the Merchandise account now shows the gross profit on sales, $16,043.28. This is transferred to the credit of Profit and Loss. It will be noted that this trans- ferred item is identical with the balance of the Profit and Loss account of the first illustration. The Merchandise account is now totaled and ruled off. On the debit side, beneath the ruling, the new inventory is entered, this being the contra to the credit entry of $1 1,267.40 above the ruling, INVENTORIES AND APPRAISALS ng and so maintaining the equilibrium of debits and credits. In this open item of $11,267.40 the account shows an asset, the goods on hand June 30. The handHng of merchandise transactions according to the second illustration is not considered good accounting but is shown because it is frequently met with. Handling Depreciation on Fixed Assets The method of handling depreciation on assets is shown in the following illustration : Furniture and Fixtures 1916 Jan. I $750-00 Depreciation Reserve for Furniture and Fixtures 1916 Dec. 31 (A) $75.00 Depreciation 1916 Dec. 31 (A) $75.00 The asset Furniture and Fixtures, valued at $750 at the beginning of the year is estimated by appraisal to have depreciated 10%, or $75, during the year. This cost or expense is charged to an account called Depreciation, and credited not to Furniture and Fixtures, but to the valua- tion account "Depreciation Reserve for Furniture and Fixtures." The Furniture account and its valuation account, taken together, show the appraisal value of $675. The Depreciation account, carrying the debit of $75, is an expense account and is to be closed into Profit and Loss, just as are all other expense accounts. ii6 ACCOUNTING— THEORY AND PRACTICE Handling Prepaid and Accrued Expenses and Income The method of handling the estimates or inventories of prepaid and accrued expenses and income is very similar to that shown for the mixed Merchandise account. Illustra- tions follow : Insurance 1916 Jan. I (Paid) $150.00 $150.00 July I $125.00 1916 June 30 Unexpired $125.00 Profit and Loss.. 25.00 $150.00 Rent Income 1916 June 30 Unearned $250.00 Profit and Loss.. 50.00 $300.00 1916 June IS (Received) . $300.00 $300.00 July I $250.00 Wages 1916 June 30 ( Paid) $2,125.00 Accrued, Unpaid $200.00 $2,325.00 1916 June 30 Profit and Loss $2,325.00 $2,325.00 July I Accrued. INVENTORIES AND APPRAISALS Interest Income 117 I9I6 June 30 Profit and Loss. $145-00 1916 June 30 (Received) . . . Accrued (due us) . . $127.50 .. 17-50 $145.00 $145-00 July I $17.50 The first account, Insurance, is a deferred or prepaid expense account, i.e., the insurance bought was for a three- year term, hence only one-sixth of it is chargeable to the first half-year, the remainder being deferred to later periods. The amount of the inventory or unexpired portion is entered to the credit in order to effect subtraction of the amount, the balance of the account, $25, thereby showing the insurance cost for the current period. This balance is carried to Profit and Loss. After closing the account, the inventory is entered to the debit below the ruling, thus showing the so-called "deferred asset" portion which will appear in the financial statement. The next account. Rent Income, is a deferred proprietor- ship income account, i.e., rent has been received for a given period which extends beyond the end of the current fiscal period. On June 15, rent for the period of, say, June 15 to September 15, was received by us. Only one- sixth of this income applies to the term January i to June 30 ; therefore, the balance of $250 must be deferred or car- ried over to the next fiscal period. The adjustment is made by an entry of $250 for unearned rent, on the debit side to effect subtraction of it, thereby reducing the earn- ings for the current period to $50. This income of $50 is transferred to the credit of the Profit and Loss account. After the account is ruled off, the deferred income is entered Il8 ACCOUNTING— THEORY AND PRACTICE below the ruling on the credit side, forming a part of the earnings of the next period. This deferred item will be shown among the liabilities in the financial statement for the current period. The third account, Wages, shows wages paid to June 30 of $2,125. At that date wages earned but not yet paid, perhaps because the pay day did not coincide with the date of closing the books, amounted to $200 and this must be included as an expense of the current period. This item directly applies to the short interval between the last pay-day in June and June 30. The $200 is there- fore entered on the debit to effect addition of it to the expense already shown there. The full amount is trans- ferred to Profit and Loss; the account is ruled ofif; and the amount of unpaid wages, $200, is shown on the credit beneath the ruling, and appears as a liability in the financial statement. Similarly with the fourth account. Interest Income. Income to date is $127.50; earned but not yet due on June 30, $17.50, showing full earnings of $145 for the current period. This total is transferred to Profit and Loss; the account is ruled off; and the earned, but not received portion, is shown as a debit beneath the ruling, and as an asset in the financial statement. Great care must be exercised in all inventories of any kind to maintain the equilibrium of the ledger by entry of each amount to both the debit and credit sides. Besides the four illustrations given above, there are many other accounts requiring the same kind of adjust- ment entries. In certain special cases it may be necessary to m.ake adjustments on both sides, as for example in a general expense account or in a mixed interest account showing both interest income and interest expense. For illustration : INVENTORIES AND APPRAISALS Interest 119 1916 June 30 (Paid) $400.00 30 (Unpaid) 50.00 30 Profit and Loss.. 150.00 $600.00 July I Accrued $100.00 1916 June 30 (Received) $500.00 30 (Accrued) (due us) 100.00 $600.00 July I Unpaid $50.00 The opening item of $100 represents an asset, an in- terest claim against outsiders, while the credit opening item of $50 represents the liability to others for interest due them but not yet paid. Problems {Assignment for Chapter XVI) 1. Give two examples each of deferred expense and income and accrued expense and income. Show these set up in account form. 2. Assuming an inventory of $2,500 for Problem 2, Chapter XIV, as correctly set up, show the accounts closed. 3. Close the ledger for Problem 2, Chapter XV. Instructions Problem i. Follow the account forms shown in the text. Problem 2. Study carefully the transfers made in closing the various merchandise accounts illustrated in the text; then solve Prob- lem 2. Problem 3. Refer to page 103, "Summarizing the Ledger," for the method of closing the accounts into Profit and Loss. Be careful to make both debit and credit entry for every transfer. Be sure to handle the inventories and deferred expense items before making the transfers to Profit and Loss. Rule up carefully all transferred ac- counts ; make no rulings in the other accounts. CHAPTER XVII SOURCES OF DATA FOR THE LEDGER Insufficiency of the Ledger Record In an earlier chapter a business transaction was defined as an exchange of values ; the ledger, as the book in which transactions are grouped under predetermined titles' or names. Thus, all transactions relating to machinery are grouped under the title "Machinery" ; those relating to cash under the title of "Cash" ; those to purchases under the name "Purchases" ; etc. Even in a small business the ledger may contain a large number of accounts, all neces- sary to give a clear-cut presentation of the volume and sig- nificance of business transactions. The ledger record presents an analysis of transactions into their component elements, each transaction being classified and recorded, usually, in at least two, and fre- quently more, ledger accounts. Consequently, in order to learn the nature of a given transaction, to see it in its entirety, it may be necessary to refer to a number of sepa- rate ledger accounts. This process, even if the ledger is small, is not always an easy matter; and when the ledger contains a large number of accounts, it becomes practically impossible. Accordingly, another kind of record is needed. The Book of First Record This other record shows the transaction in its entirety; it gives a complete statement of the conditions and all other data relating to it, and also shows its fundamental analysis under appropriate titles. This record is called the original or first record. Usually it is not the very first record I20 SOURCES OF DATA FOR THE LEDGER 12I made of the transaction but it is the first record made in the books of account. The book in which this record is kept is called the "Journal." The record as kept in the ledger is a secondary record based on the original or first record in the journal. Because of its secondary nature, courts will not accept the ledger as evidence without verification. Posting to the Ledger The act of transferring the original entry into the ledger is called posting to the ledger. In order not to lose sight of the original record in the journal, it is important that the ledger entry show by letter and number the book and page where the original entry can be found. This index is entered in what is called the reference column of the ledger account, the column just to the left of the money column, thus affording for every entry in a ledger account a reference to the original entry pertaining thereto. The Journal A journal may be defined as a diary or log in which the happenings or transactions of a business are recorded. Formerly it was sometimes called a day-book or blotter. The day-book or blotter record was a rough record giving all the essential data relating to each transaction without regard to accounting terminology, and was used as a sort of memorandum from which a formal record might be made in accounting terminology. This day-book or blotter, still in use in some places, has very largely given place to the journal which, either a single book or separated into many subsidiary books, is the book of original entry. Characteristics of the Journal I. Being of the nature of a diary, the journal shows all of the day's transactions in consecutive order with little 122 ACCOUNTING— THEORY AND PRACTICE regard to grouping. The first characteristic, therefore, of the journal is that it is a book of chronological entry, a record of each transaction just as it took place and entered according to its date. 2. Another characteristic of the journal entry is that it is an analytical and classifying record. Before the entry is made, the transaction is analyzed as to its two elements of debit and credit, determined according to its efifect as to increases and decreases on assets, liabilities, or proprietorship. The account titles used in the journal are selected on the basis of a detailed sub-classification of the three fundamental groups mentioned above. The degree of detail in classification depends on the desired minute- ness of the information required. The guiding principle in giving these titles is to use such names as will tell truth- fully and accurately what kind of information is recorded under each head. A journal entry is therefore an analytical record as to debit and credit, classifying the different elements of the transaction under such titles as will later be used in the ledger. 3. A final and a very essential characteristic of the journal is that every entry should carry in addition to account titles, with their debit and credit amounts, a brief but complete summary of all the conditions and data relat- ing to the transaction, so tlmt, if reference to it may be made in the future, the journal record will call to mind the essentials of the entire transaction. Because of these three characteristics — particularly the last two — the journal record is one of prime importance. Equilibrium of the Journal Entry ; Compound Entries As has been discussed in a previous chapter, all transactions, when analyzed as to their debit and credit elements, must show equal amounts on the debit and on SOURCES OF DATA FOR THE LEDGER 123 the credit. Since the journal entry is such an analysis of the transaction, it is plain that it must show equal amounts in the debit and credit columns. In case the analysis and classification require an entry consisting of more than one debit and one credit item, the total of the several debit items must be equal to the total of the credit items. Such an entry is called a compound journal entry. Standard Form of Journal The standard form of journal must provide spaces for the following information : date, classification as to debit and credit, ledger index column, money columns to show both the debit and credit amounts, and full record of the essentials of the transaction. The following form illus- trates a complete journal entry : 1917 Jan. 10 James Jackson Sales Terms 2/10, n/30 10 desks 12 racks IS chairs $400.00 90.00 22.50 $512.50 $512.50 The date is sometimes shown in the middle of the first blank line, but it is better to place it at the extreme left. The account titles are each placed on a separate line unencum- bered with other data, because they are of first importance in posting. The name of the debit account is shown on the extreme left of the explanation column, with a uniform mar- gin to the right for the credit. The debit and credit amounts are placed in the left and right money columns re- spectively. Data as to terms of credit and items of mer- chandise sold are shown directly below the classified debit and credit entry, slightly to the right of the credit ac- 124 ACCOUNTING— THEORY AND PRACTICE count title margin, maintaining a uniform margin down the page. The column to the left of the money columns shows the ledger pages to which the entry is posted. The entry is read James Jackson, debit; Sales, credit, $512.50. Practice Data (Assignment for Chapter XVII) The following transactions are to be set up, debit and credit, on the ledger. Use the transaction number as the day of the current month. Set up on your ledger the following account titles, in the order given, allotting to each the number of lines indicated by the numeral following the title : Cash 35 Green-Cooper Company 10 Notes Receivable 10 James Black 10 Tom J. Dukes lo U. R. Marchand, Capital 10 M. J. Scooner 10 U. R. Marchand, Personal 10 M. J. Smith 10 Profit and Loss 15 J. T. More 10 Purchases 15 M. I. Quinn 10 Freight In 10 John Cohen 10 Purchases Returns and Al- Stan Edwards 10 lowances 10 Dan J. O'Shea 10 Sales 25 Merchandise Inventory 10 Sales Returns and Allowances . . 10 Furniture and Fixtures 10 Salaries 10 Notes Payable 10 General Expense 15 Johnson Brown & Co 10 Expense Supplies 10 Jackson & Little 10 Interest and Discount 10 Purchases Discount 10 1. U. R. Marchand invested cash $1,500 and merchandise $1,700. 2. Paid rent $30; bought merchandise of Johnson Brown & Company, $1,340 on account. 3. Sold merchandise for cash $340.25 ; paid for office stationery, post- age, account books, and miscellaneous supplies, $45.75. 4. Sold merchandise $375.20 to Tom J. Dukes, receiving $250 cash. 5. Bought office safe and typewriter $85. SOURCES OF DATA FOR THE LEDGER 125 6. Bought merchandise of Jackson & Little, $327.40, paying $200 cash. Gave Johnson Brown & Co. $1,000 on account. Took merchandise for your own use $25.60. 8. Cash sales were $234.69. Paid for advertising $10. g. Paid clerk $12; fuel bill $22.50. 10. Bought merchandise for cash at receiver's sale $325. 11. Sold Dan J. O'Shea merchandise $35. Took his check in payment. 12. Paid $5 for sales tickets; postage $2.50; envelopes $1. 13. Sold bill of merchandise $175.40 to M. J. Scooner, receiving cash $7540, P. D. Jacks' note for $35, due in 10 days, and Scooner's note at 30 days for the balance. 15. Gave Johnson Brown & Co. your lo-day note for balance due. Scooner returned $10 worth of the merchandise sold him on the 13th, claiming it inferior in quality. Instructions Be sure the date — year, month, and day — is entered. Assume ad- dresses for all personal accounts. Tangibility is perhaps the best criterion by which to determine whether an item should be handled in a "Supplies" account or in an "Expense" account. If the payment is for a real, tangible thing as distinguished from a service, such as "Wages," or a use, such as rent, telephone, etc., it is best handled in a "Supplies" account. Of course, distinction must be made between merchandise purchases and supplies and also between furniture and fixtures and supplies. Such items therefore, as postage, stationery, fuel, etc., should be treated as supplies. CHAPTER XVIII THE SUBDIVISION OF THE JOURNAL Inadequacy of the Old Journal As was indicated in the previous chapter, every business transaction formerly was entered in the day-book, or journal as it was later called. This necessitated the making- of a for- mal debit and credit entry for every transaction, many of which were of the same or a similar kind. Accord- ingly, during any business day, a large number of sales had each to be analyzed, classified, and entered separately. The entry in each case was a debit to the customer and. a credit to Sales, if the sale was "on time" ; or a debit to Cash and a Credit to Sales, in the case of a cash transac- tion. This required a conscious mental effort in each case. It was soon perceived that one entry could be used for bringing into the books all of the sales for a given day. This was accomplished through the use of both a blotter and a journal. The blotter was used as a memorandum carrying the data of each individual trans- action ; the journal as the formal record in which was set up at the close of each day a summary of these items, properly indicating the debits and credits. Such a sum- mary or compound journal entry is illustrated below: A Jackson $175.00 D. Hayes 25.00 J. M. Marshall 132.50 T. P. Pollard 79.40 I. M. Cranston 93.20 M. V. Johnson : 17.15 Sales $522.25 To record the day's sales. 126 THE SUBDIVISION OF THE JOURNAL 127 In this way the principle of labor-saving was introduced into the journal. Similarly, throughout the day, there are a large number of cash transactions — receipts and disbursements — which would require a separate debit and credit record for each. Also purchases of merchandise, although not numerous for any particular day, would require a large number of entries when taken for a month or year. The Subsidiary Journal a Labor-Saving Device To save the labor of so many entries, the original journal was divided into separate books known as subsidiary journals, each containing the original entries for a particular group of similar transactions, the number of books corresponding to the number of groups into which the various transactions might be divided. For instance, where the policy of the business is to encourage the pay- ment of outstanding customers' accounts by notes from them, the use of a notes receivable book or journal would effect a very appreciable saving of labor. This book being limited absolutely to a record of notes as they are received would, in that system, contain nothing but notes receivable debits. It would not be necessary then to write each time a complete journal entry as follows : Notes Receivable $1,500.00 J. M. Johnson $1,500.00 when Johnson gave his note to the business, as the record in the notes receivable journal would in itself be evidence of a debit to Notes Receivable account. Thus only the credit side of the entry need be shown, with appropriate explanation and detail, the formal debit being suppressed. However, at a posting time the total of all these entries is formally label- 128 ACCOUNTING— THEORY AND PRACTICE led "Notes Receivable, Dr." and posted to the debit of the Notes Receivable account. So also, were it the practice of the business to issue many of its own notes either in payment of purchases or for discount purposes, a "Notes Payable Journal" might be used. The method of handling this book would be similar to that described in the preceding paragraph. Basis of Subdivisions The basis for dividing the one general journal into subsidiary journals is the frequency of occurrence of transactions of a similar nature. It would be folly evidently to create a subsidiary journal if the number of transactions to be recorded therein were small. The saving of labor in a case like this would be more than offset by the work of using an extra book. Customary Subdivisions The subsidiary journals most frequently met with in a majority of businesses are those for purchases, sales, and cash; the purchases journal containing the original entry of purchases, the sales journal recording the sales and the cash book showing all cash transactions. All other original entries are made in the general journal. For the sake of briefness, the general journal is usually designated by the single term "Journal." It should be thoroughly understood that all of these journals combined, the subsidiary and the general, com- prise the journal record of transactions. None of them is merely a memorandum record to be summarized and to be formally recorded later. The record made in each is formal, although abbreviated, and each must be posted com- pletely, both debit and credit, in order to secure in the ledger a full record of all business transactions. THE SUBDIVISION OF THE JOURNAL 129 PRACTICE Data {Assignment for Chapter XVIII) The following transactions of U. R. Marchand are to be set up on the ledger in the same manner as those given in Practice Data at end of Chapter XVII, using the transaction number as the day of the current month. 16. Cash sales were $395.40. Paid clerk $12. 17. Paid freight and drayage bills $22.30; light bill $5. 18. Drew for private use $25. 19. Bought, on account, 2/10, net/30, merchandise from Green-Cooper Company, $2,500. 20. Cash sales $425.67. 22. Sales on account: M. J. Smith $30; J. T. More $51.20; M. I. Quinn $10.03 J John Cohen $43.30 ; Stan Edwards $69.30. 23. Returned merchandise $200 to Green-Cooper Co. as unsatisfactory. 24. Paid clerk $12 ; received payment on P. D. Jacks' note and interest 2SC. Was allowed by Green-Cooper Co., $10 on damage claim. 25. Paid note, favor Johnson Brown & Co., with interest at 8%. T. J. Dukes pays $75 on account. Paid freight and drayage $25.04. 26. Took merchandise for own use $25.30; sold Dan J. O'Shea mer- chandise $125, receiving cash $40 and Jack Gibson's 6% 60-day note for $75. 27. Paid telephone bill $2 ; advertising $8 ; and bill-heads $5. 29. Allowed D. J. O'Shea $5 claim for goods soiled. Had your note for $1,200 discounted at bank, 60 days at 8%. Paid Green- Cooper Co. amount due them. 30. Cash sales $235 ; paid clerk $12 ; fuel $22.50 ; drew for private use $25. Collections were: M. J. Smith $20; J. T. More $21.20; John Cohen $5 ; Stan Edwards $25. 31. Paid Jackson & Little $100 on account; cash sales $500; received for the store farm produce $33.50 from Jas. Black, allowing him merchandise $22 and balance credited. Instructions 19. Terms of sale 2/10, net/30, give the buyer the option of making settlement on two bases, viz., 2% off the face of the bill if paid within 10 days, or the net amount to be paid in 30 days. 29. In discounting a note at the bank, the interest is prepaid by deducting it from the amount of the note. Hence, Marchand secures less cash than the $1,200, to cover interest for 60 days at 8%. Notice that the Green-Cooper bill is paid within the lo-day limit for discount. CHAPTER XIX THE PURCHASE JOURNAL Explanation will be made, at this point, of the various subsidiary journals, taking them in turn. For recording purchases of stock in trade a separate book or journal is used, limited entirely to such entries. A so-called "Invoice Book," explanation of which is given in a later chapter, is sometimes used for this purpose. Meaningless Distinction Between Book and Journal Occasionally an attempt is made to distinguish between the terms book and journal, as applied to these subsidiary records. Where such distinction is made, the "book" seems to carry considerably more detail and might even show an almost complete copy of the purchase invoice. The record in the journal does not show such detail; it simply gives the date, amount, and the index number of the purchase invoice. There is no need for a distinction of this sort, for whatever the details of the method of making the record of purchases, the essential characteristic of all the methods of recording is the same— the effect being to do away with the necessity of making a complete •double entry for each individual transaction. In this work the terms "journal" and "book" will be used synonymously. Expanded Use of the Purchase Journal The purchase journal is not always limited to a record of purchases of stock in trade, but is sometimes used to show all purchases of whatever sort. For example, pur- chases of store and office supplies, of advertising and 130 THE PURCHASE JOURNAL 131 printing, and even of services such as labor, and of uses, such as the use of a building, are sometimes recorded in the purchase journal. When so used it becomes very- much like a voucher or accounts payable register which will be explained in Volume II. For the present discussion we will limit the purchase journal to a record of purchases of stock in trade. Analysis of the Purchase Transaction The debit and credit analysis of a transaction covering a purchase of stock in trade may result in either of two groups of entries : ( i ) The debit may be to Purchases and the credit either to a personal account payable or to the Notes Payable account, if the transaction is on credit; or (2) the debit may be to Purchases and the credit to Cash, if the transaction is for cash. At the time of the purchase, in the first case, there is an increase of assets offset by an increase of liabilities; in the second case, an increase of assets offset by a decrease of assets. In neither case is proprietorship affected until after sales take place. The Purchases account, therefore, is a mixed account, repre- senting asset values as on the date of the receipt of the goods purchased, but, after sales occur,' some portion of the values in the account represents the cost of the goods sold The introduction, into the Purchases account, of the inventory of goods on hand at the close of the fiscal period, in order to separate the asset and cost or expense elements, was explained in Chapter XVI. Thus, although the handling of the Purchases account is somewhat complicated at the close of the fiscal period, the original record of the current transactions is very simple, involving entries adequate to record the analysis made above under the two groups. T32 ACCOUNTING— THEORY AND PRACTICE The Purchase on Account All purchases which are made on open account would be recorded in the purchase journal, thereby debiting the Purchases account, with a corresponding credit to the vendor's account, as was explained above under (i). Ex- pressed in journal form, the entry would be as follows: (a) Purchases Vendor (account payable) On the other hand, if at the time of the purchase a note is gi\'en to the vendor, the debit and credit of the entry would be as follows: (b) Purchases Notes Payable Where the customary subsidiary journals are used, viz., purchase, sales, and cash journals, neither of the above entries, (a) or (b), requires for its record any other than the purchase journal, as both are pure purchase transactions involving neither sales nor cash. Therefore, both can be completely recorded in the purchase journal. The Cash Purchase When purchases are made for cash, the entry, as ex- plained under (2) above, would be: Purchases Cash Here there is evidently a conflict of places of original record. Being a purchases transaction, record should be made in the purchase journal; but being also a cash trans- action, record must be made also in the cash book. Were independent record made in both places, the result would THE PURCHASE JOURNAL 133 be a duplication of the transaction. It would be twice entered, in full, causing an inflation of the purchases and the cash disbursements. In the purchase journal, only the credit Cash would be set up at the time of the transaction ; but at the time of summarization, the debit to Purchases would be included in the total of the Purchases. This makes a complete record of it. However, to show in the cash book all of the cash disbursed, this disbursement must appear therein. In the cash book, only the debit. Purchases, would be set up currently, but when the summary is made the credit to Cash would be shown in the Cash total. This would bring about two duplicate debits and credits for the same transaction. Two methods to overcome the difficulty are commonly employed, as follows : Handling the Cash Purchase I. The record is made complete in both journals, the purchase and cash. When posting is done, however, the credit to Cash from the purchase journal record is not posted, because that credit will be posted from its record in the cash book. When posting the cash book, the debit to Purchases is not posted, because that has already been posted from the purchase journal. In this way original record may be made in both journals and each journal will then show by its total what it is intended to show, viz., total purchases and total cash disbursed respectively. In the secondary record, the ledger, only half of each journal entry is set up, the debit to Purchases from the purchase journal and the credit to Cash from the cash book. This prevents the inflation mentioned above and does not destroy the equilibrium of the ledger because there is omitted, when posting from the cash book, a debit equal in amount to the credit omitted when posting the purchase journal. ^34 ACCOUNTING— THEORY AND PRACTICE 2. Another method of accomplishing the same result is by providing a personal account with the vendor in both journals. Current record in the purchase journal would show, expressing both the debit and credit for the sake of clearness of explanation: Purchases Vendor In the cash book, record would be, expressed in full : Vendor Cash When made in this way, it would require opening an account with the vendor for every cash purchase. This is some- times desirable, in order that the ledger record may thus show the volume of business, both cash and credit, done with each vendor. The same result is sometimes accomplished by the use of only one account called "Sundry Cash Creditors," instead of individual accounts with each vendor, posting thereto both from purchase journal and cash book all such cash purchase transactions. Usually, however, at posting time no account with the vendor is opened on the ledger, and the credit shown to it in the purchase journal and its debit from the cash book are both omitted. It is customary, when posting, to indicate all omitted postings like the above by entering a check mark, V, or cross, X, in the ledger folio column of the journal. Posting the Purchase Journal The purchase journal, then, contains a complete record of all purchases of stock, and at posting time the total of all the purchases for the period is transferred to the Pur- chases account in the ledger, thus saving labor not only in the original recovd but also in posting to the ledger THE PURCHASE JOURNAL 135 account. The individual items have already been posted to the credit of the various Accounts Payable accounts in the ledger, indicating the names of the vendors. A daily posting of the individual items is best, in order to keep the individual creditors' accounts right up to date. The daily posting of these credits, of course, throws the ledger out of equilibrium for the time being, but when the summary debit to Purchases account is made periodically, that equilibrium is re-established. Form and Method of Use of the Purchase Journal The simplest form of purchase journal is the same as that of the standard journal, providing space for date, classification, ledger index, two money columns, and explanation. In the purchase journal the money columns do not have "debit" and "credit" significance, but the first column may be used for the detailed extensions and the other column for the total of each purchase. Suppose, by way of illustration, that the following purchases have been made, the detail for the first only being given: Jan. 10, 1917, for cash, from S. C. Bontell: 5 tons hay @ $12.00 100 bu. corn @ .90 1,000 bu. wheat @ i.io 30 tons coal @ 4.50 Feb. 2, on account 2/10, n/30, from P. V. Stewart, $1,250. Feb. 12, on account n/30, from I. S. Van Dorn $1,050.50. Feb. 26, on account 2/10, n/60, from S. M. Sax, $567.40. The purchase journal record would be made as follows : 136 ACCOUNTING— THEORY AND PRACTICE Date Account Classification L. F. 1917 Jan. 10 S. C. Bontell Terms, cash 5 t. hay @ $12 100 bu. corn @ 90c. 1,000 bu. wheat @ $1.10 $60.00 go.oo 1,100.00 30 t. coal @ $4.50 P. V. Stewart A7190 V I2S 135.00 $1,385.00 Feb. 2 1,250.00 Terms 2/10, n/30 12 I. S. Van Dorn A9364 Terms n/30 140 1,050.50 26 S. M. Sax A700S Terms 2/10, n/60 Purchases, Dr. To close 131 10 567.40 28 $4,252.90 Under a system designed to show full details in the purchase journal, entry and full explanation would be made as indicated for the purchase of January 10, the first money column giving the detailed extensions, the second the total. As stated above, however, this detailed explanation is often omitted and in its stead the file number of the original invoice is written as part of the explanatory matter, which usually comprises only the terms of the purchase and this file reference. This is illustrated under February 2, 12, and 26. Of course, it is to be understood that either one method or the other is to be consistently used throughout. They are shown concurrently above only for sake of illustration. The purchase for January 10 was for cash. Notice that instead of showing the posting, only a check mark appears in the posting index column. This is done because no account is kept with Bontell in the ledger. A similar check mark should be placed in the cash book where the THE PURCHASE JOURNAL 137 payment is shown. Stewart's account is on page 125 of the ledger where he is credited with $1,250. At the end of the month the purchase journal is footed and the sum- mary entry, "Purchases, Dr.," is made, and posted to the debit of Purchases account on page 10 of the ledger. This one debit item in the ledger brings about the equilibrium with the individual credits posted to the various personal accounts payable. The purchase journal is ruled off and is then ready for new entries below the rulings. Where the purchase journal i's used without the full detail, as shown for entries of February 2, 12, and 26 in the illustration, there is evidently no need of the first money column for detailed extensions. Sometimes, under this method of use, the one column is used for credit purchases and the other for cash purchases in order to separate those credits which must be posted from those whose posting is omitted. Illustration of this use of the columns is given in the practice set to be worked out under Chapter XXV and following. Departmental Analysis of Purchases When it is desirable to separate the various classes of purchases so as to determine the profits from the different classes, particularly where the business is departmentized, a purchase journal similar to the one described might be used, having an additional money column for each class of purchases. If there were three departments, at least four money columns would be required. The entry in the first column would be for the total amount of the purchase ; the other three columns would each be headed with the name of the class or department, and the portion of the total purchases belonging to each department would be extended to one of these three columns. It is evident that the totals of these columns added together, must at all times be equal 138 ACCOUNTING— THEORY AND PRACTICE to the total of the first column. This affords a check on the accuracy of the distribution. At posting time a separate account is opened in the ledger, corresponding to each of these classes of purchases. The summary entry in a pur- chase journal of this kind would show as follows : L.F. Total Dept. I Dept. 2 Dept. 3 10 II 12 $10,125.40 $4,269.80 $3,197.25 $2,658.35 Purchases, Dept. i, Dr. " 2, Dr. " 3, Dr. $4,269.80 3,197.25 2,658.35 A division of purchases under separate titles would obviously call for a corresponding classification of sales. Practice Data* (Assignment for Chapter XIX) Take a trial balance of U. R. Marchand's ledger, recording it on a piece of journal paper. Marchand finds that he now has on hand goods valued at $3,364.39 and expense supplies of $21.40. Close the ledger, being careful to take account of the prepaid discount on the $1,200 note payable and the interest income accrued on Gibson's note. •See Pracfice Dsti at end of Chapters XVII and XVIII. THE PURCHASE JOURNAL 139 Instructions Close Purchases Discount direct into Profit and Loss ; do not handle it in the summary to determine cost of goods sold. Usually the temporary proprietorship accounts are closed into Profit and Loss in the same order as they appear in the statement of profit and loss, viz., Sales, Cost of Goods Sold, Selling Expenses, General Adminis- trative Expenses, and Other Income. CHAPTER XX THE SALES JOURNAL Kind of Transactions Recorded Here For the recording of sales of stock in trade, a record called the sales journal or book is used, entries in it being limited exclusively to sales of the merchandise dealt in. A sales journal of practically identical form with the pur- chase journal will serve this purpose, the columns being used in the same way and current entries being made in it just as in the purchase journal. Analysis of the Sales Transaction and Method of Record The analysis of a sales transaction shows a credit to Sales and a debit either to the customer, to Cash, or to Notes Receivable, according as the sale is "on time," for cash, or against a note given us by the customer. The current entry in the sales journal shows only the debit item, the credit to Sales account being omitted. However, the total of all these sales as indicated by the summary entry is posted to the credit side of the Sales account in the ledger. The current entries in the sales book giving the names of the customers and the amounts, are transferred to the customers' accounts in the ledger at the close of each day, in order to keep the customers' accounts up to date. In handling the cash sales the same difficulty is met with as with cash purchases, and the treatment is the same in both cases, i.e., all sales are entered in the sales journal; if for cash, the item is checked in the posting index column both in the sales journal and in the cash book where the cash receipt is shown. 140 THE SALES JOURNAL 141 Summarization of the Sales Journal At the end of the month or other posting time, the sales journal is totaled, the summary entry is made and posted, thus bringing the ledger into equilibrium by one credit to Sales account for the sum of all the debits to customers' accounts, and the closing rulings are made. The treatment is exactly similar to the corresponding work for the purchase journal, the only difference being in the summary entry, where "Sales, Cr." takes the place of "Purchases, Dr." If it is desired to keep the sales record by departments or classes of commodities, a journal with analysis columns would be used for proper distribution. When this type of sales record is used the closing summary would indicate the names of the various departmental or other sales accounts to which postings are to be made, in- stead of the one general account. Goods Sold to the Owner The treatment of goods sold to the owner of the business requires brief consideration. Where all the accounts are kept in the same ledger, no difficulty is met as to the posting of the charge, it being made to the proprietor's Personal account. Since, however, he withdraws goods at cost price, there is no element of profit in the transaction as there is in other sales. A strict analysis of the transaction would show it as a reduction of the stock of merchandise and, therefore, a credit to Purchases account instead of to Sales. Theoretically, then, such transactions should not be recorded with the regular sales, but, practically, this is the easiest method of recording them and, since they are not usually large in volume, this method does not vitiate the total sales figure as a basis for estimating percentages of profit. This matter will be discussed in detail a little later. 142 ACCOUNTING— THEORY AND PRACTICE Practice Data* {Assignment for Chapter XX) 1. Make up pro forma financial and profit and loss statements for Marchand. 2. Compare these statements with the post-closing trial balance and the Profit and Loss account in your ledger. 3. Calculate percentages cf cost of sales, gross trading profit, expenses, and net profit. Instructions 2. A post-closing trial balance is a trial balance taken after the ledger has been closed. It proves the accuracy of the closing transfer entries. 3. Use the figure of gross sales as the base for calculating these percentages. Sometimes net sales is used for this purpose; there is little uniformity in the matter. •See Practice Data, at end of Chapters XVII to XIX. CHAPTER XXI THE CASH JOURNALS The Cash Book For the recording of all transactions involving cash, two journals are used, which are known, when bound together, as the cash book. These two journals record, in one case, all receipts of cash and, in the other case, all disbursements of cash, and when bound separately are known respectively as the "Cash Receipts Journal" and the "Cash Disbursements Journal." When set up in the same binding they do not comprise distinct portions of the same book, but a page of the cash receipts journal is immediately followed by a page of the cash disbursements journal, these alternating throughout the book. This latter is the usual method of keeping the cash record. The record of cash received, being a debit to Cash, is kept on the left-hand page; and that of cash disbursed, being a credit to Cash, is kept on the right-hand page, thus forming a double page record. The debit side of the cash book may be likened as to its suppressed element and its postings to the purchase journal; and the credit side, to the sales journal. Analysis and Entry of a Cash Receipt If $ioo cash is received on account from John Doe, a customer, a classified analysis of the transaction shows "Cash" debit and "John Doe" credit. Cash $100.00 John Doe $100.00 So with all receipts of cash; the "cash" element is a debit. Their record being made on a page devoted exclusively to 143 144 ACCOUNTING— THEORY AND PRACTICE receipts of cash, the "Cash, Dr." element of the entry may be omitted and only the "credit" element need be shown; the very fact that the entry is made on the debit page of the cash book is sufficient to indicate that the cash is a debit. Analysis and Entry of a Cash Disbursement If $io is paid out for expenses of some kind, the analysis gives "Expense" debit and "Cash" credit. Expense $10.00 Cash So with all disbursements of cash, devoted exclusively to cash disbursements, the "Cash Cr." element of the entry may be omitted and only the debit shown. Thus, in the cash book all left-hand pages show receipts and all right-hand pages show disbursements. It is because it is unnecessary to Tvrite the debit element of cash received and the credit element of cash paid out, that the great saving of labor through the use of this separate cash book is secured. Nevertheless, it must be remembered that each of the $10.00 A separate page being Dr. Cash Account Classifi- Date cation (Credit) Explanation L.I. Amount Columns 1916 July I A. Conners Investment 10 $5,000.00 2 Sales Cash Sales IS $125.00 3 Sales 11 IS 150.00 5 J. B. Jackson On Account 2S 15.00 Sales Cash Sales IS 140.00 6 Sales Balance *i 15 I7S00 605.00 $5,605.00 July 8 $5,240.00 Cash Book (Left-hand Page) THE CASH JOURNALS 145 entries on either side of the cash book is essentially a journal entry, and that the missing elements — cash debit on the left page, and cash credit on the right page — are supplied at the end of the period by the totals and are posted through the medium of the two totals to the Cash account in the ledger — if one is kept there. Form of the Cash Journals For the entry on either page, provision is made, just as for all journal entries, for date, account classification, explanation, ledger posting index, and money columns. As in the purchase and sales journals, usually two money columns are provided, the one for detail — a day's or week's detail — and the other for totals. A simple form is shown on pages 144 and 145. Cash Book Taking the Place of the Cash Account When the two pages are set up side by side, it will be noticed that this cash book record is essentially of the same nature as the Cash account in the ledger. This double- Cash Cr. Date Account Classifi- cation (Debit) Explanation L.I. Amount Columns 1916 July I 2 3 5 6 Rent Stationery Purchases A. Conners Salaries Balance Store Rent July Withdrawal Clerks 18 20 16 10 19 $50.00 10.00 250.00 15-00 40.00 $365.00 5,240.00 $5,605.00 Cash Book (Right-hand Page) 146 ACCOUNTING— THEORY AND PRACTICE page record brings together both the receipts and the deductions from receipts — cash being normally a debit account. For this reason the cash book record is itself often used as a ledger account in book form, so that there is no need of posting the cash totals to the ledger account When this is done it is obvious that the balance of the cash must be included in the trial balance of the ledger, because, when so used, the cash book is not only a cash journal, but £!so constitutes a ledger account of the cash. When, however, the totals of both cash receipts and disbursements are posted to a Cash account in the ledger, it is evident that under this method the balance used in the trial balance would be taken from the ledger account and not from the cash book, although, of course, both amounts are the same. Whichever of these two methods is used, however, it must always be remembered that the cash book is essen- tially a journal and that, therefore, its analytical classifica- tion of business transactions must be transferred to their proper accounts in the ledger. Posting the Cash Book In posting the debit side of the cash book to the ledger, it is very important to remember that the debit element of the transaction is not shown in writing but merely indicated by the fact that the entry appears on the left-hand page of the cash book. The account name written in the "Account Classification" column is the credit element and must be posted to the credit of the corresponding account in the ledger. Similarly, on the right-hand side of the cash book, the cash credit element of the entry is suppressed and only the debit named. Accordingly, this should be posted to the debit of the ledger account named. After the posting of the individual items has been com- THE CASH JOURNALS 147 pleted, the total cash debits and the total cash credits may be posted to the ledger cash account as explained above, or the cash book may be kept as a combined journal record and ledger account. In this case the total cash debits and credits are not posted to the ledger, but the balance shown in the cash journal must be used in taking the trial balance of the ledger, because the ledger is out of balance by the amount of the unposted cash debits and credits. As stated above, each side of the cash book is, in reality, a journal in itself — a cash receipts journal and a cash dis- bursements journal — and it is only because these two journals are shown side by side that the cash book takes on the appearance and may serve the purpose of a ledger cash account. Balancing and Ruling the Cash Book The cash book in its simple form is balanced and ruled in the same manner as a ledger account. When the balance is brought down to the new account it is usually entered in the second or "total" column, thus reserving the first or "detail" column for the daily or weekly cash receipts, and separating these items from the balance brought down from the previous period. (See the illustration on pages 144. I45-) Where an account is to be transferred to the next page, either the current page (double page) is balanced and ruled and only the balance carried forward, or the current page is totaled and both debit and credit footings are carried forward as shown in Chapter XV for the ledger cash account. It will also be remembered that the blank lines should be closed by a diagonal ruling on either side. The cash book is closed, ruled, and transferred as of the same date and on the same line for both sides, although usually there is room for more entries on one side. This 148 ACCOUNTING— THEORY AND PRACTICE is done in order to keep the record of the receipts of a given period and that of the disbursements in nearly exact juxta- position, thereby faciUtating a review of the cash move- ments for that period. The Cash Short and Over Account It sometimes happens that when the cash book is balanced the amount which ought to be on hand as shown by this balance, does not agree with the amount of cash on hand by actual count. The discrepancy may be due to the fact that some items of receipts or disbursements have not been entered in the cash book, or it may result from errors in making change ; it may also be that petty thieving by the cash clerk is the cause of the discrepancy. If the error cannot be rectified at the time, make entry in the cash book, on whichever side necessary, of an amount sufficient to bring the cash book into agreement with the actual cash balance. The account to be debited or credited, as the case may be, will be entitled "Cash Short and Over." If the correct charge or credit is afterwards determined, the item or items should be transferred from "Cash Short and Over" to their proper accounts. Usually the Cash Short and Over account is treated as an income or expense account and closed into Profit and Loss at the close of the period. Sometimes it is treated as an asset or liabihty account, depending upon the nature of its contents, i.e., the amount of the discrepancy shown and its probable cause. Analysis of Cash Receipts and Disbursements As illustrated in the chapters on purchase and sales journals, additional money columns are often used for the purpose of analyzing the purchases and sales by depart- ments or classes of commodities. A similar analysis of both the cash receipts and cash disbursements may aid in THE CASH JOURNALS 149 segregating certain classes of cash items and will save labor in posting. Of cash receipts, two classes are usually more active than all others combined. More cash is received from cash sales and from customers on account than from any other source. Accordingly, two additional columns may be used with these headings. All cash receipts must be entered in the "Total," "Bank," or "Net Cash" column, as it is variously termed, and then distributed into any special columns provided. Thus all "Cash Sales" would be extended, both in the "Net Cash" and in the "Sales" column, and all receipts from customers would be entered in the "Net Cash" and in the "Accounts Receivable" column. In the case of cash disbursements, , the number of columns depends upon the degree of analysis desired. At least two additional columns are frequently found, one for creditors and one for expenses. Where cash purchases are numerous they may be segregated, or where any particular class of expense is of frequent occurrence it may be shown in a separate column. Where one ledger is used for cus- tomers, creditors, and general accounts, there is little gain in segregating customers and creditors except as a slight aid in posting. Where separate ledgers are used, it is important to have separate customers and creditors columns in the cash book, as will be shown later in connec- tion with the subject of controlling accounts. Cash Discounts Analyzed Sales and purchase discounts are another class of trans- actions best handled through the cash book, although, strictly speaking, they are not cash transactions. When a customer is sold goods on account, he is usually offered two bases of settlement, depending on the length of the credit term allowed. Thus, 2% off is frequently allowed if payment is made within ten days; otherwise the full I50 ACCOUNTING— THEORY AND PRACTICE amount of the invoice must be paid. Because the vendor does not know, at the time of entry on his books, on which basis settlement will be made, he makes the charge at the full invoiced amount. If the customer takes advantage of the discount ofifered, he pays less than the amount at which his account stands debited in the vendor's books, yet the vendor must credit his account for the full amount of the original charge, in order to show full cancellation of the vendor's claim against the customer. To illustrate, a cus- tomer buys $ioo worth of merchandise, with 2J0 off if paid within ten days. On the tenth day he pays $98. The sale entry would be : (i) Customer $ioo.oo Sales $100.00 The cash entry would be : (2) Cash $ 98.00 Customer ........1. $98.00 But this does not cancel in full the $100 claim against the customer. The $2 discount, an allowance for early payment, is an expense to the business and must be charged to an expense account called "Sales Discount" and the customer be given $2 additional credit, the entry being : (3) Sales Discount $ 2.00 Customer . $ 2.00 Entries (2) and (3) are usually combined in one as follows: (4) Cash $ 98.00 Sales Discount.. ,. 2.00 Customer . $100.00 THE CASH JOURNALS ,151 in what is known as a compound entry. If entry (2), being the part involving "cash," is made in the cash book, then the additional entry (3) will have to be made elsewhere because there is no cash element in it and theoretically noth- ing but cash should be recorded in the cash book. Handling Discounts in the Cash Book This recording in two separate places of what is really one transaction has led to the introduction into the cash book of a non-cash column in order to bring the whole transaction together. The customer's payment being a receipt of cash, the record must be made on the debit side of the cash book. Reference to entry (4) shows that Sales Discount is also a "debit." Where the cash book is limited strictly to cash transactions, the cash debit record shows only the "credit" element of the entry. The use of a Sales Discount column on the debit side of the cash book for the sake of making a complete record in one place, thus intro- duces an extraneous element, one out of harmony with the other entries made there. In posting, great care must be exercised not to transfer Sales Discount to the credit side of its ledger account but to the debit side. Illustration and Explanation of the Analytic Cash Receipts Journal An example of a columnar cash book debit side is given (page 152) for the purpose of illustrating some points in the above discussion. It should be understood that there is little uniformity in the columnization of cash books. The needs of a particular business govern the ruling suitable in any given case. The illustration shown is, therefore, not in- tended to present a standard form but is given only for the purpose of illustrating the manner of analysis of the cash receipts. 152 ACCOUNTING— THEORY AND PRACTICE < ti "2 fe^ ^ i =^"=-^ cS*:SS ^•^ ^ ■a o O ^^ i THE CASH JOURNALS 153 154 ACCOUNTING— THEORY AND PRACTICE As shown in the illustration, all actual cash receipts are entered in the "Net Cash" column which, in connection with the "Sales Discount" column, comprises the total cor- responding to the "Total" column of the other subsidiary- journals when an analytic record is made. All items received from customers are entered in the "Accounts Receivable" column ; but it is important to note that the amount entered in that column is not the actual cash receipt but the full amount of the original charge to the customer. Sales dis- count, if any, is entered in the "Sales Discount" column, and the net amount, the actual, cash received from the customer, is the amount appearing in the "Net Cash." Cash sales are entered in the "Cash Sales" column and also in the "Net Ca3h." All other kinds of receipts are extended to the "Sundry" column. In the ledger folio column, checks are placed for the individual cash sales entries, the posting usually being made from the summary in the sales journal, as explained a little later, or from the total of the "Cash Sales" column in the cash book if the other method is not employed. In the summary entry of illustration, it is assumed that a cash account is kept in the ledger, hence "Cash, Dr." is shown posted to ledger Cash account on page 4 ; and the total Sales Discount, also debit, on page 20. Of course, the itemized credits, except the cash sales, are posted to their respective accounts as indicated in the ledger folio column. The use of the "Sundry" column for extension of the miscellaneous items makes proof of the distribution possible. The sum of "Net Cash" and "Sales Discounts"— both debit items — must equal the sum of all the other columns. Handling Cash Sales If all sales, both cash and "on time," are entered in the sales journal, the totals of these two classes of sales are THE CASH JOURNALS 155 posted to the ledger Sales account from the summary in the sales journal. In this case there is no need of a separate "Cash Sales" column in the cash book, because such a column would simply duplicate the "Cash Sales" column in the sales journal. Needless to say, cash sales always appear in the "Net Cash" column of the cash book, because they are cash receipts, but the "Ledger Folio" would be checked. Sometimes two sales accounts are kept in the ledger, one for cash and the other for "time" sales. Here, also, if there is a "Cash Sales" column in the sales journal, no post- ing of cash sales would be made from the cash book. On the other hand, if cash sales are omitted from the sales journal, then the cash book should provide for a "Cash Sales" column and the posting must be made from the total of this column in the cash book. Illustration and Explanation of the Analytic Cash Disburse- ments Journal The cash disbursements columnar record corresponding to the cash receipts shown above, would appear as on page 153. Just as with the cash receipts, the above illustration of cash disbursements is not presented as a standardized form but merely for the purpose of showing the method of analysis which may be applied. Postings are made or omitted on the same basis as for cash receipts. Similarly, the same considerations govern the making and posting of the summary entry. Being few in number, cash purchases are not shown in a separate column. The treatment of discounts received on purchases is exactly parallel to that of sales discount. Since all net cash appears in "Net Cash" column on either side of the cash book, the cash balance is found by taking the difference between these two columns. The 156 ACCOUNTING— THEORY AND PRACTICE two sides must be ruled up and closed on corresponding lines and dates. Alternative Treatment for Cash Discounts Sometimes another treatment in the cash book of sales -rtnd purchase discounts is met with. This treatment for sales discount is based on the fiction that the full amount of ■\he original charge is received from the customer and that in immediate return is made to him of the amount of the discount. To use the example cited on page 150, the entries would be : Cash $100.00 Customer $100.00 showing receipt of the full invoice price and therefore full credit to the customer, and Sales Discount. $ 2.00 Cash ,. . $ 2.00 representing the fictitious payment in cash of a discount on sales of $2. In the cash book these two entries would appear as follows : Dr. Cash Cash Cr. Customer loo.oo Sales Discount 2.00 This method of entering discount on sales would have the same ultimate result in the ledger as the columnar method, but the objection to it is that it makes the cash book show more money received and more paid out than was actually the case, thus making it difficult to check the cash against the bank record of deposits and checks. THE CASH JOURNALS -^cy Another objection is that by this method the cash book does not show in one place a full record of the transaction, since the two items are shown on opposite sides of the cash book. Moreover, these items are seldom on contiguous lines because the one side of the Cash is often considerably "ahead" of the other. Cash discount on purchases would be handled similarly. The first method shown, requiring special columns on either side of the cash book, is the approved method. Problems {Assignment for Chapter XXI) I. For the month of January, 1917, the following purchases were made, the figures at left margin indicating day of month. I. J. N. Muks Wholesale Hay and Grain Co. : 10 T alfalfa in the bale at $9.75 ; so T timothy and clover at $10.50 ; 25 T native at $12.25 ', 1,000 bu. wheat at 93 J4 c. ; 2,500 bu. corn at 7Sc. ; 3,000 bu. oats at 42!/^ c, terms i/io, n/30. Hungarian Flour Mills: 5,000 sacks white flour at $1.40; 50 whole wheat at 90c. ; 75 yellow corn meal at 55c. ; terms cash. Rocky Mountain Fuel Co.: i car hard lump 32.51 T at $12.25; i car lignite, mine run, 25.5 T at $2.30; i car Canon nut 31.72 T at $4.50, terms 2/10, n/30. S. Howry Grain Co. ; 5,250 bu. wheat at 95c. ; 2,250 bu. corn at 67;^c. ; 1,500 bu. oats at 45c. ; terms 2/5, n/30. 10. Central Coal and Coke Co. : 2 cars bituminous lump 34.8 T at $3-75; I car hard nut 29.16 T at $10.50, terms n/30. 17. Farmers' Co-operative Elevators : 2,500 bu. oats at 39j^c. ; 1,500 bu. corn at 68^c., terms cash. 24. John Johnson: 200 T alfalfa at $8.20; 150 T native at $11.75. Paid by check. 29, J. N. Muks Wholesale Hay and Grain Co. : 5,000 bu. wheat at giy^c; 2,125 bu. corn at 72^c. ; terms n/30. Make original entry of these transactions. 158 ACCOUNTING— THEORY AND PRACTICE 2. Sales for the month of January, 1917, were : 2. Jackson & Weaver: 5 T timothy at $13.50; 10 T Canon nut at $6; ID bu. oats at 50c., terms cash. T. M. Jeffery: 5 T hard lump $15.50; 50 sacks whole wheat flour $1.10; 30 cornmeal at 70c., terms n/io. 9. J. Thompson Grocery Co. : 500 buckwheat at 60c. ; 750 graham at $1 ; 1,000 white $1.60; 100 bu. corn at goc. Peter McGuire : 10 bu. wheat at $1.40; 25 bu. corn at 95c.; 15 bu. screenings at 95 c. ; 8 T bituminous lump at $5.10. 16. Jas. T. White: 2 T alfalfa $13.50; 3 T native at $16.75; 10 T timothy at $12.50; 500 bu. corn at 91c.; 1,000 bu. wheat at $1.35, terms net cash. S. V. Sifers : 10 T lignite, mine run at $4.25 ; 3 sacks whole wheat at $1.25. Received cash in payment. 23. Ole Oleson : 10 T timothy at $11.75; I5 T hard lumps coal at $15.35; 8 sacks graham flour at $1.10; 5 sacks white $1.70, re- ceived cash. Ayres Elevator Co.: 10,000 bu. wheat at ogyic; 500 corn at SiJ^c., terms 1/5, n/30. 30. J. T. Thompson Grocery Co. : 250 cornmeal at 65c. ; 275 graham at 95c. ; 400 white at $1.55 ; 10 T timothy $12.25 ; terms 2/10, n/30. T. M. Jeffrey: 10 T hard nut at $13.25; 5 white flour at $1.75. Received cash. S. V. Sifers: 5 T Canon nut at $6.25; 10 whole wheat at $1.30; 5 cornmeal at 75c. Enter the above in your sales journal. 3. Rule up a purchase journal with distributive heads of hay, coal, grain, flour, and enter the transactions of Problem I, using totals only. 4. Rule up a sales journal with the same analysis columns as in Problem 3, and enter the sales given under Problem 2, using totals only. Instnictions Problem i. Refer to page 136 for the form and method of use of the purchase journal. Problem 3. Use blank paper and rule in the necessary columns. See page 138 for form. CHAPTER XXII THE MODERN JOURNAL Matter Left for Record in the Journal By the use of a cash book, a purchase, and a sales journal, three principal classes of transactions are taken out of the general journal and entered in separate books of record; the cash book, in effect, constituting two books though usually bound together, one for cash receipts and the other for cash disbursements. If the number of any other class of transactions is large enough to justify the use of a separate book of record, this should be done. The number of subsidiary journals each containing one kind of transactions may become very large, yet in practically all cases it is necessary to retain the general journal (often abbreviated simply to "the Journal"), in order to take care of such special items as are not recorded in any of the subsidiary journals. The standard form of journal was illustrated in Chap- ter XVII where it was stated that a journal must provide space for date of entry, account classification, ledger folio index, debit and credit money columns, and explanation. Explanation of the form, method of use, proper observance of margins, etc., was made there and will not be repeated here. Kinds of Transactions Recorded in the Journal When the number of subsidiary journals used is limited to the cash book, purchase and sales journals, as is fre- quently the case, all items not affecting these three should be 159 l6o ACCOUNTING— THEORY AND PRACTICE entered in "the Journal" ; i.e., transactions involving notes receivable and notes payable; adjustments with customers and creditors resulting from return of goods or claims and allowances thereon ; all formal opening and closing entries. Furthermore, there is usually a number of transactions, each of a special and unusual nature, which for this reason can- not be grouped with the items of the subsidiary journals. Journal Explanations These various classes of transactions are of necessity en- tered in the Journal, and a very complete explanation should be included in their entry. In fact, all entries covering set- tlements and adjustments with outsiders and within the busi- ness itself are of primary importance and the explanation should be so carefully worded as to make the intent of the entry entirely and always plain and intelligible. Closing and Posting the Journal No particular formality attaches to the closing and post- ing of the ordinary standard form of journal. There is no summary entry, no totalling, and there are no rulings to be made. Ordinary care must be exercised to see that the debits and credits are correctly posted. Since the entry in the Journal is given in its complete form and no debits or credits are suppressed, as is the case in the special journals, posting is not difficult. The Analytic Journal with Divided Columns A more recent form of the journal has its debit and credit columns separated, the debit money column appearing at the extreme left of the page followed in consecutive order across the page by columns for date, account classification, ledger folio, and credit money amount. This kind of journal is called a divided- or split-column journal and is THE MODERN JOURNAL l6l l62 ACCOUNTING— THEORY AND PRACTICE ordinarily used for the purpose of securing control over subsidiary ledgers. When so used it is provided with addi- tional debit and credit analysis columns on each side accord- ing to the subsidiary ledgers employed. A divided-column journal with three debit and three credit columns is shown on page i6v. There is always a general money column on each side, the other columns depending on the kind of analysis required by the business. In the above illustration an Accounts Receivable and an Accounts Payable column are provided. It is obvious that the Accounts Receivable column should usually appear on the credit side and the Accounts Payable column on the debit side ; although in some cases provision is also made for an Accounts Receivable column on the debit and an Accounts Payable column on the credit. The account of S. J. White, Vi/hich is paid by his note, should be credited for the amount of $510.20 and consequently the item is extended to the Accounts Receivable column. Illustrations — Opening Entries Illustration will be given of a few typical transactions requiring journal entry. The standard two-column journal will be used. For the purpose of illustrating opening entries, consider the following data : On September 30, 1916, Jack Gibson started in business, investing the following assets and liabilities: Cash $3,500; Notes Receivable $800 ; Merchandise $4,000 ; Furniture and Fixtures $450; Accounts Receivable $2,100; Accounts Pay- able $1,500; and Notes Payable $1,200. Enter these items on the books. An analysis of this transaction shows that no part of it belongs to either the purchase or sales journals. The part relating to cash is entered in the cash book. However, THE MODERN JOURNAL 163 in order to show the complete investment in one place, the entire transaction, including the cash part, is entered in the Journal and posted from there, except as to the cash item. The reason for this exception is that the cash investment is also entered in the cash book and will find its way to the ledger cash account through the total cash debits at the end of the period. For this reason the cash item in the Journal should be checked and not posted to the cash account in the ledger. Likewise, the investment item in the cash hook, showing a credit of $3,500 to Gibson, should be checked and not posted to the credit of his account in the ledger, because this item forms a part of the total investment of $8,150 posted to his credit from the Journal entry. If the student has difficulty in determining the debits and credits of entries of this kind, it may be helpful to set up the data informally first, in the form of a financial state- ment. Using this as a guide, he should then make his Journal entry, debiting all the asset items and crediting the liability and net worth items. Journal Date Account Classification L.F. 1 1916 Sept. 30 Cash V 3,500.00 Notes Receivable 2 800.00 Accounts Receivable 3 2,100.00 Merchandise 4 4,000.00 Furniture and Fixtures 6 450.00 10,850.00 Notes Payable 8 1,200.00 Accounts Payable 8 1,500.00 Jack Gibson, Capital 10 8,150.00 10,850.00 The above entry is made to bring Gibson's investment on the books. l64 ACCOUNTING— THEORY AND PRACTICE Dr. Cash Date Account Classification Explanation | L. F. 1916 Sept. 30 Jack Gibson, Capital Cash invest- ment posted from Jr. V 3,500.00 The above entries bring the transaction completely on the books of original entry and show the ledger folios to which the various items are posted. Notice the "check" in the L. F. column in the Journal opposite "Cash" and in the cash book opposite "Jack Gibson, Capital" to prevent post- ing the same item twice. For opening entries full explanation and details, where necessary, should be given in the Journal, covering lease agreements and contracts entered into when commencing business, and other similar data. Adjusting and Closing Entries Other typical entries to be illustrated are those made at Ihe close of a fiscal period so as ( i ) to adjust the books in accordance with certain data that were not obtainable before; (2) to transfer all temporary proprietorship ac- counts to the summary account. Profit and Loss; and (3) to transfer the net profit, i.e., the balance of the Profit and Loss account, to the proprietor's personal account and the balance of this latter account to the proprietor's capital account. The debits and credits of all the entries necessary to efifect the record of all the data and transfers mentioned, can be determined as in the operations with ledger accounts previously shown. The following data relate to Jack Gibson's business and THE MODERN JOURNAL 165 are given to illustrate the three classes mentioned above. During the year, sales amounted to $33,000; purchases $25,000; selhng expenses $3,500; general administrative expenses $2,025. It was estimated that of outstanding ac- counts $350 were uncollectible; that furniture and fixtures had depreciated in value $45. Merchandise inventory- showed $5,000 now on hand. Gibson had drawn $1,000 during the year. The first thing necessary is to make the adjustments on account of depreciation, bad debts estimate, and present inventory. These adjustment entries are made in the Journal as follows : 1917 Sept. 30 Depreciation 20 $45.00 Depreciation Reserve for Furni- ture and Fixtures 6 $45.00 To bring on the books the expense due to estimated de- preciation on Furniture and Fixtures. Bad Debts 21 35o.oo Reserve for Bad Debts 3 3So.oo To bring on the books the ex- pense due to estimated loss from uncollectible accounts. Purchases 15 4,000.00 Merchandise Inventory 4 4,000.00 To transfer the goods on hand at the beginning of the year to Purchases. Merchandise Inventory 4 5.000.00 Purchases IS 5,000.00 To bring on the books the in- ventory of merchandise now on hand. The first two entries, when posted, will bring on the books valuation accounts for furniture and fixtures and accounts receivable and will set up the expense accounts, l66 ACCOUNTING— THEORY AND PRACTICE Depreciation and Bad Debts. The third Journal entry, when posted, will transfer the goods on hand at the begin- ning of the year so that they can be added to the Purchases made during the year ; in this connection it may be remem- bered that the sum of these two items, old inventory plus purchases during the year, constitutes the primary factor of "cost of goods to be accounted for." The fourth entry shows the asset Merchandise now on hand and, by its credit to Purchases, effects a subtraction from it, so that the balance of Purchases, $25,000, shows the cost of goods sold. The books are now adjusted and ready for closing into Profit and Loss. The following Journal entries effect the closing operation : 1917 Sept. 30 Sales 16 $33,000.00 Profit and Loss 25 $33,000.00 To close. Profit and Loss 25 30,910.00 Purchases 15 25,000.00 Selling Expense l8 3,500.00 General Administrative Expense 19 2,025.00 Bad Debts 21 350.00 Depreciation 20 35.00 To close. 30,910.00 Profit and Loss 25 2,080.00 Jack Gibson, Personal 11 2,080.00 To transfer net profit for the year. Jack Gibson, Personal 11 1,080.00 Jackson Gibson, Capital 10 1,080.00 To transfer the portion of the year's net gain left in the business. The first entry transfers the sales income to the credit of Profit and Loss. The second entry charges the Profit and Loss account with the cost of goods sold and all other ex- penses for the fiscal year. When the posting has been com- THE MODERN JOURNAL 167 pleted up to this point, the balance of the Profit and Loss account shows a net gain of $2,080, which, belonging to the proprietor, is transferred to the credit of his personal account, as shown by the third entry. He had drawn against prospective profits to the extent of $1,000, leaving $1,080 of profit remaining in the business as an addition to his perma- nent investment. Hence, this balance is transferred to Gibson's capital account by the fourth entry. Objection to the Direct Ledger Method of Adjusting and Closing the Books These adjustment and closing transactions are some- times made direct on the face of the ledger without first entering them in the Journal. Usually this is not satisfac- tory because it does not show in one place a complete record of all the adjustments and closing summaries necessary at the close of a fiscal period. These are matters of sufficient concern to the business to warrant their entry in the Journal where full and complete explanations can be given. The more complex entries often needed to adjust and close the books of a business where numerous income and expense accounts are kept, follow the same general principles as those discussed above. Adjusting and closing entries are given fuller treatment in Chapters XXIX and XXX. These two illustrations cover certain types of Journal entries which are of a more difficult character than the cus- tomary purchases, sales, and cash entries. A keen analysis is often required to formulate these entries as to their debits and credits, and the explanatory matter should be worded with sufficient care to render them intelligible even after the immediate interest in them has been lost and their recording ink has become "cold." The other entries recorded in the Journal ought not to give the student any particular difificulty. l68 ACCOUNTING— THEORY AND PRACTICE The books of original entry, i.e., the journals, having been explained, the attention of the student will be next directed to the sources of information on which the entries in the various journals depend. Accordingly, some of the more important papers and methods used in business will be discussed, after which further accounting principles and methods will be treated. Problems (Assignment for Chapter XXII) 1. Enter the following transactions in the cash book: Ben Salzer invested cash $S,ooo ; sold merchandise for cash $75 ; paid cash for stamps $5 ; bought merchandise for cash $230 ; loaned C. W. Jenks on note at 1% a month for IS days $250; James Goodyear is admitted as a one-third interest partner by paying $1,800; a $20 counterfeit note was discovered and we were unable to trace it; paid freight bill by check $39.03 ; paid light bill $S ; bought coal $25 ; cash sales were $850 ; bought miscellaneous supplies for office $IS; paid John Smith $50 on account and Tom Jones $175 in full of account; paid store rent $90; water tax $12; received on account from Dick Roe $125, Jno. Joe $55, Chuck Adams $32.50, J. Jack Jordan $65, and from C. W. Jenks on his note $250, interest $1.25 ; paid office help $12 ; salesman $17.50. 2. Balance and post the cash book in Problem i above, taking account of a cash shortage of $3.42. 3. John Short makes the following investment: cash $1,500; mer- chandise $2,500; furniture and fixtures $500; delivery equipment $325; rent paid in advance $50; accounts receivable $1,250; accounts payable $2,000. Make the opening journal entry. 4. Make journal entries for the following items: We remit on account to the N. Y. Mfg. Co. our 60-day note for $235.67; a customer writes in claiming goods sold him are unsatisfactory and we allow him $15 if he will keep the goods ; we receive from J. W. Baker his 30-day note for $750 to apply on account; we return goods to the Rawnser Goods Co. as not being what was ordered — value $50; we receive from THE MODERN JOURNAL 169 T. C. Jones, a customer, to apply on account, R. S. Thomson's note for $250. S. Inventory at the beginning was $3,962.50, at the end $3,450.75. If the sales were $6,847.69 and there was a loss on sales of $340.27, make the journal entries necessary to close. Instructions Problem i. Use a double page of journal paper; write in head- ings as shown on pages 144, 145. Before making each entry, carefully analyze the transaction to determine its debit and credit elements. Use your own judgment as to desirable account titles. Enter the account title first, followed by the explanation, as in the illustration referred to above. Problem 2. Use a sheet of blank paper for the ledger, setting up the accounts roughly in " i " form. Problem 3. Enter the cash investment also in the cash book. Problem 4. Give brief but adequate explanation for every entry. Be careful to maintain uniform "credit" and "explanation" margins. Problem 5. Follow closely the Jack Gibson illustration in the text so far as it is applicable. CHAPTER XXIIl BUSINESS PAPERS Definition Because of the impracticability of each person's record- ing on the books the transactions which take place through him, upon completing a transaction he makes a memoran- dum of it and hands this memorandum to the bookkeeper who uses it as the basis for the formal record on the books of account. Thus, for cash received the duplicate cash receipt may be retained by the cash clerk and turned over as a memorandum to the bookkeeper; for cash disbursed a re- ceipt may be demanded from the person to whom the pay- ment is made, this receipt becoming the basis for formal entry on the books. These memoranda of business trans- actions are called "business papers" ; they comprise all of the more or less formal and informal documents which con- stitute the first-hand evidence of most transactions. Among the most common business papers may be mentioned : the goods invoice for purchases or sales ; negotiable paper, in- cluding the check, note, draft, money-order, and warehouse receipt ; the statement and account sales ; the shipping order and bill of lading ; the bill of sale ; the lease agreement ; and contracts of all sorts. A few of those most frequently used will be explained. The Invoice When a merchant sells goods to a customer he writes out an itemized "bill" which is sent along with the goods. This bill is called an invoice both from the seller's and cus- tomer's viewpoint. It is an itemized statement of goods 170 BUSINESS PAPERS 171 bought or sold, and should contain the place and date of sale, the names of vendor and vendee, the quantities, kinds, and prices of the goods, the terms of sale, and may contain additional items such as manner of shipment, etc. Handling the Purchase Invoice When goods are bought the purchase invoice received should be verified or audited. The method of audit depends tipon the organization of the business. In a small business, if the invoice is received ahead of the goods purchased, it is usually held till their arrival and then checked against them as to quantities, quality, and price. The extensions and total are verified and entry made in the purchase jour- nal, using the audited invoice as a basis. The invoice should then be placed in a temporary file till paid, after which it is usually filed under the vendor's name and held for future reference. The check in payment for the invoice is later re- turned by the bank, and this cancelled check is frequently attached to the invoice for which it was issued. At any rate the paid invoice should bear on its face a notation to show the payment. In a larger business where purchase orders are made out in manifold, one copy for the purchasing department, one for the receiving room, one for the auditing department, and the original sent to the vendor, the procedure of auditing is more complex. The copy furnished the receiving room is usually left blank as to quantities, and sometimes the items indicating the kind of goods ordered are also omitted from this copy. When the goods are received, quantities and kinds are filled in by the receiving department, and the copy is sent to the auditing department where it is checked against the auditor's copy of the original order and the purchase invoice from the vendor. If found correct as to quantity, kinds of goods, extensions, and additions, the 172 ACCOUNTING— THEORY AND PRACTICE invoice becomes the basis for entry in the purchase record-- journal or voucher register as the case may be — and then follows the customary routine as to filing, remaining in a temporary file as long as it is unpaid. Upon payment it is placed in a permanent file by the name of the vendor, by invoice number, or according to whatever system may be in use. Handling the Sales Invoice Practically all systems of handling sales require that at the time of the sale some record or memo of the transaction be made. In retail establishments the use by each salesman of a book of sales tickets with provision for duplicate or triplicate impression is very general, whether the sale be cash or charge. The cash and charge tickets are usually put up in separate books and a dififerent color of paper is used for each. At the close of the day the total cash tickets are checked against the cash received from cash sales, and the total charge tickets give a controlling figure for charges to customers. The total of the cash tickets plus that of the charge tickets gives the total credit to Sales. These sales tickets are usually entered on a daily sales sheet provided with distributive columns for analysis according to depart- ments or kinds of commodities. A recapitulation giving the totals of each of these columns is made and posted to the ledger, while the customers ledger accounts may receive their charges direct from the sales ticket. This recapitula- tion really constitutes the sales journal record, as is ex- plained in Chapter XXXIX. Where the number of charge accounts is not large a folder system is sometimes used. Each charge sales ticket is placed in the folder which takes the place of that cus- tomer's account, thus avoiding the necessity of making a formal entry on the ledger. When the customer pays this BUSINESS PAPERS 173 bill, the sales ticket is so marked and either left in the folder or transferred to a permanent file. The successful opera- tion of the folder system presupposes that the customer will pay the exact amount of his bills shortly after the date of the ticket, no provision being made to care for overlapping credits. Whatever the system, the sales ticket is the original record of the transaction and therefore valuable as evidence in case of dispute. These tickets should be filed away and may be destroyed only when all danger of dispute is past. Returned Goods Invoices If for any reason goods purchased prove unsatisfactory and are returned, record of their return should be kept by the shipping clerk and used as a basis for securing proper credit from the vendor. The vendor usually sends a re- turned goods invoice, which is similar in form to the pur- chase invoice, but the amount of the invoice constitutes a credit to the purchaser instead of a charge. These credit memos, as they are termed, are always of some distinctive color, frequently red, in order to distinguish them readily from the regular invoice. Similarly, when dissatisfied customers return goods to us, or when we make them an allowance on goods sold, a credit invoice or credit memo is sent them and the duplicate copy of this memo retained in the office becomes the basis for entering the transaction on the books. Problems (Assignment for Chapter XXIII) A trial balance taken from the books of X. Z. Snyder for the year ending December 31, I9i6 contained the following account balances : 174 ACCOUNTING— THEORY AND PRACTICE X. Z. Snyder, Capital $25,910.67; X. Z. Snyder, Personal $2,045; Merchandise, $13,294.95, Dr.; Notes Receivable $597.40; Accounts Re- ceivable $6,730.30; Accounts Payable $8,146.45; Notes Payable $2,900.75; Land $2,500; Building $5,000; Fixtures $1,210; Salesmen's Traveling Expenses $462.50; Salesmen's Salaries $1,400; Advertising $545-73; Office Salaries $700; General Expense $1,324.27; Cash $1,147.72. Set up the accounts on your ledger allowing 6 lines for each account — after Accounts Receivable, Buildings, and Fixtures allow an additional 6 lines for the properly named valuation accounts. Take a trial balance to verify your work and record it on a piece of jour- nal paper. Close the ledger, taking into account the following items : Allow 1% depreciation on buildings. Fixtures are valued at $1,090; merchandise at $21,962.40. Accrued general expense is $124.92; bad debts are estimated at $225. htstrtictioiis Set up Depreciation and Bad Debts accounts and make the inven- tory, appraisal, and accrued expense entries before closing into Profit and Loss. Make the adjusting and closing entries direct on the face of the ledger. Take a post-closing trial balance. CHAPTER XXIV BUSINESS PAPERS (Continued) Use of the Note Receivable The purpose of all sales is the ultimate conversion of stock in trade into cash to provide for the payment of services and for the purchase of commodities for future sale. This conversion of stock in trade into money may be im- mediate, as when goods are sold for cash, or deferred, as when goods are sold on account. In this last case the con- version is indirect, because the charge against the customer must be collected before conversion is complete. Frequently the "note receivable" acts as an intermediate step in the process of converting stock in trade into cash. It is an instrument in which the customer formally promises to pay his debt at a fixed time in the future. The kind of claim represented by a note receivable is, legally, different from the open account claim ; generally speaking, a note is considered a better claim than an open account. This is because the note implies a prima facie acknowledgment of the correctness of the original charge, and in event of suit relieves the holder from proving the original items of the claim. Accordingly, when we receive a promissory note from a customer, our open account claim against him ceases to exist and a different kind of claim evidenced by his promis- sory note is acquired. Therefore, the open account is cred- ited, to show cancellation of the original charge, and Notes Receivable is debited to show the new claim. It may be well to remark here that the same instrument which to us is a note receivable is a note payable to the customer. 175 176 ACCOUNTING— THEORY AND PRACTICE In some cases, it is the policy of a business to encourage the receipt of notes from customers. In such cases it is often advantageous, particularly for the credit information shown, to set up the note transactions with each customer under individual names, e.g., "John Doe, Notes Receivable." Such a title would plainly indicate the nature of the items listed under it; viz., claims against John Doe, witnessed by his promissory notes. However, the number of notes received from all cus- tomers together is usually comparatively small, and for this reason all these notes are in most cases brought together under one class title — Notes Receivable. Negotiable Instruments — Their Use and Requisites Notes receivable belong to a class of business papers termed negotiable instruments. The important service rendered by them lies in the fact that in many ways and for many purposes they take the place of money. The negotiable instrument, usually of small size but often representing a large sum of money, is used in the commerce of the world as a medinni of exchange, thereby eliminating to a very large extent the use of heavy, bulky, and valuable coin. The essential character of negotiable instruments can best be explained by summarizing their main requisites, as follows ; 1. The instrument must be in writing and signed by the maker or drawer. 2. It must contain an unconditional promise or order to pay a fixed sum of money — and the payment must be made in legal tender. 3. It must be payable on demand or at a time which is either fixed or can be determined. 4. It must be payable to bearer or to order. BUSINESS PAPERS 177 Negotiable Instruments — Kinds and Definitions Any formal or informal document possessing these es- sentials is a negotiable instrument. Examples are : promis- sory notes, notes receivable and notes payable, drafts, checks, money orders and warehouse receipts. A promissory note may be defined as an unconditional promise to pay a specified sum of money at a certain time. It usually has a form similar to the following : $500.00 Jacksonville, Fla., Sept. 9, IQ16. Si.vty days after date. .../... .promise to pay to the order of Henry Smith Five Hundred and no/ 100 Dollars At the First National Bank of Jacksonville, Fla. For value received with interest at 6% per annum. No. S5. Due Nov. S, 1916. John Johnson The Draft A draft is a written order by one party on a second party to pay to a third party the amount of money named. To be negotiable, it must be so drawn as to meet the require- ments of negotiability named above. A draft may have a form similar to the following : $125.75 Hoboken, N. J., Oct. 5, 1916. Sixty days after sight pay to the order of James Stanley Jackson and Company One Hundred Twenty-five and 75/100 Dollars Value received and charge to the account of To George S. Perkins \ ^^^^ y_ Robbins No. pj. Providence, R. /.J It will be noticed that there are three parties to a draft —the drawer, the drawee, and the payee. The drawer is the person who draws the draft and whose signature appears at the lower right-hand corner of the draft. The drawee is the person on whom the draft is drawn, George S. Perkins, 178 ACCOUNTING— THEORY AND PRACTICE above. He is sometimes called the payer. The payee is the person who is to receive the payment ordered, James Stanley Jackson & Co. To understand the use of the draft as an instrument of business, suppose the following rela- tions exist between the three parties named above : 1. George S. Perkins bought goods from Bert V. Robbins on account for $175. 2. Robbins bought goods from James Stanley Jackson & Company to the amount of $125.75 on ac- cotmt. The problem will be discussed from the standpoint of Bert V. Robbins. From the above data it is clear that Robbins has a claim against Perkins for $175 and owes $125.75 to Jackson & Co. Instead of collecting the claim against the former and paying his debt to the latter, he writes out a draft for $125.75 on Perkins, with Jackson & Co. as payee, thereby requesting (or ordering) Perkins to pay $125.75 to Jackson & Co. This draft he sends to Jack- son & Co. and they present it through their bankers to Perkins. Under ordinary circumstances Perkins acknowl- edges the correctness of the draft and writes his acceptance on the face of it, thereby promising to pay the amount when due. Acceptances are usually worded in the following man- ner: Accepted, Oct. 6, 19 16 Payable at First National Bank of Providence George S. Perkins It should be said that the three-party draft is not usually made use of without the previously obtained consent of the drawee. BUSINESS PAPERS j^n The Accepted Draft When so accepted, the draft becomes, to all intents and purposes, an ordinary promissory note — Perkins' promise to pay Jackson & Co. $12575. Until the draft is accepted by Perkins, it simply constitutes a request from Robbins to Perkins to pay the amount named and the draft as such does not bind Perkins in any way. Hence, no entry is made on the books of account of any of the three parties until acceptance. Illustrative Entries Upon acceptance by Perkins, the following entries are made : 1. On the books of Jackson & Co., the payee: Notes Receivable $125.75 Bert V. Robbins $I25.7S Robbins' draft on G. S. Perkins, accepted by Perkins, payable December 5. Perkins' acceptance, in possession of Jackson & Co., con- stitutes a claim against Perkins, and Jackson & Co. therefore debit Notes Receivable. They credit Robbins because this draft was sent to them by Robbins in payment of Jackson's open claim against Robbins for $125.75. 2. On the books of Perkins, the drawee : Bert V. Robbins $125-75 Notes Payable $I2S-7S Accepted Robbins' draft at 60 days sight, favor of J. S. Jackson & Co. This entry cancels Perkins' liability on open account to Robbins, and shows as a substitution therefor the amount of his acceptance in favor of Jackson & Co. at Robbins' request : l8o ACCOUNTING— THEORY AND PRACTICE 3. On the books of Robbins, the drawer : James Stanley Jackson & Co $I2S-7S George S. Perkins $12575 To record the cancellation of our liability to Jackson & Co. on open account, and to credit Perkins with his acceptance of our draft on him at 60 days sight. From the point of view of Bert V. Robbins the accep- tance by Perkins means two things : ( i ) the cancellation of a part of Robbins' claim against Perkins, and for this reason Robbins credits Perkins with $125.75; (2) the cancellation of Robbins' debt to Jackson & Co., hence Jackson & Co. is debited on Robbins' books for $125.75. It is important to note here that in case Perkins should fail to pay the note at maturity, Robbins will become liable to Jackson & Co. Robbins may therefore be considered the first indorser of the accepted draft. The discussion of the manner' of booking Robbins' liability contingent upon Per- kins' failure to pay is deferred to Chapter XXXVIII. Entries After Payment of the Draft Upon payment by Perkins, the following entries are made: 1. On Perkins' books, a debit to Notes Payable and a credit to Cash. 2. On Jackson & Co.'s books, a debit to Cash and a credit to Notes Receivable. The following two diagrams may further illustrate the utility of the draft as an instrument of trade. I. Showing the settlement of the several claims in cash — in case Robbins had collected $125.75 from Perkins and had paid $125.75 to Jackson & Co., the payments being made independently in each case : BUSINESS PAPERS l8l method Showing a settlement by draft — a clearing house '^ CASH $125-75 '-* Classification of Drafts There are several kinds of drafts. As to date of pay- ment drafts are sight or time. A draft drawn "at sight" is a request on the drawee to pay at sight, i.e., immediately upon presentation to him. The use of the sight draft in making collections is quite common. The delinquent cus- tomer is drawn on at sight and collection attempted through the bank. The method is oftentimes effective because re- fusal to pay may reflect on the customer's credit with his own bank. Usually no formal book entry is made of such drafts until paid. A draft drawn say "at 60 days (or 30 days) sight" is a request to pay 60 (or 30) days after presentation. Hence, the dating of the acceptance of such a draft is of prime importance. l82 ACCOUNTING— THEORY AND PRACTICE One drawn "60 (or other number) days after date" is called a time draft and is payable 60 days from the date of the instrument — not as in the first case, 60 days after presentation or acceptance. It is not necessary, although customary, to present time drafts for acceptance. Drafts may be "commercial" or "bank" according as the drawee is a merchant or a bank, respectively. B. V. Robbins' draft on Perkins shown above is a merchant's draft. A bank draft is a request by one bank on a corre- spondent bank to pay a given amount of money to a named payee. A customary method of remitting money is the purchase and remittance of bank drafts. Banks usually charge a fraction of a per cent for issuing a bank draft. To illustrate its use take the following situation : L. W. Roberts of Denver owes Field & Co. of Chicago $210 on account. Roberts goes to his Denver banker and buys a bank draft which may read as follows : First National Bank No. 37849 Denver, Colo., Aug. 16, igi6. Pay to the order of L. W. Roberts $210.00 Two Hundred Ten and no/ioo Dollars To Second National Bank, F. G. MoMt, Chicago, 111. Cashier Before sending this draft to Field & Co., Roberts indorses it in favor of Field & Co., who upon its receipt deposit it with their own bank and through it secure its collection from the Second National Bank. Roberts paid his bank $210, plus exchange, for the draft. Drafts may be foreign or domestic. They are domestic when the parties thereto live within the same state or coun- try ; if otherwise, they are foreign. According to the present usage, the term draft is used whenever the parties concerned live within the United States, although they may reside in BUSINESS PAPERS 183 different states, and the term "bill of exchange" is applied to all such instruments where some of the parties live abroad. Checks A check is a draft on a depository bank. It is an indi- vidual's order to his bank of deposit to pay a named or desig- nated payee a certain sum of money. Two illustrations are given below, somewhat different in form but identical in nature. In the first, likeness of the check to a draft is very evident. S. E, Kellar Lumber Company No. 57s Hoboken, N. J., Feb. 7, igi6. Pay to the order oi H. B. ClaAin & Co $525-79 Five Hundred Twenty-five and 79/100 Dollars To The First National Bank, S. E. Kellar Lumber Company, Hoboken, N. J. By S. E. Kellar, President (2) No. 575 Hoboken, N. J., Feb. 7, igi6. The First National Bank Pay to the order of H. B. ClaAin & Co Five Hundred Twenty-five and 79/100 Dollars $525.79 S. E. Kellar Lumber Co., By 5. E. Kellar, President The certified check is usually an individual's or firm's check bearing the certification of the bank's cashier that the check is good. This certification is evidenced by writing across the face of the check these or similar words : Good when properly indorsed First National Bank F. G. MoFFiT, Cashier Such a certification makes the bank responsible for its payment. A cashier's check is a bank's own check drawn on itself l84 ACCOUNTING— THEORY AND PRACTICE in favor of a third party and signed by its cashier. As a medium of exchange it ranks higher than the check of a private person, because the risk in connection with a cashier's check is usually smaller, due to the fact that the cashier's check of a given bank is usually more generally known in a community. Other Negotiable Instruments Express and postal 'money orders are drafts payable at sight, drawn by one express agent on another or by one postmaster on another. A warehouse receipt is a receipt from a warehouse, ele- vator, or other storage concern acknowledging the receipt of goods or property, and usually contains the contract agreements entered into by the parties, covering the condi- tions according to which the goods are accepted for storage. It is usually negotiable, or partially so, in that title to the property may pass with the transfer of the warehouse receipt. Principles Governing the Writing of Commercial Paper One fundamental rule governs the drawing of all com- mercial paper and that is : So draw it that forgery of any kind shall be rendered as difficult as possible. Corollaries to the rule are : 1. Leave no blank spaces, particularly where the amount is written. When the amount is perforated, with a per- forated star at either side, this is not so important as would otherwise be the case. 2. Write the indorsement at the top margin. Unless this is done it is possible for others to insert some statement which might change materially the effect of the signature; e.g., the payer might later write above the signature that the check is accepted in full payment for a definite bill. BUSINESS PAPERS 185 Kinds of Indorsement An indorsement is usually for the purpose of trans- ferring title. There are several kinds of indorsement, as follows : 1. A blank indorsement, which consists only of the payee's signature; this renders the instrument payable to bearer. 2. A full indorsement, reading as follows : "Pay to the order of ," giving the name of the in- dorsee, i.e., the person to whom the check is transferred, and followed by the signature of the indorser, who before his indorsement was the payee. 3. A qualiHed indorsement ; this is either a blank or full indorsement with the words "without recourse" added to it. This kind of indorsement transfers title with no liability attaching to the transferrer in case of non-payment by the maker at maturity. 4. A restrictive indorsement, giving the name of the party to whom the check is transferred, the words "for collection" or "for collection and deposit" being added and followed by the signature. This indorsement does not transfer title but merely appoints the person or bank named as agent for the purpose of collection. Problems (Assignment for Chapter XXIV) Using a page of journal paper, make entries for the following, journalizing the cash. Make ample explanations. Use transaction number as the date for the current month and year. I. We accepted May i at 60 days the draft of Johnson & Co., Chi- cago, for invoice of merchandise delivered April 30, $217.90. l86 ACCOUNTING— THEORY AND PRACTICE 2. The Hamiltonian Bank notified us May 4, that a sight draft for $175 for collection, drawn by us on Haskin & Seltzer, Bridge- port, has been paid and the amount passed to our credit. 3. We have received from A. H. Neilson & Bros, credit memo for 10 bu. apples at $1.50, which we found unsalable and returned. 4. On April 24, we drew for collection through the Mechanics Bank a 90-day draft for $273.50 on A. J. Packard & Co., Kansas City. The bank has delivered to us their acceptance. 5. Remitted to Jordan & Anderson, Plymouth, Mass., a New York draft for $579.40 in payment of our acceptance of April 10 in their favor. 6. On October 29, C. H. Henry sent us a check for $96.50 to pay for a bill of merchandise bought from us September 30, for that amount. He now puts in a claim for our regular 5% dis- count for 30 days, which we allow, sending him a credit memo. 7. C. H. Morey presents our acceptance for $250 in favor of Jackson & Co., indorsed over to Morey and requests that same be credited to his account. We do so. 8. Cash was short $2.10. 9. Accepted August 24, Bronstein & Co.'s draft on us for $195.40 in favor of A. B. Christian & Sons, drawn at 60 days' sight. 10. A counterfeit $5 bill was found in the cash sent to the bank for deposit. We are unable to trace it. Instructions By "journalizing" is meant the setting up of the debit and credit elements of a transaction according to the form used in the general journal, whether the record should properly be made there or not. Frequently the term means merely to name the debit and credit elements. CHAPTER XXV BUSINESS METHODS Shipping Goods — The Bill of Lading The purchase and sale of goods usually lavolve dealings with the railroad. It is not the purpose of this chapter to gi\'e an extensive system or method of handling shipments, but merely to touch on a few fundamentals. The shipment of goods is evidenced always by a bill of lading. The bill of lading contains the contract provisions under which the rail- road accepts freight for carriage, defining its liabilities as transportation company or warehouseman, and stating its duties and those of the shipper. Its standard content is prescribed by the Interstate Commerce Commission, although any additions to it not in conflict with the standard content are not forbidden. If he so desires, each shipper may have bills of lading printed to conform in size with his own files, instead of using those furnished by the railroad. There are two standard forms, the straight bill of lading which is not negotiable, and the order bill of lading which is negotiable. The bill of lading is always made out in triplicate, the original and the two copies being identical except as to titles and signatures. The original is signed by the shipper and the railway agent, and constitutes the shipper's receipt for the goods delivered to the railroad. The second, called the shipping order, is signed by the shipper only. It is his order to the railroad to ship the goods, and is held by the railroad as evidence of its authority. The third copy or memo is an exact duplicate of the original, signed by the shipper and the agent, and is held by 187 l88 ACCOUNTING— THEORY AND PRACTICE the shipper as a duplicate receipt. Sometimes it is for- warded with the invoice to the customer, but otherwise should be filed by the shipper with the original bill of lading. In case of claim against the railroad for loss or damage to goods in transit the original bill of lading is required as evi- dence and should therefore always be kept in the shipper's possession. Freight Notice and Expense Bill A notice called a freight notice is sent to the consignee of all incoming freight by the railroad upon arrival of the goods. A more or less formal order is given by the con- signee to the teamster or drayage company to call for the freight. This order authorizes the railroad to deliver it to the teamster or drayage company. Upon its delivery, an "expense" or freight bill is sent to the consignee itemizing the freight charges due on the shipment. The freight no- tice and the freight bill are usually made at one impression, the heading on the one being a notice of the arrival of freight, while on the other the heading is that of an ordinary invoice or bill showing the freight charges on the designated goods. By some railroads, three copies are made at one impression, consisting of (i) the freight notice, (2) the delivery receipt, and (3) the freight bill. Copy (2) is a receipt taken from the consignee tjpon delivery of the goods to him. C. O. D. Shipments C. O. D. shipments are handled through the agency of the express company or by the bank. Express companies accept for shipment freight which is to be paid for upon delivery, agreeing to collect the amount of the invoice and remit same to the consignor less collection and remittance charges. This method of shipping sometimes gives the con- BUSINESS METHODS 189 signee the privilege of examination before acceptance. It is used with customers who are unknown to the shipper or with those Mhose credit is doubtful. When the bank is made the shipper's agent to collect on delivery, a draft is drawn on the consignee and this is sent to the bank along with a special C. O. D. bill of lading, the order bill referred to above. This original C. O. D. bill together with the attached draft is sent by the bank to its correspondent located in the same city as the consignee. The correspondent bank presents the draft for acceptance or payment, as the case may be, to the consignee and thereupon delivers the special bill of lading to him. The shipper's order to the railroad provides that the goods are to be delivered only upon presentation by the consignee of this special bill of lading. In the use of the order bill of lading, it is customary for the original copy to show the goods consigned to the order of the shipper himself. This copy, indorsed by the shipper, and attached draft, are the docu- ments used by the bank in making the collection. Duties of the Traffic Department In a large business a special department known as the traflfic department is authorized to handle all shipments. Briefly, its duties are to look after all incoming freight, its receipt in good condition and its proper distribution to the several departments; to handle all outgoing freight, its proper routing so as to secure lowest tariffs and speedy delivery; and to secure adjustment of claims for damage or loss to goods in transit. The Statement of Account When goods are sold, an invoice or bill showing terms of sale, quantities, items, prices, and total amount of sale is sent to the customer. Periodically, frequently the last of I go ACCOUNTING— THEORY AND PRACTICE the month, a statement is rendered each customer whose account shows a debit balance. This statement of account is a rescript, sometimes a summary, of the customer's ledger account, i.e., it contains all charges and all credits for the period covered. If there was a balance outstanding at the beginning of the month, the current statement opens with the balance item, followed by all charges for the current period and this followed by a list of all payments and other credits; the total credits are subtracted from the total charges and the balance constitutes the amount now due and owing. Sometimes a statement of account is made out in detail, giving a copy of the original invoices which evi- dence the several sales transactions. Statements of account are issued in many different forms, but the following illus- tration shows all the essentials. Frequently the date of sending the statement is recorded in the explanation column of the ledger account, which, from a credit point of view, is a desirable practice. Monthly Statement of Account New York, N. Y., May 31, 1917 Mr. J. P. Norton, 1031 Blvd. F, Saratoga, Va. In account with D. Cohen & Company Manufacturers of Ladies' Waists and Suits May I Balance $ 325-40 S Mdse. per bill rendered 1,000.00 14 " " " '* 575-60 27 it tt a n Cr. 121.25 $2,022.25 4 Cash $ 500.00 10 Mdse. ret'd, per credit memo 50.75 20 Note Balance due 1,000.00 1,550.75 $ 471-50 BUSINESS METHODS igi Practice Data (Assignment for Chapter XXV) For the set of transactions to be recorded now you will use a general journal, a sales journal, a purchase journal, a cash book, and a ledger. Four double pages of journal paper and three of ledger will suffice. At the top of the first page write "Journal of J. M. Butcher." Allow 130-150 lines for your Journal. The next blank double page use for a cash book, marking the left page at the top left-hand margin, "Dr.," and near the middle, "Cash." Similarly the right page, "Cash," and at the right hand margin, "Cr." Allow 80-100 lines for each side of the cash book. The next blank page mark "Sales Journal," allow- ing 70-90 lines. The next blank page mark "Purchase Journal," allow- ing I page. The last 3 pages, reserve for trial balances and statements. Number consecutively all pages in both blanks. In the cash book use the first column on either side for items, the second column for totals and balances. Balance and rule the cash book at the end of each week, extending the "items" total before balancing. Enter the balance on the "Dr." side in the "Total" column and so keep each week's receipts segregated. At the bottom of a page, unless it happens to coincide with the end of the week, carry "totals" of each side forward, not the balance. In the sales and purchase journals mark the first column "On Account" and the second "Cash" and make entries in them according as sale or purchase is "on account" or "cash." If "cash," entry must be made in the cash book also. In both places "check" the item in the ledger folio column as total sales and purchases are to be posted from their respective journals. In making summary entries at the end of the month, rule and total each column, bring the cash column total over on the next line into the "On Account" column, marking it "Cash Sales, total." Add these two and rule off marking them "Sales, Cr." and "Purchases, Dr." respectively. Open the following accounts in your ledger beginning on the first page in the order given and allowing the number of lines to each account indicated by the numeral following each: Notes Receivable 5 C. W. Collier lo J. Q. Quinn 10 Meats Inventory 5 U. R. Sexton 10 Furniture & Fixtures 10 A. M. Roberts 10 Depreciation Reserve Furniture C. D. Keefe 10 and Fixtures 5 A. E. Parsons 10 Building 5 J. B. Mimmack 10 Lot No. 5, block 16 5 ig2 ACCOUNTING— THEORY AND PRACTICE Notes Payable 5 Purchases Returns 8 Marsh and Sons lo, Salesmen's Salaries lo Armour & Co lo Advertising lo Geib & Hodgson lo Delivery Expense 5 K. and B. Packing Co lo Expense Supplies 15 Mortgage Payable 5 Rent 5 J. M. Butcher, Capital 10 Insurance 8 J. M. Butcher, Personal 15 Office Salaries 10 Profit and Loss 20 Sundry Expense 8 Sales 5 Cash Short and Over 7 Purchases 10 Interest and Discount 8 Freight and Delivery Inward. . . IS Depreciation S Before recording any transactions study carefully the accounts, particularly the expense accounts, which you will keep. Make your classification strictly according to them. Keep no additional accounts. Transactions* March 2, 1917, J. M. Butcher purchased the White Front meat market, paying $1,940.16 therefor. The assets taken over were: a note signed by C. D. Keefe for $125, due March 11, after which it was to bear 8% interest; outstanding accounts, J. Q. Quinn $150.25; U. R. Sexton, $125.15; A. M. Roberts $240.20; C. D. Keefe $35.20; A. E. Parsons $115.75; J- B. Mimmack $322.45; and C. W. Collier $30.50; stock of meats and accessories $2,190.87; furniture and fixtures $500. The liabilities assumed were : a note dated December 20, 1916 for 3 months at 6% in favor of the K. & B. Packing Co. for $580.40, the accrued interest assumed being $6.96; accounts due. Marsh & Sons $522.50; Armour & Co. $435.60, and Geib & Hodgson $349.75. Butcher deposited $500 in the City Bank as an additional investment. (Make the opening journal entry, showing the cash in both journal and cash book. Be sure to give full explanations.) 3. Bought for cash : fuel $22.50, sales tickets $5, account books $3.20, rent March 3 to April 2 inclusive, $100. Sales were : on account, J. Q. Quinn $10.75 ; cash $123.19. 4. Bought from Marsh & Sons on account $592.85. Paid freight-in $17.29. Bought for cash i year's insurance $24. Sales were : on account, U. R. Sexton $12.30; cash $145.80. 5. Paid Geib & Hodgson balance due them. Sales were : on account, A. M. Roberts $14.70, C. D. Keefe $9.20, A. E. Parsons $15.75, C. W. Collier $8.25 ; cash $157.95. ♦Figures at left margin give day of month. BUSINESS METHODS 193 6. Bought from K. & B. Packing Co. on account $525.50. Returned to Marsh & Sons meats $75.20. Paid freight-in $15.26. Sales were: on account J. B. Mimmack $11.30, Quinn $12.40, Sexton $9.40; cash $161.90. 7. Received cash on account from: Quinn $50, Sexton $75, Roberts $100, Keefe $15. Paid: cashier $10, butcher $18. Cash sales were $170.29. Proprietor drew cash $15 and meat for the week $5-25. 9. Paid Armour & Co. on account $3So; ice bill $5-75; advertising $10.25. Sales were : on account, Roberts $12.50, Keefe $10.40, Parsons $17.90, Mimmack $14.90. 10. Bought from Armour & Co. on account $619.70 ; paid $125 for cash register. Received cash on account from : Parsons $82.50, Mim- mack $100. 11. Paid Marsh & Sons $475 on account. Paid freight-in $12.92. Re- turned meats to Armour & Co. $40.85. Sales were: on account, Collier $12.80, Quinn $15.90. Instructions March 9. Consider "ice" as an Expense Supplies item. Remember to balance the cash book at the close of each week. CHAPTER XXVI BUSINESS METHODS (Continued) Service of the Bank to the Community Practically all business houses at the present time take advantage of the banking facilities to be found in every community where there is enough business transacted to justify the establishment of a bank. A bank is sometimes defined as an institution which deals in money and credit. One of its chief functions and the one on which its main income is based is that of acting as a place for the deposit of moneys, these deposits forming the basis for its loans and discounts. Other important functions and services are to collect drafts and checks drawn on other banks ; to issue and sell its own drafts on other banks, thereby enabling its cus- tomers to make payments to out-of-town creditors; to dis- count commercial paper, i.e., to loan money to its patrons on approved security ; and to issue a paper currency.. Opening an Account with the Bank Because so much of the bank's business is based on the honor and integrity of its customers, a prospective depositor is usually required to present a card of introduction signed by a customer of the bank or someone else known to it. A depositor who wishes to open a checking account is asked to file a "signature" card bearing the signatures which he will use in signing checks. As considerable expense attaches to handling depositors' accounts, some banks require that the balance of the account shall never fall below a fixed minimum. 194 BUSINESS METHODS jgc The Deposit Ticket When an account is opened, the depositor is provided with a pass-book and check book. All deposits are made by means of deposit tickets, discount memoranda, or collection notices. The deposit ticket has a form similar to the following : Hamilton National Bank Deposited by Gold Silver Bills Checks (List separately) All moneys and checks deposited are listed on this ticket under the indicated classifications. The deposit is made with the receiving teller of the bank, who, after verifying the ticket, makes an entry of the amount in the depositor's ig6 ACCOUNTING— THEORY AND PRACTICE pass-book. Duplicate deposit tickets are usually kept by the depositor. It is important to note that checks must be indorsed before they are deposited, so as to make them collectible by the bank. The Pass-Book The pass-book is the record of the depositor's dealings with his bank and is usually kept from the depositor's view- point; i.e., the bank is debited with all deposits and credited with all checks presented for payment. At stated intervals, say monthly, the total amount of checks paid by the bank is entered in the pass-book, and the cancelled checks are then returned to the depositor. Sometimes the pass-book is kept in account form, the left page indicating deposits, and the right page payments by the bank. At the end of the period the account is balanced and the cancelled checks sent to the depositor. More frequently, however, the pages of the pass- book do not have debit and credit significance but constitute a continuous record. In this case, at the end of the period, the deposits are footed and the total of the checks is sub- tracted from the total deposits, thus showing the balance due the depositor. A method coming into quite general use with many banks is to send a monthly statement of account just as trading concerns do. This statement is a rescript of the bank's ledger account kept with each depositor, showing deposits and withdrawals. When this is done, withdrawals are not entered on the pass-book, which thus serves only as a memo or receipt of the moneys deposited. The Check Book The check book is provided either with a stub, counter foil, or interleaf, for making a duplicate record of the check drawn. Provision is usually made in the check book for the BUSINESS METHODS 107 entry of the deposits. Sometimes each check is subtracted from the pre\-ious balance and the amount of the new balance shown. More often, total checks and total deposits are shown separately ; in this way, while it is an easy matter to find the balance by subtracting the total checks from the total deposits, the actual figure does not appear and hence is not available to curious eyes. The balance shown in the monthly statement or by the periodic balance of the pass-book is seldom the same as that shown in the depositor's check book. This is so because at any time there is a certain number of checks, issued by the depositor but not yet presented for payment to the bank. This matter, however, is treated in Chapter LII, "Accounts Current." Securing a Loan Through the Discount of a Note A common practice of business men in borrowing money is to discount or sell to their bank or to a broker their own promissory notes and those received from customers. When merchants discount their own notes at a bank, these notes bear only one signature, that of the merchant, and for this reason they are called "one-name" paper. If, on the other hand, a merchant receives a note from another, indorses it, and then discounts it at the bank, two signatures appear on it — those of the original maker and of the indorser. Notes of this kind are called "two-name" paper. Banks usually prefer two-name paper because, if the maker fails to pay the note at maturity, the indorser can be held, while in the case of one-name paper the bank has recourse to no one except the maker. When a merchant makes out a promissory note of, say, $1,000, due 90 days after date, and discounts it at his bank, the usual method is that the interest, say, 6%, is deducted from the face of the note ; i.e., the merchant is credited not 198 ACCOUNTING— THEORY AND PRACTICE for the full $1,000 but only $985, and when the note matures he either pays the amount, $1,000, or his account is debited with it. The $15 is called "discount" because it is "sub- tracted" from the face of the note, but since this item is paid for the use of the amount loaned by the bank, it is of the same nature as interest. There is no reason, therefore, in having two separate ledger accounts, one for discount and one for interest paid. These two are usually combined under one title, "Interest and Discount" or "Interest." Principles to Be Observed in the Calculation of Interest In connection with interest computations it is important to observe the following points. The principles involved in each case will be best explained by making use of suitable illustrations. I. In commercial practice, when the interest period is expressed in months, the interest for each month is one- twelfth of the annual interest, i.e., a note for $1,000 dated April II, 191 7, due "three months from date," matures July II and the interest at 6% would be 6% of $1,000 divided by 12 multiplied by 3, or $1,000 X .06 X 3 12 $15 2. Were the same note worded "Ninety days from date," it would mature July 10 instead of July 11, the num- ber of intervening days being 19 in April, 31 in May, 30 in June, and 10 in July; total 90 days. The interest would amount to $1,000 X .06 X 90 360 ■ = $15 3. When a note is dated March 6, 19 17, and maturity is fixed in the note as of April 30, the interest period would be BUSINESS METHODS i^g 55 days (25 in March and 30 in April). Usually, in com- puting the number of days in the interest period the day of the opening date is omitted but the day of closing date is included. In some instances the practice is to include both days. It is important to note that it is almost a universal custom to use 360 as a denominator in all these cases, although the theoretically correct number would be 365. This is done for the reason that the use of 360 greatly facili- tates the computation. The government of the United States makes an exception to this rule and counts the year as 365 days, and disregards the month as a unit base; i.e., instead of counting the month of January as 1/12 of a year, its computation vi^ould require the use of the fraction 31/365 as the multiplier. Interest on $1,000 for, say, 12 days, by this method, would amount to $1,000 X .06 X 12 l^s =''■'' instead of $1,000 X .06 X 12 =$2 360 The incorrectness resulting from the commercial method (using 360 days as denominator) usually is comparatively small, and is fully justified by the economy of time in compu- tation. It might be noted that under this practice the amount of annual interest is 1/72 more than under the method used by the government. 4. When paper is discounted by a bank, even though its term be given in months, the bank invariably counts the exact number of days in estimating the amount of the dis- count. Take a note dated June 25 with a term of 3 months and due therefore on September 25, but discounted at bank 200 ACCOUNTING— THEORY AND PRACTICE on July 25. The term of discount, instead of being 2 months, would be for 62 days, a gain to the bank of 2 days on a 360-day basis. Short Methods of Interest Computation In calculating interest or discount, the so-called 12% or 6% method seems the easiest of application. Its base is taken as $1. In the 12% method the interest for a year is therefore 12 cents, for a month i cent, and for a day 1/3 mill. In the 6% method, the interest for a year is 6 cents, a month 1/2 cent, and a day 1/6 mill. Using these fractions with the years, months, and days as multipliers, the result is the interest on $1 for the given period. This result multiplied by the face of the note gives the required interest, assuming that the interest rate is 12% or 6%. A variation of the above gives the following rule, some- what easier of application. Reduce the time to days — using a 360-day year, 30-day month basis; multiply the time by the face, point off three places (i.e., treat the product as mills), and divide by 3 or 6 according as the calculation is on a 12% or 6% basis. If the basis used is 6%, but the actual rate is different, add or subtract whatever aliquot part the given rate is. more or less than 6% ; i.e., if the rate is 8'/c, add 2/6 or 1/3 ; if 5%, subtract 1/6; etc. The follow- ing example will illustrate. A note for $1,000 dated June 10, 1917, for 4 months, with interest at 7%, was discounted July 30 at 8%. Find the net proceeds. The note when due will be worth $1,000 plus 4 months' interest at 7%. That becomes the basis for the discount calculation. Applying the 6% method : 4 mo. = 120 days MultipHed by 1,000 (face of note) 120,000 BUSINESS METHODS 201 Marking off 3 points 120 Take 1/6 (index for I day) 1/6 20 = = Interest @ 6% Add 1/6 3-33 23-33 = = Interest @ 7% Add 1,000 Value of note on Oct. 10 1,023.33 This amount is the basis on which the discount is to be figured. Multiply by the term of discount (72 days)* 72 2 046 66 71 633 I 73,679.76 Marking off 3 points 7Z-^7 Take 1/6 (day index) 1/6 d 2/6 or 1/3 12.28 = 4.09 -- Discount ♦The 72 days are arrived at I day in July 31 days in August 30 " " September 10 " " October 16.37 = Discount as follows: (§6% 72 202 ACCOUNTING— THEORY AND PRACTICE Value of note Oct. lo 1,023.33 Less discount 16.37 1,006.96 = Net Proceeds on July 30 Practice Data* (Assignment for Chapter XXVI) March 12. Bought country chickens and eggs for cash $50.22. Sales were : on account, Sexton $14.90, Roberts $18.20, Keef e $12.75, Parsons $13.45. 13. Bought from Geib & Hodgson on account $490.10. Paid freight-in $14.47 ; Marsh & Sons balance due them. Sales were : on account, Mimmack $19.25. 14. Paid: cashier $10, butcher $18. Cash sales for the week were $1,097.25. Proprietor drew cash $I2 and meat for the week $7.50. 16. Bought from Marsh & Sons on account $605.14. Paid : freight-in $20.19, ice bill $6.25, advertising $10.25, billheads, stationery, and stamps $7.80. 17. Bought office safe $75 cash and paid freight on safe $7.22. Paid $25.40 for wrapping paper, twine, cartons, etc. Paid $3.25 for motor delivery service. 18. Cash was short $1.10. Sales were: on account. Collier $12.90, Quinn $15.25, Sexton $10.40, Roberts $13.00, Keefe $8.95, Parsons $14.80. 19. Paid $1.50 for sharpening knives and cleavers. Returned meats to Marsh & Sons $61.43. Bought from Armour & Co. on account $475.20. Paid freight-in $18.90. 20. Paid K. & B. Packing Co. note $580.40 and interest. 21. Paid: cashier $10, butchers $36. Cash sales for the week were $1,150.95. Proprietor drew cash $15 and meat for the week $5.75. 23. Paid: ice bill $4.90, advertising $12, vat and equipment for trying fats $25. Sold on account: Mimmack $12.45, Collier $16.50, Quinn $13.90. 24. Sold bones for cash $5.90. Bbught from Geib & Hodgson on account $520.90. Paid freight-in $17.45. •See Practice Data for Chapter XXV. The figures at left margin indicati day of month. BUSINESS METHODS 203 25. Paid delivery service $2.50. Cash was short 950. 26. Bought for cash, turkeys, chickens and eggs $75.83. Sold on account: Sexton $11.50, Roberts $16.75, Keefe $11.85, Parsons $16.20, Mimmack $17.95, Collier $13.40. 27. Returned meats to Geib & Hodgson $71.90. Cash was over $1.25. 28. Paid : cashier $10, butchers $36. Cash sales for the week were $1,175.69. Proprietor drew cash $10 and meat for the week $6.50. 30. Paid: K. & B. Packing Co. bill of March 6; Geib & Hodgson $800 on account; ice bill $5.20; advertising $12; proprietor's house milk bill $7.25. Cash was over 50c. 31. Bought of K. & B. Packing Co. on account $583.60. Paid : freight- in $11.25, light and telephone bills $12.93. Gave note at 90 days to Armour & Co. for $750 with interest at 6%. Collier paid $50 on account. Sales for the 2 days were cash $450.20. Proprietor took meat $1.10. Bought from J. S. Rogers the lot $750 and buildings $1,750 in which the meat market is located, paying $500 cash and $500 from private funds, the remainder secured by mortgage at 6%. Instructions March 17. Motor delivery service is for delivery of goods to customers. March 20. Be careful to record the interest separately from the note. March 31. Apply the $500 cash arbitrarily to lot No. 5, block 16, and handle the rest of the transaction through the Journal, giving full explanation, including the cash part of the transaction. CHAPTER XXVII METHODS OF POSTING The Journal and Ledger Records Dififerentiated — Posting When a correct and complete record of all business transactions has been made in the various journals, prac- tically all the current information needed by the business has been recorded on these books. However, because this information is recorded in chronological order, it is not available for use. It requires sorting, grouping, and index- ing. In order to meet this requirement the original chronological record must be transferred to other records which provide for the desired grouping. The separation of the general journal into journals for different classes of transactions such as sales, purchases, and cash, has resulted in making certain kinds of information somewhat more available, but this is not all that is desired by a business manager. Hence, all of the original record is grouped and summarized under proper account titles, so that the total results for the period of all the elements of the business may be had under review at one time. The book containing these account titles is called the ledger, and the transfer of the original record to the ledger is called posting. Time of Posting Where subsidiary journals are used, it is not customary to post all entries at the same time. The entries affecting personal accounts, i.e., those of customers and creditors, should be posted daily so as to keep those records up to date. Inquiries from customers as to their balances are received every day, and, in order that this information 204 METHODS OF POSTING 205 may be given promptly and correctly, customers ledger accounts should be kept up to date in every respect. This is a matter of great importance because, if the information desired by the customer is not given promptly, or if an error is made in giving it, thus calling for correction at a later date, the customer's good-will may be lost and his trade transferred to others. For this reason personal ac- counts, especially those with customers, should be posted daily, and great care should be exercised in doing the work. All other accounts may have their postings made periodically — once a week or once a month — the frequency depending upon the need of the business for the information furnished by the accounts. The flow of cash — always of importance — is shown daily by the cash book balance; the volume of sales each day can be had from the sales journal; but information as to expenses can usually be had only from the ledger after completing the weekly or monthly postings. Methods of Posting Knowing that errors in posting are easily made and that when made they may cause great confusion, it is important for the bookkeeper to know what kinds of errors occur most frequently, and to devise methods whereby he may avoid them as much as possible. Certain methods of posting have been found to produce a minimum of error. Some points in connection therewith will be considered here. One of the chief errors in posting is to make entry on the wrong side of the account, i.e., to post a debit as a credit or vice versa. The use of subsidiary journals has done away with a large part of errors of this kind, yet it is advisable to keep the following points constantly in mind when posting: 2o6 ACCOUNTING— THEORY AND PRACTICE 1. The sales journal is a "charge" journal, i.e., the individual items represent debits and must therefore be posted to the debit side of the proper ledger accounts. The sales summaries, however, are credits and must be posted as such. 2. The purchase journal is a "credit" record and all postings, except summaries, are made to the credit side of the respective accounts. 3. In the cash receipts journal, each individual item represents a credit, as explained in a previous chapter, and each individual item in the cash disbursements journal represents a debit. Hence, postings of the individual items on the debit side of the cash book must be made to the credit side of the ledger account, and postings of items on the credit side of the cash book must be made to the debit side of the ledger accounts. The posting of the summary entries of the cash book follows the debit and credit desig- nation made at the time of summarization. The principles here involved were fully discussed in Chapter XXI, "The Cash Journals." 4. In the Journal the debits and credits of each entry are fully expressed, i.e., neither element is suppressed. In posting from this record it is best to transfer all the debits consecutively and then all the credits. The possibility of posting a debit item as a credit is thereby greatly reduced. Cross-Indexing the Entries An essential part of posting, in addition to recording the date and the amount, is to cross-index every entry, i.e., to index it both in the book of original entry and in the ledger. The "folio" column in each book is used for this purpose. The index in the ledger consists of the first letter of the book of original entry followed by the page number, and the index in the book of original entry shows METHODS OF POSTING 207 < q: O -) in s •53 s o o > 2o8 ACCOUNTING— THEORY AND PRACTICE the number of the ledger page to which the item is posted. (See illustration on page 207.) In this way the indexing in both books is complete and makes it possible without loss of time to trace the entry from the journal to the ledger and vice versa. Usually the ledger folio is entered immediately in the book of original entry after each item as it is posted. When this is done the absence of a reference number in the journal indicates that the item was omitted in posting. This check is frequently helpful in tracing errors. Some bookkeepers, however, be- fore doing any posting, go through the book of original entry and from the account index of the ledger enter in the ledger folio column of that particular journal the pages where the accounts are found in the ledger. By this method, much time is saved in finding the account in the ledger, but a check mark should be placed after each item as soon as it is posted to indicate that it has been posted. Here the absence of the check mark would indicate an unposted item. Explanatory Matter in the Ledger In posting personal accounts it is customary to show the terms of credit in the explanation column of the account. In this way the face of the account shows the customer's manner of payment, prompt or slow, and affords a basis for his credit rating. Notes Payable and Notes Receivable accounts in the ledger should show essential data, such as due date, interest rate, etc. However, when a separate note or bill book is used, these data are given therein and may be omitted from the account in the ledger. With all other accounts, except sometimes the Profit and Loss account, little or no explanatory matter is carried. However, when a posting is made that is at all unusual, it is well to enter explanatory matter in the ledger. From the METHODS OF POSTING 209 business manager's point of view, the ledger is the most im- portant book of account, and if its record can be so made as to require a minimum of reference to original books, it serves its purpose so much the better. Where possible, the Profit and Loss account should carry the names of the ac- counts closed into it. In fact all transfers, whether made on the face of the ledger or by journal entry, should carry the account title and the ledger folio to which, and from which, the item is transferred. It is a fundamental prin- ciple that every entry must be indexed in such a way as to render reference to it easy at any time. Practice Data* (Assignment for Chapter XXVII) Balance the cash book, total and make summary entries for the sales and purchase journals. Post completely the sales and purchase journals, then the general journal and cash book. Take a trial balance of account balances and record it on page 13 of your journals, labelling it "Trial Balance, March 31, 1917, J. M. Butcher." Instructions Refer to page 136 for the form of the various journal summaries and to page 191, Practice Data, instructions to student for the method of summarizing. Be very careful always to cross-index every posted item in both ledger and journals just as soon as the posting of that item is com- pleted. The ledger folio columns in the journals are thus an indica- tion as to how far the work of posting has proceeded, in case the bookkeeper is interrupted before completing the postings. *See Practice Data for Chapters XXV and XXVI. CHAPTER XXVIII THE TRIAL BALANCE AND METHODS OF LOCATING ERRORS The Trial Balance In Chapter XV the trial balance was defined as a list of account totals, debit and credit, or account balances, debit or credit, for all the open accounts in the ledger. This list is set up in two columns, debit and credit, and if the work of original and secondary entry has been done correctly the totals of these two columns should be the same. Neither method of showing the trial balance has any inherent advantage over the other. Some concerns desire the account totals to be shown in the trial balance, as that indicates to some extent the volume of business. This would be true of all accounts which had been opened during the current period. As to those carried over from a previous period little current information would be given. As a general thing, however, the status of customers' ac- counts is better indicated when both total charges and total credits are shown. Where only the balance is shown, it does not provide any basis for determining whether that balance is normal for that particular account. There is a rather close relationship between the volume of trade with a customer and the amount of his unsettled balance in judg- ing a request for further extension of credit. Sometimes, even the totals of accounts that balance are shown in the trial balance, thus giving the status of all accounts appearing in the ledger. Again, concerns desirous of knowing the amount owing on customers' accounts and the amount owed on creditors' claims, require balances of 2IO TRIAL BALANCE— LOCATING ERRORS 21I all personal accounts and cash, but debit and credit totals of all other accounts. No unalterable rule can be given. The manner of showing the accounts in the trial balance is governed by the way in which the trial balance is to be used and the purpose which it is to serve. It is submitted, how- ever, that the trial balance manifestly cannot give informa- tion of every kind desired by a manager. As personal accounts are usually handled by cancelling offsetting credits against corresponding debits and carrying only balances forward, the trial balance cannot well show at the same time both total transactions and outstanding balances. Only in small concerns could the trial balance give the information which in larger concerns would be gathered statistically and furnished in addition to the trial balance. The tendency in modern accounting is to make the ledger record so detailed that all accounts are currently "uniphase," i.e., have entries on but one side, and in con- nection with such accounts the two methods of entering them in the trial balance are identical, because the total of the one side of the account is at the same time the balance of the account. It must be observed, that, as a matter of course, this modern tendency does not apply to personal accounts nor to adjustment and closing accounts. Errors in the Trial Balance The manner of entering the small pencil footings of both sides of each account and also, if it be desired, the account balances previous to taking the trial balance, was explained in an earlier chapter. This preliminary work should be done carefully so as to reduce errors to a minimum. It is not purposed here to discuss all the kinds of errors that find their way into the accounting records. Errors are frequently made in the original analysis and classification of the transaction, which, as previously stated, result in an 212 ACCOUNTING— THEORY AND PRACTICE entirely incorrect showing of . financial condition. Such errors do not affect the balance of the books and are not detected by the trial balance. Their detection is one phase of the professional auditor's work. We have prefaced this discussion by saying that if the work of original and second- ary entry has been done correctly, then the ledger should prove. Some points in connection with errors which often occur in posting will be treated here. The equality of the two totals of the trial balance proves that for every debit entry on the books there has been made an equal credit, or at any rate, that the sum of all debit entries equals the sum of all credit entries; i.e., it proves only the mathematical correctness of the work. It might happen that an item has been posted to the correct side of the ledger but has been entered in the wrong account. The trial balance would not detect an error of this kind. For example, John Doe's account might be debited with a charge belonging to Richard Roe, both being cus- tomers. This, of course, would make the books show wrong balances in those particular accounts, but would not cause an incorrect showing in the total assets. However, more serious results may accrue from an error caused by posting to the wrong account. All transactions, according to the schedules shown earher, bring about interrelations between increases and decreases of the three main groups of accounts, viz., assets, liabilities, and proprietorship. A transaction resulting in an increase of assets may have its credit in any of the three classes — ■ decrease of assets, increase of liabilities, or increase of pro- prietorship. A credit recorded in any one of these would result in an exact offset to the debit and would, therefore, so far as that transaction was concerned, result in equal debits and credits in the trial balance, but were posting made to the wrong account the entry might be in the wrong TRIAL BALANCE— LOCATING ERRORS 213 group and so bring about absolutely misleading and false results. This would be the case if a proprietorship account were credited, resulting in an increased profit, when the credit should have been to the liability group with a result- ing increase of the liabilities — two divergent results. Thus, while the trial balance does not detect errors in posting to the wrong account, it has great value in that its equality is considered as good evidence of the correctness of the books. This is so because errors of the kind just referred to are not of so frequent occurrence as those in- volving only the mathematics of the work. Suggestions for Locating Errors Where trial balance totals do not agree, it is certain that one or more errors have been made somewhere. The fol- lowing suggestions may be useful in locating them: 1. If there is a difference of i in any column, i.e., .01, .10, 1. 00, 10.00, etc., the error very likely results from wrong addition. Check additions of the trial balance and if the error is not located there, those of the ledger accounts must be checked as well. 2. If the difference between the two trial balance totals is an even number, divide this difference by two and look through the trial balance for an item of that amount but entered as a debit instead of a credit or vice versa. The amount of the error must be divided by two because the placing of a given item in the wrong column would result in a difference of twice this amount in the totals of the trial balance. If the error is not located in the trial balance, it may be necessary to look through the ledger accounts be- cause the wrong placing may have occurred there. In checking through the ledger for an error of this kind, some aid is afforded by the fact that all postings from even pages in the cash book (i.e., the cash receipts) appear on 214 ACCOUNTING— THEORY AND PRACTICE the credit side of the ledger accounts, and all postings from the odd pages in the cash book appear on the debit side of the ledger accounts. If, therefore, in any of the credit reference columns in the ledger is seen a reference like "C 13" or "C 29" or in any of the debit reference columns an index like "C 40" or "C 58," it is probable that the error is due to posting to the wrong side. 3. If the mistake has not been found in this way, the trial balance should be checked against the ledger to be sure that no open accounts have been omitted. Examine all closed accounts to see that they balance. 4. Examine the posting index column of all books of original entry to see that no items had been omitted in posting. 5. When the totals of the trial balance are unequal, the error may lie either in the debit total or in the credit total, or both may be wrong. Even when the trial balance "proves," both totals may contain the same error. In order to determine what is the correct footing, the following method may sometimes be applied : Take the total of the previous trial balance, add to it the current totals from the several journals, and deduct the total of all accounts closed during the period. The result shows the correct footing for the present trial balance. Where the number of accounts closed during the period is large, the work entailed by this method may be prohibitive. The method is of easy applica- tion only when the trial balance is taken by means of debit and credit totals. It may be left to the student to prove for himself why this is a correct method for determining the present trial balance total. Suffice it to state that it is based on the fundamental fact that for every credit item in any of the journals there is of necessity a debit or group of debits the total of which corresponds with the credit item. TRIAL BALANCE— LOCATING ERRORS 215 The following table will serve to illustrate the above method : Previous trial balance total $12,967.30 Sales journal total for current period 8,429,60 Purchase " " " " " 5,627.40 General " " " " " 564.90 Cash receipts " " " " 2,572.60 Cash disbursements " " " 1,962.75 $32,124.55 Closed accounts total 1,211.41 Correct trial balance total $30,913.14 6. If the difference between trial balance totals is divis- ible by 9, the error may be due to a transposition of figures or to a transplacement , sometimes called a slide. A trans- position is an interchange of figures as 96 for 69, 215 for 512, 6,274 for 4,276, etc. The first is called a simple or one-column transposition, the second a two-column, and the last a three-column transposition. One-column transposi- tions may also occur in numbers of three or more figures, as 172 for 712, or 3,129 for 1,329. Transpositions The following rules will be of help in locating errors of transposition. To determine divisibility by 9, the easiest way is to "cast out" the 9's. (a) If the difference between the trial balance totals is divisible by 9 and consists of less than three figures, i.e., 9, 18, 27, 36, a one-column transposition may be the cause of the error. Divide this difference by 9. If the quotient is I, the difference between the two transposed figures is i. If the quotient is 2 or 3 or 4, the difference between the transposed figures is 2 or 3 or 4, etc. For instance: 2i6 ACCOUNTING— THEORY AND PRACTICE Correct Number Transposed Number Difference 54 45 9 divided by 9 = I 87 78 9 tc "9=1 75 57 18 (C "9 = 2 97 79 18 ft "9 = 2 30 03 27 9 = 3 85 58 27 ""9 = 3 Thus, the figures in the last column indicate the differ- ence between the figures of the original item. (b) If the difference is divisible by 9 and consists of two significant figures followed by one or more naughts, the error may be caused by a one-column transposition be- tween columns of a higher order. For instance : The correct amount being , ,. .6,394 and the transposed amount • ,. .3,694 the difference is ,. 2,700 which divided by 9 gives 300. This indicates a transposi- tion between figures in the "100" and "1,000" columns, the difference between these figures being 3. Reference to the example given will show this to be the case. (c) When the difference between the trial balance totals is divisible by 9 and lies between 99 and 1,000, the error may be due to a two-column transposition. Here the middle figure of the error is always a 9, e.g., an error of 297 re- sulting from writing 512 as 215. Dividing the number (27) formed by the two outside figures of the difference by 9, the quotient (3) is the difference between the two trans- posed figures, i.e., the 5 and the 2. For instance: TRIAL BALANCE— LOCATING ERRORS 217 Correct Number Transposed Number Difference 735 981 537 189 99 198 792 9 divided by 9 = I 18 " "9 = 2 72 " "9 = 8 Thus, the figures in the last cohimn (i, 2, 8) indicate the difference between the two transposed figures in the correct item. Instead of dropping the middle figure of the difference and dividing by 9 as above, the entire difference figure may be divided by 99 with the same result. (d) Similarly, when the difference is 999 or a four- figure amount with two 9's in the middle, a three-column transposition may be indicated thereby. For instance : Correct Transposed Number Number Difference 5.174 4,17s 0,999 09 divided by 9 = I 6,392 2,396 3,996 36 " "9 = 4 7,081 1,087 5,994 54 " "9 = 6 the figures in the last column (i, 4, 6) again indicating the difference between the transposed figures in the original. Instead of dividing the number formed by the outside digits (9, 36, 54) by 9, we might divide the full amount of the difference (999, 3,996, 5,994) by 999; this would give the same result. The reason for the divisibility of this difference by 999 in an error of this kind is apparent when a number is given algebraic notation instead of Arabic. The Arabic number 2,197 expressed algebraically would be 2,000 + 100 + 90 + 7. Generalizing, we may formulate any number of four figures by i,oooa + loob + loc + d, in which a, b, c, and d may have values from o to 9 inclusive. 2i8 ACCOUNTING— THEORY AND PRACTICE A transposition between the thousands and units digits, the "a" and the "d," would result in the following number: i,oood + loob + IOC + a. The error would, therefore, be: Original number i,oooa + loob + loc + d Transposed number a + lOob + loc + i,cxx)d Difference 999^ — 999^ This error is plainly divisible by 999, and the resulting quotient (a — d) is the difference between the two trans- posed digits. It may be shown similarly why 99 is a divisor of the error cited under case (c) above. Transplacements A transplacement or slide occurs when some or all of the digits of a number are moved one or more places to the right or left without change in the order of the figures, for instance 736 written as 73.60, as 7.36, or as 700.36. The first is called a one-column slide, the second and third two- column slides. The error caused by a one-column slide is always divisible by 9, a two-column by 99, a three-column by 999, etc. The division by 9, 99, 999, etc., disregarding decimals, always gives the figures whose transplacement has caused the error. Thus, the error caused by writing 736 as 73.60 is 662.40, which divided by 9 is 736 ; or 736 written as 7.36 produces an error of 728.64 which divided by 99 gives 736; or 736 written as 700.36 causes an error of 35.64 which divided by 99 gives 36, the part transplaced. The reason is similar to that given above for the transposition. When a whole number of dollars is writt^en as cents, the resulting error is divisible by 9 and moreover the cents added to the dollars gives 99 in each case. For instance in writing : TRIAL BALANCE— LOCATING ERRORS 219 .73 instead of 73.00 the resulting error is 72.27 .58 " " 58.00 " " " " 57.42 .16 " " 16.00 " " " " 15.84 When the error in the trial balance is of this kind, the amount transplaced may be found by subtracting the cents of the error from 100. In the above examples this differ- ence would be 100 — 27, 100 — 42, 100 — 84, or 73, 58, and 16 respectively, which are in each case the figures of the transplaced amount as seen in the example. Having determined this, the trial balance and ledger accounts should be gone over to look for a slide of the given number. Checking the Postings From the above discussion, the impossibility of deter- mining, in all cases, the nature of the error is quite evident — particularly as to whether it is one caused by a transposi- tion or a slide. Unless the kind of error is readily dis- cernible, it is usually advisable to employ the method of checking, i.e., going over all the work of posting to deter- mine its correctness — or other methods to be discussed in Chapter LIV. After all, careful work in making the record with legible figures and in performing additions and sub- tractions, proven wherever possible, more than pays for itself in the time saved hunting for errors caused by slovenly and inaccurate work. Practice Data* (Assignment for Chapter XXVIII) Close the ledger taking into account the following adjustments and inventories : 220 ACCOUNTING— THEORY AND PRACTICE Interest accrued on C. D. Keefe's note 56c. Expense supplies inventory $9.50. Insurance unexpired $22. Salesmen's salaries accrued $12. Office salaries accrued $3.33. Advertising accrued $4. Prepaid rent for 2 days $6.67. Furniture and fixtures valued at $725. Meats inventory $2,236.21. Take a post-closing trial balance. histructions As required in previous similar problems, bring on the books all of the prepaid and accrued expense and income entries and those covering inventories and appraisals before making the closing entries. It will be wise to make rough drafts of financial and profit and loss statements before closing to make sure of the correctness and accuracy of the work. The profit and loss statement will prove a convenient criterion by which to judge the accuracy of the items transferred to the Profit and Loss account. Be sure to rule off the necessary accounts.- Do not balance cus- tomers' and creditors' accounts. ♦See Practice Data for Chapters XXV to XXVII. CHAPTER XXIX ADJUSTMENT ENTRIES AND CORRECTIONS The Need for Adjustment Entries In Chapter XVI it was shown that the records as they are usually kept, do not reflect the true condition of the business at any time during a fiscal period. For this reason, before making the financial and profit and loss summaries it is always necessary to bring onto the books a number of entries whose purpose is to "adjust" the record to make it reflect true condition. These adjustments may be made by entry direct on the face of the ledger, but it is better to run them through the journal, thus making it possible to give ample explanation. A further advantage of making the adjustment entries in the journal first is that in this way all such entries appear in one place in the books of account. Inventory of Stock in Trade One of the most important adjustment entries is the one by which the inventory of stock in trade is brought on the books. By reference to Chapter XVI, it will be seen that none of the accounts connected with merchandise, viz., purchases, sales, returns, etc., contain any definite and up- to-date information as to the value of merchandise on hand. However, the financial statement, the statement of profit and loss, and the Profit and Loss account call for this informa- tion. Therefore, before these statements are made the value of goods on hand should be determined and brought on the books of account. The process by which this is done is called "inventory taking." Without going into the detail of outlining a system for 221 222 ACCOUNTING— THEORY AND PRACTICE taking an inventory, three fundamental principles can be stated relative thereto : 1. Make sure that all goods belonging to the firm on the date of the inventory are included. 2. Make equally sure that there is no duplication of count, i.e., that no goods are counted twice. 3. See that the condition of the goods, viewed from the standpoint of salability, is indicated. Two factors of importance enter into the determination of the inventory, viz., the quantity of the goods on hand and their value per unit. Inaccuracy in either one of these two factors may lead to a gross error in the final amount. By falsifying the count of the goods tlie inventory could, of course, be inflated. A usual and more elusive method, often resorted to, consists in raising the price per unit, since the addition of even a fraction of a cent per unit may have the effect of converting an actual loss into a seeming profit. Without further indication of the reason for such valuation, it is now generally required that the inventory be valued on the basis of cost. The term "cost" should include all costs, not only the purchase price, but also duties, freight, drayage, insurance during transit, etc., up to the point of placing the goods in condition ready for sale. After the amount of the inventory has been determined, it is placed on the books. However, before this is done it is necessary that the Merchandise Inventory account be cleared of the goods on hand at the beginning of the period by transferring the amount to Purchases. The following journal entry will effect the transfer : Purchases Merchandise Inventory To transfer the opening in- ventory to Purchases. ADJUSTMENT ENTRIES AND CORRECTIONS 223 The posting of this entry will automatically clear the Inven- tory account and, by its addition to Purchases, will cause that account to show the "total goods to be accounted for." Purchases, as it now stands, is a mixed account containing both the cost of goods which have been sold during the cur- rent period and those which are still on hand as shown by the inventory just taken. Accordingly, to separate the two elements, the expense and the asset, the following journal entry is necessary : Merchandise Inventory Purchases To set up the inventory of goods now on hand. This entry posted will show in the Merchandise Inventory account the asset element, and will leave in the Purchases account the unmixed expense element. The effect of these two entries, then, is to adjust the books to true conditions so far as the merchandise is concerned. Other Adjustment Entries Further adjustment entries necessary at the closing date are those connected with depreciation, bad debts, prepaid and accrued expenses, prepaid and accrued income. These include such items as : 1. Depreciation of machinery, buildings, etc. 2. Losses due to uncollectible customers' accounts. 3. Prepaid expenses, as for instance, insurance paid in advance, part of which is applicable to the current period, and the balance chargeable to a later period; similarly rent and interest paid in ad- vance; also supplies bought and paid for, but chargeable to this period only in part, the balance affecting a subsequent period. 224 ACCOUNTING— THEORY AND PRACTICE 4. Accrued expenses, chargeable to the current period but not yet paid for by the business, such as wages, salaries, and taxes. 5. Prepaid income, i.e., income received in advance, as rentals, advertising contracts, magazine, news- paper, and special edition subscriptions. 6. Accrued income, i.e., income earned but not yet received, as interest, rent, dividends. All such items must be taken into account and entered upon the books before the final results for the period can be correctly shown. It may be observed here that if a business manager has an intelligent insight into the development of his enterprise, and carefully watches the volume of sales, purchases, and expenses, he may be able to forecast with some degree of accuracy the approximate results for a given period; but only by making the actual count of stock now on hand and careful estimates of the six classes of items just mentioned can accurate and dependable results be assured. These six classes of adjustment items will now be dis- cussed and the manner of handling them illustrated. Depreciation, and Loss on Doubtful Accounts As indicated in Chapter XVI, the amount of deprecia- tion of particular assets and the losses due to bad and doubtful accounts are carefully estimated at the close of the fiscal period. The individual depreciation items are all summarized in a single depreciation account — an expense account whose total debit is closed out to Profit and Loss. The depreciation reserves, however, which are credit items, are handled under separate account titles, and constitute the valuation account of the corresponding assets. . The journal entry covering depreciation will read as follows : ADJUSTxMENT ENTRIES AND CORRECTIONS 225 Depreciation Depreciation Reserve for Buildings " " Furniture and Fixtures " " Delivery Equipment " Machinery and that covering bad debts : Bad Debts Reserve for Doubtful Accounts The Reserve for Doubtful Accounts is the valuation ac- count of accounts receivable. For instance, assume that the debit balance of the latter is $15,900 and the credit of its valuation account is $600, the difference between these two accounts, viz., $15,300, would represent the estimated value of accounts receivable. Therefore, when the two entries above are posted, the present appraised value of those particular assets is brought on the books; i.e., out of those asset values, as shown at the beginning of the period, are taken the portions estimated to have been used up or lost through depreciation. These lost portions are set up as an expense item, leaving in the adjusted asset accounts true asset values as existent at the close of the period. Expense Paid in Advance When a part of the expense paid during the present period applies to the next period, this portion must be taken out of the current expenses and held over, deferred, as a charge to the expenses of next period. Taking insurance as an example, the following journal entry would effect the required adjustment : Insurance (Deferred) Insurance In posting this entry, the credit part is posted first in order to take out of the excessive cost shown chargeable to this 226 ACCOUNTING— THEORY AND PRACTICE period the portion equitably belonging to the next period. When this is done the debit balance of the insurance account indicates the amount to be charged to the current period and is the correct charge against the Profit and Loss for this period. After making allowance for the space needed for closing the account, the debit side of the above entry is posted, this debit becoming the first charge in the account for the next period. Note that the use of the bracketed "Deferred" is for the purpose of guiding in posting and is evidence that that portion of the entry is not to be posted until provision has been made for closing the account. After posting is completed the Insurance account would show as follows : Insurance January 2 $125.00 December 31 $200.00 April 10 250.00 August 15 300,00 $675.00 January i $200.00 There remains, of course, the transfer to Profit and Loss of the current balance before the account is closed. This closing work is treated in the next chapter. Accrued Expense Items These items cover expenses which .the business has in- curred but not yet paid and which are properly chargeable to this period but have not yet been charged on the books. For instance, salaries earned up to the close of the period but not paid at its close constitute an additional charge to the period's operations which must be entered on the books before they will show true conditions. This amount also ADJUSTMENT ENTRIES AND CORRECTIONS 227 constitutes a liability of the business. Accordingly, the journal entry would be : Salaries Salaries (Accrued) thus charging the Salaries account with the amount due but not paid, and bringing this amount down as a credit balance to the new account for the next period. Assuming this unpaid amount to be %y2, the account after closing will show this %'/2 as a liability on the closing date. Its effect, how- ever, during the next period will be to reduce the amount charged to salaries during that period, because this $72 although paid during that period had already been charged to the previous period. This credit to Salaries therefore serves two purposes, viz., that of showing the outstanding liability at the close of the current period and that of effect- ing a reduction of what would have been, without this credit, an overcharge to next period's salaries. For ex- ample, if the total salary paid during the next period is $600, the balance of $528 would indicate the amount applic- able to that period, although the amount actually paid is $600. Prepaid Income Items So far as debit and credit Is concerned, these items are handled in a manner similar to the accrued expense items. They cover income items received by the business during the present period, a part of which income belongs to the sub- sequent period, as for instance, rent paid in advance by a tenant. In this case the journal entry would be: Rent Income Rent Income (Deferred) the effect being to decrease the amount of rent income for 228 ACCOUNTING— THEORY AND PRACTICE the current period and to show the portion belonging to the next period deferred to the next period's account. Accrued Income Items These items' are handled in a manner similar to expenses paid in advance. Take the case of interest income earned but not due. The entry for adjusting it is : Interest and Discount (Accrued) Interest and Discount The credit part is posted immediately, thereby showing an addition to the income already recorded as earned during the current period. The debit part is posted after the cur- rent account is adjusted and allowance made for closing it into Profit and Loss. It is then entered on the debit side of the new account. Assume this debit item to be $50 and the interest received during the next period to be $170. The new account will indicate a credit balance of $120, this being the amount actually earned during that period, since the previous period took credit for the $50 accrued or earned during that period. Corrections When an error has been made in any entry on the books, it should not be erased or scratched out, because by so doing suspicion may be raised as to what was covered up by the erasure. Rule out the wrong item without destroying its identity and write the correct item above it or wherever it belongs. This applies particularly to books of original entry whose use as evidence has often been destroyed because many erasures appeared in them. Instead of making the correction as indicated above when an amount has been posted to a wrong account, cor- rection may be made by first cancelling the wrong posting ADJUSTMENT ENTRIES AND CORRECTIONS 229 through a similar entry on the other side of the same account, and then posting it to the correct account. Cross- reference to the two accounts must be made. When an amount has been posted to the wrong side of the correct account, e.g., $100 to the credit side of John Doe's account, when it should have been posted to the debit side, the incorrect credit may be cancelled by a debit of $100, after which the original $100 should be entered on the debit side; or the cancellation and correction may be combined by entering $200 on the debit side. Better still, the incor- rect posting may be ruled out and a correct posting made of the original entry whose wrong posting caused the error. Adequate cross-reference should be given so as to make easy the tracing of the items and to indicate exactly what was done. All these entries are of a somewhat unusual nature and their exact purpose should be plainly indicated in the ex- planation columns. According to the methods mentioned above, the vari- ous correcting entries are made directly on the face of the ledger. It is often preferable, however, first to make the required correction entries in the journal with full explana- tion, and then to post them to the ledger. Problem (Assignment for Chapter XXIX) A trial balance taken from the books of A. P. Lindsey for the year ending December 31, 1916 showed the following account balances : Cash $590.21; Notes Receivable $569.75; Accounts Receivable $8,275.46; Merchandise Inventory $4,975.20; Office Furniture $72580; Store Furniture $2,490 ; Buildings $10,240 ; Land $3,000 ; Accounts Pay- 230 ACCOUNTING— THEORY AND PRACTICE able $5,460.75; Notes Payable $2,192.67; A. P. Lindsey, Capital $20,000.00; A. P. Lindsey, Personal $1,701.09; Sales $45,932.75; Sales Returns and Allowances $2,193.60; Purchases $30,196.40; Purchases Returns and Allowances $2,970.80; In-Freight and Drayage $3,841.39; Salesmen's Salaries $2,390.67; Advertising $1,140.75; Insurance $316; Office Salaries $1,200; Light and Fuel $750; Office Supplies $250.30; General Expense $1,590.55; Interest and Discount $125.80 (Dr.). Set up the accounts on your ledger, allowing 6 lines for each account. Make provision for valuation accounts. Take a trial balance to verify your work. (Record the trial balance in the back of the Journal.) Draw up statements of financial condition and profit and loss, taking into account the following items : ■ Allow for depreciation: 1% on buildings, 10% on store and office furniture. Create a 3% reserve for doubtful accounts. Unexpired insurance amounts to $75.40. Salesmen's salaries accrued $100. Merchandise now on hand $5,190.34. Instntctions A double sheet of journal paper or of 3-column paper will suffice for trial balance and statements. CHAPTER XXX CLOSING THE BOOKS— SUMMARY STATEMENTS Purpose. of Summarizing After posting all adjusting entries tO' the ledger, the books reflect the true condition as of the date of these entries. However, at this stage the information contained in the ledger is usually scattered over a large number of accounts, and in order that a concise view may be obtained of the main results of the business it is necessary to summarize this information. The Profit and Loss account is the means by which the proprietorship accounts are summarized and the net results as to profits or losses indicated on the books of account. In this connection it will be remembered that the adjust- ing entries have already effected a separation of the elements of all mixed accounts, so that all temporary proprietorship items — expenses and income — applicable to the current period are now separately shown. The transfer of these proprietorship items to the Profit and Loss account consti- tutes the work of closing. Method of Closing However, instead of transferring all these accounts directly to Profit and Loss, frequently partial summarization is made elsewhere. For example, instead of transferring In Freight and Delivery, Purchases Returns and Purchases Rebates and Allowances direct to the Profit and Loss ac- 231 232 ACCOUNTING— THEORY AND PRACTICE count, they are first closed into the Purchases account. The balance of this account will then show the cost of goods sold. Likewise, Sales Returns and Sales Rebates and Allowances are closed into the Sales account which will now show by its balance the net sales. The debit balance of the Purchases account, cost of goods sold, is then transferred to the Profit and Loss account, and similarly, the credit balance of the Sales account representing net sales is transferred to Profit and Loss as a credit item. The Profit and Loss thus shows on the credit side net sales and on the debit cost of goods sold, the difference being the gross profit on sales. If it is desired to show on the face of the account, the actual figure of gross profit, the Profit and Loss account may be balanced at this stage, and the balance brought down will show the figure of gross profit for the period. After the net sales and cost of goods sold are transferred to the Profit and Loss account, all expenses directly con- nected with sales, such as Salesmen's Salaries, Salesmen's Traveling Expenses, Advertising, Delivery Expense, Depre- ciation on Delivery Equipment, on Store Furniture and Fix- tures, and similar items, are closed into the Profit and Loss account. The groups of accounts closed next are those covering "General Administrative Expenses" and "Other Income." It will be noticed that the order of closing follows the order in which the same items appear in the profit and loss statement. The Profit and Loss account now shows on the credit side all the items of income, and on the debit side all costs and expenses applicable to the current period. Its balance then gives the net profit (or loss) covering the period's transactions. Throughout the period, as the profit was accruing, the CLOSING BOOKS— SUMMARY STATEMENTS 233 proprietor has been drawing against it for personal use as shown in his personal account. In order to show the amount of profit remaining in the business, the balance of the Profit and Loss account is transferred to the personal account, the balance of which then gives this amount of undrawn profit. The balance of the personal account is closed into the capital account, the credit balance of which then represents the net worth of the business at the end of this period and at the commencement of the next,' Effect of Closing the Ledger This completes the work of closing the ledger. All open balances now shown on the ledger constitute either assets, liabilities, or vested proprietorship. After the closing pro- cess is complete, all temporary proprietorship records for the current period have been closed out. Having served their purpose of providing current information for the period, these accounts have been cleared of their current record and prepared to receive the record of the next period. The busi- ness cycle for this particular business has been completed and its correct history recorded. Profit and Loss Not an Account for Current Entry It • should be kept clearly in mind that the process of closing the books is merely a method, a device, by which the transactions for the year are summarised and the net result determined. This net result, whether a profit or a loss, be- longs to the proprietor and must ultimately be shown in his account. It is, therefore, manifest that the Profit and Loss account is only a summary account and should never be used for current entry. It is the medium by which the temporary proprietorship accounts are summarized and through which the net result is cleared into some vested proprietorship ac- count or accounts. 234 ACCOUNTING— THEORY AND PRACTICE Making the Closing Entries The two methods employed for bringing the closing transactions on the books are the same as for the adjusting entries, i.e., by entry direct on the ledger or by journal entry first and then posted to the ledger. The second method has two important advantages : first, by entering them in the journal it is possible to add such complete explanation as may be required in each case, while it is practically impos- sible to do so in the ledger; second, by entering all closing entries in the journal, they are shown together in one place. The adjustment and closing of the books constitute a most important and vital process. Consequently, the method making possible ample explanation and a complete record in one place is the best. Closing the Books Illustrated In order to give full and complete illustration of the process of adjusting and closing the books through the journal, a trial balance of M. T. Duncan's ledger is shown, ' together with the data for adjustments. The illustrations given include the adjusting and closing entries, the ledger Profit and Loss account, the profit and loss statement, and the financial statement. Arbitrary folio numbers are used throughout. Trial Balance, December 31, 1916 Cash $1,230.19 3 Notes Receivable 1,490.00 4 Accounts Receivable 3,675.40 10 Merchandise Inventory 5,187.51 10 Dehvery Equipment 560.75 1 1 Furniture and Fixtures 432.50 14 Notes Payable $1,000.00 15 Accounts Payable 1,620.15 CLOSING BOOKS— SUMMARY STATEMENTS 23=; Trial Balance — Continued 20 M. J. Duncan, Capital 10,000.00 21 M. J. Duncan, Personal 731.01 35 Sales ' 19,478.90 36 Sales Returns and Allowances 467.70 38 Purchases 16,580.20 39 Purchases Returns and Allowances 1,590.10 40 In Freight and Delivery 279.80 45 Clerks Salary 1,140.50 46 Delivery Expense 440.90 46 Insurance 51.40 47 Office Salary 695.00 47 Light and Heat 40.70 48 Office Supplies 125.60 49 General Expense 590.17 51 Interest and Discount 50.18 $33,739-3'3 $33,739-33 Adjustment Data, December 31, 19 16 Merchandise Inventory $6,720.81 Unexpired Insurance 15.20 Office Supplies Inventory 30.19 Office Salary Accrued 25.00 Interest Receivable 10.41 Depreciation of Delivery Equipment estimated at 16 2/3%. Depreciation of Furniture and Fixtures estimated at 10%. Bad Debts estimated at 2% of the outstanding Accounts Receivable. Journal of M. J. Duncan 1916 Dec.31 Purchases 38 $S,i87.5i' Merchandise Inventory. 10 $5,187.51 To transfer initial inventory. Merchandise Inventory 10 6,720.81 Purchases 38 6,720.81 To bring the final inventory onto the books. 236 ACCOUNTING— THEORY AND PRACTICE Journal of M. J. Duncan — Continued Insurance (Deferred) 46 iS-20 Insurance 46 15-20 To defer the unexpired in- surance to next year. Office Supplies (Deferred) 48 30.19 Office Supplies 48 30.19 To defer till next year the cost of supplies now on hand. Office Salary 47 25.00 Office Salary (Accrued) 47 25.00 To charge current period with unpaid salary. Interest and Discount (Accrued) 51 10.41 Interest and Discount 51 10.41 To credit current period with interest earned but not yet due. Depreciation S3 136.71 Depreciation Reserve Delivery Equipment 10 9346 Depreciation Reserve Furniture and Fixtures 11 43-25 To show the appraisals of the above assets and charge cur- rent period with expense of depreciation. Bad Debts 53 73.51 Reserve for Doubtful Accounts. . 4 73-51 To show estimated loss from uncollectible accounts. Sales 35 467.70 Sales Returns and Allowances. . . 36 467.70 To show net sales. Purchases 38 279.80 In Freight and Delivery 40 279.80 To show full cost of purchases. Purchases Returns and Allowances.. 39 1,590.10 Purchases 38 i,S90.io To show net purchases and cost of goods sold. Sales 35 19,011.20 Profit and Loss 76 19,011.20 To close. CLOSING BOOKS— SUMMARY STATEMENTS 237 Journal of M. J. Duncan— Conh'nwed Profit and Loss 76 13,736.60 Purchases 38 13,736.60 To close. Profit and Loss 76 3,274.10 Clerk's Salary 45 1,140.50 Delivery Expense 46 440.90 Depreciation 53 136.71 Office Salary 47 720.00 Light and Heat 47 40.70 Office Supplies 48 95.41 General Expense 49 S90.17 Insurance 46 36.20 Bad Debts 53 73.51 To close. Interest and Discount 51 60.59 Profit and Loss 76 60.59 To close. Profit and Loss 76 2,061.09 M. J. Duncan, Personal 21 2,061.09 To transfer net profit. M. J. Duncan, Personal 21 1,330.08 M. J. Duncan, Capital 20 1,330.08 To close Personal account. The Profit and Loss Account The first eight journal entries shown are the adjusting entries, the others are dosing entries. It will be seen that frequent use is made of compound journal entries; thus a number of proprietorship accounts are closed into Profit and Loss by means of one entry. In posting the profit and loss element of such entries, it is customary, in small concerns, not to post the single total, but the individual items shown by the contra side of the journal entry. In this way the Profit and Loss account in the ledger will show the individ- ual accounts closed into it, with the corresponding amounts charged or credited to Profit and Loss. This Profit and Loss account will then appear as follows: 238 ACCOUNTING— THEORY AND PRACTICE O u < o Oh o 0\ M .8 o 0^ »y vn ■* : M I p. fc rt Q S PO CLOSING BOOKS— SUMMARY STATEMENTS 239 Need for the Summary Statements The two periodic statements — the statement of financial condition and profit and loss— do not form an integral part of the books of account. They are drawn up periodically and submitted to the proprietor, because the latter does not always have ready access to the books of account and usually lacks sufficient knowledge of accounting to interpret cor- rectly the information shown by the journal and ledger. The periodic statements are intended to show the results of the year in a concise, non-technical form, so that a proprie- tor, even though not versed in the science of accounts, can readily understand them. The Financial Statement The statement of financial condition may be arranged in either of two forms. The first form illustrated follows the principles already laid down and is usually called the "Financial Statement." Reference to Chapter IV will give explanation of the essential points to be considered in draw- ing up this statement. The second form is usually called the "Balance Sheet." It shows financial condition by means of the account form, the subtraction of the liabilities from the assets being indicated by their respective positions in the account. It will be noticed, however, that this method of showing the subtractions is not strictly adhered to, some deductions being actually performed, as for instance in the case of Bad Debts which is subtracted from Accounts Re- ceivable. This is done in order to render the statement more intelligible. The same principles govern the arrange- ment of the items and groups of items as in the first form, viz., degree of liquidity for the assets and a similar arrange- ment for the liabilities. Form (i), sometimes called the report or non-technical form, is perhaps more in favor in the United States because 240 ACCOUNTING— THEORY AND PRACTICE it seems more readily intelligible to the man unversed ini technical account-keeping. Form (2) may be called the account or technical form and is the form used generally in statements drawn up for publication. These two forms are illustrated below. Financial Statement — Report Form M. J. Duncan Financial Statement, December 31, 1916 Assets Cash : $1,250.19 Notes Receivable 1,490.00 Accounts Receivable $31,675.40 Less, Reserve for Doubtful Accounts 73.51 3,601.89 Merchandise on Hand 6,720.81 Insurance Unexpired 15.20 Office Supplies Inventory 30.19 Interest Receivable 10.41 Delivery Equipment $560.75 Less, Reserve for Depreciation 93.46 467.29 Furniture and Fixtures $432.50 Less, Reserve for Depreciation 43.25 389.25 Total Assets $13,975.23 Liabilities Notes Payable $1,000.00 Accounts Payable 1,620.15 OflSce Salary Accrued 25.00 Total Liabilities 2,645.1s Net Worth $11,330.08 M. J. Duncan, Capital, January i, 1916 $10,000.00 Net Profit for the year $2,061.09 Less, Net Withdrawals 731.01 1,330.08 Present Worth $11,330.08 CLOSING BOOKS— SUMMARY STATEMENTS 241 < u o s 3 O u u < G V 6 u C m Q Q w w u <: 5 8 8> &3 8^ ~§ S w «9- N w- -5 rt nl CO *^ C V o cn U u o o 2; < O -?^ bo s n a - o o 5 Q sn E.g Is. i-i "^ +J CO 242 ACCOUNTING— THEORY AND PRACTICE Balance Sheet and Financial Statement Differentiated With regard to the two forms under the titles "Financial Statement" and "Balance Sheet," it will be noticed that there is no essential difference ; both show assets, liabilities, and net worth. While the titles as given are usually applied respectively to forms (i) and (2) as stated above, there is no reason why they may not be Used interchangeably with either form and they will be so used hereafter. It will be noticed that form ( i ) is the expression of financial condition in accordance with the proprietorship equation stated as, Assets — Liabilities = Proprietorship whereas form (2) expresses it as, Assets = Liabilities + Proprietorship It is this grouping together of liabilities and pro- prietorship that has often led to an attempt to find points of similarity between these two fundamental classes of ac- counts. Two Forms for the Profit and Loss Statement The statement of profit and loss may also be made up in two forms, called the report and the account form, based on the same principles as the two forms of balance sheet just discussed. Explanation of the report form has already been given in Chapters VI and VII. The account form is very nearly a rescript of the ledger Profit and Loss account. It differs chiefly in that the information concern- ing "sales" which is summarized in the Sales account on the ledger is here set up in an inner column and shown sum- marized on the face of the statement. Similarly, the information developing cost of goods sold is summarized on the face of the statement. The two forms given belowi illustrate. CLOSING BOOKS— SUMMARY STATEMENTS 243 Profit and Loss Statement — Report Form M. J. Duncan Profit and Loss Statement, December 31, 1916 Sales $19,478.90 Less, Returns and Allowances 467.70 Net Sales $19,011.20 Merchandise Inventory, January i, 1916 $5,187-51 Purchases $16,580.20 Less, Returns and Allow- ances 1,590.10 Net Purchases $14,990.10 In Freight and Delivery... 279.80 15,269.90 $20,457.41 Merchandise Inventory, December 31, 1916 6,720.81 Cost of Goods Sold 13,736.60 Gross Profit $5,274.60 Selling Expenses : Clerk's Salary $1,140.50 Delivery Expense 440.90 Depreciation 136.71 $1,718.11 General Expenses : Office Salaries $720.00 Light and Heat 4070 Office Supplies 95-41 General Expense 590-17' Insurance 36.20 Bad Debts 73Si i,SSS-99 3,274-io $2,000.50 Interest and Discount 60.59 Net Profit for the year $2,061.09 244 ACCOUNTING— THEORY AND PRACTICE < iz; Q 1-^ S 0\ w m w u w Q h" w S w H < H O c o o u g 1) m O -a c A ■(-> O o Q < O o 5 v8 Os & IT) ^ ^ & CO O ai to' •3 -J 00 c o Ph O c O •a a c o •o «3 p *<3- ^ \o -S o 0^ (N O vn -* i-i 1^ « O a; c^ ID 0\ o\ 0\ o\ in w U-) lO ^J3 <^ VD u-> O O M «^ «9- t^ « 8 2>.2 U Q Q V <" « S S c CO a; 3 o T3 sE !i= « s ^ .. o 1-1 o o w fq ;z; SQ Ph :^ CLOSING BOOKS— SUMMARY STATEMENTS 245 In conclusion, it may be remarked that often in practice, after the adjusting entries are brought on the books, these periodic statements are first made up before bringing the closing entries on the books. This makes possible a proof of the work before any entries are actually made. Where this method is followed, the profit and loss statement may be used as a guide in writing up the closing entries on the journal, because the results shown there have been proven and the statement sets forth the amounts needed for the closing entries. Problems* {Assignment for Chapter XXX) Make the adjusting and closing entries through the Journal for Lindsey's books. Calculate percentage of cost of sales, gross trading profit, selling expenses, general administrative expenses, and net profit. (Use "sales" as the basis.) *See Problems at end of Chapter XXIX. CHAPTER XXXI THE CLASSIFICATION OF ACCOUNTS The Purpose and Method of Account-Keeping Accounts record the business history of a concern. The main purpose for which accounts are kept is to secure in- formation as to the results of business activity and endeavor. The record required for this purpose can be made very brief, although the history of every business comprises a multitude of transactions covering a great mass of details. The whole scheme and method of account-keeping is de- signed chiefly to collect and summarize the detail and thus lose sight of the many items, using the detail mainly for the purpose of building up a summary which shall give in rapid review the entire record for the fiscal period. Account- keeping is to the bookkeeper what shorthand is to the stenographer — an abbreviated method of making the record. The uses to which the records are put, however, differ radi- cally. Instead of being turned back again to the story in all its details, as in the case of the stenographer, the account balance or summary is really the starting point for further summarization and abbreviation to free the essentials from their non-essential elements and coverings in order to secure the bird's-eye view of the whole. Classification of Accounts It is evident from the above, that account-keeping, having so definite a purpose and end, must be carried out with great care in the original analysis and record. To aid in securing a record correct in the first instance, certain 246 THE CLASSIFICATION OF ACCOUNTS 247 fundamental groupings or classifications of accounts have been made. It is the purpose of this chapter to discuss the various account classifications proposed and to lay down fundamental considerations governing them. Early Classifications Perhaps, because originally accounts were kept only Iwith persons, the first grouping, in point of time, was into personal and impersonal accounts, this being brought about at the time of the introduction of the present method of account-keeping as distinguished from the single-entry systems previously in use. The personal group includes all accounts with persons — customers, creditors, proprietor, and certain other accounts such as consignment and venture accounts which are not so clearly included in the personal group as the other three examples given. The impersonal group includes all others, i.e., those with other forms of assets as cash, merchandise, land; those with other forms of liability as notes and mortgages payable; those with expenses ; and finally those with earnings or income. In a controversy arising out of trouble with rival business colleges, Thomas Jones, writing in 1859 on the "Paradoxes of Debit and Credit Demolished," suggested a simple and, in most ways, a satisfactory classification of accounts. Jones was undoubtedly one of the first writers to get a true perspective of accounts and their use. Instead of building up his classification from a study of ledger accounts as usually kept, and attempting to find the points of similarity and of difference among them, he attacked the problem from the viewpoint of the final account summaries which he called the financial and the business statements, using the latter term to comprise the statement of profit and loss. Corresponding to these two summaries and based on them, all accounts in the ledger were classified by him as 248 ACCOUNTING— THEORY AND PRACTICE primary and secondary. Those destined ultimately for the financial statement were primary; those for the business statement were called secondary. He even went so far as to show how business transactions result in increases and decreases of the two classes, when recording them, on the books. So far as known, his attempt at a scientific classi- fication was the first made by any American writer. Recent Classifications Using the same basis for their groupings as did Jones, later writers have classified accounts in various ways, re- ferring to assets and liabilities as real, specific, and exterior ; and to accounts belonging to the profit and loss statement and capital items, as nominal or representative, economic, and interior. All of these classifications are good and bring out different characteristics of the two groups. Asset and liability accounts may be called "real" or "specific," because they represent, in the main, properties owned or owed which are definite and usually tangible. Perhaps, in a certain sense, liabilities are more real and specific than are assets. Still, either term connotes a true characteristic of the items covered. Exterior is used in the sense that the properties referred to and listed are "material factors outside of the proprietor, the only thing inhering in him being a right or claim to ownership in the 'net' prop- erties." This class of accounts is sometimes further sub- divided into personal and impersonal accounts, the former comprising all accounts with persons, i.e., customers, credi- tors, etc., while the latter include all other asset and liability accounts. This is the only correct use of these terms, personal and impersonal; that referred to in the preceding section being entirely wrong from the accountant's view- point, as will appear a little later after the fundamental re- quirements for a correct classification have been laid down. THE CLASSIFICATION OF ACCOUNTS 249 The accounts used in the profit and loss statement, which explain the changes in the assets and liabilities within a stated period, are nominal in the sense that, in themselves, they represent nothing real but are only the names given to the forces and factors which have brought about certain conditions. In this same sense these accounts may be termed representative, although this title is also used as an alterna- tive term for impersonal, this use being based on the per- sonification theory that "cash" represents the "cashier" and "sales" the "salesman," etc. A better title is, perhaps, economic, inasmuch as they make record of the economic progress, the character of the management and the business economy practiced in the conduct of the enterprise. The term interior as applied to these accounts indicates that the factors recorded are at work inside the business, as dis- tinguished from the outward or exterior showing of the real and tangible accounts. Classification Used Here The classification of accounts used in this work has been, in the main, a three-phase one, consisting of an asset, liabil- ity, and proprietorship nomenclature. The third group of accounts, proprietorship, is further divided into the two sub- classes, temporary and vested, as explained in Chapter XIII. At the end of the fiscal period, after the ledger has been closed, there appear only asset, liability, and vested pro- prietorship accounts; but during the fiscal period, the tem- porary proprietorship accounts come into being and certain asset and liability accounts take on a mixed character result- ing from the method in which we keep the record. This method is dictated not by a pure accounting theory, but by a theory bent to accommodate itself to the practical requirements of the average business. It is because the practical method of making the record falls short of a 250 ACCOUNTING— THEORY AND PRACTICE theoretically exact method, that adjustments must be made before summarizing^. Thus, we do not make a daily record of the portion of our assets which has been consumed that day, but adjust any particular asset account at the close of each fiscal period, separating its asset and proprietorship elements. Also, when our note is discounted at the bank, we set up the face value as a liability, but from the standpoint of accurate accounting the face value of the note overstates the liability for the current period, unless the note comes due during the period or at its close. Only at its due date does the record make a showing of true condition. If the note falls due in a later fiscal period, the face value overstates the present lia- bility by the amount of the prepaid interest charge belong- ing to the next period. Thus, a "practical" method of keeping the record necessitates the use of certain "mixed" accounts, but fundamentally the three-group classification given will answer every purpose. Fundamentals of a Good Classification In judging the fitness of a particular classification, the end and purpose for which the classification is made must always be the criterion. So, any classification of accounts must have in view the fact that all accounts lead up to the balance sheet and profit and loss statement, and that they must provide the summaries necessary for these statements. A large number of classifications may be made from different viewpoints and for different purposes, but a classification which is reasonable, carrying titles which clearly indicate the purpose for which the accounts are intended and therefore needing little or no explanation, is good. It is thought that the three-group classification — assets, liabilities, and proprietorship — meets these require- ments. THE CLASSIFICATION OF ACCOUNTS 251 Classifying Business Transactions When making the record of business transactions on the books of account, it is necessary, first, to determine the main account group or groups affected by the transaction. After this is done, it is usually easy to determine which particular account in the group is affected. Great care must be used in the determination of the main groups, since a wrong determination results in an incorrect showing in the summary statements at the close of the fiscal period. To illustrate, in Chapter XIV reference was made to the funda- mental distinction between capital and revenue expenditures, but when making the original entry of some transactions this difference is frequently lost sight of and what should be charged to an asset account is charged to some expense account or vice versa. The charging to an asset account, of items which rightly are expense items and therefore cut down the proprietorship element of the business, is one of the easiest ways of inflating the profits for a period and so of making a better showing than would be the case if the facts were recorded correctly. Correct classification of transactions is a matter of vital importance. An accurate analysis of every transaction must therefore be made before bringing it on the books. After determining the main group of accounts in which record is to be made, further analysis as indicated above is necessary in order to fit a particular transaction into its place under a suitable account title belonging to the main group. Detailed Classifications Frequently the more detailed grouping of accounts and the fitting of the transaction into them is treated under the general subject of classification. Such treatment deals, (i) with account titles in detail and what kinds and classes of transactions are to be recorded under particular titles, and 252 ACCOUNTING— THEORY AND PRACTICE (2) with the arrangement and use of these detailed accounts in the various sections of the summary statements at the close of the fiscal period. It is not purposed to give this detailed consideration here. Certain broad principles have previously been stated dealing with the selection of the account title, the objection to the inclusion of unlike items under the same title, and the care to be exercised against a more detailed analysis than is required by the needs of the business. The chart of accounts shown below gives those accounts most frequently met and their customary groupings and classes, and will serve as a guide until the detailed classification can be treated in Volume II. Chart of Accounts Asset Accounts Current Cash Petty Cash Notes Receivable Accounts Receivable Reserve for Doubtful Accounts* Merchandise Inventory Stocks and Bonds (for current investment) Accrued Income Deferred Charges to Operation, Shipping Supplies Insurance Interest Office Supplies Etc. The items in italics in the above chart are to be handled as subtraction items from the account below which they are placed or from the group in which they appear. THE CLASSIFICATION OF ACCOUNTS 253 Fixed Furniture and Fixtures Depreciation Reserve for Furniture and Fixtures Delivery Equipment Depreciation Reserve for Delivery Equipment Buildings Depreciation Reserve for Buildings Good-Will Etc. Liability Accounts Current Notes Payable Accounts Payable Dividends Payable Accrued Expenses Deferred Income Rentals Interest Subscriptions Etc. Fixed Mortgages Payable Long-Time Notes Payable Bonds Payable Debentures Etc. Proprietorship Accounts . Vested Proprietors, Personal Proprietors, Capital Surplus (Profit and Loss) Reserves of Profits (not valuation items)' 254 ACCOUNTING— THEORY AND PRACTICE Temporary Income Sales Sales Returns and Allowances Expenses Cost of Sales Initial Inventory- Purchases Purchases Returns and Allowances Inward Freight and Cartage Final Inventory Selling Expenses Salesmen's Salaries and Commissions Salesmen's Traveling and Entertainment Ex- penses Delivery Expense (wrapping, shipping room, horse and motor expenses, delivery salaries, etc.) Outward Freight Sales Management Salaries and Expense Advertising Depreciation on Sales Room, Equipment, De- livery Equipment, etc. Sundry SelHng Expense General Administrative Expenses Officers' Salaries General Salaries Stationery and Printing Legal Expense Postage Telephone and Telegraph Sundry Office Expense and Supplies Depreciation on Office Building, Equipment, etc. THE CLASSIFICATION OF ACCOUNTS 255 Light, Heat, and Power* Rentf Taxesf Insurancef Financial Management Expense and Income Interest Expense Bad Debts Sales Discount Collection Expenses Interest Income Purchase Discount Light, heat, and power expense should be distributed over the departments using It; selhng to be charged with its share and general administrative its share. tThese items are sometimes treated as Financial Management expenses or are distributed partly to Selling and partly to General Administrative where an equit- able basis for distribution can be determined. Practice Data {Assignment for Chapter XXXI) This set comprises one journal blank, one ledger, and a cash book. These books will be used in the Practice Data of Chapters XXXII to XLV. First, page each blank consecutively beginning with the first page, , excluding the index pages of the ledger. Of the journal blank, pages 1-13 inclusive will be used for the general journal, pages 14-18 inclusive for the sales journal, and pages 19-21 inclusive for the pur- chase journal; pages 22-45 inclusive will be used for the trial balances as explained later. Of the ledger blank, pages 1-19 inclusive will be used for the general accounts, pages 20-31 inclusive for customers, and pages 32-35 inclusive for creditors. The sales, purchases, and general journals will be used as in the previous set. The cash book has three columns, the first on each side being used as a sundry column in which all amounts must be entered first ; the second column is for Sales Dis- counts on the receipts side and Purchase Discounts on the disburse- ments side ; and the third column is the "Net Cash" column. The cash balance is always the difiference between the two net cash columns. When entering a sale or purchase transaction from which a discount 256 ACCOUNTING— THEORY AND PRACTICE is to be taken, the gross amount of the invoice is entered in the "Sundry" column, the discount in the discount column, and the net cash in the third column. In this way the extensions and additions may be proved, the sundry column total equalling the sum of the totals of the other columns. In handling the accounts of customers and creditors, daily postings and a careful observance of terms of credit will be necessary. The purpose of this set is primarily to give facility in the use of the various journals and in handling quickly a volume of transactions, summarization of the books, and the taking of monthly trial balances. To secure these features without too detailed work on the student's part, transactions are summarized for the month and are to be entered under date of the last day in each month. Where needed, as for interest calculations on notes, etc., specific dates are given. Before making any entries, familiarize yourself thoroughly with the accounts to be kept in your ledger and adhere strictly to that classi- fication. Open the following accounts in your ledger at the places indicated. The first numeral following the account title indicates the page, the second the line on that page. By "line i" is meant the very first line at the top of the page. Lewiston School Bonds.... i, i Notes Receivable i, 13 Reserve for Doubtful Accts.i, 25 Merchandise Inventory 2, I Electric Light Deposit 2, 13 Horses, Wagons & Harness. 3, i Depreciation Reserve for Horses, Wagons & Har- ness 3, 13 Store Furniture & Fixtures. 4, I Depreciation Reserve for Store Furniture & Fix- tures 4, 13 Office Furniture & Fix- tures 5, I Depreciation Reserve for Office Furniture & Fix- tures S, 13 Notes Payable 6, i O. W. Ward, Loan 6, 13 O. V/. Ward, Capital 7, i O. W. Ward, Personal 7, 13 C, Gneisel, Capital 8, i C. Gneisel, Personal 8, 13 Profit and Loss 9, i Sales 10, I Sales Returns & Allow- ances 10, 13 Purchases 11, i In-Freight & Cartage 11, 13 Purchases Returns & Al- lowances 11,26 Salesmen's Salaries 12, i Salesmen's Traveling Ex- pense 12, 13 Advertising 12, 25 Shipping Expense 13, i Shipping Supplies 13, 15 Out-Freight 13, 27 Rent 14, I Insurance 14, 13 Light, Heat & Power 14, 25 Depreciation 15, i Office Salaries 15, 13 Office Supplies 15,25 Office Expense ,,.,,16, i THE CLASSIFICATION OF ACCOUNTS 257 General Expense 16, 13 Cash Short & Over 16, 25 Charity Donations 17, i Credit Men's Association Membership 17, 13 Sales Discount 17,24 Bad Debts 18, i Miscellaneous Sales 18, 13 Interest Cost 18, 25 Purchase Discount 19, i Interest Income 19, 13 On pages 20-31 inclusive enter the following customers' accounts, four to the page : Quinn Bros. Stewart & Son J. Jackson S. Koenig Jacob Green Gristede Bros. M. J. Downing Dodts' Grocery Store Casazza & Sons Capella Bros. S. Brown Four Corners General Store Black Hills Mining Co. Blue Front Grocery R. B. Kennan J. Johnson Bull's Eye Mining Co. Badgley & Stewart Dewey Brown Evans Sons Fred Henry M. E. Dietrich Jas. Butler, Inc. C. A. Gerken John Johnson Fein Bros. M. Heitzman H. A. Krebs Andrew Davey Wm. Crick Russo Bros. Progressive Stores Co. J. Perlman P. Peterson Uintah Copper Co. . Circle Bar Ranch J. R. Rice Al Morton J. J. Tommich J. Henry Witt U. B. Zipkin Las Vegas Cattle Co. Beginning on page 32, enter these creditors' accounts, four to a page. Swift & Co. Korn Products Co. F. Mezzadri Austin, Nichols & Go. Reid Murdock Co. Armour Packing Co. Grand Grocery Co. Holland Gelatine Works Kataguri Bros. Van Dusen Co. Delico Food Products Co. United Supply Co. Federal Macaroni Co. Washburn Crosby Co. CHAPTER XXXII THE TWO BASIC METHODS OF ACCOUNTING AND SOME APPLICATIONS Accounting, Its Field and Method Pixley divides the field of accounting into three parts : the constructive branch, the recording branch, and the analytic or critical branch. Whether there is any particular advantage in such a division of the field is doubtful. To a beginner it may set out more clearly the scope of the work, but it does not show the method of approach and attack necessary for the satisfactory handling of the prob- lems of accounting. However, the first branch embraces the principles under- lying the records, the construction of systems to record the data required for intelligent management and control and to exhibit them in the form of periodic statements. In the second branch Pixley includes the methods of making the various records needed for the accounting of all the activities of modern business. The recording branch rests, therefore, upon the constructive, takes its direction from it, and exhibits the data and results contemplated and mapped out by it. The analytic branch comprehends the field of auditing. Montgomery in his "Auditing, Theory and Practice" says : "Auditing is the analytical, as practical accounting is the constructive, branch of accountancy," going on to say that the auditor is something more than an analyst, however. Without question, the statement brings out the controlling mental qualities needed by the accountant. He must be 258 BASIC METHODS OF ACCOUNTING 259 able to analyze facts, data, and conditions and build them into an instrument for the guidance of the business execu- tive. He uses in his work the basic methods of analysis and synthesis ; or in the language of the logician, the methods of induction and deduction. Analysis and Synthesis Analysis is the "resolution or separation of an)^hing which is compound, into its constituent elements or into its causes." In its root language, the Greek, its controlling idea is a loosening, a breaking up, and it has come to mean the freeing of an idea, fact, or condition of its extraneous elements and thereby getting at the essentials. Synthesis is the "combination of separate elements or objects into a whole." In its Greek form it gives the fundamental idea of putting several things or elements together, and it has come to mean the constructing out of the facts and essential conditions developed by analysis something to show a way of action, a policy to govern the conduct for the future. Just as the lawyer must make a careful and thorough analysis of the data and conditions involved in his case, working his way to essential and underlying facts and must then rebuild his structure in the light of well-established principles, showing their application to the essential facts discovered; so must the accountant work, proceeding by the methods of analysis and synthesis. He must, in the first place, make a study of the business and obtain a knowledge of any particular information de- sired by the owners ; in other words, he must make a careful analysis of all conditions, and then devise a method or system for the record of business dealings that shall furnish classified and partially summarized information with regard to all business activities. These data must be so combined as to bring out their proper relationships to the underlying 26o ACCOUNTING— THEORY AND PRACTICE forces of the business, and to show the final results for the period in correct perspective. This ability to weigh, judge, relate, and set forth with accuracy and truth the vital data of business, to make a diagnosis on which must rest the policy for the future — this is the type of ability demanded of the accountant by modern business. For this reason the student, in doing his daily assign- ment, should never be content with a formal solution of a problem or a technically correct record of business dealings, but should always attempt to apply underlying principles, to see the detail work in the light of the goal to which it leads. He must see the bearing, the relation which every item has to the whole ; he must allow the end towards which he is working to give direction and guidance to his effort. Otherwise his work is empty and parrotlike. Analysis and Synthesis Applied to Account Classification Thus, in our classification of accounts, the first or main groups follow closely the three general divisions of the financial statement. For purposes of detailed information, however, this threefold division has been found insufficient. So subdivisions of these main groups of assets, liabilities, and proprietorship must be made, the minuteness of sub- division being determined by the amount of detail desired. That system of accounts which groups only one kind of data under each particular account title is better than a system which mixes its records by grouping dissimilar data under a single head. Yet, caution against too great detail, an unnecessary multiplication of accounts, is always to be exercised. Oftentimes essential facts and forces of business activity are lost sight of in a maze of detail. The reasons for making certain groupings of the assets and liabilities on the basis of degree of liquidity and the advantage resulting from this grouping when making the BASIC METHODS OF ACCOUNTING 261 summary statements for the period, were discussed and illustrated in Chapter IV, and it may be pointed out here that this affords an example of the analytic and synthetic method and procedure constantly to be employed by the accountant. The Ledger; an Example of Analysis and Synthesis The book which, in the constructive work of the ac- countant, shows the application of these two methods of attack and procedure is the ledger. The ledger was defined as the book of accounts. The account is a device for sum- marizing business data of a similar or exactly opposite character. The ledger is analytic in its structure; the ac- count is synthetic in its method. Before it can be determined what accounts are to be kept in the ledger, a careful survey must be made of the requirements of the business, what in- formation is needed, and in what form such information is to be presented. This having been determined by an analysis of all the facts and conditions involved, the purpose of the ledger is to collect these facts under their respective account titles and so to summarize all the data of the business. Thus, the ledger is not only a classified, but also a sum- marized or grouped record. From the viewpoint of the information furnished, the ledger is the most important of the account books There are several kinds of ledgers, which may be classi- fied (i) as to their rulings and (2) as to their bindings. I. Rulings As to their rulings, ledgers are either standard, balance, or progressive. The standard ruling has two duplicate parts, a debit and a credit, and is usually divided-column, one money column appearing at the extreme right of each part, although sometimes the arrangement is symmetrical ACCOUNTING— THEORY AND PRACTICE ■a ■a s s ^ BASIC j\IETHODS OF ACCOUNTING 263 with both debit and credit money columns at the center, and the date columns at either side of the page. (See page 262.) The balance ruling is a three- or four-column ledger with the money columns either at the center or at the right- hand margin, or at both the center and the right-hand mar- gin. The extra columns are for the account balances. If the balance is usually either a debit or a credit, only one balance column would be necessary; where it is apt to be a debit at one time and a credit at another, a debit balance column and a credit balance column are advantageous. The balance ruling is used particularly with personal accounts where there is need for an up-to-date balance. Where this kind of ledger is used, entry of new debits or credits should always be on the next blank line as shown in the balance column, so as to allow the extension of the new balance opposite the last entry even though this should leave blank several of the preceding lines on the debit and credit sides. Typical forms of some of these are shown on pages 264 and 265. The Progressive Ruling The Boston, progressive, or tabular ledger, as it is vari- ously called, makes provision for a horizontal progress of the account as to sequence of time ; the title of the account is written at the left-hand margin, allowing one or more lines to each according to the degree of activity of each. The account title is written once at the left margin of the master or main sheet, and is sometimes repeated at the right margin, if the sheet is very wide. The page is divided into columns for each day of the period. To effect this, short-margin in- sert sheets must be bound in to give the desired room for ac- commodating a whole period's record. This style of ruling has been much used for depositors' accounts in a bank where a daily balance for each is necessary. It is capable of 264 ACCOUNTING— THEORY AND PRACTICE s 0=i BASIC METHODS OF ACCOUNTING 265 s — o 266 ACCOUNTING— THEORY AND PRACTICE UJ 3 o "t" \i^ Co cq ^^ (0 cm tn o a UJ Q 'V3 BASIC METHODS OF ACCOUNTING 267 adaptation to other uses, however. One form is shown on page 266. 2. Bindings Ledgers may be classified also as solid-bound, loose- leaf, and card; the titles being self-explanatory. One of the great advantages of the loose-leaf and card ledgers over the solid-bound ledger is their flexibility. They lend them- selves easily to any desired grouping of the accounts ; they may be numerically arranged where accounts are numbered instead of named; they may be arranged as to classes and each class made self-indexing; a geographical grouping may be made. Another great advantage is the ability to discard or file away in other binders all "dead" accounts, thus making for ease and facility in the use of the "live" ledger. Also it is possible for several clerks to work simultaneously, since the leaves or cards are removable and may be dis- tributed among any number of clerks. There is always the danger, however, of a failure to return a leaf or card, or of placing it out of regular order when returning it, or of destroying it, if it were desired fraudulently to do away with any particular account. The use of loose-leaf and card ledgers for personal accounts is pretty thoroughly established, notwithstanding the disadvantage just men- tioned. Method of Arranging Accounts in the Ledger As to the order of arrangement of accounts in the ledger, one principle governs. Arrange all accounts in such a manner as to facilitate the drawing up of the final state- ments. Thus, assets should come first in the degree of their liquidity or availability, each valuation account follow- ing its particular asset ; and the liabilities should be arranged in a similar order. Then would come the proprietor's ac- 268 ACCOUNTING— THEORY AND PRACTICE covuits, the summary Profit and Loss account, and the in- come and expense accounts in the order in which they are to be used in the statement of profit and loss. Where only one ledger is kept the personal accounts receivable and payable are usually recorded in distinct groups, after all the other accounts, towards the back part of the ledger rather than in the position required by the principle just stated. A trial balance taken from a ledger in which the order of arrangement of the accounts is strictly in accordance with this principle, is called a classified trial balance. Practice Data* (Assignment for Chapter XXXII) O. W. Ward, who had conducted a very profitable retail grocery at Big Falls, sold his business for $15,000 and moved to St. Paul to enter into a partnership with C. Gneisel for the purpose of carrying on a wholesale grocery business under the firm name of Ward & Gneisel. Ward's investment was $12,500 cash and Gneisel contributed the following assets at the values stated, which had been agreed upon by the partners: two notes receivable in his favor; one for $1,000, signed by J. B. Jackson, non-interest-bearing for 60 days, due February 4; the other for $1,500, signed by A. M, Scott, interest at 6% for 3 months, due March 8 — both accepted at face value ; a stock of groceries valued at $5,893.25 ; delivery equipment $500 ; fixtures for store $1,000 ; furniture in office $150; and cash necessary to bring his investment to an equality with Ward's. The partnership agreement provided that Ward was to be allowed a salary of $l,8oo per year and Gneisel $1,500; that each was to be charged with interest at 6% on any drawings in excess of salary from the date such drawings exceeded the salary for the half-year until the date of closing the books ; that profits and losses were to be shared equally; and that the books were to be closed twice yearly on June 30 and December 31 respectively. Make the opening entries in Journal and cash book for the above. Post these entries immediately. •See Practice Data for Chapter XXXI. BASIC METHODS OF ACCOUNTING 269 Summarized transactions for the month of January were as follows : Purchases— Swift & Co., 2/5, n/30, $512.50; Korn Products Co., 3/10, n/60, $857.90; F. Mezzadri, 8/s, 5/10, 2/30, n/90, $962.50; Austin Nichols & Co. 5/s, n/30, $1,403.25 ; Raid Murdock Co., 3/5/, 2/20, n/30, $1,865.05; Armour Packing Co., 2/20, n/30, $1,511; Grand Grocery Co., n/io, $2,667; cash purchases, $134.75. Sales— Quinn Bros., n/io, $2,189.60; Stewart & Son, 1/5, n/30, $3,942.75; J. Jackson, n/5, $2,500.25; S. Koenig, 2/10, n/30, $4,189.40; M. E. Dietrich, 2/5, n/60, $2,140.50; Jas. Butler, Inc., n/5, $3,772.37; C. A. Gerken, 3/10, n/30, $4,125; John Johnson, 1/30, n/60, $1,819.15; Jacob Green, 3/5, n/30, $2,237.40 ; Gristede Bros., i/io, n/30, $3,100.95 ; M. J. Downing, 2/10, n/30, $1,680.40; Dodt's Grocery Store, 3/5, n/20, $1,517.18; cash sales $567.45; Ward drew groceries, $50. Journal — M. E. Dietrich returned unsatisfactory goods, $250.90; made C. A. Gerken allowance of $325 for goods lost in transit and filed claim against the C. N. W. Ry. for the amount ; returned Reid Murdock Co. spoiled goods, $125 ; received 6% 60-day note, due March 28, from Gristede Bros, for January bill $3,100.95 less a special dis- count of 10%. Cash Receipts — excluding those listed above : Quinn Bros., Jan- uary bill $2,189.60 net; S. Koenig, January bill $4,189.40 less 2%; M. E. Dietrich, balance January bill $1,889.60 less 2% ; C. A. Gerken, balance January bill $3,800 less 3% ; Jacob Green, January bill $2,237.40 less 3%. Cash Disbursements — excluding those listed above : bins, shelving, partitions, counters, etc., for store $2,500 ; desks, tables, typewriters for office $580.20; new horse $300; deposit for electric current meters $50; sales salaries $2,500; sales traveling expense $2,650.50; advertising $2,180.95; shipping clerks $750; lumber, boxes and other packing ma- terial $120.80; freight and drayage bills $310.30; rent of store for January $250; insurance January I, 1917 to January i, 1918, $116.80; coal $90 ; light $10.82 ; office salaries $500 ; moving office partitions $50 ; account books, stationery, stamps, etc., $125.90; janitor and watchman wages $91.80; gift to deaf asylum $25; Ward, $150; Gneisel $125; Swift & Co. January bill $512.50 less 2% ; Korn Products Co., January bill $857.90 less 3% ; Reid Murdock Co., balance January bill $1,740.05 less 3%; rent for February $250; F. Mezzadri, January bill $962.50 less 8% ; Austin Nichols & Co., January bill $1,403.25 less 5% ; Armour Packing Co., January bill $1,511.00 less 2% ; bought 5 Lewiston School Bonds, bearing 6% interest, par $1,000, at loi and accrued interest for 60 days, coupons due November 24 and May 24; there was a cash shortage of $1.25. 2/0 ACCOUNTING— THEORY AND PRACTICE Instructions Enter the investment transactions complete in the Journal, check- ing the "cash" items. Be careful to enter all cash transactions in the cash book whether listed under "Cash" above or not. In entering the purchase of Lewiston bonds in the cash book charge "Lewiston School Bonds" account with the cost value and "Interest Income" with the accrued interest. The transaction means that he paid $1,010 for each bond and bought out the seller's right to the interest earned up to the date of sale. The entry of this accrued interest to the debit of Interest Income will offset the credit to be made there when the interest for the six months is received, and thus show, by the balance between the two entries, the true earning for the period during which the bonds were held. No record is made on the books of account of the claim for loss filed against the railroad company. Were there many such claims, a "Claims Record" book would be used as a memorandum record. The word, balance, as in the phrase, "C. A. Gerken, balance Jan- uary bill less 3%" calls attention to an adjustment of some sort — returns or allowance — to be considered in determining the amount still due. It will be noted that some transactions are, on their face, for a longer period than the 6-months period under review. It is suggested, as a convenient method for keeping track of all such data which will have to be adjusted at the end of the period, that page 48 in your Journal be used as a memo for this purpose. Make record there of original date, term covered by the payment, amount, and particulars of the transaction. For example, the i yr. insurance policy of Jan. i is an item of which to make memorandum record here. CHAPTER XXXIII PARTNERSHIP FROM THE BUSINESS VIEWPOINT Partnership Defined In Chapter III, reference was made to some of the fea- tures of a partnership — the purpose of its formation, ad- vantages, disadvantages, etc. The laws of the State of New York define a partnership as follows: "A partnership, as between the members thereof, is the association, not incor- porated, of two or more persons who have agreed to com- bine their labor, property and skill or some of them for the purpose of engaging in any lawful trade or business, and sharing the profits and losses as such between them." This definition brings out in a general way the reasons for the formation of the partnership and its essential fea- tures. Under this type of organization, where several persons combine their capitals, it is possible to secure a larger fund of capital than under the sole proprietorship. This opens to the partnership avenues of business usually closed to the sole proprietor. The bringing together of the man with a special aptitude or skill along certain lines, or of a man with a following in the community on account of social standing and acquaintanceship, with another who has money or a plant for the operation of a business, often makes successful an otherwise unpromising undertaking. Operating Feature and Working Organization Mutual agency is the essential operating feature of the partnership. Except in the case of a limited partnership, to be mentioned later, each partner has an equal voice in the 271 272 ACCOUNTING— THEORY AND PRACTICE management and control of affairs. Unlike the corporation where for management purposes the owners' powers are delegated to a controlling board, the essential character of the partnership is that each partner has, regardless of the amount of his investment, an equal right in the direction of its business. As between themselves, for purposes of division of duties and specialization of efforts, definite power to exercise control over certain features of the busi- ness may be delegated to individual partners. But such delegation means nothing more than a method of dividing the work and is simply the working organization of the firm which may be changed at any time the majority of the partners see fit. Thus, while a partner may be limited in his actions for the firm by agreement among the partners, so that he is not a general agent for the firm, still as to outsiders who know nothing of this internal arrangement, he has power to bind the partnership by his acts, because an outsider has a right to expect that any partner has power to act as an agent for the firm. This is so because such power is of the essence of the partnership form. Essential Characteristics of the Partnership Limited life is an essential characteristic of the partner- ship. The partnership relation is a very personal one. It can be terminated in a number of ways, but the death or retirement of any member automatically works a dissolution of the firm, even though another man takes his place. The legal theory is that the old partnership is dead and a new one, even though bearing the same firm name, has come into existence. Thus a partnership cannot be perpetual. The relationship between the partners is so intimate that the suc- cess of the undertaking depends fundamentally on the good faith and honor exercised by each partner towards the others, and therefore, any addition to the personnel of a PARTNERSHIP— BUSINESS VIEWPOINT 273 partnership can be made only with the consent of all mem- bers of the existing firm. The partnership being the outgrowth of the sole pro- prietorship, certain of the aspects of the earlier form still cling to it. For suit at law it is looked upon as a collection of single owners, and action on contract must usually be taken against the individual members of the firm. Suit by or against the partnership cannot, as a rule, be brought in the firm name. Some states, however, allow this under recent enactments. Title to personalty can be held and transferred under the firm name, but realty must be in the name of the individual members or in the name of one member acting as trustee for the firm. Thus, while in the view of the business community, the copartnership is a business entity under a firm name, in the sight of the law it is not an entity but merely a collection of single owners. This legal view accounts also for the full debt liability of every partner — except in a limited partnership. In case the firm assets are insufficient to meet the claim of creditors, any or all the partners' private resources may be levied. Co-ownership of the profits of a business is another feature essential to the copartnership. No sharing in the profits on any other basis than that of co-ownership will constitute a partnership. When the question comes before the courts, the intention of the parties governs, and evidence showing that each acted as principal for himself and as agent for the others, and has shared profits as profits, would be sufficient to constitute the relationship. The Partnership Contract A partnership being a contract relationship, all the re- quirements governing legality of contracts, such as agree- ment, consideration, lawful object, competency of contract- ing parties, etc., apply to the copartnership. The contract 274 ACCOUNTING— THEORY AND PRACTICE may be oral or in writing. In case of dispute an oral con- tract, on account of the difficulty of proof, is of little force in regulating the relations of the partners, and the general law of partnership would usually govern. Inasmuch as there is so great an opportunity for disputes in a relation- ship of this sort, it is imperative, if efficient working rela- tions are to be maintained, that very carefully drawn articles of copartnership be agreed upon before active business is begun. These articles should contain, at least, the following : 1. The name of the firm and of the partners. 2. The kind and place of business. 3. The duration of the partnership 4. The method of terminating it. 5. A detailed statement of the relations between the partners, such as duties and powers, capital con- tributions, withdrawals of capital, salaries, divi- sion of profits and losses, interest on capital, and the time of closing the books to secure a definite determination of the partners' interests. Even when the utmost care is exercised in drafting the articles of partnership, it almost always happens that some portion is not understood alike by all or that some con- tingency arises not specifically provided for. Nevertheless, it is the only way in which a comparative avoidance of mis- understanding and dispute can be obtained. Partnerships Classified As to the scope of their business operations, partner- ships are usually classified into general and special. The general class embraces those for the conduct of some general or ordinary lines of business. The special class comprises those formed to undertake a definite task or some particular PARTNERSHIP— BUSINESS VIEWPOINT 275 line of business. Joint ventures would come under this latter class. As to the liability of their members, partnerships may be classified as general and limited. The general partner has the full liability, referred to above ; the limited partner's liability never exceeds the amount of his investment. In a limited partnership one or more, but not all, members may limit their liability. This class of partnership can be formed only under direct authority of statute law. A limited partner is not active in the management of the business, being more in the nature of a lender of money to the firm, who gets his return in profits instead of interest. Should he become active in the firm's management, he will con- stitute himself an ordinary partner with full liability. The New York statute governing the formation of the limited partnership is as follows : Two or more persons may form a limited partnership which shall consist of one or more persons of full age, called general partners, and also of one or more persons of full age who contribute in actual cash payments, a special sum as capital, to the common stock — or fund — called special partners, for the transaction within this state of any lawful business, except banking and insurance, by making, severally signing and acknowledging and causing to be filed and recorded in the clerk's office in the county where the principal place of business of such partnership is located, a certificate in which is stated : 1. The name or firm under which such partnership is to be con- ducted and the county wherein the principal place of business is to be located. 2. The general nature of the business intended to be transacted. 3. The names, and whether of full age, of all general and special partners therein, distinguishing which are general and which are special partners and their places of residence. 4. The amount of capital which each special partner has con- tributed to the common stock — or fund. 5. The time at which the partnership is to begin and end. Affidavit of the payment of capital must be made and a notice of the formation of the partnership published in a 276 ACCOUNTING— THEORY AND PRACTICE paper of general circulation. The limited partnership is thus hedged about with safeguards for creditors, bankers, and other interested parties, particularly by the rule that a limited partnership cannot exist unless there are one or more general partners with full liability. The Joint-Stock Company The joint-stock company is a partnership or association in which ownership and voice in the management, and profit-sharing ratio are evidenced by transferable shares of stock. Control and management are exercised through a board of directors chosen by the stockholders. If the com- pany becomes bankrupt and the firm assets are insufficient to satisfy creditors, the members are personally liable to the full extent of their private property in the same way as in a general partnership. The mining partnership is a form of joint-stock com- pany which operates in mining communities. Usually the mining property itself is beyond the scope of such a partner- ship, only the development of this property by means of a lease being contemplated. Of course, the profits arising from such development are within the scope and for the benefit of the mining partnership. Partners Classified Finally, brief mention may be made of the following different classes of partners, all within the ordinary partner- ship: 1. Ostensible partners — those who hold themselves out and are known as partners. 2. Nominal^those who are known as partners but who have no real interest in the firm. T,. Dormant or silent — those who are not known to PARTNERSHIP— BUSINESS VIEWPOINT ■2'1'7 outsiders as partners and who take no active part in the management of the firm's affairs. 4. Secret partners — those who are not known as part- ners to outsiders but who have an interest and take active part in managing the firm. For more detailed information as to a partner's rights, duties, and responsibihties to his copartners and to out- siders, a standard legal text on partnerships or business law should be consulted. The student should also read Chapter III in connection with this chapter and the next. P'RACTiCE Data* {Assignment for Chapter XXXIII) Summarize the sales and purchase journals, balance the cash book, and post completely all books of original entry. The sales and purchase journals will be summarized as in the J. M. Butcher problem (at end of Chapter XXVII). Before balancing the cash book, draw a total line for the "Sales Discount" column on the debit side, enter the total on the first blank line, writing in the explanation column opposite it, "Sales Discount, Dr." This is the item which will be posted. Handle "Pur- chase Discount," similarly on the credit side, and enter the "Balance" of cash on hand on the next line below, extending it to both the "Sundry" and "Net Cash" columns. Now rule both sides on the same relative lines, show totals for all three columns, and bring down the balance, extending it in both columns. Take a trial balance of your ledger, being sure to include the cash balance, and record it under date of January 31, beginning on page 22 of the Journal blank. Write "Trial Balance 1917" at the top of the page and in the small space over the money columns "January 31." Reserve the first line of your trial balance for "Cash." From the ledger, copy the names of all accounts — whether or not there are as yet any entries in them — in the order there shown. Be careful to *See Practice Data for Chapter XXXII. 278 ACCOUNTING— THEORY AND PRACTICE write the account name at the extreme left of the "Explanation" space, close to the "Date" column. Leave one line at the bottom of the page for "Totals forward" ; likewise one line at the top and bottom of pages 28, 34, and 40. Since one page is not sufficient to complete the record, continue it on pages 28, 34, and 40, there recording the rest of the accounts and heading the page and columns as on page 22. The in- tervening pages will be used as shown in Practice Data of Chapter XXXV. CHAPTER XXXIV PARTNERSHIP FROM THE ACCOUNTING VIEWPOINT Frorrii the fact that the law looks upon the partnership as a combination or collection of sole owners, some of the accounting problems arising out of the partnership form are unique and a partial or full treatment of these problems will be given in this chapter. Profit-Sharing in the Partnership Of these problems perhaps the one occurring most fre- quently is that concerning the division of profits. Atten- tion was called in Chapter XXXIII to the need of explicit statement on this point in the articles of copartnership under the head of the inter-partnership relations. Since men com- bine their capitals for the purpose of realizing profits, it vrould naturally be supposed that all partnership agreements would be specific on that point. Yet it very often happens that many contingencies relating to the matter of profit- sharing have not been foreseen and as a result disputes arise. This is frequently the case, either because the articles were drawn up by a person — usually a lawyer — unfamiliar with partnership problems from the accountant's point of view, or because more or less formal agreements were entered into by the partners themselves without consulting others who might have been in a position to foresee certain con- tingencies and provide for them in the articles. The fundamental principles governing profit distribution may be stated as follows; 279 28o ACCOUNTING— THEORY AND PRACTICE 1. Where the agreement is silent, the law provides that profits shall be divided equally among the partners regard- less of the amounts of their respective investments of capital. Some partners may have made no investments of money or property, setting up their particular skill and aptitude or standing in the community as their share and contribution to the profit-earning capacity of the organization. Unless it is specifically agreed otherwise, these will share equally in any profits. 2. Where profits are to be shared in the same ratio as capital, the agreement should specify whether the basis of division is to be the original investments or the capitals as shown at the beginning of each period, which would be the original investments plus profits left in the business. This latter interpretation would usually result in a changing ratio for succeeding periods, whereas under the former interpretation the ratio of profit-sharing would be always the same. 3. Provision should be made, either in the original articles or at a subsequent time, for a change in the profit- sharing ratio in the event of a partner's withdrawing some portion of his original investment if such withdrawal is allowed. It may be stated here that an agreement between the partners as to any ratio for division of profits can be made at any time and will govern such ratio, but must be on a determinable basis. 4. Where the articles are silent as to the division of losses, the profit-sharing ratio governs. Where a different ratio is desired, specific statement of it must be made. Of course, upon the inception of an undertaking losses are not contemplated, but the experience of others should cause provision to be made for apportionment of losses in order to avoid possible difficulties or disputes. 5. Unless the articles — or subsequent agreements — pro- PARTNERSHIP— ACCOUNTING VIEWPOINT 281 vide for the payment of salaries to any or all of the partners, none are allowed. 6. The conditions governing the partners' drawings should be explicit as to the amount to be drawn during a given period. It should be stated explicitly whether excess drawings shall be regarded as a charge against capital, or as the basis for an interest charge, or simply as an excess drawing standing in the partner's current account without penalty other than a disallowance of future drawings until lapse of time brings the total amount drawn within the agreed limitations. Average Investment as a Basis for Profit-Sharing Attention should be called to a basis not frequently em- ployed, except in some cases of special partnerships entered into for the construction of a specific contract or for doing any special work. In these cases the capital needed may not be known at the start or, if known, may not all be required then, but is to be furnished by whichever partner may have available funds at the time of need. In such cases the basis of profit-sharing may be made the amount of capital furnished by each partner and the length of time of its use in the enterprise. Two methods of determining the ratio may be employed. First Method. Each investment may be multiplied by the number of days occurring between the date on which the investment was made and the date of profit determination, giving a result which may be called day-dollars of invest- ment in a sense similar to the term foot-pound in physics. From the total day-dollars of investment must be subtracted the day-dollars of withdrawals, arrived at similarly, thus showing net investment in terms of day-dollars. The sum of all the investments in day-dollars becomes the basis on which to prorate profits, each partner's share being the part 282 ACCOUNTING— THEORY AND PRACTICE which his individual net investment bears to this total net investment. Second Method. The original investment of each part- ner may be multiplied by the time it remains unchanged, i.e., until it is added to or some portion is withdrawn. Similarly, this changed capital is multiplied by the time it remains fixed, and so for every change. The total of these items constitutes each partner's net investment, from which the profit-sharing ratio is determinable as above. In the problem given below, to shorten the operations the dates are so taken that calculation can be made on a month- dollar instead of a day-dollar basis. The capital accounts of the partners, showing investments and withdrawals, are as follows: A. B. Card 1917 Jan. IS $2,500.00 Apr. 1 4,500.00 June IS 1,500.00 1917 Jan. I $10,000.00 Mar. 15 7,500.00 June 1 5,000.00 D. E. FOLWELL 1917 Feb. I . May 15. $3,000.00 2,000.00 1917 Jan. I $5,000.00 IS.... 5,000.00 Apr. 1 5,000.00 June IS 2,500,00 Profits as on July i, 19 17, were $5,000. Determine each share. PARTNERSHIP— ACCOUNTING VIEWPOINT 283 A. B. Card: $10,000 X 7,500 X 15,000 X 10,500 X 15,500 X 14,000 X Solution (Using the second method.) Months Month-dollars H $5,000 . 2 15,000 H 7,500 2 21,000 'A 7,750 V2 7,000 $63,250 D. E. Folwell: $5,000 X y^ $2,500 10,000 X V2 5,000 7,000 X 2 14,000 12,000 X I^ 18,000 10,000 X I 10,000 12,500 X y 6,250 Total investment in month-dollars 55,750 $119,000 Card's share of the profit: 63,250 Folwell's share: 119,000 55,750 119,000 of $5,000 = $2,657.56 of $5,000 = $2,342.44 The first method will, of course, give identical results. The second method has this slight advantage that the "Investment Months" column will always total the same as the length of the fiscal period, provided each partner made his initial investment at the first of the period — which is not always the case — and acts as a check on the. accuracy of that part of the calculation. This is a doubtful ad- 284 ACCOUNTING— THEORY AND PRACTICE vantage, however, since accuracy is a prerequisite in all work of this kind and the first method is often the quicker and easier to operate. Interest on Partners' Investments A second problem of importance in connection with partnership accounting is the matter of allowing interest on partners' investments. The purpose of allowing such interest is twofold: First, it may serve as an indication of . the excess of the profits in this enterprise over what might be obtained from the investment of a like amount in the money markets of the country, and, therefore, divides the profits into two parts, interest and management earnings; and, second, it may serve as a method of distributing profits up to a certain amount on the basis of capital investments, where the agreed-on ratio is different from the capital ratio and thus secure a distribution of the period's profits on two different bases or ratios. This is done sometimes to equalize somewhat the comparatively smaller-ratio profits of the partners who have made the larger investments. This problem, however, will be treated more fully in a later chapter where the methods of booking the interest, its treatment in case of a loss instead of a profit, and the com- putation of interest on drawings as well as on investments will be discussed and illustrated. Suffice it to say here that disputes frequently occur in connection with these problems and that detailed provision as to their handling should be made in the partnership agreement. Valuation and Correct Booking of Original Investments A third matter of importance is the valuation and correct booking of the original investments other than cash. In the case of the sole proprietor this is of comparatively little importance because he will always reap the entire gain and PARTNERSHIP— ACCOUNTING VIEWPOINT ^85 therefore suffer no harm ultimately from present under- valuation of his property investments. In the partnership, however, where separate investment and personal accounts must be kept with each member, the matter of correct valua- tion of the properties invested is of importance inasmuch as these properties, as soon as they are invested in the partnership, become the joint property of all partners and all will share ultimately in the effect of any under- or over- valuation at the time of investment. The partners' accounts are set up for the purpose of showing their respective inter- ests in the enterprise and after investments are once brought onto the books these accounts govern the equities of the various partners. Distinction Between Buying Out an Interest and Making an Investment to Secure an Interest The taking in of a partner by a sole proprietor or his admission as a- new member to an existing partnership raises a point about which a very definite understanding must be had. A distinction must be made between purchas- ing from the owners an interest in the business as it stands at any given time and making an investment in a business in order to secure an interest in it. The first transaction is of a personal nature between the owners and a third party who is a purchaser ; in the other transaction the third party, who is an investor, puts in money to acquire an interest and his investment becomes the common property of all the owners of whom he is now one. In the one case the capital of the business is not increased, in the other case it is increased by the amount of the new investment. For ex- ample, if a balance sheet shows : Cash $5,000.00 Other Assets 15,000.00 Liabilities $6,000.00 A. Jackson, Capita! 14,000.00 286 ACCOUNTING— THEORY AND PRACTICE and Jackson sells a half-interest to B. Killian for a given consideration, the new balance sheet becomes : Cash $5,000.00 Other Assets 15,000.00 Liabilities $6,000.00 A. Jackson, Capital 7,000.00 B. Killian,. Capital 7,000.00 In this case no new capital has come into the business be- cause the purchase price does not go to the business as such but to A. Jackson as a private individual. If, however, Killian is admitted as a half-interest part- ner by making a cash investment equal to the amount of Jackson's interest on the basis of book values, the balance sheet of Jackson and Killian will read : Cash $19,000.00 Other Assets 15,000.00 Liabilities $6,000.00 A. Jackson, Capital 14,000.00 B, Killian, Capital 14,000.00 showing an investment of double the capital of the original Jackson business. The question of good-will which frequently comes up when an interest in a going business is secured will be treated in Chapter XLI, where also the manner of closing the books of the old business and opening those of the new firm will be shown. Final Cc«isiderations From the foregoing discussion it is evident that the part- nership relation gives rise to some of the most vexing questions which confront the accountant and the lawyer. It is a truism, therefore, that in making the partnership agreement all eventualities should be foreseen as nearly as possible and that they should be carefully provided for. As a final safeguard it is well to provide for the submission to PARTNERSHIP— ACCOUNTING VIEWPOINT 287 arbitrators of disputes subsequently arising, the decision to be binding upon all the partners. This will avoid endless, expensive, and usually unsatisfactory actions at law and will more nearly secure justice to all. As a step in the same direction it is suggested that provision be made for the drawing up of correct balance sheets and profit and loss statements, that sufficient time be allowed each partner to examine them as to their correctness and, if satisfied, that each be compelled to subscribe to them. This will localize any dissatisfaction within a limited time period and secure its adjustment while all salient points are still fresh in the minds of the interested parties. Practice Data* (Assignment for Clmpter XXXIV) Summarized transactions for February were : Purchases— Holland Gelatine Works, 2/s, n/30, $3,3S8.2S ; Kataguri Bros. 3/10,. n/60, $2,054.75; Van Dusen Co., 8/5, 5/10, 2/30, n/90, $3,946.95 ; belico Food Products Co., 5/5, n/30, $2,506.45 ; United Sup- ply Co., 3/s, 2/20, n/30, $4,521.55; Federal Macaroni Co., 2/20, n/30, $334.05; Washburn Crosby Co. n/io, $5,568.30; cash purchases $i5S-8-- Sales— Casazza & Sons, i/S, n/30, $1,942.67; Capella Bros., 2/5, n/60, $3,189.65; S. Brown, 3/10, n/30, $3,920.18; Four Corners General Store, 3/5, n/60, $4,682.40; Black Hills Mining Co., i/io, n/30, $1,580.90; Blue Front Grocery, 2/5, n/20, $2,967.45; R. B. Kennan, 2/10, n/30, $3,852.75; J. Johnson, 1/5, n/60, $4,120.80; Bull's Eye Mining Co., n/io, $2,879.20; Badgley & Stewart, 1/5, n/30, $3,755-35; Dewey Brown, n/5, $1,925.47; Evans Sons, 2/10, n/30, $3,248.85; Fred Henry, 2/5, n/60, $3,869.68; cash sales $1,236.40; Gneisel drew groceries, $60. Journal — Goods were returned by S. Brown $179.80, and R. B. Kennan $275.20, as unsatisfactory; made Four Corners General Store an allowance of $25 account of inferior goods; the January freight •Practice Data for Ward & Gneisel set begin with Chapter XXXI. 288 ACCOUNTING— THEORY AND PRACTICE bill, charged to In-Freight, was found upon analysis to contain freight paid on sales amounting to $29.87. Cash Receipts— Stewart & Son, January bill $3,942.75 net; Jas. Butler, Inc., January bill $3,772.37 net; John Johnson, January bill $1,819.15 less 1%; Casazza & Sons, February bill $1,942.67 less 1%; S. Brown, balance of February bill $3,740.38 less 3% ; Blue Front Grocery, February bill $2,967.45 less 2% ; Badgley & Stewart, February bill $3,755-35 less 1%; Fred Henry, February bill $3,869.68 less 2%; cash was over $2.25; Jackson's note for $1,000 came due and was paid February 4; sold crating materials, $20.50. Cash Disbursements — Grand Grocery, January bill $2,667 net; Holland Gelatine Works, February bill $3,358.25 less 2% ; sales salaries $2,500 ; salesmen's railway mileage, entertainment, etc., $2,870.90 ; adver- tising $3,670.15; shipping clerks $750; paper, twine, wrapping supplies, $100.70; freight and drayage bills $750.80; rent for March $250; Kataguri Bros., February bill $2,054.75 less 3% ; light and power bill $105.18; office salaries $500; Van Dusen Co., February bill $3,946.95 less 8% ; board of horses, blacksmith, etc., $125.25 ; typewriter repairs $5 ; Delico Foods Products Co. February bill $2,506.45 less 5% ; printer's bill for office supplies $72.80; watchman and janitor $85; gift to Red Cross $28.75 ; United Supply Co., February bill $4,521.55 less 3% ; Federal Macaroni Co., February bill $334.05 less 2%; Ward drew $150; Gneisel, $125 ; cash was short $7.25. Instructions When the freight and drayage bills are paid, charge is made to In-Freight and Cartage. Subsequent analysis shows the amounts paid on sales to customers made f.o.b. destination. Journal entry is made once a month to correct the original charge. Credit sales of crating material and other similar- sales items to Miscellaneous Sales through the cash book only. CHAPTER XXXV HANDLING THE CASH General Considerations In keeping record of the various properties of a concern, the greatest care is usually exercised in accounting for the asset cash. This is done because of the difficulty in tracing money that is lost or stolen and the ease with which the thief may get rid of it, due to the universal use of money as a medium of exchange, and also because of its great value in comparison with its small bulk. Merchandise, supplies, and the like may be got away with but not so easily and profitably. Oftentimes, however, too little care is exercised in the safe-keeping of merchandise, and consec[uently in some lines of business real and large losses occur. Absolute prevention of losses cannot be expected even with the em- ployment of all possible precautions, but experience shows that certain general safeguards should be placed about both cash and merchandise. After everything possible is done in the way of system, mechanical devices, and checks against the misappropriation of funds, in its ultimate analysis the best safeguard is the integrity of the employee. However, the employer who makes the abstraction of his cash an easy matter is guilty of tempting his employee to do a dishonest act. Principle of the Double Record A fundamental principle in the handling of the cash is to secure a double — not a duplicate — record of its receipt and disbursement, The practice of depositing in a bank 289 290 ACCOUNTING— THEORY AND PRACTICE all cash receipts and making disbursements only by check secures this double record — the bank's record and the cash- ier's record. Any discrepancy is detected whenever com- parison of the two records is made. Most concerns object to issuing checks for small amounts and set a minimum below which they refuse to issue them. For the purpose of paying these small amounts, a petty cash fund is provided from which disbursements are made in cash. This fund is established, in the first instance, by a check on the general cash and is replenished by check from time to time, and in this way double record is secured. Handling the Petty Cash Two general methods of handling the petty cash are met with. Under the one, entry of the check creating the fund is made as an immediate charge to some expense ac- count and no further accounting is required. This method is based on tlie theory that it is to be used for petty expenses anyway, and might as well be so charged now as later. Subsequent amounts for replenishment of the petty cash are treated in the same way. The objection to this method, from the accounting viewpoint, is that it results in an in- accurate record of expense distribution and a misstatement of the facts in that it charges to expense an item which at the time of the charge is still a part of the general cash fund. The second and chief objection is that it encourages in the petty cashier loose methods in handling and accounting for the fund, as usually no strict reckoning is required. The second method, known as the imprest method, is in more general favor. This charges the original check creating the fund to an account called "Petty Cash." The petty cashier is required to secure a receipted bill, sales ticket, or other voucher for every petty cash item of ex- penditure, so that at all times the amount of cash in his HANDLING THE CASH 291 possession added to the receipted bills and vouchers must equal the original amount in the fund. Usually the fund is a fixed amount, its size depending upon the needs of the business for these small expenditures. When the cash in the fund becomes low, the petty cashier turns over his re- ceipted bills to the general cashier who issues a check for their exact total to replenish the petty cash by the amount of its depletion, thus restoring it to its original fixed amount. The expenditures as shown by the receipted bills and vouchers are classified and entered by either of the follow- ing methods : ( i ) as a charge to the several accounts through the general cash book, offsetting the petty cash re- plenishing check; in this case no charge ever appears in the "Petty Cash" account except the item covering the original check; or (2) entry is made through the journal debiting the various expense and other items and crediting Petty Cash. This necessitates charging in the general cash book the replenishing check to Petty Cash as an offset to the journal credit of the same amount. Most accountants con- sider the postings to the Petty Cash unnecessary — except the original — and so check both in cash book and journal. If, however, posting to the Petty Cash account in the gen- eral ledger is made whenever the fund is replenished, this would serve to indicate the activity of the fund on the face of the ledger account — information which could just as easily be obtained from the petty cash book. The imprest method thus effects a careful accounting of the petty ex- penditures. The Petty Cash Book The petty cash book is usually a columnar record with all the columns to the right of the explanation space. The first column on the left is the receipts column, the second the disbursements column, the others being distributive from 292 ACCOUNTING— THEORY AND PRACTICE HANDLING THE CASH 293 the disbursements column under appropriate titles. Its form is somewhat as shown on page 292, with typical entries and balancing. Sometimes the classified summary which is made the basis of the general cash book or journal entry referred to above is shown in the petty cash book, the account titles being- written in the explanation column with the amounts opposite in the credit column underneath the $100 total. The items of this summary are then posted to the ledger, and the debit of the replenishing check to Petty Cash on the general cash book is "checked" in the ledger folio column. Or if the distributive column titles give sufficiently analyzed account titles, their totals may be posted without formal summari- zation, posting being shown by the small-figure ledger page in each column, as in the illustration. Where the petty cash book is used as a posting medium, of course, no summari- zation of it is made either in journal or general cash book. Keeping the Bank Account Several different methods of keeping the bank account are in use. Sometimes the check stub is the only record kept; in Chapter XXVI reference was made to the two methods of keeping the account on the stub. Provision is made either on the face or back of the stub for the entry of deposits. When made on the face, each check is usually subtracted from the previous balance and the new balance shown. When deposits are recorded on the back of the stub — or on a special deposits interleaf — check totals and deposit totals may be carried forward from leaf to leaf without showing any balance. A better method is to use the stub only as a memo from which to make formal entry in the cash book where a bank column for deposits on the debit side and one for checks on the credit side are shown. These bank columns may be 294 ACCOUNTING— THEORY AND PRACTICE used solely for the purpose of keeping the bank account, by showing the totals of deposits — but not the items composing each deposit — and the checks ; and further, they may be used for the purpose of furnishing weekly or monthly totals for posting to a ledger account kept with the bank, thus making the ledger self-balancing without having to bring in the cash book balance. If, however, the principle of double rec- ord, explained early in the chapter, is followed, there is no need of a special bank deposits column since the total of the "Net Cash" column gives the amount of each day's deposits, and on the credit side similarly the "Net Cash" column shows the checks drawn against the bank. Thus the policy of depositing all receipts and disbursing only by check has an added advantage in that it simplifies the keeping of the rec- ord of cash as well as proving it. Under this method, the cash journals may be summarized, just as the other journals, and posted to a Cash account in the ledger. Detailed in- structions for the handling of the entries, balancing, and closing under this method are given in Chapter XLVII. A rather tmusual method is sometimes met with, where a "Currency" column is carried on each side of the cash book, supplemented by "Bank" columns for deposits and checks on the debit and credit sides respectively. In the debit "Currency" column are entered all receipts of money in regular course. When the bank deposit is made up, its amount is entered as a charge to the bank in the credit "Currency" column and also, as a memo, it is entered in the debit "Bank" column. All checks as drawn are entered in the credit "Bank" column. Thus it will be seen that the bal- ance of the "Currency" columns should show the actual amount of cash in the cash drawer at any time, and the dif- ference between the "Bank" columns should show the bal- ance in the bank. Though somewhat complicated, the method may under certain conditions give good results. HANDLING THE CASH 295 Of course, under all methods of keeping the cash record, the requirement that all cash received be deposited and pay- ment be made only by check should be strictly adhered to. Entering Checks on the Cash Book When all disbursements are by check, every check drawn must be entered on the cash book and accounted for. Entry should be made in numerical sequence, any spoiled checks being entered with suitable explanation in this sequence, with the amount left blank or entered as usual, but in the latter case the amount of the spoiled check must also be in- cluded in that day's deposits, and the bank's cancellation stamp must be secured. Neither the deposit nor disburse- ment is posted, each entry being marked "contra" by way of explanation. This effects an inflation of the total receipts and disbursements, but, inasmuch as the bank's record shows it also, adequate check is secured. The new check taking the place of the one spoiled is entered in regular order. The method just discussed is perhaps the best way of recording the exchange of checks for cash. Sometimes a concern is asked to exchange its check for currency, the party making the request desiring to send the check through the mails or for other purpose. The entry is best made on both the debit and the credit side of the cash book with reference "contra" in each case, but neither entry need be posted. This makes the cash book record check against the bank record and shows the full history of the transaction. When we cash others' checks from our currency, or when, we receive in payment of a debt a check of larger amount and return the difference in cash, no record need be made of it, as only the nature — not the amount — of the deposit for the day is changed and no disbursement is made which affects the bank account. When, however, we cannot make 296 ACCOUNTING— THEORY AND PRACTICE change in currency and issue our check for it, record should be made, debit and credit, as above. Branch Cash — The Working Fund Frequently in the case of branches or of a factory located at a distance from the main office, cash working funds must be provided for current expenses. When the branch or factory keeps a separate set of books, the advances of the working fund must be charged to them and a careful audit of the way they handled this fund must be made periodi- cally, just as would be done with an independent concern. Another treatment of such money transfers is along the general lines of the imprest method above referred to for handling the petty cash. The original advance is charged to "Factory" or "Branch Cash," and deposited in the branch's local bank to the credit of the head office with privilege of use by the branch. The branch may draw checks against it, sending the head office the cancelled checks as supporting vouchers for their disbursements. / These cancelled checks become the basis for the replenishing checks and also of the charges for branch expenditure on the head office books. If the branch is a selling agency making sales for cash and on account, a modification would be necessary. Daily reports should be required from the branch. Its cash re- ceipts should be deposited daily and a duplicate deposit ticket should be forwarded to the head office by the bank. The bank should be asked also to forward all cancelled checks. All collections on customers' accounts should be made from the head office. This would not prevent the abstraction of cash before deposit, but would place control or oversight of the bank cash account in the hands of the head office and secure a careful accounting of it. Proper safeguards for the cash should always be pro- HANDLING THE CASH 297 vided. Some considerations relative thereto will be pre- sented in Chapter LIII. Practice Data* {Assignment for Chapter XXXV) Post completely and take a trial balance as of February 29. In making record of this and succeeding trial balances, to obviate the necessity of rewriting account titles, fold back the two money columns on page 23 so that they "face up" on page 24, thus providing four money columns. This shortened leaf may now be used for recording trial balances for February and March. Similarly with succeeding leaves. ♦See Practice Data for Chapter XXXIV. CHAPTER XXXVI DISCOUNTS Definition and Kinds A discount is a deduction from a listed or named figure. The manufacturer and the wholesaler in making up the catalogues of their products for the trade, usually enter them therein at certain prices — called list prices — which are not selling prices, but are nominal amounts on which the sale price is based. This method contemplates a deduction from list price which is called "trade discount." The usual quotation of sale price is at so many per cent below list price. Among practically all merchants, a very common prac- tice is to bill goods to customers, allowing settlement on an optional basis. They may be billed "net," i.e., the amount shown in the invoice must be paid. Since there is a re- lationship between the time allowed for payment and the amount to be paid, most concerns have an established credit term, at the end of which time they expect full settlement of the account. For earlier payment they offer as an in- ducement a reduction in the amount to be paid. This is stated usually at so much per cent below the billed price, and is generally called "cash discount." The practice had its origin in conditions prevailing at the close of the Civil War when the risk on accounts even for short credit terms was very great. Bankers when making loans usually deduct from the face of the loan the interest charge for the use of the nionej. This deduction is called "bank discount." Merchants usually allow a deduction for the prepay- 298 DISCOUNTS 299 ment of a customer's note, and this is called "commercial discount," to distinguish it from bank discount, ahhough in their essentials the two kinds are identical; the only difference is that in the one case the bank buys another's note, while in the other case it is a transaction between two commercial houses, the one buying back its own note before it is legally due. Accounting takes cognizance of these four kinds of dis- count, although trade discounts are very seldom met with on the books, the actual selling price and not the list price being entered. In the case of cash discounts, if the merchant knew at the time of the sale, which optional basis of settlement would be chosen, he might record the transaction at a net figure on that basis without entering the discount portion. This would, of course, result in a varying figure at which sales were booked. In the case of bank discount, the discount portion has to be booked in order to show the cost of the loan and to maintain the equilibrium between the two sides of the entry. The matter of bank discount and the reason for so handling it will be treated in detail under Chapter XXXVII, "Notes and Bills." The Method and Purpose of Trade Discount Trade discounts are so universally met with that an extended discussion will be of value to the student. As was stated above, a trade discount is a deduction from the Hst price and this method of quoting prices to the trade serves two purposes. The price listed in the catalogue can not be changed until a new catalogue is printed. It would not be practicable to print a new catalogue whenever a change in selling price is made. Instead of this, new discount sheets are published at a very small expense, when- 300 ACCOUNTING— THEORY AND PRACTICE ever prices fluctuate and a change in the hst market price must be made. Another purpose served by the use of trade discounts is that of partial secrecy as to the real quotation, the catalogue telling nothing as to the real price, as the key is in the rate of discount allowed from that list. Thus a concern need not by the publication of its catalogue lay •itself open to the underbidding of competitors publishing later catalogues. Prices may be quoted at a single discount or by means of a series of discounts, each taking as its base the net amount left after deducting the previous discount. Ex- amples will illustrate : 1. Goods listed at $250 are quoted at 20% off. The sale price here is $200. 2. Goods listed at $500 are quoted at 50% and 20% off. 50% off $500 leaves $250 20% " 250 " 200 — the same real sale price as in No. i. 3. Goods listed at $750 are priced at 50%, $3}i%, and 20% off. 50% off $750 leaves $375 33M% " 375 " 250 20%: " 250 " 200 — the same as in Nos. I and 2. Thus different list prices tell nothing as to real price, the trade discount being the determining factor. Methods of Calculation Short methods for calculating the discounts when given in a series are often employed. For a discount series of only two discounts, a single rate equivalent to the two in DISCOUNTS 301 the series may be found by subtracting the product of the two discounts from their sum — always treating the dis- counts as decimals. Thus a series of 20 and 20 is equiva- lent to a single rate of 36. (.20 -f .20 = .40; .20 X .20 = .04; .40 — .04 = .36) Another method, and one applicable to a series of any number of discounts, is to treat the discount off as equivalent to one-minus-the-discount on. Thus a discount of 15% is equivalent to 85% of the list. An additional discount of io%> would be equivalent to gofo of the new base, or 90% of 85% of the original list or 76.5%. Thus a con- tinued multiplication of the "percentages on" gives the single sale-price multiplier to be used on the list price base. If the single discount rate is desired, this multiplier sub- tracted from I or 100% gives it. Take the series 60, 20, 10, and 10% off. This is equivalent to 40, 80, 90, and 90 on or 25.92% on (.40 X .80 X .90 X .90^.2592). The single discount rate equivalent to the series is, therefore, 74.08% (100% — 25.92%=74.o8%). From the above discussion, it is evident that the order in which the discounts of a series are used is immaterial as the order of the factors does not affect the product. The method just illustrated develops the reason for the special rule stated first above for the two-discounts series. Let the discounts be "a"% and "h"%. This is equivalent to (i — a)% and (i — b)%. Their product, algebraically, is I — [(a-|-b) — ab], which is the "percentage on"; from which it is readily seen that the single-rate discount is a -|- b — ab, i.e., the sum minus the product of the two rates. Similar rules can be developed for longer series, but they are too complicated for easy application. To illustrate the long and short methods, take this ex- ample: A list price of $875 with a discount offering of 25, 10, 10 and 5. To find the sale price: 302 ACCOUNTING— THEORY AND PRACTICE (i) The long method : (2) The short method: .75 X .90 X .90 X .95 875 •75 4375 6125 .90 X Equivalent 90 sing le rate 2 40 461 •75 .81 75 600 656.25 .90 .6075 ■95 590.625 .90 30375 54675 531-56 •95 •577125 875 26 5780 478 404 885625 ' 39875 7000 504.98 From the above examples it is seen that, after all, there is little choice between the two methods. There is the same number of multiplications in each and, unless the per- centages are easy products and the list is a large number, there is practically no shortening through use of the second method, when applied to any one calculation. However, for comparative purposes, to indicate which of two discount series is the more favorable, the second method is far simpler and quicker. Also, the short method has a great advantage over the long method when a large number of DISCOUNTS 303 selling prices must be computed, all having the same series discount. This is true especially when the work is done with the use of a calculating machine. The Nature of Cash Discount — Its Basic Elements In the case of cash discount, two factors enter into the determination of the invoice or billing price. There is a direct relationship between the credit period and the loss from bad debts. Thus, if a credit period of 30 days results in a given volume of bad debts, an extension of the credit term to 60 days would undoubtedly result in an increased loss from uncollectible accounts, assuming that all factors, such as investigation of the risk, credit supervision, collec- tion effort, etc., remain the same. Inasmuch as sale price must be sufficiently high to provide for loss from bad debts, the credit term has its effect in the determination of that sale price. The other factor is the interest factor, a charge ad- ditional to the sale price on a cash basis, to cover the cost of being deprived of the use of the capital tied up in out- standing accounts. Thus, when an optional settlement basis is offered, nor- mally the controlling factors are the risk or cost of in- surance against loss from bad debts and the interest cost. This is so under normal conditions, although special cir- cumstances may make it expedient to offer other more or less favorable terms of settlement. Normally, terms of 2% off if paid within 10 days (2/10, n/30), the billed price being on a 30-day credit period, have this significance : the 2% measures two things: (i) the saving secured through receipt of the money 20 days earlier, and (2) a saving in the item of bad debts expense brought about by a shortening of the term for which credit is extended, from 30 to 10 days. 304 ACCOUNTING— THEORY AND PRACTICE Showing Cash Discount in the Trading Section There has been, and is yet, quite a diversity of opinion among accountants as to the proper treatment of cash dis- counts in the profit and loss summary at the close of a period. Some maintain that the discount is a trading or selling item, and for this reason they show it in that section of the statement. Their theory is that discount on sales partakes somewhat of the nature of a trade discount, that the real selling price is, after all, what is got for a particu- lar bill of goods. If goods are billed at $i,ooo and $980 is accepted as full settlement, the sale should be shown only at $980 on the books. At the time of offering an optional basis for settlement, however, the merchant does not know which basis will be accepted, and he therefore enters the sale on his books at the highest offer. Later, if the customer settles on a more favorable option and takes his discount, this is logically a deduction from sales. Likewise, if the discount is considered as a bait offered to secure customers, it should be treated as a selling cost. Consequently, on either of these two theories, cash discount would have to be shown in the trading section of the profit and loss statement, in the one case as a direct deduction from sales, in the other as a selling cost. Correct Method of Showing Cash Discount Other accountants maintain that cash discount is a financial management item; that a manager, in order to secure ready funds with which to take advantage of the discounts offered him on his own purchases, offers his cus- tomers sufficient inducement to secure the early and prompt payment of their bills. The difference between the saving on purchases payments and the cost of securing early pay- ment on sales is the measure of the efficiency of such finan- DISCOUNTS 305 cial policy. While this element may enter in, it would seem not to give a fully satisfactory explanation of the practice. If cash discount has been correctly analyzed as being composed of the two factors, interest and bad debts expense, there can be no question as to the place of its showing, both factors being financial or administrative items and the^ should be placed in that section of the profit and loss state- ment. This analysis is believed to offer the best explanation of cash discounts. In this work they will, therefore, be treated as financial management items. Account Titles for Cash Discounts In booking cash discounts, two accounts are used, one for the discounts on sales, the other for the discounts on purchases. Self-descriptive titles are Sales Discount and Purchases Discount, which seem better than Discounts Al- lowed and Discounts Received and other similar titles. Methods of Booking Cash Discount In Chapter XXI, "The Cash Journals," two methods of handling the cash discounts Were shown and explained, and will not be repeated here except to indicate their nature. Sometimes four methods are used, as follows : I. The net cash received is entered in the cash book and the discount is entered in the journal, as follows : Cash book entry : Cash $98.00 Customer $98.00 Journal entry : Sales Discount , $2.00 Customer :■. ■ $2.00 3o6 ACCOUNTING— THEORY AND PRACTICE This method rests on the theory that the cash book should be reserved solely for cash items. The objection is the unnecessary work involved and the failure to make a complete record in one place of the whole transaction. 2. Entry is made only in the cash book — the gross amount of the bill as a cash receipt, the discount as a cash disbursement. Its showing is : Cash $100.00 Customer $100.00 Customer 2-00 Cash 2.00 The objection to this method is discussed in Chapter XXI. 3. Entry is made only in the cash book through the use of a non-cash discount column on the receipts side. This' was fully explained and illustrated also in Chapter XXI. In the illustration given there this discount column was not used in finding the cash balance, because net cash columns were employed, thus making unnecessary the use of any other column to find the cash balance. 4. Entry is made as in No. 3 above, but the discount column is used in finding the cash balance. Where, as sometimes happens, the net cash column is omitted, the true receipts can be found only by subtracting the amount of the discount from the other column totals. The closing summary for the columnar cash book showed one method of handling the discount column total (see Chapter XXI). While all other summary entries for the cash receipts are credits, the discount summary is a debit. Because of this fact, the discount total is sometimes shown on the disbursements side of the cash book among the sum- mary entries of the other columns, in which case the word "contra" is written after the words "Sales Discount," show- ing that the amount has come from the discount column on DISCOUNTS 307 B e 5 o S * <3 \i5 -^ "S ^=^ ^t= E? C3- J' O) ^O ■-5 3o8 ACCOUNTING— THEORY AND PRACTICE the opposite page. Similarly for the Purchases Discount. There is no advantage in this except to bring all summary debit postings on one side of the cash book and all credits on the other. Where the cash book is operated according to method No. 4, closing summaries would show as given on page 307, using columns for Customers, Sales Discount and Sundry on the debit side, and columns for Creditors, Purchases Discount and Sundry on the credit side. As there is no net cash column, the totals for Customers and Creditors are not all cash. To clear them of their non- cash elements, the discounts should be subtracted from their respective Customers' and Creditors' totals, and only the net brought over into the Sundry columns; or the subtrac- tion can be effected by adding the discounts to the opposite side. However, the use of a Net Cash column simplifies the summarization of the cash book and should always be employed. Treatment No. 4 is shown only because it is sometimes encountered. Securing Information as to Neglected Discounts Some authors of texts on accounting have suggested the desirability of bringing before a manager or proprietor the cost of his failure to take advantage of discounts offered him. To show this cost for a purchase transaction, the fol- lowing entry is made at time of purchase : Purchases $100.00 Purchases Discount 5.00 Vendor $105.00 the net amount of the bill being charged to Purchases, the best discount offering to Purchases Discount, and Vendor being credited with the billed amount gross. When pay- ment is made on any of the optional bases offered, entry is made: DISCOUNTS 309 (i) Vendor $105.00 Cash $105.00 or (2) Vendor . $105.00 Cash $103.00 Purchases Discount. 2.00 In the case of No. i, the net result of the whole purchase transaction would be a loss or expense of the amount in Purchases Discount through failure to take the discount. In No. 2, if the best option were taken, viz., the entire 5%, Purchases Discount would show no balance ; any less favor- able option, say 2%, would result in a debit balance in Purchases Discount of 3%, measuring the expense incurred through failure to take the best option. Unquestionably, the information given a manager by this Purchases Dis- count debit balance would claim his immediate notice and attention. A sales transaction handled on a similar basis would result in a Sales Discount credit balance representing the excess of the offering of discounts over what is taken by customers and would have to be treated as income additional to the booked sales income. Inasmuch as the sale or purchase, under this method, must be booked on a cash option basis, this treatment would seem to result in a departure from the fact of true cost or an inconsistency in booking some of the elements which enter into the cost of merchandise and not others. The price at which a merchant can sell his product must include all direct and indirect costs and provide a margin for profit. The Sales Discount offered is simply one of these indirect costs. It cannot be more accurately estimated than can the salesman's salary element which is a part of the sale price. It is not consistent to separate the invoice price into two elements and term one real selling price and the other sales discount cost when the "real" selling price is still a very 3IO ACCOUNTING— THEORY AND PRACTICE composite item. Rather, book the sale at its full invoiced price and record actual costs and apply them later as they accrue. After all, the sales policy of each concern enters largely into the determination of its normal selling- price. A con- cern with a normal credit term of 30 days fixes its sale price on that basis; one with a 60-day credit term will have its sale price fixed by the risk and interest costs, mentioned above, based on the 60-day term; and one doing a cash business will determine its sale price accordingly. However, in order that each concern may have the information neces- sary for its guidance under its particular sales policy, sales should be recorded on the basis of its normal credit term. To secure the information sought as to neglected dis- counts, it is suggested that memorandum accounts be raised for that purpose and entry be made of the expense only when incurred. Thus, failure to take a purchases discount would be recorded under these or similar captions : Neglected Discounts Reserve for Neglected Discounts At the time the books are closed these memorandum ac- counts would be closed against each other, having served their purpose of giving the desired information through being included in the trial balance submitted to the manager or owner. Trade Acceptances and Cash Discounts .Brief mention should perhaps be made of some recent discussions of the probable effect of the extended use of trade acceptances on the practice of allowing cash discounts. Some sellers to whom the cash discount practice is trouble- some and unsatisfactory welcome the use of trade accept- ance as an avenue of escape. Others have gone so far as to DISCOUNTS 211 say that the trade acceptance will eventually do away with the practice. It should be said that the use of trade accept- ances, while very attractive from the seller's standpoint, has not yet made a strong appeal to buyers largely because of the fact that it offers little that the open account method does not secure for them and it may interfere somewhat with the taking of cash discounts. Practice Data* (Assignment for Chapter XXXVI) Summarized transactions for March were: Purchases — Swift & Co. 2/5, n/30, $3,431.65; Austin Nichols & Co., S/S, n/30, $6,675; Grand Grocery, n/io, $3,821.95; Reid, Murdock Co., 3/s, 2/20, n/30, $7,384.60; Kataguri Bros., 3/10, n/60, $4,152.75; Washburn Crosby, n/io, $8,472.80; F. Mezzadri, 8/s, s/io, 2/30, n/90, $4,625 ; cash purchases $580.19. Sales — Fein Bros., n/s, $3,782.25 ; M. Heitzman, 3/10, n/30, $4,174.85 ; H. A. Krebs, 1/30, n/60, $1,279.45 ; Andrew Davey, 3/5, n/30, $2,854.20; Wm. Crick, i/io, n/30, $1,915.15; Russo Bros., 2/10, n/30, $2,518.75; Progressive Stores Co., 3/5, n/20, $4,189.60; J. Perlman, 1/5, n/30, $3,650.70; P. Peterson, 2/5, n/60, $2,500; Uintah Copper Co., 3/10, n/30, $1,755.85; Circle Bar Ranch, 3/5, n/20, $2,189.60; J. R. Rice, 3/S, n/60, $1,954.25; Al Morton, i/io, n/30, $4,520.67; J. J. Tommich 2/5, n/20, $3,979.98; Ward drew groceries, $30; cash sales $3,987.40. Journal — Accepted Austin, Nichols & Co. 30-day sight draft due April 24 for their bill of March $6,675 less 5% ; received goods returned by the Progressive Stores Co., $1,125.50; returned flour to Wash- burn Crosby $1,500; received 60-day 6% note, due May 20, from Dodts' Grocery for January bill $1,517.18; received goods from M. Heitzman, mistake in filling order, $1,000; out-freight for February was $80.19; received goods from Al Morton, inferior quality, $987.25 ; received 30-day 6% note, due April 26 from Four Corners General Store for balance of February bill $4,657.40 less 3% ; cash shortage of February is partly accounted for by failure to book a payment of $5.25 for gen- eral window cleaning. •Practice Data for Ward & Gneisel set begin with Chapter XXXI. 312 ACCOUNTING— THEORY AND PRACTICE Cash Receipts— Capella Bros., February bill $3,189.65 less 2%; Black Hills Mining Co., February bill $1,580.90 net; R. B. Kennan, balance of February bill $3,577-55 less 2%; A. M. Scott's note $1,500 fell due on the 8th and was paid with interest; Dewey Brown, February bill $1,925.47 net ; Evans Sons, February bill $3,248.85 less 2% ; Fein Bros., March bill $3,782.25 net ; M. Heitzman, balance of March bill $3,174.85 less 3% ; Gristede Bros, note $2,790.85 fell due on the 28th and was paid with interest; Andrew Davey, March bill $2,854.20 less 3% ; Progressive Stores Co., balance of March bill $3,064.10 less 3% ; Circle Bar Ranch, March bill $2,189.60 less 3%; cash was over $1.25; J. R. Rice March bill $1,954.25 less 3%. Cash Disbursements — Salesmen's salaries $3,600; salesmen's trav- eling expense $3,120.80; advertising expense $2,560.18; shipping clerk $900; Swift & Co., March bill $3,431.65 less 2%; F. Mezzadri, March bill $4,625 less 8% ; shipping supplies cost $240.25 ; freight and drayage bills were $890.20 ; rent for April $250 ; insurance, i year policy, March I, 1917 to March I, 1918, $240; extra help in shipping room, wagon repairs, etc., $190.50; Reid Murdock Co., March bill $7,384.60 less 3%; coal, power, and light bills $127.80; office salaries $575; office ex- pense $7.80; stamps, etc., $58.20; Kataguri Bros., March bill $4,152.75 less 3% ; bought office safe $250, and paid freight on same $28.30; gif*- to church bazaar $30.25; I year's membership, March 31, 1917 to March 31, 1918, in credit men's association $50; Washburn Crosby bill for February, $5,568.30 net; cash was short $18.40; Ward drew $500; Gneisel $125. Iitstructions Notice that the cash shortage recordea tor February resulted from the failure to enter an expense item for window cleaning. This is discovered in March and should be corrected by journal entry debiting General Expense and crediting Cash Short and Over, giving adequate explanation. CHAPTER XXXVII NOTES RECEIVABLE AND PAYABLE Conditions Precedent to the Present Use of Notes and Bills During the twelfth and thirteenth centuries there was much bad money in circulation in Europe, due to the machi- nations of coin shavers and an entire lack of standards of purity for the coins of any country. If a monarch needed more revenue to carry on wars or run his government, the easiest way was to increase the amount of base alloy in the coins of the country or to increase the rate of seigniorage. As the former method might be resorted to several times during the reign of one sovereign, the result would naturally be to place all metallic coins under suspicion, their weight and relative purity having no relation to their denominated value. Consequently, it was only the money dealers, those who could determine the actual value of coins by assaying, who were willing to trade for coins. These men gradually became the custodians of moneys for merchants and in re- turn for the money thus received in custody they handed to the merchant a receipt giving the assay value of the coins deposited. This receipt, because it represented tested and proven value, soon became a more acceptable medium of exchange than the coins themselves. This is supposed to be the way in which paper money came into use in Europe during that period. Mediaeval trade was subject to many perils, chief among which was that from robbers. Any safeguards that might be placed about the transportation of money from one place to another, or methods devised for settling debts without the 313 314 ACCOUNTING— THEORY AND PRACTICE transportation of coin and bullion, were more than welcome. Arising out of these conditions came the method of settling debts by means of drafts. Not countenanced by law at first, the "law merchant" soon became recognized as a code of rules governing commercial relations, and was later incor- porated by statute into the law of the country. These two kinds of paper, the one being in the nature of a demand promise to pay, the other a counterpart of the modern draft, were the forerunners of our promissory notes and bills of exchange of the present day. The law with regard to the bill or draft became settled from the practice of merchants before that relating to notes. The Titles "Notes" and "Bills" In this way, the word bill became an established term. The titles "bills receivable" and "bills payable" still cUng to both classes of items. Inasmuch as the accepted bill is practically identical with the promissory note, and the title "bill" is so often used interchangeably .with the word "invoice," it is advisable to use the terms notes receivable and notes payable instead of bills receivable and bills pay- able. Some advocate the use of the title "acceptances" in order to distinguish accepted bills from promissory notes; but to one who understands the nature of the two instru- ments, there is no advantage, either as to clearness or as to practice, in the use of the suggested title. The drawer of an accepted draft becomes the first guarantor or indorser on it and, under the theory of contingent liability discussed later, the accepted draft should receive additional treatment when notice of acceptance is received. Relation of the Note to the Open Account In Chapter XXIV, a preliminary discussion was given of the relation of the note to the open account. It was NOTES RECEIVABLE AND PAYABLE 315 pointed out that both are claims against the person liable for payment, but the one is carried under a class title "Notes ^Receivable," because the number of such notes is usually- small, while each account receivable is carried under a separate title which designates the person liable for payment. The essential difference between the two kinds of claims is that the note is looked upon as being in itself an acknow- ledgment of the justice of the claim and the correctness of the amount, whereas the claim under the open account is subject to dispute, and in case of dispute requires outside proof; besides, the open account may always be offset by counter claims and sometimes by a return of all or a part of the goods bought. As between the original parties to a note, any defenses of value under the contract for which the note was given, are good defenses under the note; but not so as between the maker and a third party who is an innocent purchaser for value. To him the maker is liable according to the exact terms and tenor of the note. Only so could the element of negotiability be insured and the note pass from hand to hand as money. In no other sense is the note a preferred claim over the open account. In case of bankruptcy a claim against the bankrupt under an open account and a claim under a promissory note or an acceptance made by the bankrupt before his insolvency, rank alike, both sharing pro rata in the net assets available for the satisfaction of the total claim of unsecured creditors. Relative Liquidity of the Note and Open Account Compared with open accounts as to their relative liquidity, promissory notes have a slight advantage in that they can more readily be turned into cash and at a better rate. Under present conditions, although assignment of open accounts is possible, the basis is almost prohibitive, 3i6 ACCOUNTING— THEORY AND PRACTICE whereas the legitimacy and the low cost of discounting notes greatly increase their liquidity. Oftentimes the question of risk, i.e., the degree of certainty of their 'payment when' due, enters into the determination of the relative liquidity as between open accounts and promissory notes, but from this standpoint there is little, if any, difference between the two claims. Occasionally, a firm^ which refuses to pay its debts on open account, will meet its notes and acceptances in an effort to bolster its credit at the local banks. This phase of the question does not usually enter into the dis- counting operation, where the credit of the discounter is the determining factor in raising money. Of course, this may be only a temporary expedient if the note is dishonored and charged back by the bank. However, the note is usu- ally classed as a more liquid asset than the open account Method of Recording Notes As to the accounting phase of the subject, a careful record is made of each note as it is received or given, entry being as a note receivable or payable according as we are not or are the maker of it and therefore are not or are liable for its payment when due. If the note transactions are few in ntunber, the general journal is used for their record. Ample explanation must be given as to the essential facts of date, maker, for what received, rate of interest, due date, etc. Notes receivable must be watched carefully, as failure to present them when due releases all indorsers. There is nothing unusual in the entry when made in the journal, its debit and credit being determined as indicated in Chapter XII. The Note Journals Because the Journal does not lend itself to an easy rec- ord of the essential data pertaining to note transactions. NOTES RECEIVABLE AND PAYABLE ^I? oftentimes a separate book is kept for this purpose. This subsidiary book may be used merely as a memorandum record for carrying the detailed explanation of the journal entry, or it may become a subsidiary journal used as an integral part, of the accounting system, and, when so used, posting to the ledgers is made direct therefrom. The use of this subsidiary journal is always advisable when note transactions are numerous. A bill or note journal often carries rulings as shown on page 318. The notes payable journal differs but slightly. If the bill book is for memorandum only, the "Amounts Credited" columns may be omitted. If it is a real note journal, its debit and credit equilibrium is shown through summary entries at posting time. The total debit is to Notes Receiv- able for the amount of that column's total. If it were not for the fact that sometimes notes are received in whose face amount is included not only the credit to the customer, but an interest item as well, there would be no need of credit columns. The note journal would then be operated on the same principle as the sales journal with a debit to Notes Receivable, the same amount being used in crediting the cus- tomer; but interest being included, treatment is best secured through an additional column, separating the credit to Cus- tomers from that to Interest. If notes are numerous, it might be well to use a distributive column in the cash book for receipts from notes and secure a total posting to the credit of the account as well as to its debit through the note journal. This is a matter for determination in individual cases, and no general rule can be laid down. Referring to the left-hand page of the illustrated ruling, the face amount of the note receivable is entered in the "Notes Receivable" column, and the due date is entered in one of the narrow columns headed "When Due," each of these columns representing a separate month. In this 3i8 ACCOUNTING— THEORY AND PRACTICE ■ — ' i^ UJ ^ K s UJ —1 a z o in UJ --§ a D UJ li 01 UJ z 1i 5 1 — ^^ I o i > < ^ ig ^^ U_ C> -z. §is o UJ y §ti or 1 / NOTES RECEIVABLE AND PAYABLE 319 way it is easy to find the total of all the notes due in a given month and the amount of cash to be expected from that source. \A'here desired, the note journal may be arranged on the principle of a "tickler" by months. One page is reserved for each month, and the notes are entered on the proper page in chronological order, thus showing month and day on which they fall due. A recapitulation would be necessary to secure one total for posting all notes received during each month, since the method described distributes the notes over separate pages according to due date and so does not show in any one place the total notes received each month. Therefore, at the end of each month, the various month pages should be totaled and "recapped" on a special page for recapitulations, or on the page assigned to that particular month for which the total receipts of notes are wanted. The separate recapitulation page specially ruled for the pur- pose would, however, seem better. Notes Entered at Face Value Always Some notes are interest-bearing from their date of issue ; others, only after their due date if not then paid. Even on non-interest-bearing notes, the law allows the charging of interest for their overdue period. From the standpoint of strict accuracy, a note payable at a future time is not worth its face value at the time of entry, unless it is interest-bearing from date at approximately as high a rate as the current discount rate. Its present value is such an amount as placed on interest would equal the face at its due date. Its value increases day by day until it reaches par or face on the due date. Because of the practical difficulties encountered in the numerous adjustments necessary under any other method of entry, universal practice countenances the bringing of the note onto the books at a slightly inflated value, i.e., face 320 ACCOUNTING— THEORY AND PRACTICE value, at the time of entry. Face value is the basis for credit to the customer, shows the amount to be collected on account of the note, and, if interest-bearing, the amount on which the interest is based. Accordingly, the note transaction is entered at its face value. Where the note is interest-bearing and the face plus the interest is paid at maturity, credit is in two items, one to Notes Receivable for the face and the other to Interest or Interest and Discount for the amount received as interest. Occasionally, the interest is figured on the amount of the debt for the period the note is to run and added to the amount of the debt. This is made the face of a non-interest- bearing note. The end aimed at by such a procedure is to secure a compounding of interest for the first period if the note is not paid at maturity. Its entry on the books is a debit to Notes Receivable for the face of the note and credits to the customer for the amount of the debt and to Interest and Discount for the amount of the pre-estimated interest; with only a credit to Notes Receivable when the note is paid. This credit to Interest and Discount, before the interest is actually received, is necessitated by its pre-estimate and in- clusion in the face of the note. The Interest Accounts Oftentimes two interest accounts are carried on the ledger, one for Interest Income and one for Interest Ex- pense. This, of course, secures analysis under those heads and is the best way when the items are numerous. Sometimes just the one account. Interest and Discount, is carried. If it is desirable to separate the two classes of interest, it may be done by entering the debit and credit totals of the Interest and Discount account — instead of simply the balance — when the trial balance is taken. It is perhaps needless to say that bank discount — interest paid in advance — is the only kind NOTES RECEIVABLE AND PAYABLE 321 of discount recorded under this account title and must not be confused with the discounts on sales and purchases. Practice Data* (Assignment for Chapter XXXVII) Post completely and take a trial balance as of March 31. •See Practice Date for Chapter XXXVI. CHAPTER XXXVIII PROBLEMS ENCOUNTERED IN RECORDING NOTES RECEIVABLE AND PAYABLE Entries in the Account ' The subject of entries to the note accounts has been treated in Chapter XV and will be reviewed and summarized here. First, where the Notes Receivable account in the ledger shows the receipt of each note as a separate item rather than by totals, good practice countenances the recording of the credits in this account in non-chronologic order. Usually, postings on both sides of any account are made according to the chronology of the transactions ; the Notes Receivable and the Notes Payable accounts, however, form an exception to this general rule. For instance, when a customer settles his promissory note and consequently the document is re- turned to him, the credit to Notes Receivable should be so entered that it appears exactly opposite the original debit item. This brings each complete note transaction on one line and shows at a glance which notes are outstanding, as evidenced by the blank lines on the credit side of the account. When, on the other hand, the credit items are entered in chronological order, the same purpose is accomplished by the use of an index figure for the original debit and the corresponding credit item. The first method, which dis- regards the chronological order, is to be preferred, because the results are shown more plainly than by the use of index figures. 322 NOTES RECEIVABLE AND PAYABLE 323 What has been said in the preceding paragraphs con- cerning notes receivable applies also to notes payable. The Discounted Note A second point, referred to in Chapter XII, concerns itself with the booking of notes receivable discounted and accepted drafts. The problem here arises from the legal right accorded the holders of notes, in case of non-payment by the maker, to look for payment to any or all of the indorsers, provided certain formal requirements are com- plied with. For this reason, whenever a business house transfers a note by any method of indorsement (except the qualified), it incurs a contingent liability, which might be- come a real liability in case the maker of the note should fail to meet the obligation at maturity. Since it is the function of good accounting to present all the facts bearing on the welfare of the business, it is evident that this fact — that of incurring a contingent liability — should be entered in the books of account. Very frequently, however, the im- portance of this matter is practically ignored, with the re- sult that the contingent liability item is lost sight of altogether. The usual, though incorrect, method of jour- nalizing a note discounted transaction is ?is follows : Cash Interest and Discount Notes Receivable showing that the note has passed out of our hands and that the amount of its face value minus the discount has been received by us. This would be correct and all that is needed, were it not for the legal condition attaching to all such sales. Accordingly, for the purpose of showing the complete facts, the entry at the time of discount should be made as follows : 324 ACCOUNTING— THEORY AND PRACTICE Cash Interest and Discount Notes Receivable Discounted and at maturity, when the note is paid by the maker : Notes Receivable Discounted Notes Receivable The effect of the first entry is to set up a suspense ac- count, Notes Receivable Discounted, representing our con- tingent liability. The effect of the second entry is, first, to cancel the credit of the Notes Receivable Discounted account because upon payment of the note by the maker our contingent liability ceases to exist, and, second, to cancel the original debit to the Notes Receivable account which was made at the time the promissory note was received but remained unchanged when the note was discounted because it was still needed to record the contingent asset which would come back into our possession in case the contingent liability became a real liability. Some authors have argued that the above treatment stretches the theory of debit and credit nearly to the breaking point. It must be observed, however, that the practical ends to be obtained are of more importance than any preconceived theories, and, whenever good practice grows faster than the corresponding theory, it is the theory that must be changed to fit the practice. It would be incorrect, however, to regard Notes Re- ceivable Discounted as an independent liability account, be- cause it only represents a contingent liability. The two accounts Notes Receivable and Notes Discounted must be considered together, the latter account being set up merely for the purpose of keeping notes discounted under review until their final status is determined. The purpose of the NOTES RECEIVABLE AND PAYABLE 325 Notes Discounted account is in a way similar to that of the valuation accounts of depreciating assets. The asset account is held at its original figure and, in order to determine the present value of the asset, the valuation account must be referred to. So with notes. The asset account, Notes Re- ceivable, is held at its original figure, even though some or all of them may be discounted; and in order to know the amount of notes receivable actually on hand, the credit of the Notes Discounted account must be subtracted from the debit of the Notes Receivable account. Under this theory Notes Receivable Discounted would not be shown in the balance sheet as a liability item, but would appear as a de- duction from its dominating or correspondent account, Notes Receivable, extending among the assets only the amount of notes now actually in our possession. It should be remarked, however, that there is a growing tendency to show this contingent liability on the liability side of the bal- ance sheet, separating the corresponding asset into two items, the one Notes on Hand, the other Notes under Dis- count per contra. Banks follow this practice in showing trade acceptances. At maturity of the note the final entry (Notes Receivable Discounted debit and Notes Receivable credit) is placed upon the books as illustrated above. Usually no formal notice is received by the indorser that the note was paid by the maker. In case the note is dishonored, prompt notice would be sent and failure to receive such notice implies that the note was duly paid. What has been said in the preceding paragraphs con- cerning notes appHes with equal force to accepted drafts, for the reason that the legal character of the latter is identi- cal with that of notes, and the status of the drawer of an accepted draft is the same as that of the first indorser of a promissory note. 326 ACCOUNTING— THEORY AND PRACTICE If A draws a draft on B in favor of C for $ioo, the customary, although theoretically incorrect, entry on. A's books is as follows : C $iooco B $100.00 Following- the theory just developed, a more accurate and fuller showing on A's books would be secured by divid- ing the transaction into three elements and treating each ele- ment separately, as follows : 1. The acceptance of the draft by B : Notes Receivable $100.00 B $100.00 2. The receipt by C of this accepted draft : C $100.00 Notes Receivable Discounted $100.00 3. The payment by B at maturity : Notes Receivable Discounted $100.00 Notes Receivable $100.00 By following this method the books would show the correct status of the transaction at any point of its develop- ment. Before maturity of the draft the credit to Notes Receivable Discounted acts as an offset to the Notes Receiv- able debit, at the same time indicating the contingent liability attached to this draft. At maturity, when C collects the amount from B (the drawee), the contingent liability ceases to exist, and Notes Discounted is therefore debited. The corresponding credit is to Notes Receivable in order to cancel the original debit item, as shown in the first entry given above. NOTES RECEIVABLE AND PAYABLE 327 Before leaving- this subject it may be well to remark that in many instances there may be good practical reasons for not -adhering to the above principles. When for instance a jarge number of notes and acceptances are handled and the experience of the business shows that practically none of them are ever dishonored, or if the matter is under close view by the financial manager, it might be considered an un- necessary loss of time and effort to make the additional entries incident to a separate Notes Receivable Discounted account. It must be left to the judgment of the accountant to decide which method is preferable in connection with the needs of the business. However, in case no current account is kept to show the contingent liability, it may be well at the end of the period to make an adjustment entry to show the amount of notes discounted still outstanding as of the closing date of the period. The Dishonored Note A third problem arises in case a note is dishonored by the maker. A note is dishonored either when the maker refuses payment upon its legal presentation at maturity or upon sufficient evidence that the maker intends to refuse payment when due. When a note has been dishonored, a formal protest is required in order to hold the indorsers. The payee appears before a notary public or other officer with notarial powers and makes oath that legal presentment of the note has been made and that the payment was re- fused. The notary then takes the note and personally pre- sents it for payment to the maker. If payment is still refused, the notary makes a certificate of protest and mails notices of the protest to all indorsers desired to be held. Such notice is sufficient as a basis for action to recover from the party or parties thus notified. In making the accounting record a number of problems 328 ACCOUNTING^THEORY AND PRACTICE may arise in connection with dishonored notes. These prob- lems deal with the situation, (i) when the note is dishon- ored in the hands of the named payee, and (2) when the note has been discounted by him and is charged back on ac- count of dishonor. The discussion will be directed to the following two cases : Case I. Promissory note made by P. Canning for $100. Payee, D. Johnson. Due December 15, 1916. At maturity Johnson presents the note for payment, but payment is re- fused. Case 2. Promissory note for $250 made by P. Canning. Payee, D. Johnson. Due December 15, 1916. Note was discounted by Johnson. Final holder is A. Andrews who presents the note for payment on December 15, 19 16, but payment is refused. The questions arising may be stated as follows : What record should be made on December 15, 1916 — (a) By D. Johnson in Case i. (b) By A. Andrews in Case 2. (c) By D. Johnson in Case 2. (a) D. Johnson at the time he received the note from Canning made the following entry : Notes Receivable $100.00 P. Canning $ioaoo and on December 15, in order to show that the note is dis- honored he may make either of the following two entries: (i) P. Canning $100.00 Notes Receivable $100.00 or (2) Notes Receivable Dishonored $100.00 Notes Receivable $100.00 NOTES RECEIVABLE AND PAYABLE 329 Entry ( i ) takes the charge out of the note account and sets it up again as a claim on Canning's open account. Entry (2) transfers the charge to a Notes Receivable Dishonored account. Entry (2) is theoretically a better entry than entry (i) because from the latter it might be inferred that the nature of the claim has changed from a note claim to an open account claim. Such change has not taken place, however ; Johnson's claim against Canning is still under the note. Therefore, entry ( i ) is not true to the facts. On the other hand entry ( i ) has an important advantage over entry (2) because by posting entry (i) Canning's per- sonal account in the ledger will show the fact that one of his promissory notes was dishonored. This is a matter of very great importance, especially with reference to future credit ratings of Canning's account. If the second method is adopted it is clear that by merely posting the entry the fact of dishonor will not be shown on Canning's account. It is essential, therefore, that the bookkeeper should make a special memo on the face of Canning's account. This would be satisfactory if the book- keeper could be absolutely depended upon to make such memorandum entry. Any treatment consistent with account- ing principles and securing a complete history in one place of all our dealings with the individual, will satisfy all re- quirements. (b) A. Andrews, who is the last indorsee of the note, at the time the note is dishonored should make the following entry : Notes Receivable Dishonored $250.00 Notes Receivable $250.00 The Notes Receivable Dishonored account represents An- drews' claim against any or all of the indorsers whom he 330 ACCOUNTING— THEORY AND PRACTICE wishes to hold responsible. Instead of this, an entry might be made corresponding to entry ( i ) discussed above. (c) In case the note should be charged back to Johnson, either by Andrews or by any one of the other indorsers, he should make the following entries : Notes Receivable Discounted $250.00 Cash $250.00 P. Canning (or Notes Receivable Dishonored) $250.00 Notes Receivable $250.00 It will be noted that these two entries will completely reverse the two original entries made by Johnson, viz. : Notes Receivable $250.00 P. Canning $250.00 at the time he received the promissory note from Canning, and Cash $250.00 Notes Receivable Discounted $250.00 when he transferred the note by indorsement. Of course, it is to be understood that all expenses in con- nection with the dishonored note should be charged either to the personal account of the maker or to the Notes Receiv- able Dishonored account, as the case may be. Where the Notes Receivable Dishonored account is used, it secures a good analysis of the claims against customers from the standpoint of probable realization and gives a rela- tively better basis for the bad debts estimate than that of- fered by the other manner of treatment. Of course, the use of such an account would be limited to the ledger ; it would never appear as such on the balance sheet, being there in- cluded with the customers' accounts with ample reserve for uncollectible items. NOTES RECEIVABLE AND PAYABLE 331 The Classification of Notes A fourth problem in connection with notes deals with their proper classification. The Notes Receivable account should carry only the short-time notes of customers, making it a truly current asset. On the other hand, all long-time notes and those secured by mortgage should be booked under another account title in order not to be confused with the short-time, liquid, or soon-to-be converted notes. For a similar reason, the notes receivable given by officers, em- ployees, or stockholders of a loosely managed corporation should have separate booking, as these are more usually given for the purpose of making formal record and ac- knowledgment of indebtedness without regard to time of payment. Since such notes usually do not constitute easily convertible assets they should not be recorded under the same account with short-time customers' notes. Notes Receivable Out as Collateral Notes receivable are sometimes given as collateral secur- ity for a loan. When so used, no accounting problem is involved — though a memorandum to show their use as such should appear in the note account. However, if these notes are sold to satisfy the loan, this would constitute a regular business transaction, which should be recorded in the proper manner. Note Renewals and Partial Payments The renewal of notes and partial payments are other features met in the accounting for notes. The renewal of a note is rather a question of business policy than of account- ing procedure. When a note is renewed, it is better to deliver up the old note and secure a new one in its stead. If the new note is of the same tenor as the old one, no separate posting of it is absolutely required, except to 332 ACCOUNTING— THEORY AND PRACTICE indicate, in the explanation space, that it is a renewal. How- ever, this would necessitate also a change in the original entry in the journal, and to avoid this it would be preferable to reverse the old entry and enter the renewal separately. From the financial standpoint, if neither note is interest- bearing, the amount of the renewal note should be larger than that of the old note to cover the cost of deferring payment to a future date. For example, if the old note amounts to $i,ooo and is renewed two months later, the amount of the new note should be fixed at $i,ooo plus i% interest, or $i,oio. In the case of partial payments, no new accounting principle is involved; however, when partial payments are numerous, additional space in the note journal and in the ledger should be provided for the purpose of facilitating the actual work of making the book record. Practice Data* (Assignment for Chapter XXXVIII) Summarized transactions for April were : Purchases — Reid Murdock Co., 3/5, 2/20, n/30, $8,954; Armour Packing Co., 2/20, n/30, $6,256.55; Korn Products Co., 3/10, n/60; $5,820.20; Holland Gelatine Works, 2/5, n/30, $7,778.90; Van Dusen Co., 8/s, 5/10, 2/30, n/90, $9,825.35 ; United Supply Co., 3/5, 2/20, n/30, $8,703.15 ; cash purchases $1,767.49. Sales — J. Henry Witt, 2/10, n/30, $3,000; U. B. Zipkin, 1/5, n/6o, $4,190.15; Las Vegas Cattle Co., 3/5, n/20, $2,150; Quinn Bros., n/io, $3,975-20; Stewart & Son, 1/5, n/30, $4,005.35; S. Koenig, 2/10, n/30, $2,875.45; M. E. Dietrich, 2/5, n/60, $4,150.60; Jas. Butler, Inc., n/S, $5,152.75; C. A. Gerken, 3/10, n/30, $2,875.60; John Johnson, 1/30, n/60, $3,105.20; Jacob Green, 3/5, n/30, $2,900; Bull's Eye Mining Co., n/io, $3,219.65 ; Badgley & Stewart, 1/5, n/30, $2,850.70 ; Dewey Brown, •Practice Data for Ward & Gneisel set begin with Chapter XXXI. NOTES RECEIVABLE AND PAYABLE 333 n/s, $3,390.79; Evans Sons, 2/10, n/30, $2,760.46; Andrew Davey, 3/5, n/30, $3,840.90; Black Hills Mining Co., i/io, n/30, $2,160.50; cash sales, $5,189.62; Gneisel drew groceries $90; R. B. Kennan, 2/10, n/30, $3,140.65. Journal— transferred oflfice cash register to cash sales department of store, $125 ; returned canned goods to Austin, Nichols & Co., $350, adjustment to be made at the time of paying their draft; received goods returned by U. B. Zipkin as unsatisfactory $875.50; received 60-day 6% note, due June 10, from M. J. Downing for January bill $1,680.40; received spoiled goods returned by Stewart & Son, of their April purchase, $1,250; out-freight for March was $100.25; received goods of April bill returned by Jas. Butler, Inc., error in filling order, $1,580.20. Cash Receipts — R. B. Kennan, April bill, $3,140.65 less 2% ; J. John- son February bill, $4,120.80 net; Bull's Eye Mining Co., February bill, $2,879.20 net; Badgley & Stewart, April bill, $2,850.70 less 1%; Dewey Brown, April bill, $3,390.79 net; Four Corners General Store note for $4,517.68 came due on the 26th and was paid with interest; H. A. Krebs, March bill, $1,279.45 less 1%; Wm. Crick, March bill, $1,915.15 net; Russo Bros. March bill, $2,518.75 less 2% ; J. Perlman, March bill, $3,650.70 less 1%; received refund of $75.80 from railroad for over- charges on freight bills already paid ; income from delivery service rendered others, $25.40 ; P. Peterson, March bill, $2,500 less 2% ; Uintah Copper Co., March bill, $1,755.85 less 3% ; Al Morton, balance of March bill, $3,533.42 less 1%; J. J. Tommich, March bill, $3,979.98 less 2% ; discounted note at 30 days 8%, due May 26, for $10,000. Cash Disbursements — Korn Products Co., April bill, $5,820.20 less 3% salesmen's salaries $5,000; salesmen's traveling expenses $4,720.80; advertising $5,000; shipping clerks, etc., $1,250.70; packing supplies $150.50; freight and drayage bills $1,206.17; Raid Murdock, April bill, $8,954 less 2%; Grand Grocery, March bill, $3,821.95 net; Washburn Crosby, balance of March bill, $6,972.80 net; rent for May $250; light and power $92.25; office salaries $750; office expense $8.50; office sup- plies $97.60 ; general expense $9568 ; sales display room furniture $375 ; comptometer and filing cabinets for office $750; new horse $315; asso- ciated charities $20.10; cash was short $3.19; Ward drew $750; Gneisel $500; paid on April 24, Austin, Nichols Co. draft with adjustment of $350. Instructions Be careful to make proper entry of the equipment transferred from office to store ; of the railroad refund ; and the delivery service income. To book the $10,000 discounted note payable, in the cash book, show 334 ACCOUNTING— THEORY AND PRACTICE the face of the note discounted in the General column; the discount, in the Sales Discount column but mark a small "x" in front of it; and the net cash as usual. The Austin, Nichols draft transaction, with $350 adjustment, will have to be entered partly in the cash book and partly in the Journal, the Note Payable debit being posted in two parts. Be careful to get the debit and credit of the transaction. Give ample explanation in the Journal, covering also the cash portion. In the cash book simply refer to the Journal entry for explanation. CHAPTER XXXIX SALES Importance of the Sales Department According to a common classification of business activities, any business organization may be divided into four major departments: (i) Production or Buying, (2) Selling, (3) Financial Administration, and (4) Accounting. In point of relative importance, the selling department ranks. first. Regardless of the efficiency secured in the other branches, regardless of the economy in buying and the excellence of administration, the life of the business largely depends upon the results obtained by the selling division. Since the sales department plays such an important part in the development of the business, it is evident that all accounting and financial problems connected with sales should be given careful attention and should be handled by the most scientific and up-to-date methods. As has been stated before, one of the most important principles of modern accounting is that the system by which the records are to be kept must be planned in advance. The modern accountant must first know what kind of information the record is desired to present, and he will then so classify the accounts that the desired in- formation may be obtained from the ledger at any time, with the least possible additional effort. Basis for Sales Classification Applying this principle to sales it must be observed that the great majority of enterprises at the present time 335 336 ACCOUNTING— THEORY AND PRACTICE deal in a number of commodities, the kind, quality, and grades of which are of such variety that careful classifica- tion is imperative. Formerly all goods were classed to- gether under a single title "Merchandise," with the result that no detailed information concerning particular goods, qualities, and grades was available and the manager or proprietor was unable to study the movement of specific classes of commodities. The basis for classification depends on the character of the business and the nature of the goods sold. Where the commodities dealt in are of such variety that it is impracticable to have a separate account for each kind, a more general grouping by classes may be had. Where the concern manufactures some of its commodities and buys the remainder in the open market, an analysis of sales on the basis of "own" product and "other" product may be wanted. Sales may also be classified on the basis of the sales contract, as cash, credit, instalment, sales to branches, consignment sales, approval sales, etc. Accounting prob- lems in connection with these various types of classifica- tion will be treated in the present chapter. The Sales Analysis in Books of Original Entry When it is once decided what kind of classification is to be shown in the ledger, it is evident that the same kind of analysis must be used in the sales journal. The manner of analysis in books of original entry always depends upon the way in which the items are distributed over the pages, which may be either vertically or horizontally. Principles Governing Booking the Analysis In most forms or records, except in banking and allied institutions, it is generally accepted practice to reserve vertical distribution for showing chronological sequence, SALES 337 while any other kind of classification is accomplished by- horizontal distribution. The reason for this lies in the fact that the time basis requires practically unlimited space and this requirement can be met only by vertical distri- bution, because consecutive pages are here treated as the continuation of preceding pages. Horizontal distribution, on the other hand, is limited to the width of the page. By reference to Chapter XXXV, "Handling the Cash," it will be noted that for the purpose of horizontal classifi- cation the sheet contains a number of money columns, each headed by an individual class title, and that each item is first entered in the general column and then ex- tended to one of the subsidiary columns. Since the liability to error is comparatively great, it is of impor- tance that the sheet should provide for an internal check. This is accomplished by entering all items in the general column and then extending each to one of the distributive columns. It is evident that the total of the general column must be equal to the sum of the totals of the other columns, thus furnishing a fair though not complete proof that the extensions were made correctly. All books, where analytical processes are involved, should provide some kind of internal check. The student should refer also to Chapters XIX and XX where a form of the analytic jour- nal and explanation of it were given. Use of the Sales Ticket in Analysis Since the sales invoice or ticket is the basis for entry and analysis in the sales journal, it must give on its face the information necessary for making the analysis. In accordance with the basis, of classification used, it should show the department number, the kind of goods sold, whether for cash or credit, etc. The use of invoices with printed department numbers and of different colors for cash. 338 ACCOUNTING— THEORY AND PRACTICE charge, and C. O. D. sales, aid in making the record effective. In a business of any size, the entry on the main sales journal only shows the total for the day's sales. The sales tickets lend themselves easily to grouping, and therefore a day's sales may be analyzed by sorting and grouping the sales tickets. Under any method of this sort, of course, each ticket must be used for the record of only one class of goods. Thus, the totals of each of these sorted groups may be entered in the sales journal at the end of the day. Besides furnishing the totals for each group of sales, the individual tickets are used also for the purpose of posting the sales to the accounts of the particular customers. After use in these various ways the tickets are filed away in binders for reference. In this way, the main books are freed of a mass of comparatively unimportant detail, and it may be said here that only in rare cases is it necessary to refer back to the original sales ticket for full particulars. Analyzing Sales Returns Attention should be called to the necessity of analyz- ing returned sales, allowances, and rebates on the same basis as sales. Provision should also be made for a separate returned goods journal, since the ordinary jour- nal does not lend itself economically to an analyzed record of that kind. Purchases and Returned Purchases It has been pointed out that the basis of classification of sales in the ledger determines the analysis in the sales journal. The same basis of classification should also be applied to purchases, returned purchases, and inventories, because only in this way is it possible to determine the profit from the different classes of merchandise. Similarly, all inward costs such as duty, freight, insur- ance, handHng, etc., which enter into the cost of goods sold must be analyzed on the same basis and each share must be applied to each particular group according to the analysis. Because of practical difificulties, however, this analysis usually is not made upon its first entry on the records, but a distribution on a more or less arbitrary basis is made at the close of the period. In a large concern where very detailed information as to results is desired, an analysis of many other expenses and costs applicable to each sales group is made. This, however, carries us into the field of cost accounting which is beyond the scope of the present discussion. The Handling of Cash Sales A simple method of booking cash sales, where no analy- sis of kind of commodity is desired, is by entry in a "Sales" column provided in the cash book. The column total would be posted to the credit of "Sales" in the ledger. Under this method, cash sales need not be entered in the sales journal. In previous chapters where the functions of the subsidiary journals were discussed, the practice of entering a cash sale in both cash book and sales journal was advised. This seems best in order that the summaries of each may show true totals for those groups of business activities. However, this principle is often departed from and the method just de- scribed for booking cash sales is followed. Where an an- alysis of the sales is desired, the practical difificulty of pro- viding analysis columns in the cash book for the cash sales in addition to analysis columns in tlie sales journal for the sales on account, gives added weight to the principle stated, 340 ACCOUNTING— THEORY AND PRACTICE Some managements desire that the cash sales be posted separately, i.e., in an account by themselves, thus requiring two accounts, the "Sales on Account" and the "Cash Sales," to show the total sales for the period. This is easily ac- complished by the use in the sales journal of the "On Ac- count" and "Cash" columns whose totals would furnish the amounts for posting to the two ledger accounts. Even were it desired to have two sales accounts, the cash and charge, for each department in a business operating a sales analysis feature, the necessary information could be secured by pro- viding in the sales journal two columns, a cash and a charge, for each department and posting their totals to the two sales accounts carried for each. A more complicated problem, however, arises when it is desired to keep an account to show the total cash sales of all departments and at the same time include these cash sales with the charge sales and show both in departmental sales accounts. The information can be placed on the ledger, but in such a way that it destroys the usual meaning of the Cash Sales account. It is accomplished by providing the sales journal with two total or general columns — in addition to the departmental columns — one for charge and one for cash sales, and by carrying a "Cash Sales" column in the cash book. The items in the Cash Sales column in the sales journal are distributed to the proper analytic columns for classification. At the end of the period the totals of these an- alytic columns (which include both cash and charge sales items) are posted to the credit of the proper departmental ac- counts in the ledger. The total of the Cash Sales column in the sales journal, however, is posted to the debit of Cash Sales in the ledger, which will be offset by a corre- sponding credit item from the Cash Sales column in the cash book. Ordinarily, these two totals would agree provided the books are completely posted. SALES "2 A I Sales to Branches Sales to branches are made on different bases in differ- ent concerns. Sometimes such sales are charged to the branch office at cost, sometimes at full selling price, and sometimes at a fictitious figure. The first method, whereby the goods are charged at cost, is theoretically the best, but is not always desirable because head of^ces frequently prefer to keep their branches ignorant as to cost prices. For this reason such sales are frequently charged to the branch ofSce at regular selling price. By this method, however, the books of the head office show these goods as if they were actually sold, while in reality they are merely transferred to a branch office. Consequently, the books show a profit which is not yet earned. In order to correct this, it is necessary at the end of the period to make an adjustment entry covering all goods still in the pos- session of the branch office unsold at that time. By billing the goods at a fictitious figure the branch is also kept in ignorance as to real profits but proper adjustment should be made at the close of the period for the same reason as explained in the preceding paragraph. Whichever method is followed, sales to branches should always be kept separate from the regular sales accounts. Where the sending of goods to branches is frequent and in regular order, a branch shipments journal similar to the sales journal should be provided. Otherwise a special column in the sales journal might suffice. The total of such sales should be credited to a Branch Shipments, Branch Consignments, or similar account so as not to confuse these transactions with regular sales. Consignment Sales It may be remarked here that consignment sales also should be recorded separately from regular sales. This is 342 ACCOUNTING— THEORY AND PRACTICE so because the title to goods out on consignment is still vested with the consignor and no element of profit ap- pears in the transaction until actual sale is made. How- ever, in the case of an occasional consignee as distinguished from a factor who deals regularly in consigned goods, it has usually been held that the title has passed to the con- signee so far as the consignee's dealings with all except the consignor are concerned. Only in this way can the interests of innocent third parties be adequately protected. The accounting for consignments is treated in Chap- ter L. Instalment Sales The instalment sale should be treated in a different manner from regular sales because of certain special fea- tures connected with it. The chief characteristic of the instalment sale is the probability of the goods' coming back into the seller's possession through forfeiture by non- payment of instalments, and the profit on the transaction of course being affected thereby. The problem is simply stated here, its handling being deferred to Chapter LIII. Sales for Future Delivery From a legal point of view, the receipt of a purchase order gives rise to certain rights and obligations enforce- able at law between buyer and seller. While the seller might not be able to enforce specific performance of the contract, yet he would be entitled to the damage incurred through non-performance. Every merchant knows, how- ever, that the cost of securing the remedy is usually higher than the resulting gain and, furthermore, an action against the customer frequently causes the loss of his trade. Sales for future delivery do not always materialize, since either the buyer or the seller may wish to cancel the SALES 343 contract. A conservative policy tlierefore demands that the sale be not booked until delivery is made. The order, however, may be received in one fiscal period and the sale be credited to the period in which the goods are delivered, while the major part of the expenses in connection with the sale was probably incurred during the period in which the order was received. The current period then is charged with the expenses but does not receive the credit to which it seems entitled. Therefore, the portion of the selling expense incurred during the period in which the order was secured should be deferred to the period which receives the credit for the sale. This policy should be followed even when the goods covered by the future sale are set aside specifically for future delivery and the sale should not be booked until delivery is made. At inventory time such goods should be included at cost, with the deferred expense charge as above. Occasionally, an unscrupulous merchant in need of cash will bill such goods and discount the invoice; but for the reason given above such goods should not be charged to the customer until delivery is made. Department Store Sales As indicated above, in a department store it is usually required to classify sales by departments. The two classes of sales tickets, cash and credit, are sorted by departments and the totals are entered either in the sales journal or on the loose sales sheets which will make up the journal. This is the entry for the day. At the end of the month the journal is posted to the various department sales accounts. Each day the entries on the sales journal are checked against the cashier's record of cash received from sales and the bookkeeper's record of charges posted to customers. 344 ACCOUNTING— THEORY AND PRACTICE C. O. D. Sales For this class, the credit is booked in the usual way and the debit made to a C. O. D. account. The packages are charged by the shipping department to the various delivery men and they are credited with the collections turned in by them. Any balance in the C. O. D. account shows the amount of the undelivered goods still on hand in the shipping department. The Bill and Charge System By this name is known the method of writing up the customer's bill and using it as the basis for the charge to his account. It is operated somewhat as follows: A duplicate of each sales ticket goes to the auditing depart- ment. There they are first sorted by departments to secure the departmental analysis of the sales, and then re- sorted according to customers. Thus, if a customer has made purchases in more than one department, the tickets covering all his purchases are brought together. Each customer's monthly bill or statement of account is started at the beginning of the month on a folded billhead per- forated at the fold, the duplicate or under portion usually being somewhat wider, with loose-leaf binder punchings. On these bill and duplicate blanks the charges for the day are entered from the sorted sales tickets. This work is usually done on a billing machine with carbon roll or with carbon paper insertion. At the end of the day the total amount of the charges entered on all monthly statements is either found by means of an adding machine or is indicated by the "tally strip" of the billing machine. This total must, of course, be equal to the aggregate amount of all sales tickets for that day, thereby proving the work of the billing clerks. Customers' bills after entry each day may either be SALES 345 passed on to the bookkeepers who charge each customer's account with the day's total purchases as shown by the bill, or the bills are returned to the file till used again for subsequent purchases. In such case the bookkeepers use these bills only once a month to enter the total monthly charge to the customer's account. Returned goods and allowances are also entered on these customers' bills, but in a separate column. The total charges entered on these statements must check against the total credit sales for the month, thus proving the additions of the bills. At the end of the month the bill is torn from its dupli- cate and is passed to the bookkeepers. They enter the previous month's balance, if any, and the current pay- ments on account and extend the amount now due. These bills or statements are then mailed to the customers. The duplicate bills are filed away, being virtually the detail of the ledger account, for use in case of dispute. This method of handHng credit sales provides a ready means of getting the bills out on time, of assuring agree- ment between the ledger accounts and the bills, of free- ing the ledger accounts of unnecessary detail, and of checking the total billings against the total sales tickets. Salesmen's Commissions and EfEciency Records Salesmen are often paid a commission in addition to salaries. Where the commission is based on the amount of sales, the sales ticket again becomes the source of information. At the end of the day, or at any other time, these tickets are re-sorted according to salesmen and a record sheet, either separate or as an adjunct to the sales journal sheets, is filled in with each salesman's total for the day. These totals should prove against the salesman's record in the back of his book of sales tickets. At the 346 ACCOUNTING— THEORY AND PRACTICE end of the month, each salesman's total sales is shown by his record sheet and his commission is determined there- from. Of course, the total for all salesmen as shown by these sheets must equal the total sales for the period. If the commission, often known as "spifs" or "P. M.'s," is allowed only on certain classes of sales in order to encourage the movement of old stock, each sales ticket should indicate the amount of premium or commission due, so that house record can be made without the necessity of depending on the individual salesmen's records. Salesmen's records besides being used for the particular purpose of computing commission or bonuses due them, serve a wider object in that they contain fairly complete and reliable data in regard to the value and efficiency of individual salesmen. For this reason such records should be kept at all times, no matter whether a commission or bonus system is operated or not. Whenever an increase in a salesman's salary is considered or when the sales force is to be decreased, in number, these efficiency records fur- nish a valuable basis for making the right decision. Practice Data* (Assignment for Chapter XXXIX) Post completely and take a trial balance as of April 30. In sum- marizing the debit side of the cash book previous to posting, remember that included in the Sales Discount column is an item of bank discount on the firm's $10,000 note, which must be shown separately and charged to Interest Cost. Be sure you show this in the summary entries, in addition to the Sales Discount summary. To accomplish this the total of the Sales Discount column is best shown in two portions, the Sales Discount total on the one line, and the Interest Cost item on the next line. *See Practice Data for Chapter XXXVIII. CHAPTER XL CAPITALIZATION OF THE PARTNERSHIP The Real Capital From an accounting viewpoint, the real capital of any business enterprise is the excess of its assets over its liabili- ties. Usually, the main fund of capital is secured by origi- nal contribution. In a partnership, each of the partners makes some investment which provides the common partner- ship fund. Thereafter, additions to the capital may be se- cured in several ways : 1. Profits may be left in the business instead of being withdrawn. 2. Specific contributions may be made by the partners, which are either to be considered as additions to their capital investment, or are to be treated as more or less temporary loans to the business. 3. Outside capital may be borrowed. 4. A new partner may be taken in, his contribution producing an increase in the partnership capital. The present chapter deals with original investments and with the first three types of additional capital mentioned above, while the next chapter discusses the admission of new members and the consolidation of partnerships. Original Contributions It sometimes happens that the partnership agreement does not state specifically how much each partner shall in- vest in the business. For example, the agreement may say 347 348 ACCOUNTING— THEORY AND PRACTICE that partner A is to contribute certain properties, i.e., place of business and equipment; that B shall contribute a stock of goods, and that the investment of the remaining partners shall consist of cash, the exact amount of which is not stated but depends upon the valuation placed upon the property and merchandise invested by A and B. After valuations are placed upon these properties, and the amounts of the cash contributions thus made definite, it may be found that the total investment thus obtained is more than the business requires. Or, it may happen that some of the partners do not have sufficient funds available to pay their shares, while others may be able to contribute more than their respective shares. It thus happens that the partnership agreement is not always rigidly enforced, some partners contributing more, and others less, than the agreed amounts. This is at the time looked upon as a temporary arrangement, but often results in a permanent condition. The partnership agreement should contain provision for such a contingency. If not, a later agreement should be made whereby the relations between the partners are reg- ulated. Adjustment of Capital Contributions Whenever a partner contributes more than his agreed share, it is customary to allow him interest on the excess amount, and other partners whose investment may be less than agreed are usually charged with interest. This is obviously an equitable method of meeting the situation. As a rule, these interest adjustments are handled through the Profit and Loss account, i.e., the partners who invest less than the agreed share are considered to owe interest to the partnership as such, and those who invest more have an interest claim against the business and not against the other partners individually. The debit or credit balance in CAPITALIZATION OF THE PARTNERSHIP 349 the Profit and Loss account resulting from these adjustments is in turn distributed among all partners in profit or loss sharing ratios. It should be clearly understood, however, that although these adjustments are made through the Profit and Loss account, yet there is no element of business profit or expense involved. For this reason, these interest entries should be made direct in the appropriation section of the Profit and Loss, and should never be booked in the reg- ular Interest accounts. The following illustrations will bring out the different methods of adjustment : A, B, and C are equal partners under an agreement to contribute each $15,000. Provision is made that excess contributions are to be credited with interest at 69^0 and that deficits are to be charged at the same rate. The records show that actual contributions were: A, $18,000; B, $13,000; and C, $11,000. The problem is how to adjust the partners' accounts in accordance with the agreement. Three methods of adjustment will be shown. First Method A's excess is $3,000, interest on which is $180. B's deficiency is $2,000, interest on which is $120. C's deficiency is $4,000, interest on which is $240. These interests are brought on the books by the follow- ing journal entries: Profit and Loss $180.00 ^ $180.00 B 120.00 C 240.00 Profit and Loss 360.00 The Profit and Loss account then shows a credit balance of $180, which is distributed as follows : 350 ACCOUNTING— THEORY AND PRACTICE Profit and Loss $180.00 A $60.00 B 60.00 C 60.00 The net effect of these adjustments is a credit to A of $240, with debits to B and C of $60 and $180 respectively. Note that A is credited with $180 for his excess of $3,000, and Profit and Loss is debited with the same amount, because it is the business that owes this interest to partner A. If this Profit and Loss debit were distributed separately, A's share in it would be $60, so that his real credit on his $3,000 excess is not $180 but $120. On the other hand, the combined debits to B and C result in a credit to Profit and Loss of $360, and, if this item were distrib- uted as such, A's share would be $120, thus making his total credit on the complete adjustment $240. A similar explanation would apply to the adjustments for B and C. Second Method The first method was based on a consideration of the respective excesses or deficits on capital investments, but the same result may be obtained by comparing all contribu- tions with the amount of the smallest investment, viz., $11,000 by C. This would show A's excess over C as $7,000, and B's excess over C as $2,000, and these two amounts may be treated in the nature of loans to the busi- ness. The result is that A is credited with 6% on $7,000, and B with 6% on $2,000, as follows : Profit and Loss $540.00 A $420.00 B 120.00 The debit to Profit and Loss is charged in equal shares to the three partners as follows : CAPITALIZATION OF THE PARTNERSHIP 351 A $180.00 B , 180.00 C 180.00 Profit and Loss $540.00 and the final result shows a net credit to A of $240, a net debit of $60 to B, and a net debit of $180 to C, the same as by the first method. Third Method The total capital contributed is $42,000. To be equal partners under the agreement, each should have contributed one-third of the common fund, or $14,000. Actually, A's investment is $4,000 in excess of this, while B's deficit is $1,000 and C's deficit $3,000. The excess contribution of A, $4,000, may be looked upon as in the nature of loans to B and C as individuals, to bring their shares up to the $14,000; viz., $1,000 to B and $3,000 to C. Instead of making the adjustment through the Profit and Loss account as in the first two methods, the interest is now adjusted be- tween the three partners as private persons, the entries affecting only the partners' personal accounts. This would result in a credit to A and a debit to B for $60, A having loaned B $1,000; and a credit to A and a debit to C for $180, for the loan of $3,000 to C. A's total credit would again be $240, and B's and C's debits respectively $60 and $180, the same as by the other two methods. Thus it is seen that any of the three methods employed leads to the same results. It will be observed, however, that in the example given the contemplated investments were to be equal amounts for the three partners ($15,000), and the profit and loss was to be shared on the same basis. The three different methods of adjusting interest lead to the same results only when the profit-sharing ratio is identical with the ratio between the contemplated investments. 352 ACCOUNTING— THEORY AND PRACTICE Averaging Investments In the case of partnerships of a temporary nature, or- ganized for carrying out a particular undertaking, very often the amount of capital needed is not known and may vary at different stages of the undertaking. Here, the partners usually contribute as need arises, and withdraw when funds not needed in the business become free. As stated in Chapter XXXIV, such additional contributions are frequently made without regard to any specified ratios, but whenever additional money is needed it is furnished by those partners who have available funds at that time. Under such conditions, the partnership agreement should always provide the manner in which the partners' interests are to be adjusted. A common method of adjustment as explained and illustrated in Chapter XXXIV is to compute the average investment of each partner and to use these amounts as the basis for profit-sharing. In this way the problem of interest adjustment as such is completely eliminated. Accretions of Capital Through Profits At the close of the fiscal period, when results are sum- marized, the net profits are transferred to the partners' accounts. The amount of profit left in the business usually is dififerent for different partners. It is evident, therefore, that the partners' capital accounts at the end of the period usually show a different ratio from that existing at the beginning. Assume that a given partnership consists of two members, one investing $2,000 and the other $i,000, and that profits are to be shared in the same ratio as these original investments, i.e., 2:1; assume further that at the end of a number of years the capital ratios have com- pletely changed, the present capitals being, say, $8,000 and $24,000 respectively. Obviously, under such circumstances it would not be just for the first partner still to receive twice CAPITALIZATION OF THE PARTNERSHIP 353 as much profit as the second partner, because the original investment ratio was 2:1. Similar conditions frequently occur. One instance is known of a partnership of two men, one of whom at the start furnished the entire capital of a few thousand dollars. The other, by leaving his profits in the business in much larger measure than the first, soon overtook him and finally when the business had grown to a half-million dollar concern he had a larger interest in it than the partner who had furnished the entire original capital. Whenever it is intended that profits are to be shared on the basis of investments, the profit-sharing ratio should be changed from time to time in order to correspond with actual investments and this should be plainly stated in the partnership agreement. Another way in which justice may be done to the partner whose investment increases more rapidly than that of the others, is by allowing him interest on his excess investment, as has been explained. It should be the policy of the firm to offer some such incentive to the members to have them leave their surplus profits in the business and so prevent the need of borrowing from the outside. Finally, it may be said that in the event of dissolution, accretions through profits constitute claims against the firm ranking before the partners' capitals. Virtually, they partake of the nature of loans and for this reason they are sometimes carried in partners' loan accounts in order to keep them separate from the original capital investments, or are left in the "Personal" accounts which are not then closed into the "Capital" accounts. Additional Contributions and Loans When contributions are made by partners there should be a specific understanding as to whether these funds are 354 ACCOUNTING-THEORY AND PRACTICE to be considered as additional capital or as loans to the partnership. In the first case the items should be shown in the capital accounts of the partners, thus equitably requiring a change in the profit-sharing ratio — although a change is not always made ; and in the second case they are entered in the partners' loan accounts with corresponding interest ad- justments as has been explained. Loans by the partners may be evidenced by firm notes signed by all partners and given to those making the loan. However, these notes should not be carried in the regular Notes Payable account because that account represents the firm's liability to outsiders, which must ordinarily be met promptly according to the terms of the instrument. At common law, a partner may not bring suit against the firm of which he is a member ; hence, there is an essential differ- ence between these two kinds of notes. For this reason, a new account is opened entitled Partners' Notes Payable which is credited whenever the firm issues a promissory note to any of its members. Where the loan is not evidenced by a formal note, record should be in the partner's loan account. As has been stated, any loans made by partners to the busi- ness rank before regular capital claims, and this priority is not changed when such loans are evidenced by promissory notes. Borrowed Capital It may happen that a firm is obliged to borrow funds from outside in order to increase its working capital. For instance, the partners may have no available private funds for further investment and yet may not desire to admit new capital on a profit and loss sharing basis. Such loans usually are on a long-time basis, and should not be included in the Notes Payable account. A special account should be opened, e.g.. Notes Payable Special, Mortgage, or other title plainly CAPITALIZATION OF THE PARTNERSHIP 355 indicating the nature of the loan. Sharp distinction should be made between funds borrowed for the purpose of increas- ing the permanent capital, and money borrowed for current needs. The need for additional current funds usually re- sults from a slow collection of customers' accounts or slow movement of stock, while the need for increased capital is caused by the fact that the original capital investment is insufficient to meet present conditions. Practice Data* (Assignment for Chapter XL) Summarized transactions for May were : Purchases — Washburn Crosby Co., n/io, $10,149.60; Federal Ma- caroni Co. 2/20, n/30, $5,219.80; United Supply Co., 3/5, 2/20, n/30, $8,620.95; Delico Food Products Co., 5/5, n/30, $5,419.40; Van Dusen Co., 8/5, s/io, 2/30, n/90, $7,684.25 ; Kataguri Bros., 3/10, n/60, $6,714.80; cash purchases $537.92. Sales — Las Vegas Cattle Co., 3/5, n/20, $1,200 ; U. B. Zipkin, i/s, n/60, $4,760.40; J. Henry Witt, 2/10, n/30, $5,120.60; J. J. Toramich, 2/5, n/20, $2,130.65 ; Al Morton, i/io, n/30, $1,825.75 ; J. R. Rice, 3/5, n/60, $3,250.75 ; Circle Bar Ranch, 3/5, n/20, $1,314.55 ; Uintah Copper Co., 3/10, n/30, $1,192.20; P. Peterson, 2/5, n/60, $4,376.80; J. Perlman, i/S. n/30, $3,895.35 ; Progressive Stores Co., 3/5, n/20, $5,940.65 ; Russo Bros., 2/10, n/30, $1,937.50; Wm. Crick, i/io, n/30, $2,562.45; Gristede Bros., i/io, n/30, $10,842.25 ; M. J. Downing, 2/10, n/30, $3,947.75 ; Casazza & Sons, 1/5, n/30, $2,100; Capella Bros., 2/5, n/60, $2,875.42; S. Brown, 3/10, n/30, $1,987.60; Black Hills Mining Co., l/io, n/30, $987.15; J. Johnson, 1/5, n/60, $1,236.40; Ward drew groceries $100; cash sales $6,725.43. Journal — received goods returned by J. Henry Witt of his April purchase as unsatisfactory, $1,320.70; out-freight for April was $125.90; received goods returned by Progressive Stores Co., error in filling order, $1,560.90 ; cash over for this month was accounted for by failure to record kindling sales, $30.25 ; received spoiled goods from Gristede Bros., $2,150; received from M. J. Downing, I. B. Perkins' 6% 60-day note due July 15, $2,000, to apply on account; returned to United Sup- *Practice Data for Ward & Gneisel set begin with Chapter XXXI, 356 ACCOUNTING— THEORY AND PRACTICE ply Co. goods, on account of error in filling our April order, $1,580.20; gave Van Dusen Co. our note dated May 8 at 60-day, non-interest bear- ing, but with 60 days' interest, $50, included in the face, for their bill of April $9,825.35 less 5% discount and cash payment of $4,334.08 for balance. Cash Receipts — Quinn Bros., April bill $3,975.20 net; Stewart & Son, balance of April bill, $2,755.35 net ; S. Koenig, April bill, $2,875.45 net; M. E. Dietrich, April bill, $4,150.60 less 2% ; Jas. Butler, Inc., bal- ance April bill, net $3,572.55 ; C. A. Gerken, April bill, $2,875.60 less 3% ; John Johnson, April bill, $3,105.20 less 1% ; Jacob Green, April bill, $2,900 less 3% ; Gristede Bros., $4,500 on account; cash was over $30.25; C. N. W. Ry. settled our claim of $325 for Gerken by paying $250; sold packing supplies, $15.75; Casazza & Sons, May bill, $2,100 less 1%; Black Hills Mining Co., April bill, $2,160.50 net ; Evans Sons, April bill, $2,760.46 less 2% ; Andrew Davey, April bill $3,840.90 less 3% ; J. Henry Witt, May bill, $5,120.60 less 2% ; U. B. Zipkin, $5,000 on ac- count; Las Vegas Cattle Co., $2,500 on account; Dodts' Grocery note $1,517.18 came due May 20 and was paid with interest; Lewiston School Bonds' interest for the half-year was received May 24. Cash Disbursements — Salesmen's salaries $6,250 ; salesmen's travel- ing expense $6,100.50; advertising $5,280.17; shipping expense $1,392.20; shipping supplies $120; in-freight and cartage, $1,319.18; rent for June, $250; insurance policy for i year, May I, 1916 to May I, 1917, $240; light and power $140.69; office salaries $980; Armour Packing Co., April bill, $6,256.55 less 2% ; Holland Gelatine Works, April bill, $7,778.90 less 2% ; Van Dusen Co., $4,334.08 on account as above ; United Supply Co., balance of April bill, $7,122.95 less 2% ; office ex- pense $19.15; office supplies $175.20; general expense $138.20; furniture for store $625 ; cash was short $27.80 ; donations to charity $18.75 ; paid our note at the bank $10,000 ; Ward drew $350 ; Gneisel $500. Instructioits Transfer the large credit of $30.25 in Cash Short and Over to Miscellaneous Sales. The receipt of $250 from the railroad in settle- ment of our claim against them might be set up as a credit to Freight Claims Income were it desirable to have the information as to income from that source. It is perhaps best handled as a credit to Sales Returns and Allowances to offset the charge here made at the time of the customer's complaint about lost goods ; it will be so treated here. The effect of adding interest to the face of a non-interest bearing note is to secure a compounding of the interest if the note is not paid at maturity, as the note will bear legal rate of interest after maturity. Be careful to get the debit and credit of this transaction with Van Dusen Co., both in cash book and in Journal. CHAPTER XLI OTHER PARTNERSHIP PROBLEMS Admission of a New Partner In Chapter XXXIV a distinction was made between buying out an interest in a business and making an invest- ment in a business. In the former case no new capital is acquired, while in the latter the capital of the firm is increased by the amount of the new partner's contribution. When a new partner is admitted he usually acquires not merely the right to share in the profits but he also obtains a share in the net worth (often called net assets) of the enterprise. For this reason it is necessary that all the partners, including the new member, are agreed as to the value of the net assets, and in this connection any of the following possibilities may arise: 1. Upon admission of the new partner the book ac- counts may be considered to represent the true status of the business. A balance sheet is drawn up and the new partner is admitted on the basis of the net worth shown thereby. 2. It may be considered that the assets are not worth the amount at which they have been carried on the books and a new valuation is placed upon them. 3. Or there may be reasons why the business is con- sidered to be worth more than the amount shown by the balance sheet. First Case In the first case little difficulty is met in making the entry for admitting the new partner. For instance, if the 357 358 ACCOUNTING— THEORY AND PRACTICE balance sheet shows a net worth of $30,000, and the new partner wishes to make an investment in order to secure a one-foufth interest in the firm, the amount to be con- tributed is evidently $10,000. Assuming that he makes a cash investment of $10,000, the following entry would meet all accounting requirements: Cash $10,000.00 A, Capital $10,000.00 As a result of this cash investment of $10,000 the net worth of the new firm now amounts to $40,000 and the one-fourth interest belonging to A is evidenced by his capital account at $10,000. The new firm may now con- tinue the old records and no further adjustments will have to be made. Second Case In the second case it is necessary to place a new valua- tion upon the assets of the old firm and the accounts of the old partners must be adjusted accordingly. For in- stance, suppose A and B are equal partners and the finan- cial status of the firm is shown by the following balance sheet: Balance Sheet of A & B Cash $1,000.00 Accounts Receivable... 10,000.00 Merchandise 6,000.00 Building and Equip- ment 16,000.00 $33,000.00 Notes Payable $3,000.00 Accounts Payable 5,000.00 Mortgage on Bldg 4,000.00 A, Capital 10,500.00 B, Capital 10,500.00 $33,000.00 More capital is needed and C is invited to make an investment. Upon investigation he finds there are in- OTHER PARTNERSHIP PROBLEMS 359 eluded under Accounts Receivable many old items of which it is estimated $1,000 will be uncollectible; the mer- chandise is overvalued to the amount of $500, and the building and equipment are worth $1,500 less than is shown on the books. He offers to make an investment to secure a one-fourth interest and his offer is accepted. As a result of the new valuations placed upon the assets, the net worth of the firm now is $18,000, against the old showing of $21,000. Consequently, the capital accounts of A and B are reduced from $10,500 to $9,000 each. The new partner is to invest a certain sum suffi- cient to acquire a one-fourth interest in the new business. Hence the combined capital of A and B, $18,000, will represent three-fourths of the new capital and conse- quently the amount to be invested by C equals $6,000. Thus the new capital of the firm will amount to $24,000, one-fourth of which, or $6,000, is credited C's capital account. The balance sheet of the new firm will show: Balance Sheet of A, B & C Cash $7,cx)o.oo Accounts Rec. . . $10,000 Less, Reserve. . . 1,000 9,000.00 Merchandise 5,500.00 Building and Equip- ment 14,500.00 $36,000.00 Notes Payable $3,000.00 Accounts Payable 5,000.00 Mortgage on Bldg 4,000.00 A, Capital 9,000.00 B, Capital 9,000.00 C, Capital 6,000.00 $36,000.00 The firm has thus secured $6,000 additional capital, on a basis somewhat unfavorable for the present, but, inas- much as the books now show conservative values, no ultimate injustice is done any of the partners. 360 ACCOUNTING— THEORY AND PRACTICE Third Case The third case shows the firm in a position to demand something more than book values as the basis for admis- sion of the new partner. It presumes that the old firm is favorably known, has an established trade and patronage built by fair dealing and judicious advertising, by favorable location, and the numerous other ways in which a sub- stantial business may be developed. Its standing in the community is a factor of real value to the firm because it brings trade to their doors. Other conditions being equal, a firm which enjoys a good reputation is worth more than a new venture. All of the factors bringing about such condition are usually classified as good-will. The essence of good-will is the ability to produce above-normal profits, i.e., profits above the average in that line. Consequently, whenever the members of a firm consider the admission of a new partner, i.e., when they intend to sell a part of their interest in the business to an outsider, good-will is regarded as one of the assets of the existing enterprise, thereby increasing its net worth. The valuation of good-will, however, is a difficult mat- ter and it is a well-established principle that good account- ing will not allow the asset good-will to be set up on the books of a concern unless it has come into possession of it either by purchase or when a part of its own good-will is sold to a new partner. In this case the price received for the portion sold becomes the basis for valuing the whole of it. The following case will serve to illustrate the foregoing discussion : Suppose that X has a one-half interest in a firm, and Y and Z a one-fourth interest each. The balance sheet of this partnership is shown in the following summarized form: OTHER PARTNERSHIP PROBLEMS 36T Balance Sheet of X, Y & Z Cash $2,000.00 Other Assets 48,000.00 $50,000.00 Liabilities $10,000.00 X, Capital 20,000.00 Y, Capital 10,000.00 Z, Capital 10,000.00 $50,000.00 An outsider, R, is now to be admitted as a one-fifth interest partner by investing $12,500, while the relative shares of the others are to remain as before. Hence, after R's admission X will have two-fifths, and Y, Z, and R one- fifth interest each. It is further assumed that no revalua- tion of the assets is necessary. The net worth of the old firm is seen to be $40,000. If book values were taken as the basis for admitting R, an investment of $10,000 would be sufficient to acquire a one- fifth interest in the new firm. However, it is considered that the business is worth $10,000 more than the $40,000 shown in the balance sheet, and for this reason, instead of paying $10,000, R is required to invest $12,500. The excess of $2,500 is paid by R as an offset to the shares of the others in the good-will of the firm. There are three ways of treating this good-will element, viz. : First Method. Debit the Good- Will account for the amount actually paid for it by R, viz., $2,500, and credit the capital accounts of the old partners in proportion to their shares in the profits : Good- Will $2,500.00 X, Capital $1,250.00 Y, Capital 625.00 Z, Capital 625.00 As a result of this entry, the capital account of X would be $21,250, and those of Y and Z $10,625 each. The capital account of R, however, would show a credit 362 ACCOUNTING— THEORY AND PRACTICE of $12,500. In other words, R's interest in the net assets — although not in the profits — of the business as shown by his account would be larger than that of Y and Z, while as a matter of fact he was to have an equal share. For this rea- son, this method of treating good-will is not satisfactory. Second Method. According to this method the matter is looked upon from a different standpoint. Taking book values as a basis, the share bought by R is worth only $10,000. However, on account of good- will, the real value of this share is considered to be higher and R is required to pay $12,500 for it. Hence, in order that the books may show actual values, this good-will item must be added to the assets of the old firm, at the same time increasing the capital accounts of X, Y, and Z in propor- tion to their shares in the profits. The entry would be : Good-Will $10,000.00 X, Capital $5,000.00 Y, Capital 2,500.00 Z, Capital 2,500.00 As a result of this adjustment the capital of the old firm is shown as $50,000. R now invests $12,500; the capital is thereby increased to $62,500. The capital ac- counts of the four partners now show $25,000, or two- fifths, for X, and $12,500, or one-fifth, each for Y, Z.and R. Third Method. Under this method of handling good- will, the extra $2,500 invested by R is treated as a bonus for distribution among the members of the old firm outside the business, their capital interests in the new firm showing the same as in the old and R's appearing at $10,000. There is no objection to this method if R is satisfied. Of the three methods, the second usually proves the most satisfactory. Another, though a similar problem, involving the han- dling of good-will is encountered when a member of an ex- OTHER PARTNERSHIP PROBLEMS 363 isting firm sells out his interest, including a share of the good-will, to another who takes his place in the firm. Here the transaction may be looked upon as a private deal be- tween buyer and seller, in which case the buyer merely suc- ceeds to the seller's interest in the firm, his capital appearing the same as the seller's former capital interest even though he paid more for it ; or the good-will may be brought onto the books and the capitals of all the partners be shown at in- creased figures just as under the second method above. Consolidation of Partnerships There are various reasons why the consolidation of partnerships may be of mutual advantage to the individual firms concerned. For instance, when two or more firms consolidate, the competition which formerly existed be- tween them is eliminated and co-operation takes its place. By uniting their businesses, many of the operations which were formerly performed by each are now co-ordinated with resulting savings of every kind. Many other advan- tages may result from consolidation of individual firms. However, looked upon from the standpoint of the ac- countant, the consohdation of partnerships is essentially of the same nature as the admission of new partners, the same principles applying to both. Before actual consolidation takes place, it is necessary for each of the partnerships to place a new valuation upon its assets and that the new figures be agreed upon by all concerned. In almost all cases good-wih enters in as an important factor. Aside from the booking of good-will, the accounting problem involved has to do mainly with the work of the auditor when investigating conditions as to profits and profit-earning capacity in order to have a correct basis for estimating the good-will of the member firms. Conditions affecting profits in the various firms must be 364 ACCOUNTING— THEORY AND PRACTICE equalized as nearly as possible so that the earning capacity of the firms can be compared on an equitable basis. Such questions as the way in which salaries to the partners, inter- est on capitals, withdrawals, and loans have been handled in the various firms, the relation of outside-the-business profits to the profit-showing of any of the member firms, and whether the consolidation contemplates taking over this source of profits — these and similar questions must be con- sidered and treated equitably for all concerned. The following illustration is given in order to assist the student in solving problems incident to consolidations. A and B, equal partners in an established business, consolidate with C and D, equal owners of an allied busi- ness. A and B are each to have a one-third, and C and D each a one-sixth interest in the new firm. The following balance sheets show their financial positions: Balance Sheet of A & B Cash $2,500.00 Notes Receivable 1,000.00 Accounts Receivable 22,000.00 Merchandise 10,000.00 Furniture and Fixtures. 2,500.00 Delivery Equipment... 1,500.00 Real Estate 9,500.00 Notes Payable $5,000.00 Accounts Payable 8,000.00 Mortgage on Real Es- tate 4,000.00 A, Capital 16,000.00 B, Capital 16,000.00 $49,000.00 Balance Sheet of C Sz; D Cash Accounts Receivable . . . Merchandise Furniture & Fixtures.. Horse & Wagon ^5,000.00 15,000.00 8,000.00 2,000.00 750.00 $30,750,00 Notes Payable. ... Accounts Payable. C, Capital D, Capital $5,000.00 7,750.00 9,000.00 9,000.00 $30,750.00 OTHER PARTNERSHIP PROBLEMS 365 A careful valuation of the various properties shows that the balance sheet of C & D represents conservative values. In regard to A & B's figures, hovi^ever, it was decided to allow $2,000 for possible bad debts, and to value their merchandise at $9,000, delivery equipment at $1,000, and real estate at $9,000. Furthermore, it is agreed that C & D's good-will shall be valued at $5,000, and A & B's at $10,000. After making the required adjustment entries the new balance sheets will show as follows: Balance Sheet of A & B Cash Notes Receivable Accounts " $22,000 Less, Reserve. . 2,000 Merchandise Furniture and Fixtures. Delivery Equipment.. . . Real Estate Good-Will $2,500.00 1,000.00 20,000.00 9,000.00 2,500.00 1,000.00 9,000.00 10,000.00 $55,000.00 Notes Payable $S,ooo.oo Accounts Payable 8,000.00 Mortgage on Real Es- tate 4,000.00 A, Capital 19,000.00 B, Capital 19,000.00 $55,000.00 Balance Sheet of C & D Cash $5,000.00 Accounts Receivable... 15,000.00 Merchandise 8,000.00 Furniture and Fixtures. 2,000.00 Horse and Wagon 750.00 Good- Will 5,000.00 $35,750.00 Notes Payable Accounts Payable. . C, Capital D, Capital $5,000.00 7,750.00 11,500.00 11,500.00 $35,750.00 It is agreed that C and D's capitals are to be taken as the one-sixth basis for capitalization of the new firm, and A and B will each contribute $4,000 in cash to bring their 366 ACCOUNTING— THEORY AND PRACTICE capitals up to the required amounts. The opening balance sheet of the consolidated firm will then read as follows: Balance Sheet of A, B, C & D Cash $15,500.00 Notes Receivable 1,000.00 Accounts Re- ceivable $37,000 Less Reserve. . . 2,000 35,000.00 Merchandise 17,000,00 Furniture and Fixtures. 4,500.00 Delivery Equipment 1,750.00 Real Estate 9,000.00 Good-Will 15,000.00 !,75o.oo Notes Payable Accounts Payable Mortgage on Real Es- tate A, Capital B, Capital C, Capital D, Capital $10,000.00 15,750.00 4,000.00 23,000.00 23,000.00 11,500.00 11,500.00 $98,750.00 Partners' Loans in Relation to Firm Credit So far as the credit of a firm is concerned, loans made by partners to the firm may be viewed in two very dififerent ways. If there is no suspicion as to the standing and financial condition of the firm, the fact that the partners themselves, who know the real condition better than any outsider, are willing to put addftional capital into the firm, is the best evidence that the firm is prospering. Con- sequently, loans made by partners under such conditions help to increase the firm's credit. On the other hand, if the integrity of the members of the firm is questioned, even then the loan made by a partner would make a better showing than a loan from an outsider since in case of insolvency and dissolution the partner's loan ranks after the claims of outside creditors. However, if a partner has invested large sums of money either as additional capital or as a loan, in case of financial trouble he may attempt secretly to withdraw part of the assets from the business and to conceal the true condition OTHER PARTNERSHIP PROBLEMS 367 of affairs from the creditors. Being on the inside he is in a position to do this before outsiders could even scent trouble. It sometimes happens that a firm allows one or more of its members to loan the firm comparatively large amounts of money and gives them demand notes as evi- dence of such loans. If the partner holding such a note is of an unscrupulous character, he may present it for payment at maturity and, if the firm is unable to pay, may demand an "accounting." He may even go further and cause the dissolution of the firm and thereupon repurchase the interests of the other partners at much less than their true value. This is one scheme by which dishonest men have sometimes succeeded in "freezing out" their partners in business. These and similar matters belong rather to the field of fraudulent finance, but are mentioned here be- cause the accountant is sometimes called upon to deal with financial problems of this kind. Practice Data* (Assignment for Chapter XLI) Post completely and take a trial balance as of May 31. *See Practice Data for Chapter XL. CHAPTER XLII PARTNERSHIP PROFITS Ambiguity of Definition of Profits The term "profits" as applied to business is perhaps used with as little uniformity as any term met with. When a concern speaks of its profits it is difficult to know exactly what is indicated thereby, because the meaning of the term depends very largely on the point of view of that particular concern. The reported profits of different firms are not a true basis for judging the relative worths of these concerns, unless it is known exactly how certain items, about which practice varies, have been handled in the particular cases. The net profits of a single proprietorship or of a partnership are usually derived in the same manner, although even here there is variation in the treatment of some items such as salaries, drawings, interest on capital invested, etc. The partnership form, like the single proprietorship, contem- plates an investment on the part of the owners not only of capital but also of time and effort. This is one of the differ- ences as to working organization between these forms and the corporation. Investment in the corporation is of capital only. If services are employed by the corporation, they are paid for and charged as services, salaries, etc. Compensation for Time and Services The partnership form presumes acti\'e and direct manage- ment of the business on the part of the owners. Where this is not the situation, as is sometimes the case in a limited partnership, or whenever one or more of the partners is not active, that partner is usually penalized in his share of PARTNERSHIP PROFITS 369 the profits by the allowance of salaries to the managing partners before any distribution of profits in the agreed ratio to all the partners. Thus, in partnership profits is included the element of salaries, not only salaries as such but, in general, a recompense for the time and contributed ability of the proprietors. The man who makes an invest- ment in a partnership does so usually because he desires to Invest his time as well as his capital. He expects, therefore, to receive not only a fair rate of interest on his money but also pay for his services with the firm. Interest on Investment In the chapter on interest, the rate paid for the use of money was seen to be dependent both on the money market and on the element of risk involved in the particular invest- ment. In mining ventures where frequently the certainty of return of the principal is small, the interest rate is suf- ficiently high to otifset, during the life of the loan, the loss of the principal at the end. So an investor in a partnership, because of the element of risk in comparison with that of so-called absolutely safe investments, requires a higher rate of return under the title, interest, than he would in an ordi- nary investment in good securities. Partnership Profits Defined Partnership profits, therefore, contain these two ele- ments — interest and recompense for services. If profits are extraordinary, above normal, such excess may be and usu- ally is the measure of the more-than-average ability of the partners, or it may result from local conditions, partaking of the nature of monopoly profits. It is the purpose of this chapter to lay down a correct definition of profits and to show the method of their dis- position and to discuss related problems. 370 ACCOUNTING— THEORY AND PRACTICE Partnership profits or the net profits of a partnership are easier of definition by a statement of what should not be considered in their determination, than by attempting to give an itemized list of the income and expense items enter- ing therein. In speaking of profits in this way, the term is used in a technical accounting sense and has reference to the manner of their showing in the Profit and Loss 'account and its content. That account or statement usually develops a so-called net profit which is distributed to the partners. We may say, therefore, that the net profit of the busi- ness is the profit determined before interest on owners' capital investments and the recompense to the partners on account of time and services are taken into account. In the ordinary partnership, all such items as interest on capital investments, salaries to partners, etc., are not to be con- sidered as expense items to be deducted from profits before the net earnings are determined, but these items themselves constitute a part of the distribution of the net profits to the several owners of the business. They are employed simply for the purpose of distributing net profits according to certain methods agreed upon by the members of the firm. Profit and Loss for Comparative Purposes In order that the Profit and Loss account may serve as a basis for periodic comparisons, it should have a fairly uni- form content from year to year. It should develop what may be called a net operating profit, in the calculation of which, account should be taken of all ordinary income and expenses incurred .in the operation of the business. This will provide the basis for comparisons, between periods, of the ordinary normal activities of the business. In the "Other Income" section all outside-the-business income and expense should be considered, such as income PARTNERSHIP PROFITS 371 from investments outside the business and expenses in con- nection therewith. Items of extraordinary income and expense, however, usually are taken directly into the part- ners' accounts, i.e., are not cleared through the Profit and Loss and so do not destroy the value of the results shown by that account from year to year. Instances of such ex- traordinary items are profits arising through the sale of good-will, profits realized on the sale of real estate, extraor- dinary losses from fire, etc. In this way, while the purpose of the Profit and Loss is to summarize all of the temporary proprietorship accounts, yet for the sake of making that summary of greater value to the proprietors, some proprietorship items may be omitted. Such a method of handling is not in conflict with principles previously laid down, but rests upon the general principle that accounting methods and forms are not hard and set but must conform in particular cases to the require- ments met with; they must be flexible to local conditions else they fail in their full purpose and efficiency. Allowance of Salaries The allowance of salaries to partners is not so much for the purpose of measuring the excess of the profits of the partnership over what the individual owners might have earned by working for others, as it is for the purpose of equalizing or adjusting their interests on an equitable basis. When, on the one hand, men invest their abilities and ser- vices in addition to their capitals, and on the other hand, the profit and loss sharing ratio is determined on the basis of the capitals invested, some adjustment must be made in order that the greater ability of a given partner may be recognized and compensated by a salary. Thus a partner of exceptional ability secures a larger share in the profits by receiving a fixed amount under the head of salary, the remaining part 372 ACCOUNTING— THEORY AND PRACTICE of the net profits being divided among all partners in the profit and loss sharing ratio. Allowance of Interest It sometimes happens that still another basis of profit- sharing is introduced in the partnership agreement. This is the device of an interest allowance to the partners for contributing in excess of the agreed amount and an interest charge on partners' deficiencies of capital. This method of equalizing unequal investments is set out in detail in Chapter XL. It is a fair arrangement to all concerned. The effect of such a provision is to secure a distribution of profits on a dual basis, viz., a part of the profits as interest on the capitals in the capital ratio and the remainder of profits in the profit and loss ratio. Thus, two partners A and B whose capitals are $10,000 and $15,000 respectively, with a 6J0 interest allowance on capi- tal and a subsequent half and half distribution of profits, have in effect a profit-sharing on two different bases. Sup- pose the profits are $6,000. The interest requirement will give A $600 and B $900, after which $4,500 will be divided equally. Interest on partners' capitals is thus in no sense an operating expense and should be handled always in the appropriation section of the Profit and Loss. If the partnership agreement makes specific provision (but not otherwise), interest may be charged on partners' drawings. This is merely an additional device for adjusting the partners' interests, and causes a slight difference in the net shares of profits to each. Where interest is allowed on capitals and also charged on drawings, the partners' ac- counts Personal and Capital combined in one, are virtually accounts current, and the interest computations may be made as explained in Chapter LII in connection with accounts current. PARTNERSHIP PROFITS 373 Interest on Partners' Loans Careful differentiation must be made between interest on partners' capitals and partners' loans. Had the loan been made by outside parties its interest cost would have been treated as a business expense to be taken account of before the determination of net profits. The fact of its being a loan from a partner does not in the least change the manner of showing the cost of it. Interest on partners' loans is not therefore to be handled in the appropriation section of the Profit and Loss but should be charged to the regular Interest — or Interest and Discount — account and cleared through the Profit and Loss. The credit is usually to the partners' personal account, or to cash if actually paid. Closing Profits to Partners' Accounts The disposition of profits under a partnership does not differ materially from that under the single proprietorship form. When the net profits are determined, they belong to the proprietors and are usually transferred to their ac- counts. The method of the transfer may be either by way of the partners' personal accounts or direct to the capital accounts. The principle involved in either treatment was discussed at the time of closing the books for the single pro- prietorship and will not be repeated here. Where the part- ners do not desire to have any change shown in their original capital accounts, the profits may be transferred to loan ac- counts for each of the partners or they may stand as open balances in their personal accounts. Reserved Profits In rare cases, before the determination of the part- ners' shares in the net profits, some portion of the profits is reserved for some specific purpose. The profits so re- served are transferred from Profit and Loss to a named 374 ACCOUNTING— THEORY AND PRACTICE reserve account to indicate their retention in the business. If these items were transferred to the partners' accounts, they would be subject to withdrawal from the business. Even when they are shown in the reserve account, however, they belong to the proprietors and are just as much a part of the net worth of the business as if shown in the pro- prietors' accounts. Such reservation of profits may be for the purpose of providing for the replacement of some fixed asset when it wears out, as building, machinery, etc., for the meeting of a liability when it comes due, or other similar purposes. This, however, is very seldom done in partner- nership accounting and a complete treatment of the problem is reserved for the work of the second year in connection with corporation accounting. It should be noted that reserves of this kind must not be confused with valuation accounts like reserves for deprecia- tion and bad debts. These are in no sense a reservation of net profits but merely adjustment entries whose contra debits to depreciation or bad debts are expenses to the business and have been taken into account before the amount of net profits is determined. Distributing a Deficit The appropriation section of the Profit and Loss thus usually shows only the distribution of net profits to the part- ners' accounts. A thorough understanding of the partner- ship agreement is necessary before the proper distribution can be made. If the agreement provides for salaries and interest on capitals and drawings, these must first be con- sidered even though there are not enough net profits to satisfy these requirements. Their purpose, as explained above, is to equalize conditions and interests among the partners preliminary to their sharing in the profit and loss ratio. If this equalization results in a deficit, a deficiency PARTNERSHIP PROFITS 375 of profits, that deficiency will then be distributed in the agreed ratio and to that extent nullify some portion of the profits distributed as salaries and interest. If specific pro- vision in the articles of copartnership requires a different handling of the salaries and interest items, that provision, of course, governs. Otherwise these items should be treated as above. If any of the partners leave profits in the business, it usually results in a changing ratio of the capital account balances. Where the distribution of profits is based upon the original contributions, it is advisable to transfer the profits left in the business to separate loan accounts for the partners. The partners' capital accounts then always show their original contributions. Partners' Withdrav(7als Partners' withdrawals and salaries are usually handled in a very unsystematic way. The amount of the drawings allowed each partner during a given period should be defi- nitely determined by agreement, and regular checks should be issued for the amounts drawn. The payment of partners' personal bills and the handling of any other personal items should never take place on the firm's books, as all personal bills should be paid out of personal funds. It also frequently happens that salaries, when allowed, are not drawn regu- larly. The best method of handling this is by crediting the partners' personal accounts with the salaries due them and by charging these accounts with all actual drawings whether those drawings are for salary or otherwise. Profits Determination Upon Admitting a New Partner In connection with the determination of profits, particu- lar care should be taken to get as nearly as possible a correct net profit at the time of any change in the partners' relations. 376 ACCOUNTING— THEORY AND PRACTICE Upon the admission of a new partner, failure to make entry in the old partners' accounts of any profit rightfully belonging to them would mean a sharing of it with the new partner and consequently a loss to the old partners. In like manner the deferring of an expense charge, right- fully belonging to the period before the admission of the new partner, to the period after the admission, results in a wrongful burden on the new partner. Similarly, when a partner is admitted on a changing profit ratio basis (as when he is admitted to a one-fourth share for three years, at the end of which time he is to have a one-third share), an incorrect determination of profits may mean a loss either to him or to the old partners. So long as the same partners continue, no inequity results through failure to include some such items in their proper periods, as they are cumulative and will be taken effect of in later periods. However, this is no excuse for a slip-shod, inaccurate determination of profits at any time. Practice Data* (Assignment for Chapter XLII) Summarized transactions for June were : Purchases — Grand Grocery, n/io, $7,978.45 ; Armour Packing Co., 2/20, n/30, $9,768.30; Reid Murdock Co., 3/5, 2/20, n/30, $12,567.90 Austin, Nichols & Co., 5/5, n/30, $8,675.20 ; F. Mezzadri, 8/5, 5/10, 2/30, n/90, $1,793.35; Korn Products Co., 3/10, n/60, $5,787.85; Swift & Co., 2/5, n/30, $9,652.40; cash purchases were $786.45. Sales — R. B. Kennan, 2/10, n/30, $3,967.20; Blue Front Grocery, 2/s, n/20, $1,282.95; Four Corners General Store, 3/5, n/60, $1,875.60; Dodts' Grocery Store, 3/5, n/20, $2,500.55 ; Andrew Davey, 3/5, n/30, $3,125.60; H. A. Krebs, 1/30, n/60, $3,527.80; M. Heitzman, 3/10, n/30, $3,768.95; Fein Bros., n/5, $4,280.20; Fred Henry, 2/5, n/60, $5,192.67; *Practice Data for Ward & Gneise] set begin with Chapter XXXI. PARTNERSHIP PROFITS 37- livans Sons, 2/10, n/30, $1,875.20; Dewey Brown, n/5, $1,225.80; Badgley & Stewart, 1/5, n/30, $i,937-6o; Bulls Eye Mining Co., n/io,' $875.20 • Quinn Bros., n/io, $3,120.67; Stewart & Son, 1/5, n/30, $3,940.55; s' Koenig, 2/10, n/30, $4,120.65; M. E. Dietrich, 2/5, n/60, $2900- Jas Butler, Inc., n/5, $10,100.55; C. A. Gerken, 3/10, n/30, $1,762.40;' John Johnson, 1/30, n/60, $789.63; Jacob Green, 3/5, n/30, $1,250; Casazza & Sons, 1/5, n/30, $1,320.25; Progressive Stores Co., 3/5, n/20, $575.80; Gristede Bros., i/io, n/30, $3,140.20; J. Henry Witt, 2/10, n/30! $2,769.75 ; Ward drew groceries $35 ; Gneisel drew groceries $65 ; cash sales were $7,267.40. Journal— Out-Freight for May was $150.50; received goods returned as unsatisfactory from Andrew Davey, $525, from Fred Henry, $1,540.10, from S. Koenig, $1,750.90; received from Capella Bros., A. M. Tuttle's 90-day 6% note, for $2,500, dated May 24, with 24 days' interest accrued to date, which we allow them, in payment of their May bill $2,875.42 less 2% and cash payment of $307.91 to balance; returned inferior goods to Reid Murdock Co. $2,180.20 and to Swift & Co. $1,650.80; cash shortage of May was partially accounted for by failure to book pur- chase of shipping supplies, $20.25. Cash Receipts— Jacob Green, June bill, $1,250 less 3% ; M. J. Down- ing $1,000 on account; Capella Bros. $307.91, balance as above; J. John- son, $1,000 on account; Bulls Eye Mining Co., April bill, $3,219.65 net; M. Heitzman, June bill, $3,768.95 less 3% ; Wm. Crick, $2,000 on ac- count; Russo Bros., $1,500 on account; Progressive Stores Co., balance May bill, $4,379-75 less 3%; J. R. Rice, $3,000 on account; Al. Morton, $1,500 on account; J. J. Tommich, May bill, $2,130.65 less 2%; M. J. Downing's note for $1,680.40 came due June 10 and was paid with inter- est; cash was over $2.50; sold horse costing $225 for $175 ; sold 3 Lew- iston School Bonds at par and 30 days' accrued interest; Ward made a loan to the business at 6%, dated June 15, of $5,000; sold kindling, etc., $51.25. Cash Disbursements— salesmen's salaries $6,000; salesmen's travel- ing expense $6,396.90; advertising $4,498.80; shipping expense $1,180.35; shipping supplies $225.40; freight and drayage $1,310.75; rent for July $250; office salaries $960; office expense $9.75; office supplies $189.15; general expense $91.75; cash was short $2.25; gifts to charity $15.90; Ward drew $150; Gneisel $125; Kataguri Bros., $4,000 on account; Van Dusen Co., May bill, $7,684.25 less 5% ; Delico Food Products Co., $3,000 on account ; Federal Macaroni Co., $5,000 on account ; Wash- burn Crosby, $3,000 on account; new delivery equipment $7So. Instructions Make a careful analysis of the Tuttle note transaction before at- 378 ACCOUNTING— THEORY AND PRACTICE tempting the formal entry of it. Give full explanation in the Journal, including explanation of the cash portion. In the cash book, the only explanation needed is a cross-reference to the Journal, such as "See J ." For the delivery horse transaction, clear H. W. & H. account of the horse sold, at cost price, by debiting Cash and Depreciation and crediting H. W. & H. with the full amount. Record the sale of the Lewiston Bonds as a credit to the Bonds account which will require adjusting at closing time to show the loss on the transaction. Credit Ward's loan, to his "Loan" account. CHAPTER XLIII PROBLEMS AND iAIETHODS CONNECTED WITH SUMMARIZING THE PERIOD'S RESULTS Introductory The method of adjusting and closing partnership books is on the whole identical with the method previously dis- cussed in connection with the sole proprietorship. One exception is that the distribution of profits involves certain problems not met with in the one-man enterprise, but these problems were amply discussed in the preceding chapter. The student should refer to this Chapter XLII for the con- tent of the appropriation section of the Profit and Loss ac- count as handled for a partnership. It is the purpose here to review briefly the entire field of adjustment and closing from the partnership point of view, and to explain more fully certain special points which received only partial at- tention in the chapters on sole proprietorship. Adjustments As stated in Chapter XXIX, the books of account usually do not reflect the true condition as to all items recorded. At the end of a fiscal period, however, it is desired to know the exact status as to assets, liabilities, and net worth; also the correct amount of income and expense for the period must be determined. Hence, before the ledger can be used to furnish this information, the accounts must be so adjusted as to repre- sent actual conditions as of the closing date of the period. The main points concerning which the books fail to reflect true condition are : the amount of goods on hand at 379 380 ACCOUNTING— TTTEORY AND PRACTICE the close of the period; depreciation of various assets; the amount of expected losses from uncollectible accounts and notes receivable ; expense items which were charged during the current period, but apply in part to later periods, i.e., deferred expenses; expenses for services used during the current period but not yet entered as charges, i.e., accrued expenses; income items received and credited during this period, but applying in part to services to be rendered by the business in a later period, i.e., deferred income; income earned during the current period, but not yet entered on the books, i.e., accrued income. Problems Connected with the Merchandise Inventory The most important of these problems is the adjustment necessary on account of the merchandise on hand at the end of the period. In this connection certain problems of a special character are usually met with and will be discussed here. Goods in Transit It may happen that certain goods have been ordered during the period, and that the invoice has been received but that the goods themselves are still in transit. The question whether or not such goods shall be included in the inventory may be viewed from different angles, as follows: 1. If the goods have been paid for in advance, they were undoubtedly entered on the books as a charge to Purchases. If this is the case, the goods in transit must, of course, be included in the inventory the same as if they were actually received. 2. If the goods are still in transit, but have not been paid for, it is customary not to charge them to Purchases until they arrive. If not charged to Purchases, they must not be included in the inventory. However, theoretically SUMMARIZING THE PERIOD'S RESULTS 381 this method is incorrect. The fact that the goods were ordered and are now in transit makes the business hable for the purchase price, and the goods, although not actually received, in reality form a part of the assets of the purchases. It is true that until the goods are received, inspected, and accepted, the purchaser has the privilege of refusing them if they are not as ordered, but this privilege is exercised only in exceptional cases. Generally speaking, therefore, it is better to consider such goods as a completed purchase, in- clude them in the inventory and credit the vendor for the amount of his invoice. Goods Received but Not Yet Booked In the case of goods which have actually been received but for some reason or other have not been entered on the books, complete record should be made and the goods must, of course, be included in the inventory. In concerns where a separate shipping and receiving department is maintained, it may happen that goods are received by this department but are not immediately transferred to stock or storage. At the end of the period it is important to see that all such goods are properly recorded as purchased and are included in the inventory. Goods In or Out on Consignment Still another problem in connection with the inventory has to do with consigned goods. If at the close of the period certain goods are held for sale which do not belong to the business but were consigned to it for sale on account of the owner, they must not be included in the inventory. Sometimes such goods are taken into stock and mingled with those belonging to the firm, and, if this is done, it is very important that these goods should be so marked as easily to distinguish them from the regular stock. 382 ACCOUNTING— THEORY AND PRACTICE Similarly, if goods were sent out on consignment to another market, they still belong to the business and must not be overlooked at inventory time. If the proper record vi^ere made at the time the goods were shipped, as will be explained in Chapter L, the memorandum accounts on the ledger would call attention to them. In some concerns all such goods are entered as sales at the time of shipment. In such cases it may happen that at the end of the period part of these consigned goods are still in the hands of agents unsold. These goods should be deducted from the sales for the period and included in the inventory at full cost. Goods for Future Delivery Goods sold for future delivery are best handled at in- ventory time in the manner suggested in Chapter XXXIX, even if they are set aside ready for delivery. Goods Ready for Current Delivery Finally, goods sold for current shipment but delayed in delivery on account of congestion in the service or other causes are best treated as sales and excluded from the in- ventory. Methods of Recording Deferred Expenses It will be remembered that deferred expense items are items which are charged in a given period but in reality apply to a succeeding period. One method of adjustment was discussed in a previous chapter and consisted in crediting the current expense account with the amount not chargeable to it and entering this same amount on the debit side of the new account. The balance of the old account then consti- tutes the expense applicable to the current period and is closed out to Profit and Loss. This method may be called the expense method because it treats the account from an expense point of view. SUMMARIZING THE PERIOD'S RESULTS 383 Sometimes another method is adopted which may be called the asset method. This method handles the portion chargeable to this period's Profit and Loss in pretty much the same way as depreciation on any asset, except that the amount of the used or consumed portion is not set up in a separate valuation account. In other words, the ad- justment of the account is made by means of the closing entry instead of through an adjusting entry. Under the expense method, the account is adjusted first to show its true expense element chargeable to the current period, and then this element is transferred to Profit and Loss. Under the asset method, the portion chargeable to the current period's expense is transferred to Profit and Loss and the account balance thus shows the "asset" portion still on hand. An illustration will bring out the differences. Sup- pose the insurance charged has been $500 and $125 is unused at the close of the period. Under the expense method the entries are : Insurance (Deferred) $125.00 Insurance $125.00 To adjust. Profit and Loss 375-00 Insurance 375-00 To close. The ledger account would show as follows: Insurance $500.00 $500.00 Inventory $125.00 Profit and Loss 37S-00 $500.00 Inventory $125.00 Journal entry and ledger account under the asset method : 384 ACCOUNTING— THEORY AND PRACTICE Profit and Loss $375.00 Insurance $37S>oo To transfer. Insurance $500.00 Profit and Loss $375-00 Preference is given to the expense method because it makes formal entry on the journal of the amounts of all such items and so draws attention to them, and, further, brings the ledger to a correct showing before closing. The chief advantage of the asset method is its saving in time in making the entry. The asset method is apphcable also to the other expense and income adjustments. The Summary Accounts In Chapter XXX, where the method of closing the books of a single proprietor was discussed, it was seen that all ex- pense and income accounts are closed into a single clearing account, i.e., Profit and Loss. Even there it was shown that certain accounts, i.e.. Purchases and Sales, are some- times used as subsidiary clearing accounts, and that all items entering into the cost of goods sold are transferred to the Purchases account instead of directly to Profit and Loss. Similarly, the accounts used in the determination of net sales were transferred to the Sales account. The Trading or Selling Account In a trading business an additional clearing account called Trading or Selling is sometimes used. Its purpose and content are indicated by its title. It is used to clear all accounts connected directly with selling the product and SUMMARIZING THE PERIOD'S RESULTS 385 summarizing the results up to that point. It would, there- fore, handle net sales, cost of sales, salesmen's salaries, sales commissions, advertising, delivery expense, etc. ; and its balance, showing a so-called net trading profit, is transferred to Profit and Loss and becomes the first entry therein. Here the rest of the clearing and summary work is done and the net profit disposed of just as formerly. The only advantages of the use of the Trading account are said to be that this ac- count draws attention by its name to the summary of that class of activities of the business and that it relieves the Profit and Loss of some items where the number of the clos- ing accounts to be summarized is large. It should be said that some authorities use the Trading account for a summarization of the items entering into cost of goods sold and net sales ; this work has here been handled in the Purchases and Sales accounts respectively. When so used, the balance of the Trading account is the gross profit on sales which is transferred to the Profit and Loss account. Inquiry and observation of methods in actual use lead the author to believe that the Trading account as such is largely an academic tool, a teaching device, and is seldom met in practice. Posting the Closing Entries Where the number of temporary proprietorship accounts to be summarized is small, there is an advantage in showing them in detail as explained in Chapter XXX. However, in a business of any magnitude usually only the totals of the profit and loss items as shown by the compound journal en- tries are set up in the Profit and Loss account. A good method to follow in making up the journal entries is to class- ify the closing items to accord with the main sections of the statement of profit and loss. In this way the posting to the Profit and Loss account will show the total figures for Net 386 ACCOUNTING-THEORY AND PRACTICE Sales, Cost of Goods Sold, Selling- Expenses, General Ad- ministrative Expenses, etc. — figures which give a good bird's-eye view of the period's activities. The Balance Sheet The partnership balance sheet does not present any prob- lems which have not yet been discussed and the student is referred to Chapter XXX where ample treatment of the subject is given. The Working Sheet Some accounting instruction makes use of a so-called six-column statement for a condensed summarization of the period's results, using two columns for the trial balance, two for the profit and loss items, and two for the balance sheet. This, at the best, is a lame instrument for its intended use. However, with the incorporation of two more columns be- tween the trial balance and the balance sheet columns, indi- cating the adjustments required before the books can be closed, the form becomes a very valuable aid in the work of summarization. Such a statement is termed a working sheet, and its use in connection with the trial balance is ex- plained by the illustration on pages 388 and 389. It will be seen that the first two columns of the working sheet are an exact copy of the trial balance. The trial bal- ance should be arranged in classified form before being en- tered on the working sheet, as this aids greatly in drawing up the statements. Trial Balance, December 31, 1916 Cash $1,500.00 Notes Receivable 2,000.00 Accounts Receivable 12,500.00 Reserve for Doubtful Accounts $200.00 Merchandise Inventory 15,000.00 SUMMARIZING THE PERIOD'S RESULTS 387 Trial Balance — Continued Delivery Equipment 1,250.00 Depreciation Reserve for Delivery Equipment... 250.00 Plant and Equipment 7,500.00 Depreciation Reserve for Plant and Equipment. . 1,250.00 Land 10,000.00 Accounts Payable 7,500.00 Mortgage Payable 5,000.00 J. W. Davis, Capital 18,000.00 J. W. Davis, Personal 2,000.00 W. F. Bingham, Capital 12,000.00 W. F. Bingham, Personal 1,500.00 Sales 30,500.00 Cash Sales 14,200.00 Sales Returns and Allowances 2,150.00 Purchases 25,500.00 In- Freight 1,000.00 Sales Salaries 3,600.00 Advertising 750.00 Insurance 500.00 Trade Expense 1,000.00 Office Salaries 900.00 Office Expense 150.00 Building Repairs 50.00 Interest and Discount 200.00 Sales Discount 7SO.oo Purchase Discount. 900.00 $89,800.00 $89,800.00 Adjustments Inventory of Merchandise $16,490,00 (a) Advertising Materials on Hand 125.00 (b) Sales Salaries Accrued 200.00 (c) Office " " 60.00 (d) Interest on Mortgage 150.00 (e) " " Notes Receivable 50.00 (f) Insurance Unexpired 200.00 (g) Create the following reserves : Doubtful Accounts, 3% of the outstanding accounts receivable (h) Depreciation Delivery Equipment, 20%' (i) Depreciation Plant and Equipment, 5% (j) 388 ACCOUNTING— THEORY AND PRACTICE WORKING Trial Balance December 31, 1916 Cash $1,500 Notes Receivable 2,000 Accounts Receivable 12,500 Reserve for Doubtful Accounts $200 Merchandise Inventory 15,000 Delivery Equipment 1,250 Depreciation Reserve for Delivery Equipment 250 Plant and Equipment 7,Soo Depreciation Reserve for Plant and Equipment 1,250 Land 10,000 Accounts Payable 7,Soo Mortgage Payable 5,ooo J. W. Davis, Capital 18,000 J. W. Davis, Personal 2,000 W. F. Bingham, Capital 12,000 W. F. Bingham, Personal i,Soo Sales 30,500 Cash Sales 14,200 Sales Returns and Allowances 2,150 Purchases 25,500 In-Freight 1,000 Sales Salaries 3,600 Advertising 750 Insurance 500 Trade Expense 1,000 Office Salaries 900 ...... Office Expense 150 Building Repairs 50 Interest and Discount 200 Sales Discount 750 Purchase Discount 900 Bad Debts Depreciation Net Profit. $89,?oo $89,800 SUMMARIZING THE PERIOD'S RESULTS SHEET 389 Adjustments h $3,75 a $16,490 (B) a 16,490 {; 1 250 i 375 c 200 c 200 (B) b 135 (B) b 125 g 200 (B) g 200 60 375/ $18,275 60 (B) e f h i 150 e 50(B) f 375 250 ■) 150 (B) 50 $18,275 Balance Sheet $1,500 Profit and Loss 2,000 12,500 16,490 1,250 7,500 10,000 2,000 1,500 125 200 50 } $575 500 1,62s 7,500 5,000 18,000 12,000 60 150 k 9,505 $15,000 $16,490 2,150 25,500 1,000 3,800 625 300 1,000 960 150 SO 300 750 375 625 30,500 14,200 900 $52,585 $62,090 k 9,505 $55,115 $55,115 $62,090 $62,090 390 ACCOUNTING— THEORY AND PRACTICE In the adjustments columns are entered both the debit and the credit of all adjusting items, not in exact accordance with their debit and credit when making the formal entry on the journal, but rather according to the use made of the particular items in drawing up the periodic statements. The purpose of the columns is not to adjust and close the books in a complete and formal manner, but rather to gather all of the adjusting data so that a correct separation of the balance sheet and profit and loss items can be made for use in the formal entries and statements. Thus, instead of showing the final inventory of merchandise as a debit to Merchandise Inventory and a credit to Purchases, both the debit and credit are entered in Merchandise Inventory, the debit or asset element being followed with a capital "(B)" to indicate its final distribution to the balance sheet columns. The initial inventory, shown in the trial balance column, and the credit entry of the final inventory in the adjustments column, are distributed, without combining, into the profit and loss columns. This method makes the profit and loss columns show the actual figures needed for use in the state- ments, whereas a combined or net figure would require tracing back to get the necessary data. The other entries in the adjustments columns may be explained in a like manner. In all cases the "(B)" follow- ing an item is for the purpose of indicating its distribution into the balance sheet columns, whereas its contra debit or credit, as the case may be, is combined with the correspond- ing figure in the trial balance columns before distribution. After all adjustments are made and their place of final distribution indicated, a complete distribution of all items in the trial balance and adjustments columns is made either to the balance sheet or the profit and loss columns. The difference between the profit and loss columns will thus show the net profit or loss for the period and is the item SUMMARIZING THE PERIOD'S RESULTS 391 needed to balance the balance sheet, thus proving the work. The difference between the profit and loss columns is $9,505, this constituting the net profit for the period. By adding the item to the credit balance sheet column, the balance sheet columns should, of course, show equal totals. On the books and in the formal statements this net profit must be shown distributed to the partners in agreed ratios, and may be so shown on the working sheet, though this manner of handling there is a little awkward. As stated before, the working sheet is used for the pur- pose of a quick summarization of the results for the period in a single statement. It serves also as the basis for closing the books and drawing up the formal statements. It pro- vides a convenient method of working from the trial bal- ance and of incorporating in it the necessary adjustments. The use of the working sheet is, of course, not limited to partnership transactions, but it is employed in other types of business organization as well. Practice Data* (Assignment for Chapter XLIII) Post completely and take a trial balance as of June 30. 'See Practice Data for Chapter XLII. CHAPTER XLIV PARTNERSHIP DISSOLUTION Temporary Nature of Partnership Because of the essential character of a partnership, its duration is necessarily limited. It must look forward to the time when its business will have to be wound up for one reason or another. The chief causes leading to a dis- solution will be briefly reviewed. Causes of Dissolution I. The Withdrawal of Any Partner. Under ordinary circumstances a partner cannot be held to a specific per- formance of his contract. If a partner becomes dissatis- fied, suspicious, or desires for other reasons to withdraw from his contract before its expiration, he has that power. It cannot be looked upon as a right but only as a power to be exercised under unusual circumstances. If his with- drawal before the agreement terminates results in damage to his copartners, they have a lawful claim against him for the amount of the damage. Under extraordinary condi- tions, specific performance of the contract might be de- creed, i.e., the partner would not be allowed to withdraw. Withdrawal does not relieve a partner from liability for debts incurred while he was a member of the firm. These creditors, if not paid by the firm, may hold the withdraw- ing partner. To be relieved from liability arising after his withdrawal, personal notice of withdrawal must be given to all the firms with which the partnership has been deal- ing. A published notice is considered sufificient notice to parties not dealing with the firm until after withdrawal. 392 PARTNERSHIP DISSOLUTION 3^3 2. Sale of a Partner's Interest or Admission of a New Partner. When a partner, with the consent of his co- partners, sells his interest in the firm to another, or when a new member is admitted to the partnership, in the eye of the law, the old partnership has ceased to exist and a new one has taken its place. 3. Limitations in the Partnership Agreement. The agreement may specify the period for which the partner- ship is to exist. If a special partnership, the object to be accomplished may be stated and the firm is automatically dissolved as soon as the object is accomplished. 4. Mutual Consent of the Partners. Whether or not the partnership period is limited by the agreement, the partners may at any time rescind their contract by mutual consent. 5. Misconduct, Insanity, Death, Assignment, or Bank- ruptcy of a Partner. Any of these works a dissolution. By misconduct may be understood a member's failure to pay the agreed contribution of capital, failure to perform his duties, his acting in bad faith towards his copartners, etc. 6. Illegal Object. A partnership entered into for the pursuit of an object which later becomes illegal is auto- matically dissolved. 7. War between Nations Represented by the Partners. This dissolves the partnership, though such dissolution may be more in the nature of a suspension, inasmuch as the re- lation may be resumed upon cessation of hostilities. 8. Bankruptcy of the Firm. This results in the firm's assets' being sold to satisfy the claims of its creditors and the firm as such ceases to exist. 9. Sale or Transfer. A firm may sell out to another firm or change its form of organization to that of a cor- poration. The old firm, therefore, no longer exists. 394 ACCOUNTING— THEORY AND PRACTICE Problems Incident to Dissolution It is purposed to consider some of the problems in- volved in winding up the affairs of a partnership. From the schedule of causes given above it will be seen that a firm may be either solvent or insolvent at dissolution. The three statements sometimes set up in the case of insolvency — the Statement of Affairs, the Deficiency Account, and the Realization and Liquidation Statement — will not be ex- plained here but the results obtained by them will be taken into account. These statements are seldom, if ever, met in practice, and are not standardized either as to form or con- tent. Treatment of them is deferred till the work of the sec- ond year. Partnership Provisions Covering Liquidation Because of the certainty of final dissolution, it is not unusual for the partnership agreement to make definite regu- lations concerning the method of liquidation. The appoint- ment of one of the members as liquidating partner, the man- ner of distributing the proceeds from liquidation, whether by instalments or otherwise, the manner of paying the Hq- uidator for his services — all these may be provided for. Where dissolution is forced by the death of one of the partners, to determine that partner's interest it would be necessary to take inventory and make appraisal of all the firm's assets. This may cause considerable inconvenience to the business, and, to avoid this, provision is sometimes made that the remaining partners shall continue the busi- ness and purchase the interest of the deceased partner. His share in the profits for the current period up to the date of his death may be determined not by taking inventory at that time, but by continuing the business till the end of the regular fiscal period and prorating the year's profit over the period in which the deceased had an interest. In this way. PARTNERSHIP DISSOLUTION 355 while the partnership is automatically dissolved, a new one is immediately created and there is no need of liquidation. In a case like this, a basis is usually decided upon for the calculation of the firm's good-will so that the estate of the deceased partner shares in it, also. Usually interest is al- lowed the estate of the deceased partner from the date of his death until the settlement of his share. Partners' Rights and Procedure During Liquidation However, in many instances dissolution is accompanied by liquidation. All of the partners have equal rights to share in the work of liquidation. Since the work usually does not require the time of all the partners, a customary procedure is to appoint one member — or an outsider — as the liquidator. The fact of the dissolution is published in the leading newspapers, and the name of the liquidator is given in the notice. If liquidation is necessary because of the death of a partner, great responsibility rests upon the liquidator. He must act in the greatest good faith and endeavor to realize the best price possible for the assets of the firm in the interest of the deceased partner's estate. A similar responsibility rests upon him when liquidation is carried on in the interest of absent members. The expenses and losses incident to liquidation must be borne by all in profit and loss ratio. The liquidator may be paid either by means of a commission on the sums realized or by a salary. If the liquidator is a partner, settlement may take place privately between the partners but a better method is to charge his commission or salary to the firm's liquida- tion expenses. Liquidation may proceed by sale of the assets in regular order and may even permit the purchase of additional goods where necessary. This may be done in order to fulfil exist- ing contracts or to complete partly manufactured goods, 396 ACCOUNTING-THEORY AND PRACTICE or where stock on hand can be disposed of to better ad- vantage by the addition of side lines or specialties. Distribution of Proceeds Upon the realization of the assets, application of the proceeds must be made in the following order : First, the claims of all outside creditors must be met in full or by- compromise where not fully recognized. Second, the claims of the partners on account of loans or advances made to the firm must be satisfied. Third, the partners share in the remainder, by first taking out their respective capital con- tributions and then, if there is a balance, by sharing it in their profit and loss ratios. If, however, there be a loss this must be shared in the profit and loss sharing ratio before withdrawal of any capital contributions. The remainder, if any, is then divided among the partners in the ratio of their capitals as diminished by the loss. Whether the net assets are either more or less than the total amount of the capitals, the difference is shared in profit and loss ratio, and what then remains is shared in capital ratios. Instead of a complete liquidation of the firm's assets, by mutual consent, certain of the assets may be taken over by each partner at agreed values and applied towards the satis- faction of his capital and loan interests. Such use of assets is spoken of as a conversion to that particular purpose. It must be distinctly understood that this is not a right which any partner can demand, but only a privilege granted by mutual agreement. Any partner can demand that all the assets be sold and that the proceeds be applied in satisfac- tion of all interests concerned. Sharing Losses In the case of insolvency, the partners are compelled to share the losses in profit and loss ratios, not in capital PARTNERSHIP DISSOLUTION 397 ratios, and these losses are chargeable against their capital accounts. If the capital account of any of the partners is not large enough to satisfy his share in the losses, a deficit in that partner's interest results, represented by the debit balance in his capital account. This shows the amount which he must contribute to the firm in order that all claims may be satisfied. The rule that profits and losses in liquidation cannot be shared in the same ratios as capitals, is responsible for the fact that upon dissolution one or more partners may have to make additional contributions, while others are not obliged to do so. This duty of contribution is inherent in the partnership relation and can be enforced by the co- partners. A few illustrations will set forth the main problems in connection with the liquidation of partners' capitals : I. Sharing Losses Equally Balance Sheet of A, B & C Cash $10,000.00 Other Assets 60,000.00 $70,000.00 Liabilities $io,ooo.co A, Capital 15,000.00 B, Capital 20,000.00 C, Capital 25,000.00 $70,000.00 A, B, and C share profits and losses equally. Dissolution becomes necessary and in the course of liqui- dation the expenses and losses incurred amount to $15,000. The above balance sheet shows, in summary form, the con- dition of the firm previous to liquidation, and also indicates the shares of the partners in the net assets as on that date, i.e., the partners share in the net assets in the ratio 15 :2o:25 or 3:4:5. The net loss of $15,000 is now divided equally among the partners, after which the capitals will amount to, 398 ACCOUNTING— THEORY AND PRACTICE A $10,000, B $15,000, and C $20,000. The result is that the capital ratio has changed from 3:4:5 to 10:15:20, or 2 :3 :4, and the net assets of $45,000 are to be shared in this new ratio. 2. Capital Deficit Balance Sheet of Jones & Smith Cash $10,000.00 Losses in Liquidation.. 15,000.00 $25,000.00 Jones, Capital $20,000.00 Smith, Capital 5,000.00 $25,000.00 Jones and Smith share profits and losses equally. The above balance sheet shows the condition of the firm after liquidation. The only thing to be done is, first, to distribute the liquidation losses among the partners, and after this they will share in the net assets according to capital ratios. Accordingly, each capital account is debited with an equal share in the loss of $15,000, after which Jones' capital is $12,500 and Smith's account shows a debit balance of $2,500. This means that Jones not only gets the entire cash of $10,000, but Smith must contribute $2,500 to the firm^ and this also goes to Jones. 3. Personal Insolvency of One Partner Balance Sheet of Smith, Jones & Green Cash . Jones $16,000.00 9,000.00 $25,000.00 Smith, Capital $15,000.00 Green, Capital 10,000.00 $25,000.00 Smith and Jones each have a 2/5 share and Green a 1/5 share in profits and losses. PARTNERSHIP DISSOLUTION oqq The above balance sheet shows condition after taking into consideration the losses incident to liquidation. From this it is seen that Jones owes the business $9,000, but it is determined that he is personally insolvent and cannot con- tribute the share due from him. The net assets available for distribution consist of $16,000 in cash. Inasmuch as Jones' interest is entirely wiped out and a contribution is due from him which he cannot pay, the amount of that con- tribution is an additional loss to be borne by the two remain- ing partners. Their respective shares in this loss are determined by their original profit and loss ratios 2/5 and 1/5, so that as between themselves Smith must bear 2/3 of the loss or $6,000, and Green 1/3 or $3,000; after which Smith's capital and share in the net assets is $9,000, and Green's $7,000. Distribution by Instalments Where the process of liquidation is of long duration, the partners may desire to receive what is due them by instal- ments rather than wait till the end and receive their re- spective shares in one amount. Where the capital ratio is different from the profit and loss ratio, it is difficult to determine the proper ratio in which these instalments should be paid. This is due to the fact that all expenses and losses are not yet determined, and consequently it is impossible to tell what the ultimate ratios will be in which the partners are to share the net assets. The payment of instalments on an arbitrary basis might result ultimately in an over- payment of some partners and an underpayment of others. The only safe method of handling the situation is to pay the first instalments to those partners whose capital ratios are in excess of their profit and loss ratios until their capitals are reduced to the point where the capital ratios of all the partners are the same as their profit and loss 400 ACCOUNTING— THEORY AND PRACTICE ratios. As soon as this point is reached, the proceeds of the assets may be distributed to the partners on the basis of their profit and loss sharing ratios, because these are now- identical with their capital ratios. A more complete treat- ment of this problem will be taken up in the work of the second year under the discussion of the realization and Hqui- dation account. Treatment of Good- Will Upon Liquidation by Sale When dissolution is brought about by the sale of the entire business, it usually happens that the amount realized on the assets is smaller than their book value, and the differ- ence is treated as a loss in accordance with the principles previously stated. Similarly, where the assets are transferred by sale and the price realized on them is larger than their book value, the excess constitutes a profit and must be distributed among the partners in profit and loss ratio. Usually such an excess is treated as a receipt on account of good-will, and two standard methods of booking it are employed. When good- will is mentioned in the sale contract and its value deter- mined, it is brought on the books as an asset and transferred immediately to the partners' accounts. Thus, if the value is $15,000 and the profit and loss ratio is 2/5 to A, 2/5 to B, and 1/5 to C, the entry would be : Good-Will $15,000.00 A, Capital $6,000.00 B, Capital 6,000.00 C, Capital 3,000.00 Good-will is now shown as an asset, and the entry closing it off would be the same as for the sale of the other assets, viz., a debit to Cash and a credit to Good- Will. On the other hand, when good-will is not specified as such in the sale contract, but the amount realized on the PARTNERSHIP DISSOLUTION 401 sale of the assets is larger than their book values, this excess is credited to Good-Will, which is then treated not as an asset account (as in the case given above), but as a profit and loss account. The balance of this account is closed out to the partners' accounts in profit-sharing ratios in the same way as above. The ultimate result is the same in either case; the first method is a little more complete since it shows possession of the asset good-will previous to its sale. The formal entries by which the sale of any business is recorded on its books, whether single proprietorship, part- nership, or corporation, are treated in Chapter XLIX under Corporations. Practice Data* (Assignment for Chapter XLIV) Close the books, through the Journal, for the six months ending June 30, 1917, taking account of the following adjustments and in- ventories : Accrued Expenses — salesmen's salaries $2,070 ; shipping clerks $200 ; board of horses $50.10; blacksmith bill $15.25; advertising $500; freight bills $150.25 ; light and power bills $106.21 ; bookkeepers, stenogra- phers, billing clerks, etc. $125; office expense $5.25; janitor and watch- man $90; interest accrued on Ward's loan $12.50. Prepaid Expenses — July rent $250; insurance $418.40; membership in Credit Men's Association, $37.50; interest on note held by Van Dusen Co. $5.83. Accrued Income — Interest on I. B. Perkins' note, 45 days, $15; interest on A. M. Tuttle's note, 37 days, $15.42; interest on Lewiston Bonds, I month 6 days, $12. Write off the J. Jackson account to Bad Debts on account of his absolute bankruptcy. Out-freight for June is $182.63. Charge depreciation as follows: •Practice Data for Ward & Gneisel set bcRin with Chapter XXXI. 402 ACCOUNTING— THEORY AND PRACTICE 10% per annum on store and office furniture and fixtures. 162/3% per annum on horses, wagons, and harness, except on the last purchase of $750, on which charge no depreciation. Set aside 3% of the outstanding accounts as a reserve for doubt- ful accounts. Inventories were : merchandise $16,497.23 ; packing materials $105.20; office supplies $75.18. Lewiston School Bonds are valued at par. Upon appropriation of profits, take account of the agreement as to salaries and excess drawings. For interest calculations, assume that drawings are made on the last day of the month. Instructions Bring the adjusting entries onto the Journal and post them. Then draw up the statements as required in the next Practice Data for Chapter XLV and close the books using the profit and loss statement for a guide. Use Chapters XXX, XLII, and XLIII for reference as to summarizing the period's results. CHAPTER XLV TYPES OF ACCOUNTING RECORDS AND THEIR DEVELOPMENT Evolution of Analytical Journals The only books absolutely necessary for an account- ing record under the double-entry method are a journal and a ledger. However, even the small business finds some subdivision of the journals advantageous, and so makes use of sales, purchases, and cash receipts and cash dis- bursements journals. As a business grows and its trans- actions increase in volume and complexity, further sub- division is needed. As the scope of its organization be- comes too great for any one man to exercise a personal oversight, a method or system must be devised for keeping the proprietor or manager in close touch with the various departments and lines of business endeavor. This is ac- complished by means of reports from the accounting department, which exists largely for the purpose of fur- nishing this kind of information. Principle to be Followed in Securing Analysis In an earlier chapter it was laid down as a fundamental principle that wherever information of a particular kind is desired by the management, the accounting department should be in a position to furnish it by means of analytical records made at the time of original entry, rather than by analyzing a composite record at the time the informa- tion is wanted. Such analytical records make possible a quicker and more up-to-date report to the management, 403 404 ACCOUNTING— THEORY AND PRACTICE and they save labor in securing the information by making the analysis at the time of record when all the facts related to it are readily available. Subdivision of the Ledgers The next step in subdivision of the records is made in the ledgers. The general or impersonal accounts of the business are of a more permanent character than the ac- counts with persons. Consequently, when once it is de- termined under what account titles information is desired by the business and those accounts are set up, there is usually little need for afterwards changing these titles. With personal accounts, however, there is constant change. Some customers are lost and new ones are con- stantly being added. We cease dealing with certain creditors and make our purchases in new markets. Ac- cordingly, this was the basis for the first subdivision of the ledgers. The accounts with customers were placed in a separate ledger called variously the sales, customers, or accounts receivable ledger, and those with creditors in a separate ledger called purchase, creditors, or accounts payable ledger. All other accounts were kept in th€ main ledger known as the general ledger. One advantage of this subdivision was that several bookkeepers could work on the various ledgers at the same time. Further subdivision of the customers ledger is fre- quently made into "city" and "country" ledgers, the former containing all accounts with customers located within the city where the business is situated, and the latter containing all out-of-the-city accounts. Other sub- divisions may be made on an alphabetical basis, i.e., cus- tomers ledger No. i containing all accounts from A to G; No. 2, H to M, etc. Sometimes the concern's sales territory is divided into arbitrary districts and the ledgers TYPES OF ACCOUNTING RECORDS 405 are subdivided to correspond with such districts. The next step in the interest of efficiency within the account- ing department was the introduction of a method to secure a separate balancing of each ledger. This is ex- plained in the next chapters on the controlling account. Types of Sales Journals and Methods of Handling The subdivision of the general journal into separate journal books is one step towards analyzing the journal record, and this is carried still further by introducing so- called columnar journal records. Reference has already been made, in Chapters XX and XXXIX to the use of additional columns in the sales book. Here a brief sketch will be given of the methods of recording sales in the various kinds of sales journals. I. One kind of sales journal, not often used now, consists of an impression book with columns for the ex- tension of the amounts and sometimes with additional columns for purposes of analysis. This is similiar to the old letter impression book and each sheet contains the press copy of invoices sent to customers. The method has the advan- tage that the entry in the sales journal is an exact copy of the invoice. Oftentimes, however, the impression is poor and nearly or quite illegible, it takes much room, the detail shown is not often used, and it increases the work of .making and handling the record. 2. Another method makes use of a perforated invoice book with a columnized inter-leaf solid-bound between the perforated invoice sheets. The sales invoice is written on one of the perforated sheets and a carbon underneath gives a duplicate on the inter-leaf, the latter constituting the formal sales record. The advantages and objections are practically the same as for the impression book method. 4o6 ACCOUNTING— THEORY AND PRACTICE 3. Another method makes a separate carbon copy for each invoice and this dupHcate is the source of entry in the sales journal. The journal entry gives only the file number of the duplicate invoice so that in case of need the dupHcate can easily be referred to. This sales journal may, of course, be analytical under any desired heads. 4. Still another method uses the duplicate invoice for posting to the customer's account after which it is filed in binders. The latter are usually provided with recapitu- lation sheets which show the totals and analysis for each day, week, or month as the case may be. Just as above, the invoice file provides the detail in support of the ledger account and the recapitulation sheets are the journal from which credit to the various sales accounts is made. Either one of these last two methods eliminates most of the ob- jections and embraces most of the advantages of the other methods mentioned above. Where several sales ledgers are used, the sales journal is sometimes subdivided on the same basis as an aid in posting, and for the purpose of securing controlling figures as explained in the next chapters. The Sales Returns and Allowances Journal Wherever an analytic sales record is made, a similar record must be made of sales returns and allowances as explained in Chapter XXXIX. A separate book, exactly similar in form to the sales journal, is employed for record- ing these items. Sometimes the pages in the back of the sales journal are used instead of the separate book. Posting the Sales Journal In the posting of these various forms of journals no difficulty should be encountered. The total sales is credited to the Sales account in the general ledger, or, TYPES OF ACCOUNTING RECORDS 407 where analysis is made, credits are to the various sales accounts as shown, by the totals of their respective columns in the sales journal. The individual sales items are posted to the debit of the customers' accounts or to cash, as the case may be. This is also done where con- trolling accounts are used, but, in addition, the total for all postings to customers is debited to the customers' controlling account in the general ledger. Development of the Purchase Journal The purchase journal has had a similar development from the old-time scrap-book for invoices to the highly analytic voucher record used in some lines. The old- fashioned invoice book was usually a big, loose-bound, coarse paper volume in which were pasted the purchase invoices for goods bought. An extension column was provided for the amount of the invoice, and the total of this gave the purchases for a given period. This was developed along analytic lines by providing additional columns for various classes of purchases. It was a cum- bersome, nondescript, unkempt record, and gave place to the formal purchase journal or register. The purchase journal or register is made up of regular account paper ruled to suit individual needs and pur- poses. Where analysis of the sales is made into separate classes, an exactly similar analysis of purchases must be made to secure a gross profit figure for each class. There- fore, its form will follow very closely that of the sales journal. Entry of the invoice is made in the purchase journal as to name, terms, and amount, also giving the number of the file where the invoice can be found in case of need. Where a separate purchasing department is main- tained, the dupHcate orders, corrected if necessary to cor- 4o8 ACCOUNTING— THEORY AND PRACTICE respond with the purchase invoice received, might be used as the basis of the purchase journal. In this case recapitu- lation sheets are inserted just as with the sales journal. The handling of purchases is not so complicated as that of sales, because purchases usually are much smaller in num- ber than sales. Posting of the purchase journal follows the general lines of the sales journal and the same general considerations apply to the handling of returned purchases as to returned sales. Handling Expenses Through the Purchase Journal Frequently expenses of all classes are regarded as regular purchase transactions and are classified as labor, rent, salaries, supplies, etc. Under this method the entry is not postponed until the item is paid, but is made at the time of securing the service or supplies. The basis for the entry may be the bill or purchase invoice received, or simply the knowledge that the expense is incurred with no formal paper to vouch for it. Some concerns make up a formal purchase memo for every transaction of this kind and use that as the basis for the entry. This is the voucher record method which will be treated in the second volume, but the following outline of it will be given here : Where expense invoices are entered and analyzed in the purchase journal, posting of such requires debits to be made to the various expense accounts and credits to the individual creditors' accounts in the ledger. In case the ledger contains only a controlling account, it is credited for the total of the expense and other purchases, but the individual accounts in the creditors ledger must be credited also. When the bill is paid, entry in the cash book will not be, as usual, to the debit of the expense account, but to the debit of the creditor's account. The entry of expense invoices in this manner secures TYPES OF ACCOUNTING RECORDS 409 an immediate record of all such liabilities, and therefore makes the books show full liabilities at all times for these expense items. However, it necessitates a little more work in making the record, and this is why many concerns never enter expenses until paid, making the debit to them through the cash book. In this latter case all unpaid expense bills should be kept in an expense file for reference whenever the information as to liability on outstanding expense ac- counts is desired. Note Journals As explained in Chapter XXXVIII, note journals are sometimes used. At posting time proper analysis must be made in order to distinguish between notes from cus- tomers and notes from other sources as explained in Chapter XXXVIII. Analysis in the Cash Book The cash journals may have any desired analysis. On the debit side, i.e., the cash receipts journal, analysis may be made to show all sources of receipts, and on the credit side to show all the objects of expenditure. This may be very detailed, the only limit to columnar analysis being the width of the page. A greatly detailed analysis is not usually made through the cash journals. Where the ex- penditures analysis is desired, it is usually made in the purchase or voucher record which thus relieves the cash book of a mass of detail. The sources of cash receipts are usually more Umited than the objects of expenditures, and do not therefore require so much analysis. The chief advantage of using additional columns in books of original entry lies in the fact that time and labor are saved in posting. The column total is posted in one item, whereas each of the numer- 4IO ACCOUNTING— THEORY AND PRACTICE ous items composing it would have to be posted in case no analytical column was provided. Hence, it would be a waste of paper to provide separate columns for items which recur not oftener than once a week or once a month. Care should be taken always to avoid needless columniza- tion. It is customary to have the following columns on the debit side of the cash book: General or Sundry, Ac- counts Receivable, Sales Discount, and "Net Cash or Bank"; on the credit side: General or Sundry, Accounts Payable, Purchases Discount, and "Net Cash or Bank." The proof of the distribution is secured by checking the sum of the net cash and discount columns against the sum of the totals of the other columns. Every item of both re- ceipts and disbursements must appear in the "Net Cash" column, from which distribution is made. Receipts from customers are distributed into the "Accounts Receivable" column for the gross amount of the item, and into "Sales Discount" for the discount, if any is taken. All other items are carried into the "General" or "Sundry" column. Where several sales ledgers are kept, additional columns may be provided so that instead of having one accounts receivable column, there are columns for each of the separate ledgers. Similar treatment is given to the disbursements. Analysis in the General Journal Where the general journal is used for returned goods, allowances, and other adjustments with customers and creditors, use is made of analytic columns with these cap- tions for both the debit and credit: Accounts Receivable, Accounts Payable, and General. Here, however, there is no column in which every item must be entered and from which it is distributed to the other columns. If a cus- tomer's or a creditor's account is afifected, entry is made in that column in the first place. All other entries are in TYPES OF ACCOUNTING RECORDS 411 the general column. The student should refer to Chapter XXII for the illustration. With regard to analysis columns in the general journal, some accountants maintain with good reason that if the number of transactions of a particular kind is sufficiently large to justify their segregation into a separate column, this in itself would be ample justification for the use of a separate journal to record these items. Whenever the analysis in the general journal requires an ever increasing number of separate columns, it is a matter of discretion with the accountant when to open a new journal for the record of such items as appear there most frequently. Practice Data* (Assignment for Chapter XLV) Draw up a pro forma statement of profit and loss and a balance sheet for Ward & Gneisel for the six months. In drawing up the balance sheet, head it as follows : Exhibit A Ward and Gneisel Balance Sheet, June 30, 1917 Show the total of all customers' accounts as "Accounts Receivable (see Schedule i)." Attach to the balance sheet a list or schedule of all customers' accounts to support the title "Accounts Receivable (see Schedule i)" carried in the balance sheet. Give to it as a formal heading : Exhibit A — Schedule I Ward and Gneisel List of Accsunts Receivable, June 30, 191 7 Attach schedules also for the other group items appearing in the balance sheet viz. : Deferred Charges to Operation, under which include in addition to the other items listed, the office supplies and packing materials still on hand ; Accrued Income ; Accounts Payable ; and Ac- 412 ACCOUNTING— THEORY AND PRACTICE crued Expenses. This method relieves the balance sheet of much detail and renders it more intelligible; also the detail is available if desired. In drawing up the profit and loss statement refer to the forms already shown, following particularly the chart of temporary pro- prietorship accounts shown in Chapter XXXI. The "Miscellaneous Sales" item should be added to the Net Sales short extended, and their total should be full extended, from which should be deducted Cost of Goods Sold as usual. Show fully the appropriation of profits. As a matter of convenience in marking the blanks, record these statements aind schedules on the last few pages of the cash book. 'Practice Data for Ward & Gneisel set begin with Chapter XXXI, CHAPTER XLVI CONTROLLING ACCOUNTS Introductory Reference has been made several times in previous chapters to controlhng accounts. It is purposed now to define them and explain their use. The separation of the various journals on the basis of an analysis of transactions has been seen to free the general journal of a vast mass of detail formerly carried by it. This separation, however, in no way affects the underlying debit and credit scheme of the whole system. Each journal is an integral part of the whole; every entry therein has its equal debit and credit which is in due course posted to the ledger ; and thuj is the equilibrium of the ledger maintained. The separation of the ledger into three or more subsidiary ledgers in the interest of economy of effort and ease of use has also been mentioned. Still, each of these subsidiary ledgers is an integral part of the whole ledger and must be taken in to secure proof of equilibrium. The customers ledger is usually the most active of the various ledgers, i.e., more postings are made in it because the majority of business transactions involve dealings of various sorts with customers, and more accounts are required to keep the records with customers. It is usually, therefore, the largest part of the whole ledger, but its accounts are all of the same kind, viz., accounts receivable. When taking a trial balance, the total of the balances of the customers ledger accounts may be set up under the title "Accounts Receivable," leaving the details for a supple- mentary list or schedule. 413 414 ACCOUNTING— THEORY AND PRACTICE Advantage of a Controlling Account The advantage of this shortening of the trial balance is apparent and suggests the desirability of obtaining the "accounts receivable" balance independently of the customers ledger. If this could be done, the bookkeeper in charge of the general ledger could not only get his trial balance virithout reference to the customers ledger but would also have the correct figure for the total of the account balances in the customers ledger. In other words, he would have a figure which controls the customers ledger and which would therefore furnish him with a check on the accuracy of the ledger clerk or bookkeeper who kept that ledger. The most convenient method of keeping record of this accounts re- ceivable figure is evidently by means of a formal account on the general ledger. When sueh an account is kept, the effect is to make it a summary account whose detail is carried in the customers ledger. Controlling Account Necessitates Changed Idea of Ledger Equilibrium By having a customers controlling account in the general ledger, the customers ledger is deprived of its use as an in- tegral part of the whole ledger and is reduced to a support- ing schedule or list of detail for the summary controlling account. The equilibrium of the ledger is now secured by summary posting to the controlling accounts. The customers ledger has ceased to be a "ledger" in the proper sense of the term but it is still a vital part of the system, carrying as it does the detail of the summary controlling account, and it is linked up to the system by being provable against its summary account. Its scheme of debit and credit is now an independent one and is not linked up to the debit and credit equilibrium of the general ledger. Thus the mathematical basis of the controlling account is simply that CONTROLLING ACCOUNTS 415 the whole is exactly equal to all its parts ; the balance of the summary account being equal to the total of the balances of all the customers' accounts of which it is the summary. In other words, if we have customers' accounts whose balances are $1,000, $2,000, $3,000, $4,000, and $5,000 respectively, then the summary account must have a balance of $15,000. Debits to the Controlling Account The principle and the purpose of the controlling account having now been established, the next problem to be con- sidered is how best to gather the summary figures for its debits and credits. If every debit which is posted to some customer's account must be posted also to the controlling account and every credit to a customer's account must be shown as a credit in the controlling account, the work in- volved would be almost doubled. Therefore, it is of im- portance to secure these figures with the least effort, i.e., in the form of summaries. In order to determine the sources of the various debits and credits of the controlling account, analysis must be made of the sources of the debits and credits to the customers' accounts. Most of the debits to customers' accounts are from the sales journal. Additional debits may be from the cash dis- bursements journal in case of a cash payment by way of rebate, refund for overpayment, or other similar trans- action; and from the general journal for adjustments of various kinds. The debits to customers for cash paid them are very few in number, because adjustments usually are not made by means of cash payments. The sales journal, as usually operated, carries a column for credit sales, whose total represents in one amount the total of all detailed debits to customers' accounts. The total of the credit sales column, therefore, controls the total debits to all customers on ac- count of charge sales to them. The controlling account in 4i6 ACCOUNTING— THEORY AND PRACTICE the general ledger is variously termed "Sales Ledger,"- "Accounts Receivable," "Trade Debtors," "Customers," etc. In summarizing the sales journal it should be shown in the summary entry that this total is to be posted not only to the credit side of the Sales account but also to the debit of the controlling account in the ledger. This is so because the customers ledger has ceased to be an integral part of the general ledger, the controlling account having taken its place. Where the total sales in the sales journal includes both cash sales and credit sales, the following summary entry should be made : Accounts Receivable Cash Sales The cash debit is set up only to show the equilibrium of the summary entry and is not posted because entered also in the cash book. This debit posting to "Accounts Receivable" account in the general ledger secures in one posting a debit amount equal to all individual debit postings to the cus- tomers ledger from this source. The two other sources of debit posting to customers' accounts are the journal and the cash book. The debit side of the journal, for this purpose, is provided with an accounts receivable analysis column in which, as explained in the pre- vious chapter, every debit to a customer's account is entered. At posting time, the total of this accounts receivable column will therefore give in one figure a debit posting item to the general ledger Accounts Receivable account equal to all in- dividual debit postings from the general journal to cus- tomers' accounts in the customers ledger. Usually it is not necessary to provide an accounts receiv- able column on the credit side of the cash book, since debit postings from there to customers' accounts are very CONTROLLING ACCOUNTS 417 infrequent, and hence no total or controlling figure for entry in the Accounts Receivable account can be obtained. Every item which is posted from this source to the debit of a customer's account must be also posted — ^item by item — to the debit of Accounts Receivable in the general ledger. This is, of course, a double debit posting, but one of these debits is to a subsidiary ledger which is no longer a part of the equilibrium scheme and therefore does not throw the general ledger out of balance. Great care must be exercised to make sure that each of these items is posted both to a customer's account and also to the Accounts Receivable ac- count. Credits to the Controlling Account An analysis of the credits to customers' accounts shows four main sources: (i) the cash receipts journal for pay- ments made by customers; (2) the sales returns journal, if one is kept, for goods returned by customers; (3) the note journal for notes received in payment; and (4) the general journal for various adjustments and also for the purpose of recording notes and returned sales where special journals are not kept for these transactions. Accordingly, analytic columns for accounts receivable are provided in the cash receipts journal and the general journal. The totals of their columns are posted to the credit of Ac- counts Receivable, and the detailed amounts to the credit of the various customers' accounts. The credit postings from these sources to the customers ledger accounts and to the general ledger Accounts Receivable account are therefore the same as far as totals are concerned. The sales returns journal is summarized at posting time by means of an entry similar to that in the sales journal entry, as follows : Sales Returns Accounts Receivable 4i8 ACCOUNTING— THEORY AND PRACTICE In this case the credit posting to the Accounts Receivable account is equal to the detailed credits to customers' ac- counts. Similarly, a summary entry for the notes receivable journal secures a controlling figure for Accounts Receivable. If the notes are all received from customers to apply on their accounts, the summary entry is : Notes Receivable Accounts Receivable the amount being the total of that journal. In this way the total of all debits and of all credits to the individual customers' accounts is represented by the summary items entered in the general ledger controlling ac- count, Accounts Receivable. Consequently, the balance of this single account is equal to the balance of the customers ledger. For the trial balance, therefore, one account takes the place of hundreds or even thousands of customers' in- dividual accounts. As a result of this much time is saved and the possibility of error on the general ledger greatly reduced. Proving the Customers Ledger This, however, does not eliminate the necessity of prov- ing the accuracy of the customers ledger. It merely makes it possible to take a trial balance without bringing the numerous customers' accounts into it. It is just as much a part of the proof of the work to make a list of customers' ac- counts balances and check it against the balance of the Accounts Receivable general ledger account, as it is to prove the general ledger by means of a trial balance. If there is discrepancy between the subsidiary ledger and its controlling account on the general ledger, that discrepancy does not necessarily prevent a trial balance of the general ledger, but CONTROLLING ACCOUNTS 419 it does show error in the work which must be searched out and corrected. Accounts Payable Account A similar arrangement will make possible a controlling account on the general ledger for the creditors or purchases ledger. This account is variously termed Accounts Payable, Purchase Ledger, Creditors, or Trade Creditors Account. Its mechanism is the same as for Accounts Receivable. Analysis of credit postings to creditors' accounts shows the purchase journal as their main source. Other credits come through the general journal and a very few through the cash receipts journal. The summary entry for the purchase journal is : Purchases Accounts Payable Cash This shows a debit to the Purchases account for the total amount of the purchases, a credit to Accounts Payable for liability to creditors, and to Cash for the amount paid on cash purchases. The cash item is not posted. The "Ac- counts Payable" column total on the credit side of the journal, and the separate items from the cash receipts journal, furnish the other credits to the Accounts Payable account in the general ledger. The debits come from the "Accounts Payable" columns in the cash disbursements journal and in the general journal, and the summaries for the notes payable and purchases re- turns journals. Basic Principle as to Postings to Controlling Accounts In the handling of all controlling accounts, the one fundamental requirement is to make sure that every entry in 420 ACCOUNTING— THEORY AND PRACTICE books of original entry which affects any account in the subsidiary ledger is reflected in the postings to the control- ling account in the general ledger. This principle resolves itself to the mathematical axiom stated above that a whole is equal to all — not just some — of its parts. Only thus can a true control be established. Making the Subsidiary Ledger Self- Balancing Using the two controlling accounts explained above, the trial balance is relieved of a large number of accounts, and the general ledger is made independent of the subsidiary ledgers. On the other hand, the subsidiary ledgers are de- pendent for their proof on the controlling account balances in the general ledger. In an effort to make every ledger "self-balancing," a further refinement of the controlling ac- count idea is frequently incorporated in each subsidiary ledger. It is accomplished in the following manner : An exact duplicate of the controlling account on the general ledger is set up in the subsidiary ledger, with this difference, that the sides of the account are reversed so that the sub- sidiary ledger account has for its debits the credits of the general ledger account, and for its credits the debits of the general ledger account. Take the accounts receivable controlling account for illustration. On the general ledger its balance is, of course, a debit balance representing the total outstanding accounts due from customers. Similarly, the schedule or list of cus- tomers' accounts taken from the sales ledger will represent debit balances whose total is the same as the controlling account balance. If, then, the controlling account itself is placed on the customers ledger as an additional account, the sides being reversed, the balance of this one account will be a credit equal to the total debit balance of all the other accounts in the customers ledger. Therefore, if the cus- CONTROLLING ACCOUNTS 421 tomers ledger is correct its own balance will be offset exactly by the credit balance of the one additional account, and the ledger then is said to be self-balancing. There is no theory or principle of debit and credit involved in this ; the device is simply introduced in order that the ledger may provide an internal proof of its correctness. The title of the balanc- ing account on the subsidiary ledger is "Adjustment" or "Balance" and has no significance other than that mentioned. In a similar manner any subsidiary ledger may be made self-balancing. Problem (Assignment for Chapter XLVI) A partnership agreement provides that before net profits shall be determined, the partners shall be charged with 6% interest on their "personal" withdrawals from the dates of such withdrawals to the date of closing the books and that net profits shall be divided in propor- tion to the net "capital" investments and the length of time of their in- vestment. The profits before taking the above into consideration were $3>S69.72 and the partners' combined capital and personal accounts show as follows : A. K. Avery 1917 Jan. 20 Capital $5,000.00 Feb. 28 Personal 300.00 April ID Capital 3,000.00 June 10 Personal 250.00 1917 Jan. I Capital $10,000.00 Feb. 15 Capital 2,500.00 May 10 Capital 5,000.00 C. E. Clarence 1917 Feb. I Personal $250.00 Mar. 15 Capital 7,500.00 May 31 Personal 300.00 1917 Jan. IS Capital $5,000.00 May 20 Capital 5,000.00 June 10 Capital 5,000.00 If the books are closed on June 30, 1917, what is each partner's share of the profits? CHAPTER XLVII HANDLING CONTROLLING ACCOUNTS Chapter XLVI concerned itself with the statement and explanation of the principles on which the controlling ac- count rests, the manner of its make-up, its advantages, and with the changed application of the fundamental scheme of debit and credit under a system of records operating con- trolling accounts. The present chapter will be devoted to a consideration of the problems met with in the practical operation of these accounts. Introduction of the Controlling Account Upon the installation of a new system or set of books, the controlling account feature may be incorporated from the start. The new system must provide for the separation from the general ledger, of the ledgers over which control is to be established. In order to secure controlling totals for posting to the general ledger controlling accounts, the detailed postings to the subsidiary ledgers must be sum- marized, and this is accomplished through the use of special analytic columns. Where it is desired to introduce the controlling ac- count features into a system which has not formerly used it, certain adjustments must be made, i.e., the accounts to be controlled must be segregated and controlling account columns must be provided for in books of original entry. With the transfer of these accounts to a separate ledger, together with the introduction of the controlling accounts into the general ledger, the equilibrium of that ledger is 422 HANDLING CONTROLLING ACCOUNTS 423 maintained. The opening entry in the newly established controlling account is, of course, the sum of the balances of the transferred accounts. If it is desired to establish the new controlling account by journal entry, that entry would appear somewhat as shown on page 429, with a suitable explanation added. All these items should be posted to the general ledger just as shown by the entry, and, in addition, the detailed items should be posted as debits to the accounts in the customers ledger. The effect of these postings would be, first, to close the individual customers' accounts formerly carried in the general ledger and open up in their stead the controlling account, and, second, to set up on the subsidiary ledger the detail of the customers' accounts. Recording Withdrawals of Stock in Trade The original basis for separating the main journal into its subsidiary parts was the analysis of all transactions ac- cording to their various kinds, such as sales, purchases, cash, etc. The sales journal was presumed to contain only sales of stock in trade. Departure from this principle was advisable in the case of goods drawn at cost, for use in the business, for the proprietor's personal use and for other sim- ilar purposes. This is done because all withdrawals of stock in trade, at whatever price and for whatever purpose, have their easiest record in the sales journal. It is theoretically incorrect, however, to enter such items in the Sales account because withdrawals at cost do not rep- resent actual sales, and for this reason should be regarded as deductions from purchases or from inventory. The only place for their record, under this view, is the general journal, entry in which would have to be by detailed debit and credit for every such entry. However, this would require much more work than entry in the sales journal. 424 ACCOUNTING— THEORY AND PRACTICE Usually the volume of such transactions is not large and would not seriously vitiate the use of the Sales account as the basis for estimating percentages of cost of goods sold, gross profit, selling expenses, etc. Moreover, the total amount of these v^^ithdrawals usually is fairly constant as between periods. Hence, record in the sales journal of items of this nature is countenanced. The Problem of the Sales Journal Summary However, when withdrawals from stock at cost price are recorded in the sales journal, a new problem arises in sum- marizing the sales journal when operating under a control- ling account system. The customers or sales ledger is usually limited absolutely to customers' accounts. Accounts with the proprietors, and with all other titles under which withdrawals may be recorded, are almost invariably car- ried in the general ledger. Therefore, while most of the items entered in the sales journal are posted to the customers ledger, these withdrawal items must be posted in detail to the general ledger. Thus the total of the sales journal does not represent the correct debit to accounts receivable in the general ledger. Evidently an analysis of the content of the sales journal must be made in order to obtain the correct controlling figure. Such analysis may be made in several ways. Where possible, three columns in addition to the departmental columns should be used. The column titles would be "Sales Ledger," "Cash," and "Sundry." The sum of these three would give the total to check against the total of the other distributive columns, but only the "Sales Ledger" total would be posted to Accounts Re- ceivable, and the individual items in that column would be posted to the customers' accounts in the sales ledger. The items in Sundry column would be posted to their named accounts in the general ledger. This method secures an HANDLING CONTROLLING ACCOUNTS 425 automatic separation of the controlling account total from other items, and should be used where possible. If the number of these extraneous items is too small to warrant the use of a separate column, they may be recorded in the Sales Ledger column and indicated by means of an "X" or other mai^k. At summary time, the sales journal must be looked over and these items picked out. Subtrac- tion of their sum from the Sales Ledger column total would give the correct controlling account posting. Still another method requires a correcting general jour- nal entry at the time the sales journal entry is made. Under this method these special items are included in the Sales Ledger column, thereby causing an overcharge to Accounts Receivable. The correcting general journal entry must therefore credit Accounts Receivable by the amount of the overcharge for each item. For instance, if stock has been drawn by the proprietor, the general journal entry at the time the sales journal entry is made would be : Proprietor, Personal Accounts Receivable the debit to proprietor being checked here and posted from the sales journal or vice versa. This method, however, results in a duplication of work. It would be preferable not to enter these items in the sales journal and to make the record only in the general journal, and so leave the Sales Ledger column total in the sales journal the correct control- ling figure. The Problem of the Purchase Journal Summary The practice of recording extraneous transactions in the purchase journal brings about at summary time a situation similar to that of the sales journal, when a controlling Accounts Payable account is m.aintained. The purchase 426 ACCOUNTING— THEORY AND PRACTICE journal is and should be the place of record for purchases made for the business. If the proprietor (or other person), for his personal account and use, purchases through the business merchandise which never goes into stock, accurate accounting requires that such transactions shall be charged direct to the proprietor and not to the purchases account of the business. Inasmuch as the liability here is assumed by the business and the creditor's account will appear in the purchase ledger, the use of the purchase journal total for credit to the Accounts Payable controlling account gives the correct figure. The trouble comes in because this same fig- ure cannot be used as the debit to Purchases. Subtraction of these extraneous items must be made to determine the proper amount chargeable to the Purchases account, thus necessitating an analysis at summary time. Accounts Both Receivable and Payable It frequently happens that purchases from, and sales to, the same party are made, i.e., goods are sometimes bought from a customer and goods are sold to a person who is normally a creditor. If the account is normally a purchase account, it is set up in the purchase ledger. If a sale is made to this creditor and charged to his purchase ledger account, such transaction should not be included in the Accounts Receivable controlling figure from the sales jour- nal unless an adjusting entry is made through the general journal. Such entry would affect only the controlling ac- counts and would be : Accounts Payable Accounts Receivable Or the item might be omitted from the sales journal con- trolling figure and stated separately in the summary entry for the sales journal. HANDLING CONTROLLING ACCOUNTS 427 A more satisfactory method is to set up two accounts with such parties — one as a creditor, the other as a cus- tomer. Then no adjustment need be made at the time of summarizing the journals, because the two accounts are treated as entirely independent of each other. The settle- ment of these two accounts may be handled separately or by a payment of the balance between the two. If settled by balance, an adjusting journal entry should be made to show on the books the two separate elements involved. This again ^^'ould affect only the controhing accounts. The Problem of the Note Journals Summaries Of notes receivable the large majority are usually re- ceived from customers. The summary entry for such is : Notes Receivable Accounts Receivable Where notes are received from other sources as from of- ficers, partners, or from outside parties to whom loans have been made, it is evident that these must not be included in the credit to Accounts Receivable, and it may be advisable also to eliminate them from Notes Receivable unless they are short-term, current items, as only such should be carried under Notes Receivable. These special notes may be carried in a "Notes Receivable Special" account. If, as sometimes happens, interest is included in the face of a note, this must be adjusted by the summary entry, as follows : Notes Receivable Accounts Receivable Interest Income The considerations stated above as applicable to the notes receivable journal are of ecjual importance in handling the 428 ACCOUNTING— THEORY AND PRACTICE notes payable journal. A very careful analysis of the note journals should be made at a summary time, which analysis should be shown by the summary entry. Summary Entries for Columnar Books Illustration will now be given of some standard forms for summarizing the columnar journals. Sometimes the summary entries for the various subsidiary journals are made in the general journal. This seems to accomplish no good purpose and is not usually recommended. With re- gard to all summary entries, theoretically it is desirable to show a formal debit and credit summary for each journal. If, however, the number of columns is small and it is readily seen that the debits and credits are equal, the formal sum- mary is often dispensed with. So also, if there is a large number of distributive columns of the same effect, i.e., debit or credit, as in the large departmental sales journal or the voucher register referred to on page 408, formal summary is not shown, the posting being made from the column totals as illustrated for Petty Cash on page 292. The Sales Journal Summary An illustration of the sales journal summary is given on page 429. The Sundry items should be posted in detail from their column and their total checked in the sum- mary entry. Where a Sundry column is not used but these items are included in the Sales Ledger column, they must be separated before the summary entry can be made. Where, also, a Cash column is not carried, as is so often the case, there being just one column for Sales Ledger, Cash, and Sun- dry items, from which distribution is made, the separation of the Cash items need not be shown in the summary entry, provided those items are entered also in the Sales Ledger column of the cash book. The overcharge to sales ledger HANDLING CONTROLLING ACCOUNTS 429 42 V S 3 IS 8 5 8 8 8 8 d d d g 0000 in q^ in of in Tf CO Accounts Receivable A (customer) B C D Q II q 13 (J Q u 10 8 d cq m 01 in 01 d < in d 9, a g. t/i ■-3 1:; 1- 8 8 8 8 a 8 g p irj PI CJ S m m u^ 'u t^ fO (N -^ c s K "rt - - C3 ^.*' a 5 j3 "2 57= s b S3 §0 H < U t^ 430 ACCOUNTING— THEORY AND PRACTICE 8 8 1.1 o o 8 "2 8 8 8 § 8 8 8 d m ! Isll § .S Ph Ph m m o a m en n C H a S S o o Q. P i2 CJ u rt o O CJ u s 8 s<: <: 1 P O 8 8 8 kS 8 o ui 0_ ■^ i-T m 8 d in II O o 8 in ^o n m- <«■ o « -3^ ^ ■3-g OJ T3 ^' OJ C -4-J OJ w c 2 (U E rt bo rt o d *-■ C id r- ^ b 1 C => C t-Hpni-H 2E SQ « "1 J o O o U CHAPTER LIV BALANCING METHODS The "Fool-Proof" Trial Balance Double-entry bookkeeping is never satisfied with any- thing short of absolute proof of the mathematical accuracy of the work. Often such proof is a very difficult thing to secure. There has not yet been devised — and, in the nature of things, never will be — any so-called royal road to the trial balance. Yet one often sees claims put forth that there is no longer any need for trial balance troubles. The use of certain methods, which are disclosed only upon payment of fees in proportion to the advantages claimed for them, makes it possible, according to their devisers, to take a trial balance within an incredibly short time or to do away with trial balances altogether. As a matter of fact, satisfactory results can be obtained only by habits of accuracy and by proving the work done wherever possible. Some methods found useful in searching stubborn errors will be explained in this chapter. Ledger Analysis By ledger analysis is meant an analysis of postings on the basis of books of original entry, i.e., on the basis of all journals whose record is transferred to the ledger. The process of making such an analysis is somewhat as follows : The ledger must be gone through carefully and for each account the last debit and credit figures which entered into the last correct trial balance must be marked distinctly so as not to be included in the analysis. If the analysis is for an interim period, the first debit and credit items belonging 5" 512 ACCOUNTING— THEORY AND PRACTICE to the next period should be marked in a similar way, as shown in the illustration. Care must be exercised here as the "date" is not always a safe guide. The use of sub- sidiary journals with one summary posting to offset many detailed contra postings and inaccurate dating of the sum- mary posting often make the "date" an uncertain guide. Care should therefore be exercised so that the points marked include a complete, i.e., a debit and credit, posting of every journal. Procedure of Analysis The content of each account between the marked points is now analyzed according to the journals from which the postings were made. Usually analysis paper is used with debit and credit columns headed for each journal. All debits in the account posted from the journal are entered in the debit journal column of the analysis sheet, all cash debits in the debit cash column, all sales journal debits in the debit sales journal column, etc. Similarly, the credit post- ings in the account are entered in the proper credit columns of the analysis sheet. Each item in the account should be checked or otherwise marked when transferred to the an- alysis sheet. Illustration of the analysis sheet is given on page 514. When the various accounts have thus been analyzed, there should remain no unchecked items in the period an- alyzed, unless there have been transfers between accounts made directly on the face of the ledger. If this has been the practice, an additional heading with debit and credit columns, entitled "Ledger Transfers," should be set up on the analysis sheet. Every account in the ledger is analyzed in the same way. To make sure that the method is under- stood, an account and its analysis are shown here: BALANCING METHODS 513 6 55/ So. Clio loo SU ^ io_ Jjl (0 H-Si> y^ ¥/ 20 CI IS 5 go ,t.t CnL aid 00 J3« SSL lb 3o lie Sioo JE 3L C/'/o J31 15- *r 5/// /it) UJ 7- & Vo It J o ll_- \ 3 ' Q U <_) < \ BALANCING METHODS 515 the balance of the cash book for the period will have to be entered on the analysis sheet before equality of the cash columns will be shown. With the exception of the items transferred to the analysis sheet from the cash account — ■ where a cash account is carried in the ledger — all items in the cash debit column of the analysis sheet represent in the cash book, credits to certain accounts, and those in its credit column represent debits to certain accounts. The entries to the cash analysis column from the ledger cash account, showing on its debit cash receipts and on its credit cash disbursements, must bring about the equilibrium. The column total, however, will not represent cash receipts and cash disbursements respectively, but the total of each column will be the sum of both receipts and disbursements; whereas the totals of the other columns are equal to the totals of the corresponding journals for the period. The cause of this lies in the fact that the two cash columns on the anah'sis sheet really cover two independent journals, viz., the cash receipts and the cash disbursements journals. If the debit and credit totals of corresponding columns agree, that is proof of equilibrium in the postings from that book, but, unless these column totals also equal the total of the corresponding journal, there is evidence of the omission from the ledger, both on the debit and on the credit side, of items recorded in the journal. Thus the ledger analysis serves also as a check against omissions ; but when used for that purpose, account must be taken of duplicate entries in the various journals, such as cash sales entered both in the cash and sales journals but posted only from one of them. Use of Ledger Analysis All that is claimed for the ledger analysis is that it lo- calizes the error, if it is an error in posting, and so makes the work of searching for it less haphazard and renders 5i6 ACCOUNTING— THEORY AND PRACTICE unnecessary a checking of all postings in the ledger. All of the means previously explained should be exhausted before resort is had to this method. If the previous trial balance, i.e., the one at the beginning of the analysis period, Vi'as correct and the ledger analysis shows no errors in posting, then certainly the trial balance for the end of the analysis period must balance. If not, the error is an error on the face of the ledger and its computations must be proven. The Slip or Reverse Posting System As indicated before, it is better to post carefully and accurately in the first place than to hunt for errors after- wards. A method of proving daily postings known as the slip or reverse posting system is used with success in many places. Formal slips of any convenient width and length are provided, one for the debit and one for the credit of each book from which postings are made. The debit slips may be easily distinguished from the credit slips by the use of different colors. The slips are ruled only with money columns and each slip bears the title of its journal. Reverse posting is made on the slip from the items posted to the ledger. Thus, when posting the debits from the general journal, the general journal debit slip is carried conveniently on the right of the ledger and entry of each debit posting to the ledger is made from the ledger to the slip. When all journal debit postings have been made, the reverse posting slip is totaled and must agree with the total of the journal debit column for the items posted. Similarly, the journal credits are posted, reverse posted, and proved. The debit postings must equal the credit postings and thus proof is secured of the equilibrium of the ledger. Each journal is posted, reverse posted, and proved in a similar way. The bookkeeper is, in this way, sure of the correctness of his BALANCING METHODS 517 work day by day. Oftentimes monthly recapitulations of these reverse posting slips are made and preserved as part of the business records. It will be seen that this method is identical with the ledger analysis method explained above but applied at the time of making the posting instead of at the close of the period. Check Figures in Posting The use of the check figures 9 and 1 1 in the verification of the arithmetic processes of addition, subtraction, multi- plication, and division was referred to earlier. Other odd numbers, such as 13, 17, and 19, are less frequently em- ployed. The number 11 gives perhaps the most satisfactory results from the standpoints of ease of application and ac- curacy of results. Its use in the verification of postings is somewhat as follows : An additional column similar to the folio column should be provided in all the books for the check numbers. As an amount is posted to the ledger the bookkeeper should deter- mine the check number from the item as it is written in the ledger — not from the journal item — and enter it in the check column in both ledger and journal. When postings from the journal are complete, the journal is totaled and the check figure for its sum found. If this agrees with the sum of the check figure column in the journal.posting is presumably cor- rect. If the two items do not agree, the check number for each amount in the journal debit column should be proved. Inasmuch as the check number used was obtained from the ledger amount, a wrong check number for the journal amount would indicate a wrong posting which should now be turned to and corrected. The check numbers in the ledger accounts are used only for verifying account totals and balances and may even be carried into the trial balance for proving it. Practice in the use of any check number 5l8 ACCOUNTING— THEORY AND PRACTICE soon develops accuracy and speed and makes the method easy of application and commendable wherever the work must be proven day by day as completed. Errors in Columnar Books and Controlling Accounts These are frequent sources of trouble unless handled with care. In the chapter on columnar books, it was laid down as a basic principle that all items appearing in the general amount column should be entered in some analysis column, i.e., analysis columns should be provided for dis- tribution of all items. This makes proof of distribution possible and establishes formal equilibrium of the book so that errors in posting are not so likely to occur. Care must be exercised in posting the discount columns of the cash book to the proper sides of the respective accounts. In the use of controlling accounts, where a special column is not provided, as for Accounts Receivable on the credit side of the cash book, posting of the item should be made both to the individual account and also to the con- trolling account. Trial Balance Adjustment Account Where error creeps into the ledger and seems impossible of detection at a monthly trial balance period, the device of forcing a balance is sometimes used by setting up an account called "Trial Balance Adjustment," "Error in Trial Bal- ance," or other similar title. To this is charged or credited the amount of the difference in the trial balance. It is a temporary makeshift, a method of holding the item in suspense until the error is located. Needless to say, the inclusion of such an account does not improve the appear- ance of a trial balance, but may be countenanced as a tem- porary expedient. BALANCING METHODS 519 Practice Data* (Assignment for Chapter LIV) Close the ledger, through the journal, taking account of the fol- lowing adjustments and inventories: Accrued Expenses — salesmen's salaries $250; general salaries $342.75 ; unpaid bills on buildings repairs $436.20 ; in-freight $314.75 ; mortgage interest $50; interest on note held by Mechanics Hardv/are Co. $4.92, and one held by American Hardware Supply Co. $10. Prepaid Expenses — advertising $983.50; insurance $2,501.67; gen- eral expense $129.60; discount on company's $S,000 note $44.17. Accrued Income — interest earned on the following notes : Salzer $17.36; Colonial Supply $4.76; Hoffman $3.67, and Mishkin $2.38. Take account of depreciation at yearly rates of : 2% on buildings. 15% on delivery equipment. 10% on all furniture and fixtures. Set aside 2% of the outstanding accounts and notes receivable as a reserve for doubtful accounts. Inventories on hand at the store and warehouses are : Department A, $41,276.20. Department B, $43,987.56. Take into consideration Department B goods out on consignment. Charge 80% of the insurance cost to trading. Apportion in-freight between the two departments on the basis of purchases. Declare a 10% dividend to be paid on December. 15 and carry the balance of the profit and loss to Surplus. *See Practice Data for Chapter LII. CHAPTER LV SINGLE OR SIMPLE ENTRY Different Systems oi Bookkeeping Someone writing of the various systems of bookkeeping facetiously makes a three-fold classification, viz., (i) No Entry, (2) Single Entry, and (3) Double Entry. Esquerre in his "Applied Theory of Accounts" gives brief explana- tion of two other systems, Logismography and Statmog- raphy, based respectively on a triple and quadruple entry method. It is the purpose of this chapter to treat only of single or simple entry, dififerentiating it broadly from double entry. From the classification given above, it may be in- ferred that single entry is not far removed from the "no entry" system; in fact, some writers and accountants say that single entry cannot be classed as a system. A system should presumably be systematic, but there are degrees of system. With that limitation single entry may be called a system. Under certain conditions, however, it serves the desired purpose and provides the information absolutely needed. An early writer defines bookkeeping as "the art of recording mercantile transactions in a regular and sys- tematic manner." In further elucidation he says, "A mer- chant's books should contain every particular which relates to the affairs of the owner. They should exhibit the state of all the branches of his business ; the connection of the vari- ous parts ; the amount and success of the whole. They should be so full and so well arranged as to afford a ready information in every point for which they may be con- 520 SINGLE OR SIMPLE ENTRY 521 suited." Single entry hardly measures up to these require- ments, but nevertheless it has its place and while it is not recommended as a system there are places and circumstances where it does well. As brought out in an early chapter, bookkeeping had a development contemporaneous with in- dustrial Ufe. Only simple records were needed so long as that life was simple, but with its increasing complexity, previous methods became inadequate. Single Entry Single entry may be defined as that method of keeping records which sorts out and classifies debits and credits only as they apply to persons, the proprietor included, and usually cash. To justify the strict application of the term system, it must needs keep record of all transactions. Methods — not systems — of single-entry account-keeping are some- times met with which do not make full record. Of them it may be said that they are retrograding towards the "no entry" method, rather than being examples of a single- entry system. The point of view of single entry is personal. All features of the business not connected with persons are looked upon as being under the direct hand of the owner, and subject to his control. But uncompleted transactions with persons, whether customers or creditors, are not capable of such oversight without the aid of individual, classified records. The necessity of safeguarding the cash and keep- ing its flow under review makes the classified cash record an almost universal feature of single entry. As a usual thing, therefore, single entry is characterized by: (i) a record of all transactions; (2) a debit and credit analysis only as applicable to persons and to cash; and (3) a classified and grouped record, i.e., ledger record, only as to persons and cash. It does not analyze every transaction in its relation to the business as a whole. It has a single point 522 ACCOUNTING— THEORY AND PRACTICE of view, i.e., it considers only persons and cash and makes entries accordingly. Hence, its name. Books Required and Methods of Record — The Journal In a single-entry system, three books of account are necessary — the journal, the cash book, and the ledger. The cash book records all cash transactions, receipts and pay- ments, classified as to persons but otherwise in narrative form. The journal records all other transactions following the same method. The ledger makes secondary record only under the heads of customers, creditors, and proprietor. The journal is the standard two-column journal, the first column being used as an "items" column, the second for totals. A three-column journal is advantageous, the first column being used for items and for all unposted amounts, the second for debit postings, and the third for credit post- ings. This aids in proving the ledger postings, as will be seen later. Transactions affecting persons are recorded under that person's name followed by "Dr." or "Cr." ac- cording to analysis of the transaction. This is necessary since position does not show it, the single-entry journal not using the method of left and right position for debit and credit. All other transactions are recorded in narrative form, i.e., merely a memorandum is made of them. Cash Book The cash book is the same as for double entry, receipts on the left and disbursements on the right-hand page or column, according as a double or single page cash book is used. Where the double page is used, one of the two columns on either side is sometimes used for the exclusive extension of the amounts to be posted to personal accounts. This facilitates posting, since these are the only amounts which are to be transferred to the ledger. SINGLE OR SIMPLE ENTRY 523 Ledger The single-entry ledger is the same as the double-entry and uses the debit and credit principle of the double-entry. As stated above, accounts are kept only with persons, in- cluding the proprietor. It is seen, therefore, that single- entry books make a record of all transactions but fail to analyze those transactions in their relations to one another and in their effects upon the business. Single Entry as Adapted to Modern Needs Recognizing the value of the analysis secured by double entry but overestimating the work required to make the record, some concerns have developed single-entry systems through use of subsidiary records and columnar books, from which they derive very full information for management purposes. A sales journal gives volume of sales, a purchase journal shows the amount of goods purchased, and analytic columns in the cash book show the main sources of receipts and their amounts and the main classes of expenses and their amounts. A bill book is used for recording notes receivable and payable, and inventory books for scheduling all kinds of property, assets and liabilities. All of these make a system approaching the double entry in completeness of detailed information, but one which lacks the fundamental principle on which the double entry rests, viz., an equality of debits and credits brought about by a classified analysis of every transaction into its debit and credit elements at time of first entry on the books. It lacks the tying together of the whole into a mathematically provable system. Since the advent of double entry there have always been strong adherents to the single-entry method. An early writer, William Perry, in 1777 presents a treatise on bookkeeping by either method. Most small enterprises, even if they keep their records by the single entry method in the beginning, usually 524 ACCOUNTING— THEORY AND PRACTICE adopt the double-entry system as their business increases, reahzing that the latter furnishes better accounting control than is obtainable under simple entry. Debits and Credits To one who knows the method of double entry, single- entry bookkeeping presents few or no difficulties. Debit and credit as applied to personal accounts are usually of easy determination and are exactly the same as in double entry. The debits and credits for cash are based on the same principles in both methods. The method of writing them in the books of original entry was sufficiently indicated above where those books were explained. Posting is done just as in double entry. With regard to all work upon single-entry books, there is always a temptation to do slovenly, inaccurate work because the system does not pro- vide internal proof as does the double-entry system. Thus, where rebates have been allowed, only the net amount re- ceived may be shown in the cash book with explanation that the payment was in full of account. After this amount is posted to the customer's account, the item does not fully offset the original debit and it is necessary to make a note in the ledger to the effect that the item is fully settled. The same thing holds true for creditors' accounts. Of course, this is not good bookkeeping whether practiced in single or double entry. The Proprietor's Account The handling of the proprietor's account is very similar to that under double entry. The proprietor's capital account shows the original investment on the credit side; his per- sonal account, if kept separately, is debited with his with- drawals, whether in merchandise or cash. Inasmuch as the single-entry ledger does not show the profit or loss, the SINGLE OR SIMPLE ENTRY 525 manner of handling the proprietor's account at closing is somewhat different. The profit, as determined by the method shown a little later may be brought directly and without journal entry from the statement of profit and loss into the proprietor's capital account, so that this account will show the true net worth of the business as at that time. The personal account is simply ruled off after its figures have been used in determining profit. Efforts have been made to work out a method whereby the proprietor's ac- count will show all current changes in net worth so that at the end of the fiscal year no adjustment will need be made. To accomplish this the profit or loss from any transaction must be recorded in the proprietor's account at the same time the transaction itself is recorded. While this can be done, there is never the certainty of correctness, and the analysis and work necessary to accomplish it are out of all proportion to the value of the results obtained. These results are much easier of accomplishment by other means. Proof of Posting The only proof of work possible under single entry is a checking of the secondary record against the original. A trial balance of the ledger cannot be taken. A schedule or list of account balances may be prepared and debit and credit totals of the Hst made. This compared with a similar list prepared at the close of the last period will show the changes taking place this period. A list of the debits and credits to personal accounts in books of original entry for this period must check against the net change shown by the above comparison. Virtually this amounts to a second post- ing of the items and, if the two postings agree, the presump- tion is that the ledger is correct. The use of the "personal" posting column for the cash book as explained above, and of similar columns in sales and purchasing journals, makes 526 ACCOUNTING— THEORY AND PRACTICE possible a much easier debit and credit summary of the books of original entry, if some proof of posting is desired. Profit and Loss Inasmuch as many of the factors afifecting the net worth have not been analyzed in making the original entry, no detailed showing of profit and loss, as understood under double entry, can be made. It is, of course, possible to go back over the books and make such an analysis, but this would result practically in rewriting the books on a double- entry basis. Single entry, therefore, has recourse to another method which is characterized by a complete inventory- taking and appraisal. It is sometimes called the asset and liability method as explained in the following section. Inventory and Appraisal A physical inventory or count of all assets, fixed, current, and deferred, is made. The books furnish only the accounts receivable and the cash. All other assets are usually made up by physical count and re-appraisal. It is consequently very easy to lose sight of some assets, particularly in the case of additions and betterments to existing assets. For the deferred items, the inventory of supplies on hand supple- mented by the proprietor's memory is the customary source. Liabilities Liabilities are more difficult of correct determination. The accounts payable are shown on the ledger, the notes payable should be shown in the bill book or by stubs in the bound blank book of notes. Any unpaid bills may be found in the current file of unpaid invoices if one is maintained and the bill has been received. For all others and for deferred income the memory must serve. The haphazard manner in which this statement must be made up is therefore apparent. SINGLE OR SIMPLE ENTRY 527 Accrued and Deferred Items There is usually little or no notice taken of accruals and deferred items on account of the difficulty in securing trust- worthy and full information. The theory of averages, viz., that one period's items of that sort will offset, in the long run, those of another period, is the theory by which the failure to include accruals and deferred data is excused. A comparison of this method with the double-entry method for handling similar items throws into strong relief the in- accuracy of the single-entry method, under which it is almost impossible to obtain correct results. The Balance Sheet and the Determination of Profit The statement of financial condition, listing all assets and all liabilities, makes a determination of proprietorship or net worth possible. The financial statement, by the in- ventory and appraisal method, must be taken periodically. A comparison of the net worths as shown by successive state- ments develops the gain or loss provided no other elements affecting net worth have become involved. The additional element to be taken into consideration is the relation of the proprietor to the funds of the business. He may have with- drawn some of the assets or he may have made additional investments, so that the condition of the assets as shown at the end of the period is not entirely the result of business activities and transactions. Profits determination by this method, therefore, must take cognizance of the two factors — (i) comparative net worths, and (2) proprietor's interim drawings and investments. A withdrawal of cash during the period equal in amount to the profits for that period would result in the same net worth at the close as at the opening of the period. Drawings in excess of profits would cause a less net worth at the end than at the beginning ; and less withdrawals than profits would cause an increased net 528 ACCOUNTING— THEORY AND PRACTICE worth. But under none of the three cases stated would a comparison of the two net worths show the actual profits. Similarly, additional investments have an opposite effect, bringing about an increase in closing net worth in the exact amount of the additional investment and so obscuring the true amount of profit or loss for the period. Accordingly, the increase or decrease of net worth as shown by the com- parative statements of financial condition must be adjusted in accordance with the proprietor's withdrawals and addi- tional investments to make a correct determination of profits. To the change in net worth — treated algebraically, i.e., positive if an increase and negative if a decrease — must be added the withdrawals, and from this sum the additional investments must be subtracted in order to determine the profits for the period. In the next chapter will be given illustration of some of the points and methods discussed here. Practice Data* (Assignment for Chapter LV) Draw up pro forma balance sheet and statement of profit and loss for the year ending November 30, 1916. Show the gross profit on both kinds of sales. Support botli the balance sheet and the profit and loss statement with properly set-up schedules. *See Practice Data for Chapter LIV. CHAPTER LVI ILLUSTRATION OF SINGLE ENTRY Single and Double Entry Compared From the points discussed in the previous chapter and the illustrations which follow in this chapter it will be seen that single entry can be worked through to a con- clusion as to profit and loss. It tells nothing of the sources of that profit or loss, nor does it give any control over ex- penses. It is true that a comparative statement of assets and liabilities as shown in Chapter V, showing the increases and decreases of the various assets and liabilities, will give more information, but even that does not show the reasons for the change, and so affords no basis for control. For such purposes, the statistical totals of the sales and purchase records and the cash book, where analytical columns are used, furnish the only information available under single entry. Its only advantage, then, is brevity, the saving of labor in making the record. No difficult analysis is met with in the original record and posting is much less in amount than with double entry. But brevity and labor- saving are secured at the expense of the very information which the business man needs. The advantages of double entry may be summarized as follows : 1. The ledger shows a classified record of every trans- action. 2. Expenditures for capital purposes, i.e., for new assets or additions and betterments to existing assets, are recorded as such and so there is no danger of losing sight of them. 529 530 ACCOUNTING— THEORY AND PRACTICE 3. A gross profit figure is obtainable and percentages of profits and expenses, making possible an estimate of merchandise inventory at any time. This is particularly valuable in case of fire loss. 4. The double-entry method provides a proof of the mathematical accuracy of the ledger. 5. A full statement of sources of profits and causes of expenses can be obtained in double entry. Where the above advantages and information are not desired nor necessary, as in a very simple business under the immediate supervision of the proprietor, or in simple executorship transactions, etc., single entry may suffice. Opening Entries Upon opening a set of books to be kept by single entry as complete a record should be made as under double entry. If the proprietor begins business with an investment of cash only, without assuming any obligations, an entry in the cash book of the amount invested as a credit to the proprietor's capital account is all that is necessary. If the investment transaction is more complex, other properties being brought in, liabilities assumed, and obligations as to lease, salaries, etc., being undertaken, a very careful and complete record should be made in the journal showing the kinds and values of all properties invested, and also the kinds and amounts of all the liabilities assumed. This is best arranged in schedule or statement form with extension into the posting money columns only of those personal items for which accounts are to be opened in the ledger. Illustration will be given of a simple set by single entry, using journal, cash book, sales and purchase records, and ledger. A separate statement or diary of the transactions will be given covering in summarized form a six months'' period so that the entries may be traced. ILLUSTRATION OF SINGLE ENTRY 531 Problem. June 30, 1916, A. B. Cornell purchased a store and business, paying therefor $7,750. He took over the following assets and liabilities at the values shown: store building and lot $3,000; furniture and fixtures $500; horse and wagon $250; accounts receivable, B. C. Davis $50, C. D. Elliot $75, D. E. Foley $100, E. F. Gaynor $25, F. G. Harvey $125 ; stock of merchandise $5,250; mortgage on real estate $500 ; accounts payable, G. H. Jackson & Co. $250, H. J. Kelsey $375, J. K. Landon Co. $500. He deposited $500 as an aditional investment. During the six months the following transactions took place: cash sales $10,000; sales on account, Davis $300, Elliot $400, Foley $500, Gaynor $600, Harvey $700; purchases were, cash $1,500, Jackson & Co. $500, Kelsey $450, Landon $750, Morey & Co. $1,000. He returned goods to Morey & Co. $50, received an allowance from Kelsey $20. He made Harvey a rebate of $25. He received cash on account from Davis $250, Elliot $300, Foley $400 and notes from Gaynor $250 and Harvey $500. He paid on account cash to Morey & Co. $500, Jackson & Co. $600, Kelsey $675, a note to Landon $1,000; he paid off the mortgage with interest $530; expenses paid were, clerks $750, cashier, stenographer, etc., $250, N. Y. C. Ry. for freight $250, horse feed and expense of driver $125, newspaper and street car advertising $300. Cornell drew $2,000, and made an additional investment of a safe valued at $250. At the close of the year inventories and appraisals of data not on the ledger showed as follows: store building and lot $2,970; furniture and fixtures $725; horse and wagon $235; merchandise $3,000; notes receivable $750, with accrued interest of $2.50; notes payable $1,000, with accrued interest $15; accrued salaries and expenses $25. It is decided to value the accounts receivable at face value less 2%. 532 ACCOUNTING— THEORY AND PRACTICE u fo HJ -t3 •o o 01 CO J2 T3 & o dj a bo ■" -a '% h-j _o rt )- "3 J3 5s 0) J3 bo O H c '-n Vi (Tl OT S c o 3 J3 •■D 1 S o o 8 8 lo d ^ 3 ho=« S 3 S 3 8 8 8 8 8 to ^s. o c^ c^ l-i U. J-. ti Ih Q Q Q Q Q e< o 5? •o « CJ I- Ih O it M Q W fe 6 III § U Q W fe d § cq U P (4 fe < e2 u ILLUSTRATION OF SINGLE ENTRY 8 8 8 8 8 8 8 i o in Q in t^ o & 00" 533 o" 8 8 vS lA vo .0 U U U Ui o u flj .— < O di p — c rt C l-rH o §dffi ^w u o u u U U J =■ C« o o •a o o 60 >> •a o o b£ ^ ^O « o != ^ >> ,^ rt tij « n a o O vo ■^ 4J < C > "i S O "i " M Q W pL( (J III § U q" w fe d § ffl U O W fa •a Da re 1^ .5 fc 1) m 3 ^; < u o ILLUSTRATION OF SINGLE ENTRY 535 «9- O X W e 8 8 O O 8 d d 8 Q in lO N o t^ N C) 8 9° q o o S 9 »" o o o o o o odd o o w CO o o\ Of 1 1— * Q OJ -M o U ° >> CO 4_t .2'o MJUQ W rl OJ " ni 538 ACCOUNTING— THEORY AND PRACTICE B. C. Davis 1916 June 30. Dec. 31. . J2 $50.00 . S4 300.00 I9I6 Dec. 31. . C4 $250.00 C. D. Elliot 1916 June 30. Dec. 31. .J2 $75.00 . S4 400.00 1916 Dec. 31. .C4 $300.00 D. E. Foley 1916 June 30. Dec. 31. .J2 $100.00 . S4 500.00 1916 Dec. 31. . C4 $400.00 E. F. Gaynor 1916 June 30. Dec. 31. .J2 $25.00 . S4 600.00 I916 Dec. 31. .J2 $250.00 F. G. Harvey 1916 June 30. Dec. 31. .J2 $125.00 . S4 700.00 I916 Dec. 31. .J2 $25.00 Soo.oo G. H. Jackson & Co. 1916 Dec. 31. . C4 $600.00 1916 June 30. Dec. 31. .J2 .P4 $250.00 500.00 H. J. Kelsey 1916 Dec. 31. li It . J2 $20.00 .C4 675.00 I916 June 30. Dec. 31. J2 .P4 $375-00 450.00 ILLUSTRATION OF SINGLE ENTRY J. K. Landon Co. 539 1916 Dec. 31- 1916 June 30. Dec. 31. •J3 $1,000.00 MOREY & Co. J3 $500.00 . P4 750.00 igi6 Dec. 31. .J2 $50.00 . C4 500.00 1916 Dec. 31. . P4 $1,000.00 A. B. Cornell, Personal 1916 Dec. 31. . C4 $2,000.00 ■J3 1,239.50 I9I6 Dec. 31. J3 $3,239-50 A. B. Cornell, Capital Net Worth (down) $9,73950 ),739-50 1916 June 30. Dec. 31. 1917 Jan. I . .J2 $8,250.00 .J3 250.00 •J3 1,239.50 $9,739-50 ■ •■• $9,739-50 Ledger List (Before Closing) B. C. Davis $100.00 175.00 200.00 375-00 300.00 CD. Elliot D. E. Foley. E. F. Gaynor F. G. Harvey G. H. Jackson & Co. . H. J. Kelsey. J. K. Landon Co Morey & Co $150.00 130.00 250.00 450.00 540 ACCOUNTING— THEORY AND PRACTICE A. B. Cornell, Personal 2,000.00 A. B. Cornell, Capital 8,500.00 $3,150.00 $9,480.00 3,150.00 Excess of credits $6,330.00 Proof Total postings from Journal $1,445.00 $10,400.00 " " " Sales Journal 2,500.00 " Purchase Journal 2,700.00 " " " Cash Book 3,775-00 950.00 $7,720.00 $14,050.00 7,720.00 Excess of credits as above $6,330.00 Net Profits Inasmuch as the change in proprietorship is determined only by a comparison of the two financial statements, at least the result of the comparison should be incorporated into a journal entry and so reach the ledger account. Some- times the statement itself and the calculation of change in net worth are made on the face of the journal, thus making permanent record of them. This is worth while since they are an essential part of the system. A permanent state- ment book would accomplish the same result. In the illus- tration the statement is entered in the journal. The net profit of $3,239.50 may be set up in the proprietor's per- sonal account, and the balance of that account, being the amount of profits retained in the business, transferred to the capital account; or the net amount left in the business may be transferred directly to the capital account and the personal account ruled off without balancing as suggested in Chapter LV. The same result is accomplished, but the ability to prove postings against the books of original ILLUSTRATION OF SINGLE ENTRY 541 entry is lost. Hence the first method which is the one shown in the illustration is the better. Change from Single to Double Entry If it is desired to change from single to double entry, all that is necessary is a complete inventory and appraisal, to be used as the basis for an opening journal entry, debit and credit, as for any opening entry. If the former single- entry ledger is to be used, only the items not already posted, i.e., the impersonal items, will be posted from this opening entry. The proprietor's account should first be adjusted to its correct figure by a determination of profits by the single- entry method. If this is done, no posting to his account is needed from the opening entry for the double-entry books. This opening entry posted will bring the ledger into equilib- rium and that will be maintained under the double-entry method. If a new ledger is to be used, the opening entry above referred to will be posted completely, personal and impersonal items, which will, of course, bring about the equilibrium desired. Thereafter all transactions will be analyzed and entered according to the double-entry system. Problems (Assignment for Chapter LVI) 1. What single rate of discount is equivalent to the series 20%, 20%, and 20% ? 50%, 10%, and 5% ? 2. February i, 1917, the bank rendered statement of account of Jackson-Richter, showing a balance subject to check of $3,950.26. Jack- son-Richter's cash book showed $4,190.38. In reconciling, the follow- ing information is secured. Jackson-Richter checks outstanding were, No. 219 for $125, No. 230 for $75.20, No. 201 for $19.18, No. 241 for $605.73, No. 236 for $5.25, No. 225 for $21.40, and No. 217 for $6.30; 542 ACCOUNTING— THEORY AND PRACTICE checks on out-of-town banks deposited for collection and credit but not yet credited, Utica $598.18, Syracuse $720.50, Buffalo $279.50. Pre- pare a reconciliation statement. 3. Upon establishing an "Accounts Receivable" controlling account on the general ledger the total of customers' balances was $21,492.17. At the close of the month the cash book showed receipts from cus- tomers of $25,487.50; the bill book total was $5,250.40, all of which except a note for $500 was received from customers ; the sales book total was $39,420.17, of which $5,280.65 was cash and $327.50 were proprietor's withdrawals ; the sales returns and allowances journal totaled $1,219.75. Set up the general ledger Accounts Receivable ac- count and show all postings to it. 4. In a manufacturing concern the total value of buildings and equipment subject to insurance was $155,000, distributed as follows: Department i, $25,000; Department 2, $45,000; Department 3, $35,000; Department 4, $10,000; Power House, $40,000. The annual insurance premium amounted to $3,105. The rates on Departments i, 2, and 3 were the same ; on Department 4 the rate was double that on Depart- ment I, and on the power house 2^ times that on Department i. Find the amount of insurance burden chargeable to each department and the power house. 5. On July I, 1917 a trader's stock of goods was destroyed by fire but he saved his books of record. His goods were fully insured and he proved his loss from the following facts : value of goods on hand January l, 1917, $21,500; purchases from January i, 1917 to July I, 1917, $54,300; sales from January i to July i, $63,750. His records for the past three years showed an average gross profit of 20% on sales. Find the value of the stock destroyed by fire. 6. On December 4 you received a consignment of goods for sale on account of Jas. Scoville & Co., showing an invoice value of $2,150. You paid freight and cartage of $50.25. Sales were made on Decem- ber 10 $750, and December 21 $1,025.75, on a 5% commission basis. On December 31, upon closing your books, you inventory the balance of the unsold consigned goods at $537.50. Show your treatment of the above, when closing. CHAPTER LVII SOME PHASES OF INTEREST The Nature of Interest Interest may be defined as the charge made for the use of money. Sprague defines it as the increase in principal due to the lapse of time. This definition brings out the essential element of time, but is practically the same as the ordinary definition. The ethics of the practice of charging interest was questioned by the ancient world and not fully conceded as right until modern times. Various economic theories have been evolved to arrive at the true character of interest. Whatever may be the theories on which it rests, interest as a commercial phenomenon is thoroughly estab- lished and countenanced by the law, although in many states an exorbitant interest charge is classed as usury. Commercial Interest Commercial interest, so called, usually contains an ele- ment in addition to the time-charge for the use of money. That element may be : ( i ) in the nature of an insurance against loss of the money loaned, i.e., the risk taken in making the loan or; (2) where capital in some fixed form is loaned, an allowance or additional charge to cover the shrinkage in the asset loaned due to wear and tear. Simple and Compound Interest As to its method of calculation, interest may be simple or compound. Simple or single interest is figured on the single base known as the principal, the only other element being the length of time. Compound interest periodically 543 544 ACCOUNTING— THEORY AND PRACTICE adds the unpaid interest to the previous principal, and so secures interest not only on the original principal but on all unpaid interests as well. In accounting both kinds of interest are recorded under the common title interest, and the business man is happy to secure its collection under any title. Some applications of the interest principle to certain special accounts will be dis- cussed. Equation of Payments The practice of averaging accounts is occasionally, though not often, met with at the present time in American business. In proceedings in bankruptcy, all claims against the bankrupt on open or running account comprising sev- eral items, when filed with the trustee, must show the aver- age due date of the items if it is expected to secure interest on the overdue amounts. The problem involved may best be seen by an example. The following account appears on A's books, showing charges against B : B Jan. 5 Mdse. 2/10, n/30. $100.00 Feb. I Mdse. 2/10, n/60. 350.00 Apr. 10 Mdse.net 200.00 June 2 Mdse. 2/10, n/60. 2,000.00 If B does not settle the various amounts as they come due, A is deprived of the use of his money longer than con- templated in the sale contract. In justice to him, interest on the overdue amounts ought to be allowed. If B should pay any of the amounts earlier than the terms of sale require, he should be allowed a discount, i.e., a rebate equal to the in- terest for the time of prepayment. It may be further that SOME PHASES OF INTEREST 545 B shortly after the last purchase on June 2 at 60 days, amounting to $2,000, will desire to settle the entire account, taking his discount for prepayment on the $2,000 and allow- ing A interest on the overdue amounts. If the date of settle- ment is fixed, the amount necessary to settle equitably may be determined by the method used for the account current in the previous chapter. Average Due Date But B may want to know the date on which he can settle equitably by paying the exact amount of the account without either paying interest on the overdue items or taking dis- count on the $2,000. The problem involved is that of averaging or equating accounts ; the equated date, due date, or average date of payment are the terms variously applied to the date of equitable settlement. If the account has only debits or only credits, equation is called simple or single equation or average ; if it has both debits and credits, equa- tion is called compound or double. In order to determine the equated date, an arbitrary date, called the focal date, is taken for the purpose of computing the interest charges and credits, and from that date interest is counted backwards or forwards according to the result arrived at through use of the arbitrary date. Interest is calculated at an arbitrary rate, usually 6% (100% per day is used by another method of calculation), and, in the case of compound equation, the same rate must be used on both debits and credits. To illustrate the method of calculation for simple equa- tion and the interest principle involved, the above cited account will be equated. In order that the expired time be- tween the focal date and each date of value may be easily computed, the last day of the previous year is taken as the focal date. Interest is at 6%. 546 ACCOUNTING— THEORY AND PRACTICE Date of Entry 1/5 Date of Value 2/4 Expired Time 35 da. Amount $100 Int. on Total Amount for 1 Day Interest on Each Amount for Expired Time $.S8 2/1 4/2 92 " 350 5-37 4/10 4/10 100 " 200 3-33 6/2 8/1 213 " 2,000 •44 1/6 71.00 $2,6so ) $80.28 182 da. The above calculation shows that, theoretically, had the various transactions been under contemplation on December 31, the focal date, payment of the total $2,650 could equit- ably have been made with a discount of $80.28. The interest (or discount) on $2,650 for i day is 44 i/6c. A discount amounting to $80.28 could therefore be demanded on $2,650 only as the result of an offer to prepay 182 days ($80.28 -^ .44 1/6 = 182) before equitably due. Hence, payment of $2,650 without discount would settle the account equitably 182 days after the focal date, or July i. That this is true can easily be proven by using July i as the settle- ment date and figuring as for a current account. It will be found that interest on the overdue items on that date amounts to $10.42, while the discount on the item not yet due amounts to $10.33 ; the difference .09 not being a large enough fraction (9-f-44 1/6) to justify payment one full day earlier. The 100% Method A short method of calculation may be used, employing the 100% per day method. Any date may be taken as a focal date, and very frequently the date of the first or last transaction is used. In the illustration below, November 30 of the previous year is taken as the focal date so that the expired time on each item is immediately indi- cated by the number of the month and the day in the SOME PHASES OF INTEREST 547 "date of value" column. The use of the 100%. rate method makes the calculation of interest on each item a simple matter of multiplication by time and amount, i.e., it reduces each amount to a "day-dollars" figure, and on that basis one day's interest on the account total is equal to that total, and, therefore, the divisor in the division to determine the focal date is the amount of the account. This greatly simplifies all the operations. Sometimes the expired time is calculated by calendar months and days, converting frac- tions of a month on a 30-day basis. The method is used in the illustration below, where the problem shown above by the accurate interest method is solved by the 100% method. The "month-dollars" column divided by the "amount" column gives 6, shown in the "equated date, months" column, with a remainder of 2,500. This is reduced, by multiplication by 30, to day-dollars and carried to that column, whose total, 80,100, is divided by 2,650, giving 30 as shown in the "equated date," days column. The equated date is therefore June 30 (6/30). The one day's difference between this and the other method is accounted for because each calendar month is counted as 30 days. Time Months Days Amount Month- Dollars Day- Dollars Equated Date Months Days 2 4 $100 $200 $400 4 2 350 1,400 700 4 10 200 800 2,000 8 I 2,000 16,000 2,000 2,650 ) 18,400 5,100 6 30 ) 18,400 5,100 IS.900 2,500 30 75-000 80,100 79,500 June 30 600 548 ACCOUNTING— THEORY AND PRACTICE Compound Equation Where the account has both debits and credits, the esti- mate is made similarly. Calculation of the month- and day- dollars is made for each side separately. At this point the totals on both sides are combined to find the balance of the account and the balance of the discounts, and these two balances are used to find the equated date. If the balance of the account is on the same side as the balance of the discount, the equated date is forward from the focal date because, if settlement were made on that date, the man who owes the balance is entitled to the theoretical discount also. If the balance of the account and the balance of interest are on different sides, the count is backward from the focal date. The following account and solution will illustrate : S. L. Davis I9I7 191 7 Mar. 8 Mdse. 1 let... . . $1,000.00 Apr. 30 Note, 30 da., 6% $500.00 June 20 " r 1/30. . . . 1,500.00 Aug. 30 Cash . . 1,500.00 Sept. 5 r 1/60.. . . 2,000.00 Sept. 10 Note, 60 da., no int. . . 2,000.00 Debits: Expired Time Amount Interest Months Days Month-Dollars Day-Dollars 3 8 $1,000 $3,000 $8,000 7 20 1,500 10,500 30,000 II 4 Totals 2,000 $4.50 22,000 3 $35,500 8,000 $46,000 Credits. 4 30 $500 $2,000 $15,000 8 30 1,500 12,000 45,000 II 9 2,000 22,000 3 36,000 18,000 4,oo( 78,000 Balance Amount y.' Dr. $50( ) Interest . Cr. $500 Cr. $32,000 SOME PHASES OF INTEREST 549 Dividing we get i month, 64 days, i.e., 3 montlis, 4 days. The balances being on opposite sides, the equated date is 3 months, 4 days, backwards from November 30 (11/30), i.e., 11/30 — 3/4 =^ 8/26 or August 26. Equitable set- tlement could therefore be made by interest-bearing note for $500, date August 26, 1916, or by cash payment of $500 plus interest on $500 for 3 months, 4 days, as would be the case had the account been handled as an account current with adjustment as of August 26, 1916. The Cash Balance When an account has been equated, to determine what cash sum would be required for equitable settlement on a given date subsequent to the equated date, the balance of the account plus interest on that balance from the equated date to the date of settlement will be the correct amount. This amount is technically called the Cash Balance of the account. It is exactly the same as the adjusted balance of an account current, and may be determined that way instead of by the equation of payments method above. Interest on Partial Pajmients Under the heads of accounts current and equation of pay- ments, the question of partial payments on open account has been treated. There remains a statement of the practices governing partial payments on notes. Two methods of calculating are in use, the legal or United States method and the so-called merchants' method. The merchants' method is used for short time notes and on any other kind by agree- ment. The method is exactly similar to that of adjustment of current accounts. Interest is charged on the face of the note from its date of issue till its due date, and allowed on each partial payment from its date of payment till the due date of the note. 550 ACCOUNTING— THEORY AND PRACTICE United States Rule The United States Supreme Court has ordered the appli- cation of the partial payments somewhat differently. The first partial payment must first be applied to the payment of the accrued interest on the principal up to the date of the first payment. Any excess shall be appHed to a reduction of the principal. Each succeeding payment is similarly applied first to cancellation of accrued interest on each new principal and then to a reduction of the principal. In case any payment is insufficient to meet the accrued interest, the payment is held in reserve, the principal remaining un- changed until a payment or payments are made which added to the previously reserved payment or payments are sufficient to cancel all accrued interests to that date. Any excess is used as above. Interest on Daily and Savings Bank Balances In the handling of balances between banks, interest on daily balances is usually figured in the settlement. Calcula- tion is on a 365-day basis in the larger banks. Banks fre- quently allow to large depositors a low fate of interest on daily balances maintained above a certain fixed minimum. Take the following account : X. Z. & Co. Date Dr. Cr. Balance Interest Base Interest Jan. 2 1,500 500 3 300 500 1,700 700 4 800 100 1,000 . . . ^ S 400 600 1,200 200 6 500 400 1,100 100 7 700 1,100 1,500 500 .11 2,000 In the above account interest is allowed on all amounts above $1,000 at the rate of 2%. If settlement is periodi- SOME PHASES OF INTEREST 551 cal, interest may be calculated on the total of the "In- terest Base" column for one day. Usually, however, if on a monthly settlement basis, the total minimum balance for the month is subtracted from the total of the "Balance" column, the remainder is the interest base. In savings banks no interest is allowed on amounts which have been withdrawn during an interest period, regardless of how long the sum may have been on deposit previous to date of withdrawal. There is no uniform practice as to when deposits shall begin to draw interest, in some banks at the beginning of the month after deposit, unless deposit is made on the first day of the current month ; in others, no interest is allowed till the beginning of the next interest period. Great care must be exercised, therefore, in handling deposit and withdrawal dates. Bank and True Discount Bank discount has been defined as the prepaid or collected interest on a discounted note, calculation being on the basis of the amount to be collected on the note at its maturity. True discount is the difference between the face of a debt and its present worth, meaning by present worth that sum of money which placed at interest now will equal or be worth the face of the debt at maturity. Problems (Assignment for Chapter LVII) I. Jackson and Edson had on June 30, 1916 the following assets and liabilities: cash $1,000; notes receivable $2,500; unexpired insurance $150; notes payable $3,150; interest unpaid $125; merchandise on hand $15,800 ; accounts receivable $20,500 ; coal $50 ; office supplies $25 ; furni- 552 ACCOUNTING— THEORY AND PRACTICE ture and fixtures $375; delivery equipment $1,100; accounts payable $8,225. Of the net worth 2/3 belonged to Jackson and 1/3 to Edson. Keeping their accounts by single entry and dividing profit and loss on the 2 to I basis referred to above, they find their condition at the end of fiscal year : cash $2,500 ; notes receivable $3,000 on which was accrued interest of $25 ; unexpired insurance $225 ; merchandise $12,490; accounts receivable $18,175; coal $140; office supplies $10; furniture and fixtures $510; delivery equipment $1,275; building $5,000 on which was a mortgage for $3,000; notes payable $4,250 with accrued interest of $50; accounts payable $8,550; and salaries unpaid but earned $150. During the year Jackson had made an additional investment of $2,500 and Edson of $1,250; Jackson had withdrawn $7,500 and Edson $4,000. Determine the net profit or loss for the period and set up the partners' accounts showing their present worth at the close of the year. 2. Equate the following account and find the cash balance due August I, 1917, money being worth 45^% : F. T. Frederick 1917 1917 May 4 Merchandise 60 May 14 Cash $360.00 da $1,360.00 Returned Mer- 14 Merchandise 30 chandise 150.00 da 720.00 June 10 Cash 800.00 26 Merchandise 60 21 Note, 20 da 750.00 da 1,080.00 3. A note for $1,500 dated June 20, 1916, bearing interest at 5%, had payments indorsed as follows : December 5, 1916, $300 ; April 2, 1917, $10; July 20, 1917, $500; December 31, 1917, $400. Find the amount due June 22, 1918. (U. S. rule.) APPENDIX A REVIEW QUESTIONS The following questions will enable the student to review briefly the essential theory presented in this volume. Chapter I 1. Give a brief account of record-keeping among the Ancients. 2. Among the Romans. 3. Among the early English. 4. Give a brief description of Italian double-entry bookkeeping. 5. Discuss the development of the ledger account. 6. Give a brief account of organized accountancy. Chapter II 1. In what way, and why, is accounting so closely related to economics ? To law? 2. What is the basic problem of accounting? 3. Define assets and habilities. 4. Define proprietorship. State the two customary forms of the pro- prietorship equation. 5. Illustrate the usual method of setting up the equation. 6. How would you define financial statement or balance sheet? Chapter III 1. What are the three types of business organization? 2. State the characteristics of the single proprietorship. 3- What are its disadvantages? 4. Define a partnership and state its essential working characteristics. 5. What advantages has the partnership over the single proprietorship? 6. Name some disadvantages of the partnership. 7- State several characteristics of the corporation. 8. Discuss its working organization. 9- Carefully distinguish between the methods of showing proprietor- ship under these three types. 553 554 ACCOUNTING— THEORY AND PRACTICE Chapter IV 1. What is the purpose of the financial statement? 2. To what uses may it be put? 3. What are current assets? Fixed assets? Current liabihties? Fixed Habihties? 4. What is the reason for subdividing the assets and liabilities into the above groups? 5. Give alternative titles for financial statement, assets, and pro- prietorship. 6. What should the formal heading of a financial statement include? 7. State the principles governing the amount of detail to be shown in the statement. 8. Explain briefly: reserve for depreciation of building; reserve for bad debts; prepaid expense; accrued expense. 9. How are the items mentioned in Question 8 shown in the financial statement ? Chapter V 1. What is the purpose of a comparison of net worths at certain periods? 2. Does it give a basis for judging effort by results? 3. What purpose does a detailed comparison of individual assets and liabilities serve? 4. What four different relationships between the assets and liabilities may develop a profit? 5. What additional factors must be taken into account to make sure that the results shown by Question 4 are correct? 6. State the conditions of the assets and liabilities which with the restriction of Question 5 will show a loss. 7. Illustrate the form of the comparative financial statement. 8. Does such a statement show the cause or the manner of the change in proprietorship? Chapter VI 1. Show the advantage of having fuller information than that fur- nished by the comparative financial statement. 2. What information, in addition to that used previously, must the accounting department furnish? 3. From what two points of view must the record of every business transaction be made? 4. Under what heads is this additional information furnished? 5. Why are these records called temporary proprietorship records? 6. Develop the logic of the profit and loss summary, using your own data. REVIEW QUESTIONS cee Chapter VII 1. By what other titles is the profit and loss summary shown? 2. What do you understand by a fiscal period? What is its customary length ? 3. Why is it necessary to take a physical inventory of stock at the close of the fiscal period? What purpose does this accomphsh? 4. State the principles governing the make-up of the profit and loss statement. 5. What are the main sections of its content? 6. Give the reasons for the order and arrangement of its content. 7. State the algebraic equations governing its content. 8. What disposition is made of the net profit? 9. What is the appropriation section? 10. State at least two advantages in being able to determine "net profit" by two means. 11. What additional information is sometimes given? Chapter VIII 1. In what various aspects may the temporary proprietorship records of a business be viewed? 2. What relationship is there between expenses and assets and lia- bilities ? 3. What relationship exists between income and assets and liabilities? 4. May assets and liabilities change among themselves without affect- ing the economic elements ? Chapter IX 1. Define the ledger account. 2. What principles govern the selection of the account title? 3. Describe the two sections of the account, as to title, the various col- umns and their use. 4. How are the items sorted in the account as to addition and sub- traction ? 5. What is the ledger? What is its purpose in account-keeping? 6. What two main classes of accounts are kept in the ledger? 7. What principle governs the number of accounts to be carried in the ledger ? Chapter X 1. What are meant by: (a) an account in balance; (b) the balance of an account? 2. Discuss the balance of the account as related to assets, liabilities, ex- penses, income. 556 ACCOUNTING— THEORY AND PRACTICE 3. Explain fully the business transaction from the standpoint of the record to be made of it. 4. State the origin of the terms "debit" and "credit" and indicate their present use. 5. Explain the basic principles of debit and credit in their relation to the various classes of accounts. Chapter XI 1. What can you say of the effort to reduce debit and credit to one fundamental working rule? 2. What relation does the proprietorship equation bear to debit and credit ? 3. How is tha placing, as to their debit and credit, of the various account groups determined ? Give the philosophy underlying. 4. Since the original investment is reducible to the fundamental equa- tion, how should all later transactions be viewed? 5. State the schedule used for the determination- of debit and credit. 6. Give at least one illustration in each group of the use of the schedule. 7. Explain the constant equilibrium of the ledger. Chapter XII 1. Give the debit and credit schedule for customers' accounts. 2. For accounts with creditors. 3. Illustrate the application of the schedule for media of exchange in the case of: (a) cash, (b) notes receivable, and (c) notes payable. 4. Explain the meaning of the term "full cost" as used in the schedule for fixed assets. 5. How is the sale of a fixed asset recorded? 6. Explain the debit and credit of other liability accounts. Chapter XIII 1. Define proprietorship accounts. 2. Distinguish between temporary and vested proprietorship accounts. 3. What explanation of relationship among the four groups of accounts would be required in order that one fundamental rule for debit and credit may be formulated. 4. Why, under the scheme of debit and credit used here, are income items credits and expenses debits? 5. Give and illustrate the schedule for income items. 6. Give and illustrate the schedule for expense items. 7. Explain fully "vested" proprietorship accounts. 8. State their debit and credit rule. 9. Illustrate the kinds of transactions frequently recorded under the two heads. REVIEW QUESTIONS tcy Chapter XIV 1. Discuss the impracticability of separating a sale into its elements of cost and profit. 2. What is the objection to the old Merchandise account ? 3. Give its schedule. 4. Give the modern practice in showing merchandise transactions and state its advantages. 5. What do you understand by a mixed account? 6. Distinguish between the terms "inventory" and "appraisal." 7. Why, at the close of a fiscal period, are accounts with assets sub- ject to depreciation, mixed accounts? 8. Illustrate, and explain the reasons for, the handling of depreciation. 9. What are valuation, offset, and adjunct accounts? 10. Why is it important to discriminate between capital and revenue expenditures ? Chapter XV 1. What is the trial balance? .What is its use? 2. Explain fully the work on the ledger preliminary to taking the trial balance. 3. Illustrate the balancing of an account. 4. Explain the various rulings in an account. 5. Explain the different methods of transferring an account. 6. What is meant by summarizing the ledger? 7. What class of accounts is summarized? What accounts are left open? 8. Explain the method of rulings and entries in personal and note accounts. 9. Explain the use of the index number or letter in personal and note accounts. Chapter XVI 1. Why, at the close of a fiscal period, does the current record of the ledger need adjustment? 2. In what particulars is the current record lacking? 3. Explain fully the manner of adjusting the merchandise record: (a) when kept under detailed accounts; (b) when kept in one account. 4. Distinguish between adjusting and closing the merchandise record. 5. Explain and illustrate the manner of bringing the appraised values of fixed assets onto the books. 6. Distinguish carefully between the depreciation account and the de- preciation reserve account. 558 ACCOUNTING— THEORY AND PRACTICE 7. Explain and illustrate the handling of deferred expenses. 8. " " " " " " accrued expenses. 9. " " " " " " accrued income. 10. " " " " " " deferred income. Chapter XVII 1. Why is the ledger record of business transactions insufficient and inconvenient? 2. What do you understand by a book of original or first entry ? 3. In what respect is the ledger a secondary record? 4. Explain the entire process of posting. 5. Define the journal. 6. Name the essential characteristics of the journal. 7. Define a compound journal entry. 8. Draw the standard form of the journal and illustrate entry thereia 9. Distinguish between expense supplies and expenses. Chapter XVIII 1. Show how the old journal is a labor-maker and consequently inade- quate for present needs. 2. Explain the principle of the subsidiary journal and state its method of operation. 3. What is the basis of subdivision of the old journal? 4. Name the customary subdivisions. Chapter XIX 1. State the content of the purchase journal. 2. Analyze a purchase transaction into its debit and credit elements and show the classes of accounts affected. 3. What is the problem of the cash purchase? 4. In what different ways may the cash purchase be handled? 5. Explain fully the posting and summarizing of the purchase journal. 6. Draw a form for the standard purchase journal and illustrate entry therein. 7. Illustrate the manner of securing a departmental analysis of purchases. 8. How is Purchase Discount closed at the end of the fiscal period? 9. What is the order of closing the expense accounts into Profit and Loss? Chapter XX 1. What kind of transactions is recorded in the sales journal? 2. What is the form of the sales journal? Illustrate. REVIEW QUESTIONS 559 3. Analyze a sales transaction and indicate the manner of recording it. 4. How are cash sales recorded? 5. Explain the summarization and posting of the sales journal 6. Discuss the problem of goods sold to the owner. 7. What is a post-closing trial balance? For what purpose is it used? 8. What is the basis for estimating percentages of profit and expenses? Chapter XXI 1. Explain the way in which the two cash journals are usually bound together. 2. Analyze a cash receipt and indicate the manner of record. 3. Analyze a cash disbursement and indicate the manner of record. 4. Draw a form for the standard cash book and illustrate entry in it on both sides. 5. How and why may the cash book take the place of the ledger account with cash? 6. Explain the posting of the cash book. 7. What is the effect of omitting the cash account from the ledger? 8. Explain the balancing and ruling of the cash book. 9. What is the purpose of the Cash Short and Over account? Explain its use. 10. How is analysis secured as to the sources of receipts and the objects of expenditures ? 11. Analyze a cash discount transaction as to its debit and credit elements. 12. Explain three methods of booking cash discounts. 13. Discuss the advantages and disadvantages of the methods. Chapter XXII 1. What general principle governs or determines the content of the general journal? 2. Name the kinds of transactions recorded here. 3. Discuss the question as to explanations required for the journal entry. 4. Why does not the journal need summarizing at the close of the period? 5. Explain the analytic journal. 6. Illustrate and explain opening entries. 7. Illustrate and explain adjusting and closing entries. 8. What objection is there to the direct method of closing the ledger? Chapter XXIII 1. What is meant by business papers ? How are they used ? 2. Give the essentials of the goods invoice. 56o ACCOUNTING— THEORY AND PRACTICE 3. Explain a method of handling the purchase invoice. 4. Explain a method of handling the sales invoice. 5. Explain the use of the sales ticket under the folder system, 6. What is the returned goods invoice ? Explain its use. Chapter XXIV 1. Explain the use of the note receivable. 2. Define negotiable instruments. Name the various kinds. 3. Explain the use of the draft and give the entries on the books of the various parties, at the time : (a) of drawing the draft, (b) of acceptance, (c) of payment. 4. Classify drafts on three different bases. 5. Define the various kinds of checks. 6. Explain some other kinds of negotiable instruments. 7. What principle governs the writing of commercial paper? 8. Define the various kinds of indorsements. Chapter XXV 1. What is the bill of lading? How is it usually made out? What use is made of the various copies? 2. What is the freight or expense bill ? 3. Explain the C. O. D. transaction through the medium of: (a) the express company; (b) the bank and the railway company. 4. Explain the statement of account. Chapter XXVI 1. What are the functions of the bank? 2. How is an account opened with the bank? How are deposits made? What is the use of the pass-book? 3. Explain the various ways of keeping the bank account on the check book. 4. Explain the process of discounting a note. 5. State the principles to be observed in interest calculations. Chapter XXVII 1. When should the books of original entry be posted? 2. Give the method of posting the various journals. 3. When should the entry be cross-indexed ? 4. What explanatory matter should be carried in the ledger? Chapter XXVIII I. State the various methods of taking the trial balance and discuss them REVIEW QUESTIONS S6i 2. What are Uniphase accounts ? 3. To what use is the trial balance put? What kinds of errors does it fail to detect? 4. Give several methods of detecting errors. 5. What are transpositions ? How may they be detected? 6. What are transplacements ? How may they be detected? Chapter XXIX 1. State the principles governing the taking of the inventory. 2. How is the inventory valued ? How can it be falsified ? 3. Explain the manner of making the journal entries for: (a) the in- ventory; (b) depreciation; (c) bad debts; (d) prepaid expense; (e) deferred income; (f) accrued expense; (g) accrued income. 4. What is the objection to erasures? How should corrections be made on the books? Chapter XXX 1. What is the purpose of summarizing the books? 2. Explain fully the entire process of closing the books. 3. Should the Profit and Loss account be used for current entry ? Why? 4. Differentiate between the financial statement and the balance sheet. 5. Give the two forms of the statement of profit and loss. State ad- vantages and disadvantages. 6. How may the profit and loss statement be used as a guide in closing the books ? Chapter XXXI 1. What is the purpose of account classification? 2. Distinguish between personal and impersonal accounts. 3. What other classifications are there? Distinguish between them. 4. What are the requirements for a good classification? 5. State and illustrate the effect of a wrong classification. 6. What is meant by detailed analysis and classification? Illustrate. Chapter XXXII 1. How does Pixley divide the field of accountancy? 2. Define analysis. Define synthesis. 3. Illustrate the manner in which the accountant makes use of these two processes. 4. What danger is there in a too detailed subdivision of accounts? 5. In what way is the ledger analytic? In what way is it synthetic? 6. What two forms of standard-ruled ledger do we have ? Illustrate. 7. What forms are there for the balance ledger? Illustrate. S62 ACCOUNTING— THEORY AND PRACTICE 8. What is a progressive or tabular ledger? Illustrate. 9. What are some of the advantages of loose-leaf and card ledgers? 10. What objections can be made to them? 11. In what order should the accounts be arranged in the ledger? 12. What is a classified trial balance? Chapter XXXIII 1. What is a partnership? 2. Name some advantages of the partnership over the sole proprietor- ship. 3. Discuss the management organization of the partnership and its legal status. 4. Explain fully the limited life and liability characteristics. S- What is meant by co-ownership of profits as profits? 6. What is the purpose of articles of copartnership? 7. What should they contain? 8. Name two standard classifications of partnerships. 9. Give the requirements in New York for the formation of a limited partnership. 10. What is a joint-stock company? Its chief features? 11. Classify partners. Chapter XXXIV 1. What should the articles of copartnership contain with regard to division of profits? 2. Where no basis for division is stated, what basis does the law supply ? 3. Are both profits and losses shared in the same ratio? 4. Where the profit-sharing ratio is equal to the capital ratio, what is the effect of partners' profits left in the business? 5. What should be the provision with regard to partners' drawings? 6. When profits are shared on the basis of capital and the length of time of its employment, how are the shares determined? 7. Under what conditions or in what kind of undertaking is the profit-sharing basis of Question 6 met with? 8. What is the purpose of allowing interest on partners' capitals? 9. Because interest is allowed on capitals, is it necessary also to allow interest on drawings? 10. Where the investment of a partner comprises property, what is the effect of an under- or over-valuation of it at time of investment? 11. Distinguish between buying an interest in a partnership as it stands and making an investment in a business to secure an interest in it. REVIEW QUESTIONS 563 12. Why should the partners have periodic statements of condition drawn up and formally accepted by signature of each? Chapter XXXV 1. What fundamental principle governs the handling of cash? 2. How is this principle applied? 3. What is the need of a petty cash fund? 4. Discuss two methods of handling petty cash. 5. How is the distribution of petty cash disbursements made? 6. Explain several methods of keeping the bank account. 7. Where, in the cash book, the net cash column is at the same time used as a bank column, how should spoiled checks be handled? 8. Describe the method of handling checks exchanged for currency. 9. Describe the method of handling checks given for "change." 10. Where branches are maintained, how should you account for working funds turned over to them? Chapter XXXVI 1. Name and define the different classes of discounts. 2. Accountancy makes record of which kinds? 3. What advantages does trade discount secure? 4. Explain the method of calculating a single rate equivalent to a given discount series. 5. What two chief factors enter into cash discount? 6. Explain fully the relation each of these factors bears to the dis- count rate offered. 7. What other factors may sometimes enter in? 8. In the profit and loss statement how should cash discounts be shown ? 9. Explain and illustrate several methods of entering cash discounts. 10. Explain the handling of cash discount where it enters into the finding of the cash balance. 11. Discuss and illustrate a method by which the information as to neglected discounts may best be secured. 12. Explain the effect of trade acceptances on the practice of cash discounts. Chapter XXXVII 1. Under what title should the account with negotiable instruments be carried? 2. Discuss the legal relation of notes to open personal accounts. 3. Discuss their relative liquidity. 4. What data should enter into the record of a note? 564 ACCOUNTING— THEORY AND PRACTICE 5. Explain the standard note or bill journal. 6. Explain the note register with special reference to due date and the method of summarizing it for posting. 7. Does the entering of notes at their face value ever result in an inflation of the assets? 8. Illustrate the entering of a note on the books when interest is included in the face of the note. Chapter XXXVIII 1. How are credits shown in the Notes Receivable account, when the debits are itemized? 2. What is meant by contingent liability under discounted or trans- ferred notes and drafts? 3. What is the best method of recording the discounting of a note receivable ? 4. What is the balance sheet status of the Notes Receivable Dis- counted account? 5. Theoretically, how should the transfer of notes and the issuing of drafts be recorded? 6. Explain the steps necessary to protest a note. 7. What is the proper accounting procedure for a note dishonored in your hands? 8. What, when the dishonored note has been discounted by you at the bank? 9. How should notes receivable out as collateral be handled? ID. Why distinguish between custodiers' notes and others? 11. How would you distinguish between customers' notes and others in entering them on the books? 12. What accounting problem is involved in the renewal of notes and in partial payments on notes? Chapter XXXIX 1. Give a classification for business activities. 2. What is the importance of the "selling end" of a business? 3. What purposes are served by an analysis or classification of sales? 4. How is distribution secured in books of original entry on a chrono- logical basis? How on any other basis? 5. What proof of distribution should always be provided for? 6. Describe a method whereby the sales ticket is used for sales analysis. 7. Where an analysis of the sales is made, how should purchases, re- turned sales, and returned purchases be handled? State the reasons. 8. How does an analysis of sales affect the ledger records? REVIEW QUESTIONS 565 9. Explain one method of handling cash sales in a ledger account where analysis of sales by departments is desired. 10. What is the problem involved in recording sales to branches? 11. In recording consignment sales ? 12. In recording instalment sales ? 13. In recording sales for future delivery? 14. In recording department store sales ? 15. How are C. O. D. sales handled? 16. Describe fully the bill and charge system. 17. How are salesmen's commissions and efficiency records handled? Chapter XL 1. In what different ways may the capital of a partnership be increased? 2. When partners fail to live up to their agreements with regard to the amount of capital to be contributed, how may their interests be equitably adjusted? 3. In special partnerships of a temporary nature where capital contri- butions are not fixed, what method of adjusting partners' inter- ests is frequently used ? 4. Where partners leave some portion of their profits in the business, how should the profit and loss ratios be adjusted? 5. Why should additional contributions be recorded differently from loans made by partners ? 6. Distinguish between the borrowing of funds for the purpose of in- creasing (a) fixed capital and (b) current capital. Chapter XLI 1. Is there any difference between purchasing a share of the profits and a share of the net assets? 2. On what three bases may a new partner be admitted? 3. Give the entry showing admission on the first basis. 4. On the second basis. 5. On the third basis. 6. What is good-will ? What condition as to earnings is the essential basis of good-will ? 7. When may good- will be shown on the books? 8. On what basis is good-will distributed among the partners? 9. What accounting problem is encountered in partnership consolida- tions ? ID. What is the relation of partners' loans to the credit of the firm? Chapter XLII 1. State the meaning of the term "profits." 2. What elenrents are included in the profits of a partnership ? c66 ACCOUNTING— THEORY AND PRACTICE 3. For the purpose of comparisons between periods, what should be the method of showing the profit and loss? 4. How may extraordinary profits and losses be cleared? 5. What is the purpose of partners' salaries ? How are they treated in Profit and Loss? 6. What is the purpose of allowing interest on partners' capitals? On partners' drawings ? How are they recorded on the books ? 7. Explain the handling of interest on partners' loans. 8. What is the purpose of a reservation of net profits? 9. How should partners' salaries be handled when allowance of such salaries results in a net loss for the period? 10. How should partners' withdrawals and salaries be booked? How should partners' personal bills be handled? 11. At the time of a change in partnership, what is the importance of a careful determination of profits ? Chapter XLIII 1. State and illustrate the four classes of adjusting entries to be made before closing. 2. How should the following items be handled at inventory time? (a) Goods ordered but not yet received. (b) Goods received but not yet booked. (c) Goods held on consignment for account of a principal. (d) Goods out on consignment for sale by an agent. (e) Goods sold for future delivery. 3. Explain and illustrate two methods of handling an expense account when a portion of it is to be deferred. 4. What different accounts are used for summarizing the results of the period? 5. What is a Trading or Selling account? What is its content and its relation to the Profit and Loss account? 6. What is the relation of the balance sheet to the post-closing trial balance ? 7. Outline and discuss a plan of arranging balance sheet items. 8. Explain fully the manner of using a working sheet. Chapter XLIV 1. State various causes leading to the dissolution of a partnership. 2. Who should receive special notice of dissolution? What other notice is required? 3. Under what arrangement may a firm be continued after the death of a partner without the necessity of taking inventory at that time? REVIEW QUESTIONS egj, 4. In what order must the net proceeds of the assets be applied in the liquidation of creditors' claims? 5. In what ratios are profits and losses and capital resulting from liq- uidation shared by the partners? 6. In what ratios are ultimate net assets shared? 7. In case of bankruptcy of one of the partners, how is his share of the losses borne by the other partners? 8. In case of liquidation, under what circumstances may a partner be liable to further contributions ? 9. What problem is involved in instalment payments to partners ? ID. What two methods are employed for recording good-will upon the sale of a partnership ? Illustrate. Chapter XLV 1. What is the main purpose of subsidiary records and columnar books ? 2. What is the basis for division of the ledger? 3. What are customary divisions? 4. Mention and describe four different types of sales journals. 5. Mention and describe three different types of purchase journals. 6. Explain two methods of handling expense invoices. 7. What analysis should be made in summarizing the note journal? 8. State and illustrate a standard columnization for the cash book. 9. What general principle governs columnization of journals? ID. State a standard columnization for the general journal. II. How does the general journal differ in the manner of proof of distribution from other journals? Chapter XLVI 1. Explain fully the debit and credit scheme of the various ledgers operating under a .controlling account system. 2. How are the subsidiary ledgers proved? What is the importance of such proof? 3. What are the sources of postings to the sales ledger controlling account ? 4. Explain the method of gathering the summary postings. 5. State the sources of postings to the purchase ledger controlhng account. 6. Explain the method used for gathering the items in the various journals for summary posting to the controlling account. 7. Under a controlling account system, what fundamental require- ments must be observed in posting items affecting both the con- trolling account and the subsidiary ledger? 568 ACCOUNTING— THEORY AND PRACTICE 8. What is a self -balancing ledger? g. Explain fully the method of making the sales ledger self-balancing. ID. Discuss the advantages of the controlling account. Chapter XL VII 1. Explain the method of opening the controlling account: (a) upon installation of a new system; (b) when introduced in an old system. 2. What general classes of items are recorded in the sales journal? 3. What is the effect of this upon securing the summary amount for posting to the controlling account? 4. How may these extraneous items be treated at summary time? 5. What extraneous items are recorded in the purchase journal? 6. How are they treated upon summarizing? 7. Explain fully two methods of treating accounts which are both receivable and payable. 8. How are the note journals summarized? 9. Illustrate a method of summarizing a columnar cash book to secure postings to controlling accounts and a ledger bank account. 10. What other controlling accounts are sometimes kept? 11. What principle governs the kind of accounts to be included in a subsidiary ledger? Chapter XL VIII 1. Define a corporation. What are its chief characteristics? 2. Discuss its advantages. 3. Discuss its disadvantages. 4. Give briefly the entire process necessary to the formation of a corporation under the New York statute. 5. What is the corporation's charter? 6. What is the basis of the state's control over the corporation? 7. Explain fully the internal organization of the corporation. 8. How is the control of the stockholders exercised? 9. Under the corporate form, how is proprietorship shown? 10. What is the purpose of this required manner of showing? 11. Explain briefly the use of the records peculiar to a corporation. Chapter XLIX 1. Distinguish between common and preferred stock. 2. Explain and illustrate four methods of opening the corporation's books. 3. Discuss the advantages and disadvantages of the various methods. 4. Illustrate the method of booking discount and premium on the sale of capital stock. REVIEW QUESTIONS 569 5. Explain the manner of accounting for payment of stock subscrip- tion in instalments. 6. Illustrate the method of opening the books when both common and preferred stock are issued. 7. Explain the method of booking payment of stock subscriptions by property. 8. Where a partnership is sold to a corporation, explain how the partnership books are closed. 9. What are a stockholder's rights as to profits? 10. What is the authority of the board of directors over profits? 11. Explain and illustrate two methods of closing the corporation's books, covering profits, reserve, surplus, declaration and pay- ment of a dividend. 12. Is a dividend declared on the entire capital stock or only on that which has been issued and is now outstanding? Chapter L 1. What is a consignment transaction? Name the parties to it. 2. How are the rules of bailment and principal and agent related to the consignment transaction? 3. Distinguish between broker, manufacturer's agent, and factor. 4. In general, what is the relation of the factor to his principal : (a) in the sale of goods — terms, title, collections, etc. ; (b) in the safe-keeping of goods? 5. May the factor mingle his principal's property with his own or others ? 6. What is the factor's lien? How may he exercise it? 7. What accounting is the factor required to make his principal? 8. What are the essentials of the account sales? 9. Give reasons for consignment trading. 10. Explain and illustrate two methods of recording the entire con- signment transaction on the consignor's books. 11. Explain and illustrate two methods of recording the entire con- signment transactions on the consignee's books. 12. At the end of the fiscal period how should the consignor handle unsold goods out on consignment? How should the consignee handle unsold goods held on consignment? How should the consignee handle commissions on partly sold goods? Chapter LI 1. What are approval sales? Are they to be booked as sales? 2. Explain a method of handling them to secure correct results. 3. How should they be handled at inventory time? 4. What is the nature of adventure trading? 570 ACCOUNTING— THEORY AND PRACTICE 5. What is the nature of the joint venture organization? 6. What records are kept for the joint venture? 7. What is the source of entry on the records of the various partners? 8. Explain fully the booking of a joint venture transaction from opening to closing. 9. At a closing time how is the joint venture account handled if still incomplete ? Chapter LII 1. What is an account current? 2. What is its use at the present time? 3. What is an adjusted account current? 4. Illustrate a form for stating the account current with interest ad- justments. 5. Illustrate two methods of showing the bank account reconciliation. 6. Where reconciliation is complex, state the heads under which analysis may be made in order to adjust. 7. Give examples of the four classes of items referred to in Ques- tion 6. 8. How are these four classes of items handled in reconciliation? Chapter LIII 1. State the general principles for safeguarding the cash. 2. What is meant by internal check? Explain the method. 3. Illustrate a statement of receipts and disbursements. 4. Explain the problem involved in handling instalment sales. 5. How are such sales accounted for? 6. Explain the method of weighted proportion and its application to apportionments. 7. How are in-freight charges distributed over purchases and the inventory? 8. Explain the method of estimating inventories. 9. Under what condition are such estimates fairly accurate? 10. What is a condensed profit and loss statement? Illustrate. 11. Illustrate the method of showing gross profit by departments in the profit and loss statement. Chapter LIV 1. State the only sure principle underlying the securing of a trial balance. 2. What is ledger analysis? 3. Explain the method of analyzing the ledger. 4. What purpose does ledger analysis serve? REVIEW QUESTIONS e-j 5. Explain the slip or reverse posting system. 6. Explain the use of check figures in posting. 7. How should columnar books be proven? 8. Explain the use of the trial balance adjustment account. Chapter LV 1. What is understood by single entry as a system? 2. What are the usual characteristics of single entry? 3. What are the fundamental records kept under single entry and how are they kept? 4. What analysis and information concerning the profits may be secured from books kept by single entry? 5. Explain the handling of the proprietor's accounts under single entry. 6. Explain a method of proving postings to a single-entry ledger. 7. What are the sources of the financial statement? 8. Explain fully the determination of profit and loss. 9. How do partners' drawings affect the determination of profits? ro. What formal record is made of the statement showing profits? Chapter LVI 1. How are single-entry books opened? 2. Review carefully the problem worked out in the text. 3. Summarize the advantages of double entry. 4. Explain the method of changing from single to double entry. Chapter LVII 1. Give briefly the theory of interest. 2. Explain briefly the theory of simple equation. 3. What is compound equation? 4. When is the method of averaging accounts applicable to present day practices? 5. What is the cash balance of an account? 6. Explain briefly the so-called commercial method of treating in- terest on partial payments on notes. 7. What is the United States Supreme Court rule? 8. Explain interest on daily bank balances. 9. What is the difference between bank and true discount? APPENDIX B PROBLEMS The following problems and examples are inserted for the use of those who find it possible to cover more ground than that laid out in the practice work at the end of each chapter of the text. Through their use, it will also be possible to vary the assignments from year to year. Consignments 1. On January 7, 1917, W, a fruit grower and dealer, consigns to Y, a New York commission merchant, 100 crates of berries, 40 boxes to the crate, at the same time drawing on consignee at sight for $100. The freight charges amount to $17.28. One-fourth of the goods is spoiled so as to be unsalable through the negligence of the R. R. Co., which pays $50 damages to Y in settlement. Of the remaining boxes, one-third are sold at 5 cents a box, and the balance at 10 cents a box, for cash, on January 10, the auction and commission charges being 5%. W's draft is paid by Y on January 8. Prepare a statement to be sent January 20 by Y to W, with check in settlement of account to that date, interest being charged and allowed at the legal rate. Show the necessary accounts set up on Y's and W's books. 2. A ships B on consignment, under date of April 4, merchandise to the value of $1,500, paying $15 cartage and $6 insurance. B receives the consignment April 20, paying freight $70 and cartage $12. He subsequently disposes of the merchandise by sale as follows : April 30, $400; May 30, $800; June 30, $600; on which latter he pays storage charges, $30. He charges commission on sales 5%, credits net interest 6%, and transmits account sales with remittance of net proceeds to A, who receives them July 10. Prepare shipment account as appearing on A's ledger, and con- signment account as appearing on B's ledger. Partnerships — Formation 3. A and B enter into partnership, A contributing $25,000, and B $20,000. Capital is to bear interest at S% per annum. Profits are to be divided equally between the partners. The profits for the first two years (after charging interest on capital) were: $6,200 first year; PROBLEMS ey, $7,400 second year; and the drawings of the partners (in excess of their salaries) were : A, $1,500 first year; $1,750 second year B, $1,200 first year; $1,500 second year At the end of the second year C was admitted to partnership, and put into the business the same amount of capital as B had in the busi- ness at the time, and on the same conditions as to interest and division of profits. The profits of the business for the third year were $13,000, and the partners' drawings in excess of salary were : A, $1,850 B, $1,700 C, $2,000 Set up the capital accounts of the partners for each of the three years, showing the balance of each at the end of the third year. 4. Two partners, named Wilson and Peters, find at the end of the first year's business the balance sheet shows that Wilson's interest is worth $18,000, and Peters' $9,000. The good-will of the firm is worth $3,000. Each draws profits in proportion to his investment. They con- clude to take in a new partner and he is to have a one-quarter interest in the new firm. What sum must the new partner contribute? How will the part- nership accounts appear after the additional capital is paid in? 5. Aul and Bitt, each carrying on a similar business, agree to form a partnership, the new firm to take over the assets and assume the lia- bilities of each. The following trial balances, representing the book accounts of each were presented : Aul Capital $ 40,000.00 Machinery and Fixtures $ 30,000.00 Cash 2,000.00 Notes Receivable 4,000.00 Accounts Receivable 30,000.00 Inventory Merchandise 25,000.00 Wages 7,000.00 Wages Due 250.00 Expense 10,000.00 Notes Payable 9,000.00 Merchandise 40,000.00 Accounts Payable 20,000.00 Repairs 1,250.00 $109,250.00 $109,250.00 574 ACCOUNTING— THEORY AND PRACTICE BiTT Capital $ 50,000.00 Machinery and Fixtures $ 30,000.00 Cash 4,000.00 Notes Receivable 8,000.00 Accounts Receivable 40,000.00 Wages 10,000.00 Wages Due 500.00 General Expense 15,000.00 Notes Payable 15,000.00 Merchandise 51,000.00 Inventory 32,000.00 Repairs Account 2,500.00 Accounts Payable 25,000.00 $141,500.00 $141,500.00 Each partner is to draw one-half the profits. Formulate opening entries for the new firm. At the end of the year a profit is made of $25,000. Divide the profit between the partners and show their capital accounts. Partnerships — Closing the Books 6. A, B, and C agree to start in business with a capital of $400,000, of which A is to furnish $200,000, B $100,000, and C $100,000. A is to have one-half share in the business, and B and C each one-quarter share; interest at the rate of 5% per annum is to be paid on excess capital if any. A contributes $200,000, B $go,ooo, and C $80,000. How would the capital accounts stand on the books after adjusting the interest accounts at the end of the year? 7. A and B are partners, carrying on a business in Winnipeg. On January I, 1917, after adding profit for the past one-half year, A's capital amounted to $150,000, and B's to $100,000. On that date they take into partnership C, upon the following terms : C is to bring in capital amounting to $25,000, and each partner is to be credited with interest on his capital 6% per annum. All profits (after debiting in- terest) up to $25,000 are to be shared by A and B exclusively in pro- portion to the amounts of their capitals at January i, 1917. All profits in excess of $25,000 are to be shared equally by the three partners. Accounts are to be prepared and profits and interest credited half- yearly. C is to be credited with a salary of $5,000 per annum. On June 30, 1917, the profits divisible after debiting C's salary, which he has drawn, but before charging interest on partners' capitals, PROBLEMS e^e amounted to $75,000. The partners' withdrawals, which are not charge- able with interest, were: A, $12,500; B, $10,000; and C, $3,750. Draw up partners' accounts as they should stand on July i, 1917. Assume that instead of a profit, a loss of $75,000 has occurred. How would you have treated it in the accounts in the absence of any direct provision in the partnership agreement relative to losses ? Partnerships — Dissolution 8. A and B are partners in a wholesale dry goods business. A, the senior partner, agrees to retire, accepting for his interest $6,000 cash and four notes of $3,000 each, without interest, maturing at three- month intervals, commencing one year hence. The following balance sheet is prepared prior to settlement of A's account: A AND B Balance Sheet, December 31, 1916 Assets Cash $10,000.00 Notes Receivable 11,000.00 Accts. Receivable 25,000.00 Merchandise 11,000.00 Fixtures 1,500.00 $58,500.00 Liabilities and Capital Notes Payable $10,000.00 Accounts Payable 16,500.00 A Capital 16,900.00 B Capital 15,100.00 $58,500.00 Show the entries on the books necessary to effect A's retirement 9. X, Y, and Z were partners and contributed the following capi- tal: X, $8,000; Y, $6,000; and Z, $4,000. Profits and losses were to be shared equally. At the end of the first year each partner had drawn $1,000. The assets were then disposed of for $3,000, the purchaser dis- charging all liabiHties of the firm. Close the books of the partnership. 10. Wilson and Rainey are partners, sharing, profits and losses equally. The partnership is dissolved December 31, 1916, at which time Wilson's capital investment is $10,000, and Raine/s $3,500. The total liabilities of the firm are $25,000, which include $5,000 due Wilson on loan account and $3,500 due Rainey on loan account. The whole of the assets of the firm are disposed of for $30,000 cash on May i, 1917- Close the partnership books. No allowance for interest is to be made. 11. A partnership on equal terms between A and B is dissolved July I, 1917, the books on that date showing the following: 576 ACCOUNTING— THEORY AND PRACTICE A's capital paid in was $16,000, and his drawings were $3,500. B's capital paid in was $2,000, and his drawings were $1,500. Goods purchased $50,000; sales $40,000; business expenses $1,800. A loss of $1,600 was made on a $5,000 consignment of goods to Liver- pool. In the settlement, A agrees to pay B an old debt of $3,500. Prepare requisite accounts, and show final balance payable by one partner to the other. 12. A and B, partners in a mercantile business, share profits and losses equally. At the end of five years the partnership terminates by limitation, and the balance sheet shows the following: Assets Plant and Machinery... $15,400.00 Inventory 36,000.00 Accounts Receivable. . . . 28,000.00 Cash in Bank 5,600.00 5,000.00 Liabilities Creditors $30,000.00 Bills Payable 10,000.00 Capital : A $30,000 B 15,000 45,000.00 $85,000.00 Subsequently the business as it stands (except the cash in bank) is sold for $30,000. Make final adjustments and closing entries, and show the amount each partner receives. 13. S and T began business August I, 1916, S investing $8,000, T $5,000. Gains were to be shared equally and no interest was to be allowed on investments or charged on withdrawals. The firm was dis- solved May I, 1917. The books had been kept in a haphazard fashion, but the partners agreed to the following statement which was submitted for settlement: net debit of S $2,100; net credit of T $3,500; cash on hand $3,400; 10 shares bank stock (market value $1,100) ; expense debit $3,000; credit $500. The bank holds the firm's note for $2,000, on which there is accrued interest of $60. Prepare a statement showing the settlement of the partnership affairs. Joint Venture 14. A, B & Co. agree with C, D & Co. that the latter shall ship on consignment to Honolulu on joint account 20 cases of commodity "X," the invoice price of which is $2,100, less 254%. A, B & Co. pay the pack- ing charges, $25; also freight, insurance, and other charges, $90, and PROBLEMS ^^^ they draw on their correspondents in Honolulu in advance for $i,6oo at go days, which is discounted at a cost of $20, and the proceeds handed to C, D & Co. as part payment. These transactions may be dated March 31. On the 30th of November A, B & Co. receive the account sales and net proceeds, $418, and they then pay C, D & Co. the balance due them. Prepare a joint consignment account, charging interest on the amount involved at 5% per annum for 8 months, closing it by dividing the loss ; also an account to be rendered by A, B & Co. to C, D & Co., closed by payment of the balance and prove that the losses borne by each are equal. 15. On April 30, 1916, St. John & Co. and Carpel Bros, enter into a joint venture agreement. They each contribute $4,000 with which they pay for goods that are shipped on May i to John Doe, of San Francisco. St. John & Co. advance $400 to defray freight and inci- dental expenses. John Doe, the consignee, is allowed 10% on the cost of the goods, and is to sell them at whatever price he can obtain for them. On June I, 1917, on the strength of a report sent by wire. Carpel Bros, draw at sight on John Doe for $4,000 to the order of Carl Peter of New York. On July i, 1917, St. John & Co. receive from the con- signee a check for $11,200, all the goods being sold; on the same day St. John & Co. settle with Carpel Bros. Interest at 6% is allowed on all the transactions affecting the partners in the venture. Prepare all the ledger accounts brought about by the above, on the books of St. John & Co., including a Joint Venture account. (Construct your ledger accounts in such a manner that they will explain fully what took place, and make a cross reference possible.) 16. Abbot and Ball are each conducting a separate business, but enter into a speculative partnership as a side line on January i, 1916, to buy and sell aeroplanes. Purchases and sales are made sometimes by Abbot and sometimes by Ball, and each puts his transactions through his own business accounts, as no joint venture books are kept. They agree to divide profits and losses equally after allowing or charging interest at 6% on cash received or paid. From the following information prepare statements due to each partner at the time of the dissolution of the partnership on December 31, 1916: Jan. I Abbot buys for cash 2 aeroplanes at $3,50O Jan. I Abbot pays expenses connected with above iSO Jan. 15 Ball " " " " " i«> June I Ball " " " " " 75 June 30 Ball sells for cash above aeroplanes at 4.1°° 578 ACCOUNTING— THEORY AND PRACTICE July I Ball buys for cash five aeroplanes, each averaging 2,500 July 31 Abbot pays expense connected with above 225 Aug. 31 " " " " " " 45 Sept. I Ball sells the five aeroplanes for 13,100 Sept. I Abbot buys one aeroplane for 2,800 Sept. 15 Abbot sells the above aeroplane for 2,750 Compute interest on even half-months. Corporations — Opening the Books 17. A firm whose resources and liabilities are stated below, is converted into a corporation: Assets Real Estate and Im- provements $65,500.00 Merchandise 16,000.00 Accounts Receivable... 5,200.00 Cash 2,100.00 8,800.00 Liabilities Accounts Payable $8,800.00 Bills Payable 25,000.00 Partners' Accounts 55,000.00 $88,800.00 The corporation receives all the assets except the cash, and assumes payment of the accounts payable but not of the bills pay- able. The real estate and improvements are taken over at a value of $100,000, and the good-will is to be considered. The purchase price is to be as follows : $30,000 in cash, $50,000 in bonds, and $50,000 in capital stock of the company. $35,000 addi- tional capital stock is sold at par for cash. Open the books of the corporation. 18. Thomas Jones and William Thompson are in partnership as wholesale grocery merchants, sharing profits equally. On January I, 1916, their balance sheet is as follows: Assets Stock in Trade $27,245.00 Furniture 2,752.00 Debtors 37,625.00 Cash 752.00 Good- Will 5,000.00 $73,374-00 Liabilities Bank of B. N. A $10,000.00 Creditors 27,528.00 Jones 25,243.00 Thompson 10,603.00 $73,37400 PROBLEMS 579 An agreement is made to amalgamate with Joseph Smith and George Brown, also trading in partnership and sharing profits respectively 2/3 and 1/3. Their balance sheet as on January i is as below : Assets Stock in Trade $35,424.00 Furniture 3,840.00 Debtors 42,741.00 Bank of Toronto 3,4iSoo $85,420.00 Liabilities Creditors $35,818.00 Smith 22,176.00 Brown 27,426.00 5,420.00 A company is formed to take over the business, under the name of Smith, Jones & Co., Ltd., with an authorized capital stock of $200,000, divided into 2,000 common shares of $100 each. George Wilkins, John Lister, and Robert Ryder subscribe for 20 shares each, for which they pay cash. The Jones and Thompson business is taken over at book figures, except that good-will is raised to $10,000, and $1,000 is set up as a re- serve for doubtful debts. The Smith and Brown business is taken as shown, with an addition of $15,000 for good-will and $1,500 reserve for doubtful debts. The partners in the two businesses are to take shares for their interests, making up an even amount by paying cash if re- •quired. All cash received is deposited in the Bank of British North America. Show by journal entries the various transactions incident to taking over the business and allotment of shares, giving the number of shares allotted to each party, and make out the balance sheet of Smith, Jones & Co., Ltd. 19. The firm of Cottey & Dorset incorporates. From the follow- ing data make entries to effect the necessary changes in the accounts, the old set of books being used: Cottey's net capital, $8,768.97; Dorset's net capital, $6,741.86. Authorized capital stock of new organization, $20,000; par value of shares, $100. It is agreed that in exchange for their respective interests in the old concern, Cottey is to have 95 shares and Dorset 75 shares in the corporation, the balance of the capital stock to remain unissued for the present. 20. Wilson and Johnson, partners in a wholesale business,^ decide to incorporate. Their balance sheet shows assets and liabilities as follows : 58o ACCOUNTING— THEORY AND PRACTICE Assets Cash $2,250.00 Merchandise 8,690.00 Accounts Receivable.. . 6,261.00 Land & Buildings 8,500.00 Auto Truck 1,300.00 Furniture & Fixtures.. 1,200.00 Interest Prepaid 40.00 Taxes Prepaid 178.00 $28,419.00 Liabilities Accounts Payable $2,550.00 Mortgage Payable 5,700.00 Salaries Accrued 105.00 Interest Accrued.. 280.00 Wilson 9,816.7s Johnson 9,967.25 $28,419.00 Authorized capital stock of the new company is to be $25,000; par value of shares, $100. Wilson is to receive in exchange for his inter- est 119 shares in the new concern; Johnson receives 120 shares. The cash is not to be turned over to the corporation, but is to be divided between the parties in proportion to the number of shares of stock re- ceived by each. J. T. Jones and W. B. Smith purchase 5 shares each for cash. It is decided that the old books are to be closed and a new set opened. Make the necessary journal entries to close out the old books and open the new set. 21. The Scott-Davis Company has been organized with an author- ized capitalization of $500,000, all common stock, par value $100. The five incorporators subscribe for fifty shares each at face value. J. W. Jackson purchases a business now being operated by Mack, Jacks & Bros., paying for the complete plant $475,000, and transfers the same to the newly incorporated company for the remaining common stock and $100,000 of first mortgage 5% bonds. Make the opening journal entries. 22. The Interboro Company has been organized with a capital stock of $150,000, shares $100 each. There are three incorporators, J. Jacks, W. Wilson, and A. Anson, each of whom has subscribed for $20,000, of which one-half is paid in cash. They are to receive full- paid stock, and $30,000 is to be charged to organization expenses. The company has a franchise from the city of Jason giving it the right to use the streets for a tramway for twenty-five years. The directors have placed on the market $50,000 of stock, which was immediately subscribed at 125, and one-half paid in, the balance to be paid in three instalments. Subscriptions have been received from I. M. Axman and W. S. Wright for 100 shares of stock each, at 150, PROBLEMS 581 on which they have paid 7570 in cash, the balance to be paid in one month. The franchise cost $35,000. Of this amount $10,000 has been paid down, and $1,000 is to be paid at the end of each year. Make the opening entries and post to the ledger, showing all the accounts involved. Show the accounts in the stock ledger also. Corporations — Closing the Books 23. The X & Y Company has a capital stock of $750,000, one-third of which is 6% cumulative preferred stock. The company has also a surplus of $75,000, and bonds outstanding of $200,000 drawing 4J4% interest, with ten years yet to run. The profits for the year are $51,550.25, out of which the directors have paid bond coupons, divi- dend on preferred stock, and 4% dividend on common stock. They have also added $5,100 to Surplus account, and $9,500 to Sinking Fund account. Show all of the entries. Rule up all of the accounts involved and show how they will appear after carrying out the above instructions. 24. A corporation has outstanding $1,500,000 of full-paid stock. Its accumulated surplus is $250,000, The profits for the current year are $150,000. The directors declare a cash dividend of 6% and a stock dividend of 20%. Make journal entries to record the dividend transactions. 25. The Arlington Manufacturing Co. was incorporated with an authorized capital stock of $100,000, of which $90,000 was subscribed for and $75,000 paid in. At the end of the fiscal period the net profit was $11,000. The board of directors declared a dividend of 10% on the subscribed stock, in proportion to amounts paid in, said dividends to be applied as part payment. Make the necessary journal entries. Corporations — Miscellaneous 26. A coal mining corporation proposes to issue bonds of the denomination of $1,000 each to the amount of $500,000 on January i, 1917, bearing interest at 6% per annum, payable semiannually. Under the terms of the mortgage a fund equal to 10 cents per ton of coal shipped is to be set aside semiannually for the first three years, and at the rate of 12 cents per ton thereafter, the fund to be used as follows : First, to pay the interest on the bonds. 582 ACCOUNTING— THEORY AND PRACTICE Second — after paying interest the balance is to be used to redeem and cancel bonds at par, as of the dates on which the interest is paid; any balances remaining in the fund thereafter to be added to the fund of the next period. It is estimated chat the tonnage will be 400,000 tons each six months for the first three years, and 300,000 tons each six months thereafter. Prepare a tabular statement showing concisely the operation and the result of carrying out the proposed plan based on the foregoing estimates. Single Entry 27. A. B. Trott and R. U. Shore, partners sharing equally in business, have determined to change their system of bookkeeping from purely single entry to double entry, continuing the use of the old ledger. The following statement shows the footings of the open accounts in their ledgers: Dr. Cr. A. B. Trott $37500 $5,000.00 R. U. Shore 1,250.00 6,000.00 A. M. Sanders 320.00 150.25 Martin Chevreaux 841.60 541.60 Hendry & Co 482.50 2,200.00 E. R. Benson 500.00 640.00 The inventories are : merchandise, $6,500 ; Iron National Bank stock (10 shares) $1,000; cash on hand and in bank $4,124.82; bills receivable as per bill book $4,920.43 ; bills payable as per bill book $1,931.60. Formulate a journal entry that, when posted, will change the ledger to double entry form, showing the items which will have to be posted. Give all the figures by which the result is obtained. 28. T. J. Slason and M. I. Howe are partners in business, sharing profits and losses in the ratio of 3 :4. Their books have been kept by single entry, but they desire to change them to the double entry method. The following is an abstract of their affairs at this date : Assets and liabilities as per ledger : T. J. Slason, investment $12,500; withdrawal $2,500 ; M. I. Howe, investment $12,500 ; withdrawal $2,000 ; sundry accounts receivable $8,500; sundry accounts payable $6,000. Other assets and liabilities not in ledger: merchandise as per in- ventory $18,000; cash in bank $5,500; bills receivable $2,300; bills pay- able $2,000 ; bank stock $2,000 ; real estate $5,000. PROBLEMS 583 Determine the amount of gain and loss of each partner at this date and formulate proper journal entry for conversion of the former single entry ledger into a double entry ledger. Inventory Adjustments 29. In examining a business for the two years ending December 31 1916, it is found that an item amounting to $750 had been omitted from the mventory of December 31, 1914; that an error had been made in the footmg of the inventory of December 31, 1915, by which that in- ventory was overstated to the amount of $1,250; and that in pricing the inventory of December 31, 1916, an error was made by which that in- ventory was understated to the amount of $1,500. State fully the effect of these errors on the profit of each of the two years. Fire Loss Adjustments 30. A fire in the office of a firm of traders partly destroyed its books of account that had been fully posted in anticipation of proving their correctness. The following ledger accounts were found to be legible : Purchases, net $23,000.00 Cash discounts lost 320.00 Cash discounts gained I 150.00 Sales, net 18,000.00 Bills receivable. 11,000.00 Upon inquiry the bank balance was ascertained 43,000.00 Bills receivable had been discounted at the bank, amounting to 15,000.00 An inspection of the checks paid by the bank showed amount paid creditors, including $20,000 notes payable 33,000.00 A balance sheet prepared at the last closing of the books and con- taining the following items was produced by one of the partners : Accounts Payable $10,000.00 Notes Payable 20,000.00 Mortgages Payable 12,000.00 Capital 84,000.0c Cash $20,000.00 Accounts Receivable . . . 42,000.00 Loans Receivable 8,000.00 Real Estate 30,000.00 Notes Receivable 14,000.00 Inventory 12,000.00 The firm stated that the real estate, loans receivable, 'and mort- gages payable remained as shown in the balance sheet. An inventory of goods in storage amounted to $15,000. With this information open a new set of books showing the position of the firm at the time of the fire. S84 ACCOUNTING— THEORY AND PRACTICE 31. The Ganver Garment Company, which was burned out on the night of September 16, filed with the insurance companies a claim for $95,436.70, which you are called in to verify or disprove. You find the following balance sheet as of August i, igi6: Assets Cash $9,224.67 Accounts Receivable.. 88,669.43 Bills Receivable 2,473.62 Merchandise Inventory 42,618.97 Machinery 20,419.04 Furniture & Fixtures. 2,000.00 Prepaid Taxes & In- surance 592.13 $165,997.86 Liabilities Accounts Payable $59,611.46 Bills Payable 42,183.24 Capital Stock 50,000.00 Surplus 14,203.16 $165,997.86 At the close of business September 16, their ledger showed the following balances : ^ _ Dr. Cr. Capital Stock $50,000.00 Surplus 14,203.16 Cash $5,418.22 Accounts Receivable 118,871.14 Notes Receivable 6,217.24 Accounts Payable 72,898.66 Notes Payable 63,114.02 Machinery 21,619.34 Furniture & Fixtures 2,147.30 Inventory August i, 1916 42,618.97 Dividends 6,000.00 Sales 162,917.31 Merchandise Purchases 103,430.22 Labor 37,619.14 Power, Light & Heat 3,716.47 Factory Expense 7,119.11 Office Salaries 2,250.00 Office Expense 319-54 Selling Expense 4,716.92 Insurance 318.16 Taxes 7S1.38 $363,133-15 $363,133.15 PROBLEMS 585 The company's gross profits on sales has been very uniform, aver- aging 20%, ever since the business was started. io% for depreciation has been written off every year from Machinery and Furniture and Fixtures. Insurance policies covering merchandise, machinery, and furni- ture and fixtures aggregate $100,000, and all contain the 80% coin- surance clause. The merchandise and furniture and fixtures were a total loss. The salvage in machinery is valued at $2,500, at which value the insured decided to retain it. Prepare statement of claims against the insurance companies. 32. James Huitt and Willis Stivers are equal partners. On the night of July 3 their stock and fixtures were destroyed by fire. A trial balance which Huitt had at his home, showed the following condition of the ledger at the close of business, June 30 : James Huitt $600.00 $5,450.00 Willis Stivers 600.00 7,450.00 Cash 3,309.00 Fixtures 1,500.00 Merchandise Purchases 32,600.00 Merchandise Sales 24,800.00 Notes Receivable 1,000.00 Notes Payable 4,000.00 Interest 120.00 50.00 Expense 780.00 Customers 4,500.00 Creditors 3.2S9-oo $45,009.00 $45,009.00 The property is fully covered by insurance. The insurance com- pany, for purposes of estimating the value of the merchandise de- stroyed, has agreed to allow 35% as the average gross gain on the sales, and to pay 662/3% on the value of the fixtures as shown by the ledger. On the basis of this agreement, state the result of the business and the capital of each partner. Notes, Drafts, etc. 33. X buys goods of Y on account for $2,500 and accepts Y's draft on himself for the amount. Y discounts the draft at a bank, the dis- count being $5. At maturity X cannot pay and the bank charges Y's account with the amount plus protest fees of $2.50. Later X pays Y the $2,500 and interest to the amount of $4.50 accrued since the original date of maturity and protest fees. 586 ACCOUNTING— THEORY AND PRACTICE Show journal entry on Y's books and on X's books for the above transactions. 34. A owed B $1,000. B offered a discount of 2^/^% for cash. Not having the ready money, A discounted his note at the bank for sixty days at the rate of 6%, the note producing the sum required to discount B's claim. Give the entries as they would appear on the books of both parties. 35- C needs funds. D, an associate of C, induces E to accommo- date C. Accordingly, D introduces C to E, for which C pays $250. E discounts for C a note for $5,000 due in three months, and turns over to him $4,750. Frame journal entries covering these transactions. Cash Disbursements 36. Find the amount of cash disbursements from the following in- formation : The ledger accounts show the following balances: Capital $6,923.50; Merchandise, Dr. $5,041,30; Fixtures $950; Bills Receivable $1,740.80; Bills Payable $3,109.10; Accounts Receivable $2,266.90; Accounts Pay- able $1,179.30. No cash account is kept in the ledger. Cash receipts were $6,381.50. How much were the disbursements? INDEX Account, 56-66, (See also "Ac- counts," "Accounting") analysis of. Form, 513 balance, nature of, 6i balancing, 98-100 Form, 99 closed, 98 consignment sales, 469 Form, 470 current. Form, 494 bank account, 495, 496 reconciliation, 498, 499 debit and credit, defined, 64, 65 rules for determining, 73 defined, 56, 57 ledger, Form, 58 defined, 56, 57 illustrations, 58, 99, 102, 106 ruling of, loi sections of, 57, 58 transferring, 101-103 transferring balances for- ward, 101-103 transferring debit and credit totals forward, 103 mechanism of, 59 mixed, 87, 88, 89 open, note in relation to, 314, 31S personal. Form, 106 address recorded, 105, 106 rulings, 105,107 statement of, Form, igo title of, classification indicated by, 61 essentials of, 57 trading, 384, 385 transferring, loi, 103 Form, 102 Accountancy, economics, relation to, 12 law, relation to, 13 Accountants, Institute of (English), 9 organizations, 9-1 1 Society of, 9 Accounting, (See also "Account," "Accounts," "Bookkeeping") adjustments, 387 closing of books, 379, 380 ancient methods of, 1-7 balancing methods, 511-519 adjustment account, 518 analysis sheet, 513-516 check figure in posting, 517, 518 columnar book errors, 518 controlling accounts errors, S18 ledger analysis, 511, S12 reverse posting system, 516, 517 basic methods of, 258-270 cash, discount, 304-308 controlling accounts, (See "Ac- counts, controlling") corporation, (See "Corporation accounting") history of, i-il 587 588 INDEX Accounting — (continued) notes payable and receivable problems, 322-334 partnership, 279-288 (See also "Partnership") profit and loss closing, 373- 375 profits reserved, 373, 374 record, analysis of transaction basis of, 64 requirements as to, 39 types and development of, 403-412 trial balance, 386, 387 working sheet, 386, 388, 389, 390, 391 Accounts, (See also "Account," "Accounting," "Ledger") asset, depreciation on, 92-94 real or specific, 248 asset and liability, debit and credit applied to, 73-79 books of, original entry, 120, 121 secondary entry, (See "Ledger") capital asset, 94 chart of, 252-255 classification, 246-257 analysis and synthesis applied to, 260, 261 basis of, 247, 248, 250 chart covering, 252-255 early, 247, 248 impersonal, 247 personal, 247 recent development, 248, 249 three-phase, 249 closing, entries, methods of making, 233, 234 guide for, 245 illustrated, 234-238 order of, 139, 231, 232 posting of entries, 385, 386 controlling, 413-437 advantages of, 414 credits, source of, 417, 418 debits, source of, 415-417 extraneous items, 423-428 introduction of, 422, 423 ledger equilibrium, re-estab- lishment of, 414, 415 other, 433 posting, basic principle of postings, 419, 420 proving accounts payable by, 419 proving customers' ledger by, 418, 419 purpose of, 413 current, 491-499 adjusting, 493-495 defined, 491 interest on balances, 491 joint venture, 492 partners' accounts, 492 impersonal, 247 journal entries, adjusting, 164-166 closing, 164, 166, 167 keeping of, purpose and method, 246 liability, real or specific, 248 merchandise, 88-91 debit and credit of, 88, 89, I 10-114 nominal, defined, 248, 249 number of, in ledger, 60 payable, accounts receivable liquid- ating, 71 balance (credit) liability, 75 controlling account to prove, 419 INDEX 589 Accounts — (continued) payable — ( continued ) journal, (See "Journal, pur- chase") notes payable liquidating, 70 simultaneously receivable and payable, 426, 427 transfer to accounts receiv- able, 426, 427 personal, 247 Form, 106 real, 248 receivable, analysis of, 54 balance (debit) an asset, 73, 74 controlling account to prove ledger of, 418, 419 debits and credits of, 73, 74 ledger, 404, 405 simultaneously receivable and payable, 426-427 statement of account, 189, igo specific defined, 248 summary, 384 temporary proprietorship, 80 debit and credit of, 80-83 transferring, loi, 103 vested proprietorship, 80 debit and credit of, 83-85 Addition, method of, in bookkeeping, 59 Adjustments, (See "Entries, ad- justing") Adventure accounts, 484-490 accounting, handling, 487-489 interest allowances and charges, 486 joint venture, 484, 485 accounting for, 485, 486 accounts current, 492 relations between parties, 485 profits, distribution of, 486, 487 single venture, 484 Agency, 465, 466 Allowances, claims, 74 discount, 74 American Institute of Account- ants, 10 Analysis, 259 account marked for. Form, S13 sheet, ledger. Form, S14 Analysis and synthesis, ledger as example of, 261 Appraisal, defined, 92 treatment of, 109-119 Appreciation, 93 Approval sales, 482-484 Arrangement of accounts, order of, 267, 268 Assets, account, 62 appreciation of, 93 classification of, 252, 253 current, 27, 30 decrease covered by credit en- try, 69 defined, 14 depreciation, 92-94 exchanges within group, 52 expenses affect, 51 fixed, 27, 30 accounts covering, 77 debit and credit of, "n depreciation of, 115 increase covered by debit entry, 69 real, 248 Assets and liabilities, statement of, 28-31 (See also "Statement, financial," "Bal- ance sheet") "Awdytowris," 9 590 INDEX B Babylon, ancient methods of accounting, i Bad debts, adjustment entries covering, 224 225 journal entries, 165 problems, 174 reserves for, 30, 31 Bailment, 465 Balance, account, 61 asset accounts, 62 bank, reconciliation of, 496-498 expense accounts, 62, 63 income accounts, 63 liability accounts, 62 sheet, 386, (See also "Statement, financial," "Assets and lia- bilities") Form, 30, 240, 241 comparative, 36, 37 content and subdivisions, 27, 28, 29 corporation, 23, 24 deferred and accrued expenses in, 29, 411, 412 deferred and accrued income in, 29, 411, 412 form different from financial statement, 242 partnership, 23, 28-31, 358, 359, 361, 364, 36s, 366, 4S8 policy of valuation shown by, 29, 31 proprietorship, 15, 16, 22, 34- 37 purpose and use, 26 Balancing methods, 511-519 Bank, account with, 293-295 balance, reconciliation of, 496- 498 deposit ticket or slip, 195, 196 depositor, account, opening an, 194 functions in community, 194 interest, daily balance, 550, 551 pass-book, 196 Bill, (See "Invoice") Bill and charge system, 344, 345 Bill of exchange, 182, 183 Bill of lading, order, 187, 188, 189 straight, 187 Bills payable, (See "Notes pay- able") Bills receivable, (See "Notes re- ceivable") Bills receivable and payable, origin of title for notes, 314 Blotter, 121 Bonis Freres, bookkeeping methods employed by, 5 Bookkeeping, (See also "Account- ing") books of record, ancient methods, 6 journal, (ancient), 6 memorial, (ancient), 6 quaderno, (ancient), 6 double entry, changing from single entry, 541 development, 5-9 origin of, 5 "Venetian" method, 5 single entry, 520-542 accrued items, 527 appraisal, 526 as adapted to modern needs, 523, 524 balance sheet, 527, 528 books required, 522-524 cash book, 522, 537 debits and credits, 524 deferred items, 527 INDEX 591 Bookkeeping — (continued) single entry — (continued) defined, 521 double entry compared with, 529, 530 inventory, 526 journal, 522, S32-S3S Form, 532^537 ledger, 523, 538-540 liabilities, 526 net profits, 540 opening entries, 531-541 postings, proof of, 525, 526 profit and loss, 526 proprietor's account, 524, 525 purchase journal, 536 sales journal, 536 text books, early, 7, 8 Books, (See also "Journal," "Ledger") closing of, summary statements, 231-245 "Boston" ledger, 263, 266, 267 Form, 266 Broker, 466 Business, economic or profit and loss ele- ments, 38-42 methods, 187-203 papers, (See "Papers, busi- ness") statement, (See "Profit and loss") transaction, analyzed as to debit and credit, 64 defined, 63, 64 Capital, account, closing profit and loss into 104 accretions through profits, 352, 353 additions to, 347 borrowed, 354, 355 expenditures, 94 investment, averaging, 352 original, 347, 348 partnership, borrowed, 354, 355 real, corporation, 450 defined, 347 Capital stock, 450 accounting entries for common and preferred stock, 456, 457 certificate book, 446 common, 450 discount on, 455 instalment payments for, 456 preferred, 450, 451 premium on, 455 stock ledger, 446 stock transfer book, 446 subscription ledger, 445, 446 subscriptions, property in payment of, 457 Capitalization, partnership, 347-356 Card ledger, 267 Cash, account, journal treated as ledger, 145 analysis of transactions, 53 balance, technical, 549 bank account, 293, 294 deposits, record of, 293, 294 book, Form, 144, 145 columnar, Form, 152, 153 discount column, Form, 307 petty, Form, 292 592 INDEX Cash — ( continued ) book — ( continued) summary, Form, 432 branch office, 296 disbursements, analysis and entry of, 144, 148, 149 checks, record of, 29S discount, 298, 303 analysis of, 149-151 cash book entry covering, 156, 157 handling in cash book, 151 employer's responsibility, 289 entries in other journals cov- ering, 162-164 factory, 296 handling of, 289-297 journals, 143-158 analysis in, 409, 410 analytical disbursement form, 155, 156 balancing of, 147, 148 discount, entry of, 306-308 entries, method of making, IS4, iSS Form, 14s posting from, 146, 147 ruling of, 147, 148 summaries, 431, 432 merchandise purchased for, recording, 70 petty, 290-293 book, 291-293 imprest system, 290, 291 receipts, analysis and entry of, 143, 144, 148, 149 deposit in bank, 289, 290 received for services, entry covering, 70 record, double, 289, 290 safeguarding, 500-502 internal check, 501 receipts and disbursements, statement of, 502 "short and over" account, 148 single-entry bookkeeping, 522, 537 wages paid, entry covering, 71 Charlemagne, accounting methods under, 4 Check, (See also "Cash, safe- guarding" ; "Internal check" ; "Ledger, posting, proof" ; "Trial balance, er- rors in") Form, 183 book, 196, 197 bank balance reconciliation, 496-498 cashier's, 183 certified, 183 defined, 183 method of entry on books, 29S Classification, accounts, 246-257 chart covering, 252-255 fundamentals of a good, 250 need and purpose, 251 business transactions, 251 Closing the books, (See also "Ac- counts, closing") effect of, 233 "C. O. D.," sales, 344 shipments, (See "Shipping, C. O. D.") Collateral, notes receivable as, 331 Columnar, books, 336, 337, 403-411 cash book. Form, 152, 153 journal. Form, 429 Commercial paper, (See "Negoti- able instruments") INDEX 593 Commission, factor's, 475, 476 sales, 345, 346 Companies, joint-stock, 276 Comparative financial statement, (See "Statement, iinancial") Consignments, 465-481 account sales, 469, 470 Form, 470 advantages of, 471 broker, 466 consignee's books, entries, 474, 475, 477-479 consignee's inventory, 476 consignor's books, entries, 471-473, 477-479 consignor's inventory, 473, 474 defined, 465 "del credere" agency, 470, 471 expenses incurred in connec- tion with, 468 factor, 466-468 compensation of, 470 lien on, 468, 469 legal status of, 465, 466 marks to distinguish, 475 merchandise, inventory affected by, 381, 382 sales, 341 separation from other goods, 468 title to goods, 342, 467-469 Consolidations, partnerships, 363- 366 Contingent liability, (See "Liabil- ity, contingent") Controlling accounts, (See "Ac- counts, controlling") Corporation, 438-464 accounting, closing of books, 450-464 current records, 460 opening books, 451-455, 458, 459 records, 450 advantages, 21, 439 balance sheet, 23, 24 by-laws, 442, 443 certificate of incorporation (N. Y.), 440-442 filing of, 442 control vested in state (N. Y.), 443 defined, 21, 22, 438 directors, election of, 444 disadvantages involved, 440 dividends, 460, 461 formation (N. Y.), 440 growth of this form of organi- zation, 438, 439 minute book, 447 officers of, 444 organization and management, 443 partnership changing to, 457- 460 profits, disposition of, 46, 47 distribution of, 461, 462 proprietorship, capital stock equivalent of, 444, 445 records peculiar to, 445-447 reserves, 462, 463 stock certificate book, 446 stockholders, 443 ultimate control held by, 461 stock ledger, 446 subscription book, 445, 446 subscription ledger, 445, 446 Corrections, erasures invalidate records, 228, 229 method of making, 228, 229 Credit, 64, 65 Cross-indexing, 206, 207 Current accounts (See "Accounts, current") 594 INDEX Dafforne, Richard, 7 Day-book, I2I Debit, 64, 6s Debit and credit, attempt to reduce to one rule, 67, 81 basis of, 68, 69 defined, 64, 65 determination illustrated, 69-71 equilibrium necessary, 71, 72 mixed accounts application, 87- 96 origin of use of, 67, 68 philosophy of, 67-72 problems in application of, 72, 78, 79, 8s, 86 proprietorship accounts, 80-86 schedule determining, 69 Deferred, charges, 29, 30 accounts covering, 116-119 to operation, schedule for, 411, 412 credits, accounts covering, 116-119 "Del credere" agency, factor's compensation under, 470, 471 Delinquency records, instalment sales, 504 Department store sales, 343 Deposit ticket. Form, 19s Depreciation, adjustment entries covering, 224, 225 assets, fixed, 115 calculated on reducing basis, 96 defined, 92 journal entries, 165 reserve for, 30, 31 account covering, 115 Directors, corporation, election of, 444 Discounts, 298-312 allowance covering, 74 bank, 298, 551, 552 capital stock, 455 cash, 149-151, 298 accounting titles of, 305 accounting treatment of, 304- 308 loss of, 308-310 nature and basic elements, 303 neglected, 308-310 trade acceptance in elimina- tion of, 310, 311 treatment as proprietorship item, 304, 30S treatment as trading account item, 304, 30s columns in cash book. Form, 307 definition, 298 purchase, closing the account, 139 sales, ledger entry of, 105 trade, 298, 299 calculation, methods of, 299- 303 true, SSI, 552 Dissolution, partnership, 392-402 Dividend, 460 accounts, 463 declaration can be from profits only, 461 "Domesday Book," 4 Double-entry bookkeeping (See "Bookkeeping") Draft, Form, 177 acceptance of, 178, 179 accounting entries covering, 179, 180 INDEX 595 Draft — (continued) bank, 182 Form, 182 collection against bill of lading, 189 commercial, 182 defined, 177 domestic, 182, 183 foreign, 182, 183 liability, contingent, when ac- cepted, 325-327 parties to a, 177 payment by, clearing-house method, 181 entries covering, 180, i8i sight, defined, 181 time, defined, 181, 182 Economic elements of business, 38-42 Economics, accountancy as related to, 12 Efficiency records, salesmen, 345, 346 Egypt, ancient methods of accounting in, 2 Elements of business, economic-financial interrelation- ship, 51-SS England, accounting methods in early use, 4, 5 "Domesday Book," 4 "Pipe Roll," 4 Treasurer's "Great Roll," 4 Entries, adjusting, basis of, no illustrated, 1 10- 117, 22-J-228, 23s, 236, 383, 384 merchandise records, 110-115 necessity for, 109, 221 without using journal, 167 closing, 103, 104 illustrated, 234-237 merchandise records, 110-115 without using journal, 167 indexing, 206, 208 Equation of accounts, defined and illustrated, 544-549 Erasures, corrections not to be made by, 228, 229 Errors, locating, 210-220 methods of correcting, 228, 229 transplacement of figures, 218, 219 transposition of figures, 215-218 Esquerre, Paul-Joseph, quoted : logismography, 520 statmography, 520 Exchange, media of, accounts with, 75 Exhibit, "A," balance sheet, 411, 412 "B," profit and loss, 510 Expense, accounts, debit and credit application to, 83 defined, 62, 63 accrued, accounts covering, 116-119 adjustment entries covering, 223, 224, 226, 227 deferred, 116-119 recording, 383, 384 invoices, journalizing, 408, 409 prepaid (See also "Deferred charges") accounts covering, 116-119 adjustment entries covering, 223-224, 225, 226 596 INDEX Factor, 466, 467, 468 account sales rendered to prin- cipal, 469, 470 books of, close of fiscal period, 475, 476 compensation of, 470 duties of, 467 lien on consignment in favor of, 468, 469 responsibility of, 467, 468 Financial, profit and loss element as re- lated to, SI -55 Financial statement (See "State- ment, financial" ; also, "As- sets," "Balance sheet," "Lia- bilities") Form, 30, 240, 241 comparative. Form, 36 preliminary work preparing, 97, 98 problems, 107, 108 Fiscal periods, 43 "Folder" system, customers' accounts by, 172, 173 Folio, indexing, 206, 207 Freight (See also "Shipping") bill, 188 bill of lading, 187-189 charges, apportioning, 506 inward, account covering, iii notice, 188 Future delivery sales, 342, 343 Gain (See "Profit and loss") Geijsbeck, J. B., quoted on bookkeeping, ancient methods, 6 General journal (See "Journal, general") Good-will, partnership dissolution, treatment of, 400, 40 1 partnership treatment of, 360- 363, 36s, 366 treatment of, 32 Greece, ancient methods of accounting in, 2, 3 H Hamilton, Robert, 7 Hammurabi, code of, business progress shown by, i Imprest, method of handling cash (See "Cash, petty") Income, accounts, debit and credit application to, 82, 83 defined, 63 accrued, accounts covering, 116-119 adjustment entries covering, 223, 224, 228 deferred, 116-119 problem, 119 prepaid, accounts covering, 116-119 adjustment entries covering, 223, 224, 227, 228 Income and expense (See "Profit and loss") Incorporation, (See "Corpora- tion") certificate of, 440-442 Indexing, in posting. Form, 207 Indorsement, blank, 185 full, i8s INDEX 597 Indorsement — ( continued ) negotiable instruments, 184, 185 qualified, 1&5 restrictive, 185 Inks, red, use on ledger, 100 Insolvency, partnership dissolution due to, 394, 395, 398, 399 Instalments, capital stock paid in, 456 sales, 342, 502-50S Instruments, negotiable (See "Ne- gotiable instruments") Insurance, account covering, 116, 117 premiums prepaid, treatment of, 109, 225, 226 Interest, accounts current, 491 average due date, 545, 546 100% method, 546-548 bank, daily balance, 550-551 calculation of, principles governing, 198, 199 short methods, 200, 201 U. S. government rule, 199 cash balance, 549 commercial, 543 compound, 543, 544 compound equation, 548, 549 expense, account covering, 116, 118, 119 income, account covering, 116, 118, 119 nature of, 543 notes payable and receivable, 320, 321 partial payments, 549, 550 U. S. Supreme Court ruling, 550 partnership, adjustment of investments, 348-351 partners' investment, 284 payments, equation of, 544, 545 phases of, 543-552 savings bank, 550-551 simple, 543, 544 Internal check, 500, 501 Inventories, (See also "Merchan- dise") adjustment entries, 221-223 book or estimated, 506, 507 physical, adjustment of accounts re- quires, 109-110 need of, 44 treatment of, 109-119 Investment, partners', interest on, 284, 369, 372 Invoice, defined, 170, 171 purchase, 171, 172 auditing of, 171, 172 scrap-book, 407 unpaid, 171 returned goods, 173 sales, 172, 173 folder system, 172, 173 Joint-stock companies, 276 Joint venture (See "Adventure accounts") Jones, Edward Thomas, 7 Jones, Thomas, quoted on : paradoxes of debit and credit, 247 Journal, analytical, evolution of the, 403 ancient use of, 6 bookkeeping, single-entry, 522, 532-535 cash, 128, 143-158 Form, 144, 145, 152, 153 598 INDEX Journal — (continued) cash — ( continued ) arrangement of entries, 143, 144 showing discount column, Form, 307 characteristics of, 121, 122 closing of, 160 columnar, summary entries, 428-432 Form, 429 defined, 121, 122 distribution, horizontal form, 336, 337 vertical form, 336, 337 divided-column, Form, 161 entries, adjusting, 164-166, 221-230 adjusting without, 167 closing, 164, 166, 167, 235-237 closing without, 167 compound, 122, 123 correction, 221-230 equilibrium of, 122, 123 explanations covering, 160 opening, 162-164 form of, standard, 123, 124 general, 128, 430 analysis in, 409, 410 class of entries included in, IS9, 160 form of, 161 summary, 431 Form, 430 inadequacy of old type, 126, 127 ledger in relation to, 204 modern, 149-169 note, 409 notes receivable. Form, 318 petty cash Form, 292 posting to ledger, 160 purchase, 128, 130-139, 206 development of the, 407, 408 entry, detail of, 136, 137 expenses handled through, 408, 409 form and method of use, 135- 137 posting ledger from, 134, 13S practice data covering, 138, 139 single-entry bookkeeping, 536 summary, 425, 426, 431 sales, 128, 140-142, 206, 208, 405, 406 allowances and returns, 406 bookkeeping, single-entry, 536 entries not belonging in, 423 posting from, 406, 407 summarization of, 141, 424, 425, 428, 429 Form, 429 single entry. Form, 532-537 standard form, 123 subdivision of, 126-129 basis for establishing, 128 subsidiary, defined, 127 labor-saving elements of, 127, 128 Journalize, defined, 186 Law, accountancy as related to, 13 Ledger (See also "Accounts," "Trial Balance") account. Form, 58, 261-265 adjusting entries in journal, 164-166 arrangement of, 267, 268 balancing, 98-100 Form, 99 INDEX 599 Ledger — (continued) account — (continued) "charge-discharge" form, 8 closing entries in journal, 164, 166, 167 development of, 7-9 index number identifying pay- ments, 105-107 receivable, 404, 405 totaling, 98 adjustment entries and correc- tions, 221-230 adjustment of current record, 109, no analysis, method and use of, 511-516 sheet. Form, 514 balance form of, 263, 264, 265 balance of account, entry of, 100 balancing methods, 511-519 "Boston," 263, 266, 267 Form, 266 bound, 267 card, 267 closing, 103, 104, 231-245 adjustment data, 235 direct entries and disadvan- tage, 233, 234 effect of, 233 journal entries covering, 233, 234 method of, 231-233 profit and loss entries, 237, 238 summarizing, purpose of, 231 trial balance, 234, 235 content of, 59, 60 customers', 404, 405 data, sources of, 120-125 defined, 59, 60, 204 discount sales, entry of, 105 explanatory matter in, 207-209 forms of, 58, 261-265 inks, red, 100 journal in relation to, 204 kinds of, 261-267 legal status of, 121 loose-leaf, 267 number of accounts in, 60 operations, problems, 107, 108 periodic work on, 97-108 posting, check figures in, 517-518 checking of, 219 cross-indexing in, 207 Form, 209 defined, 121 errors in, 205, 206 methods of, 204-209 proof of in single entry, 525, 536 slip or reverse system, 516-517 time of, 204 progressive, 263, 266, 267 purchase, proving the, 499 record, insufficiency of, 120 ruHng of ledger accounts, loi, 261-265 sales, 404, 405 proving, 499 self-balancing, 420 single-entry bookkeeping, 523, 538-540 standard, center-column, Form, 262 standard, divided column. Form, 262 subdivisions of, 404, 405 subsidiary, principle governing, 433 self-balancing feature, 420, 421 summarizing of, 103, 104 trial balance, 97, 98, 234, 235 types of, 267 Legal expense, entry covering charges, 71 6oo INDEX Liabilities, account, defined, 62 classification of, 253 current, 30 decrease covered by debit entry, 69 defined, 14 exchanges within group, 52 expenses affect, 51 fixed, 30 increase covered by credit en- try, 69 Liability, contingent, drafts, accepted, 325-327 notes receivable, discounted, 323-325 Liquidation, partnership, 392-402 Loans, notes discounted, 197, 198 Logismography, 520 Loose-leaf ledger, 267 Loss (See "Profit and loss") Loss and gain (See "Profit and loss") Losses, adjustment entries covering, 223, 224 M Marshall, (former) Chief Justice, quoted on : corporation, 438 Media of exchange, 75 Memorial (day book, ancient), 6 Merchandise, account, content and significance, 87, 88, 89 entries adjusting and closing, lio-iiS mixed, closing entries, 114 modern practice in handling, 89-91 problems, 95, 96 cost of sales, formula for determinating, 113 inventory, 89, no adjustment entries covering, 221-223 consignment items, 381, 382 entries covering, 113, 114, 115 goods in transit, 380, 381 goods received but not booked, 381 goods reserved for future de- livery, 382 goods sold not shipped to be excluded, 382 journal entries, 165 purchased for cash, recording, 70 purchased on account, recording, 70 sales, cost of, 40, 41 sales to owner, 141 shipping, 187-189 Minute book, 447 Money orders, express, 184 postal, 184 Money, paper, origin of use in Europe, 313, 314 Montgomery, Robert H., quoted on: auditing, 258 N Negotiable instruments, defined, 176, 177 kinds of, 177 notes, 313-321 writing, principles governing, 184 Net worth, 28, 30, (See also "Pro- prietorship") comparison covering different periods, 33 INDEX 60 1 New York, state of, incorporation, 440 partnership defined by law of, 271 Notation, Arabic substituted for Roman, 8 Notes, accounting entries at face value, 319, 320 classification, 331 secured, 331 short-term, 331 disc9Unting, 129, 200-201 dishonored, 327-330 interest, 320, 321 calculation of, 198-201 journal, summary of, 427, 428 maturity of, how calculated, 198 "one-name" paper, 197 open account in relation to, 314, 31S partial payment of, 331, 332 payable, 313-321 accounting entries covering, cash paid liquidating, 70 index figure to identify pay- ments, 322, 323 journal, 128, 316-319 ledger account, 106, 107, 207 Form, 106 payable and receivable, problems in accounting en- tries, 322-334 promissory. Form, 177 defined, 177 protest of, 327 receivable, 17s, 176, 313-321 accounting entries, 322 collateral for loans, 331 discounted, 323-325 disposition of, accounting en- tries, 76 index figures to identify pay- ments, 322, 323 indorsers released by failure to present when due, 316 journal, 127, 316-319 Form, 318 ledger account detail, 207 liability, contingent if dis- counted, 323-325 receivable and payable, problems in accounting en- tries, 322-334 recording of, 316 renewals of, 331, 332 secured, 331 short-term, 331 tickler, payment, 319 "two-name" paper, 197, 198 Ofiicers, corporation, 444 Oldcastle, Hugh, 7 Organization, business, 19-25 types of, corporation, 21, 22 partnership, 20, 21 proprietorship, single, 19, 20 Organizations of accountants, 10, II Original entry, books of, 120, 121 Paciolo, Luca, 6 Papers, business, 170-186 defined, 170 invoice, purchase, 171, 172 sales, 172, 173 notes receivable, 175, 176 Partial payments, 549 Partners, (See also "Partnership") dormant, 276, 277 liability of, 20, 273 6o2 INDEX Partners — (continued) new, admission of, 285, 286, 357-363 nominal, 276 ostensible, 276 secret, 277 silent, 276, 277 withdrawals, method of handling, 375 Partnership, 347-378 accounting, closing entries, 459, 460 closing for period, 379-391 profit and loss closing, 373-375 reserved profits, 373, 374 viewpoint, 279-288 admission of new partner, 357- 363 advantages and disadvantages, 20, 21 authority of individual, 271, 272 balance sheets, 23, 358, 359, 361, 364, 36s, 366 business viewpoint of, 271-278 capital, accretions through profits, 352, 353 additional, 353, 354 additions to, 347, 348 adjustment of contributions, 348-351 averaging investments, 352 borrowed, 354, 355 investment, original, 347, 348 capitalization of, 347-356 characteristics of, 272, 273 consolidation of, 363-366 contract, 273, 274 essentials of, 274 corporation taking over, 457-460 credit of, loans from partners affect, 367, 368 defined, 20, 21 N. Y. state law, 271 dissolution, 392-402 additional contributions to cover losses, 398 causes of, 392, 393 deficiency account, 394 distribution of proceeds, 396 distribution of proceeds by instalments, 399, 400 good-will, treatment of, 400, 401 insolvency (personal) of one partner, 398, 399 liquidation statement, 394 losses, sharing of, 396, 397, 398 statement of affairs, 394 financial statement, 29-31 general, 274, 275 good-will, treatment of, 360-363 incorporated, 457-460 interest, allowances, 372, 373 capital adjustment, 348-351 charges, 372 interest in, investment to obtain, 285, 286 purchase of fixed holding, 285, 286 investments, averaging, 352 valuation of, 284, 285 joint-stock companies, 276 limited, 275, 276 loans, distinguished from invested capital, 353, 354 partners' rights and procedure during liquidation, 395, 396 profit and loss statement, 47, 48 profits, 368-378 apportionment or distribution of prior to admission of new partner, 375, 376 INDEX 603 Partnership — (continued) profits — (continued) defined, 369-370 disposition of, 46 profit-sharing in, 279-284 investment, average, as basis of, 281-284 realty held by, 273 salaries, 371, 372 permissible under given con- ditions, 368, 369 special, 274-276 temporary nature, 392 termination of, 272 withdrawals, 375 Pass-book, 196 Payable, accounts (See "Accounts payable") Payments, identification on ledger, 105-107 Percentages, basis for estimating, 142 Petty cash (See "Cash, petty") Pixley, quoted on: accounting, branches of, 258 "P. M.," sales, premium money, 346 Posting (See "Ledger") Practice data (See pages at close of chapters, and Appendix B, 572-586) Premium, capital stock, 455 Premium money ("P. M."). 346 Problems, (See pages at close of chapters, and Appendix B, 572-586) Profit, capital accretions through, 352, 353 corporation, distribution of, 461, 462 net, disposition, 46 methods of determining, 49, 50 single-entry bookkeeping, 540 partnership, 368-378 reserved, 373-374 trading, 45 Profit and loss, 38-42 account, 112 closing entries, 103, 104 closing entry to surplus, 71 summary account only, 233 closing temporary proprietor- ship accounts, 231-233, 238 content uniform to permit com- parison, 370, 371 financial element as related to, 51-55 financial statement indicates, 34, 35 statement, 43-50 Forms, 47, 48, 243, 244, 510 account form, 242, 244 alternative titles for, 43 appropriation section, 46, 374 content of, 45, 46 form of departmental, 509, 510 partnership, 47, 48, 243, 244 principles governing make-up, 44 problems, 108 proprietorship, single, 47 report form, 45, Form, 47, 48, 243 sections of, 45, 46, 254, 255 summary, 43-50 Profit-sharing, partnership, 279-284 Pro forma, term defined, 50 Progressive ledger, 263, 266, 267 Proportion, simple and weighted, 505 Proprietor, capital account, 83, 84 6o4 INDEX Proprietor — (continued) personal account, 83, 84 sales to, 141, 423-425 Proprietorship, accounting, 12-18 opening entries, 162-164 accounts, classification of, 253-255 debit and credit application, 80-86 defined, 80 temporary, 80-82 balance sheet, 15, 16, 22, 23, 24, 34-37 corporation, 21, 22 decrease covered by debit entry, 69 defined, 14 equation, 14, 15-17 financial statement, 15, 16 increase covered by credit en- try, 69 partnership, 20, 21 records, temporary, 40, 41 single, advantages and disadvantages, 19, 20 defined, 19, 20 profit and loss statement, 47 temporary records, 51 vested, debits and credits, 83-85 Purchases, account covering, in cash, 132-134 classification, analysis must correspond with sales, 338, 339 departmental analysis, journal as medium of, 137, 138 discount (See "Discount, pur- chase";' "Discount, cash") invoice, 171, 172 journal, (See "Journal, pur- chase") open account, 132 rebate and allowances, account covering, in returned, account covering, in transaction, analysis of, 131-134 Quaderno, book of record (ancient), 6 Questions, review, 553-571 Realty, partnership holdings of, 273 Receipts, warehouse, 184 Receivable, accounts (See "Ac- counts receivable") Reconciliation, bank account, 495-498 factors of, 497 statement of, 497 other accounts, 498 Recourse, without, indorsement affected by prefix, 185 Red ink, use of, 100 Rent income, account covering, 116, 117, 118 Reserves, bad debts, 30, 31 corporation, 462-463 depreciation, 30, 31, 93, 94 Resources, (See "Assets") Revenue, expenditures, 94 Review questions, 553-571 Rome, ancient- methods of accounting in, 3, 4 Ruling, cash journals, 147, 148 INDEX 605 Ruling — (continued) journal, divided-column, 160 Form, 161 ledger, loi Form, 58 balance, 263 Form, 264, 265 center-column, 263 Form, 262 divided-column, 262 Form, 262 progressive or "Boston," 263 Form, 266 Safeguards (See "Cash, safe- guarding") Salaries, partners, 368, 369, 371, 372 Sale, analysis of transaction, 87 Sales, 335-346 account, consignments, 469, 470 entries to close, 112 allowances and returns, analysis required, 338 analysis, journal as means of, 336 approval, 482-484 accounting for, 482, 483 defined, 482 tickler file method of han- dling, 483, 484 bill and charge system, 344, 345 branches, 341 cash, cash journal entries covering, 154, iSS entries covering, 140 method of handling, 339-341 classification of, basis, 33s, 336 "C. O. D.," 344 commissions (salesmen), 345, 346 consignment, 341, (See also "Consignments") account, 469 Form, 470 cost of, method of calculating, 40, 41 department store, 343 future delivery, 342, 343 instalment, 342 accounting covering, 503 accounting essentials, 504, 505 delinquency record, S04 separation from regular sales, S03, 504 invoice, 172, 173 analysis based upon, 337, 338 merchandise returned, 173 terms and cash discount, 298, 303 journal (See "Journal, sales") rebate and allowances, account covering, 112 returned, account covering, 112 to proprietor, 141, 423-425 transaction, analysis of, 140 Salesmen (See "Sales") Savings banks, interest, 550, 551 Schedules, balance sheet, 411, 412 profit and loss, 509, 510 cost of goods sold, 510 Secondary entry, books of, 121 Self-balancing ledger, 420 Selling account (See "Trading account") Shipping, (See also "Freight") C. O. D., 188, 189 receipt, 187, 188 Single-entry bookkeeping (See "Bookkeeping, single entry") Single proprietorship (See "Pro- prietorship, single") Six-column statement, objection to, 386 6o6 INDEX "Spifs," sales commissions, 346 Statement, accounts receivable, 189, 190 financial, 239, 240 (See also "Balance sheet") account form, 241 comparative, 33-37 Form, 36 content of, 27, 28 fiscal periods, 43 profit and loss summary, 43- 50 purpose and use of, 26, 27 report form, 240 of account, monthly, Form, 190 profit and loss (See "Profit and loss") summary, 231-245 Statmography, 520 Stock, capital (See "Capital stock") Stockholders, corporation, 443 ultimate control of corporation held by, 461 Stock-taking (See "Inventory") Subtraction, methods in bookkeeping, 59 Summarizing the books, 103, 136, 191, 231, 424-432 (See also "Closing the books," "Ac- counts, closing") Summary, accounts, 384 (See also "Profit and loss") partial, purchases and sales, 231, 232, 384 cash book. Form, 432 entries, controlling accounts, cash book, 428 controlling accounts, general journal, 431 controlling accounts, note journal, 427, 428 controlling accounts, purchase journal, 425, 426, 431 controlling accounts, sales journal, 424, 428 general journal. Form, 430 sales journal. Form, 429 statements, need of, 239 Supplies, distinguished from expenses, I2S Synthesis, 259 Tabular ledger, 263, 266, 267 Taglienti, Giovanni Antonio, 7 "Tally stick," 4, S Tax, corporation organization (N. Y.), 442 Temporary proprietorship, 40, 80- 83 (See also "Accounts" and "Proprietorship") Terms of sale, 129 Trade acceptances, discount (cash) eliminated by, 310, 311 Trading account, 384, 385 Trading profit, gross, 45 Traffic department, duties, 189 Transferring accounts, loi, 103 Form, 102 Transplacement, errors due to, 218-219 Transposition, errors due to, 215-218 Trial balance, 386, 387 (See also "Ledger") Form, 97-98 INDEX 607 Trial balance — ( continued ) adjustment account, 518 classified, 268 defined, 97 errors, locating, 210-220 "fool proof," 511 method of showing balances, 210, 211 post-closing defined, 142 purpose and use of, 97, 212 work preliminary to, 98 Turnover, 65, 66 U United States Supreme Court, ruling covering, interest, partial payments of, 550 Vested proprietorship, 80, 83, 84 (See also "Accounts" and "Proprietorship") W Wages, accrued expense, account covering, 116, 117 cash payment of, entry covering, 71 Warehouse receipts, 184 Withdrawals of stock in trade, 423 Working sheet, 386-391 Form, 388, 389