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Author: 



Hodge, Albert Claire 



Title: 



Principles of accounting 



Place: 



Chicago 



Date: 



[1 920] 



(\W^%J^^-f^ 



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ORIGINAL MATERIAL AS FILMED • EXISTING BIBLIOGRAPHIC RECORD 







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Hodge, Albert Claire. 

Principles of accounting, by Albert Claire Hodge and 
James Oscar McKinsey. Chicago, 111., The University of 
Chicago press [1920] 



cm 



xiv, 389 p. illus. (forms) diagrs. 23 

Half-title : Materials for the study of business. 
Contains bibliographies. 



i=i".^n°""''"^- ?• ^•^foun'inK— Problems, exercises, etc i. McKinsey, 
James Uscar, jomt author. • — 



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Copyright A 576715 




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LIBRARY 




Schcx)! of Business 



MATERIAI^ FOR THE STUDY 
OF BUSINESS 



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PRINCIPLES OF ACCOUNTING 




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Principles of Accounting 



BY 



ALBERT CLAIRE HODGE 



AND 



JAMES OSCAR MCKINSEY 



THE UNIVERSITY OP OHICAOO PRESS 
CHICAGO. ILLINOIS 



THE BAKER & TAYLOR COMPANY 

raw TOBS 

THE CAMBRIDGE UNIVERSITY PRESS 

LOMDOH 

THE MARUZEN-EABUSHIEI.KAISHA 

TOKTO, OUKA, KYOTO, FUKUOEA, BUIDAI 

THE MISSION BOOK COMPANY 

BHANGHAI 




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THE UNIVERSITY OF CHICAGO PRESS 
CHICAGO, ILLINOIS 



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Copyright 1920 By 
The University of Chicago 



All Rights Reserved 



Published September iq2o 



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Composed and Printed By 

The University of Chicago Press 

Chicasro, Illinois, U.S.A. 



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EDITOR'S PREFACE 

Collegiate training for business management is now so widely 
attempted that the time has arrived when experiments should be 
conducted looking toward the organization of the business curriculum 
into a coherent whole. Training in scattered "business subjects" 
was defensible enough in the earlier days of collegiate business training, 
but such a method cannot be permanent. It must yield to a more 
comprehensive organization. 

There can be no doubt that many experiments will be conducted 
looking toward this goal; they are, indeed, already under way. This 
series, " Materials for the Study of Business, " marks one stage in such 
an experiment in the School of Commerce and Administration of the 
University of Chicago. 

It is appropriate that the hypotheses on which this experiment is 
being conducted be set forth. In general terms the reasoning back 
of the experiment runs as follows: The business manager administers 
his business under conditions imposed by his environment, both 
physical and social. The student should accordingly have an under- 
standing of the physical environment. This justifies attention to 
the earth sciences. He should also have an understanding of the 
social environment and must accordingly give attention to civics, law, 
economics, social psychology, and other branches of the social sciences. 
His knowledge of environment should not be too abstract in character. 
It should be given practical content, and should be closely related to 
his knowledge of the internal problems of management. This may be 
accomplished through a range of courses deahng with business manage- 
ment wherein the student may become acquainted with such matters 
as the measuring aids of control, the communicating aids of control, 
organization poHcies and methods; the manager's relation to pro- 
duction, to labor, to finance, to technology, to risk-bearing, to the 
market, to social control, etc. Business is, after all, a pecuniarily 
organized scheme of gratifying human wants, and, properly under- 
stood, falls little, if any, short of being as broad, as inclusive, as life 
itself in its motives, aspirations, and social obligations. It falls 

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EDITOR'S PREFACE 



little short of being as broad as all science in its technique. Training 
for the task of the business manager must have breadth and depth 
comparable with those of the task. 

Stating the matter in another way, the modem business manager 
is essentially a solver of business problems — problems of business 
p)olicy, of organization, and of operation. These problems, great in 
number and broad in scope, divide themselves into certain type 
groups, and in each type group there are certain types of obstacles 
to be overcome, as well as certain aids, or materials of solution. 

If these problems are grouped (i) to show the significance of the 
organizing and administrative, or control, activities of the modem 
responsible manager, and (2) to indicate appropriate fields of train- 
ing, the diagram on the opposite page (which disregards much over- 
lapping and interacting) results. It sets forth the present hypothesis 
of the School of Commerce and Administration conceming the basic 
elements of the business curriculum. 

This present volume in the series is designed to acquaint the 
student with the functions and methods of accounting as an instru- 
ment of business control. 

L. C. Marshall 



EDITOR'S PREFACE 



IX 



BASIC ELEMENTS OF THE BUSINESS CURRICULUM 

Of problems of adjustment to 
physical environment 

a) The earth sciences 

b) The manager's relationship 
to these 

Of problems of technology 

a) Physics through mechanics, 
basic, and other sciences 
as appropriate 

b) The manager's administra- 
tion of technology 

Of problems of finance 

a) The financial organization 
of society 

b) The manager's adminis- 
tration of finance 

Of problems connected with the 
market 

a) Market functions and mar- 
ket structure 

b) The manager's administra- 
tion of marketing (including 
purchasing and trafl&c) 

Of problems of risk and risk- 
bearing 

a) The risk aspects of modern 
industrial society 

b) The manager's administra- 
tion of risk-bearing 

Of problems of personnel 

a) The position of the worker 
in modem industrial society 

b) The manager's administra- 
tion of personnel 

Of problems of adjustment to 
social environment 

a) The historical background 

b) The socio-economic insti- 
tutional life 

c) Business law and govern- 
ment 



Control 

1. Communicating aids of control, 

for example 

a) English 

b) Foreign language 

2. Measuring aids of control, for 

example 

a) Mathematics 

b) Statistics and accounting 

3. Standards and practices of con- 

trol 

a) Psychology 

b) Organization policies and 
methods 






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AUTHORS' PREFACE 

This text is designed to accomplish three things: 

1. To give the prospective business manager a fairly definite idea 
of the type of service which can and should be provided by accounting 
as a measuring aid of business control. 

2. To give him a working knowledge of the fundamental prin- 
ciples underlying the gathering, analysis, and interpretation of 
accounting data. 

3. To give him at least an elementary knowledge of the technique 
employed in gathering accounting data, and in preparing the more 
generally used accounting reports. 

If these three objectives are successfully attained, the text should 
not only be useful to the student in a collegiate school of business but 
should serve equally well as the basis of an introductory course in 
accounting for students from other departments of a university. 

It should be understood that this text is not intended to furnish 
material for a full year's work in accounting. It is intended to give 
a survey of the accounting process, the presentation of which will 
extend over approximately one semester or quarter. A second 
volume, now in preparation, will show in some detail the application 
of the principles developed in this "survey" course to problems of 
•internal management and budgetary control. 

This text proceeds on the assumption that the primary function 
of accounting in modern industrial society is that of providing such 
statistical information for the various parties who exercise control 
over any business enterprise as will guide them in the exercise of this 
control. This idea is developed rather fully in the introductory 
chapter. Starting with this assumption, the student is led to see the 
need for the accounting reports, and is given an idea of the nature and 
form of the more widely used of these reports. The construction 
of the accounts, and the forms of accounting records used in recording 
and classifying the information which afifects the accounts, are then 
considered as means of making available such items of information 
as will be required in the preparation of the accounting reports. 
The first sixteen chapters are intended to give the student an under- 
standing of the nature of the "accounting process" as a whole. This 
first part of the book starts with a discussion of the reports and 

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AUTHORS' PREFACE 



develops the idea of the accounting process by proceeding from the 
reports to the ledger accounts, from the accounts to the books of 
original entry, from these forms of record to the vouchers, and 
thence to the business transaction. The second part begins with 
the transactions and the vouchers, proceeds to the books of original 
entry, thence to the accounts, with careful attention to their classi- 
fication, construction, and interpretation, and finally to the lise of 
the accounts in preparing the accounting reports. Thus the student 
is taken through the accounting process twice. The first time he 
starts by considering what it is that the accountant is trying to 
accomplish, and then develops the means by which this is to be 
accomplished. The second time he follows the process through in 
the order in which it actually occurs, giving considerably more 
attention than before to matters of procedure, form, and technique. 

Since college students are presumably not studying accounting 
with the aim of becoming bookkeeping clerks, an effort has been 
made to reduce the amount of routine work demanded in the labora- 
tory exercises to the minimum. At the same time, it has been the 
aim of the authors to make sure that every important principle 
developed in the text has been amply illustrated by means of 
laboratory exercises. 

The questions at the end of each chapter are designed to aid the 
student in his study of the chapter, and also to be suggestive to the 
instructor in his guidance of the class discussion. The " References 
for Further Study" are intended for both instructor and students. 
It may be suggested, however, that in the earher stages of his study, 
of accounting the student is in some danger of being confused by an 
attempt to consider the points of view of too many writers. 

The authors desire to make acknowledgment of the valuable 
assistance rendered by Mr. Robert Thorne, an undergraduate in the 
School of Commerce and Administration, who prepared the charts 
used in chapter xxxi. They desire also to acknowledge their indebted- 
ness to Dean Leon Carroll Marshall of the School of Commerce and 
Administration, and to Mr. George E. Frazer, C.P.A., each of whom 
has exercised an important influence on the point of view and the 
method of approach adopted in the preparation of the text. 



School of Commerce and Administration 

Univ'ersity of Chicago 

October i, 1920 



A. C. Hodge 

J. O. McKlNSEY 



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TABLE OF CONTENTS 

PAGE 

Chapter I. The Meaning and Function of Accounting 

Students of Accounting Are of Different Classes .... i 

Fundamentals of Accounting Same for All Classes. ... i 

Accoimting an Instrument of Business Control .... 2 

Reports May Be of Various Types 3 

Reports Useful to Various Interested Parties ..... 3 

Increased Size Has Meant Greater Complexity in Business Organi- 
zation 4 

Nature of Reports Affected by Functional Organization 6 

Reports Required by Owners and Prospective Investors . . 7 

Creditors Require Reports S 

The Public an Interested Party . 8 

Simimary of Parties Requiring Reports 9 

Accountant's Task to Gather Data and Prepare Reports . . 10 

Chapter II. The Relationship of Accounting to Proprietor- 
ship 

The Basis of Business Management . .... 13 

Business Investment Implies Existence of Assets and Liabilities 14 

Proprietorship 15 

Object of Business Operations to Increase Proprietorship . 16 

Proprietorship the Excess of Assets over Liabilities . . . 17 

Proprietorship May Assume Various Forms 18 

Single Proprietor Needs Reports for Control 18 

Partnership Form Involves Additional Considerations ... 19 

Corporation Typically a Modern Form 20 

Summary 21 

Chapter III. The Balance Sheet 

The Function of the Balance Sheet . 25 

Form of the Balance Sheet 26 

Debts Owed by Customers . . ... 27 

Merchandise on Hand 28 

Debts Owed Merchandise Creditors . 28 

The Balance Sheet with Accounting Terminology .... 29 

Methods of Determining the Value of Certain Assets ... 30 

Heading or Title of the Balance Sheet 31 

Subtitles of the Balance Sheet 31 

Illustration of the Standard Form of Balance Sheet • • . 33 

• •• 

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xiv TABLE OF CONTENTS 

PAGE 

Chapter IV. The Statement of Profit and Loss 

Statement of Profit and Loss Needed to Supplement Balance Sheet 39 

Form of Statement of Profit and Loss 41 

Sales 43 

Cost of Goods Sold • . . 43 

Gross Profit on Sales 44 

Classification of Expenses 44 

Operating and Non-operating Expenses 45 

Heading or Title of Statement of Profit and Loss .... 46 
Illustration of the Conventional Form of the Statement of Profit 

and Loss 47 

Balance Sheet and Statement of Profit and Loss Taken as Types of 

Reports 48 

Chapter V. The Account as a Means of Classifying Infor- 
mation 

A Means of Classifying Business Data Needed • • . . S3 

The Account a Means of Classification 54 

The Form of the Account 56 

The Balance of the Accoimt 57 

Interpretation of the Account Balance 58 

The Ledger and Its Contents 60 

Use of the Terms Debit and Credit in Relation to the Account . 60 

Accounts Affected by Business Transactions 61 

Determination of Debits and Credits to Accounts ... 63 

Equality of Debits and Credits to the Accounts .... 63 

Chapter VI. The Construction and Interpretation of Par- 
ticular Accounts 

Certain Facts to Be Considered in Interpreting Accounts . . 67 

Cash Account 67 

Accounts with Debtors 68 

Notes Receivable 68 

Accounts Receivable 69 

Accounts with Creditors 70 

Notes Payable 70 

Accounts Payable 71 

Accounts with Fixed Assets ' 71 

Office Furniture or Eqmpment 73 

Reserve for Depreciation of Office Furniture 74 

Delivery Equipment 75 

Reserve for Depreciation of Delivery Equipment .... 75 

Accounts with Proprietorship 76 






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TABLE OF CONTENTS 



XV 



PAG E 

Chapter VII. The Construction and Interpretation of Ac- 
counts 

Accounts with Merchandise . . . . . . . 81 

The Purchases Account 81 

The Sales Account 82 

The Inventory Account 82 

. Accounts with Operating Expenses 83 

Buying Expenses 83 

Selling Expenses 84 

Accounts with Delivery Expense and Drayage Expense . . 84 

Administrative Expenses 86 

Arrangement of Accounts in the Ledgers 86 

Summary 87 

Chapter VIII. The Trial Balance 

Purpose of the Trial Balance 92 

Method of Taking a Trial Balance 92 

Illustration of the Trial Balance 93 

The Trial Balance as a Report 97 

Chapter IX. The Adjusting Entries 

Need of Adjusting Entries 10 1 

Merchandise Inventory . . 102 

Illustration of the Inventory Account and Adjustments . . 103 

y Office Furniture and Delivery Equipment 105 

/ Methods of Showing Expenses in Accounts 106 

\Chapter X. The Closing Entries 

Purpose of the Closing Entries *. *. . 109 

Gross Profit on Sales 109 

Profit and Loss Account no 

Net Operating Profit m 

The Ledger after Closing 113 

Balancing and Closing the Accounts 114 

The Ruhng of Current Accounts with Persons and of Note 

Accounts 115 

Chapter XI. The Source of the Ledger Entries 

Need for a Record Other than the Ledger 118 

The Nature of Books of Original Entry 120 

The Journal 121 

Illustration of the Journal . . . .. . . . .122 

Posting ^.126 

Illustration of Posting 126 

Summary 129 



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XVI TABLE OF CONTENTS 

Chapter XII. Some Special Forms of the Journal 

Need for Special Books of Record— Advantages of Their Use 132 
The Purchases Journal ,^- 

The Purchases Journal Illustrated 135 

Posting from the Purchases Journal 1,7 

The Sales Journal j-o 

Illustration of Sales Journal .139 

Posting from the Sales Journal ! 140 

The Cash Journals ^.^ 

Fonn of the Cash Book ,^t 

Nature of the Cash Book , .j 

Posting the Cash Book t>.^ 

Summary . . ..... 143 

^ 143 

Chapter XIII. The Usfi of the General Journal 

Effect of Special Journals on the General Journal ... 147 

Opening Entries . 147 

Current Entries ' . 149 

Adjusting Entries j-^ 

The Closing Entries j -- 

Chapter XIV. Business Vouchers and Forms 

Purpose of the Voucher j -^ 

Classification of Vouchers and Forms 160 

The Merchandise Invoice . . j^ 

Form of the Merchandise Invoice jgj 

Negotiable Instruments jg^ 

Requisites of Negotiable Instruments . 165 

Kinds of Negotiable Instruments . . 155 

Ti'«i>'''ft .■;.:: ,66 

The Cashier's Check j^ 

Express and Postal Money Orders jy© 

Chapter XV. Business Vouchers and Forms (Concluded) 

Indorsement of Negotiable Instruments j^a 

Miscellaneous Business Forms 175 

The Statement of Account J77 

The Receipt ^« 

The Bill of Lading ••......[ lyg 

Forms Used in Transactions with the Bank 180 

The Deposit Ticket . ■ 181 

The Signature Card ! 182 

The Pass Book g 

The Bank Statement 182 

The Check « 



TABLE OF CONTENTS 



xvu 






Chapter XVI. The Accounting Process 

Purpose of the Chapter 186 

• Accoimting Reports 186 

The Accounts igg 

The Books of Original Entry 188 

Business Vouchers and Forms 189 

The Accounting Process igo 

Importance of the Accoimting Process 191 

Chapter XVII. Business Practice and Procedure— Purchases 
and Sales 

Purpose of the Chapter 193 

Methods of Handling Purchases . . . . 193 

The Purchase Requisition 194 

The Purchase Order jg^ 

The Purchase Invoice jg^ 

Methods of Handlmg Sales— the Sales Order 197 

The Sales Invoice jqq 

Shipping or Delivery of Merchandise .199 

Chapter XVIII. Business Practice and Procedure— Cash 
AND Notes 

Cash Receipts 202 

Cash Disbursements 203 

Petty Cash Funds 204 

The Imprest System for Petty Cash 204 

Method of Handling Notes Receivable and Payable . .206 

Use of the Trade Acceptance . 207 

Accounting for Trade Acceptances 210 

Chapter XIX. Books of Original Entry— Sales and Purchases 
Records 

Purpose of Books of Original Entry 212 

Subdivisions of the Journal 212 

Use of Special Colimms in Books of Original Entry . .213 

The Recording of Sales 214 

Cash Sales • 21c 

Analysis of Sales by Departments 216 

Recording Retail Sales 217 

Sales Deductions . . 217 

Sales Returns and Allowances Journal 218 

Recording Purchases 219 

Departmental Analysis in the Purchases Journal . . T 220 

Purchases Other than Merchandise 220 

Purchase Deductions 221 



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xviii TABLE OF CONTENTS 

PAGE 

Chapter XX. Books of Original Entry — The Cash Journal 

The Cash Book 223 

Cash Receipts — ^Analysis . 223 

Cash Receipts — Credits 224 

Illustration of Cash Receipts Journal 225 

Analysis of Cash Disbursements — Credits 227 

Analysis of Cash Disbursements — Debits 227 

Illustration of the Cash Disbursements Journal . . .228 

Chapter XXI. Controlling Accounts 

Some Uses of Special Columns 237 

The Controlling Accoxmt 237 

The Use of the Controlling Account Illustrated .... 242 

Summary 250 

Chapter XXII. The Construction and Interpret.\tion or 
Accounts — Assets 

Cash Account 253 

Accounts Receivable 254 

Reserve for Bad Debts 255 

Notes Receivable 256 

Notes Receivable Discounted 257 

Notes Receivable Dishonored 259 

Accounts with Fixed Assets 259 

Charges to Capital versus Charges to Revenue .... 260 

Chapter XXIII. Construction and Interpretation of Accounts- 
Liabilities 

Purpose of the Chapter 266 

Current Liabilities 266 

Accounts Payable 4 266 

Notes Payable 267 

Fixed Liabilities 268 

Mortgages Payable 269 

Bonds Payable 269 

Long-Term Notes .271 

Chapter XXIV. Construction and Interpretation of Accounts — 
Proprietorship Accounts 

Purpose of the Chapter 273 

Proprietorship Accoimts for the Single Proprietor . . .273 

The Proprietor's Personal Account 274 

Proprietorship Accounts in the Partnership 275 

The Partner's Drawing Account 275 



TABLE OF CONTENTS xix 

PAGE 

Proprietorship Accounts in the Corporation . .277 

Capital Stock . 277 

Discount on Stock 278 

Surplus 279 

Proprietorship Reserves 280 

Chapter XXV. Construction and Interpretation of Accounts — 
Income Accounts 

Kinds of Income Accounts 288 

Accounts with Operating Income 288 

Sales Account 288 

Deductions from Sales 290 

Non-operating Income Accounts 291 

Interest on Notes Receivable 291 

Cash Discount on Purchases 292 

Chapter XXVI. Construction and Interpretation of Accounts^ 
Expense Accounts 

Kinds of Expense Accounts 295 

Operating Expense Accounts . 295 

Cost of Goods Sold Accounts 296 

Purchases Accounts 296 

Accounts with Purchases Deductions 297 

Other Cost of Goods Sold Accounts 298 

Other Operating Expense Accounts 299 

Accounts with Estimated Operating Expenses . . . . 300 
Accounts with Other Deductions from Income . . .301 

Interest on Notes Payable 302 

Cash Discount on Sales 302 

Chapter XXVII. Accruals and Deferred Items 

Types of Items to Be Considered 305 

Accrued Income 305 

Accrued Expenses .......... 308 

Deferred Charges to Expense 310 

Deferred Credits to Income 313 

Chapter XXVIII. The Adjusting and Closing Entries 

Need for Such Entries ^18 

The Working Sheet 319 

Illustration of the Working Sheet .319 

The Statement of Profit and Loss 322 

The Balance Sheet 325 

The Closing Entries 326 

The Post-closing Entries 328 

The Post-closing Trial Balance 329 



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XX TABLE OF CONTENTS 

PAGE 

Chapter XXIX. The Classification of Accounts 

The Purpose Served by the Accounts 334 

The Fundamental Classification of Accounts 335 

The Property Accounts 336 

Illustration of the Property Accounts 337 

The Proprietorship Accounts 338 

The Revenue Accounts 340 

Illustration of the Revenue Accounts 341 

Numbering of Accounts 343 

Illustration of the Numbering of Accounts 344 

Lack of Uniformity in Classification and Numbering of Accounts 346 

Chapter XXX. Financial Reports 

Nature and Purpose of Financial Reports 349 

The Conventional Financial Reports 349 

Exhibits 35© 

Schedules 351 

Analytical Statements 352 

The Comparative Balance Sheet 353 

The Analysis of the Surplus Account 353 

The Comparative Statement of Profit and Loss . . -358 

The Statement of Receipts and Disbursements . .361 

Chapter XXXI. The Graphical Method of Presenting Account- 
ing Facts 

Diversified Reports Required by Management .... 364 

The Use of the Statistical Method 364 

Illustration of the Statistical Method 366 

The Graphic Method Illustrated 367 

Comparison of Gross Sales with Net Sales 370 

Comparison of Gross Sales and Cost of Goods Sold . . .370 

Comparison of Gross Sales and Advertising Expense . -372 

Comparison of Gross Sales and Operating Expenses . . 373 

Comparison of Gross Sales and Net Profit 374 

Other Methods of Graphical Presentation 374 

Advantages of the Graphic Method 376 

Limitations of the Graphic Method 376 

Summary 377 

Appendix 379 

Index 39i 




I. 
2. 

3. 

4. 

S- 
6. 

7. 
8. 

9- 
o. 

I. 

2. 

3- 
4- 

s. 

6. 

7. 
8. 

9- 
20. 

21. 

22. 

23. 
24. 

25- 
26. 

27. 

28. 

29. 

30. 

31. 

32- 

33- 
34- 
35. 
36. 
37. 



LIST OF ILLUSTRATIONS 

PAGE 

Balance Sheet, Report Form 33 

Balance Sheet, Account Form 34 

Statement of Profit and Loss 47 

The Account S^ 

The Ledger 93 

The Trial Balance 97 

Ruling OF the Account 115 

Ruling of Current Accounts 116 

The Journal 124 

Ledger 127 

Purchases Journal 136 

Sales Journal 139 

Debit Side of Cash Book 141 

Credit Side of Cash Book .142 

Adjusting Entries 153 

Closing Entries 154 

Merchandise Invoice 162 

Sales Ticket 163 

Check : . 164 

Note 164 

Bank Draft 167 

Commercial Draft 167 

Commercial Draft 168 

Cashier's Check 170 

Express Money Orde^ 170 

Statement of Account 178 

Deposit Ticket ' . . 181 

Bank Statement 183 

Purchase Requisition 194 

Purchase Order 196 

Sales Order 198 

Petty Cash Journal 204 

Petty Cash Book 205 

Notes Receivable Register . ,_ 207 

Notes Payable Register >- 207 

Trade Acceptance 208 

Debit Side of Cash Book 214 

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xxii LIST OF ILLUSTRATIONS 

PAGE 

38. Sales Journal 215 

39. Sales Journal 216 

40. Sales Journal 216 

41. Sales Journal 217 

42. Sales Returns AND Allowances Journal • .218 

43. Sales Returns and Allowances Journal 219 
44- Purchases Journal 219 

45. Purchases Journal 220 

46. Purchase Returns and Allowances Journal . . .221 

47. Debit Side of Cash Book 226 

48. Credit Side of Cash Book 229 

49. Debit Side of Cash Book 239 

50. Credit Side of Cash Book 241 

51. Purchases Journal 243 

52. Sales Journal 243 

53. Cash Book 244 

54- Journal 246 

55. Ledger, with Controlling Accounts ... .246 

56. Insurance Policy Record 311 

57. Notes Discounted Record 314 

58. Adjusting Entries 321 

59. Working Sheet 323 

60. Statement of Profit and Loss 324 

61. Balance Sheet 325 

62. Closing Entries 326 

63. Post-Closing Entries 329 

64. Post-Closing Trial Balance 330 

65. Numbering of Accounts 344 

66. Schedule of Cash Balance 351 

67. Analysis of Buying Expense . ". 352 

68. Comparative Balance Sheet 354 

69. Analysis of Surplus Account 356 

70. Comparative Statement of Profit and Loss, with Per- 

centages 359 

71. Statement OF Receipts AND Disbursements .... 361 

72. Graphic Chart Showing Comparison of Sales and Adver- 

tising Expense 366 

73. Table Showing Monthly Ratios of Gross Sales to Adver- 

tising Expense 367 

74. Table Showing Sales, Operating Expenses, and Net 

Operating Profit for a Year, Analyzed by Months . 368 



/l> 



LIST OF ILLUSTRATIONS 



xxm 



PAGE 

75. Table Showing Comparison by Means of Percentages 369 

76. Graphic Chart Showing Gross Sales 369 

77. Graphic Chart Showing Comparison of Gross Sales and 

Net Sales, by Months 37i 

78. Graphic Chart Showing Comparison of Gross Sales and 

Cost of Goods Sold, by Months 37 1 

79. Graphic Chart Showing Comparison of Gross Sales and 

Advertising Expense, by Months 372 

80. Graphic Chart Showing Comparison of Gross Sales and 

Operating Expense, by Months 373 

81. Graphic Chart Showing Comparison of Gross Sales and 

Net Operating Profit, by Months 374 

82. Graphic Chart Showing Comparison of Year's Sales with 

Sales OF Preceding Year . 375 

83. Graphic Chart Showing Comparison of Sales, Operating 

Expenses, and Profits, for Each of Three Months . 37S 



•t.i 




CHAPTER I 



f 



THE MEANING AND FUNCTION OF ACCOUNTING 

Students of accounting are of different classes. In taking up the 
study of accounting it should be recognized at the outset that there 
is more than one field in which the student may later desire to use his 
knowledge of the subject, and that to make successful use of a knowl- 
edge of accounting in any one of these fields requires a training of a 
more or less speciaUzed nature. The college and university students 
who present themselves for training in accounting may be divided 
into three rather broad groups, which may be defined as follows: 

1. Those who study accounting with the aim of understanding its 
use as a means of social control over business activities. This group 
consists for the most part of students of economics, whose special 
interest is in the relation of government to business. It is probably 
the smallest of the three groups. 

2. Those who expect eventually to qualify as certified public 
accountants and to follow the profession of pubUc accounting, in 
which they will be called upon to deal with a wide range of accounting 
problems. This is typically a larger group than the first one. 

3. Those who exj>ect to become business executives of one kind 
or another, or to furnish specialized accounting service to the manage- 
ment of a particular business enterprise as a member of the organiza- 
tion rather than as a public accountant. This is probably much the 
largest of the three groups. 

Fundamentals of accounting same for all classes. It is for the third 
of these groups that this introductory text in accounting is primarily 
designed. The primary object of schools of commerce in universities 
and colleges is to train men and women who will become business 
managers. It seems desirable that such students should be given a 
survey of the general field of accounting. They should be made famil- 
iar with the nature of the accounting process in general and with the 
broad underlying principles which are generally recognized as sound 
by practicing accountants and by writers on the subject. It will be 



# 




n 






2 PRINCIPLES OF ACCOXJNTING 

found, however, that a beginning course in accounting which furnishes 
the student with a satisfactory foundation for the continuation of his 
studies in. any one special field of accounting will serve equally well 
as the basis for specialization in any of the other fields of accounting. 
If this text is successful in furnishing the business manager or mana- 
gerial accountant with a proper approach to the subject, it should 
render an equally great service to the student who will eventually 
decide to offer his services to business owners and managers as a public 
accountant or auditor, or as a specialist in any line of accounting. 

Accounting an instrument of business control. In the study of 
accounting, one should not expect to meet with any new and exclusive 
subject-matter. As in other courses in the field of business training, 
the scope of this course must be organized industrial society as a 
whole, with all of its institutions. The prospective business man and 
the instructor who tries to help train him are interested in this indus- 
trial society primarily on account of the manner in which its organiza- 
tion affects the nature of the problems which the business manager 
must meet. In order to deal successfully with his particular prob- 
lems, the manager must have prepared for his use certain data in the 
form of reports, which will furnish him with information upon which 
to base his judgments. It is the function of accounting to prepare 
such reports and to provide the information which makes their 
preparation possible. 

It is, then, with the use of reports as a means of business control 
that the student will be chiefly concerned in the general survey of the 
accounting field which he is now beginning. Under the old ideas of 
nomenclature, such a study- probably would not be termed accounting 
in preference to statistics, but that is not a point which need cause the 
student any particular concern. Statistics is the technique of gather- 
ing, interpreting, and presenting in intelligible form information which 
is capable of being expressed numerically. The term is quite inclu- 
sive and, strictly speaking, accounting is merely a single phase of the 
employment of the statistical method. The attempts at classification, 
subdivision, and pigeonholing which have been made in the curricula 
as regards the field of statistics have served to obscure its relations to 
the uses to which it may be put rather than to clarify them. If it is 
desirable, as it probably is, to distinguish accounting from the general 
field of statistics, the demarcation is to be found partly in the nature 



I 



THE MEANING AND FUNCTION OF ACCOUNTING 3 

of the information dealt with, namely, the records of the particular 
business enterprise, and partly in the method employed in classifying 
that information, namely, the account, in the technical sense. It will 
appear, however, as the student proceeds in his investigations in the 
subject, that the reports prepared for the use of the various parties 
interested in the business are not all made up from information fur- 
nished by the accounts, so called, but in many cases are drawn from 
other kinds of records where the method of compiling the information 
is not peculiar to the field of accounting but is such as is employed in 
other kinds of statistics. For purposes of this text, then, it is not neces- 
sary or desirable that the student should attempt to narrow his con- 
cept of the field of accounting beyond that of the use of reports as an 
aid to the conduct of business, and incidentally an aid to the control and 
regulation by society of certain phases of private business enterprise. 

Reports may be of various types. It may not be safe to proceed 
on the assumption that the student is clear as to the meaning of the 
word *' report" as here employed. As a matter of fact, it is used 
in no pecuUar sense, except that a written report is contemplated 
rather than an oral one. By a report, as usfed in connection with 
business management, is meant merely a statement of certain facts 
regarding the business, or regarding plans contemplated in the con- 
duct of the business. This statement shows such analysis of the 
information presented as may seem desirable for the use of the party 
to whom the report is submitted, and is drawn in such form as seems 
most intelligible and enUghtening. Such a report may be, for example, 
a statement of the financial condition of the business, as of a given 
date, submitted to the owners, to the creditors, or to a governmental 
agency. Or it may be a statement submitted by a subordinate 
manager to the general manager of a company, settmg forth his plans 
for the coming year, or a statement showing the results of the opera- 
tions for which he is responsible during the past year. Probably this 
will be clarified to some extent by the discussion which follows con- 
cerning the need of such reports in the modern business organization. 

Reports useful to various interested parties. Assuming, on the 
basis of the above discussion, that the matter to be dealt with under 
the head of accounting has to do with the use of business reports, the 
next step is to consider from what various points of view data need 
to be gathered and reports prepared. Who are the parties that are 



INTENTIONAL SECOND EXPOSURE 



2 PRINCIPLES OF ACCOUNTING 

found, however, that a beginning course in accounting which furnishes 
the student with a satisfactory foundation for the continuation of his 
studies in any one special field of accounting will serve equally well 
as the basis for specialization in any of the other fields of accounting. 
If this text is successful in furnishing the business manager or mana- 
gerial accountant with a proper approach to the subject, it should 
render an equally great service to the student who will eventually 
decide to offer his services to business owners and managers as a public 
accountant or auditor, or as a specialist in any line of accounting. 

Accounting an instrument of business control. In the study of 
accounting, one should not expect to meet with any new and exclusive 
subject-matter. As in other courses in the field of business training, 
the scope of this course must be organized industrial society as a 
whole, with all of its institutions. The prospective business man and 
the instructor who tries to help train him are interested in this indus- 
trial society primarily on account of the manner in which its organiza- 
tion affects the nature of the problems which the business manager 
must meet. In order to deal successfully with his particular prob- 
lems, the manager must have prepared for his use certain data in the 
form of reports, which will furnish him with information upon which 
to base his judgments. It is the function of accounting to prepare 
such reports and to provide the information which makes their 
preparation possible. 

It is, then, with the use of reports as a means of business control 
that the student will be chiefly concerned in the general survey of the 
accounting field which he is now beginning. Under the old ideas of 
nomenclature, such a study probably would not be termed accounting 
in preference to statistics, but that is not a point which need cause the 
student any particular concern. Statistics is the technique of gather- 
ing, interpreting, and presenting in inteUigible form information which 
is capable of being expressed numerically. The term is quite inclu- 
sive and, strictly speaking, accounting is merely a single phase of the 
employment of the statistical method. The attempts at classification, 
subdivision, and pigeonhoUng which have been made in the curricula 
as regards the field of statistics have served to obscure its relations to 
the uses to which it may be put rather than to clarify them. If it is 
desirable, as it probably is, to distinguish accounting from the general 
field of statistics, the demarcation is to be found partly in the nature 




.cz- 



'W 



.X ' 



THE MEANING AND FUNCTION OF ACCOUNTING 3 

of the information dealt with, namely, the records of the particular 
business enterprise, and partly in the method employed in classifying 
that information, namely, the account, in the technical sense. It will 
appear, however, as the student proceeds in his investigations in the 
subject, that the reports prepared for the use of the various parties 
interested in the business are not all made up from information fur- 
nished by the accounts, so called, but in many cases are drawn from 
other kinds of records where the method of compiling the information 
is not peculiar to the field of accounting but is such as is employed in 
other kinds of statistics. For purposes of this text, then, it is not neces- 
sary or desirable that the student should attempt to narrow his con- 
cept of the field of accounting beyond that of the use of reports as an 
aid to the conduct of business, and incidentally an aid to the control and 
regulation by society of certain phases of private business enterprise. 

Reports may be of various types. It may not be safe to proceed 
on the assumption that the student is clear as to the meaning of the 
word "report" as here employed. As a matter of fact, it is used 
in no peculiar sense, except that a written report is contemplated 
rather than an oral one. By a report, as used in connection with 
business management, is meant merely a statement of certain facts 
regarding the business, or regarding plans contemplated in the con- 
duct of the business. This statement shows such analysis of the 
information presented as may seem desirable for the use of the party 
to whom the report is submitted, and is drawn in such form as seems 
most intelligible and enlightening. Such a report may be, for example, 
a statement of the financial condition of the business, as of a given 
date, submitted to the owners, to the creditors, or to a governmental 
agency. Or it may be a statement submitted by a subordinate 
manager to the general manager of a company, setting forth his plans 
for the coming year, or a statement showing the results of the opera- 
tions for which he is responsible during the past year. Probably this 
will be clarified to some extent by the discussion which follows con- 
cerning the need of such reports in the modern business organization. 

Reports useful to various interested parties. Assuming, on the 
basis of the above discussion, that the matter to be dealt with under 
the head of accounting has to do with the use of business reports, the 
next step is to consider from what various points of view data need 
to be gathered and reports prepared. Who are the parties that are 



PRINCIPLES OF ACCOUNTING 



interested in the business, and what is the nature of their respective 
interests ? The answer to this question may help to explain the great 
increase in demand for trained accountants which has been felt in 
the last few years. 

Not more than fifty years ago the typical business organization was 
one with a relatively small amount of invested capital. This capital 
was in most cases contributed by a single individual or by a small and 
closely connected group. Its problems of management, judged by 
present standards, were not especially complex, and were dealt with 
by a single manager or by a small group who were responsible for 
all of the functions of the business enterprise, and who found little 
difficulty in being familiar with most of the details, or at least the 
significant details, of the business. Outside of the so-called "public 
utility" industries, it was rarely true that the scope of the busmess 
of any single organization was so wide as to affect vitally any large 
community interest, so that the pubUc as a group had Uttle concern 
with the regulation of the affairs of the business. 

From all these circumstances it followed naturally enough that 
the reports required, and consequently the records necessary for their 
preparation, were of a fairly simple type, and were of interest to only 
a few persons. The conventional financial reports, setting forth the 
results of operations in terms of general financial condition and of 
profit and loss, were entirely adequate to the needs of the typical 
business enterprise of the period. 

Increased size has meant greater complexity in business organization. 
It is needless to point out that very great changes have been taking 
place since the time when such conditions could be said to be repre- 
sentative. A large number of business enterprises have grown up, 
each of which represents a tremendously large capital investment, this 
investment usually being made on varying terms by a large number 
of individuals. Instead of the owners carrying on the management of 
the business themselves, as was formerly the typical case, it has 
become necessary for the management to be intrusted to subordinates, 
men of special training in their particular fields of management. 
A president or general manager is placed in charge of the entire 
business, being held responsible by the owners, and he in turn intrusts 
the carrying out of particular functions of the business to certain 
subordinate managers, who report to him, and whom he holds respon- 



THE MEANING AND FUNCTION OF ACCOUNTING 



sible for the proper carrying out of their particular functions. Thus 
the president or the general manager might well have subordinate 
to him and reporting to him: 

1. A sales manager, who would be in charge of the marketing 
of the products or services upon whose sale the business depends for 
its chief revenue. This sales manager would probably also have 
subordinates, as, for example, one in charge of domestic, and one in 
charge of foreign, sales. Subordinate to or coordinate with him, 
according to the organization, would probably be the advertising 
manager, with his staff. 

2. A merchandise man, or manager in charge of purchases, in 
the case of a business which buys in a finished state the product 
which it sells. It would be the duty of this man to have general 
charge of the task of obtaining the goods which are to be sold, and 
he would have, in a large business, various subordinates who are 
speciaUsts in certain types of merchandise purchasing. 

3. A production manager in a manufacturing business who is 
responsible for supplying through production the product or service 
necessary to supply the demands of the customers. The purchasing 
of materials necessary for this purpose would be in charge of a general 
purchasing agent who might or might not be subordinate to the 
production manager, but who in any case must co-operate with him. 

4. A financial manager, who is responsible for the formulation and 
execution of the financial policy of the business. Usually he is not 
given final authority in cases of great importance, but it is his duty 
to provide the information which will serve as a basis for formulating 
the financial poUcy of the business and to execute that poUcy after 
it has been formulated. Subordinate to the financial manager, who 
is sometimes called the treasurer or comptroller, there may be a credit 
manager and a collection manager. In any case there must be close 
co-operation between the financial manager and those who guard the 
credits of the firm. 

5. Miscellaneous managers, such as superintendent of buildings, 
operating superintendent, employment manager, etc., whose titles 
indicate their duties. 

The foregoing list of subordinates who assist the president or 
general manager in the formulatioa and execution of the polides 
of the firm is intended to be suggestive rather than inclusive. The 



i 



6 PRINCIPLES OF ACCOUNTING 

ones mentioned are those who are necessary to supervise and control 
the functions which are common to businesses in general. 

It is not intended that the student shall gather from the foregoing 
that all businesses are so organized that one man is placed in charge 
of each of these fields. A smgle man may, of course, perform all of 
the functions suggested above, or they may be combined in any way 
that may be suggested by the size of the business and the special 
abiUties of the men who are in the particular organization. Thus the 
president might be also the comptroller, while the sales manager 
might be in charge of the credits and collections. 

Nature of reports affected by functional organization. It is not 
difficult to see that in a business organized along the lines indicated 
above, there would be need for reports for at least two purposes: 

(i) To furnish each of the functional managers with information 
that would enable him to judge how well his subordinates were carry- 
ing out their duties, and to aid him in planning and carrying out his 
own duties in a successful manner. (2) To furnish the president or 
general manager with information which will enable him to evaluate 
the success of the work done by his subordinate managers in the period 
or periods covered by such reports. These reports should also supply 
him with such information as will furnish a basis upon which to plan 
for the conduct of business operations during the commg period, and 
to correlate the operations of the various subordinate managers in 
conformity to this general plan. For example, when he has con- 
sidered the reports of past performances, and the plans and suggestions 
of the subordinate managers with regard to operations for the coming 
period in each of their fields, he may urge the sales manager to try 
for a volume of sales greater than that of the period just past. It is 
possible, also, that the difficulty of financing any greater volume of 
sales, as indicated by the financial manager's report, or the difficulty 
of securing the materials or labor necessary to keep up the quality 
of the product, as indicated by the report of the purchases manager 
or the personnel manager, might be so serious as to lead him to the 
conclusion that sales must be held at the level of the last period or 
even curtailed. 

The gathering and interpreting of data for such reports as have 
been suggested here, namely, reports to aid in solving the problems 
of the internal management of the business, is really the primary 



THE MEANING AND FUNCTION OF ACCOUNTING 7 

t 

function of accounting. Accounting justifies itself in any organization 
carried on for purposes of making a profit only as it serves as an aid in 
maintaining the investment in the business and in earning an adequate 
return upon that investment. It is therefore upon the use of accounts 
as an aid to management that emphasis will be placed" in this text. 

Reports required by owners and prospective investors. While report- 
ing for managerial purposes is the chief function of accounting, there 
are also other interested parties to whom reports must be submitted. 
The various parties who have investments in the business desire to 
be able to evaluate the profitableness of that investment and the/ 
desirability of continuing it or of adding to it. Also, it may be found 
desirable to interest additional investors and thus secure additional 
capital to extend the business and place it on a more profitable basis. 
Needless to say, the prospective investor would demand that infor- 
mation be furnished him which would give him some idea of the con- 
dition and earning power of the business before he would risk his 
funds by investing them therein. 

Investments in the modern business enterprise are made on a 
variety of terms. Different classes of investors have different kinds 
of claims on the business, with respect to the amount of income they 
may expect, the guaranty for the payment of that income to them, 
the conditions under which their investment is to be returned to them, 
and the security which they have for the safety of the investment. 
Most of the students who read this text are familiar in a general way 
with the nature of the contract between the investors and the average 
corporation when the latter issues any of the usual types of securities. 
There are marked points of difference in the claims on both capital 
and income among the holders of the most common types of corpora- 
tion securities, such as common stock, preferred stock, whether cumu- 
lative or non-cumulative, mortgage bonds, collateral trust bonds, 
equipment trust certificates, and so on. 

It follows from all this that the accounts must be kept not only 
for the use of the internal managerial organization, but also in such a 
manner as to permit the preparation of reports that will set forth 
clearly the status of each of the different classes of investors, not only 
to protect the rights of each class in the distribution of net profit, 
but also to enable each to estimate closely the value of his investment 
or proposed investment. 



8 



PRINCIPLES OF ACCOUNTING 



Creditors require reports. Another class which is keenly interested 
in the financial and operating health of the business enterprise is that 
of the creditors. There are two chief kinds of creditors, besides the 
bondholders, who have been included among the investors, though 
strictly speaking they are really long-time creditors. The two kinds 
of short- time creditors are: (i) trade creditors and (2) commercial 
banks. Both classes typically require reports setting forth the 
financial condition of the concerns which apply to them for credit. 
Some commercial credit agencies and many banks have standard 
forms upon which applicants for credit are required to make reports. 
The emphasis in these reports is somewhat different from that in 
reports to owners and long-time creditors like bondholders, but on the 
whole they usually contain about the same information as the latter. 
Neither type of report presents anything like as difficult a problem 
in accounting as the first class mentioned, namely, the reports for 
managerial purposes. 

The public an interested party. Such a business as we are discussing 
may be of such importance, owing to its size or to the nature of its 
product, that it involves a public interest in the way the business is 
carried on. There is nothing new or strange about this as applied to 
the so-called "utilities," such as the common carriers, the gas and 
electric companies, etc. In the case of these businesses it is recognized 
that the public is vitally concerned, and regulation is undertaken 
with the double purpose of making sure (i) that the service rendered is 
adequate and satisfactory in quality, and (2) that it is rendered at a 
reasonable rate. It is easy to see that no regulatory body could hope 
to accomplish much along the lines indicated unless they were fur- 
nished with reports showing the amount of investment in the company 
in question along with its earnings and expenses. Otherwise they 
would certainly be in no position to judge whether the company was 
earning enough to pay its investors a return sufficient to keep their 
capital in the business over a long period and to attract additional 
capital as it is needed in order to keep pace adequately with the 
demands of the public for the goods or services in question. As a 
result we find that practically every company of this character is 
required by some regulatory body to make reports on standardized 
forms at certain times. The records which must be kept in order to 



THE MEANING AND FUNCTION OF ACCOUNTING 



prepare these reports are as a rule such as would serve well enough 
as a basis for the preparation of reports to investors or to creditors, 
but they would not furnish a sufficiently detailed analysis for purposes 
of managerial reporting. 

The necessity of reporting to government agencies is not confined 
to the utilities, however, but extends now to practically every business 
enterprise. The requirements of reporting for the purpose of the 
income, excess-profits, and war-profits taxes have practically forced 
even the smaller businesses into some sort of record-keeping. During 
the war the interest of society as a whole in the individual business 
reached a point of development previously unknown. The raw 
materials and supplies used, the transportation facilities, the labor 
supply, the financing, the disposal of the product, and the rate of 
profit, all received the attention of the government as the exigencies 
of the war seemed to make it desirable. It is fairly safe to predict 
that in the future two things will be true as a result of this war-time 
regulation. In the first place, there will be a greater degree of govern- 
ment regulation of private business than in the past, necessitating 
for many businesses more complete records than they had formerly 
kept. Secondly, many small businesses, having had the matter of 
reporting forced upon their attention, will come to realize its impor- 
tance and will in the future maintain more adequate systems of records 
and will make more use of repiorts within the business. 

Summary of parties requiring reports. To summarize the dis- 
cussion with regard to the various parties interested in the modern 
business and demanding reports prepared from the records kept in 
that business, these interested parties may be indicated as follows: 
I. The managerial staff 

a) President, or general manager 

b) Sales manager 

c) Head merchandise man, or purchases manager (in a commer- 

cial business) 

d) Factory superintendent, or production manager (in a manu- 

facturing business) 

e) Comptroller, or financial manager 

/) Other functional managers, varying with the organization of 
the business 



I ■ - 

I 



lO 



PRINaPLES OF ACCOUNTING 



2. Investors, present and prospective 

a) Stockholders, of various classes 

b) Bondholders, also of various classes 

3. The creditors 

a) Trade creditors 

b) Commercial banks 

c) Other creditors 

4. The government 

a) For regulation of the price 

b) For regulation of the quality 

c) For purposes of taxation 

d) For purposes of limitation on the amounts of certain materials 

and services that can be used 

e) For the protection of those employed— regulation of hours, 

wages, working conditions, child labor, female labor, etc. 

A ccountatU's task to gather data and prepare reports. The purpose of 
going into the foregoing discussion with regard to the parties who 
require reports on various phases of the modem business has been 
that of giving the student some idea of the increasingly broad field 
in which the accountant may work. Given a certain type of business 
organization, with certain relations to its investors, to its creditors, 
and to the pubHc in general, it is the accountant's task to determine 
what forms of reports will best serve the various purposes for which 
reports are needed, to ascertain what data will need to be gathered 
to serve as a basis for the preparation of these reports, to design a 
system of records which will faciHtate the gathering and necessary 
analysis of this data, and finally to prepare from the data thus 
gathered the reports and schedules determined upon. That this 
task is not an insignificant or an easy one will be realized by the 
student as he goes farther in the study of accounting. 

To prepare him for this task several things are necessary: (i) He 
must acquire some insight into the nature of the problems in the 
solution of which the business executive may reasonably expect aid 
from the accountant. (2) He must have some idea of the type of 
information which will be helpful in solving these problems, and of 
the forms of reports in which this information may be presented. 
(3) He must understand the analysis necessary to make available the 
desired information, and the various possible bases upon which this 



THE MEANING AND FUNCTION OF ACCOUNTING 



II 



analysis may be made. (4) He must learn how to design forms of 
records which will enable him to provide for the recording of individual 
business transactions, evidenced by various types of business papers 
involved, in such a way as to make readily p>ossible the analysis which 
has been decided upon as desirable. 

Keeping in mind, then, the broad field that has been outlined 
above as the province of the accountant, the student must content 
himself for the present to deal with reports only as typified by certain 
simple and conventional kinds. These simple, conventional types 
will be studied, together with certain conventional types of records 
used in gathering the information needed for them, with the aim of 
familiarizing the student with certain more or less standard termi- 
nology and technique of accounting. If this aim can be successfully 
accomplished in the earlier part of the course, he will at that time have 
acquired not only this necessary technique but also some insight 
into the construction, meaning, and function of the reports as typified 
by the simpler forms which he has studied, and will be ready to proceed 
to more specialized problems. 



QUESTIONS FOR CLASS DISCUSSION 

1. In elementary courses in accounting there are usually thrfee classes of 
students: (a) those who are interested in accounting as a part of a 
general business training; {b) those who are interested in accounting as 
an instrument of social control; and (c) those who desire to prepare for 
the professional practice of accounting. Should the preliminary training 
in accounting of all of these be the same or different ? Why ? 

2. Explain and illustrate how accoimting is related to business management. 

3. The Brown Steel Company has its general offices in New York. It has 
ten subsidiary companies operating in ten different states. What is 
necessary in order to enable the general manager at New York to exercise 
control over the operations of the subsidiary companies ? 

4. In what way has the development of large business organizations 
affected the problem of business control or management ? 

5. Illustrate how this change in business management has affected the 
development and use of accounting. 

6. What will be the probable tendency with reference to the need and use of 
accounting in the future ? Give illustrations and evidence to support 
your answer. 



1 

r 



12 



PRINCIPLES OF ACCOUNTING 



7. Large companies sell their bonds and stocks in many markets and to 
many people. How do these purchasers determine the financial reli- 
ability of the firm issuing such bonds and stocks ? 

8. How does the credit manager of a wholesale business determine the 
financial condition and credit standing of the retaUers who purchase 
from his company ? 

9. Explain and illustrate how the government may be interested in the 
busmess affairs of the individual business. In what way does the 
government obtain the mformation which it desires from such 
businesses? 

10. State and illustrate some of the things which the accountant needs to 
know in addition to the technique of record keeping. Why does he 
need to know them ? 

REFERENCES FOR FURTHER STUDY 

Paton, W. a., and Stevenson, R. A., Principles of Accounting, chap. i. 
Greendlinger, Leo, Financial and Business Statements, chap. i. 
Mitchell, T. W., Accounting Principles, chap. i. 
WiLDMAN, John R., Principles of Accounting, chaps, i, ii, and iii. 



CHAPTER II 

THE RELATIONSHIP OF ACCOUNTING 
TO PROPRIETORSHIP 

The basis of business management. In chapter i an attempt was 
made to give a view of the field of accounting in rather a broad way 
and to give some idea of the place of the accountant among those 
who exercise guidance in modern industrial society. In that con- 
nection it was pointed out that the primary function of the accountant 
is to make available for the various parties interested in the business 
enterprise such reports as are useful to them in the management or 
control of the business. In this discussion the principal emphasis 
was placed on the use of such reports as an aid to management, and it 
was seen that the special problems of management are very likely 
to be dealt with by a number of men, each a specialist in his particular 
line. The ultimate control of the business, however, is exercised 
directly or indirectly by the owner of the business or by the executive 
head, to whom the owner delegates certain powers. It is necessary, 
therefore, for accounting to give the owner or executive manager the 
information which he needs to manage his business. In order to 
understand how accounting may do this, it is desirable to consider 
the nature of the information which he should have. 

The information which the owner of a business needs in order to 
manage it so that a profit may result may be classified as follows:- 
(i) information concerning the property employed in the conduct 
of the business, i.e., the things which the owner uses in the carrying 
on of the business, such as cash, merchandise, furniture, land, build- 
ings, etc.; (2) information concerning the operations he performs, 
i.e., the activities in which he engages, such as buying and selling 
goods and paying expenses. 

It is customary, therefore, for the owner to request from his 
accounting department at the end of certain periods of time two 
reports or statements. The first sets forth the nature and value of 
the property which he is using in the business. The second furnishes 



13 



r, . 



14 



PRINCIPLES OF ACCOUNTING 



him with information concerning the operations which the business 
has performed, i.e., the things which it has done during the period 
and the result of these operations. The purpose of both of these reports 
is the same— to give the owner information which will enable him to 
manage his business in such a manner as to make a profit. 

The first report indicates to the owner the property which he 
may use in the conduct of the business. The second report reveals 
to him the results of its use during the past period and from these 
results he can judge the best way to use it during the coming period. 
It can be seen, therefore, that these reports serve as a basis of manage- 
ment by the owner. 

In the following chapters it is intended to consider the nature of 
the information which should be contained in these two reports which 
may be taken as typical of other reports to be considered later. Con- 
sideration will also be given to the form in which this information 
may be presented advantageously and to the types of records necessary 
to gather the data needed, and the methods employed in gathering 
these data and interpreting them for the purposes of the reports 
under consideration. It must be borne in mind that these two re- 
ports, while they are the ones most generally used, are typical of 
others which are equally useful in the proper management of the 
modern business. It is desirable, however, to postpone the detailed 
discussion of other forms until later, when the student will be better 
prepared to understand their uses and the technique of accounting 
involved in their preparation. 

Business investment implies existence of assets and liabilities. In 
carrying on any business enterprise, a certain amount of property 
must be in use at any given time. In the terminology of the business 
worid, such property is known as the assets of a business. An asset 
may be defined as any property of the owner which he uses or employs 
in the conduct of his business. This does not necessarily mean that 
it must always be in active use. Property may be held in the business 
for a time without being put to such use and still be counted as an 
asset to the business. The surplus funds may be invested in securi- 
ties and even in real estate until the time when they are needed in the 
more active conduct of the business, but this property is still used to 
serve the purposes of the owner in the conduct of the business and is 
an asset. Thus, if W. A. Williams is conducting a retail store, the 



RELATIONSfflP OF ACCOUNTING TO PROPRIETORSHIP 15 

assets of his business may include building and equipment, stock of 
merchandise, the amounts owned by customers, the bank balance, 
and anything else of value belonging to the business. 

It often happens that the owner is not able to make a sufficiently 
large investment to enable the operations of the business to be carried 
on in the most profitable fashion. In such a case it becomes desirable 
to obtain from outside parties the additional property required. This 
is done by securing some form of credit. This credit may take the 
form of borrowing money for a long period, protecting the interests 
of the creditor by some sort of a hen on the assets of the business, and 
using the money to purchase the property needed. It may take the 
form of borrowing from the bank for a short time to supply a tempo- 
rary need, or it may take the form of purchasing merchandise, sup- 
plies, property, or services with the privilege of deferring payment 
for a short time. 

Obtaining property from others in any such manner results in 
giving the one who extends the credit a claim against the assets of the 
business. Such a claim is, from the point of view of the owner of the 
business, a Uability. A liability may be defined for present purposes 
as a legally enforceable claim upon the assets of a business. It is a 
claim upon the assets in the sense that sooner or later it must be 
satisfied by turning over to the creditor a certain part of the assets, 
usually in the form of cash. For instance, if W. A. WilUams pur- 
chases merchandise and supplies for which he promises to pay in 
thirty days, he incurs a Uability, since those from whom he purchases 
have a claim on his assets until he pays for these goods. 

Proprietorship. Therefore the owner in estimating the true 
worth of his property or assets invested in the business must always 
take into consideration the liabilities which are claims against these 
assets. If W. A. WilUams, the retail merchant, employs in the con- 
duct of his store cash to the amount of $1,500; merchandise to the 
amount of $3,600; show cases, counters, and store furniture worth 
$500; and equipment used in deUvering goods to customers worth 
$400; he is using a total of $6,000 of assets in his business. If, how- 
ever, he owes trade creditors $1,000, he must take this amount into 
consideration when he is thinking about his business. His net assets 
or the amount which he would have after paying his UabiUties amount 
to only $5,000. This $5,000, or the difference between his assets 



i6 



PRINCIPLES OF ACCOUNTING 



and liabilities, is known in accounting as his net worth or proprietor- 
ship. It represents the interest of the owner in the business. Report- 
ing with regard to proprietorship and the records necessary for such 
reporting are of great importance in accounting and will receive 
considerable attention in the following chapters. 

Object of business operations to increase proprietorship. To under- 
stand better the importance of proprietorship it may be well to give 
some further consideration at this point to its nature and significance. 
It should have been made clear that it is the excess of total assets over 
total liabilities and represents the net investment of the owner or 
owning group. Any increase in the amount of proprietorship which 
takes place during a given period, exclusive of any additional invest- 
ment which may be made during that period by the owner, is known 
as the net income of the business for the period. In case such net 
income is earned by the business, it is then possible for the owner to 
withdraw from the business for his private use assets to the amount 
of such increase in proprietorship without thereby impairing his 
original investment. It is only through net income that the return 
to the owner, which is his inducement for making the original invest- 
ment, is made possible. The disposal of this excess of assets over 
liabilities is of course optional with the owner. He may withdraw 
it all or any part of it, or he may allow all or any part of it to continue 
in use in the operations of the business. In any case, he has increased 
the amount of his ownership. He has realized a profit, and this is 
the object of his investment. 

In the illustration given under the discussion of proprietorship, 
W. A. Williams is using $6,000 of property in operating his grocery 
store. Others have a claim against this property for $1,000, there- 
fore his interest or ownership in the business amounts to $5,000. If 
a year later the total property invested in the business amounts to 
$8,000 and his liabilities amount to $2,000, he has an interest in the 
business of $6,000, or $1,000 more than at the beginning of the year.* 

It need scarcely be pointed out that the main object of the owner 
in conducting the business is to increase the amount of proprietorship 

'He may withdraw this $1,000 from the business and the business will be in 
the same condition as at the beginning of the year, or he may decide to leave it 
in the business, hoping that by the use of the additional $1,000 of property he 
may increase his proprietorship during the coming year more than during the past 
year. 



RELATIONSHIP OF ACCOUNTING TO PROPRIETORSHIP 17 

at as rapid a rate as possible, since that is the motive back of business 
enterprise under our present economic organization. The information 
desired by the owner with reference to the business, therefore, will be 
such as will enable him so to manipulate the assets and control the 
liabilities as to earn the highest possible rate of profit, or increase, 
in proprietorship. It is the primary object of accounting, therefore, 
to give this information. 

Proprietorship the excess of assets over liabilities. As previously 
indicated, the amount of the owner's interest or his proprietorship 
can be obtained at any time by subtracting the total amount of his 
liabilities from the total amount of his assets. To take a more 
dietailed illustration than the one given above, the assets of W. A. 
Williams may be as follows : Cash, $1 ,500 ; debts due from customers 
to whom merchandise has been sold on credit, $3,040; merchandise 
on hand, $3,500; office and store furniture and equipment, $450; 
delivery equipment, $640. By adding the above items it will be seen 
that the total assets of Williams will amount to $9,130. If he owes 
creditors from whom he has purchased merchandise $1,500, his 
liabilities are $1,500 and his net worth or proprietorship $7,630. 

The assets, liabiUties, and proprietorship of Williams may be 
shown by the following statement: 

ASSETS 

Cash $1,500.00 

Debts owing from customers . . . 3,040.00 

Merchandise on hand 3,500.00 

Furniture and fixtures .... 450.00 

Delivery equipment 640.00 

Total assets $9,130.00 

LIABILITIES 

Debts to merchandise creditors . . . . $1,500.00 

Net worth of proprietorship .... $7,630.00 

Such a statement as this is valuable to the owner from more than 
one point of view. First, it shows him the amount of his net worth 
so that he can tell whether his investment has been increased or 
impaired. Secondly, it shows him the amount and nature of the 



i8 



PRINCIPLES OF ACCOUNTING 



assests in the business and the amount and nature of the liabilities. 
Such a statement may be used by the owner, not only to determine 
the status of his investment, but also to aid him in planning such a 
policy for the future conduct of the business as seems likely to bring 
about further increases in proprietorship. Only a small part of the 
work of the accountant lies in showing what has taken place and the 
condition resulting from past operations. It is necessary to show 
this, but the real object in so doing, from the point of view of manage- 
ment, is to aid in the planning of future operations. Accordingly a 
statement showing the amount and kind of assets, the amount and 
kind of liabilities, and the amount and kind of proprietorship should 
furnish the owner with such information concerning the nature of 
the assets and the claims against them as will suggest certain possible 
courses of action in handling them during the coming period of 
operations. 

Proprietorship may assume various forms. The foregoing discussion 
of proprietorship has used as an example the single proprietorship 
business, which is the form involving the fewest legal compli- 
cations. Besides the single proprietorship, however, a number of 
other forms of proprietorship have been used, most of which can 
still be found in use. The forms of proprietorship which are in com- 
mon use today may be divided into three main types, which may be 
represented by: (i) the single proprietorship, (2) the partnership, and 
(3) the corporation. For this reason it is desirable to discuss briefly 
certain of the charactei:istic features of each of these three forms of 
proprietorship. 

Single proprietor needs reports for control. In the case of a business 
owned by an individual proprietor, there is usually a distmction to be 
made by the accountant between the proprietor's net ownership 
in the business and his property interests outside the busmess. The 
report made by the accountant on the status of the investment in a 
given business enterprise will deal only with the assets used in carrying 
on that business, the claims of creditors upon those assets, and the 
resulting net worth of the owner or owners. For purposes of control 
by the owner it is important that the facts shown should be so Umited. 
The proprietor should be able to judge of the relative success of his 
business, or of each of several businesses which he may own, by 
comparing the amount of the changes in proprietorship with the 



RELATIONSfflP OF ACCOUNTING TO PROPRIETORSHIP 19 



amount of his net investment in each such enterprise. If he has the 
information which will enable him to make such comparisons, he is in a 
position to decide intelUgently what course of action will be Ukely 
to prove most profitable with regard to a given business. His decision 
may be to continue the present investment, to add to it, to withdraw 
a part of it, or to withdraw it altogether as soon as is practicable. 
In any case it is desirable that he should be aided in reaching his 
decision by a separate report on each business enterprise in which he 
is interested as an owner. 

At the same time, so far as his creditors are concerned, there is 
little if any reason for such distinction, since the law does not recognize 
any business undertaking of a single proprietor as an entity separate 
from his ownership in other capacities. All his creditors, whether 
they are creditors of a business owned by him or creditors of the pro- 
prietor in his private capacity, may consider all his assets, no matter 
how they are invested, as a common fund to which they may look 
for the satisfaction of their claims. 

Partnership form involves additional considerations. The principle 
involved in recording the proprietorship of a partnership is no differ- 
ent from that involved in the individual proprietorship. The only 
difficulty here is in keeping distinct the respective investments of the 
two or more partners. Their respective share in the proprietorship 
may of course be decreased by withdrawals or increased by additional 
investments, and will be increased or decreased by the rise or fall in 
amount of the net assets of the firm, in proportions previously deter- 
mined by the partnership agreement. 

The law does not recognize a partnership as a legal entity, but 
recognizes only the individuals who are associated in the partnership, 
and their legal rights and duties as regards their relations to one 
another and to others. In the ordinary partnership, the creditors 
may look not only to the business assets but to the property of the 
individual partners outside ,the business, just as in the case of an 
individual proprietor. 

In the case of the partnership, however, the partnership creditors 
must, in case of insolvency, use up the partnership assets before 
turning to the individual property of the partners held outside the 
partnership, and conversely, the personal creditors of the partners 
must content themselves with the assets of the individual partner 



l- 1 



20 



PRINCIPLES OF ACCOUNTING 



outside the partnership holdings until these are exhausted, before 
turning to the firm assets. 

There are a number of peculiarities and problems that arise in 
actual practice in dealing with the records of a partnership, which 
belong peculiarly to that form of organization, and which arise in 
very large part out of the nature of the partnership agreement, but 
It IS scarcely worth while to take these up at this point, as they can be 
better treated somewhat farther on when the student has more 
knowledge of the technique of accounts. 

Corporation typically a modern form. The corporation as a form 
of business organization is a creation of statutory law, a form which 
has been gradually developed to its present status by the needs which 
have arisen with the development of the industrial order. The 
modem industrial order has made, necessary the employment of very 
large amounts of invested capital, and this fact has made certain 
features of organization desirable, if not indeed essential. A form of 
organization was needed in which (i) capital contributions could be 
secured in varying amounts from a great variety of sources, (2) the 
investor should not be liable to creditors of the concern to the full 
extent of his private fortune, (3) control and management, while 
vested in the last analysis in the owners, could be delegated to a cen- 
tralized group, the members of which should be chosen for their 
special ability to deal with the peculiar problems in the particular 
business in question, and in which (4) any owner who desired to with- 
draw his investment from the business could do so simply by trans- 
ferring all or any part of his investment to another person without in 
any way disorganizing the business. 

In attempting to meet these needs the modern corporate form of 
business organization has been developed. It is a legal entity and 
has a separate existence as a legal person apart from any of its owners, 
with practically the rights, from a business point of view, which are 
enjoyed by any citizen. The corporation as it now exists is not to 
be taken as the last word in business organization . There are still some 
problems relatmg to the financing of the business enterprise and to 
the protection of the various interests involved which have not been 
satisfactorily worked out under the corporate form of organization. 
Whether the needed reforms will eventually come about through a 
modification of the present corporation laws or through a different 



RELATIONSHIP OF ACCOUNTING TO PROPRIETORSHIP 21 

form of organization is at present scarcely a profitable subject for 
discussion. 

The ascertainment of proprietorship in a corporation involves 
exactly the same issues as in the individual proprietorship. The only 
difl5culties that arise in showing it in the case of the corporation arise 
from the fact that the owners are numerous and their investments 
are often made on varying terms. There may be several groups among 
them, each having an interest in the total proprietorship that differs 
in some way from that of the other groups. It is not desirable to 
enter into any further discussion of the problems thus arising, since 
they will be handled later and since for the present the principles of 
proprietorship may be quite amply illustrated by the use of illustra- 
tions drawn from the business of a single proprietor. 

Summary. The point of primary importance for the student to 
bear in mind at the present time is that the function of accounting 
is to provide information which can be used by those in charge of the 
management of the business to increase the proprietorship interest, 
whether that interest be vested in an individual, a partnership, or a 
corporation. It is also important for the student to understand thai; 
the purpose of such a report as that discussed in the preceding para- 
graphs of this chapter is to present this information in a form which 
makes it readily understandable and usable on the part of the manage- 
ment. It will be the purpose of the following chapters to discuss more 
in detail the construction and interpretation of this statement of 
assets and liabilities which in accounting is called the balance sheet. 

QUESTIONS FOR CLASS DISCUSSION 

1. Mr. Brown lives in New York. He owns a store in Chicago which is 
under the management of Mr. Smith. What information will Mr. 
Brown require at the end of the year to judge the efl&ciency of the 
management of Mr. Smith ? How will he obtain this information ? 

2. Explain and illustrate the meaning of "asset." Give five assets which 
the following businesses might use: {a) grocery store; (6) bank; 
(c) department store; (d) automobile factory; (e) wholesale jewelry 
house. 

3. J. H. King invests $10,000.00 in cash in a retail store. He finds that 
he needs additional funds with which to finance his business. How 
may he obtain these funds ? What effect will the obtaining of these 
f imds produce on the financial condition of King ? 



32 



PRINCIPLES OF ACCOUNTING 

From the records of James Reynolds, retail merchant, the foUowing 
items are copied: 

^' L^^^ $2,000.00 

2. Due from James Long 

3. Owed to John King . 

4. Ofl5ce furniture . 

5. Cash .... 

6. Owed to bank 

7. Due from W. E. Atkins 

8. Owed to L. S. Lyon . 

9. Merchandise on hand 

10. Owed to Reighard & Co. 

11. Delivery equipment . 

12. Buildings 



300.00 

'400.00 

800.00 

500.00 

1,000.00 
200.00 
300.00 

2,500.00 
600.00 

1,200.00 

1,300.00 



Classify these items so as to show which represent assets and which 
liabilities. 

5. Arranging in proper order the items given in Question 4, determine 
the net worth of proprietorship of James Reynolds. 

6. If one year later the assets of Reynolds have increased $3,000.00 and 
his liabilities have increased $2,000.00, what effect will this have on his 
proprietorship ? 

7. Will he regard this change in proprietorship as favorable or unfavorable ? 
What eflfect may this change in proprietorship have on his plans for 
the next year ? 

8. If Reynolds' assets increase $3 ,000.00 and his liabilities increase $4,000.00, 
what eflfect will this have on his financial condition ? What eflfect may 
it have on his plans for the next year ? What does it indicate with 
reference to the efficiency of the management of Reynolds ? 

9. In what diflferent types of business organization may the proprietorship 
of a business be vested ? State briefly the most important charac- 
teristics of each from the point of view of business management. 

10. In what way does the form of proprietorship aflfect the reporting 
requirements of the business ? 

11. ^'The owner directly or indirectly exercises control of the business." 
Can this statement be justified in connection with each type of 
ownership ? 

REFERENCES FOR FURTHER STUDY 
Stockwell, H. G., Net Worth and the Balance Sheet, chap. i. 
WiLDMAN, John R., Principles of Accounting, chap. vii. 
Kester, Roy B., Accounting Theory and Practice, Vol. I, chaps, ii and iii. 



I 



RELATIONSHIP OF ACCOUNTING TO PROPRIETORSHIP 23 

LABORATORY EXERCISE NO. 1 
Illustration of Statement Showing Proprietorship 

January i, 1919, Howard Reed entered the retail grocery business with 
an investment of $3,55000 in cash. On December 31, 1919, he was employ- 
ing in this business the following property: 

^^^ $1,300.00 

Notes receivable 200.00 

Accounts due from customers: ^ 

A. B. Trudeau 
J. F. Holmes 
F. M. Wright 
W. C. Harvey 

Total . 

Merchandise inventory 
Furniture and fixtures 
Delivery equipment . 



$450.00 




220.00 




275-00 




125.00 




• • 


1,070.00 


• • 


1,075.00 


• • 


500.00 


• • 


1,500.00 



He was indebted to trade creditors as follows: 

W. B. Smith & Co $250.00 

400.00 

275.00 

Total 



E. B. Curtis . 
Wood Brothers 



$925-00 



The Citizen's State Bank hold his promissory note for $500.00. 
There have been no withdrawals of property during the year. 

Instructions: 

Prepare a statement which will show the amount of Howard Reed's 
proprietorship as of December 31. (Show "Accounts receivable" and 
"Accounts payable" each as a single item, omitting the detail of the items 
composing each.) 

What answer does this statement give to the following questions: 

1. Has the original business investment been maintained ? 

2. Has a return on the investment been realized, and if so, what is the 
amount of such return ? 



r 



24 PRINCIPLES OF ACCOUNTING * 

LABORATORY EXERCISE NO. 2 
Illustration of Statement Showing Proprietorship 

On January i, 1919, MUton Jones invests $5,500.00 in the retail store 

business. On December 31, 1919, his assets and liabilities are as follows: 

Due to bank $2,000.00 

Cash 850.00 

Furniture and fixtures 750.00 

Accounts payable 1,500.00 

Delivery equipment 600.00 

Building and land 2,000.00 

Merchandise inventory 3,100.00 

Accounts receivable 2,700.00 

Notes of customers 200.00 

InsirucHons: 

Prepare a statement showing the proprietorship of Jones as of December 
31, 1919. 

Has the investment been impaired or increased by the operations of 
the period ? What has been the rate of return on his investment ? 

LABORATORY EXERCISE NO. 3 
Illustration of Statement Showing Proprietorship 
The Jones Mercantile Company is organized July i, 19 19, for the pur- 
pose of conducting a small department store with a cash investment of 
$100,000.00. On December 31 of that year the company has the following 
assets: 

Cash ^ 5,000.00 

Accoimts receivable 35,000.00 

Notes receivable 10,000.00 

Merchandise inventory 25,000.00 

Equipment 20,000.00 

Building and land 55,000.00 

The Company owes its trade creditors on account $15,000.00 and has 
notes payable outstanding to the amount of $20,000.00. 
Instructions: ' 

Prepare a statement showing the total proprietorship of the Jones 
Mercantile Company on December 31, 191 9. 

According to this statement, what is the proprietorship on December 
31 of a member of the company who contributed one-tenth of the original 
investment ? 



CHAPTER III 
THE BALANCE SHEET 

The junction of the balance sheet. In the preceding chapter some 
consideration was given to a simple form of statement showing the 
assets, liabilities, and proprietorship of a business enterprise. A 
statement of this nature in connection with any business is known as 
a balance sheet. From the point of view of the owner or manager, 
the balance sheet serves two important purposes: (i) It enables him 
to see whether his original investment has been maintained and 
whether any additions have been made thereto. This assists him to 
evaluate past results. (2) It enables him to plan to use his assets 
and control his liabilities in the future in such a manner as to increase 
his proprietorship. 

So far, this form of statement has been discussed only with respect 
to the information given to the owner. The student will recall, 
however, that in the first chapter it was pomted out that there are 
parties other than the owner and his subordinate managers who have 
an interest in the business enterprise and that the information fur- 
nished by the accountant must also include information which wiU 
be useful to them in forming judgments with respect to the business. 
Those other interested parties, as there indicated, are: (i) the 
creditors and prospective creditors, both long time and short time, 
including banks, trade creditors, bond holders, and other holders of 
long-time claims; and (2) the government, which may desire infor- 
mation to serve as a guide in taxation or regulation, or both. 

The balance sheet is the statement most frequently used in fur- 
nishing information to interested parties outside the business, since 
it contains information which, if clearly set forth and properly inter- 
preted, is of the greatest value to them. It should, however, be 
supplemented by a statement of the results of current operations, 
which will be discussed later. The primary purpose of the balance 
sheet is to aid the owner. However, the information desired by the 
owner, if it is to be adequate to his needs, will be sufficiently inclusive 

25 



. 1 



26 



PRINCIPLES OF ACCOUNTING 



to serve the needs of the other interested parties as well. It is there- 
fore as a report to the owner that the balance sheet will be considered 
for the present. 

The form of the balance sheet. Since the purpose of the balance 
sheet is to give the owner the information which he needs to manage 
his business, this information should be given in the most usable form. 
The balance sheet shows three main items: assets, liabiUties, and 
proprietorship. The simplest form of the balance sheet, therefore, 
would be one which showed these in total. 

If the total assets of W. A. Williams are $9,130, his total Habilities 

$1,500, and his proprietorship $7,630, his balance sheet might be 

made in the following form: 

Assets - . . ' . . $9,130.00 

LiabiHties 1,500.00 

Proprietorship $7,630.00 

Such a statement would give Williams information of some value, 
since by comparing it with previous statements he could see whether 
his proprietorship had increased or decreased and thereby judge the 
success of his business in terms of profit and loss. However, he wants 
more information than this, since he desires to know the nature of his 
assets and liabilities, as well as their amount. It follows that the 
assets and liabiUties should be shown as several items and not merely 
as totals only. In chapter ii it was suggested that W. A. Williams 
might ascertain his proprietorship by listing his assets and liabiUties 
as follows: 

ASSETS 

Cash ..... 
Debts owing from customers 



Merchandise on hand 
Furniture and fixtures 
DeUvery equipment . 

Total assets 



$1,500.00 

3,040.00 

3,500.00 

450.00 

640.00 



$9,130.00 



LIABIUTIES 

Due to merchandise creditors . 



$1,500.00 1,500.00 



Proprietorship ......... $7,630.00 

, Such a statement as this has advantages over the form suggested, 
in which only totals are shown. By listing the different kinds of 



THE BALANCE SHEET 



27 



assets and UabiUties separately the owner is given information regard- 
ing the nature and relationships of the various items which would aid 
him in determining whether or not the business is proceeding along 
sound Unes, and also in planning for the future. 

In Usting the foregoing items, the terms employed in designating 
the particular assets and liabilities are those which might be used by a 
person who does not know the generally accepted terminology of 
accounting. There is among the accounting fraternity a certain 
body of terminology which is generally accepted, especially when 
appUed to the more common kinds of assets and UabiUties. In order 
to see how the terms in accounting would be appUed in a statement 
containing the above information, it is desirable to discuss separately 
some of the items appearing on the balance sheet of W. A. Williams. 

Debts owed by customers. The debts owed by customers consist 
of promises to pay which they have given in exchange for merchandise. 
These promises may be written or they may be oral. If a customer 
gives his written promise to pay drawn in a legally vaUd form, this 
is known as a note and is classified under the head of "notes receiv- 
able." If his promise to pay is oral, or impUed from the fact that he 
orders goods from the business, he is said to owe the business on open 
account and the asset constituted by this claim is classified as an 
"account receivable." The claims of the business against its cus- 
tomers are ordinarily classified under these two headings. 

In the foregoing iUustration there is Usted as due from customers 
$3,040. In a retail store such as that of W. A. Williams, it would 
be quite unusual for written promises to be given in payment of 
merchandise. Probably the only conditions under which such written 
promises would be received would be when a customer failed to pay 
his oral promises at a specified time and gave a written promise in 
order to obtain extension of time. Such customers would be regarded 
as undesirable and therefore a large item of notes receivable would 
be looked upon with suspicion. If it is assumed in the case of W. A. 
WiUiams that he has written promises to the amount of $100 and oral 
promises of $2,940, these debts of his customers would be Usted on his 
balance sheet as foUows: 

Notes receivable $ 100.00 

Accounts receivable 2,940.00 



28 



PRINCIPLES OF ACCOUNTING 



Although few written promises or notes, as they are called by 
business men and accountants, are received by retail stores, in some 
lines of business it is customary to receive written promises in payment 
of goods. A large item of notes receivable on the balance sheet of 
such businesses would not, therefore, be regarded as unfavorable. 
This will be discussed more fully in a subsequent chapter. 

It is not worth while at this point for the student to concern him- 
self with the nature and form of the written promises discussed above. 
These will be considered in subsequent chapters. It is sufficient at 
present to know that such written promises are used in the con- 
duct of a business; that they are called ''notes receivable" when in 
favor of the business; and that they constitute an asset* of the 
business. 

The oral promises to pay which are received from customers are 
shown on the balance sheet as a total. In the accounting records, 
the amount due from each customer is shown. It is not desirable, 
however, to show on the balance sheet the name of each customer who 
owes the business. Sometimes a list of the customers and the amount 
each owes is attached to the balance sheet. The illustration on 
page 29 shows a list of the creditors of W. A. Williams. A similar 
list might be made of the customers who owe him, but such a list 
is usually omitted because of the large number of such customers. 

Merchandise on hand. The merchandise on hand at the time the 
balance sheet is made is known as the merchandise inventory. It is 
usually obtained by making a physical count of the goods on hand 
and determining their value at cost price. If, however, the current 
market price is less than cost price, the market price should ordinarily 
be used in determining their value. The value of the merchandise 
inventory is shown as an asset on the balance sheet. 

Debts owed merchandise creditors. It is explained above that 
those who purchase merchandise from the business may give either 
written or oral promises in payment. In the same manner the busi- 
ness may give either written or oral promises in payment of the 
merchandise purchased from others. The written promises so given 
are known as ''notes payable" and the oral promises as "accounts 
payable." In the illustration given, W. A. Williams owes creditors 
$1,500 and it may be assumed that $200 of this amount is represented 
by written promises and $1,300 is represented by oral promises, 



THE BALANCE SHEET 29 

in which case his debts to creditors may be shown on the balance 
sheet as follows: 

Notes payable to creditors $ 200.00 

Accounts payable 1,300.00 

The accounts payable, like the accounts receivable, are shown on 
the balance sheet as a total. Although the accounting records show 
the amount due to each creditor, it is not desirable to show the names 
of each creditor on the balance sheet. Sometimes a list of the credi- 
tors and the amount due each is attached to the balance sheet. Such 
a list of the creditors of W. A. Williams might be as follows: 

List of Accounts Payable — ^December 31, 1918 

Chicago Wholesale Grocery Co. ... $ 300.00 

Quaker Oats Co 100.00 

Rollen Mills Co 200.00 

E. C. Cline & Co 400.00 

E. R. Taylor Grocery Co. . . . ' . 180.00 

A. M. Anderson Wholesale Co. ... 120.00 

$1,300.00 

The balance sheet with accounting terminology. After the foregoing 
discussion it is possible to restate the assets and liabilities of W. A. 
Williams, using approved accounting terminology in describing them. 
Such a statement would be as follows: 

ASSETS 

Cash $1,500.00 

Notes receivable 100.00 

Accounts receivable 2,940.00 

Merchandise inventory .... 2,500.00 

Office furniture 450.00 

Delivery equipment 640.00 

Total assets $9,130.00 

LIABILITIES 

Notes payable to merchandise creditors . $ 200.00 
Accounts payable 1,300.00 

Total liabilities . . . , . . . . $1,500.00 

Proprietorship $7,630.00 



30 



PRINCIPLES OF ACCOUNTING 



Methods of determining the value of certain assets. The balance 
sheet shows, among other things, the value of the assets in the business. 
In order that the balance sheet may be of the greatest value to the 
owner as well as to others who may be interested in the business, it 
is necessary that these values be stated as accurately as possible. 
It is from the balance sheet and other such reports that the infor- 
mation is obtained which serves as a basis of judging past results and 
of making future plans. Judgments and plans based on inaccurate 
information are dangerous. The values on the balance sheet should 
therefore be stated accurately. 

To determine the value of some assets is quite easy. It is only 
necessary to refer to the accounting records and see the values at 
which they are recorded. It can be easily seen that, if all cash re- 
ceived by the business is recorded in one place and all cash paid out 
in another, the difference between the totals recorded in the two 
places will give the total of the cash on hand. To obtain the amount 
of the cash item on the balance sheet is therefore a relatively easy 
matter. However, there are some assets the correct value of which 
is not shown in the accounting records until certain adjustments or 
changes have been made. It must be ascertained, therefore, what 
these assets are and how their value is determined. 

It may be assumed that W. A. Williams purchased on January i, 
1918, furniture and fixtures costing $500 and delivery equipment 
costing $800. If Williams uses during the year the furniture and 
fixtures which cost $500 at the beginning of the year, it is evident 
that they are not worth $500 at the end of the year. He may not 
know the exact amount they have decreased in value, but he probably 
knows from the experience of himself and others that such furniture 
and fixtures will be worn out in ten years and consequently he esti- 
mates that they have decreased in value during the first year one- 
tenth of their original value, or $50. This estimated decrease in 
value of the furniture and fixtures may be deducted from their cost 
value of $500 and this asset will then be listed on the balance sheet 
as $450. Since, however, the $50 represents only the estimated 
decrease in value of the asset and an adjustment may have to he made 
later, it is thought by accountants and business men to be desirable 
to show the original cost of the asset with the decrease in value sub- 
tracted therefrom. The decrease of value of an asset because of its 



THE BALANCE SHEET 



31 



use in the business is known as depreciation, therefore the $50 allow- 
ance for the decrease in the value of the furniture and fixtures might 
be termed *' an allowance for depreciation." But, in accounting, such 
estimates of the decrease in value of fixed assets are known by the 
technical term of ''reserves." Therefore the allowance for depre- 
ciation on furniture and fixtures may be deducted from the asset 
and may be shown on the balance sheet as follows: 

Furniture and fixtures .... $5c».oo 
Less reserve for depreciation of furniture 
and fixtures 50.00 

$450.00 

Delivery equipment also decreases in value by use in the business, 
and consequently an allowance for its depreciation should be shown 
on the balance sheet. If Williams has delivery equipment valued 
at $800 at the beginning of the year and he estimates that it will 
last for five years, he should make an allowance of $160 each year 
for its depreciation. Accordingly at the end of the first year he may 
show the delivery equipment on the balance sheet at $640 and not 
show the depreciation as a separate item. A better method of showing 
it, however, is as follows: 

Delivery equipment $800.00 

Less reserve for depreciation of delivery 
equipment 160.00 

$640.00 
Heading or title of the balance sheet. The balance sheet is made to 
show the financial condition of the firm at a given date. It is cus- 
tomary, therefore, to place the name of the firm and the date of the 
balance sheet as a heading somewhat as follows: 

W. A. WILLLAMS 
Balance Sheet— December 31, 1918 

Sub-titles of the balance sheet. The assets of all mercantile firms 
can be divided into at least two classes: (i) Those in the form of 
cash or those which it is anticipated will be converted into cash in 
the near future m the regular operations of the business. In account- 
ing, these are termed "current" assets. (2) Those which are used 



r 



3a 



PRINCIPLES OF ACCOUNTING 



■} 



rather more permanently in the conduct of the business and which 
it is not anticipated will be sold or turned into cash. In accounting, 
these are called "fixed" or "permanent" assets. 

By looking at the balance sheet of W. A. Williams it will be seen 
that he has cash to the amount of $1,500; debts due from customers 
which he expects to collect in the near future to the amount of $3,040; 
and merchandise on hand to the amount of $3,500, which he plans 
to sell and realize in cash within a reasonably short period of time. 
Consequently he has current assets to the amount of $8,040. In 
addition he has $450 of office furniture and delivery equipment valued 
at $640. These assets he expects to retain in his business and does 
not expect to liquidate in cash. His fixed assets, therefore, amount to 
$1,090. 

In a similar manner the liabilities of a firm may be divided into 
two classes: (i) Those which the business has promised to pay within 
a short time after they were incurred, such as debts due to merchan- 
dise creditors and to banks. These are called "current" liabilities. 
(2) Those which are of long-time duration and may not have to be 
paid until several years after they are incurred. These are known as 
"fixed" or "permanent" liabilities. Such liabilities will be discussed 
in future chapters. ^ 

It will be seen by the balance sheet of W. A. Williams that his 
only liabilities are those to merchandise creditors, which amount to 
$1,500. According to good business practice these will be paid in 
the near future, so they are current liabilities. Williams has no 
long-time obligations, so no fixed liabilities are shown on his balance 
sheet. 

In addition to the assets and liabilities, the proprietorship or net 
worth of the business is shown on the balance sheet. This is shown 
under the separate heading or title of "proprietorship," "net worth," 
"capital," or some similar term. 

Since the purpose of the balance sheet is to give as much infor- 
mation as possible concerning the assets and liabilities of a business, 
it is desirable to classify the assets and liabilities according to their 
nature. The method of showing these classifications is illustrated 
in the balance sheet given in the next paragraph. Frequently sub- 
divisions of assets and liabilities additional to those discussed above 



THE BALANCE SHEET 33 

are shown on the balance sheet, but those given are sufficient for the 
present discussion. The others will be considered in subsequent 
chapters. 

Illustration of the standard form of balance sheet. Using the items 
and amounts previously given, a balance sheet may be made for 
W. A. Williams, which will comply with the accounting principles 
discussed above, in the following form: 

W. A. WILLIAMS 
Balance Sheet— December 31, 19 18 

ASSETS 

Current assets: 

S^^ • $1,500.00 

Notes receivable 100.00 

Accounts receivable 2,940.00 

Merchandise inventory 3,500.00 

Total current assets ... «« ^^^ /^« 

r.. . , ^^0,040.00 

rtxea assets: 

Office furniture $500.00 

Less reserve for depreciation . . 50.00 $450.00 

DeUvery equipment .... 800.00 

Uss reserve for depreciation . . 160.00 640.00 

Total fixed assets . . . ~, 7". T"". 1,090.00 

Total assets . * " 

*9,i3ooo 

r .ft.,.. LIABILITIES 

Current Itabtltttes: 

Notes payable to merchandise creditors $ 200.00 
Accounts payable 1,300.00 

Total current liabilities . . , ^^ ^ 

* • • • A, ^00, 00 

PROPRIETORSHIP 

W. A. WiUiams, proprietor $7,630.00 

A balance sheet such as this one is said to be in the "report" 
lorm While this arrangement correctly shows the financial condition 
ot a business, accountants more frequently use the form given below 
Which IS known as the "account" form: 



34 



PRINCIPLES OF ACCOUNTING 



W. A. WILLIAMS 
Balance Sheet — ^December 31, 1918 



ASSETS 

Current assets: 

Cash . . . $1,500.00 

Notes receiv- 
able . . . 100.00 

Accounts re- 
ceivable . 2,940.00 

M^chandise 
inventory . 3 , 500 . 00 



LIABILITIES 

Current liabilities: 

Notes payable 
to merchan- 
dise creditors $200 . 00 

Accounts pay- 
able. . . . 1,300.00 



Total current 
liabilities . 



Total Cur- 
rent assets . , 

Fixed assets: 
Oflfice fur- 
niture . $500.00 
Less re- 
serve for 
deprecia- 
tion . . 



$1,500.00 



$8,040 . 00 



PROPRIETORSHIP 

W. A. Williams, proprietor $7,630.00 



50.00 $450.00 



Delivery 
equip- 
ment . .$800.00 
Less re- 
serve for 
deprecia- 
tion . . 160.00 640.00 



Total fixed assets . . 1,090.00 
Total assets .... $9,130.00 



Total liabilities and pro- 

prietorship $9,130.00 



The student will notice that both these balance sheets show the 
same facts. It is only the arrangement that is different. Both are 
according to good accounting practice, but the latter form is, at 
present, used much more frequently by accountants in their reports. 
In the printed forms given by banks to customers, on which to report 
their financial condition, the first form is quite frequently called for 
by the arrangement of the items or the printed blanks. So far as 



THE BALANCE SHEET 



35 



the owner of a business is concerned either form serves his purpose 
equally well. 

QUESTIONS FOR CLASS DISCUSSION 

1. H. M. Friedman, of Kansas City, Mo., desires to purchase on account 
$1 ,000.00 of merchandise from Carson, Pirie & Scott of Chicago. What 
information would Carson, Pirie & Scott desire to obtain concerning 
H. M. Friedman before they ship the merchandise to him? How 
would they obtain this information ? 

2. You are working for the First National Bank. J. C. Adams, retail 
merchant, requests the bank to loan him $500.00. The credit manager 
of the bank instructs you to investigate the financial condition of Mr. 
Adams and report to him whether you think the loan should be granted. 
You request Mr. Adams to give you a balance sheet. Give the items 
which you would expect to find on the balance sheet of Mr. Adams. 

3. On the balance sheet of Mr. Adams there appear the following items: 

Notes receivable $3,000.00 

Accounts receivable .... 1,000.00 

What might you infer from the fact that notes receivable are three 
times as large as accounts receivable? Would you regard this as 
favorable or unfavorable ? 

4. The Ford Motor Company produces automobiles. It owns its factory, 
machinery, and equipment. The Jones Company is engaged in the retail 
dry-goods business. It rents the building in which its business is 
conducted, but owns the furniture and equipment in the store. In 
what ways will the balance sheets of these two firms differ ? 

5. H. B. Johnson, retail merchant, presents to his bank the following 
balance sheet: 



Financial Statement — September 30, 1920 



Bills receivable . 
Delivery equipment . 
Cash .... 
Furniture and fixtures 
Due from customers 
Merchandise 



$ 400.00 

800.00 

1,000.00 

600.00 

4,800.00 

5,200.00 

$12,800.00 



Net worth . 
Due to creditors 
Bills payable 



$6,800.00 
2,800.00 
3,200.00 



$12,800.00 



Explain how this balance sheet should be changed so as to provide more 
information and to correspond to current accounting practice. 



36 



PRINCIPLES OF ACCOUNTING 



6. R. E. Taylor submits to his bank in asking for credit a balance sheet 
dated December 31, 1917. Upon examination it is seen that no allow- 
ance has been made for depreciation of fixed assets. You are instructed 
by the credit manager of the bank to make an inspection of the records 
of Taylor to determine the amount which should be deducted on the 
balance sheet. Explain what information you would need in order to 
determine the amount of this reserve. 

7. H. M. Jones submits to his bank a balance sheet made as follows: 



H. M. JONES 
Balance Sheet — ^June 30, 191 8 
Current assets . . $15,000.00 Current liabilities 
Fixed assets . . 10,000.00 Proprietorship 

$25,000.00 



$ 7,000.00 
18,000 00 

$25,000.00 



You are asked by the bank to explain to Mr. Jones how this balance 
sheet should be revised so as to give the information which the bank 
desires. What instructions would you give to Mr. Jones? 

8. Mr. Jones has a great many customers who owe him. How will the 
amount which they owe be shown on the balance sheet ? If it is desired 
to know the name of the individual customers and the amount each 
owes, how may this be shown ? 

9. Explain and illustrate the difference between current and fixed assets; 
between current and fixed liabilities. 

10. What is the distinction between the "report" and the "account" form 
of the balance sheet ? 

11. What should be contained in the heading of the balance sheet ? Why ? 

REFERENCES FOR FURTHER STUDY 

Kester, Roy B., Accounting Theory and Practice, Vol. I, chaps, iv and v. 
Hatfield, H. R., Modern Accounting, chap. iii. 
Stockwell, H. G., Net Worth and the Balance Sheet. 



LABORATORY EXERCISE NO. 4 
Illustration of the Balance Sheet 

C. A. Ankromn, who is engaged in the retail implement business, has 
on January i, 19 19, the following assets and liabilities: 

Cash $ 800.00 

Notes receivable 220.00 



THE BALANCE SHEET 3.7 

Accounts due from customers: 

O. T. Gooch . 190.00 

John K. Dew 5S-oo 

W. E. Hampton 50.00 

R. E. Taylor 75.00 

D. D. Dwyer 120.00 

H. L. Cohagen 250.00 

Merchandise inventory 2,000.00 

Furniture and fixtures 75-oo 

Delivery equipment 125.00 

Due to the Continental Trust Co 300.00 

Due to creditors, as follows: 

H. M. Gooch 120.00 

A. M. Joesting 150.00 

James M. Monroe 180.00 

A. M. Chapman, who is conducting a rival business, has entered into a 
partnership agreement with C. A. Ankromn on the above date and invests 
the following assets and liabilities: 

Cash $1,000.00 

Notes receivable 300.00 

Accounts due from customers: 

E. H. Wagner 100.00 

Chas. R. Rigg 200.00 

T. M. Hamlet 150.00 

A. R. Manley 75.00 

G. B. Crawford 125.00 

M. A. McBride 85.00 

Merchandise inventory 1,500.00 

Delivery equipment 800.00 

Furniture and fixtures 600.00 

He owes notes payable 400.00 

Due to creditors: 

James Gleason 75.00 

G. L. Logan 125.00 

Instructions: 

Prepare a balance sheet, showing the net worth of Ankromn before 
consolidfition with Chapman. Show assets and liabilities properly classi- 
fied. Show accounts receivable and payable as totals. 

Prepare a similar statement showing the net worth of the firm of Chap- 
man on the above date. 

Prepare a balance sheet for the partnership of Ankromn & Chapman, 
giving the interests of each partner in the new firm. 



38 



PRINCIPLES OF ACCOUNTING 



LABORATORY EXERCISE NO. 5 

Illustration op the Balance Sheet 

On December 31, 1919, the records of Ankromn & Chapman provide the 
following information: 

Cash on hand 

Accounts receivable have increased 
Merchandise inventory has increased 
Delivery equipment, purchased on July i, 1919 
Furniture and fixtures, purchased on October i 
Notes received from customers during the year 
Notes paid by customers during the year 
Merchandise purchased on account 
Paid to creditors to apply on account 
Notes issued to bank and unpaid . 
Paid on notes due to bank 
Notes issued to customers have increased 

It is estimated that the yearly depreciation on furniture and fixtures 
and on delivery equipment is 10 per cent 
Instructions: 

Prepare a balance sheet for Ankromn & Chapman as of December 31, 
1919. Profits and losses are shared by Ankromn and Chapman in pro-' 
portion to their original investment. 

Show accounts receivable and payable as totals and show the assets 
and liabilities properly classified. 

LABORATORY EXERCISE NO. 6 
Prepare a comparative balance sheet for the firm of Ankromn & Chap- 
man, as of December 31, 1919, comparing their balance sheet at that date 
with the balance sheet at January i, 1919, the time when the partnership 
was formed. 



$3,000.00 

2,800.00 

800.00 

300.00 

100.00 

1,200.00 

800.00 

20,800.00 

18,200.00 

1,200.00 

300.00 

400.00 



CHAPTER IV 
THE STATEMENT OF PROFIT AND LOSS 

Statement of profit and loss needed to supplement balance sheet. It 
has been explained that the owner of property uses it in conducting 
a business with the expectation of making a profit. It has also been 
explained that the owner of property expects the accounting records 
to provide him information which will show him, first, whether a 
profit is being made and, if so, the amount thereof; second, how he can 
plan to use his property in the future so as to increase his profits. 
In order to give this information to the owner so that it can be easily 
understood and used, certain reports or statements are used. These 
reports show in summarized and classified form the information 
which the accounting records contain. 

One form of report which is in common use was discussed in the 
preceding chapter. The balance sheet, a conventional form of which 
was there illustrated and discussed, supplies information with respect 
to the nature and amount of the assets and liabilities and the amount 
of the resulting proprietorship. Also by comparing a balance sheet 
at the end of a given period with the balance sheet for the same business 
at the end of the preceding period, the owner may ascertain readily 
the amount of the increase or decrease in proprietorship. Moreover, 
he can tell what changes in assets and liabilities have resulted in such 
increase or decrease. The balance sheet does not, however, furnish 
any appreciable amount of information with respect to the nature or 
volume of the business operations that have brought about these 
changes in the assets and liabilities, and consequently falls far short 
of supplying the owner with the information necessary for estimating 
and providing for the operations of the coming period. An illustration 
will make this apparent. 

The balance sheet of W. A. Williams of December 31, 1918, as 
given in chapter iii, shows his net worth or proprietorship to be $7,630. 
If a year before his balance sheet showed his net worth to be $6,500, 
his proprietorship has increased $1,130. Consequently, if he had not 

39 



40 



PRINCIPLES OF ACCOUNTING 



withdrawn anything during the year or made any additional invest- 
ment, he would assume that he had made a profit of $1,130. Although 
such an ascertainment of profits by the comparison of the proprietor- 
ship at the end of the period with that at the end of the preceding 
period shows the proprietor the amount of the profits earned, it does 
not show the cause of the profit. A year later when Williams makes 
his balance sheet on December 31, 1919, he may find that his 
proprietorship has increased only $800; therefore his profits are 
$430 less than they were the year before. His balance sheet, 
however, will not show why his profits are smaller than for the year 
before. 

It may be that his sales for the year have been smaller or that the 
cost of the goods purchased has been more, or it may be that more 
has been paid for clerk hire, heat, light, and other expenses. He of 
course wishes to plan his business for the next year so as to remedy, if 
possible, the diflSculty of the past year. 

It is evident, then, that some sort of supplementary report should 
be prepared to enable the owner to understand the nature of past 
operations sufficiently well to plan future operations. Such a report 
should show the amount of the sales for the period, the cost of the 
goods sold, the expenses involved in selling them, such as advertising, 
clerk hire, and the like, as well as all the other expenses necessary 
for carrying on the business, such as heat, light, insurance, deprecia- 
tion on the different assets employed, expenses in dehvering the goods, 
expenses of accounting, and any other expenses involved in the 
administration of the business. The same considerations hold good 
whether the final results of the year's operations show a profit or a 
loss. If it is a profit, it will enable him to plan his business so as to 
continue on an equally profitable basis or an even more profitable 
one if possible. If a loss, he will wish to discover the difficulty, and 
to plan the next year's operations in such a* way as to obviate the 
reason for such a loss and to convert the loss into a profit. 

A report which embodies this information is one which is usually 
prepared at the end of the accounting period at the same time as the 
balance sheet, and is known as the statement of profit and loss. This 
report is a very important one. Used in connection with the balance 
sheet, it supplies valuable information concerning the nature of the 
operations of the past period, and the profit or loss which has resulted 



THE STATEMENT OF PROFIT AND LOSS 41 

from these operations. The two reports, considered together, are 
very useful as an aid in planning future operations. 

There are many other reports which aid in the proper conduct 
of the business, and these will be considered in detail later. The 
balance sheet and the statement of profit and loss, however, are the 
two which are indispensable in practically every business and which 
are prepared and used more commonly than any of the others. 

Form of the statement of profit and loss. The statement of profit 
and loss, as well as the other forms of reports prepared for the use of 
the owner, should be put into the form which makes readily available 
for his use the information which he needs to have. In an earlier 
paragraph some of the items of information which should be contained 
in the statement of profit and loss were suggested, but this was done 
without grouping them in the most logical way. The statement 
of profit and loss shows four principal items: (i) the amount of the 
sales made for the period; (2) the cost of the goods sold; (3) the 
totalexpensesof conducting the business; (4) the resulting net profit 
for the period. As was suggested in the case of the balance sheet, 
the very simplest form of such a statement would be one which shows 
these items as totals only. 

If W. A. Williams has made sales amounting to $24,000 during 
the year, and the cost of the goods sold is $17,000, and the expenses 
incurred in conducting the business are $6,000, with a resulting net 
profit of $1,000, the statement of profit and loss might be made in the 
following form: 

Sales for the year . , . $24,000.00 
Cost of goods sold . . . 17.000.00 

Gross profit $7,000.00 

Expenses 6,000.00 

Net profit $1,000.00 

Such a statement would be of some value to Williams if studied 
by itself and would be of even more value if compared with previous 
statements. By such a comparison he could see not only the increase 
or decrease in the net profit, but also whether his sales have increased 
or decreased and whether the cost of goods sold and the expenses of 
conducting a business have increased faster than sales. If profits 



r 



42 



PRINCIPLES OF ACCOUNTING 



THE STATEMENT OF PROFIT AND LOSS 



have increased or decreased, this may be the result of any one of 
several combinations of circumstances. Take for illustration an 
increase of profits over a preceding year. This may result from: 
(i) an increase in the volume of sales with the ratios among the four 
items listed remaining substantially the same; (2) a lower cost of 
goods sold without any increase in sales or any appreciable increase 
in the expenses of the business; (3) an increase in sales with a larger 
proportionate increase in the cost of goods sold, expenses, or both, 
still resulting in an increased profit; (4) a decrease in the sales with 
more than a proportionate decrease in cost of goods, expenses, or both. 
These are merely suggestions of some of the different combinations 
that might appear. A decrease in the net profits might result from 
an equally large number of changes in the relationships of these four 
principal items. A knowledge of these facts, as the student will 
readily understand, must be of considerable assistance to the owner in 
planning his business by indicating to him which of these four main 
groups should receive especial attention in an effort to modify the 
relations among them so as to result in a larger net profit. Thus the 
manager may decide that the expenses are too large and that he should 
make an effort either to reduce them or to increase the volume of 
sales without increasing expenses appreciably. But at this point a 
difficulty arises. If there is available no more information than is 
furnished by this brief summary, how can an owner determine what 
is the best way to go about changing this ratio ? How is he to know 
that a decrease in expenses is possible without seriously crippling the 
efficiency of the business operations ? How is he to estimate whether 
an increase of sales under the conditions prevailing is not likely to 
cause even a greater proportional increase in expenses? And if 
expenses are to be reduced, where should that reduction fall ? Shall 
it be in the expense of advertising, in the number or rate of remumera- 
tion of the sales force, in expenses of delivery, or in the office ex- 
penses ? The information made available by so simple a statement 
is not adequate for the solution of such problems as these. 

It is plain that there must be a somewhat fuller analysis of the 
main groups of the statement of profit and loss. For each of these 
p-oups such analysis must be shown as will give the owner a basis for 
intelligent planning. The four groups shown above may be considered 
one by one to determine what analysis of each is desirable. 



43 



Sales. It may be assumed that in a small business such as is 
conducted by Mr. Williams the total sales may be considered as one 
item. In many businesses it is desirable to provide an analysis of 
sales in the accounts and on the reports. In later chapters some of 
the analyses which may be of value will be considered. For the 
present, however, it will be assumed for the sake of simplicity that an 
analysis of sales is not necessary. Accordingly the sales of Mr. 
Williams will be shown on the statement of profit and loss as a total 
of $24,000. 

Cost of goods sold. The cost of goods sold is obtained by a com- 
bination of at least three items, and it is customary to show these 
separately on the profit and loss statement. Assuming that Mr. 
Williams is conducting a mercantile business, and not manufacturing 
any of the goods he sells, if he had $2,500 of merchandise on hand at 
the beginning of the year and purchased $18,000 of merchandise 
during the year he should have $20,500 of merchandise on hand on 
December 31 if none had been sold. But he has been selling through- 
out the year, and on December 31, by actual count, he finds that he 
has $3,500 of merchandise on hand. He assumes that the goods not 
on hand must have been sold; and consequently by substracting 
$3,500, the amount of goods on hand December 31, from $20,500, the 
amount of goods on hand January i plus the purchases made durinS 
the year, he obtains a difference of $17,000, which represents the 
cost of the goods sold during the year. 

As previously stated, the goods in which a mercantile business 
deals are known as merchandise and the amount on hand at any 
particular time is known as the merchandise inventory. In view of 
the foregoing, it may be understood quite easily why the cost of 
goods sold is shown on the statement of profit and loss as follows: 

Cost of Goods Sold 



Merchandise inventory, Janu- 
ary I, 1918 
Purchases .... 



$ 2,500.00 
18,000.00 



$20,500.00 
Merchandise inventory, De- 
cember 31, 1918 3,500.00 

Net cost of goods sold $17,1 



,000.00 



f 



I 




44 



PRINCIPLES OF ACCOUNTING 



Gross profit on sales. When the cost of goods sold is subtracted 
from sales, the difference represents the profit which would be made 
if no expenses were incurred in conducting the business. Expenses 
are always incurred, however, in the sale of goods; therefore, it is 
necessary to consider them in determining the profit made. Conse- 
quently the difference between the amount received from sales and 
the cost of goods sold is termed "gross profit on sales.'* It is termed 
"gross" profit because the expenses must be subtracted in order to 
obtain the final or "net" profit. 

W. A. WiUiams has made sales to the amount of $24,000 and the 
cost of goods sold is $17,000, so the gross profit on sales is $7,000. 
It appears on the statement of profit and loss as shown in the illus- 
tration of this statement at the end of the chapter. 

Classification of expenses. On page 41 the expenses of W. A. 
WilUams are shown as one item of $6,000. Although all the expenses 
of a business may be shown as one total, it is desirable that expenses 
be classified. The nature and amount of the operating expenses are 
determined by the size, nature, and organization of the business. 
In a mercantile business, since the principal operations are in con- 
nection with the purchase and sale of merchandise, it will be apparent 
that the expenses incurred in connection with buying, usually known 
as "buying expenses," and those incurred in connection with sales, 
known as "selling expenses," are two principal items. In addition 
to these, certain expenses known as "administrative expenses" are 
incurred in the general administration of the business. In a retail 
business where goods are deUvered to the customers there is another 
item of expense known as "deHvery expense." This item also occurs 
in connection with a wholesale business, since it is necessary to deliver 
to the raihoad station the goods sold. In connection with a wholesale 
business it is sometimes called "dray age" instead of delivery expense. 
In a business where large stocks are carried and as a consequence a 
large warehouse maintained, the item of "warehouse expense" will be 
found. In a manufacturing business certain expenses known as 
"manufacturing expenses" will be incurred in connection with the 
manufacturing operations. In other lines of business where other 
operations are performed other items of operating expense will occur. 
In the present discussion of the statement of profit and loss only the 
first four items mentioned, that is, buying, selling, delivery, and 



THE STATEMENT OF PROFIT AND LOSS 4S 

administrative expenses, will be considered. In later chapters other 
kinds of expense will be considered. 

The expenses incurred in connection with any one of these opera- 
tions of the business — ^buying, selling, delivering, and administering — 
may be shown under several heads so as to indicate its particular 
nature. For the sake of brevity and simpUcity it will be assumed for 
the present that all the expense in reference to each operation is 
recorded in one account and shown as one item on the statement of 
profit and loss. If kept in separate accounts these would be shown 
on the statement under the main headings suggested above. For 
instance, the selling expenses might be shown as follows: 

Selling Expenses 

Salaries and wages of sales force . . $900.00 

Advertising 500.00 

Miscellaneous ...... 40.00 

Total selling expense $1,440.00 

If only the four accounts mentioned above are kept with operating 
expenses, they will be shown on the statement of profit and loss as 
follows: 

Buying expenses . . . .^ . $ 444.00 

Selling expenses 1,440.00 

DeUvery expenses 750.00 

Administrative expenses .... 3,366.00 

Total operating expenses $6,000.00 

In a subsequent chapter the particular items which may con- 
stitute the buying, seUing, delivery, and administrative expenses 
will be indicated in connection with the consttuction and interpre- 
tation of the accounts kept with these expenses. 

Operating and non-operating expenses. In the conduct of a busi- 
ness the owner incurs certain expenses which are the result of the 
regular operations of the business. These are known as "operating 
expenses." All those already mentioned under the headings of selling, 
buying, delivery, and administrative expenses are of this type. In 
addition, the owner may incur certain other expenses which are not con- 
nected directly with the primary operations of the business and which 
are known as non-operating expenses. For example, W. A. Williams 



46 



PRINCIPLES OF ACCOUNTING 



THE STATEMENT OF PROFIT AND LOSS 



47 




H 





may purchase a garage which he retains for a time and sells for a 
profit. The profit arising from this transaction does not arise from 
the regular operations of the business, since it is not the function of a 
retail merchandise store to deal in garages. Consequently this profit 
IS termed "non-operating income." It is probable that some expenses 
will be incurred in connection with the garage before it is sold. These 
expenses, if they are not incurred in connection with the regular 
operations of the business, will be termed "non-operating expenses." 

It is quite usual to find in connection with a business enterprise 
certain income and also certain expenses which fall outside the Une 
of operations for which the business is organized. It is, therefore, 
the practice on the statement of profit and loss to distinguish between 
operating and non-operating income and expenses. 

For the present such non-operating expenses can be disregarded 
for they would not be of frequent occurrence in the case of a small 
business like that of W. A. Williams. Later they will be discussed 
and the method of showing them on the statement of profit and loss 
will be illustrated. The purpose of mentioning them here is to point 
out to the student that such expenses are not included in the oper- 
ating expenses of a business and to explain that the operating expenses 
of a business are usually indicated as such on the statement of profit 
and loss as follows: 

• 

Operating Expenses 

Buying expenses $ ^^^ no 

Selling expenses 1,440.00 

DeUvery expenses 750.00 

Administrative expenses .... 3,366.00 



Total operating expenses 



$6,000.00 



Heading or title of the statement of profit and loss. A discussion of 
the form of the statement of profit and loss would not be complete 
without some mention of the form of heading. This statement is 
drawn up to show certain facts with regard to a particular business. It 
follows that, as in the case of the balance sheet, it is essential that the 
name of the business should appear prominently in the heading. The 
balance sheet represents the condition of the business enterprise as at 
a given date and consequently it gives the name of the company and 
the date. The statement of profit and loss, however, does not give 



the condition of the business upon a given date, but gives a summary 
of the operations of the business for a given period, which may be of 
any duration, say, a year, or a month. In the heading of the state- 
ment of profit and loss, therefore, there will be shown the length of 
the period covered, whether a month, three months, six months, or a 
year; and the date at which the period ends. On the statement of 
profit and loss for Mr. Williams the heading will appear as follows: 

W. A. WILLIAMS 
Statement of Profit and Loss for Year Ending December 31, 1918 

Illustration of the conventional form of the statement of profit and loss. 
Having now discussed the main points to be considered in preparing 
the profit and loss statement, and having undertaken some analysis 
of the main groups into which such a report would be divided, as well 
as the proper form of heading, it is possible to assemble these groups 
into a form which will illustrate in a simple way the essentials of the 
statement. Using the items and the amounts previously assumed, 
the report will appear: 

W. A. WILLIAMS 
Statement of Profit and Loss for Year Ending December 31, 1918 

S^l^ $24,000.00 

Cost of goods sold: 

Merchandise inventory, 

January i, 1918 . $ 2,500.00 

Purchases . . . 18,000.00 $20,500.00 



Merchandise inventory, 
December 31, 1918 



3,500.00 



Cost of goods sold 17,000.00 



Gross profit on sales 
Operating expenses: 
Buying expense . 
Selling expense . 
Delivery expense 
Administrative expense 



$7,000.00 



Total operating expenses 
Net profit . 



$ 444.00 

1,440.00 

750.00 

3,366.00 



$6,000.00 



$1,000.00 



& 



48 



PRINCTPLES OF ACCOUNTING 




ii' 



i| 






nil 



This form of the statement of profit and loss resembles closely the 
first form of balance sheet shown on page ^^^ and, like it, is known as 
the '' report " form. The statement of profit and loss is also sometimes 
drawn in the "account" form, but this form is now almost entirely 
obsolete in general practice. It hardly seems worth while to illustrate 
it here.' Illustrations may be found in some of the older texts if 
the student wishes to see how such a statement might be shown in the 
account form. The form shown above is the logical one and is the 
one generally employed by accountants. The student should famil- 
iarize himself with it and be sure that he has a grasp of the principles 
underlying its organization. 

Balance sheet and statement of profit and loss taken as types of 
reports. It has been repeatedly emphasized that the purpose of 
accounting is to provide reports which will be of aid to the manage- 
ment in the conduct of the business. Two examples of such reports 
have been shown and some reasons for their preparation presented. 
The balance sheet and the profit and loss statement have been se- 
lected as typical of reports in general because they are the two forms 
which are at present in practically universal use. Employed in con- 
junction with each other, these two reports supply much valuable 
information. When complete and carefully prepared they present 
information that is significant not only to the owner but also to the 
creditors, both long-time and short-time, and to governmental 
agencies for taxation and regulation, as well. However, they fall far 
short of supplying all the analysis needed in the internal management 
of the business. There are a number of other forms of reports which 
are desirable, and which are actually being used by the more pro- 
gressive business organizations. 

It is scarcely worth while to present any of the more compUcated 
forms for the consideration of the student at this point. It is quite 
enough for the present if he can be made to understand the principles 
involved in the preparation of the reports needed by a very simple 
form of business organization. A clear understanding of the con- 
struction, interpretation, and use of the accounting records necessary 
to serve the reporting requirements of such a business is a considerable 
attainment for the beginning student. When he has once mastered 

'See Klein, J. J., Elements of Accounting, p. 172, for an illustration of the 
profit and loss statement in account form. 



THE STATEMENT OF PROFIT AND LOSS 49 

the fundamentals of accounting, with simple applications, it should 
not be difficult to extend the application of these principles to more 
compUcated business organizations, with more extensive reporting 
requirements. 

QUESTIONS FOR CLASS DISCUSSION 

1. Mr. Jones has three stores located in Chicago. He has a manager for 
each store. What information must he have in order to determine 
the comparative efficiency of these managers ? How would he obtain 
this information ? 

2. What are the principal items of information shown on the statement 
of profit and loss ? 

3. What would be the first item shown on the statement of profit and loss 
of the following businesses: (a) grocery store; (b) bank; (c) firm of 
lawyers; (d) commission house; (e) raiboad; (/) department store; 
(g) shoe factory. 

4. G. E. Frazer had merchandise on hand on March i to the value of 
$4,000.00. During the month he purchased $8,000.00 of merchandise 
and sold $10,000.00. On March 31 his inventory was valued at 
$4,200.00. His expenses for the month had been $1,000.00. What 
was his net profit for the month ? 

5. At the end of the next month the statement of profit and loss of Frazer 
shows that he has made a profit of only $600.00. He is puzzled as to 
the cause of the decrease and asks your advice. In looking over his 
records you find that $800.00 lost in trading on the Stock Exchange 
has been added to his expenses for the month. What report would 
you make to him ? 

6. Explain and illustrate the difference between "gross" and "net" profit. 

7. On the statement of profit and loss of the X Retail Store the operating 
expenses are listed as follows: 

Operating ' Expenses 

Salaries 

Rent 

Light 

Heat 

Taxes 

Depreciation 

Repairs 

Supplies 

Traveling expenses 

Insurance 

Is this a satisfactory classification of expense ? Why ? 



lit 



so 



PRINCIPLES OF ACCOUNTING 




,. «■ 



It 




8. On December 31, 1919, the statement of profit and loss of W. T. Hupe 
in summary form is as follows: 

Sales for the year $36,000.00 

Cost of goods sold 20,000.00 

Gross profit on sales $16,000.00 

Operating expenses 12,000.00 

. Net operating profit $ 4,000.00 

One year later the statement of profit and loss of Hupe is as follows: 

Sales for the year . $72,000.00 

Cost of goods sold 44,000.00 

Gross profit on sales $28,000.00 

Operating expenses 27,000.00 

Net operating profit $1,000.00 

Mr. Hupe is surprised to find that though his sales have doubled, his 
profits have decreased. He asks you for an explanation. What 
explanation would you give him ? 

9. Give some of the probable reasons for the imfavorable results obtained 
by Mr. Hupe during the year 1920. 

10. Explain and illustrate the difference between operating and non- 
operating expenses; operating and non-operating income. 

11. Explain and illustrate the difference between an 
"expenditure." 



"expense" and an 



REFERENCES FOR FURTHER STUDY 

Kester, Roy B., Accounting Theory and Practice, Vol. I, chaps, vi and vii. 
Mitchell, T. W., Accounting Principles, chap. ii. 

LABORATORY EXERCISE NO. 7 
Illustiiation of Statement of Profit and Loss 

The records of Howard Reed, retail merchant, show that his operations 
for the year 1918 were as follows: 

Merchandise inventory January i 
Merchandise purchases 

Merchandise sales 

Merchandise inventory December 31 
Salaries of sales clerk .... 
Depreciation on furniture and fixtiures 



$ 9,000.00 

23,000.00 

30,000.00 

12,000.00 

2,000.00 

80.00 



THE STATEMENT OF PROFIT AND LOSS 51 

Depreciation on delivery equipment . . . $ 75.00 

Salary of delivery driver ' 800.00 

Insurance on stock 60.00 

Insurance on delivery equipment .... 20.00 

Advertising 90.00 

Salary of Howard Reed 2,000.00 

Traveling expenses of Howard Reed on buying trips 120.00 

laxes .......... 70.00 

Postage and stationery 30.00 

Wrapping paper and twine 40.00 

Miscellaneous office supplies 20.00 

Instructions: 

Prepare a statement of profit and loss for the business of Howard Reed 
for the year 1918. 

LABORATORY EXERCISE NO. 8 
Illustration of the Statement of Profit and Loss 

The inventory of merchandise of the A. B. Company on January i, 
1919, is $3,500.00. During the month of January they purchase $14,989.00 
of merchandise and sell $19,500.00. On January 31 their inventory is 
$3,700.00. During the month their expenses are as follows: 

Sales salaries $500.00 

Advertising ^^^^ 

Salary of delivery driver go.oo 

Repairs to delivery truck 10.00 

Heat and Ught ^q^^ 

Telephone and telegraph 20.00 

Buying expenses ^^qq 

Office salaries joo^q 

Office supplies 80.00 

Insurance on building 15 qq 

Insurance on delivery truck 2.50 

Insurance on stock g .^ 

Depreciation on building j^qq 

Depreciation on delivery truck 3 00 

Depreciation on furniture and fixtures .... 2.00 
Instructions: 

Prepare a statement of profit and loss for the A. B. Company for the 
month of January. 



I 

I 

» 

V 



52 



PRINCIPLES OF ACCOUNTING 







LABORATORY EXCERCISE NO. 9 
Illustration of Statement of Profit and Loss 

Lewis E. Alward commences the retail grocery business on June i, 
investing the following assets: 

Cash $3,000.00 

Building . 3,000.00 

Lot 1,000.00 

During the month he purchases merchandise on credit as follows: 

On open account $4,500.00 

For notes 1,000.00 

He sells merchandise: 

On account $4,000.00 

For notes 500.00 

His cash receipts for the month are as follows: 

Cash sales $3,000.00 

Collected from customers on accounts . 2,500.00 

His cash disbursements during the month are as follows: 

Cash purchases of merchandise $3,000.00 

Furniture and fixtures '. 200.00 

Clerk hire (administrative) 150.00 

Clerk hire in selling department 300.00 

Heat and light , 100.00 

Telephone and telegraph 8.cx> 

Advertising 90.00 

Incidentals 40.00 

Stationery 10.00 

Janitor service 25.00 

Buying expenses 80.00 

Paid trade creditors on account 1,400.00 

Paid on notes payable 600.00 

Depreciation for month: 

On building ' . . 30.00 

On fiuTiiture and fixtures 5.00 

Inventory of merchandise on hand June 30, $3,000.00. 

Instructions: 

Make a statement of profit and loss showing Alward's net profit for 
the month of June. 

Make a balance sheet showing Alward's financial condition on Jime 30. 



CHAPTER V 

THE ACCOUNT AS A MEANS OF CLASSIFYING 

INFORMATION 

A means of classifying business data needed. It should have 
become quite clear that the most important function of the accountant 
is that of preparing such reports as will be of aid to the owner or 
manager of the business in planning or conducting the operations of 
the business. The balance sheet and the statement of profit and loss 
are two reports which are required in practically every case. These 
two reports may be considered as typical of all the accounting re- 
p)orts, since in these two are reflected all the elements of the business. 
These reports are prepared at least once a year and in many cases 
much more frequently. 

It is apparent from the illustrations of these statements given in 
the two preceding chapters that even in a very simple form of business 
they should contain a number of items of information. It should 
also be realized quite readily that during the fiscal period there are 
a great number of transactions taking place which change the 
amounts of these items day by day. It is thus apparent that 
there must be some means employed for classifying the data with 
regard to all the transactions and changes taking place in the business, 
in such a manner that the information desired on the reports may be 
made available at the end of the fiscal period. 

For instance, in order that W. A. Williams may be able to make a 
balance sheet he must know the amount of the various items which 
app>ear thereon. In the case of some items, such as cash and notes 
receivable, he could obtain the amount by actual count. He would 
have no means of knowing, however, whether the cash on hand was 
actually correct unless he knew the total cash received during the 
period and the total cash paid out so he could check the amount of the 
balance on hand against the amount obtained by actual count. In 
the same way he must know the total amount of the notes received 
during the period and the total paid so he can know the balance on 

S3 



\- * 



54 



PRINCIPLES OF ACCOUNTING 



1. 



m 



m 




hand. In the case of the other items, such as accounts receivable, 
their amount cannot be obtained by count because they are not rep- 
resented by anything tangible. Hence the only possible means of 
knowing the amount due from customers is to have a record of the 
amount of the promises received from customers and the promises 
they have paid or redeemed so as to obtain the difference, which 
represents the accounts receivable unpaid. Again, it would not be 
possible to know the amount of the notes payable or accounts payable 
owed by the business unless a record is kept of the written and oral 
promises issued and redeemed. 

In the case of the statement of profit and loss, an even more 
apparent need of collecting such information is seen. It is not hard 
to see that it is entirely out of the question for W. A. Williams to 
know at the end of the period the exact amount of the sales or his 
expenses unless a written record of these classes of information is 
maintained throughout the period. In short, information sufficiently 
comprehensive and exact for the preparation of the balance sheet and 
statement of profit and loss and classified according to the report- 
ing requirements which have been indicated can be made available 
only through the use of continuous written records. It is the purpose 
of the present chapter to explain the form of record ordinarily em- 
ployed by the accountant for recording and classifying the information 
necessary for the preparation of the accounting reports. 

The account a means of classification. Since it is desirable to 
keep a separate record of each item, such as cash, accounts receivable, 
accounts payable, sales, and selling expense, which is to appear on the 
balance sheet or statement of profit and loss, it would seem the logical 
thing to set apart on the records a space for each such item considered 
necessary for these reports and to record in that space under a proper 
heading all the changes which take place in connection with the item. 
This record would be kept in such a manner as to make it possible 
to reconstruct the history of that item if so desired and to secure 
at any time the information regarding it which may be required for 
reporting purposes. Such a record is known in accounting as " the 
account." In terms of this discussion the account may be defined 
as a systematic record of the changes taking place in an item which 
appears in accounting reports kept under the title of the item in 
question. With the aim of giving this definition content, the re- 



THE ACCOUNT A MEANS OF CLASSIFYING INFORMATION $5 

mainder of this chapter will be devoted to a discussion of the nature 
of the information which is recorded in the account and the form in 
which this information is entered. A discussion of the character 
and construction and interpretation of the accounts with the indi- 
vidual items will be deferred to a later chapter. 

As suggested in the preceding paragraph, an account is kept with 
each item of information which is needed in making an accounting 
report such as the balance sheet and statement of profit and loss. 
Consequently accounts are kept with assets such as cash, notes receiv- 
able, accounts receivable, office furniture, and delivery equipment; 
with liabilities such as notes payable and accounts payable; with 
expenses such as cost of selling and administration; and with the 
sources of income such as sales. In later chapters it will be shown 
that when more detailed information is desired on the balance sheet 
and the statement of profit and loss, it is necessary to have additional 
accounts so as to obtain this information. For the present it is not 
necessary to consider accounts other than those necessary to provide 
the information which appears on such simple statements as the bal- 
ance sheet and the statement of profit and loss of Williams, as given 
in the two preceding chapters. 

In some cases there are special reports of a statistical nature 
which are prepared for some of the subsidiary managers and which 
contain information which is not set forth in the regular accounts 
but is obtained from some form of supplementary records. The form 
and nature of such reports and the method of obtaining the infor- 
mation which they contain will be considered in subsequent chapters. 
For the present, however, the discussion will be confined to the means 
of obtaining the information which appears on the balance sheet 
and the statement of profit and loss, and this is obtained from the 
formal accounting record known as **the account.'* 

As indicated by the preceding definition, the title under which 
the account will be kept is the name of the item to be shown in the 
report. If the reports are to be of the greatest value to the parties 
to whom they are submitted, these titles must be carefully chosen. 
The information grouped under a single title must so far as possible 
bear upon a single item to be shown on one of the reports and the 
title must leave no doubt in the mind of the reader with respect to 
the nature of that item. Thus in reporting the assets of the firm, 



56 



PRINCIPLES OF ACCOUNTING 



the title **U.S. Bonds and Other Securities" is clearly one that might 
be misleading as to the true condition of the firm. It not only fails 
to show the amount of the bonds in relation to the amount of the other 
securities, but gives the reader no idea of the nature of the others. 
There is no way to judge whether they are conservative investment 
securities or of the most highly speculative types. The account title 
of "Miscellaneous Expense" is one which often results in concealing 
useful information in regard to the expenses of the business. In 
choosing titles for the accounts employed, the accountant should al- 
ways strive to make use of titles which are clear, descriptive, and 
unambiguous. 

The form of the account. In making the accounting record, facts 
of opposite tendencies must often be recorded in the same account. 
For instance, in the account with cash it is necessary to record cash 
received and also cash paid out, so as to be able to offset the two and 
obtain the cash on hand. The same is true with reference to accounts 
receivable where it is necessary to record both the oral promises 
received and the oral promises paid in order to determine the difference 
or the accounts receivable unpaid. Since sooner or later it may be 
necessary to record ^f acts of opposite tendencies in all accounts, it is 
expedient to divide the account into two sections so as to facilitate 
the recording of such facts. These two sections, which for the present 
may be called the right section and the left section, may be constructed 
as shown in the following illustration: 

CASH 



I9I9 












1919 












June 


I 


Balance 


— 


2,456 


75 


June 


30 


Accounts payable 


— 


1,500 







30 


Cash sales 




2,250 


00 




30 


Notes f)ayable 




1,500 


00 




30 


Accounts receiv- 










30 


Salaries — sales 


— 


200 


00 






able 


— 


1,400 


00 




30 


Office salaries 


— 


150 


00 




30 


Notes receivable 




800 


00 




30 
30 


Delivery exf>ense 
Advertising 


,„, 


' 224 
145 


50 
00 




I 


Balance 






75 
25 




30 


Balance 




3,187 


25 




6,906 


6,906 


75 


July 


3,187 







It will be seen from this illustration that the columns employed 
are the same on each side of the page. On each of the two sides 



THE ACCOUNT A MEANS OF CLASSIFYING INFORMATION $7 



provision is made for the tabulation of information with regard to the 
item of cash. The facts which may thus be recorded with reference 
to each change taking place in this item are: 

a) The date. Columns i and 2 are used for this purpose, the 
month a^id the day of the month, respectively, being entered in these 
two columns. The month, having once been entered, need not be 
entered again until the month changes or the account is transferred 
to a new page. It is customary to indicate the year by writing it 
at the top of column i on each side of a new page. 

h) Any explanation of the cause or nature of the entry which 
may seem desirable is entered in column 3. It will appear from 
later discussion (see chaps, xi and xii) that it is not often necessary 
to enter any such explanation in the account, and in the majority of 
entries this space will be left blank. 

c) The business transaction or change which affects the account 
is recorded in its entirety on another form of record before being 
transferred to the accounts involved. Column 4, known as the 
folio column, is used to show the reference to the page of the record 
from which the information has been transferred. By referring to 
this page, a complete explanation of the transaction is available. 
This is one reason for the relatively infrequent use of the column 3. 

d) The amount involved in each entry to the account is written 
in column 5, which is divided into two parts, a wider column for 
the dollars and a narrow one for the cdnts. 

The balance of the account. The object of each account, as has 
been stated, is to give certain definite information with regard to a par- 
ticular item, for purposes of the accounting reports. For this purpose 
it should be possible to reach a conclusion with regard to the item 
in question. It is shown by the foregoing illustration how facts of 
opposite tendencies with regard to an item are recorded in the accounts. 
The amount of cash on hand on June i was shown on the left-hand side 
of the account, and all additions to cash were recorded beneath it on 
the same side, while on the right-hand side all subtractions from the 
amount of cash were recorded. It is evident, then, that the difference 
between the total of the right-hand side and that of the left-hand side 
should represent the amount of cash on hand at the end of the period. 
The method by which this conclusion is shown on the account itself 
is indicated in the illustration. The amount of the difference between 



1:. 



f:i| 



S8 



PRINCIPLES OF ACCOUNTING 












I 



the totals of the two sides is written on the right-hand side, and the 
two sides are then totaled, the totals being entered opposite one 
another on the two sides of the page and double lines drawn under 
them to indicate an equality to that point. The amount of the 
excess of the left-hand side over the right is then written below the 
double line on the left-hand side. This figure represents the amount 
of cash that should be on hand at that time, and is known as the 
*' balance " of the account. If the entries in a given account are made 
correctly, by writing all additions to the item involved on one side of 
the page and all subtractions on the opposite side, such a balance may 
always be obtained by comparing the totals of the two sides, whether 
the formal balancing of the account is performed or not. 

It may happen that the two sides of the account are equal. In 
this case the account is said to be "in balance," and there is no need 
for adding anything to either side to bring about an equality, nor is 
there any balance to be written below the double lines on the side 
showing an excess, since no excess exists. Where this is true, the 
item involved will not appear in the rfeports for the period. 

Interpretation of the account balance. The necessity of care in 
selecting titles for the individual accounts was probably sufficiently 
emphasized in the preceding discussion of the heading or title of the 
account. If proper care has been exercised in this matter, there 
should be no difficulty in deciding upon the place of the item in the 
accounting reports. If the titles of all the items which appear in the 
reports are descriptive and unambiguous so that the student under- 
stands the nature of each item from the title, he should have no 
difficulty in the interpretation of the balance of the accounts with 
those items bearing the same titles. The nature of the balance of 
each account is revealed by the classification which is given that 
item on the balance sheet, statement of profit and loss, or other formal 
report. Thus if the item of furniture and fixtures is classified on the 
balance sheet as a fixed asset, it is clear that the balance of the account 
with furniture and fixtures represents the amount of the fixed asset. 
When accounts receivable are shown as a current asset on the balance 
sheet, the meaning of the balance of that account is equally plain. 
The same thing appHes to the other items on the reports, such as 
notes payable under current Uabilities, sales as an item of income, 
and sales salaries as an item of operating expense. 



THE ACCOUNT A MEANS OF CLASSIFYING INFORMATION 59 

In the definition of the account it is stated that it is a systematic 
record of information. This statement implies that a uniform pro- 
cedure is followed in the construction of the account. The chief 
factor in this uniform procedure is the manner in which the amount 
of any change in the item represented by a particular account is 
recorded in that account. The illustration already given of the 
account with Cash indicates that additions to an asset are recorded 
on the left-hand side of the asset account affected, and that sub- 
tractions are entered on the opposite, or right-hand, side of the 
account. Accounts with kinds of expenses resemble asset accounts 
in the fact that they represent values received by the business, 
though the values entered as expense are those which have been used 
up in securing income. Like additions to assets, additions to ex- 
pense are recorded on the left-hand side of the appropriate expense 
accounts. Any deduction from an expense is recorded on the right- 
hand side of the expense account. 

In the case of liability accounts, which are opposite in their 
nature to asset accounts, the additions to the liability in question are 
shown on the right-hand side, and the subtractions on the left-hand 
side. Income accounts represent items of a nature opposite to that 
of expense. Additions to income are therefore entered on the right- 
hand side of the income accounts involved, and subtractions from such 
income are entered on the left-hand side of the income account. 

It has been explained that proprietorship is the excess of the total 
assets of the business over its total liabilities. Since the total of the 
assets is equal to the sum of all the liabihties and the proprietorship, 
it is a part of the uniform procedure to enter additions to proprietor- 
ship on the right-hand side of the proprietorship account affected 
and deductions on the left-hand side. Thus the credit balances of the 
liability and proprietorship accounts are set over against the debit 
balances of the asset accounts, while the credit balances of the income 
accounts are set over against the debit balances in the accounts 
which show the expenses incurred in securing that income. 

Consequently the balance of an account which is larger on the 
left side represents either an asset or an expense, while the balance 
of the account which is larger on the right side represents either a 
liability, a source of income, or proprietorship. As previously stated, if 
the student is familiar with the items which appear on the accounting 



6o 



PRINCIPLES OF ACCOUNTING 






reports he will have no difficulty in interpreting the balance of the 
accounts kept with these items. 

The ledger and its contents. The accounts of the business are 
arranged in systematic order in a book called the ledger. The ledger 
is usually a bound book, the pages of which are ruled as shown on 
page 62, It is sometimes defined as the book of accounts. In it is 
collected in summarized form, imder proper account titles, the infor- 
mation necessary to make the accounting reports. There should be 
an account kept with each item of information which the owners 
desire to appear on the reports. 

The number of accounts kept will vary with the size of the busi- 
ness, the number and types of assets and Uabilities involved, the 
complexity of its operations, and more especially with the manner 
in which the business is organized, since the number and complexity of 
the reports needed to exercise control in the business vary with all of 
these factors. It is true that it is a waste of energy to maintain 
accounts which are not used in preparing the reports. It is equally 
true that care must be exercised that an analysis of the facts regarding 
the business and its operations is kept in sufficient detail to make 
available all information needed for the reports. It is easier to com- 
bine information where too many accounts have been maintained 
than to reconstruct an analysis where several items which should 
have been kept separate have been included under one account. 
The principles governing the arrangement and use of the ledger will 
be developed in the next few chapters through discussion and illus- 
trative exercises involving comparatively simple accounts, and these 
principles will be appUed later to business problems of greater 
complexity. 

The use of the terms debit and credit in relation to the account. It 
has been explained in the preceding paragraphs that the account is 
divided into two sides and that additions to the item with which the 
account is kept are shown on one side and subtractions on the other 
side. It has also been stated that it is the practice of accountants 
to use the left-hand side for recording additions to assets and expenses 
and the right-hand side for recording additions to liabiUties, income, 
and proprietorship. Among accountants and others familiar with 
accounting, the terms "left-hand" and "right-hand" are not em- 
ployed, but the two sides of the account are known respectively as the 
"debit" and "credit" sides. 



THE ACCOUNT A MEANS OF CLASSIFYING INFORMATION 61 

Following out this terminology, the entering of any item of infor- 
mation on the left-hand side of the account is referred to as "debiting" 
the account, and entering such an item on the right-hand side as 
"crediting" the account. When an item is entered on the left-hand 
side of the account it is called a "debit" to that account, and when 
on the right-hand side, a "credit." Similarly an account in which 
the total of the left side exceeds the total of the right is said to have a 
"debit balance," while one in which an excess occurs on the right side 
of the account is said to have a "credit balance." If the student will 
famiharize himself with the use of these terms as used in relation to 
the account, he should not experience any difficulty either in applying 
them or in understanding them as employed in the literature of 
accounting. 

Considerable space is devoted by some writers to the discussion 
of the original significance of the terms debit and credit and to the 
historical development of their use. A comparison of the various 
methods of approach that have been employed in attempting to 
introduce the student to their use would afford an interesting study, 
if not a particularly useful one. Such discussion, however, has little 
bearing on the functions of accounting and will not be introduced 
here, lest it confuse the student. For the purposes of this text, if the 
student understands the way in which the terms are employed as 
outlined above, he has all the information concerning them which will 
prove of any marked value to him. 

Accounts afected by business transactions. In order to maintain 
or increase the amount of the net investment of the business, the 
operations for which the business is organized must be carried on more 
or less continuously. This means that the various items with which 
accounts are kept, the assets, liabilities, sources of income, and kinds 
of expense will be continually changing in their amounts. Such 
changes are the result of business transactions. Since it is the func- 
tion of the accountant to report the results of the business operations, 
it is desirable that the relation of the business transactions to the 
accounts be considered. 

A business transaction may be defined as an exchange of values. 
As a result of such exchanges certain values are received by the busi- 
ness and certain values are surrendered by the business. If Williams 
sells groceries to a customer for cash, a value in the form of cash is 
received and a value in the form of merchandise is surrendered. 



I 



■'J' 









62 



PRINCIPLES OF ACCOUNTING 



When he purchases merchandise on account, giving his oral promise 
to pay, a value is received in the form of merchandise, while an equal 
amount of value is surrendered through the assumption of an addi- 
tional liability by the business. If Williams pays a certain amount 
for clerk hire, the value he receives is the services rendered by the 
clerk, while the value parted with is the amount paid to the clerk. 
So in the case of every transaction there is an exchange of values and 
it is the function of accounting to record these values, both those 
received and those parted with. 

In accounting, the values received are called "debits '* and re- 
corded on the debit side of the account to which they pertain, and the 
values paid out are called "credits" and recorded on the credit side 
of the account to which they pertain. It can be seen, therefore, that 
every transaction affects at least two accounts, involving a debit to 
one and a credit to the other. An illustration of the two will make 
this more apparent. If $800 of merchandise is sold for cash during the 
month of January, the value received is $800 of cash. Therefore the 
cash account will be debited as follows: 

CASH 



1919 
January 



Merchandise 



800 



00 



1919 



The value parted with is the merchandise. When merchandise 
is sold it is termed a sale, so the sales account will be credited as 
follows: 

SALES 



1919 



1919 
January 



Cash 



800 



00 



If during the same month $400 of merchandise is purchased for 
cash, the effect on the business is just the reverse. The value received 
is the merchandise. When merchandise is purchased it is termed 
"purchases"; so the purchases account will be debited as follows: 

PURCHASES 



1919 
January 



Cash 



400 



00 



THE ACCOUNT A MEANS OF CLASSIFYING INFORMATION 63 

The value parted with is the cash, which will be credited to the 
cash account. This account will then appear as follows: 

CASH 



1919 
January 



Merchandise 



800 



00 



1919 
January 



Purchases 



400 



00 



If Williams pays $100 for a sales clerk during the month, the value 
received is the services of the clerk, which will be recorded as a selling 
expense. The selling expense account will therefore appear as follows : 

SELLING EXPENSE 



1919 
January 



Cash 



100 



00 



The value parted with is the cash which will be credited to the 
cash account and this account will then appear as follows: 



CASH 



1919 
January 




1919 
January 



Purchases 
Selling exp)ense 



400 
100 



00 
00 



Determination of debits and credits to accounts. Many attempts 
have been made to give fixed rules for the debiting and crediting of 
accounts. As suggested previously, the determination of the debits 
and credits resulting from a transaction necessitates that the trans- 
action be analyzed and the value or values received by the business 
and the value or values parted with by the business be ascertained, 
after which the former are debited to the account to which they 
pertain and the latter credited in the same manner. H it is desired 
to express this as a formula, it might be stated as follows: Debit the 
appropriate account for all values received and credit the appropriate 
account for aU values parted with. The appUcation and illustration 
of this statement with reference to particular accounts will be given 
in the chapters immediately following. 

Equality of debits and credits to the accounts. The business trans- 
action has been defined as an exchange of values, and it has been 
shown that in recording such an exchange there will necessarily be an 






I 
I 



64 PRINCIPLES OF ACCOUNTING 

equality between the debits and the credits recorded. Thus all 
debits to accounts showing receipts of value will be accompanied by 
equal credits to accounts showing surrender of value. And all credits 
to accounts showing surrenders of value will be accompanied by 
equal debits to accounts showing the receipts of value. It follows 
from this that there must be at all times an equahty between the 
total debits made to the accounts and the total credits. One manner 
in which the student should test the correctness of his analysis of any 
transaction or other change to be recorded is to make sure that the 
total of the debits to be recorded, according to his analysis, is equal 
to the total credits to be recorded. Some of the uses that are made of 
the existence of this equality between debits and credits, and some 
of the means of testing it, will be discussed later in this course, 

QUESTIONS FOR CLASS DISCUSSION 

1. You have purchased the business of H. M. James, retail merchant, 
with the agreement that you are to acquire his assets, assimie his 
liabilities, and pay him the amount of his net worth as shown by his 
balance sheet. He presents a balance sheet which shows accounts 
receivable to the amount of $12,000.00. What additional information 
would you request with reference to this item ? How would you verify 
the information which he provides ? 

2. You are requested to instal an accounting system for Brown & King, 
wholesale merchants. What information would you desire before 
deciding upon the accounts which should be maintained on their ledger ? 

3. Explain the construction of an account. 

4. The cash on hand on January i is $1,400.00. How would this be 
shown in the cash account ? 

$. During the month $4,000,00 of cash is received and $4,200.00 of cash 
is paid out. How would this be shown in the cash account ? 

6. How would the cash on hand on February i be determined ? 

7. How are addition and subtraction indicated in the account ? 

8. Explain and illustrate the meaning of the terms "debit" and "credit." 

9. Explain and illustrate how transactions are recorded in accounts. 

10. The following list of account balances is taken from the ledger of 
A. B. Johnson: 

Selling Expenses $ 400.00 

Delivery Equipment 600.00 

Land 2,000.00 

Buying Expenses 100.00 



THE ACCOUNT A MEANS OF CLASSIFYING INFORJVIATION 65 

^^^^ $12,000.00 

Merchandise Inventory 3,000.00 

Purchases 10,000.00 

Accounts Payable 4,000.00 

Notes Receivable 200.00 

Notes Payable 1,200.00 

Cash 80000 

Dehvery Expenses ........ 340.00 

Administrative Expenses 1420.00 

Building . 2,000.00 

Accounts Receivable 3,800.00 

A. B. Johnson, Proprietor ' 2,600.00 

State which of these represent debit and which credit balances. 

11. If transactions are recorded properly in the accounts, what relation 
exists between the debits and credits shown by the accounts ? 

12. Name the debits and credits resulting from the following transactions: 

a) Purchase merchandise for cash, $200.00. 

b) Purchase merchandise from R. L. James on account, $300.00. 

c) Sell merchandise to C. R. Laws on account, $18.00. 

d) Pay $400.00 for services of stenographer. 

e) Pay A. B. Hill $20.00 to apply on account. 

f) Receive $40.00 from J. T. Hensley to apply on account. 

g) Pay $80.00 for rent of store. 

h) Sell for cash merchandise, $75.00. 

i) Pay for services of sale clerk, $50.00. 

j) Receive from A. P. James $40.00 to apply on account. 

REFERENCES FOR FURTHER STUDY 
Sprague, Chas. E., The Philosophy of Accounts, chaps, i-iv. 
Kester, Roy B., Accounting Theory and Practice, Vol. I, chaps, x and xi. 
Paton, W. a., and Stevenson, R. A., Principles of Accounting, chaps, ii 

and ni. 
Mitchell, T. W., Accounting Principles, chap. iv. 

LABORATORY EXERCISE NO. 10 
Illustration of the Account 

The following transactions were performed by J. B. Adams, retail 
merchant, during the month of June: 

1. Purchased of J. H. Bishop & Co. on account, merchandise, $246.00. 

2. Paid rent for the month, $60.00. 

3. Purchased of L. S. Lyon & Co. on account, merchandise, $340.00. 



! 

I: 



66 



PRINCIPLES OF ACCOUNTING 



4. Sold to A. B. Hill for cash, merchandise, $46.00. 

5. Sold to H. M. Peabody on account, merchandise, $27.00. 

7. Paid stenographer one week's salary, $25.00. 

8. Purchased of Marshall Field & Co. on account, merchandise, 
$250.00. 

9. Purchased of the Acme Fiumiture Co. for cash, desk and chair for 
office use, $100.00. 

10. Received from A. K. Long to apply on account, $23.00. 

11. Paid James Langley & Co. on account, $82.00. 

12. Received a thirty-day note for $27.00 from A. B. James to apply 
on account. 

14. Paid sales clerk for two weeks* services, $40.00. 

14. Paid $10.00 for repairs on delivery equipment. 

15. Paid $12.00 for repairs on bmlding. 

17. Received $20.00 from Alfred Long to apply on account. 

19. Sold M. M. McGee on account, merchandise, $16.80. 

20. Paid for services of delivery driver, $60.00. 

21. Paid for expenses of buying trip of Mr. Adams, $39.40. 

23. Paid the King Coal Co. $30.00 for coal to be used in heating store 
building. ^ 

24. Paid local newspaper $32.00 for advertising. 

26. Paid J. H. Bishop & Co. $246.00 in full of account. 

27. Purchased on accoimt from Chicago Wholesale Co., merchandise, 
$450.00. 

30. Paid the following expenses for the month: 

Light $ 4.00 

Telephone S-oo 

Telegraph 3-«> 

Sales salaries 120.00 

Stenographer and bookkeeper . . ' . . . 100.00 

Instructions: 

Draw a line lengthwise through the center of a sheet of note paper. 
On the left of the line write the debit items and on the right of the line the 
credit items resulting from the foregoing transactions. Merchandise pur- 
chased will be recorded as "purchases," and merchandise sold as "sales." 
The first two transactions when recorded will appear as follows: 
Purchases . $246.00 J. H. Bishop & Co. . $246.00 
Administrative Expense 60.00 Cash 60.00 



CHAPTER VI 

THE CONSTRUCTION AND INTERPRETATION OF 

PARTICULAR ACCOUNTS 

Certain facts to be considered in interpreting accounts. In the 
preceding chapter the use of accounts as a means of obtaining the 
information necessary to make the accounting reports which are 
needed in the business and the general principles regarding the con- 
stf iiction of accounts have been discussed. The analysis of business 
transactions according to their effect on the various accounts has also 
been considered. The next step is to explain the application of these 
principles in the construction and interpretation of particular accounts. 

In order to understand the construction and interpretation of an 
account, three things must be considered: (i) The object or purpose 
of the account, i.e., the information which it is desired to obtain 
from the account. (2) The transactions which are to be recorded in 
it or tiie debits and credits which are made to it. (3) What the 
balance of the account represents and what disposition is made of this 
balance on the accounting reports. 

• The following discussion considers certain typical accounts, the 
ones selected being such as would ordinarily be required in a sniall 
retail business like that of Mr. Williams. The aim of the discussion 
is to apply each of the three tests stated above to the interpretation 
of each of the accounts considered. Later, still other accounts will be 
considered in the same manner. 

Cash account. The term ca^h, as used in accounting, refers to 
money of all kinds and to commercial paper such as will pass readily 
as a medium of exchange. Such paper includes personal checks, 
cashiers' checks, bank drafts, so-called travelers' checks, and postal and 
express money orders. It also includes funds on deposit with the bank. 

The purpose of the cash account is to show the cash received, 
cash paid out, and the difference, or the cash on hand. This account, 
therefore, is affected by every transaction which involves either the 
receipt or payment of cash. 

67 



t 






It ' 



4 * 



68 PRINCIPLES OF ACCOUNTING 

The debits and credits to the cash account are as follows: 

CASH 



Debit: 
With cash received. 
Usually this account is not debited with 

individual cash items, but for daily, 

weekly, or monthly totals. 



Credit: 

With cash paid. 

Usually this account is not credited 
with individual cash items, but for 
daily, weekly, or monthly totals. 



The balance of the cash account must always be on the debit 
side, since cash is an asset and it is impossible to disburse more cash 
than is on hand. The balance represents the amount of cash actually 
on hand and available for use in the business. It may be that through 
some error the amount which is shown as that which should be on 
hand does not agree with that which is actually on hand. If so, it is 
very important that this should be learned, the reason accounted for, 
and the error corrected. For this reason it is desirable that a proof of 
cash should be made from time to time to check the accuracy of the 
cash balance. This involves the ascertainment of the total cash on 
hand by adding the amount of cash credited at the bank to the cash 
held by the business in any form outside of the bank and comparing 
this with the total shown by the cash account. In many businesses 
such a proof is made daily. It certainly should be made at frequent 
intervals. 

Accounts with debtors. In most businesses merchandise is sold 
on credit. In a retail business goods are usually sold on open account, 
i.e., oral promises are received in payment for them. In some cases, 
however, written promises or notes are received in payment of the 
merchandise or in payment of the oral promises originally received 
in payment for merchandise. On the balance sheet the written 
payments of customers are shown as notes receivable and the oral 
promises are shown as accounts receivable. It is desirable, therefore, 
to have accounts from which the amount of each of these items can be 
obtained. 

Notes receivable. Since written promises received from customers 
are not usually numerous, it is customary to record all notes receivable 
in one account. The amount due from each customer on notes can 
be determined at any time by examining the amount of the notes on 
hand. The date of payment of other information desired about the 



CONSTRUCTION AND INTERPRETATION OF ACCOUNTS 69 

note can be determined in the same manner. It is not necessary, 
therefore, to have a separate account with the notes due from each 
customer. 

The purpose of the "Notes Receivable" account is to show the 
notes received from others, the amount received from them in pay- 
ment of these notes, and the balance, which is the amount of notes 
receivable now held by the business. The correctness of this amount 
can be ascertained by comparing it with the amount of notes on hand. 

The debits and credits to the " Notes Receivable " account are as 

follows; 

NOTES RECEIVABLE 



Debit: 
With the face value of all notes received 
in favor of the business. 



Credit: 
With the amount of cash or other 
/ property received in payment of 

notes. 
With the face value of any notes 
transferred or disposed of. 



Since the "Notes Receivable" account is always debited for the 
face value of the notes received and credited with the face value of 
notes paid, canceled, or surrendered, it is quite clear that the balance 
of this account must always be on the debit side, since the business 
will not receive more in payment of notes than there is due. The 
balance is shown on the balance sheet as a current asset. 

Accounts receivable. In a retail business the oral promises re- 
ceived from customers are usually quite numerous; consequently, 
unlike notes receivable, it is necessary to have a separate account or 
record with each customer. There are many different methods 
employed in keeping a record of the amount due from customers. 
The purpose of the present discussion, however, is to explain to the 
student the principles involved in the construction of accounts rather 
than the practices of any particular business. Consequently, a 
consideration of special methods of recording accounts receivable 
will be postponed for the present. 

The purpose of the accounts receivable, or "customer's" account, 
is to show the oral promises received from a customer to whom mer- 
chandise has been sold on account, the amount paid by the customer 
in settlement of the amount due, and the balance, which represents 
the amount remaining unpaid. 



70 



PRINCIPLES OF ACCOUNTING 






The debits and credits to a customer's account are as follows: 

ACCOUNTS RECEIVABLE 
(Separate Accounts with Each Customer) 



Debit: 
With the amount of the account sales of 
merchandise to a customer. 



Credit: 

With cash received from a customer 
to apply on account. 

With a note or other property re- 
ceived to apply on account. 

With any allowance or deduction 
made to a customer. 



;f 



■j 1 

I 



Since customers will not pay more than they owe and the debit 
side shows the amount due and the credit side the amount paid, 
it follows that the debit side will always be the larger. The sum 
of the balances of all the customers' accounts is shown on the 
balance sheet as a current asset under the heading of "Accounts 
Receivable." 

Accounts with creditors. When a business sells merchandise on 
credit it usually finds it necessary to purchase on credit, in which case 
it may give either its written or its oral promises in payment of the 
merchandise purchased. The written promises are shown on the bal- 
ance sheet as "Notes Payable" and the oral promises as "Accounts 
Payable." Since these items are shown separately on the balance 
sheet, separate accounts must be carried with them. Separate 
records also faciUtate the prompt payment of debts due to creditors. 

Notes payable. The notes issued by the business in favor of 
others are usually not numerous, so notes payable, like notes receiv- 
able, are recorded in one account. As will be explained later, there 
is sometimes another record besides the ledger account kept with 
both notes receivable and notes payable, but in any case only one 
ledger account is kept with each. 

The purpose of the notes payable account is to show the notes 
issued in favor of others by the business, the amount paid in liqui- 
dation of these notes, and the balance, or the notes still owed. This 
account is affected by all transactions which increase or decrease the 
amount of the notes of the business outstanding. 



CONSTRUCTION AND INTERPRETATION OF ACCOUNTS 71 



The debits and credits to the Notes Payable account are as follows: 

r 
NOTES PAYABLE 



Debit: 
With the amount paid in settlement of 
notes owed. 



Credit: 
With the face value of notes issued 
by the business. 



The credit side of the Notes Payable account is always the larger 
and the balance is shown on the balance sheet as a current liability. 

Accounts payable. The accounts payable of the ordinary whole- 
sale or retail mercantile business are usually not so numerous as its 
accounts receivable. To make a record of them, therefore, is not so 
burdensome a task. Although in some businesses a separate ledger 
account is not kept with each creditor, for the purpose of the present 
discussion and illustrations such a practice may be assumed. 

The purpose of an accounts payable or "creditor's" account is to 
show the oral promises issued by the business to a creditor from whom 
merchandise has been purchased on account, the amount paid in 
settlement thereof, and the balance or the amount still owed to the 
creditor. A creditor's account is affected by all transactions which 
cause an increase or decrease in the amount due him. 

The debits and credits to a creditor's account are as follows: 

ACCOUNTS PAYABLE 
, (Separate Accounts with Each Creditor) 



Debit: 
With cash paid or notes issued to a 

creditor to apply on account. 
With allowances or deductions granted 

by a creditor which decrease the 

amount owed. 



Credit: 
With purchases of merchandise on 
account from a creditor. 



Since more will not be paid to a creditor than is owed to him, except 
by mistake, the credit side of this account should always be the larger. 
The balance of the account is a current liability and is so shown on the 
balance sheet. 

Accounts with fixed assets. In a previous chapter it is stated that 
the assets of a business may be divided into two classes: those which 
are in the form of cash or which will be liquidated in cash within a 



*\ 



72 



PRINCIPLES OF ACCOUNTING 






i 



relatively short time in the regular operations of the business, and 
those which the owner plans to retain in the business. As previously 
explained, the former are known as current assets and the latter 
as fixed assets. The construction and interpretation of the accounts 
with some of the principal current assets, such as cash, accounts 
receivable, and notes receivable, has been discussed. The construc- 
tion of accounts with such fixed assets as office furniture and delivery 
equipment may now be examined. 

In every business certain equipment, such as desks, chairs, 
tables, counters, typewriters, adding machines, etc., is employed. 
This equipment is known by various terms, but may appropriately be 
called "office equipment." The business, of course, does not pur- 
chase this equipment for purposes of resale, although, of course, it 
may be sold as scrap when the asset can no longer be used in the 
business. The manager intends to retain it for use in the business, 
and such use, of course, will cause it to decrease steadily in value. 
This decrease in value takes place during the entire life of the asset, 
and its amount should be distributed over the period of its life. 

For instance, if the proprietor purchases for $ioo a typewriter 
which will give satisfactory service for ten years, and has a scrap 
value of $20 at the end of that time, his investment in the typewriter 
has evidently declined in value during that period by the amount of 
$80. This yearly decrease in value of the typewriter, due to its use 
in the business, which is known in accounting as "depreciation," 
must be shown in the accounting records in two ways. It must be 
shown as a deduction from the asset value of the typewriter and it 
must also be shown as an expense of the business. The student 
should readily realize that if the typewriter will be decreased in value 
$80 in ten years, it would be unwise to wait until the end of ten years 
and then show the entire decrease. The balance sheets made up in 
the meantime would show the typewriter at its original value of $100, 
which would be clearly erroneous. This yearly decrease in value 
should also be treated as an expense of conducting the busmess, just 
as a yearly rental of $8 would be treated. 

The proper recording of the depreciation which arises from their 
use in the business is the chief accounting problem in connection with 
the accounting for fixed assets. With a very few exceptions, such as 
certain kinds of land, or the roadbed of a railroad, this depreciation 



CONSTRUCTION AND INTERPRETATION OF ACCOUNTS 73 

is continually going on in connection with fixed assets, and it is 
emphasized at this point so that the student will see from the very 
beginnmg of his study of accounting that no accurate or trustworthy 
reports can be made concerning the financial condition of a business 
unless the depreciation of its fixed assets is taken into consideration. 
As stated in chapter iii, it is customary for the owner to retain or 
reserve m the business sufficient of his profits to cover the amount of 
the estimated depreciation of his fixed assets. This estimated 
decrease, which is called a "reserve for depreciation," is, as illustrated 
in the preceding chapter, shown on the balance sheet as a deduction 
from the original cost of the asset. For instance, in the balance 
sheet of W. A. Williams his furniture and fixtures are shown as 
follows: 



Furniture and fixtures 

Less reserve for depreciation 



$500.00 
50.00 

$450.00 



If the original cost of the fixed asset and the amount by which it 
has depreciated are to be shown as separate items on the balance 
sheet, it will be realized, since this information is obtained from the 
accounts, that two accounts must be kept with each fixed asset sub- 
ject to depreciation. The construction and interpretation of these 
accounts for such fixed assets as are necessary for a retail business 
such as that of W. A. Williams will be discussed below. 

Office Furniture or Equipment. Under this heading is included 
the property purchased for use in the office of a business, such as 
desks, typewriters, safes, filing cabinets, bookcases, chairs, tables, etc. 
In a small business, counters, show cases, etc., may be included under 
this heading, though in most cases a separate account called "store 
fixtures" is kept with such property. 

It has been explained that two accounts may be kept with such 
property, one with the asset itself and one to show the amount by 
which the asset has depreciated. The purpose of the office furniture 
account is to show the cost of such equipment purchased, the cost of 
the equipment disposed of or no longer used in the busmess, and 
the balance, which represents the cost of the equipment employed 
in the conduct of the business. 



t( > 



74 PRINCIPLES OF ACCOUNTING 

The debits and credits to this account are as follows: 

FURNITURE AND FIXTURES 



Debit: 
With the cost value of furniture and 
fixtures purchased. 



Credit: 
With the cost value of furniture and 
fixtures sold, exchanged, destroyed, 
or discarded. 



The balance of this account shows the cost value of the furniture and 
fixtures used in the conduct of the business and is shown as a fixed 
asset on the balance sheet. 

Reserve for Depreciation of Office Furniture. The purpose of the 
reserve for depreciation of furniture and fixtures account is to show 
the net amount of the reserve created to take care of the decrease in 
value of the property used in the office. 

The debits and credits to this account are as follows: 

RESERVE FOR DEPRECIATION OF FURNITURE AND FIXTURES 



Debit: 
With the cost value of furniture and 

fixtures discarded or destroyed. 
With the excess of the cost over the 

selling price of furniture and fixtures 

sold. 



Credit: 
At the close of each fiscal period with 
the amount of depreciation of the 
furniture and fixtures which is 
estimated to be properly charge- 
able against that period's oper- 
ations. 



After adjustment at the end of a period, the balance of this 
account shows the total amount which has been charged against 
revenue up to date for depreciation on the furniture and fixtures which 
are still in use. The balance should appear on the balance sheet as a 
deduction from the furniture and fixtures account. In case of the 
loss of a fixed asset through accident, such loss not properly falling 
under the head of depreciation, the asset account would be credited 
for the cost of the property destroyed, and the reserve for depreciation 
account would be debited with an amount representing the estimated 
accrued depreciation on the property to date. The difference be- 
tween the cost of the asset and the accrued depreciation would be 
debited to a special account, such as "Loss from Fire." 

If an account is kept with store fixtures, it will be necessary to 
keep also a reserve for depreciation of store fixtures account. The 
principles governing the construction of these accounts and the treat- 



CONSTRUCTION AND INTERPRETATION OF ACCOUNTS 75 

ment of their balances are exactly the same as in the case of furniture 
and fixtures. It is accordingly not necessary to give a discussion 

of them here. 

Delivery Equipment. The purpose of the account with delivery 
equipment is to show the cost of property purchased for use in deliver- 
ing goods. This includes cost of teams, wagons, harness, automobiles, 
or any other conveyances that may be used by the business in deliver- 
ing goods to customers. Cost of repairs to delivery equipment must 
not be charged to this account, but to the delivery expense account. 

The debits and credits to this account are as follows: 

DELIVERY EQUIPMENT 



Debit: 
With cost of property purchased for use 
in delivering goods to customers. 



Credit: 
With the cost price of any property 
sold or discarded which has pre- 
viously been charged to this 
accoimt. 



The balance of this account shows the cost value of the delivery 
equipment on hand. It is shown as a fixed asset on the balance sheet. 

Reserve for Depreciation of Delivery Equipment. As with other 
fixed assets, it may be desirable to keep two accounts with delivery 
equipment. The first, as explained and illustrated above, shows the 
cost of the asset. The second, as explained and illustrated below, 
records the estimate^ amount of the depreciation which has resulted 
from the use of the asset in the business. 

The purpose of the reserve for depreciation of delivery equipment 
account is to show the net amount of the estimated decrease in value 
of the property purchased for delivery purposes. 

The debits and credits to this account are as follows: 

RESERVE FOR DEPRECIATION OF DELIVERY EQUIPMENT 



Debit: 

With the cost price of delivery equip- 
ment discarded. 

With the excess of the cost over the 
selling price of delivery equipment 
sold. 



Credit: 

At the close of each fiscal period with 
the estimated depreciation of de- 
livery equipment charged to the 
operations of that period. 



The balance of this account is shown on the balance sheet as a deduc- 
tion from the amount of the delivery equipment account. It represents 



> 



76 



PRINCIPLES OF ACCOUNTING 



I I 



the amount which has been charged off to date for depreciation on 
such of this class of property as is still in use in the business. 

Accounts mth proprietorship. In the preceding chapters it has 
been repeatedly emphasized that proprietorship is the excess of the 
total assets of a business over its total liabilities, or the owner's net 
investment in the business. The amount of this net worth can be 
obtained at any time by taking the difference between the total 
assets and total liabilities. But, as has been pointed out previously, 
it is customary to maintain at all times a balance between the total 
of the debits and of the credits. For this reason accounts are kept 
with proprietorship. An account is maintained which shows the 
amount of the original investment made by the proprietor, all addi- 
tions to that investment, and all subtractions from it. Also at the 
end of each fiscal period the net profit or loss of the business for the 
period is added to or subtracted from the figure of the net investment 
shown by the account, which then reflects the status of the proprietor's 
net interest at that time. This account is usually known as the 
proprietor's "capital" account. 

Debits and credits will be made to this account as follows: 
PROPRIETOR'S CAPITAL ACCOUNT 



Debit: 
With all withdrawals of investment. 
With the net loss for the accounting 
period. 



Credit: 

With the amount of the proprietor's 
original investment. 

With all additions made to that 
investment. 

With the net profit for the account- 
ing period. 



So long as the owner has any proprietorship in the business, this 
account will always show a credit balance. If it should happen that 
the liabilities of the business are in excess of the assets, the business 
is insolvent and normally would not continue to operate. When 
such a condition exists, the balance in the proprietor's capital account 
will appear on the debit side and show the amount of the discrepancy 
between assets and liabilities, that is, the amount of the deficit. The 
credit balance which normally appears in this account is shown on the 
balance sheet, being added to the total of the UabiUties, the total of 
liabilities and proprietorship being equal in amount to the total of 
assets. 



CONSTRUCTION AND INTERPRETATION OF ACCOUNTS ^^ 

In a business with a single proprietor, it is customary to keep an 
account showing the amount of the drawings of the owner and the 
amount that is supposed to be subject to his withdrawal, according 
to the plans of the business. Such an account is known as the pro- 
prietor's ** personal" account. It is supposed to reflect the amounts 
which the proprietor draws during the fiscal period for his personal 
needs and in anticipation of the period's profits. As already shown, 
any withdrawals intended to reduce permanently the original or 
accumulated investment will be shown, not in this account, but in 
the capital account. In many cases the proprietor allows himself a 
fixed salary, which may represent the amount which he intends to 
withdraw each period out of profits. Where this scheme is followed, 
this salary is charged as an expense in the group of administrative 
expenses, and the amount so charged is credited to the personal 
account of the owner. In such a case the balance of the account 
will show at any time whether the owner has withdrawn more or less 
than the amount of salary with which he has been credited up to that 

time. 

The debits and credits to the personal account are as follows: 

PROPRIETOR'S PERSONAL ACCOUNT 



Debit: 
With amounts drawn by the owner 
against anticipated current profits or 
salary allowance. 



Credit: 
With periodical allowance for salary 
of the owner. 



As Stated above, this account may show either a debit or a credit 
balance, depending on whether the allowance made for the owner's 
salary has been overdrawn or left partly undrawn. In either case the 
balance of this account must be considered in conjunction with the 
balance of the capital account in order to ascertain the exact net 
proprietorship at a given time. A credit balance in the personal 
account is to be added to the balance in the capital account to show 
total proprietorship, while a debit balance, representing an overdraft, 
or advance drawing against profits, is to be deducted. The distinction 
between personal and capital accounts is more important where there 
is more than one owner; that is, in a partnership. There it is impor- 
tant to know how much each of the owners is entitled to draw and 
how his drawings stand in relation to that amount at any given time. 



If 



)l 



78 



PRINCIPLES OF ACCOUNTING 
QUESTIONS FOR CLASS DISCUSSION 



1. You are requested to examine the accounts of the X.Y. Manufacturing 
Company to determine whether they are maintained in such a way 
that they provide accurate and comprehensive information for the 
accounting reports. What information would you desire with reference 
to each account in order to determine this ? 

2. James King is employed as bookkeeper by the X.Y. Manufacturing 
Company. He is unfamiliar with the account titles which they use. 
What will he need to know with reference to each account in order to 
perform his duties intelligently. 

3. In inspecting the ledger of the X.Y. Manufacturing Company you find 
that the cash account shows a credit balance of $100.00. What would 
you infer from this ? 

4. How would you proceed to prove the correctness of the balance of the 
cash account ? 

5. On January i H. B. Jones owes the business $100.00. In response 
to a request for payment he sends $40.00 in cash and his thirty-day 
note for $60.00. What entries would be made in the accounts when 
the cash and note are received from Jones ? 

6. On the ledger of the A.B. Company the account of J. R. Baker appears 
as follows: 

J. R. BAKER 



January i 
22 



80 
40 



00 
00 



January 12 



80 



00 



Is Baker a customer or a creditor of the company ? 
7. On the same ledger the account of T. W. Torr appears as follows: 

T. W. TORR 



January 10 



76 



00 



January 25 



76 



00 



Is Torr a creditor or a customer of the company ? 

8. On January i H. R. DuPont purchases delivery equipment which costs 
$3,000.00. On December 31 should this asset be shown on the balance 
sheet at cost ? If not, how would you determine the amount at which 
it should be shown ? 

9. At the end of the fiscal period your employer estimates that his office 
furniture has depreciated during the year to the amount of $40.00. 
In what way would you treat this depreciation in making a balance 
sheet ? How would it be treated on the statement of profit and loss ? 



CONSTRUCTION AND INTERPRETATION OF ACCOUNTS 79 

10. How is depreciation on fixed assets shown in the accoimts ? 

11. The following transactions were performed by James Monroe, single 
proprietor: 

Jan. I. Invests $2,000.00 in cash. 

Feb. 3. Makes an additional investment of $200.00. 

Mar. I. Withdraws $50.00 for personal use. 

June I. Withdraws $70.00 for personal use. 

July 2. Makes an additional investment of $1,500.00. 

Sept. 30. Decides to reduce his investment and withdraws $1000.00. 

Oct. I. Withdraws $80.00 for personal use. 

Dec. 31. Determines from his statement of profit and loss that his 
profits for the year are $800.00. 
Explain how the above transactions would be shown in the proprietor's 
capital and personal accounts. 

REFERENCES FOR FURTHER STUDY 

Sprague, Charles E., Philosophy of Accounts, chaps, vi, vii, viii, ix. 
Mitchell, T. W., Accounting Principles, chap. xi. 
Kester, Roy B., Accounting Theory and Practice, Vol. I, chaps, xii, xiii. 
Stockwell, H. G., Net Worth and the Balance Sheet. 

LABORATORY EXERCISE NO. 11 

iLLUSTRAnON OF BALANCE ShEET ACCOUNTS 

On January i, 1919, you are employed as bookkeeper by G. T. Davies. 
Mr. Davies* accoimting system consists of only memorandum records. 
You find it necessary to open new records for him. With his aid you deter- 
mine that his assets and liabilities are as follows: 

Cash $1,300.00 

Notes receivable 40.00 

Accounts receivable 3,800.00 

Merchandise inventory 3,200.00 

Office furniture AS^-oo 

Building 2,000.00 

Land 1,000.00 

Notes payable 1,300.00 

Accounts payable 2,700.00 

Instructions: 

On ledger paper open the accounts necessary to show the financial con- 
dition of Mr. Davies on January i, 1919. Allow ten lines for each account. 

V 



8o 



PRINCIPLES OF ACCOUNTING 



LABORATORY EXCERCISE NO. 12 
Illustration or Balance Sheet Accounts 

During the month of January, Davies performs the following trans- 
actions: 

Jan. I. Receives cash from customers to apply on account, $320.00. 

2. Pays for the erection of an additional room to the building, 
$800.00. 

3. Receives from customers to apply on account, $240.00. 

4. Receives a note from a customer to apply on account, $80.00. 
6. Pays creditors to apply on account, $120.00. 

10. Withdraws for private use, $60.00. 

12. Purchases a desk for office use, $65.00. 

14. Gives a thirty-day note for $110.00 to a creditor to apply on 

account. 
16. Receives $60.00 in payment of a note due from a customer. 
20. Makes an additional cash investment, $300.00. 
22. Pays a note due to a creditor, $45.00. 

25. Pays creditors to apply on account, $240.00. 

26. Receives from customers to apply on account, $200.00. 
28. Withdraws for private use, $80.00. 

30. Reduces his investment in the business by withdrawing 
$300.00 in cash. 

Instructions: 

Make the entries on the ledger which are necessary to record these 
transactions. 

Preserve this exercise for future use. 



CHAPTER VII 

THE CONSTRUCTION AND INTERPRETATION 

OF ACCOV^TS— Concluded 

Accounts with merchandise. Merchandise is a general term applied 
to goods bought and sold by a mercantile business, such as groceries, 
dry goods, hardware, etc. In accounting, merchandise bought is 
termed "purchases," merchandise sold is termed "sales," and the 
merchandise on hand at the beginning or end of a fiscal period is 
termed "merchandise inventory." It is from the purchase and sale 
of merchandise that the owner of a mercantile business expects to 
derive his profit, and most of the current transactions which such a 
business performs pertain to purchases and sales. 

By referring to the statement of profit and loss given in chapter 
iv, it will be seen that sales, purchases, and inventory are shown as 
separate items, therefore there must be some means by which the 
amount of each can be obtained at the end of the fiscal period. The 
amount of the purchases and sales for the period are obtained from 
the ledger accounts which are kept for the purpose. The inventory of 
merchandise is usually obtained by making a physical count of the 
goods in stock, and determining their value at cost price. At the end 
of the fiscal period, after the amount of the inventory is thus deter- 
mined, it is customary to open an account to record its amount. 
The present discussion will be confined to a consideration of the ac- 
counts with purchases, sales, and inventory. In subsequent chapters 
the use of other accounts to provide more detailed information 
concerning merchandise will be discussed. 

The purchases account. The use of the purchases account is 
peculiar to mercantile concerns. Its purpose is to show the cost of 
goods purchased. Only purchases of goods intended for resale are 
recorded in this account. Purchases of fixed assets, of raw materials 
for manufacturing, or of miscellaneous supplies, such as pens, paper, 
clips, etc., must be recorded in separate accounts. 

81 



82 



PRINCIPLES OF ACCOUNTING 



The debits and credits to the purchases account are as follows: 

PURCHASES 



Debit: 
With the invoice price of merchandise 

purchased. 
With the amounts paid for freight and 

drayage on merchandise purchased, 

if a separate account is not kept with 

these items. 



Credit: 
Allowances and deductions are some- 
times credited to this account, but 
it is better to have a separate 
accoimt for them, as will oe ex- 
plained later. 



The balance of this account shows the cost of goods purchased and 
is shown on the statement of profit and loss as an item of cost of goods 
sold. 

The sales account. The purpose of the sales account is to show the 
amounts received from the sale of merchandise, manufactured product, 
or services, as the case may be. For the present, the discussion will 
be confined to mercantile businesses, and only sales of merchandise 
will be considered. 

The debits and credits to this account are as follows: 

SALES 



Debit: 
Allowances and deductions to custom- 
ers are sometimes debited to this 
account, but it is better to have a 
separate account, as will be explained 
later. 



Credit: 
With the selling price of merchandise 
sold. 



The balance of this account shows the amount of sales made during 
the fiscal period and is shown as the principal item of income on the 
statement of profit and loss. 

The inventory account. Entries are made in the inventory account 
only at the end of the fiscal period. Its construction and use may be 
better explained, therefore, in connection with the discussion of the 
sunmiary of operations at the end of the fiscal period. Consequently 
the discussion of this account will be postponed until the following 
chapter. 



CONSTRUCTION AND INTERPRETATION OF ACCOUNTS 83 

A ccounts with operating expenses. As previously stated, the nature 
and the amount of the operating expenses are determined in the main 
by the size, nature, and organization of the business. In turn, the 
nature and amount of the expenses determine to a considerable 
extent their sub-classifications and the accounts which are kept to 
record them. In deciding what accounts should be kept with ex- 
penses it should always be remembered that, although it is important 
to have information which will show what the expenses have been for a 
certain period, it is equally important to have information which will 
make possible plans for the reduction of expenses during succeeding 
periods. 

Usually the operations of a business are capable of a more or less 
definite classification. For instance, the operations of a mercantile 
business may be classified as follows: purchasing goods; selling goods; 
transporting and delivering goods; and administering the business as 
a whole. Of course, each of these classes of operations is capable of 
considerable subdivision, but they indicate fairly well the operations 
of a business of average size. The expenses of a mercantile business 
may accordingly be classified as follows: (i) buying expenses; (2) 
selling expenses; (3) drayage and delivery expenses; (4) administrative 
expenses. 

If such a classification is used, there must be at least one account 
with each class. Of course there may be several accounts kept with 
each of these divisions. For the sake of simplicity it will be assumed 
that only one account will be kept with each class of expense. The 
more detailed accounts will be introduced later. 

Buying expenses. The purpose of the account with buying 
expenses is to show the expenses incurred in the purchase of merchan- 
dise. In a store which does not have one or more buyers to devote 
their entire rime to the purchase of merchandise, this function may 
be performed by the owner, manager, or other executive of the busi- 
ness. In this case the proportionate part of the salary of the person 
who performs the duties of the buyer may be treated as a buying 
expense. Similarly, the estimated number of hours a week given by 
any member or members of the oflice force to buying may be charged 
to this accoimt. This account should also be charged with traveling 
expenses of buying trips and other miscellaneous buying expenses. 



1 t 



i i 
ll 



84 PRINCIPLES OF ACCOUNTING 

The debits and credits to this account are as follows: 

BUYING EXPENSES 



Debit: 
With all expenses incurred in the pur- 
chase of merchandise. 



Credit: 
With any adjustments which reduce 
the amounts debited to this 
account. 



The balance of this account shows the expenses incurred in the pur- 
chase of merchandise and is shown in the statement of profit and loss 
as an operating expense. 

Selling expenses. The purpose of the account with selling expenses 
is to show the expenses incurred in the sale of merchandise. The 
wages and other remunerations of sales persons, order takers, and all 
others engaged in selling should be treated as selling expense. If it 
is the duty of some executive to supervise the sales department of the 
business, his salary should also be charged to this account. Expendi- 
tures for advertising purposes such as space in newspapers, periodicals; 
space on the street cars and billboards; circulars and postage thereon; 
advertising novelties; charitable donations; window display, etc., 
should be treated as a part of selling expense. Such expenses may be 
charged to an advertising account, but if so, they should be added to 
the other selling expenses in arriving at the total sales expense of the 
business. In addition to the above, the cost of wrapping paper, 
cartons, twine, salesmen's order books, and all other items of direct 
selling expense should be charged to this account. 

The debits and credits to this account are as follows: 

SELLING EXPENSES 



Debit: 

All expenses incurred in connection 
with the sales of merchandise. 



Credit: 
With any adjustments which reduce 
the amount of the charges made to 
this account. 



The balance of this account shows the expenses incurred in the sale 
of merchandise and is shown in the statement of profit and loss as an 
operating expense. 

Accounts with delivery expense and drayage expense. In every 
mercantile business there are certain expenses incurred in connection 



CONSTRUCTION AND INTERPRETATION OF ACCOUNTS 85 

with the local transportation of merchandise. In a retail business the 
goods purchased must be transported from the railroad depot to the 
storeroom of the business. Such transportation may be performed 
by the business itself or it may employ others to do it. In either case 
certain expenses are incurred. These expenses — usually known as 
drayage — constitute a part of the cost of the merchandise and are 
added to the invoice price in arriving at the cost of the goods sold. 

Then, too, a retail business usually incurs certain expenses in 
connection with the delivery of goods sold to customers. This expen- 
diture constitutes an operating expense and may be shown on the 
accounting reports as a separate item or as a subdivision of selling 
expense. 

In a wholesale business certain expenses are incurred in connection 
with transporting merchandise from the railroad depot to the ware- 
house of the business. As in the case of the retail business, these 
expenses — known as drayage expenses — constitute a part of the cost 
of the goods purchased. The wholesale company also incurs expenses 
in connection with transporting goods sold from its warehouse to the 
railroad depot. As in the case of the delivery expenses in the retail 
business, these expenses — by whatever name known — constitute a 
selling expense. Sometimes the wholesale company uses the same 
equipment to deliver goods to the depot and bring goods from the 
depot, in which case, it may be impracticable to attempt to keep the 
cost of these two services separately. In this case the total cost is 
recorded in one account and at the end of the period it is allocated on 
some rational basis between the cost of goods purchased and selling 
expense. 

In the following discussion, the term "delivery expense" will be 
used to refer to the cost of delivering goods sold, whether these goods 
are delivered directly to the purchasers, as in the case of the retail 
business, or only to the raikoad depot, as in the case of the wholesale 
business. 

The purpose of the account with delivery expense is to show the 
cost of delivering merchandise to customers. Wages of employees 
engaged in delivering the goods should be treated as delivery expense. 
In addition, all stable and garage expenses, also all repairs, licenses, 
upkeep, and depreciation of delivery equipment should be charged 
to this account. 



i t 



m'^ 



86 PRINCIPLES OF ACCOUNTING 

The debits and credits to this account are as follows: 

DELIVERY EXPENSE 



Debit: 
All expense incurred in connection with 
the delivery of merchandise. 



Credit: 
With any adjustments which reduce 
the amount debited to this 
account. 



The balance of this account shows the cost of delivering merchandise 
to customers and may be shown in the statement of profit and loss as a 
separate item under operating expense, or it may be shown as a sub- 
item under selUng expense. 

Administrative expenses. The purpose of the account with ad- 
ministrative expenses is to show expenses incurred in the admin- 
istration and management of the business. The various items of 
expense which may be charged to this account are too numerous to 
mention. Some of the most important, however, are salaries of the 
manager, bookkeepers, office clerks, stenographers, and general office 
help not otherwise charged. The cost of stationery of all sorts, 
account books, forms, typewriter supplies, printing, postage, and 
depreciation of office equipment, the expenses of insurance on store 
equipment, as well as taxes on the same; the cost of heat, light, 
repairs, depreciation on store equipment, and other miscellaneous 
items are usually charged to administrative expenses. 

The debits and credits for this account are as follows: 

ADMINISTRATIVE EXPENSE 



Debit: 
With all expenses incurred in connec- 
tion with the administration and 
management of the business. 



Credit: 
With any adjustments which reduce 
the amounts debited to this 
account. 



The balance of this account shows the cost of the administration and 
management of the business and is shown as an operating expense in 
the statement of profit and loss. 

Arrangement of accounts in the ledgers. As explained in chapter v, 
the accounts of a business are arranged in systematic order in the 
ledger. Usually they are arranged in the ledger in the same order 
in which they appear on the balance sheet and on the statement of 
profit and loss. On the balance sheet the items are listed as follows: 



CONSTRUCTION AND INTERPRETATION OF ACCOUNTS 87 

current assets, fixed assets, current liabilities, and proprietorship. 
In the ledger the accounts necessary to provide the information from 
which the balance sheet is made are arranged in the same order. 
In the statement of profit and loss the items are as follows: sales, cost 
of goods sold, and expenses. In the ledger the accounts necessary to 
obtain the amount of each of these items are arranged accordingly. 

The accounts in the ledger should always be arranged in the same 
order in which they appear in the balance sheet and the statement of 
profit and loss. This arrangement facilitates the making of the 
reports and the comparison of the reports with the accounts. 

Summary. In chapter v it has been explained that the primary 
function of the account is to provide a classified and summarized 
record of the information which the owner needs in the management 
of his business. This information he obtains by means of reports 
such as the balance sheet and statement of profit and loss. The 
accounts of a business should provide, therefore, the information 
necessary to make such reports. 

In the present and the preceding chapter the construction and 
interpretation of the accounts necessary to provide the information 
shown on the simple balance sheet and statement of profit and loss of 
W. A. Williams have been discussed. Later, when more compre- 
hensive reports are discussed, it will be seen that additional accounts 
must be maintained. If the student has mastered the principles 
governing the use and construction of the accounts discussed in these 
two chapters, he will have little difficulty in applying these principles 
to the accounts which will be discussed in subsequent chapters. 

QUESTIONS FOR CLASS DISCUSSION 

1. On June i K. P. Spear had $2,000.00 of merchandise on hand. During 
the month he purchased $5,000.00 of merchandise and sold $6,000.00. 
How would these facts be recorded in the accounts ? 

2. How would he determine the amoimt of his merchandise on hand at the 
end of the month ? 

3. J. P. Long, retail dry goods merchant, makes the following cash 
payments: 

a) For dry goods, $300.00. 

b) For repairs to delivery truck, $20.00. 

c) For services of delivery driver, $40.00. 

d) For wrapping paper and twine, $15.00. 

e) For an adding machine, $250.00. 

How would these transactions be recorded in his accounts ? 



88 



PRINCIPLES OF ACCOUNTING 



CONSTRUCTION AND INTERPRETATION OF ACCOUNTS 89 



w 



4. What information is required in order that the cost of goods sold may 
be shown on the statement of profit and loss? Explain how this 
information is obtained. 

5. You are employed by the Jones Company as general manager. You 
find by an inspection of the accounting reports submitted by the book- 
keeper that all the expenses of the business are recorded m one expense 
account termed "miscellaneous expense." As general manager should 
you regard this method desirable ? Why ? 

6. What basis or system would you instruct the bookkeeper to use in 
recording the expenses ? 

7. The following represents the "miscellaneous expense" account of the 
Jones Company for the first eight days of July: 

MISCELLANEOUS EXPENSE 



July I 



8 



Sales salaries 

Errand boy 

Rep>airs to delivery wagon 

Janitor ] 

Rent for month 

Wrapping p)aper 

Newspaper advertising 

Traveling ex|>enses to Chicago to buy goods 

Repairs to store fixtures 

Handbills printed 

Paid boys to distribute handbills 

Sales salaries 

Errand boy ]] 

Stenographer 

Light bill. ....;■; 

Gas bill '.'.'.'.'.'.'.'.'.'.'.'.['.'. 

Repairs on typewriter [][ 

Stationery for ofl5ce 

Repairs to building 



25 

5 
8 

15 
80 

4 
8 
10 
6 
6 

4 

30 
6 

18 

4 
6 

10 
12 



00 
00 
00 
00 
00 
00 
00 
00 
00 
60 
90 
00 
00 
00 
20 
40 
90 
00 
00 



Making any assumptions you deem necessary, what classification 
should you mstruct the bookkeeper to make of these expenses ? 
8. The expenses of A. S. Joesting, retail merchant, during the month of 
August as shown by his check stubs are as follows: 

I. Salaries of sales clerks $1^0.00 



2. Salary of stenographer . 

3. Office boy 

4. Repairs on delivery truck 

5. Gasoline for delivery truck 

6. Repairs on typewriter . 



20.00 

36.00 

10.00 

4.70 

1.90 



7.40 

2.80 

2.90 

200.00 

32.00 
2.70 

20.00 
9.00 

20.00 

1500 
2.40 
6.40 

40.00 

2.80 

200.00 



7. Traveling expenses of Joesting on buying trip . 42. 70 

8. Repairs on adding machine . . . . . 2 . 40 

9. Telephone bill 6 . 40 

10. Telegrams and long distance calls in purchasing 
goods 

11. Repairs on oflfice furniture and fixtures 

1 2. Gasoline for delivery truck . 

13. Salaries of sales clerks .... 

14. Salary of delivery man .... 

15. Gasoline for delivery truck . 

16. Advertising circulars .... 

17. Paid for distributing circulars 

18. Salary of stenographer .... 

19. Janitor 

20. Errand boy (sales) . . • . 

21. Light for store 

22. Commissions of sales clerks . 

23. Gasoline for delivery truck . 

24. Salaries of sales clerks .... 

25. Delivery driver 34- 00 

26. Office boy 16.00 

27. Rent 80.00 

You decide that Mr. Joesting should have his expenses classified under 
the following heads: 

a) Buying expense 

b) Selling expense 

c) Delivery expense 

d) Administrative expense 

Show how the foregoing expenses would be classified under these four 
heads. 
9. J. M. Jones is a retail merchant, H. P. King is a manfacturer, and 
J. H. Bishop is a lawyer. Would their expenses be classified in the 
same manner ? Why ? 
10. State the proper arrangement of accounts in the ledger and the reasons 
for such an arrangement. 

REFERENCES FOR FURTHER STUDY 

Sprague, Charles E., Philosophy of Accounts, chap. xii. 
Kester, Roy B., Accounting Theory and Practice, Vol. I, chap. xiv. 
Mitchell, T. W., Accounting Principles, chap. x. 



90 



PRINCIPLES OF ACCOUNTING 






if 



LABORATORY EXERCISE NO. 13 

Illustrations of Classification of Transactions 
BY Means of Accounts 

The following transactions are to be recorded in the ledger. Be carefxil 
to make the proper debit and credit for each transaction. Set up in the 
ledger (loose ledger sheets) the following accounts on the pages indicated: 



Cash . 


• 


• 


• 


I 


French Bros. . 


6 


Notes Receivable . 


• 


• 


I 


Meyer & King 


6 


F. M. Jones 






2 


H. P. John.son . 


7 


Martin Hotel 








2 


J. A. McCoy & Co. 


7 


Congress Hotel . 








2 


Gartman Bros. 


7 


M. J. Torr 








3 


J. B. Moseley, Proprietor . 8 


B. K. Shaeflfer 








3 


J. B. Moseley, Personal . 


8 


M. M. McGee 








. 3 


Sales 


9 


J. J. Reighard 








4 


Purchases 


9 


J. W. Baker 








4 


Selling Expense 


xo 


Inventory . 








S 


Administrative Expense. 


lO 


OflSce Furniture 








. 5 


Buying Expense 


zo 


Ames & Co. 








6 







June I. J. T. Moseley invests $3,000.00 in the retail store business. 

2. Bought of Ames & Co. on account, merchandise, $8 2. 50. 

3. Bought of French Bros, on account, merchandise, %i 28.60. 

4. Paid rent for the month, $40.00. 

5. Sold F. M. Jones on account, merchandise, $18.40. 
Bought of J. A. McCoy & Co. for cash, merchandise, $198.00. 

6. Received for sundry cash sales to date, $30.00. 
Paid Ames & Co. in full of account, $82.50. 

8. Sold Martin Hotel on account, merchandise, $62.40. 
Paid salary of sales clerk, $24.00. 

9. Received $10.00 from F. M. Jones to apply on account. 

10. Bought of Meyer & King on account, merchandise, $230.40. 

11. Paid as expenses of a buying trip, $43.00. 

Sold F. M. Jones on account, merchandise, $64.20. 

12. Received from the Martin Hotel to apply on account, $30.00 

13. Received $60.00 for sundry cash sales to date. 
Paid French Bros. $128.60 to apply on account. 

14. Sold J. W. Baker on account, merchandise, $46.80. 
Paid salary of sales clerk, $24.00. 

15. Bought of Ames & Co. on account, merchandise, $256.00. 

16. Sold Congress Hotel on account, merchandise, $69.40. 



CONSTRUCTION AND INTERPRETATION OF ACCOUNTS 91 



17. Bought of H. P. Johnson on account, merchandise, $34.00. 

18. Received of J. W. Baker $36.00 to apply on accoimt. 
Paid O. M. Haines $100.00 for ofl&ce furniture. 

19. Sold M. J. Torr on account, merchandise, $48.50. 

21. Received $50.00 for sundry cash sales to date. 

22. Sold B. J. Shaeflfer on account, merchandise, $28.40. 

23. Bought of J. A. McCoy & Co. on accoimt, merchandise, 

$187.40. 

24. Received from the Martin Hotel in part payment of amount 

due, $15.00. 
Paid Meyer & King $180.00 to apply on account. 

25. Sold Martin Hotel on account, merchandise $70.40. 

26. Received of F. M. Jones $8.40 to apply on account. 
Sold M. M. McGee on account, merchandise, $60.40. 

27. Sold J. J. Reighard on account, merchandise, $62.25. 

28. Received $48.50 for sundry cash sales. 

Bought of Gartman Bros, on accoimt, merchandise, $180.60. 

29. Received $50.00 from M. M. McGee to apply on account. 

30. Paid Ames & Co. $150.00 to apply on accoimt. 

Paid bookkeeper's salary, $60.00; salary of sales clerk, $48.00. 
Received note for $48.50 from M. J. Torr to apply on account. 
Moseley withdrew for private use, $40.00. 

Instructions: 

Record these transactions in the accounts. 
Preserve this exercise for future use. 



t 



CHAPTER VIII 



THE TRIAL BALANCE 

Purpose of the trial balance. In chapters v, vi, and vii, the account 
has been discussed as a means of making a current record of trans- 
actions. A business transaction consists of an exchange of equal 
values. The values received are termed debits and the values sur- 
rendered are termed credits. To record a transaction one must first 
determine the debits and credits to which it gives rise and then record 
these debits and credits in the proper accounts. 

Since the debits arising from each transaction are equal to the * 
credits arising from the same transaction, it follows logically that, 
if a correct record is made of any number of transactions, the debits 
arising from these transactions will equal the credits arising therefrom. ■ 
In other words, the debits recorded in the ledger should equal or 
balance the credits recorded therein. In order to see if this is true, 
it is customary to make periodical tests of their equality. Such a 
test is known as a trial balance. The purpose of the present chapter 
is to explain and illustrate how the trial balance is made. 

Method of taking a trial balance. In many of the accounts there 
are several debits and several credits. One method of proving the 
equality between the total debits and the total credits would be to list 
and total: (a) all the debits recorded m all the accounts and (b) all 
the credits recorded in all the accounts, and compare the two totals. 
Such a procedure, however, would make the trial balance very long 
and inconvenient for use as a report. It is customary, therefore, 
before making a trial balance to go through the ledger and total each 
side, making a notation of the total in small pencil figures just below 
the last entry appearing on each side of the account. 

After the totals of (a) the debits and (b) the credits of each account 
are obtained, the trial balance may be made in two ways: The first 
method is to list all the debit totals and all the credit totals and after 
adding to compare the total of the former with the total of the latter. 
The second method is to subtract the total of the debits of each account 
from the total of the credits of each account, or vice versa, and obtain 

92 



THE TRIAL BALANCE 



93 



thereby the debit or credit balance of the account. Then the debit 
and credit balances of all the accounts are listed in the trial balance, 
and if the sum of the debit balances equals the sum of the credit 
balances it is evidence that the debits and credits in the ledger are 
equal. Either method serves equally well to test the equality of 
debits and credits. The latter method is more frequently used be- 
cause it makes the trial balance more simple and more usable. Both 
methods will be illustrated. 

Illustration of the trial balance. In order to illustrate how the 
trial balance is made, a trial balance will be made of the following 

simple ledger: 

CASH 



1919 
Jan. I 
22 



2,00000 
4200 



1919 
Jan. I 
2 

S 

8 

16 

22 

27 

31 
31 



500 
27 
120 
100 
800 

30 

78 

47 



60 

00 
00 
00 
00 
00 
00 
00 
00 



NOTES RECEIVABLE 


Jan. 17 




S8 


00 










R. D. JAMES 


Jan. 3 
12 




58 
42 


00 
00 


Jan. 17 




S8 


00 














G. E. FRAZER 


Jan. 3 
12 




42 
23 


00 
00 


Jan. 26 




42 


00 














G. B. HOBBS 


Jan. 3 

28 




29 
62 


00 
00 












. 


. 


J. S. ADAMS 


Jan. 12 
28 




18 
30 


00 
00 























94 



PRINCIPLES OF ACCOUNTING 



MERCHANDISE INVENTORY 



Jan. 3 

3 
3 

12 
12 
12 
28 
28 



Jan. I 




1,00000 








~" 








FURNITURE AND FIXTURES 


Jan. i6 




100 00 










NOTES PAYABLE 






Jan. 24 




120 


00 








N. W. BARNES 


Jan. 22 




800 


00 


Jan. 2 
20 




800 

78 


QQ 






00 








L. S. LYON 


Jan. 24 




Z20 


00 


Jan. IS 
20 




120 
92 


00 








00 








W. H. SPENCER 






Jan. IS 




80 


00 








J. H. BISHOP, PROPRIETOR 






Jan. I 

I 




2,000 
1,000 


00 


' 




00 










J. H. BISHOP, PERSONAL 




Jan. 27 




30 


00 










SALES 



58 

42 
29 

42 

23 
18 
62 
30 



00 
00 
00 
00 
00 
00 
00 
00 



THE TRIAL BALANCE 



PURCHASES 



95 



Jan. I 

3 

IS 

IS 
20 

30 



800 
Soo 
120 

80 

78 

92 



00 
00 
00 
00 
00 
00 



BUYING EXPENSES 

• 


Jan. 25 




27 


00 








SELLING EXPENSES 


Jan. 8 
31 




120 

78 


00 
00 












ADMINISTRATIVE EXPENSES 


Jan. I 
31 




60 
47 


00 
00 






• 







Firsi method. K the total debits and credits of each account are 
to be shown in the trial balance it will be as follows: 

J. H. BISHOP 
Trial Balance, January 31, 1919 



Cash 

Notes Receivable 

R. D. James 

G. E. Frazer 

G. B. Hobbs 

J. S, Adams 

Merchandise Inventory. . 
Furniture and Fixtures . . 

Notes Payable 

N.W.Barnes 

L. S. Lyon 

W. H. Spencer 

J. H. Bishop, Proprietor . 
J. H. Bishop, Personal. . . 

Sales 

Purchases 

Buying Expenses 

Selling Expenses 

Administrative Exp>enses 



2,042 
58 



65 
91 
48 



00 
00 

100 00 

00 

00 

00 

1,00000 

100 00 



80000 
12000 



30 



1,67 
27 
198 
107 

6,456 



00 



000 
00 
00 
00 

00 



1,762 

S8 
42 



00 

00 
00 



12000 

878 

212 

80 

3,00000 



30400 



6456 



00 
00 
00 



00 



96 



PRINCIPLES OF ACCOUNTING 



Since the trial balance shows that the total of all the debits in the 
ledger is equal to the total of all the credits, the ledger is said to be in 
balance. 

Second method. When the second method is employed, only the 
debit or credit balance of each account is shown on the trial balance. 
In order to show the relation between the two methods, the following 
illustration will be given: 

J. H. BISHOP • 

Trial Balance, January 31, 1919 



Cash :. 

Notes Receivable 

R. D. James 

G. E. Frazer 

G. B. Hobbs 

J. S. Adams 

Merchandise Inventory. 
Furniture and Fixtures . 

Notes Payable 

N.W. Barnes 

L. S. Lyon 

W. H. Spencer 

J. H. Bishop, Proprietor 
J. H. Bishop, Personal. . 

Sales , 

Purchases 

Buying Expenses 

Selling Expenses 

Administrative Expenses 



2,042 

S8 


00 
00 


1,762 


00 


280 
S8 


00 
00 






100 


00 


S8 


00 


4200 






65 


00 


42 


00 


23 


00 






91 
48 


00 
00 






91 

48 


00 
00 






1,000 


00 






1,00000 






100 


00 






lOOlOO 










120 


00 






120 


00 


800 


00 


878 


00 






78 


00 


120 


00 


212 

80 

3,000 


00 
00 
00 






9200 

8000 

3,00000 


30 


00 






3o|oo 






1,670 


00 


304 


00 


1,67000 


30400 


27 


00 






27 


00 






198 


00 






198 


00 






107 


00 




00 


107 


00 






6,456 


00 


6,456 


3.674 


00 


3,674 


00 



It will be seen that in the first two columns the total of the debits 
and the total of the credits of each account are shown. These two 
columns show the same results as the trial balance given in the pre- 
ceding paragraph. In the last two columns the debit or credit bal- 
ance of each account is shown. The balance of the account is obtained 
by the subtraction of the amounts shown in the first two columns, 
wherever the account shows both a debit and a credit total. If the 
account shows only a debit or credit total, this is carried over as the 
debit or credit balance of the account. It can be seen from this 
illustration that the equality of the debits and credits is shown by 
taking only the balance of each account just as well as if the total of 
the debits and the total of the credits of each account are taken. 



THE TRIAL BALANCE 



97 



From the foregoing illustration it can be seen that the trial balance 
of J. H. Bishop, showing the debit and credit balance of each account, 
will be as follows: 

J. H. BISHOP 
Trial Balance, January 31, 1919 



Cash 

Notes Receivable 

R. D. James 

G. E. Frazer 

G.B. Hobbs 

J. S. Adams 

Merchandise Inventory.. 
Furniture and Fixtures. , 

Notes Payable 

N.W. Barnes 

L. S. Lyon 

W. H. Spencer 

J. H. Bishop, Proprietor . 
J. H. Bishop, Personal. . . 

Sales 

Purchases 

Buying Expenses 

Selling Expenses 

Administrative Expenses. 



280 


00 




58 


00 




42 


00 




23 


00 




91 


00 




48 


00 




1,000 


00 




100 


00 


120 

78 

92 

80 

3,000 


30 


00 


304 


1,670 


00 




27 


00 




198 


00 




107 


00 
00 




3.674 


3,674 



00 
00 
00 
00 
00 

00 



00 



The trial balance as a report. As previously stated, the primary 
purpose of the trial balance is to prove the equality of the debits and 
credits recorded in the accounts. Although this is its primary 
function, it may serve other purposes. The accountant as a rule 
uses the trial balance as the basis of his reports. The method of 
doing this can be explained better after the working sheet has been 
discussed in a subsequent chapter. The trial balance may also be of 
some value as a report to the owner or manager. In many businesses 
it is not thought feasible to make a statement of profit and loss 
monthly. In such cases a comparative monthly trial balance will 
afford some useful information to the business manager. It will 
enable him to compare the balance of any given asset or liabiUty 
account at the end of a month with its balance at the end of any 
preceding month in the year. Also, the approximate amount of any 
kind of income or expense for the current month may be obtained 
by subtracting from the present balance of the account the balance of 
the month before. The information obtained from this statement 



9» 



PRINCIPLES OF ACCOUNTING 



is not likely to be complete or accurate, but will at least indicate to 
the manager the general trend of the operations of the business. 

REFERENCES FOR FURTHER STUDY 

Paton, W. a., and Stevenson, R. A., Principles of Accounting, pp. 151-54. 

Mitchell, T. W., Accounting Principles, chap. ix. 

Kester, Roy B., Accounting Theory and Practice, Vol. I, chap. xv. 

LABORATORY EXERCISE NO. 14 

The ledger of H. T. Jones on September 30, after one month's opera- 
tions, appears as follows: 

CASH 



1919 
Sept. I 
II 
22 
22 
27 
27 







1919 


4,000 


00 


Sept. 2 


250 


00 


3 


10 


SO 


4 


12 


00 


25 


200 


00 


30 


16 


00 


30 



300 

3,000 

25 

600 
100 

42 



00 
00 
00 
Ob 
00 
00 



W. C. CHAMBERLAIN 


1919 
Sept. 8 
16 




10 
13 


50 
00 


1919 
Sept. 22 


'>. * 


zo 


50 










0. S. GLOVER 


1919 
Sept. 8 
16 




12 
20 


00 
00 


1919 
Sept. 22 




12 


00 














H. G. MOULTON 


1919 
Sept. 8 




18 


00 










L. C. SORRELL 


1919 
Sept. 16 
28 


1 


16 
14 


00 
00 


1919 
Sept. 27 




16 


00 















THE TRIAL BALANCE 



99 



MERCHANDISE INVENTORY 



1919 

Sept. 8 

8 

8 

II 

16 

16 

16 

27 

28 



- 






OFFICE FURNITURE 




I9I9 

Sept. 2 




300 


00 












MINNEAPOLIS MILLING COMPANY 




1919 
Sept. 25 




600 


00 


1919 
Sept. 5 




600 


00 










McHENRY MERCANTILE COMPANY 




« 




1919 
Sept. 14 


( 


200 


00 








NEW YORK WHOLESALE COMPANY 


1919 
Sept. xo 




100 


00 


1919 
Sept. 20 




250 


00 










H. T. JONES, PROPRIETOR 




• 


1919 
Sept. I 




4,000 


00 








SALES 



10 

12 

18 

250 

13 
16 

20 

200 

14 



50 
00 
00 
00 
00 
00 
00 
00 
00 



lOO 



PRINCIPLES OF ACCOUNTING 



PURCHASES 



'jt' 

1 • .-Ti 



.■:1 

i 



Sept. 3 
5 

20 



3,000 
600 
200 
250 



00 
00 
00 
00 



SELLING EXPENSES 



1919 
Sept. 4 



as 



00 



ADMINISTRATIVE EXPENSES 



1919 
Sept. 30 



42 



00 



Instructions: 

Copy the ledger of Jones on loose leaf ledger paper, placing four ac- 
counts on each page. 

Take a trial balance of the ledger you have copied, showing only the 
debit or credit balance of each account. 

LABORATORY EXERCISE NO. 15 

On September 30, Jones has a merchandise inventory of $3,800.00. 
He estimates a yearly depreciation of 10 per cent on office furniture. 
I ?* Make a balance sheet for Jones as of September 30 and a statement of 
profit and loss showing the result of the operations for September. 

Preserve this exercise for future use. 

LABORATORY EXERCISE NO. 16 

Make a trial balance of the ledger of J. B. Moseley prepared in Exerciso 
No. 13. 

LABORATORY EXERCISE NO. 17 

Make a trial balance of the ledger of G. T. Davies prepared in Exercise 
No. 12. 

LABORATORY EXERCISE NO. 18 

The inventory of Moseley on June 30 is |i, 000.00. He estimates that 
the yearly depreciation on his fixed assets is 10 per cent. 

Make a balance sheet for Moseley as at June 30, and a statement of 
profit and loss showing results of the operations for June. 

Preserve this exercise for future use. 



CHAPTER IX 
THE ADJUSTING ENTRIES 

Need of adjusting entries. A current record of the transactions 
which a business performs is made in the accounts. The making of 
this record involves, first, the analysis of the transactions to determine 
the debits and credits arising therefrom, and, second, the recording 
of these debits and credits in the appropriate accounts. The record 
made at the time the transaction is performed shows the effect of the 
transaction on the financial condition of the business. This effect 
on the financial condition is indicated by making certain changes in 
the items which will later appear on the accounting reports. For 
instance, if cash is paid for a service which is to be treated as an 
expense, the change in the financial condition of the business which is 
produced by this transaction is shown by subtracting the cash paid 
in the cash account and adding the service received in some exjjense 
account. So in the case of every transaction its effect on the financial 
condition of the business is reflected in the accounts. 

There are, however, some changes in financial conditions which 
are not the direct result of a transaction or which cannot be recorded 
conveniently at the time they take place. To illustrate, at the be- 
ginning of the fiscal period there is certain merchandise on hand. 
Its amount, expressed in monetary units, is shown in a merchandise 
inventory account. During the year additional merchandise is 
purchased, and merchandise is sold. Consequently the amount of 
merchandise on hand at any time during the year will in all probability 
be different from the amount shown in the records. In most mer- 
cantile firms it is not practicable to show in the records the daily 
changes in the value of the inventory. The usual method is to wait 
until the end of the fiscal period and then determine by count the 
amount and value of merchandise on hand. The amount of the inven- 
tory as shown in the reports prepared at the end of the period must 
be that of the inventory taken at closing time. Therefore an entry 
must be made to correct the balance of the inventory account, show 
the amount of the new inventory, instead of the old inventory balance. 



lOI 



i: 



I02 



PRINCIPLES OF ACCOUNTING 



THE ADJUSTING ENTRIES 



103 



To take another simple illustration, the fixed assets of the business 
are decreasing in value constantly, due to their use in the business. 
This decrease in value, however, cannot be recorded in the accounts 
day by day as it takes place. At the end of the fiscal period, therefore, 
the amount of the depreciation on fixed assets must be estimated 
and entries made which will show the effect of such depreciation on the 
financial condition of the business. 

The foregoing are samples of numerous changes in the financial 
condition of the business which take place during the fiscal period, 
but which cannot be conveniently recorded until the end of the fiscal 
period. The entries made at the end of the fiscal period to give effect 
to such changes are known as adjusting entries. Their purpose is to 
adjust the accounts so that these will reflect the true financial con- 
dition of the business and will agree with the accounting reports. In 
the present chapter such adjusting entries will be considered as 
would be used in a simple business like that of W. A. Williams. 

Merchandise inventory. As previously stated, it is customary 
in mercantile firms to ascertain the amount of the merchandise inven- 
tory by taking an actual count of the goods on hand at the end of the 
fiscal period. These goods are then priced at the cost price, unless 
the market price is lower than cost, in which case conservative prac- 
tice dictates that they should be evaluated at the lower price. The 
value of the inventory thus obtained is recorded in the account with 
merchandise inventory. 

The purpose of the inventory account is, therefore, to show the 
amount of salable merchandise on hand at the end of the fiscal period 
valued at cost or market price, whichever is the lower. 

The debits and credits to this account are as follows: 

MERCHANDISE INVENTORY 



Debit: 
At the end of each fiscal period with the 
amount of the inventory taken at the 
end of that period. The correspond- 
ing credit is to purchases or some 
other account showing the cost of the 
goods sold. 



Credit: 
At the end of each fiscal period with 
the amount of the inventory at the 
beginning of that period. (This 
will be the amount of the debit bal- 
ance in the account previous to 
the entry of the new inventory. 
The corresponding debit will be to 
the purchases account or some 
other account designed to show the 
cost of goods sold.; 



The balance of the inventory account is always a debit balance, since 
it is an asset account and shows the amount of the inventory at 
the end of the last fiscal period for which reports were prepared. 

Illustration of the inventory account and the adjustments. The 
nature of the entries necessary to make the adjustments required to 
show the inventory changes may be made clearer to the student by 
showing how they affect the accounts involved. Wayne Williams* 
inventory for December 31, 19 18, is $2,500, and that is the debit 
balance which would appear in the account at the time the preliminary 
trial balance is taken on December 31, 19 19. The account before 
any adjusting entry is made appears as follows: 

MERCHANDISE INVENTORY 



1919 
Jan. I 



2,500 



00 



It was seen that on the statement of profit and loss the inventory 
at the beginning of the period is added to the amount of the purchases 
for the period as part of the process of obtaining the cost of goods sold. 
In order to bring the ledger into accord with this statement, the 
amount of this old inventory will be added to the purchases as shown 
in the purchases account. This is accomplished by debiting the 
purchases account with the amount of the old inventory, and crediting 
the inventory account with that amount. This has the effect of 
subtracting from the inventory account the amount of the old balance, 
and of adding it to the amount of purchases, thus showing the total 
amount of goods which were available during the period and which 
could possibly have been sold. The two accounts affected by this 
entry will appear as follows: 



• 




MERCHANDISE INVENTORY 






I9I9 

Jan. I 




• 

2,500 


00 


1919 
Dec. 31 


Purchases 


2,500 


00 






PURCHASES 


1919 
Dec. 31 
31 


Balance 
Inventory 


18,000 
2,500 


00 
00 


• 



I04 



PRINCIPLES OF ACCOUNTING 



THE ADJUSTING ENTRIES 



105 



By reference to the inventory account it will be seen that the 
debits and credits in that account are now equal. When this is true 
of any account, the account is said to be in balance. This may be 
indicated by totaling the two sides, writing both totals on the line 
where the total of the longer side falls, and drawing double lines 
beneath the two totals. These double lines signify that there is 
equality between the two sides to that point, and that all above the 
double lines may be ignored in the future. In this account there is 
only one item on each side, and the fact that the account is in balance 
may be indicated as follows: 

INVENTORY 



1919 
Jan. I 



3»Soo 



00 



1919 
Dec. 31 



Purchases 



3,50000 



In the statement of profit and loss it was seen that the amount 
of the inventory on hand at the end of the period was deducted from 
the sum of the inventory at the beginning and the purchases for the 
period, in order to arrive at the cost of the goods sold. This deduc- 
tion can be shown in the ledger and the inventory account be made to 
show the amount of the newly ascertained inventory by an entry 
debiting the inventory account and crediting purchases account. 
Such an entry, as will appear from the illustration, has the double 
effect of deducting the amount from purchases and of setting up in the 
ledger the amount of the inventory now on hand. The following 
illustration shows how these accoimts will then appear: 

INVENTORY 



I9I9 

Jan. I 




2,500 


00 
00 


1919 
Dec. 31 


Purchases 


3,500 


00 




\^>f 


Dec. 31 


3,500 










PURCHASES 


1919 
Dec. 31 
31 


Balance 
Inventory 


18,000 
2,500 


00 
00 


1919 
Dec. 31 


Inventory 


3.500 


00 



Office furniture and delivery equipment. The inventory account 
having been adjusted so as to be in harmony with the balance sheet, 
it is now necessary to adjust the accounts with the fixed assets so as 
to show the estimated depreciation as shown by the balance sheet. 
If it is estimated that the office furniture has depreciated in value 
to the amount of $50, this amount may be shown as a credit to a 
reserve for depreciation account, and as a debit to some expense 
account. Since the office furniture is used in the administration 
of the business, the depreciation arising therefrom may be considered 
as a charge or debit to administrative expense. Since the delivery 
equipment is used in connection with the delivery of merchandise, 
the depreciation on it may be treated as a delivery expense. Accord- 
ingly the estimated depreciation of $160 on delivery equipment will 
be debited to the delivery expense account. 

After these entries have been made, the two reserve accounts and 
the administrative expense and deUvery expense accounts will appear 

as follows: 

ADMINISTRATIVE EXPENSE 



1919 
Dec. 31 
31 



Balance 

Depreciation on 
equipment 



3,316 
SO 



00 



00 



DELIVERY EXPENSE 



I9I9 










Dec. 31 


Balance 


590 


00 




31 


Depreciation on 
delivery equip- 


















ment 


150 


00 





RESERVE FOR DEPRECIATION OF OFFICE FURNITURE 



1919 
Dec. 31 



50 



00 



RESERVE FOR DEPRECIATION OF DELIVERY EQUIPMENT 



1919 
Dec. 31 



160 



00 



It 



io6 



PRINCIPLES OF ACCOUNTING 



THE ADJUSTING ENTRIES 



107 



i' ! 



,1 •• 



Methods of showing expenses in accounts. In the accounts shown 
in this chapter and the following chapter the expenses of the year are 
shown in total. The student will understand that numerous debits 
may be made to the accounts during the year. In the illustrations 
the total only is shown for the sake of simplicity. 

QUESTIONS FOR CLASS DISCUSSION 

1. Explain and illustrate the meaning and purpose of adjusting entries. 

2. H. B. Jones purchases office furniture on January i for $400.00 which he 
estimates wiU be of service for ten years. What entries wUl be necessary 
in Jones's ledger at the end of the fiscal year December 31, 1918, in 
order to show the depreciation on office furniture ? 

3. On December 31 A. B. King has 500 units of merchandise on hand which 
cost 80 cents a unit, but which he can now purchase at 70 cents a unit. 
The retail seUing price of the articles is 90 cents. At what price should 
this merchandise appear on the balance sheet of King ? 

4. On the statement of profit and loss of H. M. James the cost of goods 
sold is shown as follows: 

COST OF GOODS SOLD 

Inventory, January i, 1919 . $ 4,cxx).oo 
Purchases 12,000.00 

Less: $16,000.00 

Inventory, December 31, 1919 5,000.00 

Net cost of goods sold . . . $11,000.00 

What entries would be required to show the cost of goods sold in the 
ledger of H. M. James ? 

5. Explain and illustrate the use of the inventory account. 

6. On January i A. M. Long purchases delivery equipment which costs 
$1,600.00. He estimates that it will be of service ten years and will have 
a scrap value of $200,000. What entries would be made in connection 
with delivery equipment on December 31 ? 

7. The store buUding of the Chicago Mercantile Company has depre- 
ciated $500.00 during the year. What entries should be made to record 
this depreciation ? 

8. On the statement of profit and loss of the Brown Retail Store there 
appears the following item: 

Depreciation $460.00 

What does this probably include ? What criticism would yo^ offer 
of this method of showing depreciation ? 



9. At the end of the fiscal period you are instructed to make the adjusting 
entries for the records of the X.Y. Manufacturing Company. Explain 
how you would proceed and what information you would desire before 
making these entries. 
10. Explain the difference between the adjusting entries required by a 
manufacturing firm and by a mercantile firm. 

REFERENCES FOR FURTHER STUDY 

Kester, Roy B., Accounting Theory and Practice, Vol. I, chap. xvi. 

Mitchell, T. W., Accounting Principles, chap. x. 

Paton, W. a., and Stevenson, R. A., Principles of Accounting, pp. 154-56. 

LABORATORY EXERCISE NO. 19 
The following is the trial balance of H. A. Smith: 

H. A. SMITH 
Trial Balance, December 31, 1919 



Cash 

Notes Receivable 

Accounts Receivable . . . . 
Merchandise Inventory . . 

OflSce Furniture 

Buildings 

Land 

Notes Payable 

Accounts Payable 

H. A. Smith, Proprietor . . 
H. A. Smith, Personal . . . 

Sales 

Purchases 

Buying Expenses 

Selling Expenses 

Delivery Expenses 

Administrative Expenses. 



2,000 
300 
3,700 
3,100 
500 
2,000 
1,500 



250 

29,000 

1,000 

3,000 

800 

3,400 



50,550 



00 
00 
00 
00 
00 
00 
00 



00 

00 
00 
00 
00 
00 



00 



800 
2,900 
6,850 

30,000 



50,550 



00 
00 
00 

00 



00 



Assuming that Smith's inventory on December 31 is $4,500.00 and that 
the depreciation on oflSce furniture is 10 per cent and on buildings 5 per cent, 
make a balance sheet and statement of profit and loss for Smith. 

LABORATORY EXERCISE NO. 20 

On loose leaf ledger paper open accounts to give effect to trial balance 
of Smith. Allow five lines for each account. Make the entries necessary 
to adjust the ledger accounts of Smith so they will agree with his balance 
sheet and statement of profit and loss. 

Preserve this exercise for future use. 



io8 



PRINCIPLES OF ACCOUNTING 



''1, 



t 

i 
■ » 



LABORATORY EXERCISE NO. 21 
Make the entries necessary to adjust the ledger of J. B. Moseley as 

prepared in Exercise No. 13, so as to give effect to the adjustments stated 

in Exercise No. 18. 

Preserve this exercise for future use. 

LABORATORY EXERCISE NO. 22 
Make the entries necessary to adjust the ledger of H. T. Jones as given 

in Exercise No. 14. The data for the adjustments is given in Exercise 

No. 15. •• 

Preserve this exercise for future use. 



CHAPTER X 
THE CLOSING ENTRIES 

Purpose of the closing entries. After the adjusting entries are 
made at the end of the fiscal period, the accounts, with the exception 
of the proprietorship accounts, furnish the information which should 
appear in the accounting reports. The next steps are: (i) to make 
the ledger show a summary of income and expense similar to that 
which will appear in the profit and loss statement; and (2) to bring 
the balances of the proprietorship accounts up to date, so that these 
balances will show the amount of proprietorship which should appear 
in the balance sheet. In order that these two things may be accom- 
plished, certain accounts must be "closed." The entries necessary 
to afiFect tl\is closing are known as "closing entries," and it is the 
purpose of the present chapter to explain how these entries are 
made. 

Gross profit on sales. In making the ledger summary it is desirable 
to follow the order indicated by the statement of profit and loss. 
By reference to the statement of profit and loss it will be seen that 
the cost of goods sold is subtracted from the amount of the sales, to 
arrrive at the gross profit from sales. It appears there also that the 
cost of goods sold is obtained by adding to purchases the inventory 
at the beginning and subtracting from the sum thus obtained the 
inventory at the end of the period. In the adjusting entries discussed 
in the preceding chapter, the purchases account was so adjusted, by 
adding the initial inventory and subtracting the final inventory, 
as to make the balance of that account show the cost of the goods 
sold for the period. The next step, then, is to show the cost of goods 
sold as shown by the purchases account as a subtraction from sales, 
and this is accomplished by transferring the debit balance of the 
purchases account to the sales account. This transfer is effected by 
debiting the sales account and crediting the purchases account with 
the balance of the purchases account. When this entry has been 
made, the purchases and sales accounts will appear on page no. 



109 



no 



PRINCIPLES OF ACCOUNTING 







PURCHASES 








IQIQ 

Dec. 31 
31 


Balance 
Inventory 


18,000 
2,500 


00 
00 

00 


IQIQ 

Dec. 31 
31 


Inventory 
Cost of goods 
sold 


3,500 
17,000 


00 
00 




20,500 


20,500 


00 










SALES 


IQIQ 

Dec. 31 
31 


Cost of goods 

sold 
Gross profit on 

sales 


17,000 
7,000 


00 
00 
00 


IQIQ 

Dec, 31 


Balance 


24,000 


00 




24,000 


24,000 


00 











It will be seen that crediting the purchases account for the amount 
of the cost of goods sold makes the debits and credits in that account 
equal in amount; in other words, it brings the account to a balance. 
This would be indicated by totaling the two sides of the account, 
writing the totals opposite one another, and drawing double lines 
under each of the totals, which mdicates that the debits and credits 
in the account up to this point are equal. The purchases account 
is now said to be "closed" for the period, and no further entries will 
appear in it until the transactions of the next period begin to be 
recorded. 

Profit and loss account. When the cost of goods sold has been 
transferred to the sales account, the balance of this account shows the 
gross profit on sales. By reference to the statement of profit and loss 
it will be seen that the next step in making a summary of the oper- 
ations of the period is to subtract from the gross profit on sales the 
operating expenses, so as to determine the net operating profit. In 
order to show the net operating profit in the ledger it is customary 
to open an account termed the profit and loss account, to which the 
operating expenses are debited and the operating income credited. 

The purpose of the profit and loss account is to oflFset the operating 
expenses of the period against the operating income with the resulting 



THE CLOSING ENTRIES 



III 



balance, which shows the net operating profit. This account is 
sometimes termed a summary account because it is used to summarize 
the operations of the period. It is opened only at the end of the fiscal 
period and is closed as soon as the ledger summary is made. Entries 
during the fiscal period should not be entered in this account. 

The debits and credits to be made to the profit and loss account 
are as follows: 

PROFIT AND LOSS 



Debit: 
With the amount of the balance of each 
account which shows an item of oper- 
ating expense. 



Credit: 
With the amount of the balance of 
each account which shows an item 
of operating income. 



As indicated in the discussion of the statement of profit and loss, 
there may be non-operating expenses and non-operating income, and 
frequently both of these are shown in the profit and loss account. 
However, such items should be shown in a separate section of the 
profit and loss account, just as they are shown in a separate section of 
the statement of profit and loss. The recording and reporting of these 
items will be considered later. For the present, the profit and loss 
account may be considered as a summary of operating income and 
expense only. 

The balance of the profit and loss account may appear on either 
side, depending on whether the total expense balances or the total 
income balances are in excess. A credit balance in this account shows 
the amount of the net operating profit for the period and is transferred 
to the credit side of the proprietor's account. A debit balance in this 
account shows a net loss for the period and is transferred to the 
debit side of the proprietor's account. 

Net operating profit. In the previous discussion it appeared that 
the gross profit on sales as shown by the balance of the sales account 
is $7,000. This credit balance of the sales account will next be trans- 
ferred to the profit and loss account by debiting sales for that amount 
and crediting Profit and Loss. After this is done, the balances of all 
the operating expense accounts will be transferred to the debit of the 
profit and loss account by crediting each expense account with the 
amount of its debit balance and debiting Profit and Loss for that 



112 



PRINCIPLES OF ACCOUNTING 



amount. When this has been done, the accounts with purchases 
and sales and with each item of operating expense will be balanced 
and may be ruled up as *' closed." The profit and loss account will 
show a credit balance of $i,ooo, agreeing with the net income shown 
by the statement of profit and loss. This credit balance will then 
be transferred from the profit and loss account to the credit of the 
proprietor's account by debiting Profit and Loss for the amount 
and crediting the proprietor's account. 

When all these closing entries have been made, the accounts 
affected by them, omitting the details of the entries made during the 
period just past, will be as follows: 

PURCHASES 



IQIQ 

Dec. 31 
31 


Balance 
Inventory 


18,000 
2,500 


00 
00 

00 


IQIQ 

Dec. 31 
31 


Inventory 

Cost of goods sold 


3.S00 
17,000 


00 
00 




20,500 


20,500 


00 













SALES 



IQIQ 

Dec. 31 
31 


Cost of goods 

sold 
Gross profit on 

sales 


17,000 
7,000 


00 
00 
00 


IQIQ 

Dec. 31 


Balance 


24,000 


00 




24,000 


24,000 


00 











BUYING EXPENSES 



IQIQ 

Dec. 31 



Balance 



444 



00 



IQIQ 

Dec. 31 



Profit and loss 



00 



SELLING EXPENSES 



IQIQ 

Dec. 31 



Balance 



1,440 



c» 



IQIQ 

Dec. 31 



Profit and loss 



1,440 



00 



THE CLOSING ENTRIES 



113 



DELIVERY EXPENSES 



IQIQ 

Dec. 31 
31 


Balance 

Depreciation on 
delivery equip- 
ment 


590 
160 


(X> 

00 
00 


IQIQ 

Dec. 31 


Profit and loss 


750 


cx> 




750 


750 


00 











ADMINISTRATIVE EXPENSES 



IQIQ 

Dec. 31 
31 



Balance 

Depreciation on 

office furniture 



3,316 

so 


00 
00 
00 


IQIQ 

Dec. 31 


3,366 



Profit and loss 



3,366 



00 



PROFIT AND Loss 



IQIQ 

Dec. 31 
31 
31 
31 

31 


Buying expense 
Selling expense 
Delivery expense 
Administrative 

expense 
Net profit 


444 

1,440 

750 

3,366 
1,000 


CX) 

00 
00 

00 
00 

00 


IQIQ 

Dec. 31 


Gross profit on 
sales 


7,000 


00 




7,000 


7,000 


00 








' 





W. A. 


WILLIAMS, PROPRIETOR 






IQIQ 

Dec. 31 


Net worth 


7,630 


00 
00 


IQIQ 

Jan. I 
Dec. 31 

Dec. 31 




6,630 
1,000 


00 


Profit and loss 


00 




7,630 


7,630 


(X> 






7.630 


00 









The ledger after closing. After the closing entries have been made, 
all of the expense and income accounts have been brought to a bal- 
ance and "closed" or ruled off. They are now ready for the first 



l|4 



PRINCIPLES OF ACCOUNTING 



THE CLOSING ENTRIES 



"5 



entries to be made in them to show the income and expense of thp 
next period. The profit and loss account has been made to show a 
summary of income and expense in such a way as to give in the ledger 
the information used in preparing the statement of profit and loss 
and the results shown by the account are in harmony with the results 
presented in the statement. The accounts which still remain "open," 
that is, have balances, are the asset, liability, and proprietorship 
accounts. If a trial balance is taken at this time, the items appear- 
ing thereon will correspond with the items shown on the balance 
sheet. 

Balancing and closing the accounts. The method of ruling up and 
closing an account when it is in balance has been explained. When 
an account is in balance and is closed, nothing appears below the 
double lines, and the accountant understands from a glance at the 
account that there is no balance to be considered. 

Occasionally, however, it is desirable to rule up an account in such 
a way as to show the difference between the two sides. This is done 
by writing the balance, or the excess of one side over the other, on the 
side having the smaller amount, drawing the single lines under the 
two sides and totaling the two sides which must now be equal, since 
the difference has been added to the smaller side. The double lines 
are then drawn beneath the totals, indicating equality to that point, 
and the balance is entered below these double lines and on the side 
which is in excess by that amount. The equality between debits and 
credits is not disturbed by this process, since the same amount is 
added to each side of the account. When an account is ruled up in 
this manner, the accountant can see at a glance what the balance is. 
It is not customary in the case of most of the accounts to balance 
them and bring down the balance. The usual procedure in getting 
the balance is, as previously explained, to enter the total under each 
side in small pencil figures', and note the balance to that point, also in 
pencil, on the side which is in excess of the other. The cash account 
is usually the only one that is regularly balanced in the formal fashion 
described above. Assuming that an account with cash was carried 
in Wayne Williams' ledger, the totals being entered monthly, it might 
appear at the end of the year, after a balance had been taken, as 
follows: 



CASH 



\ 



1920 


Jan. 


I 


Jan. 


31 


Feb. 


29 


Mar. 


.^i 


April 30 
May 31 


June 


30 


July 


31 


Aug. 


31 


Sept. 


30 


Oct. 


31 


Nov. 


30 


Dec. 


31 



Balance 



1921 



Balance 







1920 


1,800! 


00 


Jan. 31 


4,000 


00 


Feb. 29 


3.206 


00 


Mar. 31 


3.400 


00 


April 30 


4,000 


00 


May 31 


3,800 


00 


June 30 


3,100 


00 


July 31 


2,900 


00 


Aug. 31 


3.000 


00 


Sept. 30 


3.100 


00 


Oct. 31 


3.700 


00 


Nov. 30 


4,100 


00 


Dec. 31 


4,000 


00 
00 
00 


Dec. 31 


44,100 


1. 500 



Balance 



I 

4,20000 

2,70000 

3,800^ 

4,000 joo 

2,50000 

3.300 

3,000 

2,500 

3,500 

3,500 

4,100 

5,500 

1,500 



44,100 



00 
00 
00 
00 
00 
00 
00 
00 

00 



The riding of current accounts with persons and of note accounts. 
It was pointed out in the foregoing discussion that the cash account is 
usually the only one of the property accounts that is balanced under 
ordinary circumstances. The others are usually left open, since they 
furnish thus a better means of tracing through the account the history 
of the particular item involved. 

Accounts with persons, particularly the accounts with customers, 
making up the item of accounts receivable, and those with creditors, 
composing the accounts payable group, offer a peculiar problem, as 
do aJso notes receivable and notes payable. Such accounts have so 
many items that they cannot be allowed to run on indefinitely, taking 
the complete total of the debits and credits up to date. Such a pro- 
cedure would compel the bookkeeper, whenever he wished to ascer- 
tain the present balance of the account, to add all the debits and all 
the credits which had been made to that account. But in order to 
be able to obtain a clear analysis of the balance in such an account at a 
given time, it is not desirable to balance it formally, since it is a current 
account, and it should be kept so that its current balance at a given 
time can be readily analyzed. It is usual for a customer, when he 
does make a payment, to pay an amount which covers certain definite 
items with which his account has been previously debited, rather than 
simply to make "on account" a payment of an amount which does 
not correspond with any of the debits to his account. It is desirable, 



ii6 



PRINCIPLES OF ACCOUNTING 



therefore, that in keeping such an account, whether from the stand- 
point of the buyer or that of the seller, some attempt should be made 
to identify as nearly as possible the debit items with the particular 
credits which record the discharge of the indebtedness shown by these 
debits. This may be accomplished by lettering the items, which can be 
identified as thus offsetting one another. It will also usually be found 
true that all the debits up to a certain point are canceled by the 
credits up to a certain point, so that the balance of the account, 
whether debit or credit, is to be arrived at by a consideration of items 
below a certain line on each side of the account. This is true of 
accounts receivable, accounts payable, notes receivable, and notes 
payable. 

The use of the devices discussed may be illustrated by an account 
with an individual customer. 

H. E. WHITE 



1920 
Jan. I 
Jan. 9 

Jan. 16 
Jan. 22 
Jan. 29 

Feb. I 
Feb. 25 

Mar. 5 
Mar. 27 



Balance 









1920 


a 


35 


00 


Jan. 16 


a 


15 


00 








— 


Feb. 2 


b 


12 


50 




b 


17 


50 


Mar. 3 


b 


15 


00 




c 


10 


00 




c 


18 


00 






25 


00 






15 


00 





a so 

* 45 
c 28 



00 
00 
00 



This should be enough to indicate the method employed. The 
number of debit items canceled by one credit item will vary in different 
kinds of businesses according to the practice of the trade and accord- 
ing to the habit of the customer. In a wholesale business it is usual 
to receive a separate check from the customer to cover each invoice 
separately. In accounts with notes, there will usually be the same 
number of debits as there are offsetting credit items, since a note is 
usually canceled by a smgle payment. A practice sometimes fol- 
lowed in keeping note accounts is to enter each item, indicating the 
cancellation of a note on the line opposite the item which it cancels, 
regardless of chronological order. This is hardly necessary, however, 
if the device just illustrated is employed. 



THE CLOSING ENTRIES 



117 



» 



QUESTIONS FOR CLASS DISCUSSION 

1. Explain and illustrate the meaning and purpose of "closing entries.' 

2. J. A. Bowen has made sales to the amount of $12,000.00 during the 
month. The cost of the goods sold is $9,000.00. Explain how the 
gross profit on sales would be shown in the ledger. 

3. The expenses of Bowen for the month are as follows: buying expenses, 
$200.00; selling expenses, $600.00; delivery expenses, $300.00; admin- 
istrative expenses, $900.00. What would be the net profit of Bowen 
and how would this be shown on his ledger ? 

4. Explain the purpose of the profit and loss account. 

5. What is the relation between the profit and loss account and the state- 
ment of profit and loss ? 

6. What entries would be necessary to close the profit and loss account of 
J. A. Bowen ? 

7. The total o^ the debits to the sales account is $8,000.00 and the total of 
the credits to this account are the same. How is the equality of debits 
and credits shown ? 

8. The total of the debits to the cash account is $6,000.00 and the total of 
the credits is $4,000.00. What is the cash balance ? How may this 
balance be shown in the accoimt ? 

9. Explain how a personal account may be ruled. 

10. The total of the debits to the cash account is $1 2,000.00 and the totals of 
the credits is $8,000.00. The ledger page on which the cash account 
appears is filled and it is necessary to transfer this accoimt to a new page. 
Explain how this may be done. 

11. Explain any other method than the one outlined in chapter x which 
might be used to close the ledger at the end of the fiscal period. 

12. After the closing entries have been made, what accounts remain open 
in the ledger ? 

REFERENCES FOR FURTHER STUDY 
Mitchell, T. W., Accounting Principles, chap. xiv. 
Kester, Roy B., Accounting Theory and Practice, Vol. I, chap. xxx. 
Paton, W. a., and Stevenson, R. A., Principles of Accounting, pp. 184-86. 

LABORATORY EXERCISE NO. 23 
Make the entries necessary to close the ledger of H. A. Smith as prepared 
iri Exercise No. 20. Rule the accounts that balance. 

LABORATORY EXERCISE NO. 24 
Make the entries necessary to close the ledger of J. B. Moseley as 
prepared in Exercise No. 21. Rule the accounts that balance. 

LABORATORY EXERCISE NO. 25 
Make the entries necessary to close the ledger of H. T. Jones as prepared 
in Exercise No. 22. Rule the accounts that balance. 



CHAPTER XI 
THE SOURCE OF THE LEDGER ENTRIES 

Need of a record other than the ledger. In the foregoing chapters 
it has been seen that the function of the accountant is primarily that 
of furnishing the business manager with such information about his 
business as will be of the greatest aid to him in planning further 
business operations. It has been explained that this information is 
presented in the form of reports, and that it should be classified and 
presented in such fashion as to make it not only intelligible but also 
applicable to the solution of the particular problems of the business 
manager for whose use it is prepared. Since there are typically 
several different parties interested in the business, each interested 
from a somewhat different point of view from the others, there will 
usually be need for several types of reports, each of which will present 
certain data about the business, classified on a basis which will make 
it most useful to the individual or group for whom the report is drawn 
up. Thus the vice-president in charge of finance might desire infor- 
mation concerning past sales, as weU as the estimates of future sales, 
classified to show what amount of the sales were made for cash and 
what amount on credit, and might also wish to have the credit sales 
classified according to the terms of credit allowed. The merchandise 
manager, with the departmental buyers, might be interested in the 
classification of sales on the basis of the commodities sold, and the 
amount of each commodity sold during each month of the year, since 
it is the task of these functionaries to see that the stock is kept' up to 
meet demands, and at the same time to avoid being caught with an 
excess of any type of goods. 

The wide range of classification required in the reports means that 
there mu^t be an equally wide range in the ledger, since the data for each 
Item in the reports must be gathered into a separate account in the 
ledger. It has been previously explained how each transaction may be 
analyzed with regard to its effect upon the ledger accounts, and how 
this analysis is reflected in the accounts themselves. 

xi8 



THE SOURCE OF THE LEDGER ENTRIES 



119 



Accounting experience has shown clearly, however, that it is not 
desirable to enter this information into the account directly, at the 
time that each transaction takes place. It is better to maintain some 
earlier form of record, in which may be entered the analysis of each 
transaction, showing each account to be debited and each one to be 
credited, together with the amount of each debit or credit and any 
other explanation which may seem desirable with regard to the nature 
of the transaction. 

One reason why this method of procedure has been found desirable 
is that it would plainly be inconvenient and a waste of time to turn 
to each of the ledger accounts affected by each transaction and make 
the entries there at the time when the transaction occurs. It is 
better to enter the analysis of each transaction in its chronological 
order on a special record kept for that purpose, and to transfer these 
items to the appropriate ledger accounts at a time when this transfer 
may be made systematically and efficiently. 

Another reason is that the account is employed merely as a means 
of classifying and summarizing information concerning certain items 
appearing on the reports, and is not designed to furnish any history 
or explanation of the particular transactions. It is desirable to keep 
a record of certain details with regard to each transaction, and this 
can be done best by the use of an additional record, such as is here 
under consideration. Also, the transactions as a whole are by this 
means entered in chronological order, thus supplying a continuous 
record of the transactions of the business over any given period of 
time. 

Again, the debits and credits resulting from any transaction are 
entered in different accounts, and if an error should be made in enter- 
ing one of them, the error would be very difl&cult to trace without the 
aid of an original record of the transaction as a whole. Thus if Wayne 
Williams sells Milton Jones goods to the amount of $100, Jones's 
account should be debited with that amount, and sales credited. 
If through an error sales is credited with $10 instead of $100, and the 
trial balance at the end of the p>eriod is found to be out of balance 
as a consequence, it will be much more difficult to locate the error if 
there is no book of original entry showing a complete record of the 
transaction with its debits and credits, which may be compared with 
the debits and credits in the ledger. 



i 



X20 



PRINCIPLES OF ACCOUNTING 



The books of original entry may also be used as a means of pro- 
viding analyses of some of the more important classes of transactions, 
such analyses being more difficult to obtain in any other way. Such 
are the analyses of sales, purchases, cash receipts, and cash disburse- 
ments. The advantages which may be obtained in this way will be 
explained later. 

The main reasons why it is desirable to employ so-called books of 
original entry to show the first analysis of the transactions, and as a 
medium for transferring the desired information into the accounts, 
may be summarized as follows: (i) The inconvenience and ineffi- 
ciency of making the entries direct to the ledger. (2) The possibility 
of showing more detail regarding transactions when books of original 
entry are used. (3) Each transaction may be entered as a whole, 
and in its chronological order. This may be useful for purposes of 
reference. (4) It is easier to discover errors when the ledger items 
can be checked back to the books of original entry. (5) Books of 
original entry may be used to show valuable analysis which would be 
harder to obtain by direct entries to the ledger accounts. 

The nature of hooks of original entry. Books of original entry 
may be of various types as regards their form, although all are aUke 
in the fact that they are designed to show the analysis of the debits 
and credits arising out of each transaction recorded. The form of such 
books, as will appear later, depends primarily upon what accounts 
are to be carried in the ledger. As the student aheady knows, the 
accounts carried in the ledger are determined by the items of infor- 
mation which it is desired to have shown on the reports. This fact 
constitutes a valid reason for a consideration of the nature and use 
of the reports before taking up the matter of the books of original 
entry. The number and the types of reports required, and the items 
shown by them, vary with the nature of the business operations and 
the organization of the managerial force. There will be a resulting 
variation in the number of the accounts which must be kept to make 
possible these reports, and in the number and types of books of original 
entry which will be used to provide an analysis of the business 
transactions. 

While the form of the books of original entry depends primarily 
on what accounts are carried in the ledger, it also varies secondarily 
according to the frequency with which certain types of transactions 
occur. Thus if a certain type of transaction, for example, the receipt 



THE SOURCE OF THE LEDGER ENTRIES 



121 



from customers of "trade acceptances," occurs frequently, some 
special provision for recording such transactions will be made. If it 
occurs infrequently, such special provision may not be necessary. 

But no matter what forms of such records may be best under any 
given circumstances, the underlying principles governing their use 
are the same in every case. In the following chapter some of the 
special forms of books of original entry will be explained, with their 
uses and advantages, but the remainder of the present chapter will 
be devoted to a consideration of the general principles applicable 
to the use of the books of original entry, as exemplified by a simple 
type of such a record. 

The journal. It is possible to record in a single book all the trans- 
actions which occur in the business. Such a book, in which every 
transaction would be entered in its chronological order, and analyzed 
as to its debits and credits, is known as the journal. While it is pos- 
sible to use only this one book, modern practice employs a number of 
special records, each of which takes over some of the original functions 
of the journal, leaving comparatively few entries to be made in the 
latter. These special forms of record are sometimes called journals 
also, such as sales journal, notes journal, and the Uke, but they are 
generally referred to as hooks or records^ each being distinguished 
according to the type of transaction to be recorded in it. Common 
examples are cash books, sales books, purchase books, and notes 
records. The original journal, from which all these forms have been 
developed, is used to record all transactions which find no place in any 
of the special records, and is known as the general journal^ or, more 
commonly, simply as the journal. 

It is nevertheless probable that the student can best arrive at an 
understanding of the nature and use of books of original entry by 
first studying the use of the general journal, since the other forms are 
simply subdivisions or modifications of the journal. After the use of 
this form has been made clear, the various modifications should oflFer 
little difficulty. The form of the journal may vary somewhat in 
practice, but the following may be taken as the standard form : 

JOURNAL 



(I) 



(a) 



(3) 



(4) 



(5) 



122 



PRINCIPLES OF ACCOUNTING 



R 



The use of each of the five columns indicated on the standard 
form of journal page here illustrated may be described as follows: 

1. Column (i) is known as the folio column, and is used to enter 
the number of the page in the ledger to which the item recorded on 
that line is transferred. 

2. Column (2) may be called the account column. It is used to 
enter the names of the accounts which are to be debited and credited 
for the transaction which is being entered. The account to be debited 
is written first, beginning at the left-hand side of the column, and the 
account to be credited is written on the next line beneath, but slightly 
indented, so that it will be easy in looking down the journal page to 
distinguish the debits from the credits. 

3. Column (3) is the explanation column, in which may be written 
any desired explanation with respect to the nature of the transaction 
whose debits and credits are being entered. Frequently the expla- 
nation is not confined to this column, but begins on the line beneath 
the name of the account to be credited, and extends across columns 
(2) and (3). 

4. Column (4) is the debit money column. In this column, and 
opposite the name of the account to be debited, is written the amount 
of the debit. 

5. Column (5) is the credit money column, and is used to show, on 
the same line with the name of the account to be credited, the amount 
of that credit. 

It is customary to write the date of the first transaction which is 
entered in the journal at the top of the page above the double ruling, 
giving the month, day, and year. The date of each later transaction 
occurring in the same month is recorded by writing the number of the 
day of the month in the center of the line just beneath the record of 
the last preceding transaction. When the first transaction is entered 
in the new month, both the month and day will be given. 

Illustration of the journal. A few simple illustrations of the use 
of the journal as a book of original entry is probably the best means 
of aiding the student to understand such use. For purposes of illus- 
tration it is not desirable to attempt to show a sufficient range or num- 
ber of transactions to represent the typical business operations of even 
a very small business. Certain transactions will be shown, however, 



THE SOURCE OF THE LEDGER ENTRIES 



123 



chosen to illustrate some of the transactions which take place in a 
small clothing store. 

Sept. I. Paul Nelson invests $10,000.00 in cash in retail clothing 
business. 

2. Purchases stock of goods from O. M. Sims for cash, 
$5,000.00. 

3. Pays a month's rent of storeroom, in advance, $75.00. 
Purchases furniture and fittings for storeroom for 
$350.00 cash. 

4. Pays for advertising in local daily paper, $65.00. 
Cash sales, $105.00. 

5. Purchases goods from Cluett, Peabody & Co. on account, 
$750.00. 

Purchases auto delivery wagon, $800.00 cash. 

6. Sells goods on account as follows: 

Charles Dwan, $15.00. 

C. O. Seitz, $45.00. 
Cash sales, $115.00. 
Pays salaries of sales force, $50.00. 

8. Purchases typewriter for cash, $85.00. 

Purchases goods from Wilson Bros., $500.00 on account. 

9. Receives $15.00 cash from Charles Dwan, in payment 
of his account. 

m 

Cash sales, $125.00. 

10. Purchases office supplies (stamps, stationery, etc.), for 
cash, $50.00. 

Sells for cash, $75.00 on account as follows: 
J. S. Hanson, $55.00. 
L. M. Sedgwick, $80.00. 

11. Purchases from Adler Bros., $850.00 on account. 

12. Receives $25.00 from C. O. Seitz on his account. 

13. Pays Cluett, Peabody & Co., $750.00. 

15. Pays salaries as follows: sales salaries, $50.00; book- 
keeper-stenographer, $25.00; deliverymen, $20.00. 

As stated above, any kind of transaction that can occur may be 
entered in the journal. Assuming for purposes of our illustration that 
all of these transactions are entered in the journal, they would appear 
as follows: 



I 



f 



V 



124 



PRINCIPLES OF ACCOUNTING 
SEPTEMBER, 1919 



Cash 

Paul Nelson, proprietor 
Paul Nelson invests $10,000 cash 
in the retail clothing business 
a 
Purchases 
Cash 

Bought of O. M. Sims stock of 
men's furnishings for cash 

3 
Administrative Expense 
Cash 
Paid rent of store for September 

3 
Store Equipment 
Cash 
Purchased store furniture 

4 
Selling Expense 
Cash 
Paid for September ads. in Daily 

News 

Cash 
Sales 
Cash sales to date 

Purchases 

Cluett, Peabody & Co. 
Purchased goods from Cluett, 
Peabody & Co. 

S 
Delivery Equipment 
Cash 
Purchased delivery car for cash 
6 
Charles Dwan 
Sales 
Sold merchandise to Charles Dwan 
on account 

6 
C. O. Seitz 
Sales 

Sold to C. O. Seitz merchandise on 
account 

6 
Cash 
Sales 
Sundry cash sales 
6 
Selling Expense 
Cash 
Paid week's salaries to sales force 



10,000 



S.ooo 



00 



00 



75 



3SO 



65 



loS 



750 



00 



00 



00 



800 



IS 



00 



00 



00 



00 



45 



"5 



50 



00 



00 



00 



10,000 



5,000 



75 



350 



00 



00 



65 



105 



750 



00 



00 



00 



00 



00 



800 



15 



00 



00 



45 



"5 



SO 



00 



00 



00 



THE SOURCE OF THE LEDGER ENTRIES 
SEPTEMBER, 1919 



125 



8 

OfiBce Equipment 
Cash ■ 
Bought used typewriter 
8 
Purchases 

Wilson Bros. 

Bought merchandise on accoimt 

9 
Cash 

Charles Dwan 
Received cash in payment of 
Charles Dwan's account 

9 
Cash 
Sales 
Received for sundry cash sales 
10 
Administrative Expense 
Cash 
Purchased stamps and other office 
supplies 

10 
Cash 
Sales 
Sundry cash sales 
10 
J. S. Hanson 
Sales 
Sold to J. S. Hanson on account 
10 
L. M. Sedgwick 
Sales 
Sold L. M. Sedgwick on account 
II 
Purchases 

Adler Bros. 
Purchased merchandise on account 
12 
Cash 

C. O. Seitz 
Received from C. O. Seitz on 
account 

13 
Cluett, Peabody & Co. 

Cash 
Paid their invoice of September 5 

IS 

Selling Expense 

Administrative Expense 
Delivery Expense 
Cash 
Paid salaries for the week 



8S 



500 



15 



125 



50 



00 



00 



00 



00 



00 



75 



55 



80 



850 



25 



00 



00 



00 



00 



00 



750 



50 

25 
20 



00 



00 
00 
00 



85 



500 



IS 



00 



00 



00 



125 



SO 



00 



00 



75 



55 



80 



850 



25 



00 



00 



00 



00 



00 



750 



00 



95 



00 



126 



PRINCIPLES OF ACCOUNTING 



Posting. The analysis of the transaction into its debits and 
credits, as recorded in the journal or other book of origmal entry, 
facilitates the transfer of the information into the accounts which are 
affected by the transaction in question. The process by which this 
information is transferred from the books of original entry to the 
accounts in the ledger is known as posting. The exact process of 
posting varies somewhat with the type of book of original entry. In 
the case of the journal it consists in the simple but laborious process of 
transferring each item appearing in the debit money column of the 
journal to the debit side of the account whose name appears opposite 
that item, and transferring each item appearing in the credit money 
column of the journal to the credit of the account thus indicated. 
A practice quite often followed is that of posting all the debit items 
to their proper accounts before beginning the credit postings. This 
is to be recommended as lessening the likelihood of posting an item 
to the wrong side of an account. 

When any item is posted from a book of original entry into the 
ledger, the page in the book of original entry from which the item is 
taken is entered in the folio column of the ledger account, and the 
page in the ledger to which it is posted is entered in the foUo column 
in the book of original entry. This practice is known as paging, and 
serves the double purpose of indicating that the item has been posted 
from the book of original entry, and of facilitating any desired com- 
parison between the items entered in such record with the same items 
as entered in the ledger accounts. 

There is no stated time at which posting must be done, so long as 
all posting is completed in time for the summary and reports to be 
made at the end of a period. It is desirable, however, to keep the 
posting as nearly up to date as is practicable. This is especially true 
in the case of personal accounts, and more particularly the accounts 
of customers. The reasons which make it desirable to keep the latter 
class of accounts up to date will be discussed in chapter xvii. 

Illustration of posting. The journal entries given above for the 
purpose of illustrating the form of such a record may also be used to 
illustrate the posting of journal entries to the ledger. The ledger 
accounts which would be affected by the entries there shown are 
presented below as they would appear after the posting had been 
completed. In order to derive the most benefit from this illustration, 



Ur, 



THE SOURCE OF THE LEDGER ENTRIES 



127 



it is desirable that the student should trace each item from the journal 
to the ledger accounts. 

CASH 



Sept. I 

4 
6 

9 

19 
10 

Z2 



10,000 


00 


Sept. 2 


105 


00 


3 


"5 


00 


3 


15 


00 


4 


125 


00 


S 


75 


00 


6 


25 


00 


8 
10 

13 

IS 



3,000 

75 

350 

65 
800 

50 
85 
50 
750 
95 



00 
00 
00 
00 
00 
00 
00 
00 
00 
00 





CHARLES DWAN 


Sept. 4 




15 


00 


Sept. 9 




15 


00 










C. 0. SEITZ 




Sept. 6 




45 


00 


Sept. 12 




25 


00 








J. S. HANSON 


Sept. 10 




55 


00 














L. M. SEDGWICK 


Sept. 10 




80 


00 














STORE EQUIPMENT 


Sept. 3 




350 


00 














DELIVERY EQUIPMENT 


Sept. 5 




800 


00 














OFFICE EQUIPMENT 


Sept. 8 




85 


00 
















CLUE'lT, PEABODY & COMPANY 




Sept. 13 




750 


00 


Sept. s 




750 


00 









■H 



128 



PRINCIPLES OF ACCOUNTING 



WILSON BROTHERS 



Sept. 8 



Soooo 



ADLER BROTHERS 



Sept. II 



850 



00 



NOTES PAYABLE 



Sept. 2 



2,000 



00 



PAUL NELSON, PROPRIETOR 



Sept. I 



10,000 



00 




SALES 



«■( • 



:S 



Sept. 4 
6 
6 
6 

9 
10 

10 

10 



IS 

45 

"5 

"5 

75 

55 
80 



00 
00 
00 
00 
00 
00 
00 
00 



PURCHASES 



Sept. 2 

5 

8 

II 



S,ooo 

750 
500 

850 



00 
00 
00 
00 



SELLING EXPENSE 



Sept. 4 
6 



65 
SO 
SO 



00 
00 
00 



DELIVERY EXPENSE 



Sept. IS 



20 



00 




THE SOURCE OF THE LEDGER ENTRIES 



ADMINISTRATIVE EXPENSE 



129 



Sept. 3 
10 

15 



75 
50 
20 

25 



00 
00 
00 
00 



Summary. The books of original entry are employed to record 
the analysis of transactions into their debits and credits. This record 
is made in such a way as to show the effect of the transactions on the 
various ledger accounts, and serves as a basis for transferring this 
information into the accounts. The journal form has been used to 
illustrate the principles involved in the use of books of original entry. 
Before a transaction can be entered in any book of original entry, it 
is necessary to go through a mental process of journalization, whereby 
the transaction is analyzed into its debits and credits. The journal 
form is used here for illustration because the form of entry in the 
journal sets forth this fundamental analysis more clearly than the 
form of entry in any of the other books of original entry. The aim of 
this chapter has been to establish a famiUarity with principles rather 
than with practices. In subsequent chapters other typical forms of 
books of original entry will be illustrated and their use explained, and 
some attempt will be made to famiUarize the student with current 
practice in the use of such records. 

QUESTIONS FOR CLASS DISCUSSION 

1. J. B. Ames, retail merchant, has followed the practice of recording his 
transactions directly in his ledger accounts. At the present time he 
has been unable to obtain a trial balance for several months and is 
unable to locate the error. Several customers claim that the monthly 
statements which he has sent them are incorrect and it has been quite 
difficult for him to locate the reason. He requests you to explain how 
his records may be kept so as to decrease the number of such errors 
and to make their detection easier. State what you would recommend 
to him and how you would show him the advantages of the method you 
recommend. 

2. Upon your recommendation Mr. Ames has decided to use a journal in 
which to record his transactions before they go to the ledger accounts. 
He has never used a journal and is unfamiliar with its ruling and the 
purpose of the various columns of the standard journal page. State 
how you would explain the. use of the standard journal page to him. 



HI 



i 



I30 



PRINCIPLES OF ACCOUNTING 



THE SOURCE OF THE LEDGER ENTRIES 



131 



3. It is also necessary for you to explain to Mr. Long how he may transfer 
the items recorded in the journal to the ledger accounts. Show by 
means of illustrations how you would explain this to him. 

4. How often should you suggest to Mr. Ames that he post his journal ? 

5. Assuming that customers frequently ask for the amount they owe, 
what method may be followed so that their accounts will show the 
amount due at any time? 

6. If a customer disputes the amount of some item shown in his account, 
how can the explanation with reference to this item be easily found ? 

7. Mr. Ames after posting his ledger is unable to obtain a trial balance. 
Explain how he may be able to find the error. 

8. Explain the advantages of the use of original records of entry. 

9. Would other records than the journal be desirable in accounting practice ? 
Why ? What would determine the nature of these additional records ? 

REFERENCES FOR FURTHER STUDY 

Paton, W. a., and Stevenson, R. A., Principles of Accounting, pp. 56-61. 

Klein, J. J., Elements of Accounting, pp. 7-12. 

Kester, Roy B., Accounting Theory and Practice, Vol. I, chap. xvii. 

LABORATORY EXERCISE NO. 26 

On November i, 1919, R. B. Baker made the following investment in 
the retail shoe business: cash, $5,000.00; a building valued at $7,500.00, 
on a lot valued at $2,500.00. 

Nov. 3. He purchases from Hamilton Brown & Co. a bill of goods 
amounting to $750.00, terms net cash in thirty days. 

4. Pays $450.00 for store equipment and fixtures, including 
their installation. 

• 

5. Buys for cash an office safe, $75.00, and a typewriter, $90.00. 

6. Cash sales, $45.00. 

7. Purchases merchandise from Stacy Adams & Co., $900.00, 
terms net cash in twenty days. 

8. Sells merchandise to James Ryder on account, $18.00. 
Cash sales, $58.00. 

Pays salaries of sales clerks, $45.00. 

10. Purchases from Smith Bros. $600.00 for his note at thirty 
days without interest. 

Sells H. W. Griffith on account, $25.00. 

11. Buys office desk for cash, $40.00. 

12. Cash sales for the past three days were $140.00. 

13. Sells J. C. Cununings $45.00 on account. 



14. Buys stamps and stationery, $50.00 cash. 

Pays $20.00 to have a broken show window replaced. 

15. Pays salaries for the week; sales salaries, $60.00 and office 
salaries, $25.00. 

17. Cash sales for the past three days, $325.00. 
Sells James Ryder on account, $32.00. 

18. Pays freight and cartage on goods received, $18.00. 

19. Cash sales, $120.00. 

R. B. Baker withdraws for personal use, $100.00. 

20. James Ryder gave his note for sbtty days, with interest at 
6 per cent, for $50.00, the amount of his account. 

21. Pays for advertising in local paper, $50.00. 
Cash sales, $150.00. 

22. Purchases merchandise from Goodyear Rubber Co., $450.00, 
terms net cash in thirty days. 

Pays sales salaries, $60.00, office salaries, $25.00, delivery 
boy, $18.00. 

23. Pays sales salaries, $60.00, office salaries $25.00, delivery 

boy, $18.00. 

24. Pays Hamilton Brown & Co. the amount of their invoice, 

$750.00. 

Cash sales, $220.00. 

25. Purchases a bicycle for the use of the delivery boy, $40.00. 

26. Receives $45.00 from J. C. Cummings, in payment of his 
account. 

29. Cash sales, $300.00. 

Pays salaries, the same as on November 22. 

Instructions: 

Make journal entries for each of these transactions, including a brief 
explanation of each transaction. Use your own judgment with regard to 
the accounts which you will open. 

Post these entries to the ledget accounts indicated by the journal en- 
tries. Place four accounts to the page, with the exception of the cash 
account, which should be placed on a separate page. 

Take a trial balance. 



:l^ 



SOME SPECIAL FORMS OF THE JOURNAL 



^33 



CHAPTER XII 
SOME SPECIAL FORMS OF THE JOURNAL 

Need of special hooks of record — advantages of their use. In the 
preceding chapter the nature of the books of original entry was 
explained and some reasons for their use set forth. The journal was 
there illustrated and explained as the simplest form of such a record, 
and the one best adapted to aid the student in understanding the 
fundamental principles of "journalization." As was there indicated, 
it is possible to enter all the transactions of the business and get them 
into the appropriate ledger accounts by means of the journal alone. 
But accounting experience has shown that this would be too slow and 
laborious a method of recording the data concerning a modern business 
and that it is much more efficient to take certain classes of entries 
out of the general journal and enter them in special forms of books, 
each of which is designed for the entry of transactions falling within 
a certain Hmited class. This practice of segregating certain definite 
classes of transactions into special books of original entry, each of 
which may be considered as a subdivision of the general journal, has 
been carried so far in modern accounting practice that only very few 
types of entries, including a very limited number of individual items, 
are now made in the general journal. What these types of entries are 
which still remain to be handled in the journal will be discussed after 
some consideration has been given to the types of entries which are 
generally handled by means of special books or records. 

In every business there are certain kinds of transactions which 
occur very frequently, for example, purchases, sales, cash receipts, 
and cash disbursements. If all transactions which fall under a certam 
class are entered together in a special book, designed for that purpose, 
considerable labor is saved in entering them and in posting them to the 
accounts. Furthermore, by the use of such a special book it is pos- 
sible to obtain additional analysis of the data, which would not be so 
readily obtainable if only the general journal were used. The truth 

Z32 



of these statements may be best demonstrated by means of an 

illustration. 

In any mercantile establishment, one kind of transaction which 
occurs quite frequently is the purchase of merchandise. The analysis 
of such a transaction shows that in every case there is a debit to be 
made to the purchases account, and a credit to some other account, 
typically to that of a trade creditor. If these purchase transactions 
are recorded in the general journal, it will be necessary in recording 
each individual transaction to indicate both the debit to purchases 
account and the credit to the other account affected. Assume that 
W. A. Williams makes the following purchases of groceries during the 
first week in September, 1919: on September i, from Washburn- 
Crosby Company, $450; on September 2, from Chase & Sanborn, 
$300; on September 4, from the National Biscuit Company, $250; 
on September 5, from Wilson & Company, $300; and on Septem- 
ber 6, from Armour & Company, $275. Omitting the explana- 
tions, the entries in the journal for these transactions would appear 
as follows: 

SEPTEMBER, 1919 



Purchases 

Washbum-Crosby Co. 
a 
Purchases 

Chase & Sanborn 

4 
Purchases 

National Biscuit Co. 

S 

Purchases 

Wilson & Co. 

6 
Purchases 

Armour & Co. 



4SO 
300 
250 
300 
27s 



00 



00 



00 



00 



00 



450 
300 

250 
300 

27s 



00 



00 



00 



00 



00 






It will be apparent from the illustration appearing above that 
there must be five separate postings from the journal to the purchases 
account for the five transactions there shown. The same results 
may be obtained with less labor on the part of the bookkeeper if all 
the purchase transactions are kept out of the general journal and 



134 



PRINCIPLES OF ACCOUNTING 



recorded in a special book. The simplest form of such a record might 
appear as follows: 

MERCHANDISE PURCHASES 



1919 
Sept. 



I 
2 

4 

5 
6 



Washburn-Crosby Co. 
Chase & Sanborn 
National Biscuit Co. 
Wilson & Co. 
Annour & Co. 

Purchases, Dr. 





4SO 


00 






300 


00 






250 


00 






300 


00 






275 


00 
00 




1,575 



It will be seen that in this form of record, as is indicated by its 
heading, only one class of transactions is entered. Since nothing but 
merchandise purchases is entered here, there is of course no necessity 
of writing the name of the purchases account in recording each 
transaction, since every transaction is understood to involve a debit 
to purchases account and a credit to the account which is entered in 
the explanation column. Nor is there any need of entering the 
amount in more than one money column, since it is understood in 
each case that the amount debited to purchases is the same as that 
credited to the other account involved. In posting to the ledger 
accounts from such a record, the footing of the column would be posted 
to purchases account as a total, while the credits to the accounts of 
trade creditors would be posted in detail, just as they were from the 
journal. Whether the number of the items of this class thus entered 
were five or fifty, there would be for any one accounting period one 
posting of the total to the purchases account. 

The foregoing illustration indicates the saving of labor resulting 
from the use of a separate journal or record in recording merchandise 
purchases, since the use of such a special record reduces by ahnost 
half the labor involved in the process of making the original entry, 
and in posting. The same saving is possible in the case of any 
other class of transactions which occur at all frequently in the conduct 
of the business. In the ordinary mercantile concern the kinds of 
transactions which are of most frequent occurrence are the ones 
mentioned in an earlier paragraph of this chapter: (i) merchandise 
purchases, (2) merchandise sales, (3) cash receipts, and (4) cash 
disbursements. In ahnost every mercantile business these four classes 



SOME SPECIAL FORMS OF THE JOURNAL 



13s 



of transactions, and usually some other classes as well, are not re- 
corded in the general journal, but are entered on special forms of 
records. These records vary somewhat in their form with the nature 
of the business and according to the information which they are 
designed to show. In the present chapter the general nature and use 
of such books will be explained, employing as illustrations very simple 
forms of such records. These simple forms will illustrate the 
principles involved. 

The purchases journal. It has already become apparent that the 
purpose of the purchases journal is to record the purchases made, 
showing in each case the account to be credited. This type of pur- 
chase record is variously termed ''purchase book," "invoice book," 
"purchases record," "purchases register," and the like, but regardless 
of what it may be called, it is nothing more or less than a subdivision 
of the general journal, and is, like all forms of books of original entry, 
in the nature of a journal. Every entry made in it involves an equal- 
ity between the amounts debited and the amounts credited. For 
the present, then, it will be referred to as the purchases journal. 
Also, for purposes of the present discussion, it will be considered as a 
record of purchases of merchandise only. Some businesses employ a 
form of purchase journal in which every kind of purchases is shown. 
Such a journal, however, is usually called by some special name, 
such as "vouchers payable register," "vouchers register," or 
"accounts payable register." No consideration will be given such 
books for the present. 

It will be noted that in the foregoing illustration only purchases 
on account were shown. A question very naturally arises with regard 
to the treatment of purchases for cash. These might be handled 
either in the purchases journal or in the cash disbursements record or 
journal. . But as will appear in the discussion of the cash records, no 
items affecting cash, whether receipts or disbursements, can be well 
left out of the cash record, and if cash purchases are to be shown in 
the purchases journal, some duplication of entries will be involved. 
Under some circumstances, as will be shown later, it may be desirable, 
for purposes of obtaining complete information in the purchases 
record, to show cash purchases in that book, but usually the cash 
purchases of merchandise are so infrequent that little is gained by 
recording them there, and they are therefore shown only in the cash 



/ 



^. " ■^ --» 



136 



PRINCIPLES OF ACCOUNTING 



record and posted from that source. For the present, then, the 
purchases journal will be considered as a record of merchandise pur- 
chased on account. 

The purchases journal illustrated. As has been intimated, there is 
no one correct form for the purchases journal. The form varies 
with the size and the organization of the business and with the nature 
and extent of the information desired by the owner concerning 
merchandise purchases. Assuming that no classification of purchases 
on a departmental, commodity, or other basis is desired by the owner, 
the information which should be generally considered desirable 
would be furnished by the form which follows: 

PURCHASES JOURNAL 



Date 



1919 
Sept. 



4 

8 

12 

27 
30 

30 



L.F. 



Name of Creditor 



The Buda Co. 
Barrett-Christie Co. 
Simmons Hardware Co. 
Gerlinger Bros. 
Electric Wheel Co. 
Simmons Hardware Co. 
W. F. Hebard Co. 

Total (Purchases, Dr.) 



Address 



Chicago 

Chicago 

St. Louis, Mo 

Whiting, Ind. 

Detroit.Mich 

St. Louis, Mo 

Chicago 



Terms 



2/io/n/3o 
2/io/n/6o 
n/30 
2/io/n/3o 
2/io/n/3o 
2/io/n/3o 
2/io/n/3o 



a 



86 

87 

87 

588 

89 
90 



Amount 



400 

550 
200 

250 
450 
340 
225 



2,415 



00 

00 
00 
00 
00 
00 
00 



00 



The columns shown in the foregoing illustration are, with their 
headings, for the most part self-explanatory. Three of them, how- 
ever, may require a few words of explanation. The column headed 
" L.F. " is used to record the page in the ledger of the account to which 
the credit for the purchase transaction is posted in each case, such 
account being the same as the name of the creditor written in the next 
column. The column headed "Terms" needs no explanation to 
those at all familiar with business practice. It is used to show the 
credit terms upon which the goods are purchased. Thus " 2/io/n/3o" 
means that the purchaser will be allowed to deduct 2 per cent from the 
price stated in the invoice if he pays it within ten days, and that in 
any case he is not supposed to delay paying for the goods for more than 



SOME SPECIAL FORMS OF THE JOURNAL 



137 



thirty days. The column headed 'invoice Number" is to record the 
number of the "invoice" or statement of the shipment of goods, 
which shows the items shipped, their prices, the terms of payment, and 
other information. The handling of the invoice will be discussed 
in more detail later. The invoice number in connection with the 
entry of the transaction is useful in case any question arises later 
which makes desirable more information concerning the transaction, 
or which requires a verification of the information in the purchases 
journal. It is still the custom in some businesses to enter in the 
purchases book practically all the detail that is shown on the invoice 
for each transaction. This adds greatly to the size of the book and is 
a laborious process, besides being quite unnecessary. Modern prac- 
tice depends on the invoices, which are filed in some logical order, to 
furnish any such details as are needed, the invoice number in the 
purchases book serving as a reference to the invoice in question. 

Posting from the purchases journal. Posting from the purchases 
journal is simpler than the posting from the general journal. It 
consists in transferring the total of the "amount" column to the 
debit of purchases account, and in transferring the amount of each of 
the items to the credit of the account named in the column headed 
"Name of Creditor." It is generally desirable to keep the accounts 
with creditors posted up to date, so that information concerning their 
claims may be readily obtained at any time. For this reason such 
accounts should be posted daily. This posting is often made directly 
from the purchase invoice, after the latter has been used as a basis for 
entering the transaction in the purchases journal and stamped to 
indicate that such entry has been made. The routine of handling 
the purchase and sales invoices and using them as posting media will 
be discussed at length in the chapters on business vouchers and 
forms (see chapter xiv), and in the chapters on purchases and sales 
(see chapter xvii). The posting of the total of the " amount " column 
to the purchases account can only be made when that column is 
totaled, and this is usually done only at the time when a trial balance 
is to be taken, which is generally at the close of each month. The 
illustration of the purchases journal shown above indicates the method 
of ruling the purchases journal after such a posting has been made. The 
number of the ledger page of each creditor's account, or some other 



\\ 



'I 



PpI 



138 PRINCIPLES OF ACCOUNTING 

form of check on the posting, would appear in the folio column oppo- 
site the name of the account, and the page number of the purchases 
account would appear opposite the last item, "Purchases, Dr." 

The sales journal. The sales journal is a special form of record 
whose purpose is to provide a record of the transactions involving sales 
of merchandise by the business. It may be used to record all sales of 
merchandise, whether for cash, on open account, or for notes. On 
the other hand, it is often used to record only sales on account. In a 
wholesale business, where the sales are relatively few in number and 
large in amount, it is quite practicable to record all sales in the sales 
journal, treating them all as credit sales, even though actually made 
for cash, and in the case of cash sales to debit cash and credit the 
customer by means of an entry in the cash journal made at the same 
time. In a retail business, where there are a large number of cash 
sales, often for small amounts, such a procedure is not practicable, 
and here the cash sales are ordinarily entered in the cash journal and 
posted to the sales account from that record, while only sales on 
account are entered in the sales journal. On account of the large num- 
ber of individual sales in a retail establishment, both cash and credit 
sales would usually be entered in total at the end of the day, the totals 
being obtained by listing and adding the amounts of the sales tickets, 
and the posting to the customers' accounts in the case of credit sales 
would in this case be made direct from the sales tickets. 

To make sure that the student understands the first method of 
procedure described above, an illustration will be given. Suppose 
that the National Biscuit Company sells W. A. Williams, a retail 
merchant, merchandise to the value of $400, for which he pays cash. 
According to the method outlined above, the entries made by the 
wholesale concern to record this transaction, if put in journal form, 
would appear as follows: 

W.A.Williams $400.00 

Sales $400.00 

Cash 400.00 

W. A. Williams $400.00 

If the student will picture in his mind the effect of these entries 
on the accounts, it will be clear that the customer's account is in no 
way changed by the entry except to increase the total of each side, 



SOME SPECIAL FORMS OF THE JOURl^AL 



139 



and that the net effect of the entry is a debit to cash and a credit to 
sales. But since these entries are not actually made in the journal, 
but in two separate books, and usually by two different persons, it is 
really more convenient to have them recorded in this manner than it 
would be to try to combine the record of the transaction into one entry. 

The sales record, like the purchases record, is known by a number 
of different titles, being variously called "sales record," "sales book," 
"sales register," etc. The name is immaterial so long as the nature 
of the record is understood. It will be known here as the sales journal, 
since that is the name which seems best to indicate its real nature. 

Illustration of sales journal. It was stated on page 120 that the 
form of the purchases journal would vary considerably in different 
business establishments according to the amount of analysis and 
detailed information desired by the managers concerning the pur- 
chases. There are more possible bases which may seem desirable for 
analyzing sales than there are in the case of purchases. The form of 
the sales journal may therefore vary still more widely than that of the 
purchases journal. The matter of sales analysis by means of the sales 
journal must be left for consideration in a later chapter. Omitting 
that for the present, a simple form of sales journal which would furnish 
the essential information might appear as follows: 

SALES JOURNAL 



Date 


I 
3 
5 
7 
10 

IS 

30 
31 


L.F. 


Name of Customer 


Address 


Terms 


-1 
II 

a 

I 

2 

3 
4 

5 
6 

7 
8 

9 


Amount 


X920 
Jan. 


D. F. Anderson 
H. Schroeder 
Paul Carroll 
P. Hathaway 
F. K. Enke 
Oliver F^mes 
R. B. McCall 
J. H. Gray 
P. Hathaway 

Sales, credit 


624 Ninth Ave., S.E. 
1525 University Ave. 
2408 Fourth St., S.E. 
945 Oak St. 
1 214 Fourth St., S.E. 
2546 University Ave. 
468 Sanborn Ave. 
1278 Riverside Blvd. 
945 Oak St. 


• 


45 
27 

18 

22 
28 

35 
24 
47 
25 


00 

50 
00 

50 
00 
00 

SO 

50 
40 




273 


40 



In view of the explanations already given of the use of the columns 
in the journal and the purchase journal, it is not necessary to explain 






■i: 



i 



<\\ 



i 



il 

4 



II 



:l 



I40 



PRINCIPLES OF ACCOUNTING 






the use of the foregoing columns. The ledger folio column will be used , 
of course, when the debits to customers are posted to their accounts. 
It will be noted that the column headed ''Terms" is left blank in this 
illustration. The reason is that the business involved is assumed to be 
a retail business, and in such a business all goods are usually sold 
either for cash or on "monthly account," the balance of each cus- 
tomer's account being payable at the end of each month. This being 
the case, a statement of terms of sale is superfluous. This column 
would be used in the case of a manufacturing or wholesale mercantile 
concern, since such concerns sell goods which are to be paid for within 
a definite number of days after the date of the invoice, usually with the 
privilege of deducting a discount for payment within a stated shorter 
time. 

Posting from the sales journal. The method of posting from the 
sales journal is similar to that described on page 137 for the purchases 
journal. The total of the "Amount " column is posted to the credit of 
the sales account. Each of the items in that column is posted to the 
debit of the customer whose name appears in the column headed " Name 
of Customer." The total of the sales will be posted to the sales account 
only at the time when a trial balance is to be taken, but the debits to 
the customers' accounts should be posted daily. This is especially 
true in a manufacturing or wholesale business where customers may 
wish to extend their credit to a considerable amount. In passing on 
the granting of credit to a customer, the particular manager who is 
responsible for credit and collections will require all the data which are 
available with regard to that customer, and this will, of course, include 
the standing of his account at that date. Also, whether or not 
accounts are posted daily, they must be posted in time to prepare the 
periodical statements of account which are sent out by many wholesale 
houses and by practically all retail houses to their customers. 

The cash journals. In most businesses the transactions involving 
cash are of the most frequent occurrence. Such transactions are 
really of two kinds: (i) those involving the receipt of cash and (2) 
those involving the disbursement of cash. There is ordinarily found 
in use, therefore, a special form of journal for each of these types of 
transactions. Each of these records is, of course, a complete and 
separate journal, but the two are generally both included in keeping 
a complete record of cash, this record being known as the "cash book." 



SOME SPECIAL FORMS OF THE JOURNAL 



141 



All through this book the two forms are bound together, so that on 
the left-hand page is shown the record of the receipts of cash, and on 
the right-hand side the record of the cash disbursements. Since 
every transaction involving the receipt of cash means a debit to the 
cash account and every one involving a disbursement means a credit 
to that account, this arrangement of the cash book is in accord with 
the practice observed elsewhere of recording debits on the left side 
of the account and in the left-hand money column of the journal. 
These two forms of record, then, while each a complete journal in 
itself, constitute the two sides of the cash book, the left-hand page, 
showing the receipts, being known as the debit side, and the right-hand 
page, showing disbursements, being known as the credit side. 

Form of the cash book. Like the sales journal, purchases journal, 
and other special forms of books of original entry, the cash book may 
be used to show a considerable amount of detail in analyzing the 
transactions involved. The extent to which such detail will be shown 
will depend on the reporting requirements of the management. For 
the present it is best to illustrate the principles involved in the use of 
such a record by a very simple form of cash book, such as might be 
suitable for a small mercantile business with a limited range of trans- 
actions and simple reporting requirements. Such a form might be 

ruled as follows: 

CASH RECEIPTS 



Date 



Jan. 



Feb. 



I 
2 

5 

9 

IS 

21 

21 

27 
30 

31 



L.F. 



Account Credited 



George Dailey, Cap. 
Sales 

H. Schroeder 
Sales 

D. F. Anderson 
Notes receivable 
Interest on notes re- 
ceivable 
Sales 
R. B. McCall 

Cash, Dr. 



Explanation 



Investment 

Cash sales 

In full of account 

Cash sales 

In full of account 

D. Gray's note 11/22 

D. Gray's note 11/22 

Cash sales 

In full of account 



Amount 



Balance on hand 



7,500 

8S 

27 

122 

45 
200 

2 

145 
24 



00 
00 
50 
50 
00 
00 
00 

00 
50 



Total 
Cash, Dr. 



8,151 



8,151 



6,5«4 



50 

|0 
00 



III 



I 



142 



PRINCIPLES OF ACCOUNTING 



SOME SPECIAL FORMS OF THE JOURNAL 



143 



CASH DISBURSEMENTS 



Date 


I 


L.F. 


Account Debited 


Explanation 


Amount 


ToUl 
Cash, Cr. 


Jan. 


Prepaid insurance 


Paid insurance for yr. 


72 


00 








3 




Rent 


Rent of store for Jan. 


90 


00 








b 




Sales salaries 


Pay-roll for week 


75 


00 








6 




Office salaries 


Pay-roll for week 


*S 


00 








10 




Purchases 


Buda Co. for cash 


125 


50 








13 




Sales salaries 


Pay-roll for week 


75 


00 








18 




Simmons Co. 


Invoice 1/8 


200 


00 








24 




Office equipment 


Typ)ewriter and desk 


125 


00 








28 




Electric Wheel Co. 


Invoice 1/19 


450 


00 








30 




Office supplies 


Stationery & printing 


80 


00 








30 




Advertismg 


Ad. in Daily News 


25 


00 








31 




Office salaries 


Salaries to date 


7S 


00 








31 
31 




Sales salaries 
Cash, Cr. 


Salaries to date 


150 


00 


1,567 










50 




31 




Balance on hand 








6,584 


00 




8,151 


50 



Nature of the cash book. Although the two sides of the cash book 
are practically always shown bound together so that they fall on 
alternate and opposite pages, and must both be taken together in 
order to have a complete record of cash, it is well for the student to 
remember that they are in reality two complete journals. That is 
to say, each of these two forms provides for a complete record of the 
transaction to be recorded, with an equality between the debits and 
the credits for each such entry. This equality between debits and 
credits may not be apparent from a glance at either of the cash jour- 
nals, but it becomes apparent when the posting is considered. Thus, 
if H. Schroeder pays $27.50, the amount of his account with the 
business, the joumaUzation of the entry as it would appear in the 
general journal is as follows: 

Cash $27.50 

H. Schroeder $27.50 

Here, of course, the equaUty of debit and credit is quite apparent. 
But when this transaction is recorded in the cash receipts journal, or 
debit side of the cash book, the amount will only be entered once, 
according to the illustration given above. The reason for this is that 
the total of all items entered on this record is understood to be a 
debit to cash, and this total will be posted as a single item at the end 



of the accounting period, so that there will be an equality between the 
debits and credits posted to the ledger from this journal, since the 
total amount debited to cash is the sum of all the individual items 
credited to other accounts. 

It is easy to see that the same is true of the other side of the cash 
book, on which the disbursements are recorded. Here each entry 
involves a credit to cash and an equal debit to some other account or 
accounts. The debits will be posted separately, item by item, while 
the credit to cash will be obtained from the footing of the "amount" 
column. The total of the items debited to other accounts must be 
equal to the amount of the credit to cash, since this is also the total 
of the items entered in the "amount" column. 

Both the record of cash receipts and the record of cash disburse- 
ments, then, Uke the purchases journal and the sales journal, are 
special forms of the journal, each dealing with a particular kind of 
transaction. Every entry made in either of them is complete in its 
analysis of the transaction into debits and credits, and the principles 
involved in the use of these forms are in no way different from those 
governing the use of the general journal. 

Posting the cash hook. The posting of the cash book should be 
sufficiently indicated by the foregoing discussion, taken in connection 
with the instructions for the posting of the purchases book and sales 
book. On the debit side the individual items appearing in the 
"amount" column are to be posted to the credit of the accounts 
indicated in the column headed "account credited," while the total of 
the "amount" column goes to the debit of the account with cash. 
On the credit side the items are posted to the debit of the different 
accounts indicated, and the total to the credit of cash. 

Summary. The discussion in the present chapter has as its 
object the explanation of the general principles involved in the use of 
special journals. For this reason it is not considered desirable to risk 
confusing the student by introducing at this point any but the very 
simplest forms of such books. As a matter of fact, such simple forms 
as the ones here presented are usually found only in very small or 
simply organized businesses. Most of the records are much more 
elaborate, in order better to serve the purposes of labor saving and 
analysis of information. Illustrations of such forms, with a discussion 
of the principles governing their design, will be presented in chapters 



1 1 

I! 



1« 



144 



PRINCIPLES OF ACCOUNTING 



xix and xx. For the present the student should secure a clear 
understanding of the connection between the books of original entry 
and the reporting requirements of the business. That connection 
may be briefly stated as follows: In any given business there are 
certain items of information which it is desirable to have presented in 
periodical reports. In order to have these items of information 
available when needed, it is well to keep a continuous record of the 
changes taking place in each of these items in the form of an account 
with such an item. The number of such accounts required by the 
business, and the nature of the information to be shown in these 
accounts, will determine the number and form of the books of original 
entry designed to show the analysis of the business transactions 
according to their effect upon the various accounts. If the student 
can clearly see this relation as applied to the simple forms of records 
so far used for illustrations, he should have little difficulty in under- 
standing, using, and designing the more complicated forms which will 
be considered in later chapters. 

QUESTIONS FOR CLASS DISCUSSION 

1. The X. Y. Mercantile Company makes numerous purchases of farm 
products, both on account and for cash. What method would you 
recommend for recording these purchases? Would you record the 
purchases on account and cash purchases in the same book ? Why, or 
why not? 

2. The bookkeeper for the X. Y. Company says that the purchases of pro- 
duce on account have always been entered in the general journal, and 
wishes to continue the practice. Explain just why it would be to his 
interest to use a different method. 

3. Most of the farmers who sell produce to the X. Y. Mercantile Company 
later purchase merchandise from the company to an amount not greatly 
different from the amount of the produce sales. What record would 
be made when the sales take place ? 

4. The X. Y. Mercantile Company decides to issue "due bills" to those 
from whom they purchase produce. These " due bills " will be returned 
later in payment of merchandise. Explain the accounting procedure 
involved in establishing this practice. 

5. Describe the procedure followed in posting from the purchases journaL 
By what other names is this book sometimes called ? 

6. Can the form of sales journal illustrated in chapter xii be used to record 
cash sales ? Explain. 

7. A form of sales record formerly used was a large book, into which the 
sales invoices were pasted. This is now obsolete. Why should this 
be so ? Is less information concerning sales required now than formerly ? 



SOME SPECIAL FORMS OF THE JOURNAL 



145 



8. Describe the procedure followed m posting from the sales journal. 

9. Is the "cash book" one or two journals? Describe its posting. 

10. Jones & Wilson give the Citizens State Bank their note for $1,000.00 
at sixty days, without interest. The bank discounts the note at 6 
per cent, and credits their account with $990.00. How could this 
transaction be recorded in the form of cash book which has been 

described ? 

11. Explain what is necessary in order that customers' accounts may show 
at any time the amount which they owe. 

12. Mention as many special journals as you can which might be used by 
different businesses, and explain the purpose of each. 

REFERENCES FOR FURTHER STUDY 
Kester, Roy B., Accounting Theory and Practice, Vol. I, chaps, xviii-xxi. 
Klein, J. J., Elements of Accounting, pp. 12-15. 
Mitchell, T. W., Accounting Principles, chap. v. 
Paton, W. a., and Stevenson, R. A., Principles of Accounting, pp. 77-93- 

LABORATORY EXERCISE NO. 27 
The following are the purchases of H. F. Ford during the month of May: 
May 2. Bought of King Mercantile Co., terms n/io, merchandise, 
$480.50. 

3. Bought of Hodge & Lyon, terms n/io, merchandise, $370.40. 

4. Bought from O. P. Read, terms n/30, merchandise, $1,640.40. 
18. Bought of King Mercantile Co., terms n/30, merchandise, 

$950.60. 

25. Bought of Hodge & Lyon, terms n/30, merchandise, $450.80. 

26. Bought of Lane Shoe Co., terms n/30, merchandise, $75040- 

30. Bought of J. C. Adams, terms n/6o, merchandise, $340.60. 

31. Bought of O. P. Read, terms n/30, merchandise, $480.20. 

Instructions: 

Rule a sheet of paper to represent a purchases journal and enter the 

foregoing transactions. 

Preserve this exercise for future use. 

LABORATORY EXERCISE NO. 28 
The following are the sales of H. F. Ford during the month of May: 
May I. Sold J. O. Murdock, 215 Main St., merchandise, $13.00. 

4. Sold L. L. Koelsch, 5714 Blackstone Ave., merchandise, $16.50. 
9. Sold M. J. Torr, 4674 University Ave., merchandise, $34 00. 

12. Sold N. W. Barnes, 5742 Dorchester Ave., merchandise, $8.00. 

15. Sold W. E. Atkins, 6048 Woodlawn Ave., merchandise, $22.00. 

18. Sold C. O. Hardy, 6140 University Ave., merchandise, $19.00. 

21. Sold J. C. Christ, 5842 Woodlawn Ave., merchandise, $28.00. 

26. Sold A. M. Rogers, 4872 Main St., merchandise, $16.00. 

30. Sold J. D. Hohnes, 6175 King St., merchandise, $26.00. 



fl I 
ll < 



146 



PRINCIPLES OF ACCOUNTING 






Instructions: 

Rule a sheet of paper to represent a sales journal and enter the foregoing 
transactions. 

Preserve this exercise for future use. 

LABORATORY EXERCISE NO. 29 

The following are the cash transactions of H. F. Ford during the month 
of May: 

May I. H. F. Ford invests $2,600.00 cash in the retail merchandise 
business. 

2. Bought of A. M. Hall for cash, stock of merchandise, invoiced 
at $1,740.60. 

3. Paid rent for the month, $50.00. 
Received from cash sales, $80.40. 

5. Paid clerk hire, $18.00. 

6. Received $13.00 from J. 0. Murdock in full of account. 

8. Paid King Mercantile Co. $480 . 50 in full of account. 

9. Received $280.40 for cash sales. 

12. Paid clerk hire, $20.00. 

13. Paid $28.00 for expenses of buying trip. 

16. Purchased delivery equipment for cash, $210.00. 

17. Paid Hodge & Lyon $370.40 in full of account. 

17. Received $16.50 from L. L. Koelsch in full of account. 

18. Paid $12.20 for stamps and stationery. 

19. Paid clerk hire, $21.00. 

22. Received from M. J. Torr $34.00 in full of account. 
24. Received from C. O. Hardy $19.00 in full of account. 

26. Received $640.20 for cash sales. 
Paid salary of delivery clerk, $18.00. 

27. H. F. Ford withdrew for personal use, $25.00. 

29. Received from N. W. Barnes $8.00 in full of account. 
31. Received $420.80 for cash sales. 

Paid miscellaneous administrative expenses, $42.00. 
Instructions: 

Using a double sheet of journal paper as a cash book, enter the fore- 
going transactions. 

LABORATORY EXERCISE NO. 30 

Exercises Nos. 27, 28, and 29 together constitute the purchase, sales, 
and cash transactions of H. F. Ford for the month of May. Post the 
records prepared in the three exercises, placing four accounts to the page. 

Take a trial balance. 



[I 



CHAPTER XIII 
THE USE OF THE GENERAL JOURNAL 

Effect of special journals on the general journal. In discussing the 
books of original entry in chapter x the general journal was explained 
and illustrated as a posting medium for transactions of all kinds. It 
was stated at that time, however, that this journal was not so em- 
ployed in modern practice. It was used in chapter x merely to illus- 
trate in a simple way the nature and function of books of original 
entry and the method of recording transactions in them. In chapter 
xi, special journals for recording transactions with purchases, sales, and 
cash were discussed and illustrated. These journals were discussed 
because they are the ones in general use, although many other special 
journals are found in use in various businesses, and because they are 
typical of all special journals. 

By the use of these journals three principal classes of transactions 
are taken out of the general journal and entered in these separate 
records. An analysis of the transactions of a mercantile business will 
show that most of its transactions involve the purchase or sale of 
merchandise or the receipt or payment of cash. Since this is true, 
it is interesting to inquire what transactions are left to be recorded in 
the journal, which, as previously stated, is used to record all trans- 
actions not placed in any special journal. For the sake of discussion 
the entries recorded in the journal may be classified as follows: (1) 
opening entries; (2) current entries; (3) adjusting entries; (4) 
closing entries. In order that the present use of the journal as a 
posting medium may be better understood, each of these will be 
discussed in turn. 

Opening entries. Opening entries are those which are made to 
record the financial condition of the business at the time of its begin- 
ning or organization. The financial condition of a business is shown 
by its assets and liabilities and the difiference between the two, which 
is its net worth. The opening entry or entries must record these so 
that they will, when posted, be properly shown in the accounts. In 

147 



148 



PRINCIPLES OF ACCOUNTING 



the case of a sole proprietor, his investment may consist entirely of 
cash, in which case the opening entry may be made through the cash 
book by a debit to cash and a credit to the proprietor's account. 

In many cases the proprietor has other property, such as land, 
buildings, and merchandise which he desires to invest in the business, 
in which case a journal entry must be made, since these items cannot 
be recorded in the special journals. 

For purposes of illustration it may be assumed that on June i, 
19 1 8, J. R. Bell started in business by investing the following 
assets: cash, $1,000; merchandise, $2,000; building, $4,000; land, 
$1,000. By adding these items it will be seen that the total assets of 
Bell are $8,000, and since he has no Habilities this amount 
represents his proprietorship or net worth. Bell's books may be 
opened by the following journal entry: 



Cash 

Merchandise Inventory 

Building 

Land 

J. R. Bell, proprietor 





1,000 


00 






2,000 


00 






4,000 


00 






1,000 


00 


8,000 



00 



■..^ 



Although the posting of this entry will show Bell's financial 
condition in the accounts, all cash must be recorded in the cash book, 
consequently the cash item will be recorded on the debit side of the 
cash book as well as in the journal. It is readily apparent that this 
item cannot be posted from both the journal and the cash book, for 
if it is it would show a cash investment of $2,000 instead of $1,000. 
To avoid this, the individual item is not posted from either book. 
It is included in the total of $8,000 which is posted from the journal 
to the credit of Bell's account and it will be included in the cash 
total posted from the cash book to the debit of the cash account. 
Another method of treating this item is not to enter it in the journal, 
but only in the cash book, and to post it from there. The advantage 
of entering it in the journal is that the total investment is shown in 
one place. Both methods give the same result so far as the effect 
on the accounts and the reports is concerned. 

In some cases the proprietor has liabilities at the inception of the 
business which he desires the business to assume. In this case these 



THE USE OF THE GENERAL JOURNAL 



149 



liabilities must be shown as part of the journal entry. If Bell 
owes $1,000 on account to creditors, his opening entry would be: 



Cash 

Merchandise Inventory 

Building 

Land 

Accounts payable 
J. R. Bell, proprietoi 



1,000 
2,000 
4,000 
1,000 



00 
00 
00 
00 



1,000 
7,000 



00 
00 



The cash item will be treated in this case in the same manner as 
explained above. - ^ 

The example just given illustrates the nature of the opening entries 
for a single proprietor. The same principles are followed in the case 
of a partnership or of a corporation, but the entries may be somewhat 
more complicated. The method of making such entries will be 
explained and illustrated in subsequent chapters. 

Current entries. As previously stated, the general journal is used 
to record all transactions which cannot wisely be recorded in any of 
the special journals. It is impossible to discuss all such transactions 
which may arise during the fiscal period in connection with different 
businesses, but a few which occur most frequently will be considered. 

In the discussion of the purchases and sales journals it has been 
explained that these records are used only to record purchases and 
sales of merchandise. In every business certain property other than 
salable merchandise must be purchased from time to time to use in 
the conduct of the business. Then, too, discarded property, or prop- 
erty no longer needed in the conduct of the business, may be sold. 
If these purchases and sales are for cash they may be recorded in the 
cash book, but if they are on account the only means of recording 
them is in the journal. For instance, if $600 of office equipment is 
purchased on account from the Brown Furniture Company the asset 
account with office equipment should be debited and the account 
of the Brown Furniture Company should be credited. This is accom- 
plished by the following journal entry: 

Office Equipment .... $600.00 

Brown Furniture Company .... $600.00 

In case of a sale of property on account, the reverse entry is made in 
the journal, the account of the customer being debited and the 



ISO 



PRINCIPLES OF ACCOUNTING 



i 



property account being credited. As explained in the discussion of 
the fixed assets accounts, the latter transaction may also involve an 
entry to the reserve for depreciation account (see chapter vi). 

It has been explained in chapter xii that when goods are sold on 
account a record of the transaction is made in the sales journal, and 
that when cash is received in payment a record of the cash received is 
made on the debit side of the cash book. However, written promises 
or notes are sometimes received in payment of merchandise sold, 
the note being given at the time of the sale or later in payment of the 
oral promise previously given. In either case, it is customary to 
record the sale of the merchandise as an account sale in the sales 
journal and record the receipt of the note in payment separately in 
the journal. If the student will follow through a transaction of this 
kind he will readily see the effect of this procedure. If James King 
purchases $200 of merchandise on account, there would be an entry 
or entries in the sales journal by which King's account would be 
debited and the sales account credited for $200. If he sends his 
thirty-day note at the end of the month in payment of the account, 
an entry would be made in the journal as follows: 



Notes Receivable 
James King 



$200.00 



I200.00 



The effect of this entry is to cancel the charge made to the account of 
James King at the time of the sale, and to show the claim of the 
business against James King in the form of a written claim as reflected 
in the notes receivable account, instead of showing it as an oral claim. 
When notes are used by the business in payment of merchandise 
bought, a similar procedure is followed. The purchase is recorded 
in the purchases journal as a debit to the purchases account and a 
credit to the account of the creditor. When the note is issued in 
payment, whether immediately or at some future time, a journal 
entry is made debiting the creditor's account and crediting the notes 
payable account. This changes the form of the obligation of the 
business to the creditor from an oral to a written promise. Occa- 
sionally errors are made in recording transactions, and these errors 
result in incorrect amounts being debited and credited to the accounts, 
or in debits and credits being made to wrong accounts. These 
errors may be discovered later in the fiscal period and frequently the 



THE USE OF THE GENERAL JOURNAL 



151 



easiest method of correcting them is by means of a new journal 
entry. For instance, there may have been an expenditure of $200 
which should have been charged to administrative expense, but the 
bookkeeper carelessly recorded it as a debit to selling expense and 
posted it accordingly. The owner in looking over the trial balance 
notices that the selling expense for the month is larger than usual 
and very naturally seeks the cause. He may notice that the admin- 
istrative expense is smaller than for the previous month and this may 
suggest to him that an error has been made. In any case the book- 
keeper, in seeking an explanation of the variation of the selling ex- 
penses, will take the items in the selling expense account and trace 
them through the paging given in the folio column back to the book 
of original entry whence they came. By looking at the explanations 
recorded in the books of original entry he will seek to find any item 
which has been improperly charged. If by this means he located the 
entry by which the $200 is improperly charged to selling expenses, 
he must by some means correct the error. As they stand, the admin- 
istrative expenses are $200 too small and the selling expenses are $200 
too large. The easiest method of correcting the error is to make a 
journal entry as follows: 

Administrative Expenses . . . $200.00 

Selling Expenses $200.00 

To correct error made by 
charging through the cash 
book on June 16 $200 to sell- 
ing expenses whidi should 
« have been charged to admin- 

istrative expense. 

In the case of a correcting entry such as the above, a very complete 
explanation must be given so that the reason for the entry can be 
readily determined if the matter again arises. 

Correcting entries of various kinds will also be required during the 
fiscal period in a business which performs numerous and varied trans- 
actions. The correcting entry just shown serves only as an 
illustration of one type, but from it the student should be able to 
understand the nature of such entries. In the laboratory exercises 
given at the end of the various chapters he will find illustrations of 
other correcting entries. 



? 



152 



PRINCIPLES OF ACCOUNTING 



Although it is impossible to give an inclusive discussion of the 
transactions which may be recorded in the general journal during the 
course of the fiscal period, the following list gives the more common 
ones. These entries may be included under the heading of "current 
entries," since they are all made from time to time during the period, 
rather than at its end. 

1. Purchases on account of services and of property other than 
merchandise. 

2. Sales on account of property other than merchandise. 

3. Receipt of property other than cash in payment of obligations 
due the business. 

4. Issuance of property other than cash in payment of obligations 
owned by the business. 

5. Corrections of entries which have been incorrectly recorded 
or which have been wholly or in part canceled. 

Adjusting entries. In the discussion of the periodic summary of 
the ledger (chapter ix) it was explained that at the end of the fiscal 
period certain entries are necessary in order to adjust some of the 
accounts so that they will reflect correctly the financial condition of 
the business. These entries as explained in the previous discussion 
are known as adjusting entries. The student should not confuse 
these entries with those discussed under the head of correcting entries 
in the preceding paragraph. Correcting entries are made during the 
fiscal period to correct an erroneous entry or to record the partial or 
complete cancellation of a transaction. Adjusting entries are made 
at the end of the fiscal period to adjust the value of accounts which 
reflected accurately the financial condition of the business at the 
beginning of the period or at the time of their construction, but which 
have changed in value since that time. • 

In chapter ix it was explained that, in connection with the 
accounts of W. A. WiUiams, the following adjustments were necessary: 
The inventory account must be adjusted so as to show the disposition 
of the beginning inventory of $2,500 and the possession of an ending 
inventory of $3,500; and this was accomplished by a debit to the 
purchases account and a credit to the inventory account for the old 
inventory and a debit to the inventory account and a credit to the 
purchases account for the new inventory; there was an estimated 
depreciation of $50 on office furniture and of $200 on the building, and 
this depreciation must be recorded by a debit to administrative 



THE USE OF THE GENERAL JOURNAL 



J53 



expense and a credit to a reserve for depreciation of office furniture 
and to a, reserve for depreciation of building. 

The entries of these adjustments were made (see pages 109, 112,1 13) 
directly in the accounts, since the purpose of the discussion at that time 
was to show the effect of business operations on the ledger accounts. 
Books of original entry had not been introduced. In subsequent 
chapters, however, the use of books of original entry was explained. 
The advantage of having all transactions recorded in some book of 
original entry prior to their entry in the accounts has been seen. 
To secure this advantage, adjusting and closing entries should be 
recorded in the journal, and from there posted to their respective 
accounts. The chief advantage of this method is that all entries in 
the ledger can be traced back to their original source and an expla- 
nation therefor obtained. It also minimizes error and greatly facili- 
tates the finding of any errors which may occur. 

The adjusting entries required in connection with the accounts of 
W. A. Williams given in chapter ix in journal form will be as follows; 



31 
Purchases 

Inventory 
To transfer the inventory of Janu- 
ary I, 1918, to purchases 

31 

Inventory 

Purchases 
To record the inventory of Decem- 
ber 31, 1918 

Administrative expenses 

Reserve for depreciation of ofl&ce 

furniture 
To record the estimated deprecia- 
tion on office furniture 

31 
Administrative exi)enses 

Reserve for depreciation of building 
To record the estimated deprecia- 
tion on building 



3,000 



3.500 



SO 



200 



00 



00 



00 



00 



3,000 



00 



3,50000 



20000 



5000 



When these entries are posted, the accounts will show the same results 
as they do in the illustrations given in chapter ix. 

The closing entries. In chapter ix it was explained that there are 
certain entries necessary at the end of the fiscal period in order to 
summarize the results of the period and make the income and expense 
accounts on the ledger correspond to the summary shown on the 



'^'4 



I 



154 



PRINCIPLES OF ACCOUNTING 



Statement of profit and loss. In that chapter it was also explained 
that the closing of the imaginary ledger of W. A. Williams would 
involve the following: the transfer of the balance of the purchases 
account to the debit of the sales account; the transfer of the balance 
of the sales account to the credit of the profit and loss account; the 
transfer of the balances of the selling expense and administrative 
expense, buying expense, and delivery expense accounts to the debit 
of the profit and loss account; and the transfer of the balance of the 
profit and loss account to the credit of the proprietor's account. 

For the same reasons given in the case of adjusting entries, the 
closing entries should be recorded in the journal and posted from 
there to the ledger accounts. The journal entries for closing the 
ledger of W. A. Williams are as follows: 



Sales 



31 



Purchases 
To transfer cost of goods sold to the 
sales account 



Sales 



31 



Profit and Loss 
To transfer gross profit on sales to 
the profit and loss account 

31 
Profit and Loss 

Buying Expenses 

To transfer buying expenses to the 

profit and loss account 

31 
Profit and Loss 

Selling Expenses 

To transfer selling exp>enses to 

profit and loss account 

31 
Profit and Loss 

Delivery Expenses 

To transfer delivery expenses to 

profit and loss account 

31 
Profit and Loss 

Administrative Expenses 

To transfer administrative exp>enses 

to profit and loss account 

31 
Profit and Loss 

W. A. Williams 

To transfer net profit for the fiscal 

period to the proprietor's account 



24,000 


00 


24,000 


7,000 


00 


7,000 


444 


00 


444 


1,440 


00 


1,440 


750 


00 


750 


3.3<^ 


00 


• 

3,366 


1,000 


00 


1,000 



00 



00 



00 



00 



00 



00 



00 



THE USE OF THE GENERAL JOURNAL 1 55 

When the entries on page 154 are posted, the accounts vAM show the 
same results that they do in chapter ix, where the entries are made 
directly in the accounts. 

QUESTIONS FOR CLASS DISCUSSION 

1. A. M. Jones has been recording all the transactions of his business in a 
journal. His business has increased until he thinks it desirable to use 
a purchases journal, a sales journal, and a cash book. He is in doubt 
whether he should retain the general journal and, if so, what entries 
should be made in it. What advice should you give him ? Why ? 

2. J. A. Hoffer opens a retail store on January i, 1920, when his assets 
and liabilities are as follows: 

Cash % 500.00 

Merchandise inventory 2,200.00 

Ofl&ce furniture 300.00 

Building 2,000.00 

Land 1,000.00 

Notes payable 1,500.00 

Accounts payable 500.00 

Explain the opening entry necessary to record Hoffer's investment. 

3. Mr. Hoflfer purchases on accoimt delivery equipment to the value of 
$300.00. Explain the entries necessary to record this transaction. 

4. Later, Mr. Hoflfer has old delivery equipment for which he originally 
paid $200.00. He sells this for $25.00. State what entries should be 
made at the time of sale. 

5. Mr. Hoflfer gives the Kmg Mercantile Company a note for $300.00 to 
apply on account. Explain how this transaction would be recorded. 

6. The bookkeeper of the X. Y. Company has charged $100.00 to delivery 
expenses that should have been charged to administrative expenses. 
Explain how this error should be corrected. 

7. On January i, 191 7, A. R. King has an mventory of $3,000.00. On 
December 31, 191 7, he has an inventory of $4,000.00. Explain the 
entries necessary to show the disposition of the old inventory and the 
possession of the new inventory. State where these entries would be 

made. 

8. On December 31, 191 7, King desires to show a summary of his year's 
operations on his ledger. On his ledger he maintains the following 
income and expense accounts: 

Purchases account 

Sales account 

Selling expense account 



I 



iS6 



PRINCIPLES OF ACCOUNTING 



Buying expense account 

Delivery expense account 

Administrative expense account 

Profit and loss account 

Proprietor's account 
Briefly explain how a summary of his ledger would be made. Where 
would the necessary entries be made in his record ? What are such 
entries called ? 
9. A. R. King has these entries recorded in his journal: 



Jan. I 
Cash 

Merchandise Inventory 
Building 
Land 

Notes Payable 
Accounts Payable 
A. R. King, Proprietor 
Jan. 5 
Office Equipment 

Chicago Furniture Co. 
Jan. 10 
Notes Receivable 
William James 

Jan. 16 
James Randolph 
Office Furniture 

Dec. I 
H. R. Johnson 
Notes Payable 

Dec. 1$ 
Selling Expenses 

Administrative Expenses 
Dec. 31 
Selling Expenses 

Reserve for Bad Debts 
Dec. 31 
Sales 

Purchases 

Dec. 31 
Profit and Loss 

Administrative Expenses 



500 
2,000 
3,000 
1,500 



300 
80 



100 00 



00 
00 
00 
00 



00 



00 



ISO 
46 

8S 
3i000 
1,200 



00 



00 



00 



00 



00 



1,000 
1,500 

4,500 



300 

80 

100 



i5o|oo 
46 



85 
3,000 
r,2oo 



00 
00 
00 



00 



00 



00 



00 



00 



00 



00 



Explam the purpose of each of the entries above and state whether it 
would be termed an opening, correcting, adjusting, or closing entry. 

REFERENCES FOR FURTHER STUDY 
Kester, Roy B., Accounting Theory and Practice, Vol. I, chap. xxii. 



THE USE OF THE GENERAL JOURNAL 



157 



LABORATORY EXERCISE NO. 31 

Record the following transactions, using the sales book, purchases book, 
cash book, and journal. lUustrations of these are given in chapters xi 

and xii. 

March i. R. E. Taylor invests $5,000.00 in the wholesale business at 

200 South State St. 

2. Rents store and warehouse for one year at a monthly rental 
of $1 50.00, giving his check for that amount. 

Purchases from A. R. Miller on thirty-day account, mer- 
chandise, $400.00. 

3. Paid Blattner Bros, for office furniture, $225.00. 

4. Purchases of Ralph McCoy on twenty-day account, 
merchandise, $350.00. 

5. Purchases from A. P. Copeland, thirty-day account, 
merchandise, $40.00. 

6. Sells A. K. Davies, ninety-day account, merchandise, $92.50. 

7. Purchases of A. R. Miller, thirty-day account, merchandise, 
$250.00. 

8. Pays for postage and stationery, $7.80. 

9. Pays clerk hire for week, Harry James, $15.00, and David 
Swanson, $12.00. 

10. Purchases as follows: 

F. M. Jones, ten-day account, merchandise, $180.00. 
A. P. Copeland, twenty-day account, merchandise, 

$150.00. 

Carl Hamlet, ten-day account, merchandise, $120.00. 

11. Sells as follows: 

A. L. Anderson, ten-day account, merchandise, $250.00. 
M. M. McGee, twenty-day account, merchandise, 

$300.00. 

12. E. Taylor withdraws for personal use, $60.00. 

13. Buys of J. H. Holliday and Company for cash, office fur- 
niture, $110.00. 

14. Buys of H. H. Smith Typewriter Company for cash, one 
typewriter, $100.00. 

15. Sells as follows: 

E. R. Mears, cash, $75.00. 

L. O. Lay, thirty-day account, merchandise, $280.00. 

16. Pays clerk hire as follows: 

Harry James, $15.00. 

David Swanson, $12.00. 
Received of A. K. Davies payment of invoice of March 6, 
$92.50. 



158 PRINCIPLES OF ACCOUNTING 

17. Sells as follows: 

G. B. Crawford, merchandise, $975.00. 

E. B. Case, merchandise, $275.00. 

18. Purchases as follows: 

Ralph McCoy, n/20, merchandise, $650.00. 

F. M. Jones, n/20, merchandise, $340.00. 
W. T. Dickens, n/io, merchandise, $700.00. 

19. E. Taylor has sent to his home for private use merchandise 
to the value of $15.00. 

Note. — This exercise is continued at the end of the next chapter. 



CHAPTER XIV 

BUSINESS VOUCHERS AND FORMS 

Purpose of the voucher.— Tht student now has an understanding 
of the nature and purpose of the accounting reports. The use of the 
ledger accounts in classifying the information needed for making such 
reports has also been explained, as well as the use of the books of 
original entry as a convenient means of analyzing each business 
transaction, and as a basis for posting to the ledger accounts. 

It is scarcely to be thought, however, that a correct record can be 
kept in the books of original entry of all the transactions that take 
place in the business without some sort of written memoranda of such 
transactions being transmitted to the bookkeeper. Without such 
memoranda he cannot possibly know all the happenings of the 
business which affect the accounts. This is well illustrated by the 
case of a large department store, whose sales clerks are making 
hundreds of sales each day, while its buyers are purchasing goods and 
letting contracts- for the different departments in the various source 
markets. Clearly enough, in any modem business establishment 
larger than a small one-room shop, there must be some regular pro- 
vision for notifying the accounting department of each transaction 
that takes place in the business. Even if the person who performs 
the transaction is also the one who enters it in the books, some memo- 
randum should be made of it, since otherwise the details may be for- 
gotten before the record can be made. It will be found, therefore, 
that almost every business concern uses certain forms for making a 
notation of the essentials of each business transaction at the time it is 
performed. Such forms are known as vouchers. A voucher, in this 
use of the word, may be defined as the written evidence of a business 
transaction. 

It will be found that there are vouchers which serve not only as a 
basis for recording the transactions out of which they rise but also 
as a means of facilitating these transactions. Indeeci^ some of the 
vouchers which will be discussed in the following pages are not used as 

IS9 



ii 



i5 



' 



i6o 



PRINCIPLES OF ACCOUNTING 



a basis for making entries, but only for the facilitation of the operation. 
These will be discussed along with the others, but it is in the use of the 
voucher as the primary evidence of the transaction that we are at 
present primarily interested. 

Classification of vouchers and forms. Owing to the variations in 
systems of accounting used by different businesses, there is even a 
greater number of kinds of vouchers than of books of original entry. 
It is evident that all these forms cannot be considered here. Not 
even an inclusive classification will be made at this point. A simple 
classification which will serve well enough for purposes of the present 
discussion is as follows: (i) vouchers used in connection with the 
purchase and sale of merchandise; (2) negotiable vouchers; (3) mis- 
cellaneous vouchers and forms not included in either of the first two 
classes. 

The merchandise invoice. When a sale of goods is made, it is 
customary for the seller to make out a statement of essential facts, 
a copy of which he sends to the buyer. Such a statement is known to 
both buyer and seller as an invoice. To the buyer it is a purchases 
invoice^ while to the seller it is a sales invoice. It is an itemized state- 
ment from the seller to the buyer of the goods sold, together with the 
prices and the total amount of the sale. Other items of information 
ordinarily shown are the name and address of both buyer and seller, 
the date of sale, the terms of sale, the method of shipment or delivery, 
and the serial number of the sales invoice. Any other desired infor- 
mation, such as the number of the salesman making the sale, and the 
department from which the goods is sold, may also be shown. The 
method employed in making use of the invoice for purposes of 
the purchase or sales rec&rd will be discussed briefly below. 

When goods are purchased by a business concern, the invoice 
for the goods usually arrives before the goods themselves. If so, it is 
placed in a temporary file until the arrival of the goods. As- soon as 
the latter are received, they are checked with the invoice to see that 
they correspond to the goods listed on the invoice in quantity, kind, 
and price, and the extensions and total are verified. If everything is 
found to be correct and in order, the invoice is then used as the basis 
for an entry in the purchases journal, as described in a previous 
chapter. Each purchases invoice when received is given its serial 
number in the purchaser's records, and this number is entered in the 



BUSINESS VOUCHERS AND FORMS 



161 



appropriate column in the purchases journal. After being entered, 
the invoice is filed. If it represents a credit purchase, it is filed in a 
"tickler file" of unpaid invoices, under the date upon which it should 
be paid. When it has been paid and the payment recorded properly 
in the cash book, it is placed in a permanent file, according to some 
appropriate system of filing. It is there available for future reference 
in case need should arise. 

The routines followed in handling the sales invoice, or the "sales 
ticket," as it is usually termed in retail establishments, are by no 
means identical. In a wholesale business, one or more copies of the 
invoice are generally retained by the selling organization. One of 
these is sent to the accounting department, where it serves as a basis- 
of entering the transaction in the sales journal. When remittance 
is received from the customer, the check may pass through the 
accounting department, thus serving as a basis for the entry in the 
cash book to show the payment of the invoice, or a special form may be 
used to notify this department of the payment. Sometimes a copy 
of the invoice itself, stamped "Paid" is sent to the accounting depart- 
ment iot this purpose. The entry in all of these cases is the same. 
A copy of the invoice may also be kept in the files of the credit depart- 
ment until it is paid. After payment, this or some other copy is 
filed in a permanent file, where it may be located by means of its 
serial number in case any reference to it is desired. 

In a retail business the cash sales are generally of much greater 
importance, relatively, than they are in a wholesale business. The 
duplicate sales tickets for the cash sales in each department are 
totaled at the end of the day's business, these totals being checked 
against the total of cash received from that source, and then entered 
in the proper records as totals. The credit sales are sometimes 
entered item by item in the sales journal and the posting to the 
customers' accounts done from that record, but in the larger retail 
concerns it is usual for them to be entered by totals, and for the post- 
ing to the customers' accounts to be made directly from the sales 
tickets. In some retail stores no posting is done to the accounts with 
customers. Instead, the credit sales are entered by totals, and the 
duplicate sales tickets filed under the name of the customer. When 
a remittance is received from the customer, the proper entry is made 
in the cash book, and the tickets covered by the remittances are 



>f 



'V 



162 



PRINCIPLES OF ACCOUNTING 



either sent to the customer or destroyed. The amount owed to the 
business by a customer at any time is shown by the total of the 
tickets filed under his name. These tickets serve as the basis of 
the monthly statement of account to be sent to the customer, if it is 
the practice of the business to send out such statements. 

Form of the merchandise invoice. The form of the invoices used 
by different businesses varies considerably in detail, as suggested 
in the foregoing discussion. The following form, however, may be 
considered typical of the sales invoices sent by wholesale businesses 
to their customers. 



MARSHALL-WELLS HARDWARE COMPANY 
615 Marquette Ave., MINNEAPOLIS, MINN. 

WHOLESALE HARDWARE 
Sold to 



Telephone: 
Central 450 



Order No. 



Terms: Sixty Days. 
If paid within ten 
days from date, 2 per 
cent may be de- 
ducted. 

Other terms and 
conditions shown on 
reverse side. 



In referring to this invoice, please give date and number. If any of these 
goods are unsatisfactory, complaint should be made within five days of their 
receipt. They are not returnable without our permission. 



On page 163 is shown a form of the sales ticket which is given to 
the customer by a large retail estabUshment. It may be considered 
typical of the sales tickets used in retail businesses. 

Negotiable instruments. In earlier chapters it was pointed out 
that business consists of a series of operations, each of which involves 



BUSINESS VOUCHERS AND FORMS 



163 



Order No. 
or Buyer 



Date 



19- 



Customer's Memorandum 



Salesperson's 
No 



Delivered by 

Floorman 



CHARGE. 



This memorandum should be kept to check monthly bill, except 
when merchandise is returned, when it should be sent back with 
goods, in order that the proper credit be made. 

Merchandise to be credited on current bill must be returned before 
the last day of the month. 

THE CHICAGO STORE 
CracAGO 



207 



25 



an exchange of values. Such exchanges of values are assisted greatly 
by the use of negotiable instruments. It has been explamed that cus- 
tomers often paid for merchandise by means of checks. This means 
that the customer has in some manner established a credit to his 
account at a bank, and that he writes an order to the bank to pay a 
certain amount to the order of his creditor, the acceptance of this 
order by the creditor serving to discharge the obUgation. The 
method by which credit may be established at the bank will be dis- 
cussed in chapter xv. For the present it is sufficient to point out 
that the usual method by which *'cash" payments are made between 
businesses is by the delivery to the creditor of a check drawn by the 
debtor against some bank with which he has a balance. The creditor 
will then ordinarily "indorse" the check, in a manner to be explained 



164 



PRINCIPLES OF ACCOUNTING 



later, and send it to his own bank to be credited to his account there. 
When he does this he is said to deposit it. The bank with which the 
check is deposited then secures settlement on the check from the bank 
upon which it is drawn. This may be done by sending it directly 
to the other bank; by sending it to the clearing house, the organization 
through which banks adjust their claims against each other; or by 
sending it to another bank which will secure payment on it. A form 
of check which shows the essentials of such an instrument is given 
below: 



•MMC or ^M* 




"^ ru..>^r.ol,. ^^fc^ /. \<^k/ mo^^/. 



Paytotheordcrof 




ThefirslNationalBankofEn|Ie^'oo(l2io9 



%Z^± 



Dollars 



lJU>iES DEPARTMKHT. 




Another possible method of payment is that of giving the creditor 
a note, which, as already explained, is the debtor's written promise 
to pay the specified sum at a certain future date. Such a note re- 
ceived from a customer is a note receivable to the business to whom it is 
payable, and a note payable to the business making the promise to pay. 
The essentials of such an instrument, and the form which it ordinarily 
takes, are indicated by the following illustration: 



s-Ai^sLa. 



^ 1>fE NATI 



No..JL4[^ 



Dm. 






data for oakH nahitd tkt wimlffma prmnlrn lo ptg l» Urn 

National City Bank of Chicago 






• ^«# -at^dt^t.e^ ^it ^ t^ti 



, - DOLLARS 

^iJ^SSutJi^iL^^i^J!!!^^ '*'2P MATURITY at the rat, of sevn per cnt ftr 

^"TL^g ^^f^ "^«^«^*«^'°" «^<'ni»«'>MeaUonteyfnifnotpaidat maturity. Prntntmmt 
g" y?"^ fer piq^wMiH noHa oi imn-patimmt, pnlat and notkt of protest arteacM and all kerwbiiwSmdki 



'"''?" T^!*?: *" Ote unaanigned or to any endorser or guarantor maa be a p p r op ri ated and aooUed bu a^i ZI 
•rjval holder on thu note at any lime either before or afttr maturfiy oft^kSSmd^Mhi^dmZX»rt 



•UWMCSS AC 



d^^ 



^-^^^Z*^ 



-Mrf_ 



-iW^ 



^^^^'-g^'^*-"— ^-^^^^^^ 



BUSINESS VOUCHERS AND FORMS 



l6S 



In the foregoing discussion of the use of the note, it was referred 
to as settling the obligation. But it is readily seen that it does this 
only in the sense that one form of obligation is settled by creating a 
different form. When the time for which the note is drawn has 
elapsed, payment must be made on the note itself. This is usually 
done by means of a check. If goods are purchased on open account, 
payment may be made by check, or a note may be given to discharge 
the obligation on open account, and the note paid at maturity by 
check, thus involving both forms discussed above. A firm unable 
to meet its open accounts at the time when they are due will some- 
times secure an extension by giving a note for the amount, payable 
at a later time. This does not represent a desirable situation. 

The processes described above are the same, whether looked at 
from the point of view of the selling concern or from that of the one 
doing the purchasing. They will, of course, be recorded differently 
on the books of the two. The note and check are used not only in the 
purchase of merchandise but also in payment for other assets, current 
and fixed, and for services. In the purchase of fixed assets, such as 
land and buildings, notes may be given which have a more distant 
maturity. Sometimes they run for several years. Such notes are 
usually secured by a mortgage on the property. The nature of such 
long-time liabilities and their treatment in the accounts will be con- 
sidered in a later chapter. The point of the present discussion is 
that the note may be used in facilitating practically any sort of 
transaction. 

It should be apparent that notes, checks, and instruments of similar 
legal import have a very important part to play in business trans- 
actions. Since this is true, the accountant, dealing with them almost 
continually, should have some idea of their nature and of their peculiar 
legal aspects, so that he may record properly the transactions involving 
their use. This class of business papers, serving as they do to facilitate 
exchange, are known as negotiable instruments, and their importance 
has led to the attaching of certain definite legal consequences to 
their use. 

Requisites of negotiable instruments. The important part played 
by negotiable instruments in business has made it desirable that there 
should be some very definite formulation of the rules for their form and 
use, which should apply generally, and not vary from state to state. 



I) 



I 



W: 



w 



w 



i66 



PRINCIPLES OF ACCOUNTING 



This need has led to the adoption in a number of states, of the Uni- 
form Negotiable Instruments Law, the purpose of which is to formu- 
late the generally accepted usages and rulings with regard to negotiable 
instruments, and to make such law apply uniformly in the various 
states. This law states certain requisites of a negotiable instrument, 
and these are summarized below. 

1. The instrument must be in writing and signed by the maker or 
drawer. 

2. It must contain an unconditional promise to pay a fixed sum of 
money. 

3. It must be payable on demand or at a time which is either 
fixed or determinable. 

4. It must be payable to bearer or to order. 

Kinds of negotiable instruments. There is no particular specified 
form which must be followed in order to give any particular instrument 
these requisites. Any written instrument which possesses the essen- 
tials will be held by a court to be a negotiable instrument. The 
forms employed, however, have become more or less standardized 
through general usage, and the standard form should be used without 
any considerable variation, in order to avoid any possible difliculty. 
There are several kinds of negotiable instruments, each having a 
somewhat different use, and each having its peculiar form. The 
principal kinds may be listed as follows: (i) notes; (2) checks; 
(3) drafts; (4) cashier's checks; ($) express money orders; (6) postal 
money orders. 

The draft. An example of one form of draft, the bank check, has 
already been given. A draft is a written order from one party to 
another, directing this second party to pay a certain sum of money to a 
specified third party. The bank check is, of course, such an order. 
Owing to the special nature of the check, and the special manner of 
its use, it was not discussed under the general head of drafts but was 
considered by itself. Drafts other than checks may be classified 
as (i) bank drafts and (2) conmiercial drafts. 

A hank draft is to all intents and purposes a check drawn by one 
bank on another. The bank drawing such a draft generally has funds 
on deposit with the bank against which it draws, or else some under- 
standing by which it is permitted to draw in advance of its making 
such deposit. Bank drafts are used for making payments at some 



HI 



BUSINESS VOUCHERS AND FORMS 



167 



considerable distance by mail. The bank draft will circulate more 
freely away from home than will the personal check, and the draft 
does not usually cost the recipient anything for collection, while the 
check may. Thus if Mr. Fred Dole, of Chicago, has to make a pay- 
ment to a firm in Philadelphia, he may go to his bank in Chicago and 
ask for a New York draft in favor of the Philadelphia concern. He 
asks for a New York draft, since New York is our financial center, 
and banks in all parts of the country have connections with New York 
banks. Mr. Dole will draw a check payable to his Chicago bank for 
the amount of the draft he is asking for, possibly including a small 
charge for the service. He will mail the draft to the Philadelphia 
concern, who will probably deposit it at their Philadelphia bank. 
The latter bank will usually send it to their correspondent bank in 
New York for credit, and this bank, if not the one upon which the' 
draft is drawn, will usually send it to the bank upon which it is drawn 
for collection. The form of such a draft may be as follows; 



The Corn Exchange Bank 



Pay to the Order of 

Eight Hundred and. 

To The National City Bank 
New York, N.Y. 



Chicago, III., May 15, 1920 
$800.00 



.no/ioo Dollars 

J. S. Harvey 
Cashier 



The commercial draft is a draft drawn by one private individual 
or business concern upon another, directing the second party to pay 
a certain sum of money to a third party named. Such a draft would 
have the following form: 



$200 



At sight pay to the order of. 
Two Hundred and . , 



Danville, III., May 3, 1920 
William Johnson 



no/ioo Dollars 

Value received and charge to the account of 

To Clanahan & Son Grant Brothers 

Springfield, III. 



This is the form of draft, or "bill of exchange," that was used to some 
extent in the past, before our present credit and banking system was 



i 





i68 



PRINCIPLES OF ACCOUNTING 



developed. The theory of such a draft was that Clanahan and Son, 
of Springfield, were indebted to Grant Brothers, of Danville, and the 
latter owed William Johnson, of Springfield. Grant Brothers, by 
giving Johnson a draft against Clanahan and Son, could reduce their 
indebtedness by that amount without sending any money, and Clana- 
han and Son, by accepting and paying the draft, could reduce their 
indebtedness to Grant Brothers without sending money to Danville. 
With the modern system of banking, such a procedure has become 
archaic, and is of interest only from a historian's point of view. 
Such indebtedness would today be settled very easily by mailing a 
personal check or a bank draft. The chief reason why such a " three- 
cornered" draft is impracticable is that it would be only by the rarest 
coincidence that the amount which Clanahan and Son owed Grant 
Brothers would correspond with the amount that the latter owed 
Johnson. 

A form of commercial draft which is at present in use is one by 
which one party draws upon a second party, making the draft payable 
to the party drawing it. The nature of such a draft can be better 
understood by seeing the form of it, which is as follows: 



CfflCAco, Illinois, May 20, 1920 



$250 

At sight pay to the order of 
Ourselves 

Two Hundred Fifty and no/ioo Dollars 

Value received, and charge the same to the account of 

To A. P. Jens, West and Dennett 

Champaign, III. 



Such a draft as this is ordinarily used for the purpose of speeding up 
collections. The typical case represented by this draft would be that 
Jens owes West and Dennett, and that they draw on him in an effort 
to collect the amount of the debt. The draft would ordinarily be 
given to West and Dennett's bank for collection. The bank, in turn, 
would forward it to some bank in Champaign, which would notify Jens 
of the draft. If he pays it, the Champaign bank would either remit 
to the Chicago bank or credit the account of the Chicago bank for 
the amount, and West and Dennett's account would be credited by 
the Chicago bank, that firm bemg notified of the collection. 



>. 



BUSINESS VOUCHERS AND FORMS 



169 



The same result might have been obtained by making the draft 
payable to the Chicago bank instead of to West and Dennett, the 
form of the draft remaining otherwise the same. The procedure 
would not be changed by this variation in form. 

Another possible classification of drafts, according to the time 
when they are payable, is into (i) sight drafts and (2) time drafts. 
The forms given so far have all been sight drafts. This is indicated 
by the fact that they are worded "At sight pay to the order of," etc., 
which means that they are payable at the time of their presentation. 
A time draft is one which is drawn payable a certain number of days 
after sight or after date. In the case of a time draft, if the party upon 
whom it is drawn is willing to pay it and intends to do so, he indicates 
this by accepting it at the time it is presented to him, and returning 
it to the party in whose favor it is drawn. Accepting a draft is 
accomplished by the acceptor writing the word ^'Accepted" across the 
face of the instrument and signing his name. It then becomes hi^ 
written promise to pay, just as though it were his promissory note. 
From that time on it will be treated as a promissory note in the 
records of all parties concerned. The form of a time draft differs in 
no way from the forms given above, except that instead of the words 

"At sight" it bears the words "At days sight," 01; " days 

after date." 

From the illustrations given, it is apparent that there are three 
parties to a draft. The one who gives the order is known as the 
drawer; the one to whom the ordei; is addressed, as the drawee; and the 
one to whom it is made payable, as the payee. Where a draft is made 
payable to self, the same party is both drawer and payee. The one 
who accepts the draft, usually the drawee, is also the acceptor ^ and an 
accepted draft is usually referred to as an acceptance. A special 
type of draft known as a trade acceptance will be discussed later. 

It has already been stated that the accepted draft is to be treated 
as a note. The entry made to record the receipt of such a draft 
would, therefore, be a debit to notes receivable and a credit to the 
customer, while the entry to record the acceptance of a draft would 
be a debit to the creditor and a credit to notes payable. 

The cashier^s check. The cashier's check is a check drawn by a 
bank against itself, being signed by the cashier as agent of the bank. 
Such checks are used for the payment of obligations of the bank itself, 



!'.' 



170 



PRINCIPLES OF ACCOUNTING 



and for transmitting the proceeds of collections made for persons or 
firms who do not have accounts with the bank making such collections. 
The form of such a check might be as follows: 




Express and postal money orders. Express and postal money orders 
are quite similar, except that the first are issued by the express com- 
pany and the second by the United States Post-Office. Both these 
forms of drafts are used for transferring money safely from one city 
to another. In the case of the express money order, the person 
desiring to transmit the money pays the company the amount that 
he desires to transmit, plus the fee for the service, and is given an 
order payable to the party to whom the money is to be transmitted. 
This order is sent to the payee, who cashes it at the local office of the 
express company. The form of an express money order is illustrated 
below: 



EXPRESS MONEY ORDER 

WHEN COUNTERSIGNED 
By Agent at Point of Issue 

AMERICAN EXPRESS COMPANY 
agrees to transmit and 

Pay to the order of Donald F. Tollefson 



13-478392 



-$750.00 



the sum of Seven Hundred Fifty and no/ 100 Dollars 

Paul Nelson Agent 



Issued at 

St. Paul, State of Minnesota 
Date June 5. 1020 



Raymond S. Gleason 



i" 



BUSINESS VOUCHERS AND FORMS 



171 



The postal money order will be issued by a postmaster, upon the 
sender's written application and the payment of the amount named, 
plus a fee for the service. Postal money orders will be honored by 
any postmaster when the holder has been satisfactorily identified. 

QUESTIONS FOR CLASS DISCUSSION 

1. The James Mercantile Company has five departments and there are 
ten sales clerks in each department. The accounting department 
records the sales of all of the clerks. How does it obtain the amount 
of their sales ? 

2. The James Mercantile Company desires to know the daily, weekly, 
and monthly sales of each clerk. How may these statistics be obtained ? 

3. What is a voucher ? Give two purposes which it may serve. 

4. The X. Y. Manufacturing Company has a stores department, a pur- 
chasing department, and a receiving department. The stores depart- 
ment keeps a record of aU goods on hand and when the quantity of 
any article falls to a certain limit notifies the purchasing department, 
which places an order for the goods. The goods are received by the 
receiving department. In case the quantity of goods received does not 
correspond with the quantity ordered or the quantity shown on the 
invoice, how can this be detected ? 

5. What is the difference between the sales invoice and the sales ticket ? 

6. Explain how the sales ticket may be used as a means of facilitating the 
recording of both cash and credit sales in the case of a large department 

store. 

7. The Boston Store of Wichita, Kansas, owes Marshall Field and Company, 
of Chicago, $800.00 for merchandise. Explain three ways by which 
the Boston Store may pay this amount. Which way will probably be 
employed ? 

8. A. M. Elliott owes E. C. Cline $400.00 due this day. Being unable to 
pay the amount, Elliott offers Cline a note for thirty days in settlement 
of the account and Cline accepts the offer. State the contents of the 
note which Elliott will give Cline. 

9. Give the entry which Cline will make when he receives the note of 
Elliott. ( 

10. What are the distinguishing features of 
a) A bank draft ? 
h) A commercial draft ? 

c) A cashier's check ? 

d) An express money order ? 

Are these different forms interchangeable as regards their use ? 
Explain. 



- m.'iui—-^.- -.r-ti^mm^imHSJimtm^ 



172 



PRINCIPLES OF ACCOUNTING 



REFERENCES FOR FURTHER STUDY 

Kester, Roy B., Accounting Theory and Practice, Vol. I, chaps, xxiii and 
xxiv. 

MouLTON, H. G., Financial Organization of Society, chap. xii. 

LABORATORY EXERCISE NO. Sl-<:ontinued 

March 20. Issues checks to the following: 

F. M. Jones, $1 80.00 in payment of invoice of March 10. 
Carl Hamlet, $1 20.00 in pa)rment of invoice of March 10. 
21. Receives from A. L. Anderson $250.00 in payment of 
invoice of March 11. 

Pays Missouri Pacific Railroad Company $60.00 in pay- 
ment of freight on merchandise sent over their roads since 
March i. 

23. Pays hire of sales clerks as foUows: 

Harry James, $15.00. 

David Swanson, $12.00. 

J. B. Hall, $14.00. 
Purchases from Chicago Real Estate Company a lot and 
building at 200 South State Street, where the business is 
now conducted, for $5,000.00 cash. The building is valued 
at $3,000.00 and the lot at $2,000.00. You are allowed 
$25.00 for unexpired rent. Give check for the balance. 

24. Pays Ralph McCoy $350.00 in payment of invoice of 
March 4 Pays Wabash Raihroad Company $60.00 in pay- 
ment of freight on merchandise received over that road. 

26. Sells as follows: 

H. L. Dickerson, cash, merchandise, $240.00. 
E. N. Atkins, n/io, merchandise, $750.00. 
J. B. Foreman, n/15, merchandise, $930.00. 

27. Mr. Taylor gives $20.00 of merchandise to the Salvation 
Army. 

28. Gives a thirty-day note for $650.00 to Ralph McCoy 
in payment of invoice of March 18. 

Pays W. T. Dickens $700.00 in payment of invoice of 
March 18. 

• 

Pays F. M. Jones $340.00 in payment of invoice of March 18 . 

29. Purchases as follows: 

Charles A. Hines, n/io, merchandise, $1,010.00. 
Mandel Brothers, n/15, merchandise, $2,210.00. 



BUSINESS VOUCHERS AND FORMS 



173 



30. Pays A. B. Copeland $450.00 in payment of mvoice of 
March 10. 

Sells M. J. Torr for cash, merchandise, $500.00. 
Sells I. M. Allen, n/30, merchandise, $1,480.00. 

31. Receives twenty-day note for $300.00 from M. M. McGee in 
payment of invoice of March 11. 

Pays petty expense, $30.00. 
Note.— This exercise is completed at the end of the next chapter. 



CHAPTER XV 
BUSINESS VOUCHERS AND FOmAS-^oncluded 

Indorsement of negotiable instruments. Since the present discus- 
sion has to do with negotiable instruments, whose distinguishing 
characteristic, as indicated by the name, is their abiUty to pass readily 
from hand to hand and thereby serve to facilitate the transfer of 
goods, some consideration of the method by which such instruments 
are to be transferred is appropriate. A legal transfer of a negotiable 
instrument may be made by means of an indorsement and delivery 
of the instrument, or, in the case of an instrument made payable to 
bearer, by delivery alone. The indorsement is made by the payee or 
the holder of the note. It transfers the legal title in the instrument 
to the one to whom it is indorsed and delivered. It has also the legal 
effect of a guaranty on the part of the indorser that the instrument is 
genuine and valid and that he has legal title to it. The indorsement 
also usually enables the subsequent holder to hold the indorser for the 
payment of the instrument at maturity, in case the one primarily 
responsible for such payment should default. In order to so hold the 
indorser, certJEiin legal requirements concerning notice must be satisfied 
by the holder. It is not possible to discuss here all the legal questions 
involved in the mdorsement of negotiable instruments. It is possible, 
however, to point out certain legal consequences of the more common 
forms of indorsement. 

The forms of indorsement which are generally used are as 
follows: 

I. Indorsement in blank. An indorsement in blank consists of the 
name of the payee or holder, written in the customary place on 
the back of the instrument, without any other writing. It has the 
effect of making the instrument payable to bearer, and it may be 
legally transferred by any subsequent holder, without any further 
indorsement. As a matter of fact, however, it is usual for each 
holder to be required to mdorse the instrument, both for purposes of 

174 



BUSINESS VOUCHERS AND FORMS 



175 



identification and to add his guaranty to that of the previous indorsers. 
An indorsement in blank appears as follows: 



Fred S. Lane 



2. Indorsement in full. This type of indorsement consists of the 
words "Pay to the order of," written above the name of the party to 
whom the instriunent is to be transferred, with the signature of the 
indorser appended. This has the effect of making it necessary for the 
party to whom it is thus transferred to indorse it again in order to 
transfer the legal title to any subsequent holder. Where negotiable 
papers are to be sent through the mail, or are to be held for some time 
by the person to whom they are transferred, this type of indorsement 
is desirable, since it serves as a protection against any improper use 
being made of the instrument in case it falls into the possession of 
someone other than the legal holder. An indorsement in full takes 
the following form: 



Pay to the order of 

W. A. Peterson 

Henry Wilson 



3. Restrictive indorsement. A restrictive indorsement is one which 
transfers the title but restricts the use of the instrument. Checks 
and other negotiable instruments sent to the bank for deposit should 
be safeguarded by including in the indorsement the words "For 
Deposit." This prevents their use for any other purpose, as it serves 
notice on anyone to whom they might be transferred, and prevents 
such subsequent transferee from acquiring a legal title. Many business 
concerns use a rubber stamp with the form of this type of indorsement, 

bearing the words " Pay to the order of Bank, for deposits," 

to which is added the signature of the depositor. The form in which 
such indorsement appears is as follows: 



Pay to the order of 

The University State Bank 

For Deposit 

H. L. Murray 



p 



1 



m 



■■% 




'1.1 ,. 



5 



I 



176 



PRINCIPLES OF ACCOUNTING 



4. Qualified indorsement. A qualified indorsement is one which 
transfers the title to the instrument, but does not guarantee its pay- 
ment. This indorsement is accomplished by adding the words 
" Without Recourse." When an instrument is so indorsed the indorsee 
cannot recover from the indorser if the maker of the instrument fails 
to pay it. The form of such an indorsement is as follows: - 



Pay to the order of 

The Kenwood Trust Company 

Without Recourse 

Thos. H. SHERroAN 



The proper position of the indorsement on a negotiable instrument 
is on the back of the instrument, written across the left-hand end of the 
paper, as in the above illustrations. 

Sometimes partial payments are made on negotiable instruments, 
such as promissory notes and time drafts. In such a case, it is cus- 
tomary for the holder to record such payments on the back of the 
instrument by writing the date and the amount of the payment. 
No signature should be attached to such a memorandum on the back 
of the instrument, since such signature might be interpreted as an 
indorsement and open the way to an improper use of the paper by 
anyone who might get possession of it. 

A negotiable instrument should be signed or indorsed by the 
party or parties who assume the responsibility indicated by such 
signature or indorsement, or by a duly authorized agent. In a part- 
nership known as a "trading" partnership, as distinguished from 
partnerships of professional men, each partner has the power to sign 
negotiable instruments and to bind the firm by his action, provided 
such instruments are given in connection with the regular conduct of 
the partnership business. In a corporation the by-laws specify who 
shall be authorized to sign such instruments. In the case of a nego- 
tiable instrument bearing the signature of a partnership or a corpora- 
tion, not only the signature of the firm appears but also that of the 
duly authorized agent who signs the firm name. 

Miscellaneous business forms. Besides the special class of nego- 
tiable vouchers discussed above, and the vouchers used in connection 
with the purchase and sale of merchandise, there are a great number 



BUSINESS VOUCHERS AND FORMS 



177 



of other forms which may arise in connection with business trans- 
actions. It is neither practicable nor useful to attempt to name or 
discuss all of these forms at this point, but certain of the more common 
ones may be briefly considered here. The more important of these 
forms, for present purposes, are as follows: 

1. The statement of account ; 

2. The receipt 

3. The bill of lading 

4. Forms used in connection with banking transactions: 

a) The deposit ticket 

b) The signature card 

c) The pass book 

d) The bank statement 

e) The check book 

The statement of account. It has already been explained that 
when goods are sold an invoice or sales ticket is dehvered to the 
customer, giving the essential facts with regard to the sale, including 
the quantities of the goods, the prices, the total amount, and the 
terms of sale. In the case of goods sold at wholesale each invoice is 
payable at a certain date, and the customer is supposed to remit on 
or before that date without any reminder from the creditor. How- 
ever, such reminders are in fact frequently necessary, and usually 
take the form of letters requesting a remittance. If several invoices 
are due and unpaid at any one time, the creditor may send a statement 
of the amounts of such invoices and the total due to date. The send- 
ing of statements of account, however, is not a usual practice among 
wholesale businesses. 

Retail sales made on credit are usually understood to be on 
monthly account, unless otherwise specified, and since the customer 
cannot be reasonably expected to keep a record of his exact indebted- 
ness and remit when the amount is due, it is customary for retail 
establishments to send each customer a summary of his account at the 
beginning of each month. This serves the double purpose of a con- 
venience to the customer and of facilitating and hastening collections. 
Such a summary is known as a "statement of account." An illus- 
tration of the form of statement of account which is typical of the 
larger retail businesses is shown on page 178. 



178 



PRINCIPLES OF ACCOUNTING 



To avoid delays address all correspondence direct to MANDEL 
BROTHERS, State to Wabash at Madison Street 
Bought of 

MANDEL BROTHERS 
CHICAGO 



W. S. SCHULER 

912 E S3d St. 

Chicago, HI. 
Please detach and return this 
coupon with your remittance 



May 1, 1920 



Folio. 



7/3245 



.AmounL 



Bought of MANDEL BROTHERS, Chicago 



Payable first to tenth of month following that of purchase 





March 






April 




8251 


5 


I pr. low shoes 


8762 


IS 


2 shirts 


923s 


aa 


I hat 


9568 


aa 


4 pr. hose 


9568 


as 


2 pr. hose returned 


9783 


as 


I dress tie 



I4.2S 

•7S 
.7$ 



Total 
Less credits 



$16.28 

XI. 10 
8.50 

10.50 
300 

1. 00 

$50.38 
1.50 

$48.88 



$1.50 



Paid. 



19^ 



Check No- 



Amount- 



The top part of this statement, which is perforated for detachment 
from the lower part, is really another kind of voucher. It is a 
remittance slip, intended to be detached and returned with the remit- 
tance, and is used by the seUing concern as a voucher for the recording' 
of cash received from customers in payment of their accounts. The 
use of this form will be discussed in a later chapter. 

The receipt. A receipt is a written acknowledgment given by 
the party receiving money in discharge of an obUgation to the one 
making such payment. In the past this form was much in use, but 
in modem business practice it is almost obsolete. Where payments are 



BUSINESS VOUCHERS AND FORMS 



179 



made by check, as is the general practice, the canceled check from the 
bank, bearing the indorsement of the creditor, usually serves well 
enough as a receipt. Or the bill or statement may be receipted by 
stamping on its face some such form as the following: 



Received Payment 
June 3, 1920 
Central Supply Co. 
Per 



Most modern business concerns do not return to the customer 
any form of receipt other than that of the canceled check which he 
eventually receives from the bank, bearing the creditor's indorsement. 
If the customer desires a receipt which can be identified with the 
particular invoice or invoices covered by the check, he can secure this 
by having a form printed on the check for the entry of the numbers of 
the invoice covered, or of any other information of similar type. 

The hill of lading. In connection with the work of marketing 
(buying and selling goods), one very important function which must 
be performed is that of transportation. This involves dealings with 
railroad companies and other transportation agencies. When goods 
are turned over to a railroad company for shipment the shipper 
receives from the railroad company an instrument which constitutes 
evidence of the contract entered into between the two parties, and 
also serves the shipper as a receipt for the deUvery of the goods to the 
carrier. This rather formal document is known as a hill of lading. 
It sets forth the provisions of the contract under which the carrier 
accepts the goods for shipment, defines the carrier's Uabilities, and 
states the duties of the shipper in connection with such shipment. 
The form of the bill of lading is a standard one, being prescribed for 
the use of all the roads doing interstate business by the Interstate 
Commerce Commission. In case the shipper wishes to halve the bills 
of lading used in shipping his goods printed on his own form for 
convenience in filing he is permitted to do so, provided the form used 
conforms to the requirenients of the standard form. 

There are two forms of the bill of lading. The one more conmionly 
used is known as the straight bill of lading. In this form the goods 
are consigned to the party who is eventually to receive them, and the 



i8o 



PRINCIPLES OF ACCOUNTING 



^1: 



II 



bill of lading is not negotiable. This form is used where satisfactory 
credit relations exist between the shipper and the party to whom the 
goods are shipped, and no conditions are intended to be attached to 
the receipt of the goods by the latter. The other form is known 
as the order bill of lading, and is negotiable. In the use of this form, 
the goods are consigned to the shipper or some agent of the shipper, 
and the purchaser cannot get the goods until he has the bill of lading. 
This enables the shipper to withhold actual delivery of the goods 
until the purchaser has satisfied the shipper's conditions with respect 
to payment for the goods. The use of this method of shipment will 
be discussed more fully in chapter xvii. 

The bill of lading is usually made out in triplicate. The original 
is signed by both the shipper and the agent of the carrier, and serves 
the shipper as evidence of his contract with the transportation com- 
pany, and as a receipt for the delivery of the goods to the company. 
This copy must be preserved for use in case of any claims for damages 
which are later made by the shipper. The second copy is known as 
the shipping order, and is signed only by the shipper. It is retained 
by the raikoad as evidence of its authorization to ship the goods. 
The third copy is a duplicate of the first, being signed by both parties, 
and given to the shipper as a duplicate receipt. It may be sent with 
the invoice to the consignee. In some cities where a central traflSc 
association is maintained by the business men of the city, a fourth 
copy is made for filing in the oflSces of this organization. 

Forms used in connection with transactions with the hank. It has 
ab-eady been indicated that it is customary for business men to 
deposit all cash (including checks and other bankable paper) received 
with some bank, and to discharge their obligations by giving the 
creditor a check against the bank. This practice is ahnost universal 
in modern business. The receiver of the check deposits it with his 
own bank, which credits his account with the amount, and then 
collects from the bank on which the check is drawn. In case both 
deal with the same bank, the bank merely subtracts the amount of 
the check from the account of the drawer, and adds it to the account 
of the one depositing the check. Some of the forms in common use 
in connection with banking transactions of this character are: (i) the 
deposit ticket; (2) the signature card; (3) the pass book; (4) the bank 
statement; (5) the check book. 



BUSINESS VOUCHERS AND FORMS 



181 



The deposit ticket. When a depositor makes a deposit with his 
bank, he fills out a form supplied by the bank, known as a deposit 
ticket. This form provides for a record of the name of the depositor, 
the date, the total amount of currency, gold, and silver deposited, and 
for a classification of the checks deposited. A form of such a deposit 
ticket is shown below: 



FIRST NATIONAL BANK 

Credit Account of 

Wm. J. Conway 


May s, 1920 


Checks on Other Banks 


Checks on This Bank 


Cont. and Com. $125 


00 

25 

75 






$212 


80 

80 

75 
00 

65 


Drovers Nat'l. 65 








Com Exchange 236 








Total 426 














« 




Total Checks on 


212 




Total Checks on 

Other Banks 


4^6 




Currency 

Gold 

Silver 

ToUl 

Less Exchange 


. 


ids 








S3 




861 


20 
24 










860 


96 





If the deposit to be made is large in amount, and in various forms, 
the following suggestions may be worth while: (i) If a considerable 
number of coins are to be deposited, they should be wrapped in con- 
venient amounts in coin wrappers provided by the bank. (2) Paper 



l82 



PRINCIPLES OF ACCOUNTING 



money should be arranged in the order of its denomination, with the 
smallest bills on top. (3) Checks should be arranged in the order in 
which they are listed on the deposit ticket. (4) Each check should 
be properly indorsed. (5) The items should be totaled and the total 
entered in the space provided. 

The signature card used for idetUification of depositor's signature. 
The signature card is merely a card kept in the records of the bank 
by means of which the signature of the depositor may be identified 
at any time. The depositor is required to fill out such a card at the 
time he opens his account with the bank. If at any time the depositor 
desires to change the signature that is to be honored on checks against 
his account, a record of this change must be given the bank. 

The pass book. When the depositor opens his account with the 
bank and makes his first deposit, he is given a book known as a pass 
book in which a record is made of each deposit. Whenever he makes 
a deposit he is supposed to bring this pass book and present it to the 
teller along with the deposit slip. The teller retains the deposit slip 
as a basis for the bank's record of the transaction, and enters the 
amount of the deposit in the pass book to serve as the depositor's 
record of the transaction. Formerly it was customary for the deposi- 
tor to leave his pass book at the bank once a month, when the amount 
of his withdrawals, as evidenced by his canceled checks returned, was 
entered in the book, being subtracted from the amount of the balance 
at the beginning plus the total deposits for the month to give his 
balance at the end of the month. This practice is no longer generally 
followed. Most of the banks now present monthly statements of the 
depositor's account in place of the balanced pass book. These 
statements are made up by the use of a bank posting machine which 
saves labor and adds to the accuracy of the computations. 

The bank statement. The statement rendered by a bank to each 
of its customers at the end of the month is not unlike that sent out 
by a large retail establishment, except that it shows a balance due the 
customer frcm the bank instead of a balance due the store from the 
customer. Some banks use what is known as the envelope form of 
statement, which means simply that the statement is made out on the 
back of an envelope, in which the canceled checks are inclosed. A 
form of bank statement, such as is used by the more up-to-date banks, 
is illustrated on page 183. 



BUSINESS VOUCHERS AND FORMS 



183 



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aaaaaa.ai a a a, a. a a, a a. 



i84 



PRINCIPLES OF ACCOUNTING 



The check. Considerable attention has been given in the preceding 
pages to the nature, form, and use of the check. Checks are ordi- 
narily issued from a bound book, which contains stubs for entering 
the details of each check issued. The check and the stub should be 
filled out at the same time, both bearing the same serial number. 
The check is then torn ofiF at the perforation and issued, while the stub 
is kept in the book as a record of the issued check. If accounts are 
carried with more than one bank, a different check book will be used 
for each bank. The stubs in the check book frequently serve as a 
basis for the entry in the cash book of cash disbursements and as 
vouchers for such disbursements. 

QUESTIONS FOR CLASS DISCUSSION 

1. Of what importance to the busmess man is a knowledge of the legal 
effect of the various methods of indorsement ? 

2. Do you consider it justifiable to devote space in an accounting text to 
a discussion of forms used m connection with banking operations? 
Why, or why not ? 

3. What purposes may be served by a statement of account like the one 
illustrated on page 178? What method or methods might be employed 
in preparing such a statement ? 

4. What is "two-name paper"? Is it necessarily more acceptable to a 
bank than "one-name paper " ? Discuss. 

5. The Columbia Phonograph Company, of New York, sells a large order 
of goods to the Jones Music Company, of Chicago. The selling com- 
pany is doubtful of the purchaser's credit, and stipulates that the 
Chicago office of the seller shall collect for the merchandise before it is 
delivered to the purchaser. At the same tune this order is shipped, 
a consignment of goods is shipped to the Chicago branch of the Colum- 
bia Phonograph Company for display purposes. What method of 
shipment would you recommend for each lot of goods ? Explain your 
answer. 

6. What is the importance of the bank statement to the accountant? 
What uses can he make of this statement ? 

7. What is the purpose of the deposit ticket ? Who makes it out ? Is the 
deposit ticket a voucher ? Explain. 

8. You transfer the check of a customer to a creditor. The latter presents 
it to the bank upon which it is drawn, and payment is refused because 
the maker has not sufficient funds on deposit. In what way will this 
affect you ? 



BUSINESS VOUCHERS AND FORMS 



185 



9. On June 30 your bank statement shows a balance to your credit of 
$1,500.00. Your records show that your bank balance is $1,150.00. 
Explain. 

REFERENCES FOR FURTHER STUDY 

Kester, Roy B., Accounting Theory and Practice, Vol. I, chap. xxiv. 
MouLTON, H. G., Financial Organization of Society y chap. xii. 

LABORATORY EXERCISE NO. ^l— Concluded 
Instructions: 

In charging the salaries of clerks, the salary of Harry James is to be 
considered an administrative expense and the salaries of all others are to be 
considered a selling expense. 

Post all transactions to the ledger and take a trial balance. 

Make a statement of profit and loss and the balance sheet, taking into 
consideration the following points: 

a) Inventory of merchandise, $2,900.00. 

h) Depreciation of buildings, i per cent. 

c) Depreciation on office furniture, 2 per cent. 

Make the journal entries necessary to give affect to the adjustments 
stated above and post these entries. 

Close ledger by means of journal entries, rule up all books of original 
entry. 



W ' 



CHAPTER XVI 
THE ACCOUNTING PROCESS 

Purpose of the chapter. In the preceding chapters it was intended 
to present in the simplest possible manner the various steps or 
processes necessary in gathering, recording, summarizing, and inter- 
preting the data of business operations from the point of view of mak- 
ing such data available for the use of the business manager in planning 
and controlling the future operations. Notwithstanding the effort 
to simplify this presentation, it has run through a considerable number 
of pages and has involved a considerable amount of detail. It is expe- 
dient, therefore, to give a brief summary of the various steps thus far 
outlined. 

A ccounting reports. Throughout the discussion it has been empha- 
sized that the aim of the accounting process is to make available 
the information needed for reports to the management, and to have 
this information classified in such a manner as to make these reports 
as useful as possible. By the "management," as the term is here 
used, is meant the owners of the business or the persons to whom these 
Owners have delegated their managerial authority. It is, accordingly, 
to the owners or their representatives that the accounting reports are 
to be submitted, and it is to their peculiar needs that the presentation 
of the data should be adapted. It must be remembered that the 
typical owner or manager is not a man trained in the technicalities 
of accounting. The reports must therefore be freed from such 
technicalities in so far as this is possible, while presenting the 
information which will be of the most use to the manager in 
question. It is quite evident that the nature of such information 
will vary with the nature of the business enterprise and with its 
internal organization. This means that the information needed as an 
aid to the management of a retail clothing store would be of a different 
nature and would be classified on a different basis from that needed by 
the management of a shoe factory. It means also that the infor- 
mation which should be presented for the use of the management of a 

i86 



THE ACCOUNTING PROCESS 



187 



small clothing store, with all the buying and the entire administration 
of the shop in the hands of a single man, would be quite different in 
the amount of detail and in the classification of the items from that 
needed for the use of the management of a large retail clothing estab- 
lishment with several departments and a manager in charge of each 
department. 

In both cases, however, the need for reports of some kind unmis- 
takably exists. The reports for the manager of the small retail store 
might be prepared by himself, and might be very simple indeed. 
The big clothing store might maintain a considerable staff and a 
complex accounting system for the purpose of gathering the infor- 
mation, and might require several kinds of reports, each classifying 
the information on a different basis and for a different purpose. In 
each case, however, some kind of reporting is necessary, and the 
accounting system and records must be designed with the aim of 
gathering and classifying the business data in such a way as to make 
this rep>orting possible. In designing these records for any given 
business, therefore, one should first determine what use is to be made 
of the data and then set up the records which will best perform their 
function of furnishing the information needed in preparing each of the 
reports needed. 

There is almost no limit to the number of reports which may be 
useful in a large business with a number of subordinate managers. 
There are, however, two reports which are used in every kind of 
business. These two reports, which furnish certain information 
about the business as a whole, will be considered for the present as 
typical of all accounting reports. They are: (i) the balance sheet , 
which shows the amount and nature of the assets, liabilities, and 
proprietorship of the business as they appear at a stated time; (2) the 
statement of profit and loss^ which gives the amount and nature of the 
income and expenses of the business for a stated period, and 
the difference between the two — the net profit or loss for the period. 

In the preceding chapters these two reports have been used to 
illustrate the function of reports as a whole, and to bring out the rela- 
tionship between the reports and the whole accounting process 
necessary for their preparation. They have been used for this purpose 
because they are the most generally used of all accounting reports, 
and because they serve better than any other forms to illustrate the 



i88 



PRINCIPLES OF ACCOUNTING 



relationship between the reports and the accounting process as a 
whole. If the student succeeds in understanding thoroughly the 
function of these rep>orts and their relationship to the accounting 
process, it should not be very difficult for him to understand the other 
forms which he will need to use in his later work. 

The accounts. It was explained in the preceding chapters that the 
accounting reports are prepared from the information furnished by 
the accounts. It follows that the number and nature of the accounts 
to be kept will be determined by the information which is to appear in 
the reports. For each item of information which is to be shown on 
any accounting report there must be maintained an account. This 
rule has certain exceptions in those items on the reports which are 
obtained by combining other items. Examples of such items are 
"gross profit on sales" and "total current assets." The accounts 
are so constructed as to reflect the effect of every business transaction 
on the financial condition of the business. The nature of the item 
whose status is reflected by the account is indicated by the account 
title. In order that the information presented by the accounting 
reports shall be intelligible and free from ambiguity, the account 
titles should be very carefully chosen to represent in each case exactly 
the nature of the item in question. The primary function of the 
account is to classify and keep a record of the information desired for 
the accounting reports. No attempt should be made, therefore, to 
prepare a list of accounts to be used by any business until the nature 
of the reports needed by that business and the information to be shown 
by each such report have been determined. It is for this reason that, 
in the discussion of the accounting process in the preceding chapters, 
the reports were considered first. 

The hooks of original entry. It has been shown that every business 
transaction affects certain of the accounts, and that this effect must 
be recorded in every account so affected. But for various reasons 
previously explained it is not desirable that the entries for the trans- 
actions should be made directly to the accounts themselves. In- 
stead, a record of each transaction, showing all the accounts affected 
and the manner in which they are affected, is made in one of the books 
of original entry, from which the information is later "posted" to the 
proper accounts. The number of such books of original entry and 
the nature of each should be determined by the number of types of 



THE ACCOUNTING PROCESS 



189 



transactions occurring in the business, the importance of each type, 
and the classification which is desired of each kind of transaction. 
Whenever a given type of transaction becomes frequent enough to 
assume importance, a special book of original entry should be provided 
for recording such transactions. All transactions for which no such 
special journal is provided will be entered in the general journal. 
Each book of original entry aside from the general journal, should be 
designed to provide a summary of all transactions of a certain kind. 

In the ordinary mercantile business the transactions which occur 
most frequently are those involving cash receipts, cash disbursements, 
merchandise purchases, and merchandise sales. For this reason the 
special journals that have been discussed in the preceding chapters 
for purposes of illustration are the cash receipts journal and cash 
disbursements journal,. which together compose the cash book or 
cash journal, the purchases journal, and the sales journal. It should 
be remembered that any special form of book of original entry is a 
journal, and any entry made in such a book involves debits and 
credits of equal amount. In making an entry in a book of original 
entry, therefore, the transaction should first be mentally "journal- 
ized." That is to say, the transaction should be analyzed with regard 
to its effect on the accounts and ultimately on the reports before it is 
entered in a book which serves as a basis of posting to the accounts. 

Business vouchers and forms. The information which serves as a 
basis for entering a transaction in the proper book of original entry is 
usually furnished by some form of voucher arising out of the trans- 
action itself. As previously pointed out, such vouchers serve not 
only as evidence of the transactions giving rise to them, and as a 
basis of entering these transactions in the books of original entry, 
but also in many cases as a means of facilitating the transaction. 
There are certain types of vouchers which serve only the latter pur- 
pose. One very important class of vouchers is composed of the papers 
arising out of transactions involved in the purchase or sale of mer- 
chandise. Another important class is composed of those papers 
which serve as a means of discharging obligation between various 
individuals and firms. This class has certain peculiar features which 
are recognized by the courts and embodied in the statute law of a 
number of states, and papers of this class are known as negotiable 
instruments. The classification under which vouchers in general are 



\\ 



ri^ 




IhR 



190 



PRINCIPLES OF ACCOUNTING 



considered in a previous chapter may be repeated here, as follows: 
(i) vouchers used in connection with the purchase and sale of mer- 
chandise; (2) negotiable instruments, or negotiable vouchers; (3) 
miscellaneous vouchers and forms. 

The accounting process. The steps outlined in the foregoing dis- 
cussion form a regular sequence, which may be called the accounting 
process. This process begins with the performance of the trans- 
action itself and ends in showing in the reports of the business the 
effect of the transactions recorded. The steps in this sequence, in the 
order in which they actually occur, may be indicated as follows: 
transactions — ^vouchers — ^books of original entry — accounts — reports. 
Each step of this process has been described somewhere in the pre- 
ceding pages. The transactions which are performed in carrying on 
the business operations give rise to various types of vouchers which 
serve as evidences of these transactions, and as a basis of entering 
them. From these vouchers a record of each transaction is made in 
the appropriate journal, or book of original entry: Each of these books 
of original entry, with the exception of the general journal, is designed 
for the recording of one particular class of transactions, and provides 
for a sunmiary of all the transactions of that class. After the trans- 
actions have been entered in the various journals, they are posted 
from the books of original entry to the ctccounts in the ledger, and at 
the end of the period a sunmiary is made of the accounts, and the 
information thus obtained is used in the preparation of the reports. 
This summarizes the accounting process of all businesses which have 
an accounting system, though the process will, of course, vary in the 
amount of its detail and in the complexity of the routine to be followed. 
It is not to be supposed that the forms of the vouchers, books of 
original entry, and reports given in the preceding chapters for pur- 
poses of illustration represent standardized forms applicable in all 
businesses. They are intended only to be suggestive and to illustrate 
in a simple way the fundamental principles involved in the use of such 
forms. These fundamental principles, which were applied in working 
out the illustrations given in the first part of the course, will be found 
to apply, with few exceptions, to any sort of accounting system that 
may be under consideration. 

The order which has just been indicated as the order in which the 
steps of the accounting process actually occur is not the order in which 



THE ACCOUNTING PROCESS 



191 



they have been discussed in the preceding chapters, as the student 
will readily recall. The steps have been taken up for discussion in 
exactly the reverse order to that in which they take place. 

The reason for following this reverse order has been explained 
more than once. It is that the type of information and the classi- 
fication of this information which is desired in the reports determines 
for the most part the number and the nature of the accounts. The 
information which is desired in the accounts and the classification 
to be made of that information in turn determine largely the number 
and form of the books of original entry. The information to be 
recorded in the books of original entry influences to a considerable 
degree the information which will need to be provided by the vouchers 
concerning the original transactions. Thus by following the order 
that has been followed in the consideration of the accounting process 
in the earlier chapters, it is possible to see and understand the factors 
which affect each of the steps in the accounting process, before pro- 
ceeding to a consideration of that step itself. 

Importance of the accounting process. The student need not hope to 
be able to familiarize himself with all the various accounting systems 
and forms employed by business concerns. It would be impossible to 
do this during a college course, and probably even during a lifetime. 
And if such a thing were possible, it would scarcely be a valuable 
form of knowledge. If the student has a working knowledge of the 
nature and function of the accounting process, he should experience 
little difficulty in understanding the special forms and records 
employed by any business as a part of its accounting system. Also, 
he should be able readily to interpret any special forms of reports 
that may come before him in case his work lies outside the 
accounting department. 

QUESTIONS FOR CLASS DISCUSSION 

1. Explain and illustrate the relation of accounting to business 
management. 

2. What is the purpose of an accounting report ? 

3. What are the two reports which are most frequently used by business 
men ? Discuss, the uses which may be made of the information pre- 
sented in each of these reports. 

4. How are the assets and liabilities of a business classified on the balance 
sheet ? Give the significance of this classification. 



192 



PRINCIPLES OF ACCOUNTING 



1! 





5. Give the points which you would regard as of most importance in 
determining the financial condition of a business from its balance sheet. 

6. What items have to be considered in arriving at the cost of goods sold ? 

7. How is the value of the inventory which appears on the balance sheet 
and the statement of profit and loss determined ? 

8. Explain and illustrate the difference between operating and non- 
operating expenses; operating and non-operating income. 

9. What determines the number and nature of the accounts kept by a 
business ? 

10. Explain the construction of accounts with fixed assets. 

11. What is meant by the "balance" of an account ? When an account is 
"in balance" how is this indicated? 

12. Explain how the number and nature of the expense accounts which a 
business maintains is determined. 

13. What is the purpose of the trial balance and how often should it be 
made ? 

14. What is the purpose of "adjusting" entries? Explain and illustrate 
how they are made. 

15. What is the purpose of the "closing" entries? Explain and illustrate 
how they are made. 

16. Why are entries first made in books of original entry instead of being 
entered directly in the accounts ? 

17. Give the principal books of original entry, the purpose of each and how 
each is posted. 

18. Explain and illustrate the purpose of a voucher. 

19. What are the requisites of a negotiable instrument ? Illustrate each. 

20. Explain and illustrate the ways in which a negotiable instrument may 
be indorsed. 

21. What is meant by the "accoimting process" ? Why is an understand- 
ing of this process important ? 



CHAPTER XVII 

BUSINESS PRACTICE AND PROCEDURE- 
PURCHASES AND SALES 

Purpose of the chapter, f n chapter xvi the successive steps of the 
accounting process were reviewed, and their relations to one another 
discussed. In the present chapter the business transaction and the 
nature of the routine involved in handling certain of the more common 
types of such transaction will be considered. This will involve a 
discussion of business practice and a further consideration of the use 
of business papers in handling some of these transactions. 

Methods of handling purchases. Under present business practice, 
there is no such thing as a standardized purchase routine. The rou- 
tine used varies with the nature of the business and is therefore 
usually different in wholesale, retail, and manufacturing businesses. 
Also, within any one of these three classes the purchase routine may 
be expected to vary somewhat with the size of the business, the 
nature of the goods handled, and more especially with the organiza- 
tion of the business. Thus the internal organization may be such that 
all the purchasing may be handled by the proprietor, by one of the 
partners, or by a single subordinate. Or a single purchasing depart- 
ment may be provided, headed by a purchasing manager who is in 
charge of all purchases. Or the business may be divided into 
departments, corresponding to a certain grouping of the commodities 
sold, and the head of each department, or someone under him, made 
responsible for the purchase of all merchandise to be sold in that 
department. With this last form of organization there would usually 
still be a purchasing department for the entire business, the head of 
this department being responsible for the purchase of supplies for the 
entire establishment. In addition, there may be an ojficial known as 
the merchandise manager, who exercises a general supervision over 
the work of all the departmental buyers. 

The single purchase manager, responsible for all purchases for the 
business and heading a special purchasing department, is usually to 

193 




ig4 



PRINCIPLES OF ACCOUNTING 



be found in a manufacturing business, while the departmental organi- 
zation, with each department head responsible for the merchandise 
purchases within his department, is characteristic of wholesale busi- 
nesses and the larger retail establishments. 

The purchase requisition. Where the organization provides for a 
general purchasing agent, he may make a large part of his purchases 



PURCHASE REQUISITION No._L£; 
Date ^"g-4 From W.H.S. 



Quantity SM- 



Artirlo h' Hexagonal Nuts 



Date required ^H- ^o 



Advise Mr. ^Jordan 



on delivery 



Required for Production Order No. 98 



Purchase Order No. 475 Date ^«g- 7 
Issued tn W. F. Hebard Co. 



Originated by H. G. M. 



Approved by L. C. M. 



according to a predetermined plan, drawn up by him after conference 
with others of the managerial staff, and representing his judgment of 
the ordinary needs of the business. Large purchases in advance of 
actual needs may sometimes be made by him when market conditions 
make it seem desirable to build up a reserve stock of certain articles. 
Still other purchases may be made at the request of other departments 



BUSINESS PRACTICE AND PROCEDURE 



195 



of the business, to fill special needs that will arise from time to time. 
An example of this is a purchase of steel castings required for the 
manufacture of a special order received by a manufacturing company. 
In cases where request is made of the purchasing agent for the pur- 
chase of any particular lot of material, such request usually follows 
a regular form, known as a purchase requisition. The essentials of 
a purchase requisition are indicated by the illustration shown 
on page 194. 

The purchase order. Regardless of the nature of the purchasing 
organization, or of the kind of goods that are to be purchased, there 
must always issue some sort of purchase order from the purchasing 
concern to the one from which the goods are purchased. And in 
a business establishment where any systematic attempt at record 
keeping is made, such an order will be in writing, or will be confirmed 
in writing, and at least one copy will be kept for the files of the pur- 
chasing concern. Ordinarily there will be a regular printed form for 
purchase orders, and this form will be filled out, with one or more 
carbon copies, each time an order is sent. In a small business with 
simple organization, it is sufficient to have the order made out in 
duplicate, the original sent to the seller, and the copy retained in the 
office. But in a large business, or one with a more elaborate organiza- 
tion, there may be, besides the original order, the following copies: 
(i) a copy to be retained by the purchasing department; (2) a copy 
to be sent to the department where the purchase requisition origi- 
nated; (3) a copy for the accounting department; (4) a copy for the 
receiving clerk (this copy is often left blank as to quantities, so that 
the quantities may be filled in upon receipt and count of the goods 
themselves) ; (5) a copy for the stores clerk or store keeper, so that 
he may known not only what goods are on hand but what are ordered 
and when delivery may be expected. 

The information furnished by the purchase order varies somewhat 
in different businesses, but the information usually considered essential 
is provided in the order blank illustrated on page 196. 

The form shown above is a simple one. For a more elaborate 
form the student is referred to the illustration of the sales order shown 
on page 198, since from the point of view of the purchasing concern 
that form represents a purchases order. 



196 



PRINCIPLES OF ACCOUNTING 



THE CENTRAL SUPPLY COMPANY 
INDIANAPOLIS 

Date 19 Req. No. Purch Ord. No. 
To Via 




Address n R 






Ship to 


> 






Shipment to be made 


Terms 


































] 




















« 




















" 




Signed 



The purchase invoice. The purchase invoice, which was discussed 
in chapter xiv, is usually received from the seller before the goods 
arrive. The form of such an invoice is shown on page 162. The 
invoice should be sent first to the purchasing department or to the 
member of the organization who is responsible for the purchase, and 
should there be checked to ascertain whether it agrees with the pur- 
chase order in quantities, prices, and terms. When the shipment of 
goods arrives, it should be checked to see if the quantity is correct, 
and the purchasing agent, department head, or other responsible 
individual should make sure, by tests if necessary, that the quality is 
satisfactory and according to the purchase agreement. In checking 
the quantity of goods received, the invoice may be used or the receiving 
department may make a separate report on quantities received, which 
is then compared with the invoice and with the purchase order. This 
report is often made by filling in the quantities on a copy of the pur- 
chase order from which the quantities have been omitted for that 
purpose. 



BUSINESS PRACTICE AND PROCEDURE 



197 



When the invoice has been verified in every essential respect, 
it goes to the accounting department, where the extensions are 
verified, and is then used as a basis for recording the purchase. If 
the amount of the invoice differs from what the purchaser considers 
the correct figure, it may be entered at the face of the invoice and a 
claim put in for an adjustment to bring about the necessary correct 
tions, or its entry may be postponed until the purchaser and seller 
have come to an agreement on the matter. ; 

Methods of handling sales — the sales order. The methods employed 
in making sales and in conducting the sales routine also vary quite 
widely with the nature of the particular business and with the manner 
of its internal organization. But whether the business is large or 
small, and whether sales are made at wholesale or at retail, the sales 
transaction always starts with the sales order. The sales order as it 
comes from the customer may be either written or oral. In a whole- 
sale business the order may come directly from the customer, by mail 
or by telegram, in written form. It may be given orally by the cus- 
tomer to a salesman, either at the. salesrooms of the selling concern 
or at the customer's place of business. Or it may be given by the 
customer over the telephone. In any case the procedure is usually 
to make out the order on a regular house form, drawn up in such a way 
as to facilitate the various steps involved in filling the order. Where 
the customer sends in a written order on his own form, this can be 
used by stamping on it a form providing for a check on each of the 
various steps. An illustration of a sales order, showing what informa- 
tion would usually be sought, is shown on page 198. 

The sales order in the wholesale estabUshment, once made out, 
ordinarily goes first to the credit department for approval. If 
approved there, it is usually Hsted in an order book or order register 
to avoid losing track of it. It may then be sent to the pricing depart- 
ment to have the prices entered, if this has not been done earlier. 
The next step is to send the order to the stock room, where the goods 
are set out, each item being checked on the order as it is selected. 
The order and the goods are then turned over to the shipping depart- 
ment, where the goods are packed, marked, and shipped, and the order 
is checked to indicate that the goods have been shipped. The order 
then goes back to the office. If an order register is kept, an entry will 
be made in it to show that the order has been shipped. The order is 



198 



PRINCIPLES OF ACCOUNTING 



fflBBARD, SPENCER, BARTLETT & CO. 

SUte Street Bridge 

CfflCAGO 



Estimate 
Order No. _ 



Date Sold 



Salesman 



No. 



Name 



P.O. 



(If different from 
destination) 



Destination 



SUte. 



Via 



R.R. 



O.K. 



Order 
Qerk 



Sent to 
Office 



Pricer 



Exam- 
iner 



Name 



Date 



Time 



This order is given as specified below, for shipment from __: 

about 19 — , invoice to date sixty days or 2 per 

cent discount for cash in ten days. The order is subject to approved credit 
at date of shipment. 

(Signed) 



Shipping 
Cneck 



Quantity 



Items 



List 
Price 



Net 
Price 



Extensions 



then used as a basis for making out the sales invoice, and either the 
order itself or a copy of the invoice is sent to the accounting depart- 
ment to serve as a basis of recording the sales transaction. This 
discussion of the use made of the sales order contemplates an order 
made out on a house form of the selling concern, with one or more 



BUSINESS PRACTICE AND PROCEDURE 



199 



copies. Where no copy of the order exists except the one sent by the 
purchaser, the invoice might be made out at once and a copy of the 
invoice used as a basis for the routine just described. 

The sales invoice. In a retail establishment orders may come in 
any form, but are typically given orally by the customer. The order 
is filled immediately, and the sales ticket is made, usually in duplicate. 
One of these copies goes to the customer and the other serves as a 
basis of analyzing and entering the sales transactions in the accounting 
department. In many of the larger establishments additional copies 
are used. 

In a wholesale business at least two copies of the sales invoice are 
filled out, and usually a greater number. Besides the original, which 
goes to the customer, other copies may be required as follows: 

1. A copy for the files of the accounting department, where it 
may be used for the following purposes: 

a) As a basis of entering the transaction 

b) To be filed ma" ticUer " file until paid 

c) To be kept for possible reference in an audit at the end of the 
account period 

d) To fumish»any information concerning sales not shown by 
the ledger accounts, which may be desired in the preparation 
of special reports, such as sales, estimates 

2. A copy for the "tickler" file kept on unpaid invoices by the 
credit department, assuming this to be separate from the accounting 
department. 

3. A copy for the sales manager, who may wish to obtain from the 
invoices some special information concerning sales, such as the apaount 
sold by each of his salesmen. 

4. A copy for the office of the treasurer, who may wish to use the 
sales tickets as a basis for estimating the funds that will be available 
from this source in the near future. 

Shipping or delivery of merchandise. It is apparent that a part of 
the process of filling a sales order consists in shipping or delivering the 
goods to the customer. In a retail store this may mean merely wrap- 
ping the goods and handing them to the customer at the time of the 
sale, or it may mean delivering the goods through the deUvery service 
of the store. Neither method involves any problems that need to be 
discussed in this chapter. 



200 



PRINCIPLES OF ACCOUNTING 



In a wholesale business, however, a large part of the sales are 
often made to customers outside the city, and practically all sales 
require arrangements for their delivery. Leaving out of consideration 
all city deliveries, which may be delivered by the concern's own 
trucks or contracted for with a transfer company, out-of-town deliv- 
eries may be made by freight, express, or parcels post. In shipping 
"^ goods by express the shipper receives from the carrier an express 
receipt. In shipping by freight he receives a bill of lading, the form 
of which has already been discussed. / 

In shipping by freight when credit matters have been satis- 
factorily arranged, the "straight" bill of lading is used, by which the 
goods are consigned direct to the purchaser, who is notified by the 
carrier as soon as the goods arrive and proceeds to get them without 
further ceremony. But where the seller is unwilling to relinquish the 
goods without receiving payment the shipment is made by an "order" 
bill of lading, in which the shipper or his agent is made the consignee. 
A draft is drawn by the shipper upon the purchaser, and this draft 
is attached to the bill of lading. The latter, with the attached draft, 
may then be forwarded to some agent of the shipper in the city to 
which the goods are shipped, or more usually deposited with the 
seller's home bank. The bank proceeds to forward the papers to its 
correspondent bank in the purchaser's city. In the meantime the 
purchaser will be given notice of the method of shipment and where the 
bill of lading pan be obtained. Only by paying the draft is he able 
to secure the bill of lading and so get the goods from the carrier. This 
method of shipment is known as shipment "by bill of lading with 
draft attached." 

QUESTIONS FOR CLASS DISCUSSION 

1. What persons should you expect to be responsible for purchases of 
merchandise, raw materials, or supplies in each of the following busi- 
nesses: 

a) A retail shoe store ? 

h) A wholesale hardware business ? 

c) An automobile factory ? 

d) A department store ? 

e) A mail order business ? 

2. What is a purchase requisition? What advantages are there in the 
use of such a requisition ? 



BUSINESS PRACTICE AND PROCEDURE 



20I 



3. In which of the businesses listed under Question i should you expect to 
find purchase requisitions in use ? For what type of purchases would 
requisitions be used in each case ? 

4. W. D. Allen & Company, a wholesale hardware business, order a ship- 
ment of cutlery from the William B. Simmons Company, of St. Louis. 
What items of information should the purchase order furnish ? What 
purpose does each such item of information serve ? 

5. How many copies of the purchase order do you think W. D. Allen & 
Company should have made ? What purpose would each copy serve ? 

6. When W. D. Allen & Company receive the purchase invoice for the 
goods ordered, what procedure should be followed before recording this 
invoice in the purchases journal ? 

7. What would be the nature of the sales orders received, and the sources 
from which such orders might be received, in each of the businesses 
listed in Question i ? 

8. When the William B. Simmons Company made out the invoice for the 
goods shipped to W. D. Allen & Company, how many copies do you 
think they should make ? What use might be made of each copy ? 

9. Suppose the Simmons Company were unwilling to sell to the Allen 
Company on credit. What method or methods of collection might 
they employ in order to protect themselves ? 

REFERENCES FOR FURTHER STUDY 

Greendlinger, Leo, Financial and Business Statements^ pp. 48-57- 
Jones, E. D., The Administration of Industrial Enterprises, chap. xvii. 



>» 



I! 



r^' ' 



CHAPTER XVIII 
BUSINESS PRACTICE AND PROCEDURE— Conc/wJerf 

Cash receipts. The procedure involved in handling the cash of a 
business, using the term "cash" in the accountmg sense, is of con- 
siderable importance, since a careless handling may ofiFer tempting 
opportunities for its misappropriation, with comparatively slight 
chances of detection. Taking up first the matter of cash receipts, 
it is apparent that cash is received from several sources and in 
several forms. Some sources of cash receipts are: (i) cash taken in 
direct payment for goods sold; (2) cash collected from customers on 
open account; (3) cash received in payment of notes and drafts; 
(4) cash from the sale of assets other than merchandise; (5) cash 
secured by short- time borrowing at the bank; (6) cash secured through 
long-time borrowing or the sale of securities. 

Some of the forms in which cash is received are as follows: 
(i) checks; (2) currency; (3) postal and express money orders; 
(4) stamps; (5) bank credits, arising from notes discounted, interest 
on bank balances, or collections deposited to the firm's account. 

All cash received, no matter what its form or source, should be 
recorded in two places: (i) m the cash book of the business and (2) on 
the record kept by the business of its relations with the bank. That 
is to say, all the cash receipts of any business should be deposited in 
the bank. Such deposit should be made, as far as is possible, on the 
day of receipt. The fact that a record of the firm's bank balance is 
kept by both the depositor and the bank acts as a check on the 
correctness of the records of cash transactions. 

In a retail establishment the two chief sources of cash receipts 
are cash sales and collections from customers on account. Receipts 
of cash from sales are verified by checking the actual cash received 
with the totals of the cash sales tickets, after which a record of such 
receipts is made in the cash book and the cash sent in for deposit. 
The second great source of receipts, remittances through the mail 
from customers, is also the chief source in a wholesale establishment. 



202 



BUSINESS PRACTICE AND PROCEDURE 



203 



In either a wholesale or a retail business of any considerable size, 
therefore, the manner in which the incoming mail is handled is of 
considerable importance. It is well to have one responsible person, 
preferably a member of the firm or an officer of the company, to take 
charge of all remittances so received. In the larger retail establish- 
ments it is usual for each check to be accompanied by a "remittance 
slip," which is sometimes the statement of account itself, but generally 
a coupon which accompanies the statement and which is detached 
and inclosed with the remittance. Such a remittance slip serves as a 
basis for recording in the cash journal the receipt of cash from the 
customer, and also, as will appear later, for posting to his account. 
After listing, either on an adding-machine tape or on a special form of 
memorandum blank, all checks or other forms of remittance, this 
adding-machine tape or other form of memorandum serving the same 
purpose is sent to the accounting department to be used in making 
the records. The checks and other forms of cash received are sent to 
the cashier to be taken care of and deposited. Some variation of this 
procedure is permissible, but it is not ordinarily desirable that the 
man who opens the mail, the one who records the receipts in the cash 
book, and the one who deposits the cash should be the same man, 
since such a situation offers too great an opportunity for the mis- 
appropriation of fimds. 

At the end of the month, as soon as the monthly -statement from 
the bank is available, it should be possible to check the cash receipts 
against the bank's record of deposits, and to establish an equality 
between the total receipts for the month and the total deposits. 
Amounts placed to the credit of the business on the books of the bank, 
arising from discounted notes, interest items, or collections, must 
also be recorded in the cash book as cash receipts, so that such items 
shall not disturb the equality between receipts and deposits. 

Cash disbursements. In the foregoing discussion of cash receipts 
it was pointed out that by depositing all cash received, a check on the 
correctness of the entries on the receipts side of the cash book is 
available in the monthly bank statement. An equally effective 
check can be maintained on the cash disbursements if every cash 
disbursement entered in the cash book is effected by means of a check. 
It is evident, however, that there are many cast disbursements of such 
a small amoimt that it would be inconvenient and in fact impracticable 



204 



PRINCIPLES OF ACCOUNTING 



111 



Kiarr 



t 



I 



to draw a check for each one of them. This difficulty can be avoided 
and the general cash-book record still kept in agreement with the bank 
statement by maintaining what is known as a petty cash fund. 

Petty cash funds. A petty cash fund is a sum taken out of general 
cash and set aside for the purpose of making small payments in 
currency. No matter how it is administered or what method is used 
in accounting for it, it will be originally established by drawing a 
check for the amount to be made available for this purpose. An entry 
will be made in the general cash book debiting petty cash and crediting 
cash for the amount of the check. From this pomt on there are two 
methods in common use for handling the fund. 

One of these methods is to carry an account in the ledger with 
petty cash which will reflect all the fluctuations in the amount of this 
fund. A petty cash journal would be used which would serve as a 
medium for posting to all the accounts affected by petty cash expen- 
ditures. Such a journal might assume the following form: 

PETTY CASH JOURNAL 





Expla- 
nation 


Petty 

Cash 

Dr. 


DlSBtTSSKMENTS 


Dati 


Adminis- 
trative 
Expenses 


Selling 
Expenses 


Sundry Accounts 


Petty 




Name 


Folio 


Amount 


Cash 
Cr. 










. 






- 





The petty cash account, when posted to date, would show the 
amount in the petty cash fund at the time. Every check drawn to 
reimburse the fund would be entered in the cash disbursements journal 
as a debit to petty cash and a credit to cash. 

The imprest system for petty cask. The other method, which is 
probably more generally used in large concerns, is known as the 
imprest system. When this system is employed, the petty cash book 
is not ordinarily used as a posting medium' but only as a subsidiary 



BUSINESS PRACTICE AND PROCEDURE 



205 



record. When the fund is depleted, the one in charge of the fund 
prepares a statement in which he lists the expenditures made since the 
last check was drawn to petty cash and classifies them according to 
the accounts to be debited. This statement, accompanied by some 
form of receipt or voucher for each of the expenditures, evidencing 
their bona fide nature, is submitted to the general cashier or disbursing 
officer. The latter then draws, or authorizes to be drawn, a check for 
the amount necessary to bring the fund up to the original sum. The 
entry in the general cash book is a debit to each of the accounts shown 
by the petty cash analysis to be chargeable, and a credit to cash. 
Thus the showing of the petty cash account in the ledger does not 
change, but remains always at the same figure. The debits to 
accounts affected by petty cash expenditures are made through the 
medium of the general cash book, and not through the petty cash 
book, as under the other method. 

Under this method the petty cash book, being only a subsidiary 
record, may assume whatever form is convenient under the circum- 
stances. A possible form for such a record is shown below: 

PETTY CASH BOOK 



Date 


Explanation 


Receipts 


Administra- 
tive Expenses 


Selling 
Expenses 


Miscel- 
laneous 


* 


• 








* 

• 



To illustrate this use of the petty cash fund it may be assumed 
that a fund is established, the amount of which is set at $100. A 
check is drawn for that amount, petty cash being debited and cash 
credited. The one in charge of the fund cashes the check and uses 
the currency for making small cash payments. Sooner or later the 
fund will be depleted and must be renewed. Assume that the amount 
remaining in the fund is $14.50, and that of the $85.50 which has been 
expended, $49.60 is chargeable to administrative expense and the 



:I1H 



tit 



206 



PRINCIPLES OF ACCOUNTING 



rest, $35.90, to selling expense. A statement wUl be handed to the 
cashier accounting for the entire amount spent and showing the amount 
chargeable to each account. He will accordingly draw a check for 
$85.50, debiting administrative expense with $49.60, selling expense 
with $35.90, and crediting cash with $85.50. 

It is desirable that such an adjustment should be made at the end of 
each accounting period, so that the total of expense for the period and of 
cash actually available at the end of the period may be correctly shown. 
Method of handling notes receivable and payable. In case the size 
or nature of the business is such that notes received are few in number, 
they may be recorded in the general journal and posted item by item 
from that book to the notes receivable account. If transactions in- 
volving notes receivable occur rather frequently, it may be desirable 
to introduce into the general journal an additional column headed 
"Notes Receivable, Dr." This will allow posting to the debit of this 
account to be made through the footing of this column, rather than 
by single items. If the business is such that notes receivable are 
handled with very great frequency, it becomes expedient to make 
use of a separate notes receivable journal in which to record them. 

The discussion of the special notes receivable journal will be 
deferred to a later point in the course. For the present it is assumed 
that all such transactions are recorded in the general journal. But 
the general journal, while it serves as a medium through which the 
information may be posted into the appropriate accounts, is not well 
adapted for recording and classifying all the information which should 
be kept with regard to notes receivable. Any such information desked 
may be obtained by consulting the notes themselves, but it is more 
convenient to use a form of supplementary record which may be called 
a notes receivable book^ or notes receivable register, 

A possible form of such a subsidiary record, indicating by its 
colunm headings the information for which it makes provision, is 
shown on page 207. 

What has been said with regard to the treatment of notes receiv- 
able appUes equally well to the treatment of notes payable. In only 
a few businesses, however, do notes payable occur with sufl&cient 
frequency to justify a special notes payable journal. As in the case 
of notes receivable, it is usually desirable to keep a record of significant 



BUSINESS PRACTICE AND PROCEDURE 



207 



details with regard to each note. This may be accomplished by means 
of a supplementary record of a nature similar to the one discussed 



NOTES RECEIVABLE REGISTER 



Date 


Number 

or 

Note 


Name OF 
Maker 

OR Ac- 
ceptor 


Face 
Va- 

lUE 


TnfE 
TO Ma- 
turity 


Inter- 
est 
Rate 


Amount 
AT Ma- 
turity 


Date 
OF Ma- 
turity 


Date 
OF Pay- 
ment 


Discounted 


Date 


By 


Amount 






: 




^ 




■ ■— ' 











4' 



imder notes receivable. Such a book would be called a notes payable 
book or notes payable register. A possible form of such a book, 
showing provision for recording the information which would usually 
be considered desirable, is shown below: 

NOTES PAYABLE REGISTER 



Date 


Number 

of 

Note 


Pa}ree 


Face 
Value 


Time 

to 

Maturity 


Interest 
Rate 


Amount 

at 
Maturity 


Date 

of 

Maturity 


Date 

of 

Pa3rment 


Check 
Number 


• 












• 









Use of the trade acceptance. Since the adoption of the Federal 
Reserve System as the basis of banking operations in the United 
States, a considerable amount of attention has been given to the use 
of the trade acceptance, and a strong effort has been made by the 
Federal Reserve Board to induce business men to make greater use 
of this form of credit. The trade acceptance is a special form of 



i 1 



208 



PRINCIPLES OF ACCOUNTING 



; 



Trade Acceptance 



AMIBICANTBAM AOOPTANa COONOL 

■miACiiio cwMnmi w tm 
>P £OMMERCB_PP THf JUNrnp ITAtIi 



A'nONOf CRI 




Trade Acceptance 



BUSINESS PRACTICE AND PROCEDURE 



209 



draft, really differing very little in its essentials from forms of drafts 
previously illustrated and discussed. It is defined by the Federal 
Reserve Board as "a bill of exchange drawn by the seller on the 
purchaser of goods sold, and accepted by such purchaser." 

The foregoing illustration shows the form of a trade acceptance 
which has been approved by the American Trade Acceptance Council. 
A comparison of this form with the form of accepted draft shown on 
page 167 will show that the two are essentially the same. The dis- 
tinguishing point in connection with the trade acceptance, and the 
one on which the Federal Reserve Board lays great emphasis, is that 
this form shows on its face that it has arisen out of an actual transfer 
of goods from the drawer of the draft to the acceptor, while the 
ordinary acceptance may arise out of any sort of indebtedness or 
may even represent a form of loan by the acceptor to the drawer. 
The fact that the trade acceptance is a form of credit instrument 
reflecting an actual transfer of goods is considered by the Federal 
Reserve Board to make it a more desirable form of commercial paper 
and consequently more readily eligible to rediscount by Federal 
Reserve banks. As a matter of fact, little if any at£ention seems to 
be paid this feature by the banks. The eligibiUty of any piece of 
commercial paper for discount or rediscount depends mainly on the 
general reputation of the firms responsible for its payment, and on their 
financial soundness as reflected in their accounting reports. 

An illustration will show how the trade acceptance may be used. 
Hibbard, Spencer, Bartlett & Company, of Chicago, sell the Central 
Supply Company, of Indianapolis, merchandise to the amount of 
$4,000. The terms of the sale are net thirty days, with an agreement 
on the part of the Central Supply Company to accept a thirty-day 
draft. Hibbard, Spencer, Bartlett & Company proceed to draw upon 
them at thirty days, using the trade acceptance form of draft. They 
send this draft to the Central Supply Company, who accept and return 
it. Hibbard, Spencer, Bartlett & Company may retain the draft and 
collect the amount of its face at maturity, or they may discount it 
at their bank. In case it is discounted, the Chicago bank will credit 
Hibbard, Spencer, Bartlett & Company with the face of the draft 
less the discount. The Chicago bank may hold it till maturity, at 
which time it will be sent to their correspondent bank in Indianapolis 



I 



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m 



If. 



2IO 



PRINCIPLES OF ACCOUNTING 



for collection, or, as was suggested above, the Chicago bank, if a 
member of the Federal Reserve System, may rediscount such paper 
with the Federal Reserve Bank of Chicago, thus securing funds or 
credit with that institution. 

Accounting for trade acceptances. This illustration may also be 
used to explain the accounting involved in connection with the trade 
acceptance. When Hibbard, Spencer, Bartlett & Company ship the 
goods to the Central Supply Company, the entry on the books of the 
seller will be a debit to accounts receivable and a credit to sales. 
When they receive the accepted draft the entry will be debit to notes 
receivable and a credit to accounts receivable. If, on the other hand, 
they discount it before maturity, the entry will be a debit to cash for 
the proceeds, to discount or interest for the amount of the discount 
deducted by the bank, and a credit to notes receivable or notes receiv- 
able discounted. In the same way a time draft drawn against a con- 
cern and accepted by it is treated in its accounts as notes payable. 
Thus trade acceptances and other accepted time drafts receivable 
and payable are included in the same accounts as notes receivable 
and payable, since an accepted draft is legally of the same import as a 
promissory note. 

QUESTIONS FOR CLASS DISCUSSION 

1. The Wilson Manufacturing Company manufactures shoes, which they 
sell to jobbers. They sell for cash, on open accoimt, and for trade 
acceptances. How many kinds of transactions might occur in such a 
concern which would result in debits to cash ? 

2. How many kinds of transactions can you think of as occurring in con- 
nection with the operations of this business which would result in cash 
being credited ? 

3. You are being considered for the position of chief accountant in a large 
retail store and are asked to outline a scheme for handling the cash in 
that establishment. What questions would you ask before giving 
yoiu: answer ? Outline in general terms a plan for handling cash which 
you think would apply in the ordinary business of this nature. What 
provisions, if any, would your plan make for guarding against the 
embezzlement of fimds by members of the organization ? 

4. What do you consider the most desirable form of handling petty cash 
disbursements ? Why do you consider it the most desirable plan ? 



BUSINESS PRACTICE AND PROCEDURE 



211 



5. What is the purpose of a notes receivable register? Under what 
circumstances would you recommend its use ? A notes payable register ? 

6. Define a trade acceptance. Describe its use, giving an illustration. 
What are the advantages in the use of this form of credit? The 
disadvantages ? 

7. Which do you consider the more desirable form of credit, the trade 
acceptance or the open account ? Why ? 

REFERENCES FOR FURTHER STUDY 

Mitchell, T. W., Accounting Principles, chap. xv. 

Kester, Roy B., Accounting Theory and Practice, Vol. I, chaps, xxxv and 

xxxvii. 
EsQUEEsi, Paul Joseph, Applied Theory of Accounts, chaps, xiii and xv. 



!■ 



V 



:-:3 



CHAPTER XIX 

BOOKS OF ORIGINAL ENTRY-SALES AND 
PURCHASES RECORD 

Purpose of hooks of original entry. In chapter xi it was pointed 
out that it is inexpedient to enter the record of a business transaction 
directly into the ledger accounts affected, and that it is customary 
to make a preliminary record of the transaction as a whole, analyzed 
according to the accounts affected, in some book of original entry. 
This preliminary record shows the debits and credits involved, and 
serves as a medium for posting them into the ledger. Besides' this, 
it may provide for the recording of certain significant facts concerning 
each transaction, such as could not be conveniently entered in the 
ledger. It may also have a very important use in facilitating the 
analysis of certain groups of transactions. This last point will be 
developed further in the subsequent discussion of particular types of 
such records. The form which the books of original entry will assume 
will vary with the type of transaction which the particular book is 
intended to record, and with the classification which it seems desirable 
to make of the financial facts arising from such transactions. It 
foUows that there can be no fixed form for any book of original entry. 
The correct form in each case is the one which best answers the purpose 
for which it is intended. 

Subdivisions of the journal. Whenever a given type of trans- 
actions occurs in a business with sufficient frequency, it becomes 
desirable that a special journal should be devoted to that particular 
class of transactions. Thus it is usual to find a separate journal for 
the recording of each of the foUowing types of transactions: purchases, 
sales, cash receipts, cash disbursements. In a business where it is 
the usual thing to receive a considerable number of notes or trade 
acceptances from customers, a special notes receivable journal would be 
desirable as an additional form of record. In the same way, if a 
business frequently gives notes or trade acceptances to its creditors, 
a notes payable journal may become worth while. Sales returned by 

312 



BOOKS OF ORIGINAL ENTRY 



213 



customers and allowances made to satisfy claims of customers may 
easily become important enough to justify a sales returns and allow- 
ances journal, and the same may readily become true of purchase 
returns and allowances. Any other type of transaction which occurs 
frequently enough may call for a special journal, for purposes of 
analysis and for convenience in posting. 

The use of the general journal, and of simple forms of the purchases 
journal, sales journal, and cash journals, has been previously explained. 
Some of the more complex forms of the commonly used books of 
original entry will now be considered. 

Use of special columns in hooks of original entry. Probably the 
most important advantage of the use of special journals is that they . 
make possible the analysis of transactions into certain definite classes. 
There have been mentioned in this chapter the following classes: 
(i) purchases, (2) sales, (3) cash receipts, (4) cash disbursements, 
(5) notes receivable transactions, (6) notes payable transactions, 
(7) sales returns and allowances, and (8) purchase returns and allow- 
ances. Still other special classes might be mentioned, in addition to 
the remaining group of miscellaneous transactions. But if a special 
journal should be devoted to each of the types of entries indicated 
and all remaining transactions entered in the general journal, there 
might well remain a need for still further classification within some or 
all of these special groups. 

To illustrate this, the case of cash receipts may be used. The 
simple form of cash journal shown in a previous chapter provides a 
record for all cash received. But it may be desired to classify cash 
receipts still further with regard to their sources. Thus in a retail 
establishment the chief sources of cash receipts would be: (i) the 
payment by customers of their accounts, (2) cash sales, and (3) mis- 
cellaneous receipts, which might include payment of occasional notes 
receivable, interest on such notes, sale of fixed assets, and other items. 

A classification of cash receipts along these lines might be obtained 
by having three journals for cash receipts, and recording receipts 
from each of the three sources in a separate journal. This method 
would prove undesirable, however, for the reason that it is desirable 
to keep in one journal a record of all cash receipts, since this facilitates 
the auditing of cash receipts and the ascertainment of the cash balance. 
A satisfactory solution to this problem is to introduce into the cash 



1 



V ' 



i '! 



fflna 



I 



214 



PRINCIPLES OF ACCOUNTING 



receipts journal three special columns, recording the receipts from 
each of the three sources in a separate column. The total of each 
colunm will then indicate the total amount of cash received from the 
source in question. In addition to these three special columns, still 
another column would be used to show the total of cash receipts from 
all sources. Assuming a retail business in which customers are not 
allowed any cash discounts, such a journal might appear as follows: 

CASH RECEIPTS 



Date 


Explanation 


Gen. 


Accts. 


Sundry 


Accts. 


Sales 


Cash 






L.F. 


Rec. F. 


Accts. Cr. 


Rec. Cr. 


Cr. 


Dr. 


May I 


Balance 
















2,420 


50 


2 


Henry Wilson, on 


















2 
3 


acct. 
Cash sales for day 
Notes receiv., James 

Thompson 






100 


00 


SO 


00 


90 


00 


50 
90 

100 


00 
00 

00 


3 


Int. on notes rec., 
James Thompson 






2 


00 










3 


00 


3 


John Seely, on acct. 










35 


00 






35 
no 


00 


3 


Cash sales for day 














1 10 


00 


00 



The foregoing discussion of the cash receipts journal illustrates 
the principles mvolved in the use of special colunms in the books of 
original entry. Just as the types of transactions which* occur most 
frequently are taken out of the general journal and recorded in special 
journals, so the subdivisions within each general type of transaction 
may be designated by the use of special colunms within the special 
journals. In the laboratory exercises which are given the student 
will have occasion to use various special columns in the books of 
original entry, as the nature of the business transactions to be dealt 
with becomes more varied and complicated. 

The recording of sales. It is not a matter of great importance 
whether sales or purchases is discussed first. The reason for taking 
up sales first is that in any mercantile business the fundamental 
classification which will be made of purchases and of purchase returns 
and allowances, as well as of sales returns and allowances, depends to 
some extent on the basis taken for the classification of sales. The 
sales result in the income which makes it possible to continue pur- 
chasing goods. Also in a mercantile business merchandise is pur- 
chased only for the purpose of resale to customers, and any plans for 



BOOKS OF ORIGINAL ENTRY 



215 



future purchasing must be made on the basis of an estimate of future 
sales. These facts make it desirable that the actual sales for a given 
period and the actual purchases for the same period should be classified 
on a common basis. 

A brief discussion of the routine involved in handling sales trans- 
actions was given in chapter xvii, so that the present discussion may 
be devoted entirely to the analysis and recording of such trans- 
actions. The analysis of a sales transaction into its debits and credits 
is very simple. In every case value is received by the business in 
some form, whether cash, notes receivable, or other forms of claim 
against the customer. The debit therefore will be to the account or 
accounts representing the form of value which is received, and the 
credit to a sales account. In a business which sold only on open 
account and made no attempt to classify the commodities sold, the 
form of record required would be very simple. Such a sales journal 
might appear as follows: 

SALES JOURNAL 



Date 


L.F. 


Account Debited 


Address 


Terms 


Invoice 
Number 


Amount 


June 


I 




William Henderson 


Monee, 111. 

• 


2/10/60 


132 


455 


00 



Here there is only one form of asset received and only one sales 
account to be credited, so that a single column is sufficient. The 
footing of this colunm is a debit to accounts receivable and a credit 
to sales. 

Cash sales. If in such a business it became necessary to record 
sales for cash as well as sales on account, it would be possible to do this 
by means of a sales column in the cash receipts journal, as shown on 
page 214. The posting to sales account could be accomplished 
satisfactorily through the footing of this column. However, the 
sales journal would no longer show the total of sales, and would also 
fail to show an analysis of sales according to credit terms, which in 
such a case might well be desired. The sales journal may be made to 
show the essential information with regard to sales by the introduction 
of extra columns as follows: 



I'. V, 



m\\ 



^ ' 



216 



PRINCIPLES OF ACCOUNTING 









SALES JOURNAL 
















Date 


Account Debited 


Address 


Terras 


Invoice 
Number 


Accts. 
Rec. 
Dr. 


Cash 
Dr. 


Sales 
Cr. 


June 


I 

2 


Joseph Lipman 
Thompson Bros. 


Keokuk, Iowa 
Hammond, Ind. 


2/10/60 
2/10/60 


I4S 
146 


348 


SO 


125 


00 


348 
125 


SO 
00 



The "Cash Dr." column would not be posted, since all cash received 
must be recorded in the cash receipts journal, and this debit is already 
included in the total debit to cash. The cash column in the sales 
journal is there only for purposes of analysis. In the same way the 
"Sales Cr." colunm in the cash receipts journal would not be posted 
when this form of sales journal is used, but would be used only as an 
aid to the analysis of cash receipts. 

Analysis of sales by departments. It will be found that in most 
businesses of any considerable size, whether wholesale or retail, the 
commodities sold are assigned on some basis or other to departments. 
The management desires such information as will enable it to compare 
results obtained in the different departments, and also such infor- 
mation as will serve as a basis of planning future business for each 
department. This means that information concerning sales, sales 
deductions, and the cost of goods sold must be analyzed by depart- 
ments. Such an analysis of sales can easily be provided in the sales 
journal. Thus, assuming a wholesale business with three depart- 
ments, which may be called A, B, and C, and assuming that this 
concern sells goods on open account and for cash, a sales journal 
which would provide the desired analysis might have the following 
form: 

SALES JOURNAL 



Date 



July 



In 
voicel 



153 
IS4 



Sold to 



J. Dole 
Cent. Hard- 
ware Co. 



Address 



Manteno,Ill, 
Chicago 



Terms 



n/30 
2/10/60 



L.F. 



Accts. 

Rec. 

Dr. 



400 



00 



Cash 
Dr. 



300 



00 



Sales 

Dept. 

A 



15000 
100 00 



Sales 

Dept. 

B 



100 



00 



Sales 
De^t. 



150 
200 



00 
00 



BOOKS OF ORIGINAL ENTRY 



217 



The foregoing illustration being for a wholesale business, each invoice 
is entered as a separate item. Where an invoice includes sales from 
more than one department, a separate sheet would usually be devoted 
to the sales of each department affected. This facilitates its analysis 
when it is entered by the accounting department in the sales journal. 
Recording retail sales. In recording sales in a retail establishment, 
where they are likely to be much greater in number, it is not usual to 
enter each sale as a separate item. The sales tickets within each 
department would be collected at the end of the day's business. 
Cash sales, credit sales, C.O.D. sales, instalment sales, etc., would 
each have a distinctive color of ticket. Each of these classes would 
be grouped and totaled, and the sales for the day would then be 
summarized and entered in the sales journal. Assuming a retail 
business with only three departments, such a form of sales journal 
might appear as follows: ' . 

SALES JOURNAL 



Date 




) 
Cash 


C.O.D. 


Accounts 
Receivable 


Sales 

Dfpt a 


Sales 
nFPT a 


Sales 
Dept. C 


Total 

^ AT Va 








City 


Country 








May 


I 


47S 


00 


125 


00 


520 


00 


210 


00 


S2S 


00 


410 


00 


395 


00 


1,330 


00 



In the illustration above it is also assumed that customers' accounts 
are divided into two groups, city customers and out-of-town customers. 
The column for ** Total Sales" is usually not posted, the credits being 
ordinarily made to the departmental sales accounts instead. The 
information furnished by this "total" column, however, is usually 
considered to be of sufficient interest to justify the use of the colunm. 
Sales deductions. In nearly every business the total credit to 
sales, which represents the total of the invoices or sales tickets for the 
particular department or for the business as a whole, is subject to certain 
deductions. Some goods will be returned as unsatisfactory. Allow- 
ances or rebates may have to be given the customer on account of the 
failure of goods sold to give satisfactory service. Such occurrences 
represent deductions from the item of gross revenue from sales, the 
amount of which revenue is shown by the sales accounts. 



M 



'§1 



I 

1 



I I 



hm 






II 



I 



■<*» 



1 



2l8 



PRINCIPLES OF ACCOUNTING 



It would be possible to ascertain the amount of net sales for each 
department by debiting any such deductions directly to the sales 
account to which they belong. But the sales reports will be much 
more useful as an aid to the planning of future business if such deduc- 
tions are shown separately instead of being hidden in the sales accounts. 
Separate accounts should therefore be carried in the ledger for sales 
deductions, and these accounts must provide the means of classify- 
ing such deductions on the same basis used for the classification of 
sales. Sales returns and allowances are the most common forms 
of sales deductions, and will be considered here for purposes of 
illustration. 

Sales return and allowances journal. The nature of sales allow- 
ances really differs somewhat from that of sales returns, and if the 
former become considerable in amounf, they should be recorded as a 
separate item. It is usual, however, for all deductions from these two 
sources to be carried in a single account entitled "Sales Returns and 
Allowances." Whatever classification is maintained for sales, the 
same will be required for sales returns and allowances. Thus if the 
wholesale business whose sales journal was shown on page 216 finds 
that sales returns and allowances occur with sufficient frequency to 
justify a separate journal, this journal would take the following 
form: 







SALES RETURNS AND ALLOWANCES JOURNAL 










Date 


In- 
voice 
Num- 
ber 


Acct. Credited 


Address 


L.F. 


Accts. 

Rec. 

Cr. 


Caiih 
Cr. 


R.and 

A. 
Dept. 

A 


R.and 

A. 

Dept 


R.and 

A. 
Dept. 


July 


2 
5 


149 
153 


Thos. Moran 
J. Dole 


Niles, Mich. 
Manteno, 111. 




55 
40 


00 
00 






55 


00 


15 


00 


25 


00 



A retail business whose sales are classified on the basis indicated 
in the form of sales journal iUustrated on page 217 will probably 
require a sales returns and allowances journal similar to the following 
form: 



BOOKS OF ORIGINAL ENTRY 219 

SALES RETURNS AND ALLOWANCES JOURNAL 



Datb 


Cash 
C«. 


C.O.D. 


Accounts 
Receivable 


R. AND 
A 


R. AND 

A 


R. AND 

A 


Total 

R. AND A. 


/ 




City 


Country 


Dept. A 


Dept. B 


Dept. C 


May 


I 


45 


00 


30 


00 


60 


00 


125 


00 


75 


00 


90 


00 


95 


00 


260 


00 



Recording purchases, A consideration of purchases in the broad* 
meaning of the term would include every form of purchase made by 
the business, whether of salable merchandise, raw materials for manu- 
facture, supplies, or services such as rent, labor, and the like. It is 
desirable to confine the present discussion to the recording of purchases 
of salable merchandise. The routine of such purchases: has been 
briefly considered in chapter xvii, and the form of the record is now 
to be taken up. 

In most businesses purchases of merchandise are generally made on 
credit. The account to be credited is therefore Accounts Payable. 
This is so nearly the pule that the typical business concern will enter 
the occasional exception as though it were a purchase on account, and 
then make a second entry to show the debit to Accounts Payable and 
the credit to Cash, Notes Payable, or whatever other account may be 
affected. . 

The analysis of the debits involved in a purchase transaction will 
usually depend on the classification that is made of sales in that par- 
ticular business, since, as has been previously pointed out, the accounts 
showing cost of goods sold must correspond in classification to the 
accounts with sales. In a business which maintained no classification 
of sales the purchases journal might have the following form: 

PURCHASES JOURNAL 



Date 


L.F. 


Account Credited 


Address 


Terms 


Invoice 
Number 


Amount 


June 


I 


Wilson Bros. 


Chicago, 111. 


2/io/n/6o 


45 


457 


50 




Mil 



It 



II 



220 



PRINCIPLES OF ACCOUNTING 



The footing of the '* Amount'' column is a debit to purchases and a 
credit to accounts payable. All purchase invoices are entered in 
this journal and filed according to whatever system is used in the 
business. 

Departmental analysis in the purchases journal. In a business 
which is organized into departments according to the commodities 
handled, the purchases journal must show the same analysis as does 
the sales journal. Thus, assuming a business which may be either 
wholesale or retail, but with three departments, the following form of 

purchases journal may be used; 

• 

PURCHASES JOURNAL 



Date 


L.F. 


Account 
Credited 


Address 


Terms 


Invoice 
No. 


Ac- 
counts 
Pay- 
able 
Cr. 


Pur- 
chases 


Pur- 
chases 


Pur- 
chases 
Dg... 


Total 
Pur- 
chases 


June 


I 
6 
8 


Cobb Mfg. Co. 
The Buda Co. 
W. F. Hebard 
Co. 


St. Paul 
Chicago 

Chicago 


2/10/60 
2/10/30 

2/10/60 


122 
123 

"4 


67s 
4SO 

525 


._„. 
00 
00 

00 


675 


00 


525 


00 


4SO 


00 


675 
450 

52s 


00 
00 

00 



It might be considered worth while to introduce still other columns 
into the purchases journal. Thus if the business made a practice Of 
giving notes or trade acceptances in payment for goods, as well as 
purchasing on open account, an additional column headed ** Notes 
Payable, Cr." might well be introduced, just to the right of the 
column headed ''Accounts Payable, Cr." Or the column headed 
*' Terms" might be followed by two colimins, headed respectively 
*'When Due" and ''When Paid." This would make the purchases 
record show the date when each invoice must be paid in order to take 
advantage of the discount offered, and the date when each was paid, 
if it had been paid. 

It hardly seems necessary to attempt to illustrate various possible 
forms of the purchases journal. The foregoing illustrations and dis- 
cussion should have furnished the student with a working knowledge 
of the principles involved in designing such records. 

Purchases other than merchandise. All the forms of purchase 
records just illustrated provide only for recording the purchase of 



BOOKS OF ORIGINAL ENTRY 



221 



salable merchandise. Other purchases, such as items of equipment, 
supplies, and services, would be recorded in the cash book if purchased 
for cash, and when purchased on credit would be recorded either in 
the general journal or in some special journal designed for that pur- 
pose. It is possible to have a single purchases journal in which all 
purchases on account are recorded. This would necessitate only the 
addition of other columns to provide for debiting other than mer- 
chandise accounts for other types of purchases. The discussion of 
such forms of journals as would be necessitated by handling other 
than merchandise purchases in the purchases journal is best deferred 
to a later point in the study of accounting. 

Purchase deductions. In connection with purchases, as with sales, 
there are certain deductions to be considered. An analysis of these 
deductions must be maintained along the same lines on which sales 
and purchases are analyzed. The classification of purchase returns 
and allowances, therefore, will be similar to that of the merchandise 
purchases, and the form of journal used to record them will be deter- 
mined by the form of the purchases journal. A single illustration 
should serve to make this matter clear. Taking the form of purchases 
journal shown on page 220, the purchase returns and allowances 
journal which would be used to correspond to the analysis shown 
there would appear as follows: 







PURCHASE RETURNS AND ALLOWANCES JOURNAL 






Date 


L.F. 


Account Debited 


« 

Address 


Invoice 
Number 


Accounts 

Payable 

Dr. 


R. and 

A. 
Dept. A 


R. and 

A. 
Dept. B 


R. and 

A. 
Dept. C 


Jan. 


4 


Cobb Mfg. Co. 


St. Paul 


122 


50 


00 


SO 


00 






' 





This form of journal should serve to indicate the necessary cor- 
respondence between the analysis of purchases and that of purchase 
deductions, and the student should not meet with any appreciable 
difficulty in designing a purchase returns and allowances journal after 
he has once determined upon the form to be used for the purchases 
journal. 



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222 PRINCIPLES OF ACCOUNTING 

QUESTIONS FOR CLASS DISCUSSION 

1. What purposes are served by the books of original entry? 

2. You are asked to design an accounting system for the J. B. Saunders 
Company, a wholesale hardware business. What information should 
you obtam before determining what books of original entry to use ? 

3. From your present general knowledge of the nature of the wholesale 
hardware business, what books of original entry do you think you might 
use for recording the transactions of such a business? 

4. What purposes are served by the use of special columns in the books of 
original entry ? 

5. Assume that the J. B. Saunders Company is organized with four 
departments, which may be indicated as Departments A, B, C, and D, 
and that sales are made on open account and for trade acceptances! 
List the colunms which you would use in the sales journal which you 
would design for this business; in the sales returns and allowances 
journal. 

6. What columns would you suggest for the sales journal of the F. C. Miller 
Company, a retail clothing business with four departments, which sells 
for cash and on monthly account ? Describe the routine which would 
be followed in making entries in this journal. 

7. List the colunms which would be needed in the sales returns and allow- 
ances journal of the Miller Company, and describe the routine which 
would be followed in connection with entries of this type. 

8. What differences, if any, would you make between the form of purchases 
journal to be used for the Saunders Company and that used by the 
Miller Company ? List the colunms which you would use for each of 
them. 

9- List the colunms which you would use in the purchase returns and 
allowances journal of each of these businesses. 

10. In view of the recommendations which you have made for the pur- 
chases, sales, purchase returns and allowances, and sales returns and 
aUowances journals of the Saunders Company, list the trading accounts 
which would be maintained in the ledger of that business. 

11. What difference, if any, would there be in the trading accounts of the 
two businesses? 

REFERENCES FOR FURTHER STUDY 
EsQUERR^, Paul-Joseph, Applied Theory of Accounts, chap. viii. 
Kester, Roy B., Accounting Theory and Practice, Vol. I, chap. xxm. 
Mitchell, T. W., Accounting Principles, chap. viL 



C3IAPTER XX 

BOOKS OF ORIGINAL ENTRY— THE 
CASH JOURNAL 

The cash book. The nature of the record that must be kept with 
cash receipts and cash disbursements was explained in chapter xii, 
where certain very simple forms of records with cash were suggested. 
It was there explained that the two journals, one for receipts and the 
other for disbursements, together constitute what is known as the 
cash book. By comparing the total debits to cash on the one side with 
the total credits to cash on the other side, it is possible at any time to 
ascertain the balance of available cash. In the preceding chapter the 
desirabiUty of maintaining an analysis of cash receipts and of cash 
disbursements was indicated, and the use of special columns in the 
cash journals for this purpose was illustrated. In the present chapter 
the possibilities of such analysis will be considered further, as applied 
to both receipts and disbursements, and the use of special columns 
for this purpose will be given further discussion. 

In chapter xviii the business procedure and routine involved in the 
handling of cash transactions was discussed. A- knowledge of the 
subject-matter of that chapter will therefore be assumed at this point, 
and the present discussion confined to the matter of recording these 
transactions. 

. Cash receipts — analysis. In recording transactions involving cash 
receipts it might seem that the cash account is the only one to be 
debited. Further consideration, however, reveals the fact that the 
receipt of cash may involve a debit to some other account, along with 
a debit to Cash. The most common instance of this is in the case of 
cash discount on sales, which occurs regularly in wholesale businesses, 
and in certain departments of some retail businesses. Thus in selling 
goods at wholesale, they are usually invoiced to the customer at a 
certain price, payable within a fixed time (usually thirty or sixty days), 
but subject to discount if paid within a shorter period, generally ten 
days from the date of the invoice. In such a case, when the customer 

223 



^ 





4 




224 



PRINCIPLES OF ACCOUNTING 



remits within ten days, the amount of the check will be the total of 
the invoice less the discount allowed. In recording the receipt of 
such a remittance, the customer must be credited with the amount 
of the invoice, while Cash can be credited only for the amount of the 
check. The difference is a debit to Cash Discount on Sales. It will 
therefore be necessary to have a special column introduced into the 
cash receipts journal to provide for debits to this account. 

The nature of the account with cash discount on sales, and its 
treatment in the reports, will be discussed in a later chapter. 

A somewhat similar case occurs when a note is discounted at the 
bank. Assuming that a business borrows at the bank, giving its 
own note for $i,ooo, due in sixty days, without interest, and that 
the discount rate is 6 per cent, the journalization of the transaction 
involves a credit to Notes Payable for $i,ooo, a debit to Cash for $990, 
and $10 debit to Interest on Notes Payable. This type of transaction 
is much less frequent than that involving cash discount on sales, 
but must be provided for in some manner in the books of original 
entry. It is possible to divide the transaction into two parts, with an 
entry in the cash receipts journal debiting Cash for $990 and crediting 
Notes Payable for the same amount, and to make another entry in the 
general journal, debiting Interest on Notes Payable for $10 and credit- 
ing Notes Payable. Such a transaction may be recorded in the cash 
book by an entry in the cash receipts journal debiting Cash for $1,000 
and crediting Notes Payable for that amount, with another entry in 
the cash disbursements journal debiting Interest and crediting Cash 
for $10, the amount of the interest. Or it may all be recorded in the 
cash receipts journal by having a special column for debits to Interest. 
Such a column would be hardly worth while if transactions of this 
type are very infrequent. 

Cash receipts— credits. The analysis of cash receipts according 
to their sources may involve several accounts, although not so great 
a number as will usually be involved in an analysis of the cash dis- 
bursements. Some idea of the accounts that may be credited when 
cash is received may be gained from a consideration of the sources 
from which cash may be received. These may be listed as follows: 
(i) receipts from cash sales; (2) receipts from customers in payment 
of open accounts; (3) receipts in payment of notes receivable; 



BOOKS OF ORIGINAL ENTRY 



225 



(4) receipts from discounting notes receivable at the bank; (5) re- 
ceipts from additional investment in the business by the owners (sole 
proprietor, partners, or stockholders); (6) receipts from interest on 
notes receivable or on bank balances; (7) receipts from borrowing 
on short- time notes payable (from the bank) ; (8) receipts from borrow- 
ing on long-time obligations; (9) receipts from the sale of fixed assets; 
(10) receipts from the income on long-time investments held by the 
business; (11) miscellaneous (sales of waste, rentals of equipment, 
etc.). 

An examination of this list of possible sources of receipts shows 
that there may be a number of accounts to be credited for cash 
receipts. But it is also apparent that only a few of these accounts will 
be credited with any considerable degree of frequency. In planning 
the form to be used for the cash receipts journal, then, special col- 
umns should be provided to take care of the credits to those accounts, 
which occur with the greatest frequency, leaving the credits to ac- 
counts which occur less often to be entered in the general credit 
column, which may be headed "Sundry Accounts, Cr." Credits 
entered in this column could not be posted through the footing of the 
column, but would be posted item by item to the credit of the proper 
accounts. In making a complete analysis of cash receipts for a given 
period, it would be necessary to prepare a separate schedule showing 
further analysis of the terms entered in this general column, in such 
detail as might be considered desirable. The information shown by 
this schedule would then be embodied in the general analysis of total 
cash receipts. 

Illmtration of cash receipts journal. In the preceding chapter a 
simple form of. cash receipts journal was shown, illustrating the use of 
special columns. The form that will prove desirable in any particular 
business depends on the accounts that are affected by cash receipts, 
and the frequency with which cash receipts from each particular 
source occur. The form of cash receipts journal which appears below 
provides special columns for the analysis of receipts according to the 
more usual sources. All other credits are entered in a general column 
and posted item by item to the ledger account. If further analysis of 
receipts is desired for any purpose, it may be obtained by making a 
recapitulation of this general column. 



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PRINCIPLES OF ACCOUNTING 



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BOOKS OF ORIGINAL ENTRY 



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It should not be difficult for the student to understand the purpose of 
the money columns in the form of journal shown on page 226. It is 
probable, however, that he will not fully understand the process of 
posting or the use in this connection of the two folio columns. These 
points may well be passed over few: the purpyose of the present chapter. 
They will be fully explained and illustrated in the next chapter. For 
|the present it is enough if the student understands how the forms here 
shown are used for purpose of analysis. 

Analysis of cash disbursements — credits. Every entry made in the 
cash disbursements journal is supposed to involve a credit to cash, 
and actually does involve such a credit. But one type of cash dis- 
bursement also involves credits to another account as well. This is 
the account with cash discount on purchases. The nature of the 
transactions which result in a debit to Cash Discount on Sales was 
explained in the discussion of the recording of cash receipts. From 
the point of view of the individual or firm who pays for the goods and 
takes the discount, this is cash discount on purchases. Thus when we 
pay an invoice upon which a cash discount is allowed, remitting 
within the time limit and deducting the discount, the entry is a debit 
to Accounts Payable for the amount of the invoice, a credit to Cash 
for the amount of the check, and a credit to Cash Discoimt on Pur- 
chases for the amount deducted. The cash disbursements journal, 
therefore, will usually provide two credit columns — one for Cash, and 
the other for Cash Discount on Purchases. 

Analysis of cash disbursements — debits. Cash disbursements may 
involve debits to a number of different accounts, since expenditures 
of cash may be chargeable to practically any expense account or asset 
account in the ledger. The greater number of these accounts will not 
be affected very frequently, however, and there are usually a very 
few accoimts which are charged through the cash disbursements 
journal often enough to justify carrying special columns for them. 
The nature of the business and the frequency with which certain 
accounts are affected by cash disbursements will determine what 
special colunms should be used in this journal. The one which 
usually occurs with the greatest regularity is Accounts Payable. This 
account will practically always require a special column. It is not 
usual for any entry affecting purchases account to be made in the 



228 



PRINCIPLES OF ACCOUNTING 



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11 



cash book, since purchases are generally classified in the purchases 
journal and therefore entered in that book and posted from it. Cash 
purchases of merchandise are very rare in most businesses, and where 
they do occur are usually entered as purchases on account, accounts 
payable being credited through the purchases journal. The payment 
is then recorded in the cash disbursements journal as a credit to Cash 
and a debit to Accoimts Payable. 

If the business makes a practice of giving notes payable to trade 
creditors, so that such notes occur rather frequently, a special column 
for recording them may be provided in the cash disbursements journal. 
It may be said, however, that there are not very many businesses 
where the notes payable are numerous enough to justify this. Other 
special columns may be provided for debits to any expense accounts 
which are affected frequently enough to make such columns worth 
while. The debits for which no special columns are provided will be 
entered in a general column, which is usually headed "Sundry 
Accounts, Dr." or with some similar caption, and these debits will be 
posted to the ledger, item by item. A complete analysis of cash dis- 
bursements would require that a recapitulation be made of the items 
in this general column. 

Illustrations of the cash disbursements journal. It has been 
explained that the recording of cash requires the use of two journals, 
one for receipts and one for disbursements, and that the two together 
constitute the cash book. The amount of analysis provided for in 
each of these journals will depend on the size and complexity of the 
business. A very simple form of cash book for a small wholesale 
business which takes discounts on purchases and allows discounts 
on sales might make use of the following colimins; 

CASH RECEIPTS 



' Doe 


L.F. 


Account Credited 


— 1 

Explanation 


Accounts 
Receiv- 
able Cr. 


Sales 

Discount 

Dr. 


Cash Dr. 


Jan. 


I 

2 


Balance 
J. Henry 


On hand 
Invoice No. 43 


200 


00 


4 


00 


2,SOO 
X96 


00 
00 



BOOKS OF ORIGINAL ENTRY 



229 









CASH DISBURSEMENTS 












Dtte 


L.F. 


Account Debited 


Explanation 


Accounts 
Payable 


Purchases 

Discount 

Cr. 


Cash Cr. 


Jan. 


2 
3 


Rent 
James Bros. 


For January 
Invoice No. 23 


SOO 


CO 


10 


00 


ICO 
490 


CO 
CO 



The relation between the two sides of the cash book, which is most 
apparent when it has been balanced and ruled up at the end of the 
period, is not clearly shown in the foregoing illustration. For a better 
illustration of this relationship, the student is referred to page 245 
in the following chapter. 

A cash book for a somewhat larger business, providing more 
analysis than the form just shown, might combine the form of cash 
receipts journal shown on page 214 with the form of cash disbursements 
journal shown below: 

CASH DISBURSEMENTS 



Date 


Explanation 


• 

I 


L.F. Accounts 
Payable 


Sundry Ac- 
counts Dr. 


Accounts 
Payable 
Dr. 


Office Ex- 
penses Dr. 


Purchases 
Discount 

Cr. 


CashCr. 


Jan. 


2 
3 


Rent for January 
J. E. Williams, In- 


125 


00 














125 


00 




4 

4 

S 


voice No. 51 
Light bill for January 
Office equipment — 

typewriter 
Jones and Co., In- 
voice No. S3 






ICO 


00 


7SO 
600 


CO 

00 


12 


75 


IS 
12 


00 
CO 


735 
12 

100 

588 


00 
75 

00 
00 



The illustrations offered in this chapter' give the student a view of 
the ways in which the cash book may be used for purposes of analysis. 

« It is not considered worth while to illustrate forms of notes journals at this 
point. The laboratory work for this elementary presentation does not involve 
the use of such journals, and the ordinary business is not likely to find it worth 
while to use them. 



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230 



PRINCIPLES OF ACCOUNTING 



In the following chapter a somewhat fuller discussion is given of the 
manner in which transactions are to be entered in such a record, and 
the manner of posting from them to the ledger accounts. 

QUESTIONS FOR CLASS DISCUSSION 

1. What accounts besides cash may be debited as a result of transactions 
mvolving cash receipts ? What methods may be employed in entering 
such debits in the books of original entry ? What will determine the 
relative desirability of these methods in a given case ? 

2. What accounts besides cash may be credited as a result of transactions 
involving cash disbiursements ? What methods may be employed for 
the entry of such credits ? What will determine the relative desirability 
of these methods in a given case ? 

3. The J. B. Saimders Company, mentioned in the questions at the end 
of the preceding chapter, sells goods on open account, all such accounts 
being payable in sixty days, and allows its customers to deduct a 2 per 
cent discount if the invoice is paid for within ten days. It occasionally 
borrows money from the bank on its notes, and sometimes obtains 
funds from the bank by discounting the notes of its customers. List 
all the sources from which you think this company might receive cash. 
Which of these sources of cash receipts do you think would require 
special columns in the cash receipts journal ? 

4. The F. C. Miller Company, also mentioned in the questions at the end 
of the preceding chapter, does not allow cash discounts to customers, 
and does not make a practice of taking the notes of customers. List 
as many possible sources of cash receipts as you can think of for this 
business. Which of these would require special columns in the cash 
receipts journal ? 

5. Making any assumptions you may consider necessary and stating what 
assumptions you do make, design a cash book which you think would 
serve for the use of the J. B. Saunders Company. 

6. Follow the same instructions and design a cash book for the F. C. 
Miller Company. 

7. Comment on any differences in the forms prepared imder Questions 
S and 6. Give reasons for such differences. 

REFERENCES FOR FURTHER STUDY 

EsQUEMif, Paul-Joseph, Applied Theory of Accounts , chaps, viii and xiii. 
Kestee, Roy B., Accounting Theory and Practice, Vol. I, chap. xn. 



BOOKS OF ORIGINAL ENTRY 



LABORATORY EXERCISE NO. 32 



231 



W. C. Harvey has decided to go into the retail hardware business. He 
engages you to instal a suitable system of accounting for his business, to 
oversee the daily work of the bookkeeper until you are sure that the latter 
understands the use of the accounts, and to prepare reports monthly until 
you are satisfied that these can be prepared properly by the bookkeeper. 
After some discussion of Mr. Harvey's plans for the business, you have 
drawn up the following as a tentative outline of the accounts that will be 
needed for the preparation of the accounting reports. 

1. Asset accoimts 

11. Current asset accounts 

111. Cash 

112. Accoimts Receivable (individual accounts) 

113. Notes Receivable 

1 103. Reserve for Bad Debts' 

114. Merchandise Inventory 
11$. Accrued Interest Receivable 

12. Deferred charges accounts 

121. Prepaid Insurance 

122. Other Prepaid Expense 

13. Fixed assets accounts 

131. Delivery Equipment 

1301. Reserve for Depreciation of Delivery Equipment 

132. Store and Office Equipment 

1302. Reserve for Depreciation of Store and Office Equipment 

2. Liability accounts 

21. Ciurent liability accoimts 

211. Accounts Payable (individual accounts) 

212. Notes Payable — ^Trade Creditors 

213. Notes Payable — ^Banks 

214. Expense Accrued 

3. Proprietorship accoimts 

31. W. C. Harvey, Capital 

32. W. C. Harvey, Personal 

' To indicate that certain accounts are of an opposite nature to those with 
which they are included, and are to be considered "valuation" or deduction 
accounts, a cipher b introduced before the final integer in the number indicating 
such an account. 



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232 



PRINCIPLES OF ACCOUNTING 



BOOKS OF ORIGINAL ENTRY 



233 



li ^ 



4. Income accounts 

41. Operating income accounts 
411. Merchandise Sales 

4101. Sales Returns and Allowances 

42. Other income accounts 

421. Interest on Notes Receivable 

422. Cash Discount on Purchases 

5. Expense accounts 

SI. Operating expense accoimts 

511. Purchases 

5101. Purchase Returns and Allowances 

512. Selling expense accounts 

51 21. Sales Salaries 

5122. Advertising 

5123. Delivery Expense 

5124. Other Selling Expense 

513. General and administrative expense accounts 
5131- Rent 

5132. Heat and Light 

5133. OflSce Salaries 

5134. Insurance and Taxes 
5135- Other Office Expense 

52. Other deductions from income • 

521. Interest on Notes Payable. 

For the present, books of original entry to be used are (i) a journal, 
(2) a cash book, (3) a purchases journal, and (4) a sales journal. (For the 
forms of these books see illustrations in the chapter on the use of special 
columns in books of original entry.) AU cash transactions are to be entered 
in the cash book. All sales on account are to be entered in the sales journal. 
All purchases of merchandise on account are to be entered in the purchases 
journal. Other purchases on account are to be entered in the journal. It 
is anticipated that some sales may be made of farm equipment for which 
notes will be taken. In such cases the procedure wiU be to record the sale 
in the sales journal as a sale on account, and then to record the receipt of the 
note in the journal as a separate transaction, debiting notes receivable and 
crediting the customer. Unless otherwise specified in the description of the 
transaction, sales and purchases are assumed to be made on account. 

For the purchases journal and the sales journal, journal ruled paper 
may be used. For the cash book, however, the special columnar journal 
form will be required. 



In this exercise controlling accounts (explained in chapter xxi) will be 
carried in the ledger for accounts receivable and accoimts payable. The 
accoimts with individual customers and creditors should be carried on 
separate sheets of ledger paper, representing the customers' ledger and 
creditors' ledger. These accounts may be carried three to the page. The 
general ledger accounts may be carried two to the page. 

It is desirable that the accounts with individual customers and creditors 
should be kept posted up to date day by day, since the proper entry for 
some of the transactions will require a knowledge of the standing of certain 
individual accounts in these ledgers. 

Transactions for April 
April I 

W. C. Harvey enters the retail hardware business, investing cash, 
$6,000.00. He rents a store building for $125.00 a month, paying the first 
month's rent in advance. He purchases a ladder, scales, and other equip- 
ment necessary for the store, amoxmting to $250.00, and gives his check 
or the amount. 

AprU 2 

Buys of Western Supply Co. a typewriter, table desk, and office diairs, 
for $175.00, terms net cash in fifteen days. Pays cash for stationery, 
stamps, and other office supplies, $50.00. Receives invoice of hardware 
from the W. D. Allen Co., amount $5,000.00, terms 2/io/n/6o. Cash 
sales for the day, $53.65. 

Aprils 

Pays insurance premium on stock for one year, $36.00. Sells* Peter 
Henderson a stove, $50.00, on accoimt. Sells Adam Jones builders* sup- 
plies, $7500, on accoimt. Cash sales, $45.00. 

April 4 
Buys for cash a used Ford truck for hauling and for making deliveries, 
$350.00. Receives invoice of shipment from Barrett-Christie Hardware 
Co., Chicago, $i7500f 2/io/n/6o. Sells Andrew Anderson on account, 
$45.00. SeUs Jacob Gunderson builders' hardware, $160.00, on accoimt. 
Cash sales, $68.oa 

Aprils 
Pays for repairing car and for gasoline and supplies, $45.00. Sells 
Charles Robinson on account, $35.00. Pays postage, $20.00. Cash sales, 
$58.00. 



II 








234 



PRINCIPLES OF ACCOUNTING 



AprU 6 

Pays bookkeeper, $20.00; clerk, $25.00; driver, $25.00. Withdraws 
for personal use, $35.00. 

^ AprUS 

Buys five tons of coal, $55.00, paying cash. Sells William Gibson 
$48.00, on account. Cash sales, $62.50. 

April 9 

Sells Jacob Gunderson $42.00, on account. Adam Jones pays for goods 
sold him on April 3. Cash sales, $71.00. 

April 10 
Sells James Freeman builders' hardware, $200.00, taking his sixty-day 
note with interest at 6 per cent in payment. Borrows $2,000.00 from the 
Merchants Bank, on a ninety-day note, with interest at 6 per cent. Cash 
sales, $68.00. 

April II 
Pays W. D. Allen Company's invoice of April 2, less discount. 
Receives invoice for shipment of merchandise from the Moline Manufactur- 
ing Co., $450.00, terms 2/io/n/3o. Cash sales, $65.00. 

April 12 
Sells William Gibson $70.00 on account. Receives invoice, W. D. 
Allen Co., $500.00, 2/io/n/3o. Pays for office supplies, $15.00. Cash 
sales, $74.00. 

April I J 

Pays the Barrett-Christie Company's invoice of April 4, less discount. 
Pays salaries the same as last week's. Withdraws $50.00 for personal use. 
Sells Adam Jones $57.50 on account. Cash sales, $65.00. 

AprU 15 

Pays Western Supply Company's invoice of April 2, net. Cash sales, 
$60.00. 

April 16 

Receives and pays a bill from the garage where the car is kept, for 
$30.00. Purchases a lot of hardware at a bankrupt sale, giving his check 
for the amount, $750.00. Returns to Moline Manufacturing Co. goods 
which cost $35.00, receiving credit for that amount. Cash sales, $58.00. • 

April 17 

William Gibson returns as unsatisfactory goods purchased on April 8, 
to the amount of $7.50. He is given credit for that amount, and pays the 



BOOKS OF ORIGINAL ENTRY 



23s 



balance of his bill for that date. Receives an invoice from the Sinmions 
Hardware Co., St. Louis, Mo., $750.00, 2/io/n/30. Pays freight on this 

shipment, $30.00. 

April 18 

Sells Herman Rowe, Morgan Park, Illinois, builders' hardware, $180.00 
on account, f.o.b. his station. Pays freight on same, $250.00. Cash 

sales, $67.50. 

AprU 19 

Sells Andrew Anderson $75.00 on account. Jacob Gunderson pays his 

bill of April 9. Cash sales, $77.50. 

April 20 

Pays salaries for the week, with addition of $15.00 to a boy for general 

office and errand work. Pays Moline Manufacturing Cp.'s invoice of 

April II, less discount. Cash sales, $75.00. Henceforth cash sales will be 

reported as weekly totals. 

. AprU 22 

Withdraws for personal use, $50.00. Pays W. D. Allen Co.'s invoice 

of April .1 2 , less discount. 

April 23 

Andrew Anderson is allowed credit of $15.00 for merchandise which 
proved defective. He pays his accoimt to date. 

AprU 24 
Sells Henry Greiner, Monee, Illinois, builders' hardware to the amount 
of $200.00. We prepay the freight, $4.50, and add it to the amoimt of the 
invoice, charging his account with the total. 

AprU 25 
Purchases a clock for the office, $1 5.00. Sells Herman Rowe on account, 
$50.00. Discounts own note at bank, $500.00 for thirty days, discounted 
at 6 per cent. 

AprU 26 

Pays $10.00 for repairs on store furniture. Pays $7.50 for materials 
used in decorating the show windows. Receives invoice from Hibbard, 
Spencer, and Bartlett, for $400.00, 2/2o/n/3o. Sells Jacob Gimderson 
$65.00 on account. 

AprU 27 

Sells William Gibson $75.00 on account. Pays salaries, same as last 
week. Withdraws $50.00 for personal use. Pays Simmons Hardware 
Co.'s invoice of April 17, less discount. Cash sales for the week, $395.00. 



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PRINCIPLES OF ACCOUNTING 



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April 2Q 
Pays a biU at the garage, $27.00, for supplies and work on the car. 
Receives invoice from Simmons Hardware Co., $300.00, 2/io/n/3o. Cash 
sales, $69.00. 

April JO 

Herman Rowe pays his account to date. Sells Henry Greiner $90.00 
on account. Cash sales, $105.00. 

Post all accounts up to date and take a trial balance. Merchandise 
inventory April 30 is $6,740.00. Office supplies on hand amount to $35.00. 
Depreciation on the auto truck is taken to be 24 per cent for the year, and 
on office and store equipment it is taken to be 1 2 per cent yearly. Make all 
necessary adjustments for insurance and interest, in order to show as 
correctly as possible the true amount of the month's profit or loss. The 
pay-roll for two dajrs (one-third of a week) is accrued. 

Make all the entries necessary to adjust the accoimts and close the 
books, and post these entries to' the ledger. 

Prepare a balance sheet as of April 30, and a statement of profit and 
loss for the month of April. 



CHAPTER XXI 

CONTROLLING ACCOUNTS 

Some uses of special columns. Chapters xix and xx were devoted 
to a discussion of the books of original entry, with particular emphasis 
on the use of special columns in such books. There appeared, from 
this discussion, at least three distinct advantages resulting from the 
iise of special columns in the various journals. These advantages 
are: (i) greater simplicity in posting; (2) further analysis of particu- 
lar classes of transactions; (3) a further check on the accuracy of the 
entries. There is another advantageous use that may be made of the 
special column. This is its use in grouping a certain class of items of 
a similar nature for posting to a single account in the ledger, while 
allowing the details of this class of items to be shown in some form of 
subsidiary record. 

The controlling account, Accoimts Receivable furnishes an 
example of such a class of items, and Accounts Payable another. 
These two will be discussed in this chapter as representative of 
controlling accounts^ since they are the two examples of the controlUng 
account which are used in the accounting of nearly every business 
concern. Thus in the case of a business which sells on accoimt to a 
considerable number of customers, it is clearly undesirable to carry 
an account in the general ledger with each one of these customers. 
Such a practice would make the ledger accounts so numerous as to 
cause confusion and make the work of obtaining a trial balance at the 
end of a period a slow and difficult process. It is much better to 
carry the accounts with individual customers in a separate " customers* 
ledger" or "sales ledger," and to carry in the general ledger an account 
entitled Accounts Receivable, to which all debits and credits to 
customers will be posted. The posting to this general ledger account 
will be done, for the most part, from the footings of certain special 
columns in the books of original entry. 

The method by which this is accomplished can best be made clear 
by means of an illustration, which will be made as simple as possible. 

237 









238 



PRINCIPLES OF ACCOUNTING 



Assume, then, a small retail business in which practically all pur- 
chases are made on account, and in which sales are made both on 
account and for cash. The following books of entry are used: (i) a 
general journal; (2) a purchases journal; (3) a sales journal; (4) a 
^cash book: (a) cash receipts journal, (b) cash disbursements journal. 

All purchases are entered in the purchases journal as purchases on 
account and so posted, the payments being recorded in the cash book 
if made by cash, and in the general journal if by note. All sales on 
account are recorded in the sales journal, cash sales being entered 
in the cash book. No attempt is made to show any analysis of either 
purchases or sales in the books of original entry. Sales tickets are 
made out in duplicate for each sale, different colors being used for 
cash and credit sales. The amount of each charge sale (meaning by 
"sale" the total of the goods sold to any customer at one time) is 
entered separately in the sales journal, while the cash sales tickets are 
totaled at the end of each day and entered in the cash book as a single 
item, debiting cash and crediting sales. 

The forms to be used for the purchases journal and the sales 
journal in such a business may be made very simple indeed. Such 
forms are shown on pages 219 and 215, respectively. Each of them 
has only one money column, headed ''Amount." And if controlling 
accounts are not to be carried for customers or creditors, the cash 
book might be equally simple, providing only one money column in 
each of the cash journals, as shown on page 141. 

Assume, however, that it is intended to make use of "controlling" 
accounts for accounts receivable and accounts payable. This means 
that there will appear in the general ledger a single account which will 
show the total due from customers on open account, and a single 
account to show the total due to creditors on open account. These 
two accounts, known as "Accounts Receivable" and "Accounts Pay- 
able," respectively, are controlling accounts. The detailed debits and 
credits to each customer will be entered in his individual accoimt in a 
subsidiary ledger known as the "customers* ledger" or "sales ledger." 
Similarly, the individual account of each creditor will appear in another 
subsidiary ledger known as the "creditors 'ledger" or "purchases 
ledger." 

This change in the ledger accounts will necessitate certain modifica- 
tions of the forms of books of original entry, as previously illustrated. 



CONTROLLING ACCOUNTS 



239 



This is not true of the purchases journal or the sales journal, 
however, under the conditons assumed for this business. Thus, in 
order to carry an Accounts Receivable account it is not necessary 
to change the form of the sales journal, nor to introduce any additional 
columns. Since the sales recorded are all sales on account, the foot- 
ing of the single "Amount" column may be posted not only to the 
credit of sales but at the same time to the debit of accounts receivable. 
The amount of each sale would be posted to the debit of the account 
with the individual customer, in the "customers' ledger," or "sales 
ledger," such posting being made either from the items entered in the 
sales journal or from the sales tickets or invoices. 

But while the same form of sales book may be employed to record 
the debits to customers, some modification must be made in any form 
of journal which is used to record the credits to customers. The 
greater part of Such credits are entered on the debit or receipts side of 
the 'cash book. If the Accounts Receivable account in the general 
ledger is to be used as a control on all accounts with individual cus- 
tomers, a column for "Accounts Receivable, Credit" must be included 
in the cash receipts journal. If posting to the credit of customers' 
accounts is to be done from the cash receipts journal and not from 
remittance slips or other vouchers, a separate ledger folio column will 
be needed to show postings to the customers' ledger. If cash discounts 
are to be granted to customers, still another column will be needed 
in the cash receipts journal for "Cash Discount on Sales, Debit." 
Since such discounts are not usually allowed in a retail business, the 
cash receipts journal might take the following form: 

CASH RECEIPTS 



Date 


Account 
Credited 


Explanation 


General 
L.F. 


Cus- 
tomers' 
L.F. 


General 

Ledger 

Cr. 


Accounts 
Receiv- 
able 
Cr. 


Sales 
Cr. 


Cash 
Dr. 


Jan. 


z 
a 
2 
s 

4 


Balance 

H. B. Reed 

Sales 

Int. on bonds 

B. L. Strong 


On hand 
On account 
Cash sales 
Int. fifth L.L. 
In full of acct. 






10 


00 


SO 
80 


00 
00 


8s 


00 


3,500 
50 

8s 
10 
80 


00 
00 
00 
00 
00 



It will be apparent that in using this form of cash receipts journal 
no posting of single items will be made into the general ledger except 




1 1 



w ■ 



ii 



't ii. 







240 



PRINCIPLES OF ACCOUNTING 



from the column headed " General Ledger, Cr." In this column are 
entered the amounts to be credited to general ledger accounts whose 
names appear in the ** Account Credited" column, and for which no 
special column is provided. The credit to sales will be posted, as 
explained previously, through the footing of the column for sales. 
The total of the colunm headed ** Accounts Receivable, Cr." will be 
posted to the credit of the controlling account, accoimts receivable, 
in the general ledger, while the credits to the individual customers' 
accounts will be posted item by item to the appropriate accounts in 
the customers' ledger, the total of these items being, of course, the 
same as the total of the column. A separate folio column is provided 
for the folio numbers in the customers* ledger. 

It is apparent that following this procedure in connection with 
the record of sales on account and with cash receipts would result in 
having posted into a single account in the general ledger, at the end 
of the accounting period, the total of the debits made to customers 
for merchandise sold them on account, and also the total of the 
credits made to these customers for cash received in payment of 
their accounts. The items composing the total of such a debit will 
have been posted to the proper accoimts in the subsidiary ledger, 
as will the items composing the total credit mentioned above. 
If no entries were made to the debit or credit of customers' accounts 
from any other books of original entry, then it is evident that, when all 
posting had been done to date, the balance in Accounts Receivable, the 
controlling account, would equal the total of the balances of the 
customers' accounts. In the type of business under discussion, any 
entries made to the customers' accounts which are not recorded in 
one of these two journals would be recorded in the general journal. 
Any such entry made in the general journal and affecting accounts 
receivable would need to indicate not only the debit or credit to 
accounts receivable in the general ledger but also the name of the 
customer's account which was to be debited or credited in the cus- 
tomers' ledger. Thus if B. L. Strong had given his note for the 
amount of his account, instead of paying cash, the entry would have 
been made in the general journal, the journalization being as follows: 

Notes receivable $80.00 

Accounts receivable, B. L. Strong .... $80.00 



CONTROLLING ACCOUNTS 



241 



The credit would be posted to accounts receivable in the general 
ledger, and also to the credit of Strong's account in the customers' 
ledger, so that the control on the individual accounts would still be 
maintained in the accounts receivable account. This principle must 
always be held in mind in making any entry by which a controlling 
account is affected. 

Assuming that the retail establishment under discussion had 
dealings with several wholesale houses from which they purchased 
merchandise on account, it is probable that they would also make use 
of a creditors* ledger to show the detail of these accounts, with a 
controlling account in the general ledger, headed "Accounts Payable." 
The same form of purchases journal that has already been discussed (see 
page 219) could be used, provided a different procedure were followed 
in posting from this journal. Since the amoimts entered in this 
record all represent purchases on account, the total would be posted 
to the debit of Purchases and to the credit of Accounts Payable. 
The credits to the accounts of the individual creditors might, as in 
the case of the sales, be posted either from the entries in the book of 
original entry or from the invoices. 

The chief source of credit posting to Accoimts Payable is the cash 
disbursements journal, in which payments to creditors are recorded. 
A form of such a journal which would fill the needs of such a business 
as the one assumed here is as follows: 









CASH DISBURSEMENTS 














Date 


Account 
Debited 


Explanation 


General 
L.F. 


Credi- 
tors' 
L.F. 

• 


General 

Ledger 

Dr. 


Accounts 
Payable 


Cash 
Discount 
on Pur- 
chases 
Cr. 


Cash 
Cr. 


Jan. 


I 
2 
3 

4 


Rent 

Smith & Co. 
Notes payable 

Wilson & Co. 


Rent for Jan. 
InvoiceNo.145 
Hyde Park 

Bank 13/2 
Invoice N0.147 






100 
1,000 


00 
00 


Soo 
4SO 


00 
00 


10 
9 


00 
00 


xoo 

490 

1,000 
441 


00 
00 

00 
00 



In using such a form as this, each item entered in the "General 
Ledger, Dr." column would be posted separately to the debit of the 
account whose name appears opposite it in the "Account Debited" 
colimm. The total of the colunm headed "Accounts Payable, Dr." 



1 



1 i 



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11' -i 



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i 



V 



im 



242 



PRINCIPLES OF ACCOUNTING 



would be posted to the debit of that account in the general ledger, 
each iteni in that column being posted separately to the individual 
creditor's account in the creditors' ledger. The footing of the column 
headed ''Cash Discount on Purchases" would be posted to the credit 
of the account of that title. The last column, headed "Cash, Cr.," 
is used to show the net cash payment involved in each case, and is in 
effect the credit side of the cash account, the debit side being the 
"Cash, Dr." column in the cash receipts journal. 

Entries for transactions affecting any of the accounts with trade 
creditors which do not happen to fall into either the purchases journal 
or the cash disbursements journal must still be made in such a way as 
to make possible the posting to both the item account in the subsidiary 
ledger and to the controlling account in the general ledger. The 
principle governing this was discussed in connection with accounts 
receivable, and what was said there applies also to the creditors* 
accounts. Thus, if the business returns to a trade creditor unsatis- 
factory goods to the amount of $100, the entry could not be made in 
any of the special journals discussed above, but would have to be 
made in the general journal, the journalization being as follows: 

Accpimts Payable, Smith Brothers '. . $icx>.oo 

Purchase Returns and Allowances . . . $100.00 

The debit here would, as stated above, be posted both to the general 
ledger account and to the item account in the subsidiary ledger. 

The use of the controlling account illustrated. The relation of the 
controlling account to the subsidiary ledger which it controls, and the 
relations of the special columnar journals to each other and to the use 
of the controlling accounts, may be made clearer by means of a simple 
illustration. This illustration will present all the books of entry 
which would be required by a simple retail business. Representative 
entries will be made in these books, and the effect of these entries 
on the accounts will be depicted. It would of course be impracticable 
to show the entries for a month's business, but for purposes of illus- 
tration the few entries shown below may be taken as representing the 
total business transactions for a month. The skeleton ledger accounts, 
used to represent the ledger, are numbered, the number of each 
representing the page upon which that account is found. The forms 



CONTROLLING ACCOUNTS 



243 



of the various journals are those already illustrated and discussed. 

They are combined here into what might be called a tabloid set of 

books, as follows: 

PURCHASES JOURNAL Page 1 



Date 


L.F. 


Name of Creditor 


Address 


Terms 


Invoice 
Number 


Accounts 
Payable, Cr. 


Oct. 


I 


4 


Hart, Schaffner 


















& Marx 




2/io/n/30 


I 


600 


00 




4 


I 


Adler Bros. 




2/io/n/30 


2 


7SO 


00 




10 


S 


Johnson & Mur- 


















phy 




Net 30 


3 


SOO 


00 




16 


6 


Wilson Bros. 




2/io/n/3o 


4 


450 


00 




17 


7 


J. B. Stetson Co. 




2/io/n/6o 


5 


300 


00 




24 


2 


Black Cat Tex- 


















tile Co. 




2/io/n/30 


6 


250 


00 




29 


3 


Cluett, Peabody 














31 


L.Q 


&Co. 
Purchases, Dr. 




Net 30 


7 


300 


00 




(5)3,150 


00 



Note. — It will be seen here that there are two items posted to the general 
ledger, both of the same amount. The ledger page of the purchases account is in- 
dicated in the folio column at the left. That of accounts payable is shown in 
parenthesb just to the left of the footing of the amount colimm. 











SALES JOURNAL 






Pagel 




Date 


L.F. 

I 
6 
4 
5 
7 
I 

3 
6 

5 
2 

L.7 


Name of Customer 


Address 


Terms 


Invoice 
No. 


Accounts 

Receivable, 

Dr. 


Oct. 


I 

4 
8 
10 
14 
17 
20 

24 
27 
30 

31 


0. L. Buhr 
D. Tollefson 
H. A. Howard 
P. T. Nelson 
A. Wyman 
0. L. Buhr 
F. T. Enke 
D. Tollefson 
P. T. Nelson 
F. B. Barton 

Sales, Cr. 


1 2 14 Fourth St. 
515 Oak St. 
744 University Ave. 
1525 Riverside Ave. 
1206 Como Ave. 
1 2 14 Fourth St. 
625 Ninth Ave. 
SIS Oak St. 
1525 Riverside Ave. 
78 Prospect Place 




I 

2 

3 

4 

5 
6 

7 
8 

9 
10 


75 
50 

35 
12 

65 
14 
60 
18 
50 
65 


00 
00 
00 

50 
00 
50 
00 
00 
00 
00 


. 


(i) 445 


00 



Note. — ^The folio numbers of the general ledger accounts affected are shown 
in the same manner as in the purchases journal. Thus the page of sales account 
is indicated in the folio column, while that of accounts receivable is written in 
parenthesis next to the footing of the amount column. 



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PRINCIPLES OF ACCOUNTING 



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General 
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CONTROLLING ACCOUNTS 



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For October 
Stamps and stationery 
Weekly pay-roll 
Invoice No. i 
Invoice No. 2 
Week's pay-roll 
Adding machine 
Week's pay-roll 
Invoice No. 4 
Invoice No. 5 
Week's pay-roll 
Telephone and telegimph 


• 


1 

< 


Rent 

Office expense 
Sales salaries 
Hart, SchaflFner&Marx 
Adler Bros. 
Sales salaries 
Office equipment 
Sales salanes 
Wilson Bros. 
J. B. Stetson Co. 
Sales salaries 
Office expense 


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246 



PRINCIPLES OF ACCOUNTING 



JOURNAL 



Ptgel 



2 
6 



2 

I 



5 
10 



8 

I 



Oct. I 
Cash 
Notes Receivable 

J. B. Wright, Proprietor 
To record J. B. Wright's original 
investment in retail clothing 
business 
(Cash $6,500 and F. Johnson's 
note for $100, dated 8/7/19, 
with interest at 6 per cent) 
25 
Notes Receivable 

Accounts Receivable, F. T. Enke 
His thirty-day note without 
interest for our Invoice No. 118 
29 
Accounts Payable, Wilson Bros. 

Purchase Returns and Allowances 
Returned unsatisfactory goods 
Invoice No. 78 

30 
Sales Returns and Allowances 

Accounts Receivable, P.T.Nelson 
Returned goods on Invoice No. 9 



6,500 
100 



60 



12500 



00 
00 



00 



20 



00 



GENERAL LEDGER 



6,600 



60 



125 



20 



00 



00 



00 



00 







Accounts Receivable 




Pagel 


Oct. 31 




SJ I 


445 


00 


Oct. 31 
30 
25 




C 2 


243 
20 

60 


00 
00 
00 


Notes Receivable 


Page 2 


Oct. I 
25 




J I 
J I 


100 
60 


00 
00 


Oct. 7 




C 2 


100 


00 


Office Equipment 


Pages 


Oct. 17 




C3 


225 ( 


30 












Accounts Payable 


Page 4 


Oct. 31 
29 




C3 
J I 


2,100 ( 
125 ( 


00 

cx> 


Oct. 31 




pji 


3.150 


00 



Oct. 6 

13 
20 

27 



CONTROLLING ACCOUNTS 



J. B. Wright, Proprietor 



^3 


125 


00 




C3 


125 


00 




C3 


125 


00 




C3 


"5 


00 





247 

Page 6 





• 








Oct. I 


Investment 


J I 


6,600 


00 




Merchandise Sales 




Page 6 

^m. 












Oct. 31 
31 




SJ I 

C 2 


w 

445 
960 


00 
00 




Sales Returns and Allowances 

! 




Page? 


Oct. 30 




J I 


20 


00 












Merchandise Purchases 




Pages 


Oct. 31 




PJi 


3,15000 














Purchases Returns asd Allowances 




Pages 










Oct. 29 




J I 


125 


00 




Sales Salaries 




Page 10 



Office Expense 




Page 11 


Oct. 3 

30 




C3 


60 
18 


00 
00 










• 


Rent 




Page 12 


Oct. I 




C3 


100 


00 












Cash Discount on Purchases 




Page IS 


• 










Oct. 31 




C3 


42 


00 


Interest on Notes Receivable 




PageU 




< 






Oct. 7 




C 2 


I 


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248 



Oct. 13 



PRINCIPLES OF ACCOUNTING 

CUSTOMERS' LEDGER 
O. L. BuHR, 1 2 14 FouETH Street 



CREDITORS* LEDGER 
Adler Brothers 



C3 



7SO 



cx> 



Oct. 4 



Black Cat Textile Company 



Oct. 17 



P I 



P I 



Pagel 



Oct. I 

17 




S I 
S I 


75 
14 


00 
50 


Oct. II 




C 2 


75 


00 


t 


F. B. Barton, 78 Prospect Place 




Page 2 


Oct. 30 




S I 


65 


00 














F. T. Enke, 625 Ninth Avenue 




Pages 


Oct. 20 




S I 


60 


00 


Oct. 25 




Ji 


60 


00 




H. A. Howard, 744 University Avenue 




Page 4 


Oct. 8 




S I 


35 


00 


Oct. 21 




C 2 


35 


00 




P. T. Nf.t.son, 1525 Riverside Avenue 




Page 6 


Oct. n 

27 




S I 
S I 


12 
SO 


50 
00 


Oct. 3a 




Ji 


20 


00 




D. ToLLEisoN, 515 Oak Street 




Page 6 


Oct. 4 

24 




S I 
S I 


50 
18 


00 
00 


Oct. 17 
30 




C 2 
C 2 


50 
18 


00 
00 




A. D. Wyman, 1206 CoMO Avenue 




Page? 


Oct. 14 




S I 


65 


00 


Oct. 29 




C 2 


65 


00 



Pagel 



750 



00 



Page a 



250 



00 



I 



CONTROLLING ACCOUNTS 



Cluett, Peabody & Company 



249 
Pages 













Oct. 29 




P I 


300 


00 


Hart, Schapfner & Marx 




Page 4 


Oct. 9 




C3 


600 


00 


Oct. I 




P I 


600 


(X> 


Johnson and Murphy 




Pages 










Oct. 10 




P I 


500 


00 


Wilson Brothers 




Page 6 


Oct. 29 
26 




J I 
C3 


125 
450 


00 
00 


Oct. 16 




P I 


450 


00 


J. B. Stetson Company 




Page? 


Oct. 27 




C3 


300 


00 


Oct. 17 




P I 


300 


00 



A trial balance taken from the ledger at the end of the month 

appears as follows: 

J. B. WRIGHT 

Trial Balance— October 31, 1919 

Cash $4,843.00 

Accounts receivable 122.00 

Notes receivable 60.00 

Office equipment 225.00 

Accounts payable $ 925.00 

J. B. Wright, capital 6,600.00 

Sales 1,405.00 



Sales returns and allowances . 

Purchases 

Purchase returns and allowances 
Sales salaries .... 
Office expense .... 

Rent 

Cash discount on purchases 
Interest on notes receivable 



20.00 
3,150.00 

500.00 

78.00 

100.00 



125.00 



42.00 
i.oo 



$9,098.00 $9,098.00 



! 






250 PRINCIPLES OF ACCOUNTING 

The two subsidiary ledgers may be summarized as follows: 

Schedule No. i — Accounts Receivable 

O. L. Buhr I 1450 

F. B. Barton 65.00 

P.T.Nelson 42.50 

Total $122.00 

Schedule No. 2 — Accounts Payable 

Black Cat Textile Co $ 250.00 

Cluett, Peabody & Co . . . . . 300.00 
Johnson & Murphy 500.00 

Total •. $1,050.00 

Less Wilson Bros, (debit balance) . . . 125.00 

Balance $ 925-00 

It will be noted that the result of each of these summaries agrees 
with the balance shown by the controlling account for the subsidiary 
ledger in question. 

Summary. The prmciples which have been developed in con- 
nection with the use of the controlling account may be summarized 
as follows: 

1. If a group of accounts of similar nature becomes very numerous, 
it is often undesirable to carry the individual accounts which compose 
this group in the general ledger. (For example: "Accounts Receiv- 
able," "Accounts Payable," "Machmery," "^Law Materials.") 

2. The situation described in (i) may be met by carrying the 
individual accounts of this group in a special subsidiary ledger, and 
carrying in the general ledger a single controlling account for the 
entire group. 

3. The use of a subsidiary ledger and a controlling account neces- 
sitates some means of posting the items of debit and credit to the 
individual accounts, and also of posting the same items in summarized 
form into the controlling account. 

4. In order to secure postings in summarized form to a controlling 
account, special colunms will be required in books of original entry in 
which entries are made affecting such controlling account. 

5. Posting to the accounts in the subsidiary ledger may be made 
either from the individual entries in the books of original entry, or 



CONTROLLING ACCOUNTS 



251 



directly from the vouchers made out in connection with the transac- 
tions which affect these individual accounts. 

Also, the discussion and the illustrations given in this chapter 
should indicate that at least four purposes may be served by special 
columns in books of originar entry. These four purposes are: 
(i) the saving of labor in posting; (2) check on the equality between 
debit and credit entries in any given journal, obtained by comparing 
the totals of the debit columns with the totals of the credit columns; 
(3) analysis of data in the books of original entry; (4) the use of 
subsidiary ledgers and controlling accounts. 

QUESTIONS FOR CLASS DISCUSSION 

1. You are asked to design a complete accounting system for a wholesale 
hardware establishment. Outline the information which you should 
require before you could decide upon the form of the various books of 
original entry. 

2. Define the controlling account. Give examples of such accoimts. 
What are the advantages in the use of controlling accounts ? 

3. Refer to the books of original entry that you were asked to plan for the 
use of the Miller Company aj^d the Saunders Company, in the questions 
at the end of chapters xix and xx. Would you need to modify these 
forms in order to make use of controlling accounts with accoimts receiv- 
able and accoimts payable ? Why, or why not ? If such modifications 
are necessary, describe them in detail. 

4. Give an analysis of the debits and the credits that affect the account 
with accounts receivable. Through what book or books of original 
entry will each of these debits and credits be posted ? 

5. Answer the same questions with regard to accoimts payable that are 
asked in Question 4 with regard to accounts receivable. 

6. Referring again to the Miller Company, assume that they use a sub- 
sidiary ledger for accounts with trade creditors, one for city customers, 
and one for country customers, and that all posting to these subsidiary 
ledgers is done directly from the vouchers. You are asked: 

a) To design a complete set of books of original entry for this company. 

b) To describe in detail the posting to be made from each of the books 
of original entry. 

c) To describe in detail the posting to the item accounts in the sub- 
sidiary ledger, telling what vouchers are used for this posting. 

What bases of analysis do the books of original entry which you have 
designed provide for each class of transactions ? Discuss the value of 
each such basis of analysis. 



I 




252 PRINCIPLES OF ACCOUNTING 

7, Can you suggest any classes of accounts beside accotmts with customers 
and accounts with creditors, which might advantageously be kept in 
subsidiary ledgers? If so, outline a method of recording the debits 
and credits to such accounts, and of posting these debits and credi's 
to the general ledger and to the subsidiary ledger. 

REFERENCES FOR FURTHER STUDY 
Kester, Roy B., Accounting Theory and Practice^ Vol. I, chaps, xlvi and 

xlvii. 
EsQUERKE, Paul- Joseph, Applied Theory of Accounts, chap. xi. 
Paton, W. a., and Stevenson, R. A., Principles of Accounting, pp. 96-102. 



W \ 



CHAPTER XXn 

THE CONSTRUCTION AND INTERPRETATION 

OF ACCOUNTS— ASSETS 

Chapters vi and vii were devoted to a consideration of the con- 
struction and interpretation of various kinds of accounts. The dis- 
cussion there given was quite elementary and did not mention some 
accounts which are frequently used. Beginning with the present 
chapter, that earlier discussion will be reviewed and some things 
will be introduced which were there omitted. 

In doing this, the method of approach employed will be the same 
as that employed in the earlier discussion of the subject. Thus, in 
connection with each account taken up, the following points will be 
considered: (i) the purpose of the account; i.e., the information 
which is sought from the account; (2) the transactions which are to 
be recorded in it, or the debits and credits which are to be made to it; 
(3) what the balance of the account represents, and what disposition 
is made of this balance in the accounting reports. 

Cash account. Cash has already been considered from various 
aspects, and there is nothing to be gained by repeating some of the 
points that have previously been made. The student may be re- 
minded, however, that Cash includes not only money of all kinds but 
commercial paper, such as checks, bank drafts, and money orders, 
which is immediately bankable without being discounted. It also 
includes credit which the business may have with any bank. Such 
credit may be established by dep)Ositing money or bankable paper, 
or by borrowing from the bank. Borrowing from the bank may be 
accomplished either by giving the one-name note of the borrowing 
concern, or by discounting a note or trade acceptance on which some 
trade debtor of the borrowing firm is primarily liable. Credit with 
the bank may also arise through collections from customers made 
by the bank and deposited to the credit of the business, through 
interest accruing on the balance at the bank, and through collections 
of interest coupons (on bonds). 

253 



i 



I : 

t 



I 



I 




« \ 



I 



254 



PRmaPLES OF ACCOUNTING 



The transactions affecting the Cash account, and the debits and 
credits to be made to that account, may be indicated as follows: 

CASH 



Debit: 

With the amount of all money and 
bankable paper received. 

With all credits made to the account 
of the business (aside from credits 
made as a result of the deposit of 
the foregoing) by the bank, for col- 
lections, interest, etc. 



Credit: 
With all money paid out in the form 

of currency (usually from a petty 

cash fund). 
With all checks drawn. 
With all other charges made to the 

account of the business by the bank, 

for any cause whatever. 



tTie entries for all these debits and credits will be made in the 
cash book, as previously explained. The amount of cash on hand 
(held by the business) at any time includes cash received by the busi- 
ness but not yet deposited, as well as the amounts of any special 
funds that may be carried by the business, such as petty cash, o^ce 
cash, and the like. 

In chapter vii it was stated that a proof of cash should be taken 
frequently. It is also desirable to affect a reconciliation of cash as 
shown by the records of the business with the figure shown by the 
bank statement, whenever such a statement is received. This means 
comparing the amount of unused credit at the bank as shown by the 
firm's records with the amount of such credit as shown by the bank 
statement. The figure shown by the records of the business, plus 
the total of checks drawn but not included in the bank statement, 
should equal the balance shown by that statement. Any discrepancy 
must be accounted for and adjusted. 

A ccounts Receivable. Accounts Receivable is a controlling account, 
showing the total amount owed to the business on open account by its 
customers. Posting to this account is done chiefly from the footings 
of certain special columns in the books of original entry, while the 
accounts in the customers' ledger, which show the amounts due from 
individual customers, are posted either from the entries in the book 
of original entry or directly from the vouchers. 

The kinds of transactions affecting the Accounts Receivable 
account, and the nature of the debits and credits to this account, 
may be indicated as follows: 



CONSTRUCTION OF ACCOUNTS— ASSETS 



ACCOUNTS RECEIVABLE 



255 



DebU: 

With the invoiced price of all sales 
to customers on open account. 

With freight, cartage, etc., prepaid, 
where such items are added on the 
invoice (sometimes included in in- 
voiced price). 

With the amount of notes receivable 
given by customers and dishonored 
at maturity, when such dishonored 
notes are not otherwise recorded. 

With all charges incurred in connec- 
tion with notes receivable dishon- 
ored, when such charges are not 
debited to a separate account. 



Credit: 

With cash received from customers in 
payment of accounts. 

With the amotmt of all discounts 
allowed to customers for cash pay- 
ments. 

With the amount of all allowances 
and rebates of any sort granted to 
customers. 

With notes given by customers m 
pajrment of accounts. 

With the invoice price of goods re- 
turned by customers. 



The balance of this account shows the total owed the business on 
open account by its customers. It is desirable that the individual 
accounts should be totaled rather frequently, perhaps at the end of 
each month, and the total compared with the balance of the controlling 
account. Any discrepancy should be discovered and explained, and 
the necessary adjustments made to bring the individual accounts 
into agreement with the controlling account. 

Reserve for Bad Debts. It has already been suggested that the 
assets which take the form of claims against customers are subject to 
some evaluation. Experience has demonstrated that customers do not 
always make good their promises to pay. In order to guard against 
an overstatement of the proprietorship and of the current profits, a 
charge is made at the end of the fiscal period to an account with bad 
debts, or loss from bad debts, and a credit made to an account with 
reserve for bad debts. The latter account is a validation account, so 
named because it is used, in connection with an asset account, for 
the purpose of helping to show the correct valuation of the asset in 
question. It is similar in its nature to the depreciation reserve 
accounts, and should be shown on the balance sheet as a deduction 
from the amount of the total accounts receivable, as follows: 



Accounts Receivable . 
Reserve for Bad Debts 



$2,500.00 
50.00 



$2,450.00 



I 

i 

I 

i 



r- 

f 
I' 



I 



k 



Il I 



256 



PRINCIPLES OF ACCOUNTING 



CONSTRUCTION OF ACCOUNTS— ASSETS 



257 



h 




?l 




The amount to be charged against income and credited to the re- 
serve for bad debts account at the end of the period depends partly 
on the experience of the business, and partly on the character of the 
accounts receivable at that particular tune. It should be sufficient 
each period to cover the estimated losses of that period. Whenever 
such a loss is definitely ascertained to have occurred, the reserve 
account will be debited and the customer's account credited with the 
amount of such loss. This serves to write ofiE the now worthless 
account, and to indicate that a loss of that amount has actually been 

sustained. 

The type of transactions affecting the Reserve for Bad Debts 
account, and the nature of the debits and credits to be made to this 
account, may be indicated as follows: 

RESERVE FOR BAD DEBTS 



DebU: 

With the amount of any account claim 
against a customer which is written 
off as uncollectable. 



Credit: 

At the close of the accounting period 

with the amount estimated to be 

equal to the losses from bad debts 

attribuUble to the period just past. 



The balance of such an account, if a credit, indicates the amount 
by which the estimated losses exceed the actual losses ascertained to 
that date. If a debit balance, it shows the amount by which such 
ascertained losses have exceeded the estimate. A debit balance in 
this account may mean that some extraordinary loss has occurred. 
Or it may mean that the the actual losses for the period have exceeded 
the credit made at the end of the preceding period. Or it may mean 
that the administration of credits and collections has been inefficient. 
In any case it is a matter of interest to the management, and requires 
an explanation. 

Notes Receivable. The nature of Notes Receivable and the cir- 
cumstances under which they may be received have aheady been 
discussed rather fully. It is the purpose of the Notes Receivable 
account to show the amount of short-time notes and accepted time 
drafts held by the business, including only those which have not yet 
reached maturity. Where notes are received from parties other 
than customers, it is desirable to set up a separate Notes Receivable 
account for such notes. 



The kind of transactions which affect the Notes Receivable 
account, and the nature of the debits and credits to this account, are 
indicated by the following: 

NOTES RECEIVABLE 



DebU: 
With the face value of all notes 

received. 
With the face value of accepted time 

drafts received. 



CredU: 
With the amount of cash or other 

property received in payment of 

notes. 
With the face value of any notes 

transferred, sold, discounted, or in 

any way disposed of. 
With the face value of notes dis- 

honored(not paid at maturity). 



The balance of this account shows the total face value of all the 
unmatured written promises to pay received by the business from its 
customers, and which are still held by the busmess. As stated above, 
it is generally well to have a separate account for notes received from 
those other than customers. Also, as soon as a note passes maturity 
without being paid, it should no longer be carried under the head of 
notes receivable, since it is presumably inferior in quality to the other 
assets composing that group, and should therefore be valued on a 
different basis. Of course, where a business holds only a few notes 
and the manager knows the circumstances in connection with each, 
such a division of this account may be unnecessary. 

Notes Receivable Discounted. It is quite usual for a business con- 
cern to discount customers' notes at the bank, in order to secure the 
means of meeting its own obligations. In order to transfer such a 
note to the bank, it must be indorsed by the payee, who thus assumes 
a secondary liability for its payment at maturity. In most such 
cases the bank is in reality lending the money to the concern which 
sold the goods, and which discounts the note, mainly on the credit 
of that concern, reinforced by whatever additional security the 
signature of the maker may represent. For if at maturity the maker 
fails to take up the note at the bank, the payee, who indorsed it, 
must do so. 

When a customer's note is discoimted at the bank, therefore, a 
credit to Notes Receivable scarcely causes the accounts to reflect the 
true condition of affairs, as it entirely ignores the liability to the bank 



1 



\r-x 



in 

ii 




n 

k \ 



258 



PRINCIPLES OF ACCOUNTING 



which has been assumed by the indorser. This liabiUty is not an 
absolute one, but is contingent upon the failure of the maker to pay 
the note at maturity. It is therefore known as a contingent liability. 
There is more than one way in which these facts may be shown in the 
accounts and on the balance sheet. One method which is acceptable 
will be indicated here. When the note is discounted, cash and interest 
will be debited, and an account called Notes Receivable Discounted will 
be credited. This leaves the amount of the discounted note included 
in the balance of the Notes Receivable account, this amount being 
offset by the credit to Notes Receivable Discounted. 

Assuming the balance of the notes receivable account to be $600, 
and the balance of the Notes Receivable Discounted account to be 
$200, the showing on the balance sheet would be as follows: 

Notes Receivable $600.00 

Less Notes Receivable Discounted . . 200 . 00 

$400.00 

This has the effect of showing the notes receivable at their net 
figure, $400, and at the same time it serves notice to anyone reading 
the balance sheet that a contingent Uability exists, to the amount of 
$200. When one of the discounted notes matures, if no notice is 
received from the bank of its non-payment by the maker, an entry 
is made debiting Notes Receivable Discounted and crediting Notes 
Receivable. If such notice is received, Notes Receivable Discounted is 
debited and Cash credited, since the note must be taken up at the bank 
by the indorser. The face value of the dishonored note is then 
transferred from the Notes Receivable account, being debited either 
to the customer's open account or to an account with Notes Receivable 
Dishonored, which will be considered later. 

The debits and credits to be made to the account with Notes 
Receivable Discounted may be indicated as follows: 

NOTES RECEIVABLE DISCOUNTED 



Debit: 
At the time the note is paid with the 
face value of the discounted note 
paid. 
At the time the note is dishonored 
with the face value of the dis- 
counted note dishonored (crediting 
notes receivable). 



Credit: 
At the time of discount with the face 
value of the notes receivable 
discounted. 



CONSTRUCTION OF ACCOUNTS— ASSETS 



259 



Notes Receivable Dishonored. As indicated in the foregoing, a 
dishonored note should not continue to be carried in the Notes Receiv- 
able account. The face value of the note may be transferred back to 
the customer's open account, which would also be charged with any 
ex{)enses incurred in connection with the note's dishonor, such as 
protest fees, or the face value of the note may be carried to an account 
entitled Notes Receivable Dishonored. If the first method, that of 
debiting the customer's account, is used, special attention must be 
given to the valuation of such accoimts for balance-sheet purposes. 
K the Notes Receivable Dishonored account is used, the debits and 
credits to be made to this account may be indicated as follows: 

NOTES RECEIVABLE DISHONORED 



Debit: 
At the time of dishonor the face value 
of any note receivable dishonored 
(crediting notes receivable). 



Credit: 

With the face value of any note dis- 
honored which is later paid by the 
maker or any previous indorser. 

With the face value of any dishon- 
ored note for which a new note is 
accepted. 

With the face value of any dishonored 
note written off as uncollectable 
(debiting reserve for bad debts, or 
some special account, such as "loss 
from uncollectable notes," accord- 
ing to the method in use in the 
business). 



The balance of the Notes Receivable Dishonored accoimt shows 
the face value of all such notes still held in the hope of collection, and 
is shown on the balance sheet as an asset, subject to a valuation which 
must be made after careful consideration of the circumstances in 
connection with each such note. Protest fees and other charges 
incurred in connection with such notes will be charged to the open 
account of the maker of the note. If ascertained to be uncollectable, 
the amount of such charges will be credited to Accounts Receivable 
and debited to Reserve for Bad Debts. 

Accounts with fixed assets. In chapter vi it was explained that 
an account with a fixed asset should be debited with the cost value 
of any additions to that asset, and credited with the cost value of 
any part of the asset destroyed, sold, or otherwise retired from use in 
the business. It was also pointed out that while the asset account 



II 

II 



26o 



PRINCIPLES OF ACCOUNTING 



M 




\\ I 



showed the particular asset always at cost, an account must be carried 
with reserve for depreciation on the fixed asset in order to keep a 
record of the loss in its value which is estimated to have occurred 
through its approach to the end of its useful life. 

The generally accepted basis of valuation of the fixed assets for 
accounting purposes, then, is that of cost less accrued depreciation. 
The principles involved seem logical enough, and should not be 
difl5cult to understand, and the student should by this time be quite 
familiar with the manner in which such estimated depreciation is 
booked, as well as the method by which the valuation of fixed assets 
is shown on the balance sheet. 

Charges to capital versus charges to revenm. It is not always simple 
or easy to carry out correctly and consistently the method of valu- 
ation indicated in the foregoing discussion. The difficulty in doing 
so arises from two main sources: (i) the difficulty in establishing a 
correct rate for estimating depreciation; (2) the difficulty of dis- 
tinguishing in every case between expenditures which add to the value 
of the fixed assets and those which are properly to be charged as 
current expenses. 

The first source of difficulty, that of the depreciation rate, is 
merely a matter of estimating the probable useful life of the asset. 
Such estimates are best made on the basis of experience with similar 
assets, either in the business in question or in other like business 
concerns. An adequate record of the life and performance of each 
imit of fixed assets used in the business will aid greatly in setting future 
depreciation rates and revising existing ones. The problem involved 
here may well receive careful and detailed study by the student of 
accounting, but it does not seem wise to devote more time to it at 
present. 

The other problem mentioned, that of the distinction between 
expenditures for current expenses and those for additions to fixed 
assets, must also be considered rather briefly here. The problem may 
be divided into two parts, as follows: (i) What expenditures are 
properly chargeable to the original cost of the asset? (2) What 
expenditures are properly chargeable as additions to the value of the 
asset ? 

As regards the first point, the original cost, it may be illustrated 
by indicating a few of the typical questions of this nature which are 



CONSTRUCTION OF ACCOUNTS— ASSETS 



261 



likely to come up. Thus in the case of a building which is constructed 
by the business, a decision would have to be made whether each of the 
following expenditures represented a part of the cost of the building 
or a current operating expense of the business: (i) the cost of a pre- 
liminary survey of the site; (2) payment for the architect's plans; 
(3) interest on the money invested in materials during the process 
of construction; (4) insurance of the materials during the process 
of construction. Or, in purchasing a new machine, is the cost of 
making a concrete base for its installation and the expense of actually 
installing it to be charged as part of the cost of the asset or as an 
operating expense ? The principle that governs in all such cases is 
that the expenditure should be treated as a part of the cost of the 
asset if it is an expenditure necessary to the acquisition of the asset 
in a working condition. On this basis all of the expenditures cited 
would be properly chargeable to the asset accounts. 

As the asset continues in use, certain expenditures will be neces- 
sary to maintain it in efficient operating condition. The building will 
require repairs and paint; taxes and insurance premiums must be 
paid in connection with its use. The machine or the office equipment 
will require repairs from time to time, as well as certain supplies 
necessary to their operation, such as oil, waste, and the like, and will 
necessitate the payment of taxes and insurance premiums. Expen- 
ditures of this type, representing as they do part of the necessary cost 
of using the asset for the current period, are pure expense, and should 
be charged as part of the current operating expense of the business. 
Such expenditures are said to be charges to revenue. 

Opposed to this type of expenditures is the class of expenditures 
which add to the investment in the asset, or the cost value of the asset. 
Such expenditures are those involved in the construction of the new 
building, or of a new wing to the old building, or in equipping the 
machine with some improved device that adds to its length of life or 
productiveness. Such expenditures are said to be charges to capital, 
since they represent additions to the long-time investment of the 
proprietors. 

Unless considerable care is used, expenditures of one of these 
classes may be confused with those of the other class. Thus it is not 
difficult to consider as an addition to the asset some expenditure which, 
if its effects were carefully analyzed, would be foimd to be necessary 



j 



I' 



''}, 




262 



PRINCIPLES OF ACCOUNTING 



for the maintenance of the asset, and not an addition to its value. 
On the other hand, a real addition to investment might easily be mis- 
taken for an operating expense. This distinction between capiial 
and revenue is an important one, since the showing of the current 
profits for each period and the showing of the proprietorship from 
time to time depend on the correctness with which such distinction 
is made. Thus if certain expenditures made in connection with the 
maintenance of a fixed asset, and properly chargeable to revenue, are 
wrongly charged to capital, or ** capitalized," not only will the assets, 
and consequently the proprietorship, be overstated, but the expenses 
for the period will be understated and the net profit therefore over- 
stated by that amoimt. 

The problem of distinguishing between capital and revenue 
charges is one which continually faces the accountant. There is no 
absolute rule to be laid down which will serve as a formula for its 
solution. It is merely a matter of careful judgment whether the 
expenditure in question represents an addition to the investment or 
whether it represents an operating expense of the current period. 

The debits and credits to a fixed asset account and the correspond- 
ing reserve for depreciation, or valuation account, may be indicated 
by the following statement: 

BUILDINGS 



Debit: 
With the total cost of all buildings 

purchased or constructed. 
With the cost of any additions or 

improvements which add to the 

value of a building. 



Credit: 
With the cost value of any buildings 

sold or otherwise disposed of. 
With the cost value of any part of a 

building destroyed or otherwise 

retired from use. 



RESERVE FOR DEPRECIATION OF BUILDINGS 



Debit: 
With the excess of cost value over the 
sale price or salvage value of any 
building or part of a building sold, 
destroyed, or otherwise retired from 
use in the business as a result of the 
operation of the depreciation factor. 



Credit: 
At the close of each with fiscal period 
the estimated depreciation on build- 
ings for that penod. 



As previously stited, the balance m the fixed asset account will 
show the cost value of all the buildings which are at that time owned 



CONSTRUCTION OF ACCOUNTS— ASSETS 



263 



and used by the business. The balance of the valuation account will 
show the amount of depreciation estimated to have accrued on the 
buildings then in use. The difference between the two balances 
represents the present valuation placed on the buildings for purposes 
of the balance sheet. These statements hold true so long as the 
depreciation reserve account is debited only with the amount of the 
realized loss of value which results from depreciation in some form. 
Thus if a building is destroyed by fire, storm, or other unforeseen 
accidental cause. Reserve for Depreciation of Buildings should be 
debited only with the amount of the estimated depreciation on that 
building up to the time of its destruction. If the amount of insurance 
collected is less than the excess of cost over estimated depreciation, 
the difference should be charged to some special profit and loss 
account, such as "Loss from Fire.'* Assume that the cost of a new 
building is $100,000, and its estimated life twenty years. Early in 
the second year of its life a wing of the building, the original cost of 
which is $20,000, is destroyed, and only $10,000 in insurance is 
collected. At the end of the first year, after the entry had been 
made to record the depreciation, the buildings account and deprecia- 
tion reserve account would appear as follows: 







BUILDINGS 








- 




100,000 


00 










RESERVE FOR DEPRECIATION ON BUILDINGS 








S,ooo 


00 



The portion of estimated accrued depreciation applicable to the 
wing which is destroyed is $1,000. The entry to record the loss might 
be made as follows: 

Cash (from the insurance company) . $10,000.00 
Reserve for Depreciation of Buildings 1,000.00 

Loss from Fire 9,000.00 

Buildings $20,000.00 



H 



ii 



264 PRINCIPLES OF ACCOXJNTING 

The two accounts under discussion would then appear: 

BUILDINGS 



100,000 



00 



20.000 



00 



RESERVE FOR DEPRECIATION ON BUILDINGS 



x,ooo 



00 



S,ooo 



00 



Such a situation might be handled differently, but if the depre- 
ciation reserve account is to retain its character as a valuation account, 
the foregoing method is the one to be used. 

QUESTIONS FOR CLASS DISCUSSION 

1. List as many kinds of transactions as you can which affect the account 
with cash. What is the nature of the voucher which occurs in connec- 
tion with each such transaction ? 

2. Mention as many kinds of transactions as you can which affect the 
account with accounts receivable, telling whether each such transaction 
results in a debit or credit to the accoimt. What kind of voucher or 
vouchers is involved in each ? 

3. What are the debits and credits involved when a business receives a 
customer's check in pajrment for an invoice, less discount for cash ? 

4. On Jime 5 the Saunders Company sells the firm of Mears & Pierce goods 
amounting to $700, sending them a sixty-day trade acceptance with the 
invoice, according to previous agreement. Mears & Pierce accept 
the draft and return it to the seller. What entry should be made on 
the books of the Saimders Company ? 

5. On Jime 25, the Saunders Company discoimts this trade acceptance 
at the bank at 6 per cent. What entry should be made on their books 
for this transaction ? 

6. This trade acceptance matures, and the Saimders Company receives 
no notice from the bank in regard to it and are therefore reheved from 
their secondary liabiHty as drawer. Should any entry be made to 
record this, and if so, what would the entry be ? 

7. Suppose the Saimders Company had received a notice from the bank 
that the acceptance had been dishonored by non-payment, and that the 
company was charged by the bank for the amount of the acceptance 



CONSTRUCTION OF ACCOUNTS-ASSETS 



265 



plus .a three-dollar protest fee. Is there more than one possible entry 
that might be made in such a case ? If so, give each entry that might 
be made. Which of them do you prefer, and why ? 

8. Assuming the acceptance to have gone to protest and to have been paid 
by the Saunders Company, with the charges, what entry would be made 
on the books of that company if Mears & Pierce later pay them the 
amount of the acceptance plus the charges ? 

9. On December 31, 1919, the Saunders Company decides to allow $125 
as the probable amount necessary to cover their losses from bad debts 
for the period just ended. Give the entry to show this. 

10. On February 12, 1920, the Saunders Company discover that an open 
account carried with one of their customers, having a balance at that 
time of $50, is absolutely uncollectable. What entry will they make to 
show their recognition of this fact ? 

11. What is meant by charging the amount of a given expenditure to 
capital? By charging it to revenue? What difference will it make if 
an expenditure is charged to capital which should properly have been 
charged to revenue ? If an expenditure properly chargeable to capital 
is charged to revenue ? 

12. Of the following expenditures, which do you think are properly charge- 
able to capital and which to revenue ? 

a) Freight-in on machinery purchased for use in factory. 

b) Replacement of window panes broken by a hail storm. 

c) Mechanics wages in making dies for use in manufacturing. 

d) Replacement of roof on building. 

e) Cost of construction of an unloading platform at warehouse. 
, f) Repairs on drayage equipment. 

g) Cost of a partition in an office building constructed at request of new 

tenants. 
h) Cost of demolishing old building on site Where a new building is to 

be constructed. 

REFERENCES FOR FURTHER STUDY 

Paton, W. a., and Stevenson, R. A., Principles of Accounting^ chaps. 

vi, xix-xxii. 
Mitchell, T. W., Accounting Principles y chap, xviii. 
Kester, Roy B., Accounting Theory and Practice, Vol. II, chaps, v, vi, 

and xi. 
Stockwell, H. G., Net Worth and the Balance Sheet. 
WiLDMAN, J. R., Principles of Accounting^ chaps, xvi-xxvii. 
Greendlinger, Leo, Financial and Business StatementSy chaps, vii, viii, 

and ix. 



r J 



h : 



Jl 



I (■ 



CHAPTER XXIII 

THE CONSTRUCTION AND INTERPRETATION 
OF ACCOUNTS— LIABILITIES 

Purpose of the chapter. In chapter viii a brief discussion was given 
of the current liabilities, as represented by accounts payable and notes 
payable, the two accounts of this class which appear in nearly every 
business. In the present chapter some further consideration will be 
devoted to the accounts with current liabiUties, and also to the 
relatively long-time or ** fixed" liabilities. 

Current liabilities. As a rule the current liabilities of a business 
consist chiefly of its liabilities to trade creditors and to the bank. 
The liabilities to trade creditors assume two forms, open accounts 
and notes. The liability to the bank or banks is ordinarily repre- 
sented by notes outstanding. There may, of course, be liabilities 
on open account to other than trade creditors, and there may be notes 
due to others beside banks and trade creditors. Whether separate 
accounts will be carried with such liabilities depends on the importance 
which they assume. 

Accounts Payable. Like Accounts Receivable, Accounts Payable 
is usually a controlling account. It shows the amount owed by the 
business to its creditors on open accounts. The items posted to this 
account are for the most part footings of special columns in the 
various books of original entry. Accounts with individual creditors 
are carried in a subsidiary ledger, and may be posted either from the 
items entered in the books of original entry or directly from the 
vouchers arising out of transactions with creditors. 

The kinds of transactions affecting this account, and the nature 
of the debits and credits to be made to it, may be indicated as in 
Accounts Payable, p. 267. 

The balance of Accounts Payable account is always on the credit 
side, and represents the total amount owed by the business on open 
account to its creditors. At any time when the books are posted to 
date, this balance should equal the total of the credit balances in the 

266 



CONSTRUCTION OF ACCOUNTS— LIABILITIES 



ACCOUNTS PAYABLE 



267 



Debit: 

With cash paid to creditors in pay- 
ment of open accounts. 

With discounts allowed by creditors 
for cash p>ayments. 

With the invoice value of goods re- 
turned to creditors. 

With the amount of any credit allowed 
the business by a creditor for freight 
or other charges on goods returned. 

With all allowances and rebates 
allowed by creditors for any reason 
whatever. 



Credit: 
With the total of all invoices of goods 
purchased on account. 



individual creditor's accounts. It is desirable that the two amounts 
should be compared at the end of each month, or as often as the books 
are completely posted up to date; and where a discrepancy is found to 
exist, it should be traced to its source and the necessary corrections 
made. 

As has been suggested, there may be a considerable number of 
items other than merchandise which are purchased on open account. 
It is sometimes considered desirable to keep the amount of liability 
incurred for such items separate from that incurred for merchandise. 
In such a case two accounts would be carried with accounts payable, 
one of which would be called *' Accounts Payable — Trade Creditors," 
and the other one "Other Accounts Payable." Such. a separation of 
accounts payable is not usually considered necessary. 

Notes Payable. The nature of the account with notes payable has 
already been explained rather fully. This account shows the total of 
the face of all the notes issued and time drafts accepted by the busi- 
ness which remain unpaid and outstanding. The transactions 
affecting this account, and the nature of the debits and credits to be 
made to it, may be shown as follows: 

NOTES PAYABLE 



Debit: 
With all amounts paid in settlement 
of notes or drafts outstanding. 



Credit: 
With the face value of all promissory 

notes^ issued by the busmess to its 

creditors. 
With the face value of all time drafts 

accepted by the business. 



268 



PRINCIPLES OF ACCOUNTING 



The balance of Notes Payable account represents at any time the 
face value of all the notes and drafts outstanding against the business 
at that time. This does not mean that only one account with notes 
payable may be used, if the need for a division or classification of 
such notes exists. A business may secure credit from trade creditors 
in some cases by giving notes or trade acceptances. The same busi- 
ness may borrow money from the bank on its notes to enable it to take 
the discounts offered by other creditors for cash payments. In such 
a case there might well be a distinction made between the two classes 
of notes outstanding, according to the class of creditors who hold them. 
Such a distinction would involve the use of two accounts with notes 
payable: (i) "Notes Payable— Trade Creditors," and (2) "Notes 
Payable— Banks.'' 

Occasionally it occurs that money is borrowed for a short term 
from someone other than the bank. Such borrowing might be from 
a partner in the business, an officer in the corporation, or some friend 
or relative of the proprietor or member of the firm who is in a position 
to make the business a short-time loan on its note. In such a case 
still another notes payable account will be required. The title of 
such an account should indicate its nature, as "Notes Payable — 
Others," "Notes Payable— Partners," or "Notes Payable— Officers." 
There is no need for any further discussion of the nature of such an 
account, or of the debits and credits to be made to it, since it does not 
differ in that respect from the general account with notes payable, 
which has already been discussed. 

Fixed liabilities. In addition to the lines of short-term credit 
which business concerns ordinarily secure from their trade creditors 
and from the banks, it is often found desirable to secure the use of 
funds for a longer period. Such funds may be secured from additional 
investment by the owners, or by admitting new members into the 
owning group, as- by admitting an additional partner who would 
bring in a certain amount of investment, or by issuing additional 
capital stock to outsiders, in the case of a corporation. In case none 
of these courses seem desirable, the money may be secured by long- 
time borrowing from outsiders. Such borrowing gives rise to long- 
time or fixed liabiUties, certain types of which will be considered at 
this'point. 



CONSTRUCTION OF ACCOUNTS— LIABILITIES 



269 



Mortgages Payable. Where the borrowing concern is a single 
proprietorship or a partnership, this long-time borrowing is usually 
done by means of an interest-bearing note, secured by a mortgage. 
This means that a formal written and sealed instrument is delivered 
to the lender, giving him a lien for the amount of the note and for any 
cost incurred in collecting it, on certain specified property of the 
borrower. Failure on the part of the borrower to pay either principal 
or interest when due gives the mortgage-note holder the right to 
foreclose on the property named in the mortgage, sell it at auction, 
and reimburse himself from the proceeds. Long-time borrowing of 
this sort may be for one or more of the following purposes: (i) in- 
creasing the amount of fixed assets; (2) refundmg outstanding long- 
time liabilities; (3) increasing the amount of current assets; (4) 
funding current liabilities. 

The account representing such a liability as the one just described 
is called Mortgages Payable. The nature of the transactions affecting 
this account, and the debits and credits to be made to it, may be 
summarized as follows: 

MORTGAGES PAYABLE 



Debit: 
With all payments made on mortgage 

notes payable. 
With the face value of mortgage notes 

payable canceled in any manner. 



Credit: 
With the face value of all long-time 
notes issued by the business and 
secured by mortgages. 



The balance of this account is on the credit side, and shows the face 
value of all long-time notes secured by mortgages which are outstand- 
ing against the business. 

Bonds Payable. If the borrowing concern is a corporation, its 
long-time borrowing is usually accomplished through the sale of 
bonds. Thus when it has been decided by the corporation to issue 
bonds up to a certain amount, a formal agreement as to the terms of 
the issue is made with some bank or trust company whose duty it is 
to protect the interests of the purchasers, and the bonds are then 
offered for sale. In a few states it is necessary for the issuing company 
to secure the sanction of a state regulatory body of some sort as a 
prerequisite to offering the bonds for sale. The largest of such issues 
are usually marketed through some investment company or bond 



l! 



270 



PRINCIPLES OF ACCOUNTING 



house, or through a syndicate of such investment banking estab- 
lishments. 

The bonds are printed in convenient denominations, ranging 
usually from $100 to $10,000. Each bond has printed on it a brief 
statement of the terms of the contract between the issuing company 
and the investor. This contract may vary widely in different bond 
issues with regard to the nature of the security, interest rate, con- 
vertibility into other securities of the company, redeemability, etc. 
Thus a bond issue may be secured by a mortgage on any or all of 
the fixed assets of the company, or by no mortgage at all. The only 
limits to the variations that may appear in such contracts are: (i) 
what the law will permit, and (2) what the investors will accept. 

The interest on bonds outstanding is a fixed charge against the 
issuing company. Upon its failure to make payment of the principal 
or interest when due, the trustee for the bondholders may act to 
secure a foreclosure on the property of the company subject to such 
foreclosure by the terms of the bond, or may petition the courts for 
the appointment of a receiver for the company. The receiver will 
take charge of the affairs of the company and act to protect the 
interests of the bondholders and other creditors. Such a receivership 
may involve a liquidation of the company's assets and a closing up 
of its affairs, or it may involve a reorganization^ for the purpose of 
continuing the business operations in such a manner as to protect 
the creditors' interests. 

The account with Bonds Payable shows the total face value of the 
company's bonds outstanding. The debits and credits to this account 
are as follows: 

BONDS PAYABLE 



Debit: 
With the face value of all bonds 
redeemed or otherwise retired. 



Credit: 
With the face value of all bonds sold 
or otherwise issued. 



Where a company has several issues of bonds outstanding, a separate 
account will usually be carried in the ledger for each such issue. 
On the balance sheet of the issuing company the amount of each such 
issue may be shown as a separate item, but more usually only one 
item of bonds payable is shown, this representing the total of all such 



CONSTRUCTION OF ACCOUNTS— LIABILITIES 



271 



issues outstanding. The balance of any account with bonds payable 
represents the face value of such bonds outstanding at the time. 

Long-term notes. Corporations often issue notes for periods 
which are relatively short as compared with the maturity of the 
average bond, but longer than that of the ordinary note, such as is 
given to the bank or to a trade creditor. The maturity of these notes 
is usually from one to five years from the time of their issue. The 
purpose of selling such notes is usually to secure fixed capital at a time 
when the investment market is not considered favorable to an issue 
of long-term bonds, it being the expectation that bonds will later be 
issued to take their place. These notes are not different from bonds 
except in the length of the term for which they are issued, being 
issued and marketed in exactly the same manner. They are not 
usually secured by mortgages, but depend for their salability on the 
earning power and general credit of the company. 

The accounts which will be carried with such notes outstanding 
are similar to the account with any issue of bonds, except that the 
title indicates the type of the issue. The nature of such an account 
may be indicated as follows: 

1925 FIVE-YEAR 7 PER CENT GOLD NOTES 



Debit: 
With the face value of all such notes 
redeemed or otherwise retired. 



Credit: 
With the face value of all such notes 
sold or otherwise issued. 



The balance of such a notes account as the foregoing shows at any 
time the face value of all such notes issued and outstanding at that 

time. 

QUESTIONS FOR CLASS DISCUSSION 

1. In a well-managed wholesale business, which should you expect to be 
normally the larger item, Notes Payable or Accounts Payable ? Why ? 

2. Under what circumstances should you carry more than one account 
with Notes Payable ? What purposes would be served by such sub- 
division of this account ? 

3. What are some of the purposes for which long-time liabilities are 
inoured ? 

4. In what forms may long-time liability be incurred ? What similarities 
have these various forms ? What difference ? 



^\ 



% 



272 



PRINCIPLES OF ACCOUNTING 



5. The A Company cannot pay the interest on its first mortgage bonds. 
What course of action is op)en to the bondholders? What factors 
will determine the policy which they should follow ? 

6. In 1920 the B Company has the alternative of issuing fifteen-year 
mortgage bonds, yielding 6j per cent, or five-year gold notes yielding 
7f per cent. They choose to issue the notes. Why ? 

7. The Consolidated Gas Company has outstanding the following 
securities: 

Equipment trust certificates 

Collateral trust bonds 

First mortgage sinking fund gold bonds 

Consohdated and refunding mortgage bonds 
Judging from the titles, what should you suppose to be the distinguishing 
characteristics of each of these issues ? 

8. Assume that you are the treasurer and auditor of the Fabrikoid Manu- 
facturing Company. The president proposes the issue of $500,000 of 
ten-year gold notes, for the purpose of liquidating that amount of 
current liabilities. What facts would you require before you could 
advise him with regard to the wisdom of this proposal ? 

9. You are employed by a bond house. You are asked to give your 
opinion of the wisdom of the participation by your house in a new issue 
of bonds, amounting to $3,000,000. You find that the earnings of the 
issuing company for the past five years have not been very satisfactory, 
but that the bonds are secured by a closed first mortgage on the plant 
and equipment of the company, valued at $6,000,000. This plant and 
equipment is new and highly specialized. What do you think your 
answer would be? Is there any additional information which you 
would require ? 

REFERENCES FOR FURTHER STUDY 

WiLDMAN, J. R., Principles of Accounting, chap. xxix. 

Stockwell, H. G., Net Worth and the Balance Sheet , chaps, xvii-xxii. 

Greendlinger, Leo, Financial and Business Statements, chap. xiii. 



<> .^^IjilLJI 



CHAPTER XXIV 

THE CONSTRUCTION AND INTERPRETATION OF 
ACCOUNTS— PROPRIETORSHIP ACCOUNTS 

Purpose of the chapter. From the beginning of the course it has 
been pointed out that the proprietorship in any business is the differ- 
ence between the total assets and the total liabilities. It has also 
been shown that, since this proprietorship or net worth must be 
reported on the balance sheet, one or more accounts must be carried 
in the ledger to show the status of the net investment. The accounts 
maintained for this purpose will differ somewhat in their titles, their 
number, and their construction, according to the form of organization 
under which the business is conducted. In the present chapter 
consideration will be given to the kinds of proprietorship accounts 
used in connection with the three main forms of proprietorship under 
which business is conducted: the single proprietorship, the partnership, 
and the corporation. 

Proprietorship accounts for the single proprietor. An adequate 
discussion of the proprietorship accounts ordinarily used in a single 
proprietorship business was given in chapter vi. It is enough to 
recall that in such a business the two accounts with proprietorship 
which are ordinarily used are: (i) proprietor, capital account; 
(2) proprietor, personal account. The proprietor's capital account 
is used to show the status of his investment in the business. It is 
debited and credited as follows: 

PROPRIETOR, CAPITAL 



Debit: 
With all withdrawals of investment. 
With the amount of the net loss for the 

accounting period, in case such a 

loss exists. 
With the debit balance of his personal 

account at the end of the period. 



Credit: 

With the amount of the proprietor's 
original investment. 

With any additions made to the 
original investment. 

WiUi the amount of net profits ascer- 
tained at the end of the accounting 
period. 



273 



I I 



^r I 



274 



PRINCIPLES OF ACCOUNTING 



The balance of this account, as already indicated, represents the 
amount of the proprietor's net investment in the business at the time. 
As long as total assets exceed total liabilities, this will be a credit 
balance. If assets should become less than liabilities, the balance 
of the account will appear on the debit side and will represent a 
deficit. 

The proprietor's personal account. The proprietor's personal 
account is generally used to show the amount of his drawings for the 
period, and the amount subject to his withdrawal at any time. As 
stated in chapter viii, the proprietor often allows himself a stated 
salary, the amount of which is debited to operating expense for the 
period, and credited to his personal or drawing account. His per- 
sonal account will show whether he has drawn more or less than the 
amount of his salary allowance. If this account shows any very 
considerable overdraft as against his salary allowance, it may be 
closed into his capital account at the end of a period, to show a de- 
crease in his total investment. The debits and credits to the 
proprietor's personal account may be indicated as follows; 

PROPRIETOR, PERSONAL 



Debit: 

With amounts drawn by the owner 
against anticipated current profits, 
or against a stipulated salary 
allowance. 

With the amount of the credit balance 
of this accoimt whenever it is 
desired to close such balance into 
the proprietor's capital account. 



Credit: 
With the periodical allowance made 

to the owner as salary. 
With the amount of the debit balance 
of this account whenever it is con- 
sidered desirable to close it into the- 
proprietor's capital account. 



The balance of this account may be either a debit or a credit 
balance. If a credit, it shows the amount of the proprietor's salary 
allowance which is still undrawn. If a debit, it shows the amount 
by which he 'has overdrawn the credit from this source. In stating 
the net proprietorship on the balance sheet, the amount of the balance 
of the personal account may well be combined with that of the capital 
account to show the proprietor's total net ownership at that time. 
This combination is usually effected by a journal entry at the end of 
the fiscal period, closing the balance of the personal account into the 
capital account. 



CONSTRUCTION OF ACCOUNTS— PROPRIETORSHIP ACCOUNTS 275 



Proprietorship accounts in the partnership. Where there is more 
than one proprietor and the business is carried on as a partnership, 
the accounts with proprietorship are very similar to those just dis- 
cussed except that there must be a separate capital account and a 
separate personal account for each of the partners. 

Whether the partners are to be credited periodically with a stated 
salary, and what the amount of such salary shall be for each one, 
should be determined by the terms of the partnership agreement. 
The agreement should also state whether each partner is to be credited 
with interest on the amount of his investment before a division of 
profits is made, and what ratio is to be used in dividing profits or 
losses among the partners. The provisions of the agreement of each 
of these points must be considered before any disposition of net 
profits is made at the end of an accounting period. If there is no 
formal agreement, or if the agreement is silent on these points, then 
no allowance is to be made for either salary or interest, and profits 
and losses will be shared equally among the partners, regardless of 
the amount of the investment of each. 

The nature of a partner's capital account, and the kinds of 
changes for which it will be debited and credited, may be indicated 
as follows: i 



JOHN DOE, PARTNER, CAPITAL 



DeUt: 
With all withdrawals of the partner's 

investment. 
With the partner's share of net losses 

for an accounting period. 



Credit: 

With the amount of the partner's 
original investment. 

With all additional investments made 
by the partner. 

With the amount of any undrawn 
credit balance transferred from 
the partner's personal or drawing 
account. 

With the amount of any net profits 
accruing to the partner in excess of 
salary and interest allowances, 
which may be carried directly to 
the partner's capital account. 



The partner's drawing account. The personal account of a partner 
is usually known as his drawing account. Like the personal account 
of the smgle proprietor, it is debited with all amounts drawn by the 
partner for personal use. 



276 



PRINCIPLES OF ACCOUNTING 



i^^ 



111' 






If the agreement provides for salary allowances, these will be 
charged to expense on the same basis as any other salaries, and credited 
to the drawing accounts at the end of the period, along with any 
interest allowances that may be made. The matter of interest 
allowances is one which is discussed in nearly every accounting text, 
but seldom if ever encountered in practice. The kind of transactions 
which may affect a partner's drawing account, and the nature of the 
debits and credits which may be made to such an account, may be 
indicated as follows: 

JOHN DOE, PARTNER, DRAWING ACCOUNT 



Debit: 

With amount of all drawings made by 
the partner for personal use. 

With any undrawn credit balance 
transferred from this accoimt to the 
partner's capital account, as an 
addition to his net investment. 



Credit: 

With periodical allowance for part- 
ner's salary, if such allowance is 
provided. 

With allowances for interest on the 
p)artner's investment, if this is 
provided for in the agreement. 

With the amount of any debit balance 
in this account which is transferred 
to the partner's capital account 
to show a reduction in his net 
investment. 



If the balance of this account appears on the credit side, it shows 
the amount which the partner is still entitled to withdraw from the 
business without affecting his capital investment. If it appears as a 
debit balance, it shows the amount by which he has overdrawn his 
personal allowances. Any considerable credit balance which accumu- 
lates in this account may be transferred to the partner's capital 
account in case the partnership agreement permits and the partner in 
question so desires. Also, the amount ol any considerable overdraft 
shown by a debit balance in the drawing account may be transferred 
to his capital account to show a reduction of his long-time investment, 
if the circumstances make this seem desirable. 

On the balance sheet, the balance of the partner's drawing account 
is added to that of his capital account to show his total proprietorship 
if the drawing account has a credit balance, and deducted from the 
balance of the capital account if the drawing account shows a debit 
balance. 



li 



CONSTRUCTION OF ACCOUNTS-PROPRIETORSIHP ACCOUNTS 277 

Proprietorship accounts in the corporation. Something of the 
nature of the corporate form of organization for conducting a business 
enterprise was discussed in chapter ii. It was there pointed out that 
the corporation is a legal entity entirely apart from its individual 
stockholders. This means that although the total proprietorship 
of the stockholders in the corporation will be ascertained m exactly 
the same way as the total proprietorship of the partners or the indi- 
vidual proprietor, it will not be stated in quite the same way in the 
accounts or on the reports. The proprietorship of individual owners 
will not be shown in separate ledger accounts, as in the case of the 
single proprietorship or the partnership. It will be shown rather by 
a few general accounts in the ledger, while a subsidiary record known 
as a "stock ledger" furnishes the names of the individual stockholders 
and the number of shares of each kind of stock which each holds. 
The proprietorship accounts which are carried in the general ledger of 
the corporation are typically classified as follows: (i) Capital Stock: 
(a) Preferred Capital Stock, (b) Common Capital Stock; (2) Surplus 
(general); (3) Reserves (special appropriations of surplus). These 
accounts will be taken up for discussion in the order in which they are 
listed above. 

Capital stock. Contributions of capital by the prospective pro- 
prietors in the corporation take the form of the purchase of shares of 
stock. At the time when the corporation is organized authorization 
is secured from the proper authorities for the issue of a certain number 
of shares of stock, each such share usually having a definite par value, 
although this is not always the case. Part or all of these shares are 
then subscribed for, and are issued in exchange for cash or other 
property paid to the corporation. If the authorized stock is not all 
issued at the outset, the remainder may be issued at a later time, when 
further investment is required, or when the market is more favorable. 
Also, authorization may be secured for stock issues in addition to 
those originally contemplated. 

In case the stock has a definite par value, it may be. issued (i) in 
exchange for cash or other property equal in value to the par value of 
the stock (issued at par); (2) in exchange for property whose value is 
less than the par value of the stock {issued at a discount) ; (3) in ex- 
change for property whose value is in excess of the par value of the 
stock {issued at a premium). 



278 



PRINCIPLES OF ACCOUNTING 



Regardless of the value of the assets received in exchange for the 
stock issued, if this stock has a par value, the capital stock account 
will always show the exact par value of the shares of stock which are 
issued and outstanding. It is desirable to preserve in this account 
the par of the stock issued, not only for legal reasons, but because it 
serves as the basis for dividends, and enables a reader of the balance 
sheet to calculate the amount of ownership represented by a single 
share of a given par value. The nature of the account with capital 
stock, and of the debits and credits to be made to that account, may 
be indicated as follows: 

CAPITAL STOCK 



Debit: 
With the par value of all shares of 
stock redeemed by the corporation, 
or otherwise retired. 



Credit: 
With the par value of all shares 
stock issued by the corporation. 



of 



The balance of this account always appears on the credit side, and 
represents the par value of the stock then outstanding. 

Contracts entered into between the corporation and the stock- 
holders may be of various kinds. Thus a corporation may issue not 
only common stock, entitling the holders to certain specified rights, 
but also preferred stock, which enjoys certain preferences as to divi- 
dends, and in many cases in its claim on the assets of the company 
in case of dissolution. Also, there may be more than one class of 
common, and more than one class of preferred, stock, the classification 
in each case depending on the terms of the contract. Where there is 
more than one class of stock outstanding, an account will be carried 
in the general ledger with each such class. Thus the capital stock 
accounts of a given corporation might be classified as follows: First 
Preferred Capital Stock; Second Preferred Capital Stock; First 
Common Capital Stock; Second Common Capital Stock. Since each 
such account is only a subdivision of the capital stock account, its 
nature and the debits and credits to be made to it are in no way 
different and do not need to be repeated at this point. 

Discount on stock. In case the stock is originally issued for assets 
whose value is less than the par of the stock, it will be necessary to 
carry a valuation account to show the amount by which the par of the 
capital stock outstanding exceeds the actual investment. Such an 



CONSTRUCTION OF ACCOUNTS— PROPRIETORSHIP ACCOUNTS 279 



account is called Discount on Stock, and debits and credits are to be 

made to it as follows: 

DISCOUNT ON STOCK 



Debit: 
At time stock is issued with excess of 
par of stock issued over value of 
assets received. 



Credit: 

With amount of current net profits 
transferred to this account to reduce 
its balance. 

With amount of any portion of sur- 
plus transferred to this account to 
reduce its balance. 



The balance of such an account will be a debit, and represents the 
excess of the par value of the stock outstanding over the actual invest- 
ment represented by that stock. It should be written off, as indicated 
above, by the appropriation of net earnings for that purpose. 

The issue of stock at a premium will be considered under the 
discussion of surplus. 

Surplus. If the operations of the corporation are successful, net 
profits will be earned. If these profits are not all withdrawn (and 
usually they are not), the proprietorship of the corporation will 
mcrease to an amount in excess of the par of the stock o^itstanding. 
This increased proprietorship cannot be reflected by the capital stock 
account, which shows only the par of the stock. Such an excess of 
total proprietorship over capital stock is shown by a surplus account. 
The nature of the debits and credits to be made to the surplus account 

may be shown as follows: 

SURPLUS 



Debit: 

With the amount of all appropriations 
made of surplus for any purpose, 
such as dividends, reserves, and the 
like. 

With the amount of any recognized 
decrease in proprietorship, resulting 
from operating of other losses. 



Credit: - 

At the end of the fiscal period with 
amount of all current net profits 
not otherwise appropriated. 



The balance of this account must always be on the credit side, and 
represents the amount by which the net investment not appropriated 
for any. special purpose exceeds the par value of the capital stock 
outstanding. If for any reason the net proprietorship falls below the 
par of the stock outstanding, the surplus account will be closed out, 
and an account of the opposite nature, headed '' Deficit," or some such 
appropriate title, will be set up to show the deficiency. 



\ 



ir* 



i 

I 



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280 



PRINCIPLES OF ACCOUNTING 



Where stock is issued at a premium, the amount by which the 

original investment exceeds the par value of the stock issued is usually 

entered in a special surplus account, known as Capital Surplus, or 

Contributed Surplus. The analysis of this account may be indicated 

as follows: 

CAPITAL SURPLUS 



Debit: 
With the amount of any appropriation 
made of this surplus, such as an 
offset to stock later issued at dis- 
count. 



Credit: 
With the amount by which assets 
received in exchange for capital 
stock issued exceed the par value 
of such stock. 



The balance of this surplus account will be on the credit side, and 
represents the excess of capital contributed by the stockholders over 
the par value of the stock issued. The amount of such surplus, 
representing as it does original contributions of capital, is not ordi- 
narily considered to be available for distribution as dividends. 

Proprietorship reserves. In discussing the surplus account it was 
stated that the balance of that account represents the amount of the 
surplus which is not appropriated for any special purpose. Whenever 
any portion of surplus or of current net profits is appropriated for a 
particular purpose, the amount so appropriated is transferred to the 
credit of some proprietorship reserve account. Examples of accounts 
with such proprietorship reserves are: Reserve for Addition to Plant, 
Reserve for Redemption of Bonds, and Sinking Fund Reserve. Such 
accounts are here designated as proprietorship reserves in order to 
distinguish them from the so-called ''reserve" accounts which really 
represent valuations on assets, or deductions from the balance carried 
in some asset account. Such valuation reserve accounts are Reserve 
for Bad Debts and Reserve for Depreciation. 

Reserve for Addition to Plant may be taken as representative of 
proprietorship reserve accounts. The nature of this account, and the 
debits and credits to be made to it may be indicated as follows: 

RESERVE FOR ADDITION TO PLANT 



Debit: 
With the value of assets applied to the 
accomplishment of the purpose for 
which the reserve was appropriated 
(to transfer such amount back to 
the general surplus account). 



Credit: 
With the amount of surplus or current 
net profits appropnated for the 
purpose indicated by the title of the 
account. 



iir 



CONSTRUCTION OF ACCOUNTS— PROPRIETORSHIP ACCOUNTS 281 



The balance of such a reserve account shows the amount of that part 
of the total proprietorship which has been appropriated to the desig- 
nated purpose and which has not yet been applied to the accomplish- 
ment of that purpose. Such a balance will appear on the credit side 
of the account. 

Proprietorship reserves are to be considered as a portion of surplus, 
but as a portion appropriated for a specific purpose and therefore not 
available for dividends. The capital stock account or accounts, the 
general surplus account, and the proprietorship reserve accounts are 
to be taken together to show the total of the proprietorship in the 
corporation, and should therefore be grouped together on the balance 
sheet for this purpose. 



QUESTIONS FOR CLASS DISCUSSION 

1. What is the purpose of the proprietor's capital account? What 
entries may be made to this account ? 

2. What transactions would affect the personal account of the proprietor? 
How should you show the balance of this account on the balance sheet ? 

3. Are the differences between the proprietorship accounts of the partner- 
ship and those of the single proprietor marked enough to merit dis- 
cussion ? 

If so, what are these differences, and why do they exist ? 

4. What is there about the nature of a corporation that causes its pro- 
prietorship accounts to be different from those of the partnership of the 
single proprietor ? 

5. Why should the amount of capital stock outstanding always be shown at 
par ? When should there be more than one class of capital stock ? 

6. What is the purpose of the account with discount on stock? How 
should it appear on the balance sheet ? 

7. What record is made when stock is issued above par? How will this 
fact be shown on the balance sheet ? 

8. What is the nature of the surplus accoimt ? Could this account have 
a debit balance ? Why, or why not ? Can you identify any particular 
group of assets with the surplus account ? 

9. What is a reserve ? Is there more than one kind of reserve accoimt ? 
If so, what are the distinguishing features of each kind ? Which is more 
properly known as a "reserve" account? 

10. Must a reserve account be identified with a particular group of assets ? 
May it be so identified? Under what circumstances would this be 
desirable ? 



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282 



PRINCIPLES OF ACCOUNTING 



11. Name as many so-called "reserve" accounts as you can, and discuss 
briefly the nature and purpose of each. 

12. You are engaged to audit the accounts of the X Company, which has 
been in operation for one year. You find that the accounts show capital 
stock outstanding (all common) to be $500,000, and surplus account has 
a balance of $150,000. Upon inquiry you learn that $100,000 of this 
was contributed by the stockholders, who subscribed to the stock at a 
premium of 20 per cent. Should you suggest any modification of the 
accounts ? If so, give the journal entry required to put these modifi- 
cations into effect. Justify any recommendation which you would 
see fit to make in regard to this matter. 

REFERENCES FOR FURTHER STUDY 

WiLDMAN, J. R., Principles of Accounting, chaps, xxx, xxxi, xxxii. 
Hatfield, H. R., Modern Accounting, chaps, viii, ix, xiii, xiv. 
Dickinson A. L., Accounting Practice and Procedure, pp. 127-33. 
Stockwell, H. G., Net Worth and the Balance Sheet, chaps, xxiii-xxvi. 
Greendlinger, Leo, Financial and Business Statements, chaps, xii, xiv, xv. 

LABORATORY EXERCISE NO. 33 

W. C. Harvey has decided to put in a stock of furniture along with his 
hardware. He does not think that, it would be worth while to attempt any 
division of the operating expenses of the business with regard to whether 
they are chargeable against the income from the sale of hardware or of 
furniture, but he does wish to know the gross profit from each of the two 
classes of sales separately. This means that you will need to carry two in- 
ventory accounts, two purchases accounts, two sales accounts, two accounts 
with in-freight, two with sales returns and allowances, and two with pur- 
chase returns and allowances. The additional analysis thus required will 
make necessary some modification in the form and number of the books of 
original entry. In addition to the general journal, which is always indis- 
pensable, the books of original entry to be used in this exercise may be 
outlined as follows: 

Purchases Journal. Use columnar journal paper, and provide colunms 
as follows: (i) Date, (2) Name, (3) Address, (4) Terms, (5) Invoice Number, 
(6) Folio, (7) Accounts Payable, Cr., (8) Hardware Purchases, Dr., (9) Fur- 
niture Purchases, Dr. All purchases of merchandise, on any terms what- 
ever, will be entered into this journal, the amount of the invoice being 
credited in each case to Accounts Payable. In case the purchase is really 
paid for immediately by cash or by a note, the payment would be recorded 
elsewhere and posted to the debit of Accounts Payable. The posting from 
this form of purchases journal is the same as that for the form used in the 
last exercise, except that there are two purchases accounts instead of one. 



CONSTRUCTION OF ACCOUNTS— PROPRIETORSHIP ACCOUNTS 283 

Purchase Returns and Allowances Journal. Use the same kind of paper, 
with columns as follows: (i) Date, (2) Name, (3) Address, (4) Terms, 
(s) Invoice Number, (6) Folio Number, (7) Accounts Payable, Dr., (8) Pur- 
chase Returns and Allowances (Hardware), Cr., (9) Purchase Returns and 
Allowances (Furniture), Cr. The posting procedure for this journal is the 
same as for the purchases journal, except that the debits and credits are in 
each case directly reversed. 

Sales Journal. Use columnar journal paper. Provide columns as 
follows: (i) Date, (2) Name, (3) Address, (4) Terms, (5) Invoice Number, 

(6) Folio Number, (7) Accounts Receivable, Dr., (8) Cash, Dr., (9) Hard- 
ware Sales, Cr., (10) Furniture Sales, Cr. The "Cash, Dr." column is 
included for purposes of analysis, and to make this journal balance. Its 
footing is not to be posted, since all debits to cash will be included in the cash 
book. Otherwise the posting is as indicated by the form of the journal. 

Sales Returns and Allowances Journal. Columnar journal paper. 
Columns as follows: (i) Date, (2) Name, (3) Address, (4) Terms, (5) Invoice 
Number, (6) Folio Number, (7) Accounts Receivable, Cr., (8) Cash, Cr., 

(9) Hardware Sales Returns and Allowances, Dr., (10) Furniture Sales 
Returns and Allowances, Cr. Here again the " Cash, Cr. " column is not 
to be posted. All cash refunds for returns and allowances are to be shown 
in the cash book, as well as all cash sales. The credits to Sales, and the 
debits to Sales Returns and Allowances, will not be posted from the cash 
book, but from the sales journal and the returns and allowances journal. 
In the cash book a check will be placed in the folio column opposite each 
such item, to indicate that it is not to be posted from that book. 

Cash Receipts Journal. Use columnar journal paper. Columns as 
follows: (i) Date, (2) Account Credited, (3) Explanation, (4) General 
Ledger Folio, (5) Accounts Receivable Folio, (6) Sundry Accounts, Cr., 

(7) Accounts Receivable, Cr., (8) Sales, Cr., (9) Cash, Dr. In the column 
for "Sundry Accounts, Cr." will be entered the credits to all accounts for 
which special columns have not been provided. Each of the credits in this 
column must be posted to the general ledger separately, entering the foHo 
number in the "General Ledger Folio" column. As was previously ex- 
plained, the footing of the "Sales, Cr." column is not to be posted. The 
rest of the posting follows the procedure already familiar to the student. 

Cash Disbursements Journal. Use columnar journal paper. Columns 
as follows: (i) Date, (2) Account Debited, (3) Explanation, (4) General 
Ledger Folio, (5) Accounts Payable FoHo, (6) Sundry Accounts, Dr., (7) 
Accounts Payable, Dr., (8) Cash Discount on Purchases, Cr., (9) Cash, Cr., 

(10) DeUvery Expense, Dr., (11) Ofiice Expense, Dr. The "Sundry Ac- 
counts, Dr." column in this form is used in the same manner as that indi- 
cated in the discussion of the corresponding column in the cash receipts 
journal. The posting to the accounts debited in this column, and the 



284 



PRINCIPLES OF ACCOUNTING 



posting to the individual accounts in the creditor's ledger, is the only detailed 
posting to be made from this journal. The footings of all the other columns 
are to be posted as indicated by the column headings. 

Transactions for May 

May I 

Received a check from J. Gunderson for $225.00, the amount of his 
account to date. Received from Boutell Furniture Co., St. Paul, an invoice 
for a shipment of furniture, $900.00, 2/io/n/6o. (Open separate account 
with furniture purchases.) Paid freight on this shipment, $25.00. (Also 
open separate account for in-freight, furniture.) Cash sales, hardware, 

$95 oo- 

May 2 

Sold William Gibson on accoimt $205.00, hardware. Sold Charles 
Robinson hardware on account, $95.00. Paid rent of store for May, 
$1 2 5 . 00. Cash sales hardware, $7 2 . 00. 

May J 

H. Greiner paid his account in full to date, $290.00. Paid $50.00 for 
stamps. Paid bills as follows: light, $9.40; telephone, $6.00; telegrams, 
$8.90. Cash sales, hardware, $65.00. 

May 4 

Sold Howard Jones furniture on account, $250.00. Sold Andrew 
Anderson hardware on account, $100.00. Paid Hibbard, Spencer, Bart- 
lett's invoice of April 26, less discount. Paid salaries, same as last week. 
(Week ended April 27.) Withdrew $40.00 for personal use. Cash sales, 
hardware, $60.00; furniture, $40.00. 

May 6 

Sold Thomas Dodge hardware on account, $140 . 00. Sold John Wright, 
furniture on account, $65.00. Received invoice from Marshall- Wells 
Hardware Co., $350.00, 2/10/n/so. Paid freight on this shipment, $7. 50. 
Cash sales, hardware, $65 .00. 

May 7 

Received from Simmons Hardware Co. notification of a credit for goods 
returned to them out of invoice of April 29, $95 . 00. Sold Charles Clayton 
furniture on account, $7 5 . 00. Sold Jacob Gunderson hardware on account, 
$80.00. Cash sales, hardware, $53.00; furniture, $35.00. 

May 8 

Received invoice from New England Furniture Co., Detroit, Mich., 
$450.00, 2/io/n/6o. Paid $12.00 freight on this shipment. Sold E. F. 



CONSTRUCTION OF ACCOUNTS— PROPRIETORSHIP ACCOUNTS 285 

Hughes furniture on account, $95.00. Cash sales, hardware, $67.00; 
furniture, $90.00. 

May Q 

Paid balance due on Simmons Hardware Co.'s invoice of April 29, less 
discount. Sold H. Rowe hardware, $ 1 2 5 . 00, on account. Cash sales, hard- 
ware, $55.00; furniture, $25.00. 

May 10 

Discounted our sixty-day note for $1,000.00 at the bank, at 6 per cent. 
Sold Charles Clayton furniture on accoimt, $110.00. Paid for advertising 
in the local paper, $45 . 00. Cash sales, hardware, $87 . 00 ; furniture, $24 . 00. 

May II 

Paid salaries for the week, including an additional sales clerk at $22 . 00. 
Withdrew $50.00 for personal use. Paid Boutell Furniture Co.'s invoice 
of May I, less discount. Sold Howard Strong hardware on account, 
$85.00. Cash sales, hardware, $67.00; furniture, $30.00. 

May I J 

Received invoice from Huron Supply Co. for wrapping paper and twine, 
$125.00, net. Paid a garage bill of $17.00. Sold John Wright hardware 
on account, $40.00. Charles Robinson paid his account to date. Cash 
sales, hardware, $78.00; furniture, $24.00. 

May 14 ' 

Sold Charles Robinson hardware on account, $45.00. Paid for adver- 
tising circulars, $25.00. Paid $5.00 for their distribution. Cash sales, 
hardware, $60.00; furniture, $41.00. 

May 15 

Charles Clayton made a claim that certain goods purchased by him 
on May 10 were inferior in quality. He was allowed $15.00. Sold James 
Freeman furniture on account, $90.00. Cash sales, hardware, $70.00; 
furniture, $15.00. 

May 16 

Sold D. W. Kelly hardware on account, $15.60. Sold C. E. Pierce 
furniture on account, $300.00. Cash sales, hardware, $105.00. Paid 
Marshall-Wells Hardware Co.'s invoice of May 6, less discount. 

May 17 

Received a memorandum from the New England Furniture Co., allow- 
ing our claim for $15.00 for defective goods, $75.00 for goods returned. 
Sold H. Greiner hardware on account, $120.00. Cash sales, hardware, 
$67 . 50; furniture, $3 2 . 90. 



I. 



286 



PRINCIPLES OF ACCOUNTING 



May i8 

Paid balance on New England Furniture Co.'s invoice of May 8, less 
discount. Withdrew $50.00 for personal use. Cash sales, hardware, 
$83 . 00; furniture, $37 . 50. 

May 20 

Paid salaries, same as last week. Received invoice from Lindell and 
Evans, Grand Rapids, Mich., for furniture, $375.00, 2/io/n/30. Sold 
E. F. Hughes hardware on account, $47 . 50. Cash sales, hardware, $68. 00; 
furniture, $17.50. 

May 2t 

Sold Herman Rowe builders' hardware, on account, f.o.b. his station, 
$250.00. Paid freight on the same, $3.00. Paid $4.50 for repairs on 
typewriter. Cash sales, hardware, $74.00; furniture, $45.00. 

May 22 

Bought stationery amounting to $18.00. Peter Henderson paid his 
account in full. Sold James Freeman hardware on account, $35 . 00. Cash 
sales, hardware, $56.00; furniture $38.00. 

May 2 J 

Received of Western Supply Co. invoice for additional showcases, 
$75.00, n/15. Paid $7.50 for installation of same, and freight on the 
shipment, $6.00. Sold Adam Jones hardware on account, $48.00. Cash 
sales hardware, $72.00. 

May 24 

Cash sales, hardware, $37 . 50; furniture, $25 . 00. 

May 25 

Received invoice for hardware from W. D. Allen Co., $250 . 00, 2/io/n/30. 
Paid salaries same as last week. Withdrew $50. 00 for personal use. Cash 
sales, hardware, $87.50; furniture, $35.00. 

May 27 

Refunded $25.00 on furniture bought for cash and returned. Sold 
N. I. Cluff furniture on account, $1 22 . 00. Cash sales hardware, $79 . 00. 

May 28 

Paid the Daily News for advertising, $20.00. Cash sales, hardware, 
$71.00; furniture, $55.00. 

May 2Q 

Sold Peter Henderson hardware on account, $63.00. H. Rowe re- 
turned goods purchased May 21, $20.00. Cash sales, hardware, $45.00; 
furniture, $27.50. 1 



CONSTRUCTION OF ACCOUNTS— PROPRIETORSHIP ACCOUNTS 287 

May 30 

Paid Huron Supply Co.'s invoice of May 13, net. Sold Dr. D. Kelly 
furniture on account, $105.00. Cash sales, hardware, $57.00. 

May 31 
Cash sales, hardware, $68.00; furniture, $50.00. 

Take the totals of all the columns in your special books of original entry. 
Make sure that the total of the debit columns in each journal equals the total 
of the credit footings. (For purposes of this checking subtract the begin- 
ning cash balance from the total of the debits in the cash receipts journal.) 
Rule up these special books of entry and complete all posting, both to the 
general ledger and to the subsidiary ledgers. Make sure that the balances 
of your two controlling accounts agree with the totals of the balances in the 
subsidiary ledgers. 

The merchandise inventories on May 31 are as follows: hardware, 
$4,560.00; furniture, $525.00. Store supplies on hand (paper, twine, etc.) 
are valued at $90.00. Salaries are accrued for five days. An allowance 
for bad debts is to be made equal to i per cent of the total amoimt at present 
due from customers. Depreciation on each class of equipment is to be 
taken at the same rate as was indicated last month. 

On the basis of this information and of your own investigation with 
respect to the interest prepaid or accrued on the various notes receivable 
and payable, and as to the amount of insurance expired, prepare the balance 
sheet and the statement of profit and loss. 

Make in the journal the entries necessary to bring the ledger accounts 
into agreement with the items shown in the reports (adjusting entries) 
Post these entries. 

Make and post the entries necessary to close the books. 

Note. — For those who desire further laboratory material, an additional 
month's transactions are given in the appendix on page 379. 



ii 



'I 






CHAPTER XXV 

THE CONSTRUCTION AND INTERPRETATION OF 
ACCOUNTS— INCOME ACCOUNTS 

Kinds of income accounts. There are two classes of income ac- 
counts, so clearly set apart from each other that they appear in differ- 
ent parts of the profit and loss statement. They are: (i) accounts 
with operating income; (2) accounts with "other income," or non- 
operating income accounts. By "operating income" is meant the 
income derived from the operations for which the business is organized, 
and to which the management may look for the chief source of income. 
This sort of income arises from the sale of the goods or servdces in which 
the particular business deals, the nature of such goods and services 
varying with the type of the business enterprise. 

The non-operating income of any business is that income which 
accrues to the business from sources other than those upon which the 
business depends for its primary income. An example of such non- 
operating income is the rent received from a building or other real 
estate held by the business as an incidental investment. Interest 
earned on notes and investments held, or on bank balances, is non- 
operating income to any but a financial business. Almost any item of 
income may be either operating or non-operating income, according 
to the nature and purpose of the business in which such income accrues. 

Accounts with operating income. It was pointed out above that 
there may be several kinds of operating income in connection with as 
many kinds of business. Thus in the case of a railroad , accounts would 
be needed to show income from passenger traffic, freight traffic, and 
earnings from express and mail business. In connection with a hotel 
the main operating income is usually the rent of the rooms. But for 
the present it is not necessary to give consideration to types of business 
other than the ordinary mercantile and manufacturing businesses, 
in which operating income arises from the sale of goods and may be 
represented by one or more sales accounts. 

Sales account. Thus in a manufacturing or mercantile business 
there will always be a sales account in which will be recorded the 
amount of the sales made during each accounting period, and the 

aS8 



CONSTRUCTION OF ACCOUNTS— INCOME ACCOUNTS 289 

balance of thisv account at the end of the period shows the amount of 
operating revenue from this source during the period. From this 
the operating expenses must be deducted in order to ascertain the 
net operating profit or loss. 

If the business sells different lines of commodities, or if it is organ- 
ized into several departments, each of which is making sales, the 
sales account will be subdivided to show whatever classification of 
sales may be desirable for the particular organization. Thus a 
mercantile business with several departments may have its sales 
account divided into "Sales — Department A," "Sales — Depart- 
ment B," and a similar account for every other selling department. 
A manufacturing concern making and selling three lines of product 
may have a sales account for each, as follows: " Sales-^Product 
No. I," " Sales— Product No. 2," " Sales— Product No. 3." It is 
also possible that the departmental or product sales accounts may be 
further classified. There might be a sales account to show the amount 
of the sales of each of the three products in each of the territories in 
which the manufacturing concern markets its goods. This matter of 
the subdivision of the sales account is one of classification, and any- 
thing like an adequate consideration of the subject must be deferred 
to a later point in the study of accounting. 

The nature of any subsidiary sales account is exactly the same as 
that of the general sales account which shows the total sales. To 
show the construction and interpretation of accounts with sales, then, 
it is not necessary to consider more than one such account. The 
debits and credits to the sales account are as seen on page 290. 

It will be seen from the foregoing discussion that the balance of 
the sales account before any of the closing entries have been made and 
posted will be a credit balance, and will represent the amount of gross 
sales for the period. This is the item that will appear on the reports. 
The account is not debited, as a usual thing, except through the closing 
entries, though in some smaller businesses the sales deductions may 
not be kept in sej>arate accounts but entered directly to the debit of 
sales at the time when they occur. This would make the credit 
balance of the sales account show the amount of net sales. This 
method is not usually a desirable one in a larger business, since in 
most cases there would be required a more detailed analysis of these 
deductions than could be readily obtained from the sales account. 



^\ 



290 



PRINCIPLES OF ACCOUNTING 



The sales account, like other revenue accounts, is closed into 
profit and loss at the close of each fiscal period, and shows no balance 
at the beginning of a new period. The exact procedure to be fol- 
lowed in the process of closing this account may vary somewhat. 
This matter was discussed in chapter x, and will be further consid- 
ered in chapter xxviii. 

SALES 



Debit: 
Only with the closing entries made at 
the end of the fiscal period, which 
will probably be as follows: 

a) With any sales deductions to be 
closed into sales account. 

b) With the balance of purchases 
account, showing cost of goods 
sold (provided this method is 
followed in closing). 

c) With the credit balance of sales 
account, to be transferred to the 
profit and loss account (sales 
might show a debit balance, but 
such is not normally the case). 



Credit: 
With the amount of all invoices of 
merchandise or finished product 
sold. 



Deductions from sales. As indicated previously, the figure of 
sales shown in the reports is usually that of gross sales. By gross sales 
is meant the total of all sales invoices, before any deductions are made 
for returns, allowances, and the like. This figure is a useful one for 
reporting purposes, since it affords a basis for comparison between 
total sales and sales deductions. It does not, however, show the 
amount of the actual income derived from the sales of the period until 
these deductions have been made. 

The deductions most commonly made from gross sales are those 
for returns and allowances, and for outward freight prepaid by the 
seller. The amount of goods returned, as well as allowances or 
rebates made to customers on sales, quite plainly represent a part of 
the total of gross sales that will never become realized income, and 
should therefore be deducted to arrive at the figure of net sales. And 
where the seller pays the charges on an out-of-town shipment of 
goods, such charges are usually treated as a deduction from gross sales. 
Such charges are ordinarily borne by the purchaser, and when the 
shipper pays the freight he is either adding it to his normal selling 



I,' I 



CONSTRUCTION OF ACCOUNTS— INCOME ACCOUNTS 291 

price or else is taking this method of making a special price concession 
to the purchaser. In either case, it is usually treated as a direct 
deduction from gross sales, though in the latter case it may be treated 
as a selling expense, like delivery expense. 

Sales Returns and Allowances may be taken as typical of the 
accounts which represent such items of sales deductions. It is 
debited and credited as follows: 

SALES RETURNS AND ALLOWANCES 



Debit: 
With invoice price of goods returned 

by customers for cash refunds or for 

credit. 
With all rebates and allowances made 

to customers for any reason. 



Credit: 
Only for the closing entry which 
transfers the balance of this account 
to the debit of sales at the end of 
the fiscal year. 



The debit balance of such an account represents the amoimt that must 
be deducted from the gross sales for the period in order to obtain the 
figure of net sales or of actual income realized from sales. 

Where the sales account is subdivided on a departmental or a 
commodity basis, the accounts with sales deductions would also need 
to be subdivided on the same basis. Thus each sales account would 
have a corresponding sales deductions account for each class of such 
items. 

Non-operating income accounts. It has been suggested that there 
may be a considerable variety of non-operating income accounts, 
since any possible form of income accruing in a given business which 
does not fall under the regular operating income of that business is 
classified as non-operating income. Interest earned, rentals earned, 
sales of scrap and waste, income from incidental investments, and 
cash discounts taken on purchases, may all fall under this head. 

It is not worth while to discuss every conceivable form of non- 
operating income, or even to name them, but two items of frequent 
occurrence in the average business may be taken as typical of the 
entire class. These are: (i) interest on notes receivable and (2) cash 
discount on purchases. 

Interest on notes receivable. Sometimes notes are received from 
customers and others which are made payable with interest at a stated 
rate. In such a case, if the note is held for any part of the time it has 



% 



u 



i 



292 



PRINCIPLES OF ACCOUNTING 



to run, some interest wiU accrue to the business holding it. Such 
accrual represents an earning of that business for the period during 
which it occurs, but an earning of a purely financial nature, which is 
outside the primary income-earning operations of the business, like 
interest earned on outside investments. It is therefore classed as 
non-operating, or "other" income. The debits and credits to be 
made to the account with interest on notes receivable may be indicated 
as follows: 

INTEREST ON NOTES RECEIVABLE 



Debit: 
When the books are closed at the end 
of a fiscal period, with the amount 
of the credit balance transferred to 
profit and loss account. 



Credit: 
With the amounts of all interest 

payments received on such notes. 
At the end of each fiscal period with 
the amount of all such interest 
accrued but not yet due. 



The balance of this account is normally on the credit side, and should 
represent the amount of such interest earned by the business during 
the current period. The method by which this account is to be 
adjusted and closed will be explained in a later chapter. 

Cash discount on purchases. The student is already familiar with 
the nature of cash discount on purchases. This is a certain percent- 
age, frequently 2 per cent, but sometimes more or less, which the 
purchaser is allowed to deduct from the face of the invoice if he 
pays it within a time limit set. Some accountants argue that, since 
this represents a reduction of the price actually paid for the goods, it 
should be treated not as other income but as a deduction from pur- 
chases. The weight of opinion among writers on the subject is, 
however, that this item should be included under other income! 
The reason assigned for this is that it is not really a reduction in the 
purchase price, which is the same whether the purchaser exercises 
his option of taking the discount or not. It represents rather a 
saving due to proper financial management, and to the ability to 
secure credit at the bank when this is needed to be able to take 
discounts. Also, since the interest incurred on funds borrowed from 
the bank for the purpose of enabling the concern to take its discounts 
is treated as a deduction from total income, as will be explained later, 
it would be rather misleading to show the total of cash discounts as a 
deduction from the purchase price of the goods. It is really income 



CONSTRUCTION OF ACCOUNTS— INCOME ACCOUNTS 293 

arising out of the financial operations of the business, like interest 

earned on notes and investments. 

The debits and credits to be made to this account may be indicated 

as follows: 

CASH DISCOUNT ON PURCHASE 



DebU: 
When the account is closed at the end 
of the fiscal period, with the amount 
of the credit balance transferred to 
profit and loss. 



Credit: 
With all discounts taken for payment 
of purchase invoices within the time 
limit set. 



The credit balance shown by this account at the end of a period rep- 
resents the amount of cash discounts taken on purchases during the 
fiscal p>eriod. It app)ears as an item on the statement of profit and 
loss under the head of "Other Income." 

QUESTIONS FOR CLASS DISCUSSION 

1. What purpose, if any, is served by dividing income accounts into two 
main groups, operating and non-operating? Define the basis of dis- 
tinction. 

2. Should you prefer the terms "primary" and "secondary" to "oper- 
ating" and "non-operating" as applied to the classification of income? 
What reasons have you for your answer ? 

3. The X Music Company sells pianos, phonographs and records, band 
instruments, and sheet music. The company has its main office in 
Chicago, where its principal selling establishment is located. It has 
branches in St. Louis, Kansas City, and Omaha. Each of its stores 
sells both to dealers and direct to consumers. What basis or bases 
should you suggest for the classification of this company's sales account ? 
What purposes would be served by the classification suggested by you ? 

4. Should you advise that the X Company carry separate accounts to 
show sales deductions ? Why, or why not ? If you advise keeping such 
accounts, how should they be classified ? 

5. What possible sources can you suggest from which the X Company 
might derive non-operating income? Explain clearly in each case 
why you classify the particular type of income as non-operating. 
What accounts would be required to record such income ? 

6. Which do you consider the correct view: That cash discounts taken 
on purchases are a source of income, or that all such discounts which 
are not taken represent a loss ? Will either of these views differ from 
the other with respect to the accounts needed to carry it out ? Explain. 



294 



PRINCIPLES OF ACCOUNTING 



7. Can you justify the current accounting practice of showing income 
resulting from the financial management of the business as non-operating 
income? Discuss. 

REFERENCES FOR FURTHER STUDY J 

WiLDMAN, J. R., Principles of Accounting, chaps, xxxiii and xxxviii. 
Hatfield, H. R., Modern Accounting, chaps, xi and xii. 
Kester, Roy B., Accounting Theory and Practice, Vol. II, chap. xxii. 



CHAPTER XXVI 

THE CONSTRUCTION AND INTERPRETATION OF 
ACCOUNTS— EXPENSE ACCOUNTS 

Kinds of expense accounts. Like income accounts, expense 
accounts may be divided into two main groups: operating and non- 
operating. The operating expenses may be classified in any way that 
seems desirable in the particular business organization, but in any 
case they may be divided into two groups. The first of these consists 
of those items which show the cost of the goods sold, and the second 
consists of the remainder of the operating expenses necessary to carry 
on the business, provide for the purchase, and sale of goods, for their 
delivery, and for all other necessary phases of the primary operations 
of the business. This classification of expense accounts may be 
indicated as follows: 

I. Operating expense accounts 

1. Accounts with cost of goods sold 
a) Purchases account 

h) Other cost of goods sold accounts 

2. Other operating expense accounts (classified according to 
the reporting requirements of the individual business) 

II. Non-operating expense accounts, or "other deductions from 
income" accounts 
The classes of accounts shown by this outline will be considered in the 
order in which they there appear. 

Operating expense accounts. It was pointed out in the preceding 
chapter that there may be a considerable variation in the operating 
income accounts of different businesses. The operating expenses 
may vary even more widely, as regards the individual items with 
which such accounts will be kept. But for all that, it is not par- 
ticularly difl5cult to distinguish between operating expenses and 
non-operating expenses in any given business, once the nature and 
purpose of the business is clearly understood. The operating expenses 
in general are those expenses that are incurred necessarily and directly 



29s 



^ 



I 



ir, 






'1 



296 



PRINCIPLES OF ACCOUNTING 



in carrying on those operations which lead to the earning of the 
primary or operating income of the business. 

Cost-of-goodS'Sold accounts. The primary income of any business 
comes through the sale of something, whether a commodity or a 
service. It follows that a prime essential for the securing of this 
income is to have something to sell. In this connection, businesses 
selling services will for the present be omitted from the discussion 
and consideration given only to those selling commodities of one 
kind or another. A business selling goods of any kind must secure 
the goods either by purchasing them or by producing them. In 
either case, certain accounts will be needed to show the cost of the 
goods sold. It does not seem desirable at this point to enter into a 
discussion of the accounts necessary for this purpose in a manu- 
facturing business, smce a satisfactory explanation of the purpose and 
use of these accounts would require more space than can well be 
devoted to it in this text. The present discussion of accounts with 
the cost of goods sold will therefore be confined to those used in 
mercantile businesses. 

Purchases accounts. The most important account in use for this 
purpose in a mercantile busmess is the one with purchases. By this is 
meant the purchases of merchandise for resale. This account is 
used to show the amount of the merchandise purchased by the business 
during the current fiscal period, at the invoice price. The reader 
is already quite familiar with the nature of the transactions affecting 
this account, and with the routine of handling such transactions and 
entering them on the books of original entry. He is also aware of the 
fact that to be of the greatest use for reporting purposes, the pur- 
chases account should show only one thing, namely, the total pur- 
chases for the period at the invoiced price. This means that the 
entries which will be made to this account during the accounting 
period are as follows: 

PURCHASES 



Debit: 
With the invoiced price of all mer 
chandise purchased. 




In closing the accounts at the end of the fiscal period, however, 
various methods of procedure may be followed. A desirable method 



CONSTRUCTION OF ACCOUNTS— EXPENSE ACCOUNTS 297 

that has been explained in this text is to close all the accounts affecting 
the cost of goods sold into purchases account, so that the debit 
balance remaining to be transferred from purchases when that account 
is finally closed represents the cost of goods sold. According to that 
method, also, that balance is transferred to the sales account. Taking 
into consideration the closing entries, made according to the method 
indicated, the debits and credits to the purchases account are as 

follows: 

PURCHASES 



Debit: 

With the invoiced price of all mer- 
chandise purchased during the 
period. 

By an adjusting entry at the close of 
the i>eriod, with the amount of the 
merchandise inventory at the begin- 
ning of the period. 

By the closing entries, with the debit 
balances of any other accounts 
with cost of goods sold, transferred 
to purchases account. 



Credit: 

By an adjusting entry at the close of 
the period, with the amount of the 
merchandise inventory at the close 
of the period. 

By the closing entries, with the credit 
balances of any accounts with pur- 
chases deductions, transferred to 
purchases account. 

By a closing entry, with the debit 
balance of purchases account, trans- 
ferred to sales, or to some other ac- 
count used in summarizing the 
revenue accounts. 



From the foregoing discussion, it appears that the balance of the 
purchases account as it appears on the trial balance taken at the end 
of the accounting period and on the accounting reports is a debit 
balance, and shows the total gross purchases. In closing the books, 
it may be used as a summary account and made to show the cost of 
goods sold, if so desired. There will be no balance at all in the 
purchases account at the beginning of a new period. 

If the mercantile business in question is organized by departments, 
and the sales accounts subdivided by departments, in order to make 
possible the reporting of operating income by departments, the pur- 
chases account will need to be subdivided on the same basis, so that 
gross profits may be shown by departments. But whatever classi- 
fication is made of purchases, the nature of each purchases account is 
the same as that of the general purchases accoimt, and involves the 
same debits and credits. 

Accounts with purchases deductions. As in the case of sales, so in 
ascertaining the net amount of the cost of goods purchased during a 
period, there are certain deductions to be made. In some smaller 



W I 



It 



298 



PRINCIPLES OF ACCOUNTING 



businesses these items are credited directly to the purchases account, 
but where such deductions amount to any considerable figure, it is 
considered worth while to have them shown as separate items on the 
statement of profit and loss. Usually only one such account is kept 
in connection with purchases, and that is the account with purchase 
returns and allowances. The debits and credits to this account are 
as follows: 

PURCHASE RETURNS AND ALLOWANCES 



Debit: 
For the closing entry, with the credit 
balance of this account transferred 
to the purchases account. 



Credit: 
With the invoiced price of all goods 

returned to creditors with their 

permission. 
With credit allowed the business by 

creditors for freight paid on goods 

returned. 
With all allowances or rebates allowed 

the business by creditors for any 

reason whatever. 



The balance of this account at the end of an accounting period 
is a credit balance, and shows the total credit received by the business 
for goods returned, and for rebates and allowances of all sorts, this 
total representing a deduction to be made from the amount of gross 
purchases in order to ascertain the net cost of goods purchased during 
the period. If any subdivision is made of accounts with purchases, 
it will be necessary to have a subdivision of the purchases returns and 
allowances account on the same basis, in order to show in the reports 
the amount of the net purchases for each class into which purchases 
are divided. 

Other cost-of-goods-sold accounts. There are certain items to be 
included in the cost of goods sold, in addition to the purchase price 
of the goods. Thus the total **laid-down" cost of the goods sold 
includes not only the purchase price of such goods but also all freight, 
express, parcels post, and cartage charges incurred in getting them 
to the place where they are to be sold, as well as any duties or other 
charges that may have been incurred. A large importing concern 
might find it desirable to maintain several accounts to show the 
charges of this nature in more or less detail. Ordinarily, however, not 
more than one or two such accounts will be mamtained. Often there 
is only one such account, termed variously ** In-Freight," ** Freight 



CONSTRUCTION OF ACCOUNTS— EXPENSE ACCOUNTS 299 



and Cartage Inward,'' and "Freight, Express, and Cartage Inward." 
The nature of all the accounts representing additional charges to 
cost of goods sold should by this time be fairly clear. The account 
with freight, express, and cartage inward may be considered typical 
of all such accounts, and the nature of the debits and credits to this 
account is shown by the following: 

FREIGHT, EXPRESS, AND CARTAGE INWARD 



Debit: 
With all expenses incurred for freight, 
express, or hauling on merchandise 
purchased. 



Credit: 
By a closing entry at the end of the 
fiscal period, to transfer the debit 
balance of this account to pur- 
chases. 



The balance of this account which will appear on the reports is a 
debit balance, and will be added to the amount of purchases for the 
period in that part of the profit and loss statement which shows the 
cost of goods sold. Since this represents an addition to the purchases 
account, it should be subdivided or classified on the same basis as 
the purchases account for purposes of reporting. Thus if a business 
has four departments, and a separate sales account and purchases 
account is maintained for each department, a separate account with 
freight, express, and cartage inward should also be maintained for 
each department, so that cost of goods sold and gross profit on sales 
may be reported by departments. 

Other operating expense accounts. In addition to the accounts 
which show the cost of the goods sold, there are a number of accounts 
showing the amount of various other operating expenses incurred in 
conducting the business. The number of such operating accoAits, 
and the classification that will be made of them, will be determined 
by the reporting requirements of the business, which will in turn be 
determined by the size of the business, the nature of its operations, 
and the manner in which it is organized. Thus the accounts of a 
particular business may be such as to show the expense of each kind 
of service rendered, such as buying, selling, delivering, collecting 
the accounts due, etc., and to show the cost of each of these services 
for each department of the business. A discussion of the classifi- 
cation of accounts is reserved for chapter xxix. But in a business of 
any considerable size there will be a number of such accounts kept. 



-1 



i'l " <• 



300 



PRINCIPLES OF ACCOUNTING 



classified in such a manner as seems most useful for the reporting 
requirements of that particular business. 

The nature and construction of these operating expense accounts 
differ only with the nature of the expense and the manner in which 
it is incurred and brought into the books. For the most part, the 
debits and credits to the operating expense accounts are all made in 
the same manner. Wages of Sales Clerks may be taken as a type of 
the ordinary operating expense account. The debits and credits to 
be made to this account would be as follows: 

WAGES OF SALES CLERKS 



Debit: 
With the amount of all wages paid to 

sales clerks during the fiscal period. 
At the end of the period with any wages 

of sales clerks which have accrued 

but are not yet payable. 



Credit: 
By a closing entry, with the debit 
balance of the account, representing 
the amount of this class of expense 
for the period, which is transferred 
to profit and loss. 
By a "pwst-closing" entry, to transfer 
back to this account the amount of 
wages accrued but not yet payable 
at the end of the period (for expla- 
nation,- see chapter xxvii). 



The debit balance of this account at the end of the period represents 
the amount of such expense which is chargeable against the operating 
income of the period. Where a post-closing entry causes this account 
to show a credit balance at the beginning of the new period, this 
balance represents the amount of such expense which was charged 
against the operations of the period just ended, but which has not 
been paid. This credit balance will be wiped out by the debit to 
this account resulting from the first payment of such wages. The 
resulting debit balance will be the part of that payment which is 
chargeable to the operations of the new period. 

In a business having several selling departments, this account may 
be subdivided to show the amount of such expenses chargeable to each 
of these departments. 

Accounts with estimated operating expenses. Another type of 
operating expense which deserves some attention here is that kind of 
expense which is not reckoned by the amount actually paid out or 
definitely accrued, but by the amount which is estimated according 
to some predetermined scheme, to be properly chargeable as an 



CONSTRUCTION OF ACCOUNTS— EXPENSE ACCOUNTS 301 

expense of the current period. Examples of this type of expense are: 
(i) loss from bad debts, and (2) depreciation on store equipment. 
In the case of each of these expenses, the amount is determined by 
an estimate, made at the end of the period, and an entry is then made, 
debiting the expense account and crediting a valuation reserve 
account. The account with depreciation on store equipment may be 
taken as typical of such accounts. The amount with which this 
account will be debited at the end of a fiscal period is determined by 
the original cost of the equipment then in use, and its estimated 
length of useful life. The debits and credits to this account are as 
follows: 

DEPRECIATION OF STORE EQUIPMENT 



Debit: 
At the end of the fiscal period with 
the amount of that portion of the 
value of store equipment to be 
charged to expense for the current 
period as determined by the depre- 
ciation schedule. 



Credit: 
By a closing entry, with the debit 
balance of the account, to be trans- 
ferred to profit and loss. 



The debit balance of this account, which appears on the statement of 
profit and loss for the period, represents the amount that is estimated 
as chargeable against the period's operations for the loss in value 
resulting from the use of the store equipment. 

Accounts with other deductions from income. Just as there are 
certain items of income accruing to a business which cannot be 
classed as a part of the operating income of that business, so there are 
certain items of expense incurred in the ordinary business which cannot 
be properly classified as operating expense. That is to say, it cannot 
be definitely connected with any of the primary operating functions 
of the business, and must therefore be omitted from consideration 
on the statement of profit and loss until after the net operating in- 
come has been ascertained by a comparison of total operating income 
and total operating expense. Just what such items will be in a 
particular business will depend largely on the nature of the operations 
of that business. Two such items that occur in most mercantile 
concerns are: (i) interest on notes payable, and (2) cash discount on 
sales. 



302 



PRINCIPLES OF ACCOUNTING 



; * 



t:f 



Interest on notes payable. It is quite usual for the average business 
to give its notes to the bank in order to secure credit there which will 
serve as a means of discharging the obligations which the business has 
incurred to its creditors. In many cases, also, notes are issued to trade 
creditors. Notes to trade creditors sometimes bear interest and 
sometimes do not. Notes given to the bank may bear interest also. 
If not, the bank deducts the interest from the face of the note and 
credits the borrowing concern with the difference. Interest on notes 
payable, therefore, is an item of frequent occurrence in the ordinary 
business. This item represents an expense incurred in financing the 
business, and should be kept entirely separate from the expenses 
incurred in carrying on the operations for which the business is 
organized. It is therefore to be classed as "other deductions from 
income." The debits and credits to this account are as follows: 

INTEREST ON NOTES PAYABLE 



Debit: 

With the amount of all interest pay- 
ments made on such notes. 

With the amount of discount deducted 
from the face of notes payable by 
the bank. 

At the end of each fiscal period with 
the amount of all such interest 
accrued but not yet payable. 



Credit: 

By a closmg entry, with the amount 
of the debit balance of this account 
transferred to profit and loss ac- 
coimt. 

By a post-closing entry with the 
amount of interest accrued for the 
current period, but not yet payable 
(for explanation, see chapter xxvii). 



The debit balance of this account which appears on the statement 
of profit and loss represents the total amount of such interest accruing 
during the current period. The credit balance which may appear 
in the account as the result of a post-closing entry shows the amount 
of such interest accrued and charged against the income of the period 
just past, but not yet payable. This matter will be explained at 
length in the following chapter. 

Cash discount on sales. Cash discount on sales is a discount 
allowed to customers for the payment within a certain limited time of 
invoices sold them. It is sometimes argued that this item should be 
treated as a direct deduction from sales, like sales returns and allow- 
ances, since it represents a reduction of the price of goods. The 
weight of opinion among accountants, however, seems to be in favor of 
treating it as other deductions from income. The reason for this is 
that this item represents a cost of a financial nature. The price of the 



CONSTRUCTION OF ACCOUNTS— EXPENSE ACCOUNTS 303 

goods is the same, whether the customer exercises his option with re- 
gard to the discount or not. The discount allowed is partly in the 
nature of insurance against bad debts, and partly in the nature of 
interest paid for the use of the money between the discount date 
and the time when the payment would otherwise be due. For this 
reason, this item is to be considered rather as a financial expense 
than as a deduction from sales. It is therefore usually classified as 
non-operating. 

The debits and credits to the account with cash discount on sales 
are as follows: 

CASH DISCOUNT ON SALES 



Debit: 
With all discounts taken by customers 
for the payment of sales invoices 
within the time allowed. 



Credit: 
By a closing entry, with the amount 
of the debit balance of the account 
transferred to profit and loss 
account. 



The debit balance shown by this account at the end of a fiscal period 
represents the amount of cash discounts taken by customers during 
the current period. This balance appears on the statement of profit 
and loss under the head of ** other deductions from income." 

QUESTIONS FOR CLASS DISCUSSION 

1. How do you justify the discussion of purchases account under the head 
of operating expenses ? 

2. Does the balance in purchases account at the end of a p)eriod, and before 
any adjustments have been made, represent an expense? If not, 
what does it represent ? 

3. What basis of analysis should you suggest for the purchase accounts of 
the X Music Company (see question 3 at the end of chapter xxv) ? 
Give a complete classification of the accoimts which should be used in 
this business to show the cost of sales. Justify your classification. 

4. Besides its four selling departments, divided according to conmiodities, 
the X Music Company maintains a delivery service, a credit and 
collection department, and a service department for the purpose of 
giving service to customers on goods covered by guarantees. The 
company also has a central advertising department, which handles the 
advertising for all its branches, and gives advertising aid to dealers. 
W^at does this suggest to you with regard to the classification of oper- 
ating expense which should be maintained by this company ? 



304 



PRINCIPLES OF ACCOUNTING 



$. In your classification of expense accounts for the X Company, what 
disposal should you make of depreciation on buildings ? loss from bad 
debts? 

6. List all of the non-operating expenses that you can think of which might 
occur in the X Company's business. Explain why each of these ex- 
penses is considered non-operating in its nature. 

7. Does the current practice of including cash discount on sales under 
non-operating expenses seem to you to be based on logical reasons ? 
Discuss. 

REFERENCES FOR FURTHER STUDY 

WiLDMAN, J. R., Principles of Accounting, chaps, xxxiv, xxxvi-xliv. 
Greendlinger, Leo, Financial and Business Statements, chap. iv. 
Dickinson, A. L., Accounting Practice and Procedure, chap. iii. 



CHAPTER XXVII 
ACCRUALS AND DEFERRED ITEMS 

Special entries necessary at close of period. At the end of any fiscal 
period, there are always many facts concerning the financial status 
of the business which have not yet been recorded in the ledger ac- 
counts, but which must, nevertheless, be considered if the financial 
reports are to be complete and correct in their showing. Thus there 
may be certain items which really exist as assets of the business, but 
which have not been entered on the books, since no clearly defined 
transaction has arisen to cause such entry to be made. In the same way 
liabilities may have arisen which have not yet any sort of voucher, 
and which have therefore not been recorded as liabilities. Income 
may have been earned or expense incurred without giving rise to an 
entry; or there may be items standing on the books as expense which 
are not properly chargeable against the earnings of the current fiscal 
period. Sometimes, also, credits are entered on the books for income 
which are not properly to be considered as an earning of the current 

fiscal period. 

A correct statement of the proprietorship and of net income 
for the period requires that such facts, so far as they can be ascer- 
tained, be recognized and recorded. The items of this kind which will 
be considered in the present chapter may be classified as follows: 
(i) accrued income; (2) accrued expense; (3) deferred charges to 
expense; (4) deferred credits to income. 

Accrued income. In order to state correctly the income of a 
given fiscal period, all the income which has been earned by the 
business during the period must be included in the statement. In- 
come may be earned during one period which does not become due 
and payable until some time which falls in a later fiscal period. Such 
items are not ordinarily entered on the books before they become 
payable, since no voucher arises as the basis of such entry, and since 
up to that time the amount is as a rule continually changing. At the 
end of an accounting period, however, they must be recognized and 

30s 



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it 



306 



PRINCIPLES OF ACCOUNTING 



correctly recorded if the income is to be properly apportioned between 
periods. 

An illustration of such income is to be found in the case of interest 
on notes receivable. Thus if the business accepts a customer's 
sixty-day note for $1,000 with interest at 6 per cent, dated December 
I, and continues to hold this note until December 31, the day of 
closing the books, it is apparent that one month's interest, or $5, has 
been earned during the period just ended. On December 31, then, 
the claim of the business for this amount should be shown on the 
balance sheet as an asset, and the amount of the earning should appear 
on the statement of profit and loss for the current period. 

If this item of accrued interest is to appear in the financial reports, 
it should also appear in the accounts, since the balance sheet and 
statement of profit and loss are supposed to reflect the financial facts 
about the business as shown by the accounts. To bring this item 
into the accounts there must be a debit made to some asset account, 
which may be called "Accrued Interest Receivable," and a credit to 
the income account, "Interest on Notes Receivable." Assume that 
this income account has been credited throughout the year for various 
items, amounting altogether to $41, and that there is no other 
item of accrued interest receivable. Under these circumstances the 
two accounts affected by the entry might appear as follows: 

INTEREST ACCRUED RECEIVABLE 



1919 
Dec. 31 



00 



INTEREST ON NOTES RECEIVABLE 



1919 
Feb. IS 
May 2S 
July 7 
Sept. 20 
Nov. 18 
Dec. 31 




When the closmg entries, as of December 31, are made, the income 
account will be closed to profit and loss, and will appear, after posting, 
as follows: 



ACCRUALS AND DEFERRED ITEMS 



INTEREST ON NOTES RECEIVABLE 



307 



I9I9 

Dec. 31 


To Profit and Loss 

« 


46 


00 


1919 
Feb. IS 
May 2S 
July 7 
Sept. 20 
Nov. 18 


■ • • • 


4 

10 

6 

3 
S 


40 
80 

75 

25 
80 


*j 






00 


Dec. 31 




S 


00 




46 


46 


00 









On January 30 the note will mature and be paid, with the $10 
interest. The amount of interest received will be credited to interest 
on notes receivable account, but as a matter of fact only one-half of 
that amount represents an. earning of the period in which the entry 
for its receipt is made. The other half of the interest was earned and 
credited to income in the preceding period. This fact may be indi- 
cated and a correct showing of income provided for in the ledger by 
closing the accrued income account into the income account after the 
ledger has been closed at the end of a period. After this entry has 
been made and posted, the two accounts affected will appear as follows: 

INTEREST ACCRUED RECEIVABLE 



1919 
Dec. 31 



00 



1920 
Jan. I 



00 



INTEREST ON NOTES RECEIVABLE 



I9I9 

Dec. 31 


To Profit and Loss 
• • • • 


46 

• 


00 

00 
00 


1919 
Feb. IS 
May 2S 
July 7 
Sept. 20 
Nov. 18 
Dec. 31 


• 

Accrued 


4 

10 

6 

3 
5 
5 


40 
80 

75 

25 

80 
00 




46 
5 


46 


00 


1920 
Jan. I 







On January 30, when the $10 interest is received and credited to 
interest on notes receivable, the $$ debit akeady made to that account 



I . I 









< ;.1 



111 



•II ; 

■f 



I •! i' 






!'»! 

I,i:i! 



308 



PRINCIPLES OF ACCOUNTING 



by transferring the balance back from the accrued asset account will 
offset the credit by that amount, making the net credit only $5, which 
is the amount actually earned during 1920. 

The foregoing discussion of the treatment of acctued interest 
receivable apphes to other items of accrued income. If there are a 
number of such items at the end of a period, it is not always necessary 
to carry a separate account for each kind of income accrued. It is 
usually sufficient to carry a single account with accrued income. 
Whether one or several times of this nature are shown in the ledger 
accounts will of course depend on the classification which is desired 
in the balance sheet. Such items are shown on the balance sheet 
among the current assets. 

Accrued expenses. If it is necessary to the correctness of the 
financial reports that all items of current income should be included, 
it is equally necessary that all items of current expense should be 
shown. At the end of a fiscal period there are almost always some 
services which have been received by the business but for which pay- 
ment will not be due until some time in thje following period. In the 
normal course of business procedure no entry is made on the books 
of either the expense or the liability until the latter becomes payable, 
and some sort of voucher arises to serve as a basis of such entry. The 
most common example of such an accrued expense item is to be found 
in the pay-roll. Assuming that wages are payable on Saturday, and 
that the fiscal period ends on Wednesday, it is evident that the busi- 
ness has incurred as an item of expense the cost of three days* wages, 
and also that they have a UabiUty for this amount. These "accrued 
wages" should appear on the balance sheet as a liabiUty, and also 
on the statement of profit and loss as an expense of the current period. 

Since such items of accrued expense are to be shown on the bal- 
ance sheet and the statement of profit and loss, they must also be 
shown by the accounts at the time these reports are made up. This 
necessitates an entry debiting the appropriate expense account and 
crediting the account which represents the accrued Uability. The 
account with salaries of sales force may be used for illustration. It 
may be assumed that on December 31 this account shows a balance of 
$5*630, which represents the total charges to the account for the year 
1919. The amount accrued for the first three days of the week ending 
January 3, 1920, is $55. After the entry recording the accrual has 



ACCRUALS AND DEFERRED ITEMS 



309 



been made and posted, the two accounts involved will appear as 

follows: 

SALARIES OF SALES FORCE 



1919 
Dec. 31 

31 



Balance 
Accrued 



5,630 
55 



00 
00 



ACCRUED WAGES 




When the closing entries for the period have been made and 
posted, this expense account will have been closed to profit and loss, 
and will show the following: 

SALARIES OF SALES FORCE 



1919 
Dec. 31 
31 



Balance 
Accrued 



5.630 
55 



5,68s 



00 
00 



00 



1919 
Dec. 31 



To Profit and Loss 



5,68s 



00 



5,68s 



00 



When the week's wages are paid on January 3, $110 will be paid 
to the sales force. This will be debited to the account with salaries 
of sales force. But if no other adjustment is made of the account 
balances, this account will be overstated by $55, since that portion 
of the week's pay-roll has already been charged off against last 
period's earnings. This would also fail to show that the accrued 
liability is now canceled. This difl&culty is avoided by an entry 
made immediately after closing the ledger for 1919, by which accrued 
wages is debited for the amount of its balance, and salaries of sales 
force credited. Assuming that such an entry is made, and that an 
entry is made on January 3 to record the payment of the week's 
wages, the expense account and accrued liability account would then 
appear as on page 310. 

It is apparent from the following illustration that after the wages 
have been paid on January 3, the account with salaries of sales force 
will show the correct balance, since the $110 debit is offset by the $55 
credit, representing the amount which has already been charged to 



I \ 



310 



Principles of accounting 



profit and loss and is therefore not to be included in the expense of 
the current period. 

The foregoing discussion, with the illustration, applies to the 
treatment of accrued expenses in general. It is not always necessary 
to set up a separate liability account for each kind of expense which 
is accrued. A single account with accrued expense will usually serve 
satisfactorily, unless for some reason further analysis of such liabilities 
is to be shown on the balance sheet. The place of such an account on 
the balance sheet is among the current liabilities. 

SALARIES OF SALES FORCE 



I9I9 

Dec. 31 
31 


Balance 
Accrued 

Cash 


5,630 
55 


88 8 8 


1919 

Dec. 31 


To Profit and Loss 

• • • • 


5,68s 


00 




5,685 


5,68s 


00 


1920 
Jan. 3 


no 


1920 
Jan. I 


55 


00 



ACCRUED WAGES 



1920 
Jan. 1 



55 



00 



1919 
Dec. 31 



55 



00 



The entries affecting accrued income and expenses are part of the 
entire group of adjusting entries made at the end of a fiscal period. 
In illustrating these two kinds of adjusting entries the accounts as 
affected by the entries have been shown, rather than the entries them- 
selves. The adjusting entries as a group will be considered in chapter 
xxviii. 

Deferred charges to expense. It very often happens that a business 
pays in advance for the right to receive a certain service, or purchases 
certain kinds of supplies in sufficient quantity to last for some time. 
At the time when such services are received by the business the 
amount so used up becomes an expense. Also, the amount of any 
kind of supplies used up in a given period is an expense of that period. 
But the amount of such services or supplies which are paid for and still 
unused at the end of a fiscal period is said to be a deferred charge to 
expense, or a prepaid expense. Some examples of such deferred 
charges are: prepaid interest, prepaid insurance, office supplies 



ACCRUALS AND DEFERRED ITEMS 



3" 



remaining on hand at the end of a period, and unused service or sup- 
plies of almost any sort, such as coal, wrapping paper and twine, 
supplies for window dressing, and the like. For purposes of illus- 
tration unexpired insurance will be used as typical of services unused, 
and office supplies as typical of supplies on hand. 
. The nature of the service of insurance is well known. Business 
men, in order to minimize the risks attendant on conducting a busi- 
ness, usually contract with one or more insurance companies for the 
assumption of certain of these risks by the insurance company. Such 
a contract provides that in return for a certain consideration, known 
as the insurance premium^ the company agrees to indemnify the 
owner for the loss of such property as is covered by the contract, such 
indemnity not to exceed a sum set in the contract. Such contracts 
have assumed a fairly standardized form, and are known as insurance 
' policies. Such a policy is drawn to cover a definite period of time, 
usually a year, and the premium is always payable in advance. 







INSURANCE POLICY RECORD 

(Left-hand Page) 






Date of 
Policy 


Number 


Name of 
Company 


Property 
Insured 


Amount 


Expires 


Total 


Premium 
















- 



INSURANCE POLICY RECORD 

(Right-hand Page) 



Monthly Expirations 


Amount 


Jan. 


Feb. 


Mar. 


April 


May 


June 


July 


Aug. 


Sept. 


Oct. 


Nov. 


Dec. 


Carried 
Forward 





























It is quite usual for a business firm to have at one time several 
such policies, entered into with different companies, at different 
times, and covering risks on different property. Where this is 
true, it is desirable to have some record of the different policies. 



312 



PRINCIPLES OF ACCOUNTING 




Such a record should show when each policy expires, and also the 
amount of the premium which is to be charged to expense during a 
given fiscal j>eriod, and the amount which represents a deferred charge 
at the end of such period. A form of such an insurance policy yecord, 
which furnishes the information desirable with regard to the policies 
held by the business, is shown on page 311. 

Whenever an insurance policy is taken out by a business using 
such a record as the above, it is recorded, entering in the monthly 
columns the amount of the premium which will expire during the 
current year, and in the column headed "Amount Carried Forward" 
the amount that will be unused at the end of the current fiscal year. 
The entry for the payment of the premium is made in the cash book, 
debiting prepaid insurance account, or insurance unexpired. 

The purpose of the prepaid insurance account is to show the 
amount of insurance premiums paid which have not yet expired. 
It is debited with the amount of all premiums paid, and credited 
at the end of each month with the total of the premiums showa by 
the insurance policy record to have expired within that month, the 
corresponding debit being to the expense -account affected by such 
expiration. The debits and credits to the prepaid insurance account 
may be summarized as follows: 

PREPAID INSURANCE 



Debit: 
With amounts of all insurance premi- 
ums paid. 



Credit: 

At the end of each month with all 
amounts of insurance premiums 
expired, as shown by the insurance 
policy record, or otherwise deter- 
mined. 

With insurance premiums reftmded 
on canceled policies. 



The balance of this account after the proper credits have been made 
to it shows the amount of the unexpired premiums and appears on the 
balance sheet as a prepaid expense, or deferred charge to expense. 

At the beginning of a new fiscal year the insurance policy record 
will be ruled up and a new entry made for the policies still in force, 
carrying down the amount of premium unexpired on each, and 
distributing the expirations for the new year by months, as before. 

Office supplies may be taken as an example of supplies on hand at 
the end of a fiscal period. This item includes such things as station- 



^ 



ACCRUALS AND DEFERRED ITEMS 



313 



ery, stamps, pencils, pens, clips, etc. The account with office supplies 
is intended to show the cost of all such supplies purchased, the amount 
used up within the period, and the amount remaining unused at the 
end of the period. It will be debited and credited as follows: 

OFFICE SUPPLIES 



Debit: 
With the cost of all office supplies 
purchased during the accounting 
period. 



Credit: 
With the cost of all office supplies 
used or in any way disposed of 
during the period. 



When *' Office Supplies" is credited, the corresponding debit is to 
the expense account chargeable with the supplies used. This is 
usually *' Office Expense" or "Administrative Expense." Except in 
very large businesses, it is not usually considered worth while to keep 
a continuous record of the amount of office supplies on hand and the 
amount used. Where this is not done, the cost of the supplies used is 
obtained by taking an inventory of such supplies at the end of each 
period. The amount of the inventory represents the amount of the 
debit balance that should appear in the office supplies account. The 
difference between this amount and the balance actually shown in 
that account is therefore taken to represent the amount used during 
the period, and this amount is debited to some expense account and 
credited to the office supplies account. The balance remaining is 
consequently the amount of the inventory, and this amount is shown 
on the balance sheet as a deferred charge to expense. 

Deferred credits to income. Income is sometimes received during 
one period which has not been earned by the business during that 
period but will be earned in the following fiscal period. Such items 
of income are known as deferred credits to income. Examples of such 
deferred credits are to be found in the case of the insurance company 
which receives payments for insurance premiums which do not 
expire during the current period; in the case of a publishing concern 
which receives subscriptions to its publication, paid in advance, for 
a period of time which runs past the end of the current fiscal period; 
and in the case of a commercial bank which discounts the note of a 
customer, deducting in advance the amount of the interest, which 
may be for a period which runs beyond the end of the year. 




I 





314 



PRINCIPLES OF ACCOUNTING 



The case of the commercial bank may be used for an illustration. 
When the bank discounts a customer's note, an entry would be made 
debiting Loans and Discounts for the face of the note, crediting the 
customer, or possibly Cash, for the proceeds of the note, and crediting 
Discount Earned for the amount of the interest or discount deducted. 
At the end of a fiscal period this account will show a credit balance, 
including not only all the discount earned during the period but also 
a considerable amount that will not be earned until some time in the 
following period. At the end of a fiscal period, if the proprietorship 
in the bank and its income for the period are to be shown correctly, 
it will be necessary to show as income only that portion of the dis- 
counts which have been earned within the period, and to show the 
unearned discounts on the balance sheet as a deferred credit to income. 





NOTES DISCOUNTED RECORD 








Date 
Dis- 
counted 


Maker of Note 

or 

Acceptor of Draft 


Indorser of Note 

or 
Drawer of Draft 


Date 
Dis- 
counted 


Date 

of 

Maturity 


Discount 
Rate 


Amount 

of 

Note 


When 
Paid 
















: 









NOTES DISCOUNTED RECORD 






• 


EXPIKATIONS OF INTEREST 


Amocnt 


Jan. 


Feb. 


Mar. 


April 


May 


June 


July 


Aug. 


Sept. 


Oct. 


Nov. 


Dec. 


Carried 
Forward 





























Certain classes of banks are now required by the federal examiners 
to show the amount of discounts unearned as an item on the balance 
sheet. The accounting departments of many of them objected to this 
because of the tremendous amount of work involved in classifying 
the notes and dividing the discount deducted as between earned and 
unearned. The work required for this may be minimized by the use 
of a record along the lines of the insurance policy record illustrated 



ACCRUALS AND DEFERRED ITEMS 



315 



above. Such a form would need to provide for certain essential 
information about each note, draft, or trade acceptance discounted, 
and also to show an analysis by months of the discount earned. The 
information needed would probably be about as given on page 314. 
Such a record as this, modified in any way necessary to fit the 
needs of the bank using it, would furnish the information necessary 
to divide the Discount Earned during a given fiscal period from that 
unearned. An entry would then be made at the end of the period 
debiting Discounts Earned and crediting Discounts Unearned for the 
amount of discounts shown by this record to be unexpired at the end 
of the period. The two accounts, used in this manner, would be 
debited and credited as follows: 

DISCOUNT EARNED 



Debit: 
At the end of the period with the 
amount of discount unearned. 



Credit: 
With the amount of discount deducted 

when the note or draft is discounted. 
At the beginning of a new period with 

the balance of discount unearned 

account. 



DISCOUNT UNEARNED 



DebU: 
At the beginning of a new period with 
the amount of the balance, to 
transfer back to discount earned 
account. 



Credit: 
At the end of a period with the amount 
of discount imexpired. 



The foregoing represents the method by which most of the banks 
seem to have handled these two accounts. A more logical method, 
which would avoid the necessity of closing discounts unearned back 
into discounts earned account at the beginning of each period, would 
be to debit and credit these accounts as follows: 

DISCOUNT UNEARNED 



Debit: 
At the end of each month with all 
amoimts of discoimts expired, as 
shown by the notes discounted 
record. 



Credit: 
With the amounts of all discounts 
received on notes and drafts 
discounted. 



3i6 





PRINCIPLES OF ACCOUNTING 



DISCOUNT EARNED 



Debit: 
With closing entry (to profit and loss) 



Credit: 
At the end of the month with all 
amounts of discounts ej^ired, as 
shown by the notes discounted 
record. 



Other types of payments received by a business in advance of the 
rendering of the service by the business may be handled in the same 
manner. Where any considerable number of such payments are 
received, it is highly desirable that some sort of supplementary 
record should be maintained to show at any time what portion of 
this income has been earned and what portion is still unearned. 
The amount of all such receipts should be credited to an unearned in- 
come account and transferred from this account to an appropriate 
income account, as the supplementary record shows them to have 
become earned income. 

QUESTIONS FOR CLASS DISCUSSION 

1. The Fashion Publishing Company issues a magazme, Modes. Sub- 
scriptions are all paid in advance. They are made and renewed at 
various times throughout the year, being paid for periods of one, two, 
or three years. Outline the method which you should recommend for 
accounting with this source of income. Should you employ any special 
types of records ? 

Give the journal entries which would be necessary to adjust this matter 
at the end of the fiscal year. 

2. The Fashion Publishing Company issues with each copy of its maga- 
zine a coupon good for a pattern. These patterns are available at 
various stores throughout the United States. What is the nature of 
the accounting problems to which this practice would give rise ? 

3. On December 2 the firm of Taylor and Wilson discounts its sucty-day 
note for $1,000.00 at the bank, the rate being 6 per cent. On December 
15 the firm gives a trade creditor its thirty-day note for $1,500.00, with 
interest at 6 per cent. The fiscal period ends December 31. 

a) What journal entries should Ije made when each of these notes was 
issued ? 

b) What journal entries affecting the interest on notes payable account 
should be made at the end of the fiscal period? What term or 
terms may be used to characterize these entries ? 

c) What entries should be made when each of these notes matures ? 



ACCRUALS AND DEFERRED ITEMS 



317 



4. Explain the purpose of the "post-closing" entries, in the case of (a) 
. accrued expense; (6) accrued income. What difference woxild the 

omission of such entries make in the later accounting? Illustrate by 
means of skeleton accounts. 

5. Taylor and Wilson have in their ledger an account with "Office Sup- 
plies," which is debited with all purchases of such supplies. Explain 
two methods by which this account may be adjusted at the end of a 
fiscal period. Illustrate by means of skeleton ledger accounts. Would 
either of these methods necessitate the use of "post-closing" entries? 
Have you a preference as between the two methods ? Discuss. 

REFERENCES FOR FURTHER STUDY 

Esquerr£, Paul- Joseph, Applied Theory of Accounts ^ chaps, xxv and 

xxvi. 
WiLDMAN, J. R., Principles of Accounting, chaps, xxvii and xlv. 
Kester, Roy B., Accounting Theory and Practice, Vol. I, chap. xvi. 



1 



CHAPTER XXVIII 
ADJUSTING AND CLOSING ENTRIES 

Need for such entries. It has been repeatedly pointed out that a 
business concern reports on its financial condition or on the success of 
its operations at the end of cexXSim fiscal periods, or accounting periods. 
The length of the period is set by the management, and may be a 
month, three months, six months, a year, or any time that seems best. 
The fiscal period was formerly generally set at one year, and usually 
began and ended with the calendar year. The increased importance 
attached to the use of the reports as an aid in management has had 
the effect of shortening the fiscal period in a great many businesses, 
so that a reporting period of one month is not at all unusual. At the 
end of the fiscal period, whatever its length, it is the practice to brmg 
the information in the accounts up to date in order to make the 
accounts state as correctly as possible the operations of the period just 
ended, and the status of the business as on the last day of that period. 
This information is set forth in the balance sheet and the statement 
of profit and loss prepared at that time, and the various revenue 
accounts are summarized in the ledger to show the net effect of the 
period's operations on the proprietorship of the business. Making 
such a summary is known as the process of "closing the ledger." 
It is explained in full at a later point in this chapter. 

In order to make the accounts show complete and correct infor- 
mation at the end of the period, it is necessary to record certain facts 
which for one reason or another have not been recorded in the regular 
routine of entering business transactions. For example, recognition 
must be given to the fact that a certain amount of depreciation on 
the fixed assets is chargeable against the income of the period, and 
the value of the assets affected must be adjusted on this basis. The 
estimated loss on bad debts which is to be charged against the income 
of the period must be entered, and a revaluation made of current 
receivables on the basis of this estimate. Recognition must be given 
in the accounts to items of accrued income, accrued expense, deferred 

318 



ADJUSTING AND CLOSING ENTRIES 



319 



charges to expense, and deferred credits to income, if such items exist. 
The adjustment of the accounts to show such facts necessitates the 
making of certain adjusting entries at the close of the period. 

The working sheet. Before making the adjusting entries at the 
end of a period, it is customary to post all the ledger accounts to date 
and take a trial balance. This trial balance shows the condition of 
the accounts as affected by the current transactions for the period. 
The trial balance cannot be used for preparing the financial reports, 
however, until the necessary adjusting entries have been made. To 
facilitate the making of these adjustments the accountant frequently 
makes use of the working sheet, by means of which he is able to sum- 
marize the information which is to go into the reports. It is a form 
used for scheduling or tabulating the information in question, and 
consists of the trial balance and six or more additional columns. 
The columns needed, and their purpose, may be seen from the 

following form: 

WORKING SHEET 



TUAL Balance 


ADjvsnrp.NTS 


Pkofit and Loss 


Balance Sheet 


Name 

of 
Account 


Debits 


Credits 


Debito 


Credits 


Debits 


Credits 


Debits 


CrediU 










• 











The names of the accounts involved appear first at the left-hand side 
of the page. The first two money colunms show the trial balance as 
taken from the books after they are posted at the end of the fiscal 
period. The next two columns, headed "Adjustments," show the 
adjustments which must be made to the various accounts in order 
to bring them up to date for reporting purposes. The two columns 
headed "Profit and Loss" show the items which will appear in the 
statement of profit and loss, classified according to their effect on net 
income. The two "Balance Sheet" columns show the items which 
will appear in the balance sheet, the left-hand side showing the assets, 
and the right-hand side showing liabilities, asset valuation accounts, 
and proprietorship items. 

Illustration of the working sheet. The use of the working sheet may 
be simply illustrated. Assume that John Haynes is conducting a 



-I 



•( 



h ) 



320 PRINCIPLES OF ACCOUNTING 

retail business, and that the fiscal period is one month. After the 
posting has been done at the end of the month, a trial balance is 
taken, which is as follows : 

JOHN HAYNES 

Trial Balance,* July 31, 1920 

Cash . . $ 5,120.00 

I Accounts Receivable .... 15,990.00 

Notes Receivable 4,000.00 

Merchandise Inventory (June i) . . 11,500.00 

, Store Equipment 725.00 

Reserve for Depreciation Store Equipment . $ 125.00 

^ Delivery Equipment .... 1,500.00 

Reserve for Depreciation Delivery Equipment . . 300.00 

Accounts Payable . 8,140.00 

Notes Payable 9,000.00 

Purchases 19,600.00 

Purchases Returns and Allowances .... 650.00 

Freight and Cartage Inward . . . 220.00 

Sales 23,625.00 

Sales Returns and Allowances . . 460.00 

Sales Salaries , 1,500.00 

Advertising 220.00 

DeUvery Expense* 190.00 

Rent 300.00 

Insiurance Prepaid (to end of year) . 120.00 

Heat and Light 56.00 

Cash Discount on Purchases . . . . ' . 245.00 

John Haynes, Capital 19,466.00 

John Haynes, Personal .... 50.00 

$61,551.00 $61,551.00 

Supplementary Data 

1. Inventories: 

Merchandise inventory, July 31, $13,000.00 

2. Depreciation: 

Store equipment, 12 per cent 
Delivery equipment, 18 per cent 

3. Reserve for bad debts: 

One-fifth of i per cent on accounts receivable 

' This trial balance is not to be taken as representing a desirable or repre- 
sentative classification of accounts. The thing to be illustrated here is the method 
employed in sunmiarizing the accounts at the close of the period. 



ADJUSTING AND CLOSING ENTRIES 32r 

4. Deferred charges: 
Coal on hand, $17.00 

Gasoline and auto supplies, $30.00 
Insurance has expired to the amount of $30.00 

5. Accrued expense: 
Salaries accrued, $90.00 
Interest on notes payable, $18.00 

6. Accrued income: 

Interest on notes receivable, $12.00 

The adjusting entries. The journal entries which will be necessary 
to adjust the accounts to give recognition to the additional data 
listed above are as follows: 

July 31 

Purchases $11,500.00 

Merchandise Inventory $11,500.00 

To close the beginning inventory into Purchases accoimt 

31 
Merchandise Inventory .... 13,000.00 

Purchases . 13,000.00 

To enter the inventory as at July 31 

31 
Depreciation on Store Equipment . 7.25 

Reserve for Deprecation Store Equipment . . 7.25 

To enter period's depreciation on store equipment 

31 
Delivery Expense . . . . . 22.50 

Reserve for Depreciation on Delivery equipment 22.50 

To enter period's depreciation on deHvery equipment 

31 
Loss from Bad Debts .... 30.00 

Reserve for Bad Debts 30.00 

To enter estimated loss from bad debts 

31 
Supplies Inventory* .... 47 -oo 

Heat and Light , 17.00 

DeHvery Expense 30.00 

To enter deferred charge for supplies inventory and adjust 

expense for the period 

' Another method, illustrated in the preceding chapter, would probably be 
preferable here, but would involve a different arrangement of accounts in the trial 
balance. This method would be that of charging purchases of supplies to the 
supply accounts, and at the end of the period crediting the supply accounts and 
debiting the expense accounts. 



322 



PRINCIPLES OF ACCOUNTING 



ADJUSTING AND CLOSING ENTRIES 



323 



U 



31 

Insurance . . T . . . $20.00 

Insurance Prepaid 

To record insurance expired for the period 

Sales Salaries 90.00 

Salaries Accrued 

To record accrued sales salaries 



$20.00 



90.00 



3' 



18.00 



Interest on Notes Payable 
Interest Accrued Payable 
To record interest accrued on notes payable 



18.00 



3^ 

Interest Accrued Receivable . . . i2!oo 

Interest on Notes Receivable .... 
To record interest accrued on notes receivable 



12.00 



The trial balance, the adjustments to be made on the accounts as 
there shown, and the disposal of the adjusted balances as between the 
balance sheet and the statement of profit and loss', can all be sum- 
marized on the working sheet, on page 323. 

The statement of profit and loss. When the working sheet is com- 
pleted, the accountant has before him a summary of the accounts, 
corrected to show the true condition of the business at the end of the 
period. He is then ready to prepare the financial statements from 
the information furnished by this schedule. The corrected balances 
of the accounts aflFectmg the statement of profit and loss have been 
carried into the two columns headed "Profit and Loss," and those 
affecting the balance sheet are carried into the two columns headed 
" Balance Sheet." The profit and loss columns and the balance sheet 
columns are then totaled to make sure that the excess of the credit 
column under "Profit and Loss" over the debit columns, showing the 
net profit for the period, is the same in amount as the excess of the 
debit colunm under "Balance Sheet" over the credit column under 
that heading, this excess also representing the increase in proprietor- 
ship, or net profit for the period. The statement of profit and loss 



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! 



324 PRINCIPLES OF ACCOUNTING 

may then be prepared from the items appearing in the profit and loss 
columns, as follows: 

JOHN HAYNES 
Statement of Profit and Loss for Month Ending July 31, 1920 

Gross Sales $23,625.00 

Less Returns and Allowances 460.00 

Net Sales ... * «, ,<- ^^ 

. . • 23,105.00 

Cost of Goods Sold: 

Gross Purchases $19,600.00 

Less Returns and Allowances . . 650.00 

Net Purchases 18,950.00 

Freight and Cartage Inward . , 220.00 

Inventory, July i, 1920 . . . 11,500.00 

30.670.00 
Less Inventory, July 31, 1920 . . 13,000.00 

Cost of Goods Sold 17 670.00 

Gross Profit on Sales . , . . . , , S,495.oo 
Operating Expenses: 
Selling Expenses : 

Sales Salaries . . $1,590.00 

Advertising , . 220.00 

Total Selling Expense . . , 1,810.00 

Delivery Expense . . . , 182.50 

Administrative Expense: 
Rent .... 300.00 
Insurance . . , 20.00 
Heat and Light . . 39.00 
Depreciation Store Equip- 
ment . . . 7.25 

Loss from Bad Debts 30.00 / 

— — — — » 

Total Administrative Expense . 396.25 

Total Operating Expense 2,388.75 

Net Operating Profit 3,106.25 



ADJUSTING AND CLOSING ENTRIES 32$ 

Other Income: 
Interest on Notes Receivable . . $ 12.00 
Cash Discount on Purchases . . 245.00 

Total Other Income $ 257.00 

Gross Income 3,363.25 

Deductions from Income: 
Interest on Notes Payable . . . 18.00 

Total Deductions from Income .... 18.00 

Net Income $ 3,345-25 

The balance sheet. From the items appearing in the balance sheet 
columns, the following balance sheet may be prepared: 

JOHN HAYNES 
Balance Sheet, as of July 31, 1920 

ASSETS 

Current Assets: 

Cash $ 5,120.00 

Notes Receivable 4,000.00 

Accounts Receivable . $15,990.00 

Less Reserve for Bad Debts 30.00 1 5,960.00 

Merchandise Inventory . . . 13,000.00 
Interest Accrued on Notes Receivable ^ 12.00 

Total Current Assets $38,092.00 

Fixed Assets: 
Store Equipment . . 725.00 

Less Reserve for De- 
preciation . . 132.25 592.75 

Delivery Equipment . 1,500.00 
Less Reserve for De- 
preciation . . 322.50 1,177.50 

Total Fixed Assets . - 1,770.25 

Deferred Charges to Expense: 
Insurance Prepaid .... 100.00 

Suf^Ues Inventory . . . . 47.00 

Total Deferred Charges . . . . . 147.00 

Total Assets $40,009.25 



i'f 



326 PRINCIPLES OF ACCOUNTING 

LIABILITIES AND PROPRIETORSHIP 

Current Liabilities: 

Notes Payable $9,000.00 

Accounts Payable .... 8,140.00 

Salaries Accrued 90.00 

Interest Accrued on Notes Payable . 18.00 

Total Current Liabilities $17,248.00 

Proprietorship: 
John Haynes, Proprietor 22,761.25 

Total Liabilities and Proprietorship. , . $40,009.25 

The closing entries. An examination of the profit and loss columns 
of the working sheet shows what accounts must be closed in order to 
summarize the results of the period's operations. Those columns 
show the revenue accounts which still have balances, and the amount 
of each such balance after the adjusting entries are made and posted. 
Taking the balances of the revenue accounts as they appear on the 
working sheet after being adjusted, the closing entries necessary to 
summarize them are as follows: 

, Jtdy 31 

Purchase Returns and Allowances. . $ 650.00 

Purchases $650.00 

To dose purchases returns and 
allowances account into pur- 
chases account 

31 

Purchases 220.00 

Freight and Cartage Inward 220.00 

To transfer in-freight to pur- 
chases account, as part of the cost 
of goods sold 

31 

Sales 460.00 

Sales Returns and Allowances .... 460.00 

To dose sales returns and allow- 
ances account into sales account 



ADJUSTING AND CLOSING ENTRIES 



327 



III 



3i 

Sales $17,670.00 

Purchases $17,670.00 

To close purchases account and 
transfer the cost of goods sold to 
the debit of sales 

31 

Sales 5,49500 

Profit and Loss 5,495oo 

To close sales account and trans- 
fer the gross profit on sales to 
profit and loss account 

31 

Profit and Loss 2,358.75 

Sales Salaries i,S9o.oo 

Advertising 220.00 

Depreciation on Store Equipment. . . . 7-25 

Delivery Expense 182.50 

Rent 300.00 

Insurance 20.00 

Heat and Light 3900 

To close the operating expense 

accounts and transfer their total 

to the debit of profit and loss 

account ) 

31 
Interest on Notes Receivable . . . 12.00 

Cash Discount on Purchases . . . 245.00 

Profit and Loss 257.00 

To transfer the balances of the 
non-operating income accounts 
to profit and loss 

31 

Profit and Loss 48.00 

Interest on Notes Payable . ., . . . 18.00 

Loss from bad debts 30.00 

To close the non-operating ex- 
pense accounts and transfer their 
balances to profit and loss 



328 



PRINCIPLES OF ACCOUNTING 




'W 



1 1 



^3,345-25 



13,34525 



50.00 



50.00 



31 
Profit and Loss . . . 

John Haynes, Capital . 
To close profit and loss account 
and transfer the net profit for the 
fiscal period to the proprietor's 
capital account 

31 

John Haynes, Capital .... 
John Haynes, Personal . 
To transfer the balance of the 
proprietor's personal account to 
his capital account 



After these "closing "entries have been posted, and aU the accounts 
which are m balance ruled to indicate that fact, the accounts which 
wiU still remain open and show balances will be only the asset accounts, 
Uabihty accounts, and the proprietor's capital account. The infor- 
mation furnished by the balances of the accounts remaining open in 
the ledger wiU be exactly the same as that furnished by the balance 
sheet at the close of the period, as illustrated on page 325. 

The post-closing entries. In the chapter on "Accruals and De- 
ferred Items," it was explained that it was customary to transfer the 
amount of accrued items back to the appropriate income or expense 
accounts after the books had been closed. The reasons for^uch 
transfers were explained in that chapter, along with the effect in 
correcting the balance of the income or expense account affected with 
respect to its showing for the coming period. In the case of the busi- 
ness of John Haynes, there are three accruals to be considered: 
I accrued interest receivable, (2) accrued interest payable, and 

. Tk""^"* "***"*"■ '^^'^ '"PP"*' inventory account must also be 
closed back into the expense accounts that were credited when it was 
set up. This is an awkward feature of the method of adjustment 
used for those deferred charges, and could have been avoided by a 
better arrangement of the accounts, as was previously explained. 
Ihe entnes necessary to close these accounts are as follows- 



ADJUSTING AND CLOSING ENTRIES 3*9 

3' 

Interest on Notes Receivable . . . $12.00 

Interest Accrued Receivable $12.00 

To close the interest accrued 
receivable into the interest on 
notes receivable account 

31 

Interest Accrued Payable . . . 18.00 

Interest on Notes Payable 18.00 

To close the interest accrued 
payable into the interest on notes 
payable account 

31 

Delivery Expense 30.00 

Heat and Light 17.00 

Supplies Inventory 47.00 

To close the deferred charge 
account into the expense ac- 
counts affected 

31 

Salaries Accrued 90.00 

Sales Salaries ........ QO.oo 

To close the salaries accrued into 

« 

the sales salaries account 

The post-closing trial balance. It has been explained that at the 
end of a fiscal period a preliminary trial balance is taken to make sure 
that there is an equality between the debits and credits which have 
been posted to the accounts. Adjustments to the accounts as shown 
by that trial balance are then made, on the basis of such supplementary 
information as is obtainable, by means of adjusting entries in the 
journal, which are posted to the accounts. The accounts are then 
summarized to show the result of the period's operations by means of 
the closing entries j after which the accrued items are carried back to 
the revenue accounts to which they pertain by means of post-closing 
entries. In order to insure to some extent the accuracy of all these 
entries, at least to the extent of an equality between their debits and 
credits, it is customary to take a post-closing trial balance before 
proceeding with the entries of the following period. Such a 



\ 





f 



^^° PRINCIPLES OF ACCOUNTING 

post-closing trial balance taken from the ledger of John Haynes 
would appear as follows: ™ynes 

JOHN HAYNES 

Post-Closing Trial Balance, July 31, 1920 
Cash . . ^ ^ 

Accounts Receivable .... 15,990.00 

Notes Receivable 400000 

Merchandise Inventory . . [ [ i3',ooo;oo 

Store Equipment ^^s.oo 

Reserve for Depreciation on Store Equipment . $ r,, .. 

DeUveiy Equipment .... 1,500.00* 
Reserve for Depreciation on Dehveiy Equipment. . ^22 ko 

Accounts Payable . m f . 322.50 

Notes Payable . ^''^''•°° 

Sales Salaries '.',[[',[': ^'"^'^ 

Insurance Prepaid . . . . [ ' 100 00 ^°° 

John Haynes, Capital . . . .* . / 227612 c 

Reserve for Bad Debts * " • ^ 

T%^r T. 30.00 

Dehvery Expense ^^^ 

Heat and Light ^^^ 

Interest on Notes Payable ..... jg 

Interest on Notes Receivable . . ] iVoo '^ °° 

$40,494.00 $40,494.00 

When the equality of the debits and credits has been ascertained 
by means of a post-closing trial balance like the one shown above the 
ledger is then ready to have posted to it the transactions of the new 
accounting period. 

QUESTIONS FOR CLASS DISCUSSION 

1. Assuming any type of business you please, make a Hst of facts concern- 
ing that busmess which would necessitate ten different adjustinir 
entries at the 6nd of the fiscal period, and give the entries. 

2. Outline step by step the order of procedure which you would foUow 
m closing the books" and preparing th^ financial statements of a 
business at the end of its fiscal period. Justify the order indicated in 
your answer. 

3. Under what circumstances would it be worth while to include in the 
workmg sheet an " adjusted trial balance " ? 



ADJUSTING AND CLOSING ENTRIES 33i 

4. From the mformation shown by the working sheet m the illustrative 
exercise in chapter xxviii, construct journal entries necessary to set up 
a summary account headed "Trading," the balance of which shall 
represent the gross trading profit for the period, and to close this 
account into profit and loss. 

5. What journal entries would be necessary to record the followmg: 

a) An appropriation of the net earnings of a corporation for dividends 
amounting to $7,500.00 ? 

b) An appropriation of eammgs for the addition of $5,000.00 to 
reserve for redemption of bonds ? 

c) An appropriation of earnings to the amount of $10,000.00 for the 
purpose of reducing the amount of discoimt on stock ? 

6. Should you always use a working sheet in preparing the statements at 
the end of a fiscal period? If not, under what circumstances migh; 
you dispense with its use ? 

REFERENCES FOR FURTHER STUDY 

EsQUERRE, Paul- Joseph, Applied Theory of Accounts, chap, xxxiv. 
Paton. W. a., and Stevenson, R. A., Principles of Accounting, chaps 

viii and ix. 
Klein, J. J., Elements of Accounting, chap. k. 
Hatfield, H. R., Modern Accounting, chap. xv. 

LABORATORY EXERCISE NO. 34 

The following trial balance was taken from the books of the Moore & 
Smith Hardware Company, December 31, 1919: 

DEBIT CREDIT 

Cash on hand . . . . . $ 100.00 

Cash in bank . . . . . 3,000.00 

Sales $1,150,000.00 

Discounts on purchases 20,000.00 

Interest on notes receivable " 1,000.00 

Accounts receivable .... 150,000.00 
Notes receivable .... 10,000.00 

Capital stock (common) 200,000.00 

Real estate 50,000.00 

Buildings 200,000.00 

Equipment 50,000.00 

Horses, wagons, and harness . . 5,000.00 

Motor trucks 5,000.00 

Insurance 2,000.00 









f 




332 



PRINCIPLES OF ACCOUNTING 



Taxes • • , , 

Purchases . , , , 
Discounts on sales— K:ash 
Wages of men in warehouse 
Salaries of department managers 
Salaries of office assistants 
Drivers, teamsters, etc. . 
Horse feed . 

A • • • . • 

Auto expense , 
Inventories, January i, 1919 . 
Inventories of horse feed, auto 

accessories, etc., January i, 1919 
Inventories of stationery, adver 

tising, etc., January i, 1919 
Office supplies, stationery, etc. 
Advertising .... 
Salesmen's salaries . 
Salesmen's commissions . 
Interest on notes payable 
Dividend on capital— 6 per cent 
Notes payable .... 
Accounts payable . 
Real estate— not used in business 
Investment in Union Hotel Com 
pany (at cost) .... 
Sprinkler system— at face of con 
tract 

Liability on sprinkler system . 
Surplus 



DEBIT 

I SjOOO.OO 

900,000.00 

20,000.00 

25,000.00 

10,000.00 

S,ooo.oo 
S,ooo.oo 

2,000.00 

1,500.00 

300,000.00 

3,000.00 

2,000.00 
3,000.00 
50,000.00 
20,000.00 
11,000.00 
10,000.00 
12,000.00 



CREDIT 



150,000.00 
50,000.00 
10,000.00 



$250,000.00 
150,000.00 



8,000.00 
290,600.00 



$2,069,600.00 $2,069,600.00 

On December 31, 1919, the company authorized the issue of $300 000 00 
ounuktive 7 per cent preferred stock and sold same to the Grand Wmen t 
Company at 95. $70,000.00 common stock was sold to the present stock- 
holders at par, the total issue of common stock being $200,000 00 O the 
proceeds of these sales $150,000.00 was to be exp^ded onTe'buiSb^ 
the balance to be retained for workmg capital. ^unarngs, 

On January 2, 1920, a dividend of $40,000.00 was declared, payable 
on January 15, 1920. ' *^**^**"*^ 



ADJUSTING AND CLOSING ENTRIES 



333 



The mventories at December 31, 1919, were: . 

Merchandise $325,000.00 

Horse feed, auto accessories, etc. . , . 2,000.00 

Stationery, advertising, etc. . . . . 1,500.00 

Of the insurance paid, $500.00 applies to the year 1920; also $1,500.00 

of the taxes. 

Of the interest $2,000.00 applies to the period subsequent to January i, 

1920. 

The depreciation of buildings for the year is $10,000.00, and of equip- 
ment, $5,000.00. The real estate not used in business has appreciated 
$50,000.00, while that used in business has been appraised at $75,000.00. 

From the foregoing trial balance and data prepare and submit: 

1. Working sheet. 

2. Adjusting and closing entries. 

3. Balance sheet. 

4. Statement of profit and loss. 



r 



f 

-{ 






i 



CHAPTER XXDC 
THE CLASSIFICATION OF ACCOUNTS 

The purpose served by the accounts. It has been repeatedly 
emphasized that the accounts are the means of analyzing information 
concerning the financial operations and status of the business in such a 
manner as to make this information available for reporting purposes. 
The account has been defined as a systematic record of information 
pertaining to some item appearmg on the accounting reports, this 
information being arranged under an appropriate title. Since each 
account contains information pertaining to some item which is to 
appear on the reports, the number of the accounts and the basis upon 
which they will be classified and subdivided will depend in every case 
upon the nature of the reports desired for the particular business and 
the amount of detail these reports are to contain. In other words, 
the items with which accounts will be carried are entirely dependent 
on the items to be shown in the reports. 

The reports which have been discussed and illustrated up to this 
point in the course are all of the simplest and most conventional type. 
In fact, only the two forms which are in almost universal use, the 
balance sheet and the statement of profit anfi loss, have been con- 
sidered. These two statements, however, furnish information con- 
cerning the fundamental facts of the business— those having to do 
with the status of the investment and the nature and net result of the 
current operations. Any other reports taken directly from the ac- 
counts must consist for the most part of information concerning these 
same facts, reclassified to be of greater assistance to some functional 
manager, or to show more detail with regard to some particular kind 
of assets, liabilities, proprietorship, or some phase of operations. 
It is true that, in addition to the reports prepared from the information 
shown by the accounts, there may also be some very useful reports 
made up from statistics gathered from other sources and not appearing 
in the accounts. 

Since the accounting reports other than the balance sheet and 
statement of profit and loss are mainly rearrangements or elaborations 



THE CLASSIFICATION OF ACCOUNTS 



335 



of certain facts shown in one or the other of these two statements, the 
general scheme upon which the accounts will be classified may very 
well follow the arrangement of the items in these two general reports. 
Whether any of the items of information required for either of these 
two statements will be further classified in the accounts will depend 
on the nature of the additional accounting reports which will be re- 
quired for the use of the management of the particular business. 
In the following discussion it will be impracticable to do more than 
suggest the possibility of such sub-classifications, and the classification 
shown will be the one determined by the form of the balance sheet and 
the statement of profit and loss. 

The fundamental classification of accounts. There is certain fun- 
damental information which the owner or manager of any business 
will desire to have available. This information concerns: (i) the 
financial condition of the business, which is shown by the balance 
sheet, and (2) the nature and results of the business operations for the 
current accounting period, which is shown by the statement of profit 
and loss. In view of these facts it would be logical to assume that 
the fun"damental classification of accounts should be twofold: (i) the 
accounts reflecting financial condition, which appear on the balance 
sheet; and (2) the accounts reflecting the nature and results of business 
operations, which appear in the statement of profit and loss. This 
classification of accounts into balance sheet accounts and profit and 
loss accounts is one that is used by several writers of high standing. 
The first class of accounts is ordinarily designated as the "real" 
accounts, while the second class is variously designated as "nominal," 
"economic," and the "revenue" accounts. 

Such a division of accounts into these two broad classes undoubt- 
edly exists, but this classification overlooks the very important point 
that the balance sheet items are divisible into two classes, each of 
which is quite distinct in its nature, and each of which is co-ordinate 
in rank with the other, and with the revenue group of accounts. The 
first of these two classes consists of these accounts which show the 
assets owned by the business and the claims which creditors hold 
against those assets; and the accounts of this group may therefore be 
termed the property accounts. The second class shows the net 
investment in the business of the proprietor or proprietary group 
and the accounts composing this class maybe termed the proprietorship 



I 



33^ 



PRINCIPLES OF ACCOUNTING 



THE CLASSIFICATION OF ACCOUNTS 



337 



i 



accounts. In view of these facts it would seem desirable that a 
threefold classification of accounts should be adopted, as follows: 
(i) property accounts; (2) proprietorship accounts; (3) revenue 
accounts. 

To one who has followed the discussion contained in the previous 
chapters of the use, construction, and interpretation of accounts, 
this classification will seem a perfectly natural and logical one! 
Property accounts include accounts with assets, showing the amount 
• of various kinds of property owned by the business, along with any 
valuation accounts used to show corrections on the value of such 
assets. The property accounts also include the liabiUty accounts, 
which show the claims which the creditors of the business hold 
against the assets of the business. Proprietorship accounts include 
such accounts as may be used to show the amount of the net proprie- 
torship of the business, this amount being the difference between 
its total assets and total liabilities. Revenue accounts include all 
accounts showing the amount and sources of different types of income 
accruing to the business during the current accounting period, as 
well as all accounts showing the amount and kinds of expenses incurred 
in securing that income, and all deductions to be made from it before 
the net income of the business can be ascertained. The property 
accounts and proprietorship accounts furnish the information which 
is used in preparing the balance sheet, and the revenue accounts 
furnish the information shown by the statement of profit and loss. 
These three main classes, with their subdivisions, will be discussed in 
the order in which they have been listed. 

The property accounts. As explained in the foregoing paragraph, 
the property accounts consist of the accounts which show the value of 
the property, or assets, owned by the business, and of the accounts 
with the liabilites, or claims outstanding against those assets. The 
two main groups of property accounts, then, are the asset accounts and 
the liability accounts, and these will be considered in that order. 

The classification usually shown on the balance sheet for the asset 
accounts is as follows: (i) current assets; (2) deferred charges to 
income; (3) fixed assets. 

The liability accounts are usually shown on the balance sheet in 
two groups, which are as follows: (i) current liabilities; (2) fixed 



liabilities. The typical accounts with both these classes of liabilities 
have been rather fully discussed in the previous chapters, with ref- 
erence to the nature and construction of the accounts involved, and 
to the method of reporting these items on the balance sheet. They 
will require no further discussion at this point. The manner in which 
these items are reported, as well as the nature of the accounts included 
under each of these heads, has abready been discussed to such an 
extent as to make further consideration at this point unnecessary. 

Illustration of the property accounts. On the basis of the funda- 
mental classification indicated in the present chapter, and of the 
discussion of the nature of particular accounts given in earlier chap- 
ters, an outline of the property accounts in a more or less typical 
business concern may be drawn up as follows: 

I. Property accounts 
A. Assets accounts 

1. Current assets 

a) Cash 

b) Notes Receivable 

(i) Notes Receivable Discounted 

c) Accounts Receivable 

(i) Reserve for Bad Debts (valuation account) 

d) Merchandise Inventory 

e) Accrued Interest Receivable 

2. Deferred charges 

a) Prepaid Advertising 

b) Unexpired Insurance 

c) Inventory of Current Supplies 

3. Fixed assets 

a) Store Equipment 

(i) Reserve for Depreciation of Store Equipment 

b) Delivery Equipment 

(i) Reserve for Depreciation of Delivery Equipment 

c) Office Equipment 

(i) Reserve for Depreciation of Office Equipment 

d) Buildings 

(i) Reserve for Depreciation on Buildings 

e) Land 



hi 



33^ 



PRINCIPLES OF ACCOUNTING 



1 



B. Liability accounts 

1. Current liabilities 

a) Notes Payable — Banks 

b) Notes Payable— Trade Creditors 

c) Accounts Payable 

d) Accrued Wages 

e) Accrued Interest Payable 

2. Fixed liabilities 

a) Mortgages Payable 

b) Bonds Payable 

This list of acounts is intended to be suggestive rather than 
exhaustive. If the student understands clearly the basis of the 
classification, he should have no difficulty in locating in this classi- 
fication the proper place of any additional items which he may 
encounter in practice. 

The proprietorship accounts. It should be quite clear by this time 
that the proprietorship accounts are the accounts which represent the 
amount of the net investment of the owner or owners of the business. 
This is the excess of the total assets over the total liabilities. In a 
previous chapter dealing with the construction and interpretation of 
the proprietorship accounts it was explained that the individual ac- 
counts with proprietorship will diflfer somewhat in their nature 
according to the form of organization under which the business is 
carried on. The three common forms of business organization— 
the single proprietorship, the partnership, and the corporation— were 
considered with respect to the method used to show the proprietorship 
of each. 

In the case of a single proprieter, two such accounts will ordinarily 
be found in use: (i) the proprietor's capital account, and (2) the 
proprietor's personal account. It was explained that the personal 
account was used to show the proprietor's drawings and the amount 
of any salary allowance with which he might credit himself. This 
account is usually closed in to the capital account at the end of the 
accounting period, so that the balance sheet of the single proprietor 
will usually show only one account with proprietorship. 

If the business under consideration is a single proprietorship, 
then, the proprietorship group of accounts will be very simple, and 
may be shown as follows: 



THE CLASSIFICATION OF ACCOUNTS 



339 



V 

1; 

l 



n. Proprietorship accoimts 

a) John Haynes, Capital 

b) John Haynes, Personal 

In the partnership there will be a capital account and a personal or 
drawing account for each partner. Sometimes a portion of the part- 
nership profits is not immmediately distributed to the partners' 
accounts, but is carried for a while in an undivided profits account. 
Thus if the business used for illustration were a partnership, operating 
under the name of Adams & Jones, the partners being F. A. Adams 
and P. R. Jones, the proprietorship accounts carried might be as 
follows: 

II. Proprietorship accounts 

a) F. A. Adams, Capital 

b) F. A. Adams, Personal 

c) P. R. Jones, Capital 
(f) P. R. Jones, Personal 
e) Undivided Profits 

In a corporation the accounts with proprietorship consist of the 
account or accounts showing the capital stock outstanding, at its par 
figure, the accounts showing the amount of the discount or pre- 
mium at which such stock was actually issued, the accounts showing 
the amount of net earnings which have been appropriated for specific 
purposes, and the amount of the unappropriated surplus, or pro- 
prietorship in excess of the par of capital stock. In case the 
investment represented by the par of the stock has been impaired by 
operating or other losses, this fact will be reflected by a deficit account. 
If the business used for illustration were the Haynes Company, a 
corporation, the proprietorship group of accounts might show the 
following accounts: 

II. Proprietorship accounts 
I. Capital Stock 

a) Common Stock 

(i) Discount on Common Stock' (if stock issued at discount) 

b) Preferred Stock 

(i) Discount on Preferred Stock* (if stock issued at discount) 

* Discount on Stock and capital Surplus will not both appear on the same 
balance sheet, since one represents a deduction from the par of the capital stock 
and the other an addition. Where some stock is issued at a premium and other 
at a discount, the two will be offset against one another, and only the net result 
will be shown. 



i 



y.\ 



m 



340 



PRINCIPLES OF ACCOUNTING 



2. Reserves 

a) Reserve for Addition to Plant 

b) Sinking Fund Reserve 

c) Reserve for Redemption of Bonds • 

3. Capital Surplus (if stock issued at a premium) 

4. Surplus 

The revenue accounts. The third of the three main groups into 
which accounts have been divided by the classification here adopted 
is that of the revenue accounts. The revenue accounts, as previously 
stated, consist of (i) the income accounts, which show the sources and 
amount of the income of the business for the current fiscal period, 
and (2) the expense accounts, which show the kinds and amount of the 
expenses incurred in the process of securing that income. 

In a previous chapter on the construction and interpretation of 
income accounts it was explained that the income accounts are to be 
divided into two main groups. These two groups were also illustrated 
in the statement of profit and loss shown in the chapter preceding 
this one. They are: (i) operating income accounts; (2) non- 
operating income accounts, or "other" income accounts. 

It was explained in the chapter on the construction and inter- 
pretation of expense accounts, and illustrated in the statement of 
profit and loss just referred to, that the expense accounts are also 
divided into two main groups, as follows: (i) operating expense 
accounts; (2) non-operating expense accounts, or "deduction from 
income" accounts. 

The operatmg expenses are susceptible of very elaborate classifi- 
cation, where the size and complexity of the business enterprise 
justifies it. As has been previously suggested, both the operating 
income and expense accounts may be classified in such a manner as 
to show operating income and operating expense for each department 
of a business, and also to show a classification of each department's 
expenses according to the kind of services rendered. No attempt will 
be made to show any such elaborate classification in this chapter. 
The classification indicated in the following pages will be for the busi- 
ness as a whole, on the assumption that no departmental organization 
exists. Where departmental organization does exist, the classification 
of revenue accounts by departments may extend only to the trading 
accounts, so that it is possible to report the gross profit on sales by 



THE CLASSIFICATION OF ACCOUNTS 



341 



departments, with no attempt to classify other operating expenses on a 
departmental basis. On the other hand, a systematic attempt may 
be made to show all operating expenses classified according to the 
departments to which they are chargeable, so that net operating 
profit may be reported by departments. The classification of accounts 
in this chapter is for the business as a whole, but it should not be 
difficult for the student to see how a similar classification of accounts 
might be made for each department of a business, the extent and 
the details of such classification being modified by the reporting 
requirements of the particular business and department. 

A sunple classification of operating expenses according to the type 
of services performed is as follows: (i) cost of sales accounts; 
(2) buying expense accounts; (3) selling expense accounts; (4) deliv- 
ery expense accounts; (5) administrative expense accounts. 

The cost of sales accounts, which furnish the information neces- 
sary to ascertain the cost of the goods sold, are not usually thought of 
as expense accounts, or termed expense accounts in the statement of 
profit and loss. They do, however, represent a part of the cost of the 
product or service sold, and even though they are somewhat different 
in then- nature from the other operating expense accounts, they have 
enough in common with them to justify including them under expense 
in the present classification. 

Each of the classes of operating expense listed above has been 
sufficiently discussed in 'a previous chapter to make further con- 
sideration at this point unnecessary. 

Illustration of the revenue accounts. Taking the basis of classifi- 
cation previously indicated, and assuming a mercantile business whose 
operations are not to be classified by departments, the more common 
and representative revenue accounts may be outlined as follows: 

III. Revenue accounts 
A. Income accounts 

1. Operating income 

a) Merchandise Sales 

(i) Sales Returns and Allowances 

2. Non-operating income 

a) Interest on Notes Receivable 
h) Interest on Securities Held 

c) Rentals Earned 

d) Cash Discount on Purchases 



in 



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342 PRINCIPLES OF ACCOUNTING 

B. Expense accounts 
I. Operating expenses 

a) Cost of Sales 

(i) Merchandise Purchases 

(o) Purchases Returns and Allowances 

(2) Freight, Express, and Cartage Inward 

(Purchases account to be adjusted for the change in 
merchandise inventory) 

b) Buying Expense 

(i) Salaries of Buyers 

(2) Traveling Expense — Buyers 

(3) OflSce Expense 

(4) Other Buying Expense 

c) Selling Expenses 

(i) Salaries of Sales Force 

(2) Expenses of Salesmen 

(3) Advertising 

(4) OflSce Expense 

(5) Packing and Shippmg Expense 

(6) Other Selling Expense 

d) Delivery Expenses 
(i) Wages of Drivers 

(2) Maintenance and Repairs — Delivery Equipment 

(3) Depreciation of Delivery Equipment 

(4) Other Delivery Expense 

e) Administrative Expense 
(i) Ofl&ce Salaries 

(2) Ofl5ce Expense 

(3) Repairs and Maintenance of Buildings (or rent) 

(4) Depreciation of Buildings 

(s) Repairs and Maintenance of Equipment 

(6) Depreciation of Office Equipment 

(7) Insurance and Taxes 

(8) Heat and Light 

(9) Other Administrative Expense 
2. Non-operating expenses 

a) Interest on Notes Payable 

b) Cash Discount on Sales 

This list of revenue accounts is by no means exhaustive, but it 
shows the accounts which are more frequently found in use. The 
classification is not an exact or a scientific one, such as would be used 



THE CLASSIFICATION OF ACCOUNTS 



343 



in a big department store or other type of business concern where it 
was considered worth while to allocate operating expenses carefully 
between departments and between kinds of expense or service 
rendered. However, the discussion of accounts and their use up to this 
point has not been such as to prepare the student for a consideration 
of any more elaborate or exact classification than the one shown above. 
The principles of classification are well illustrated here, and the con- 
sideration of further refinements in account classification must be 
deferred to a later time. 

Numbering of accounts. In any business possessing a well- 
developed accounting system, some definite classification of accounts 
will be worked out and maintained. A classification along the lines 
indicated, further subdivided to show departmental organization or 
further division of functions in the business, would be an entirely 
satisfactory one. In this classification, however, no adequate method 
is provided for referring to the individual accounts, since the same 
letters and figures are used to indicate different items under various 
heads and subheads. Also, with the system employed to list the 
accounts, the addition of a new item or class of items might involve 
some difficulty in a rearrangement of the numbering. In order to 
facilitate the classification of accounts, and the reference to particular 
accounts in a system, accountants have adopted a system of number- 
ing accounts which is a modification of the Dewey decimal system 
used in cataloguing the contents of a library. Under this system 
each account has a separate number, which is usually written before 
the descriptive name of the account, and which serves to place the 
class to which that account belongs. This number may even be used 
instead of the descriptive name in referring to the account. 

The use of this system may be best explained by a description 
and illustration of the method of its application, using the same 
classification of accounts that was given above. In that classification, 
the three main groups into which all accounts were divided were 
property accounts, proprietorship accounts, and revenue accounts. 
These primary classes will each be given a number consisting of a 
single digit, thus: 

1. Property accounts 

2. Proprietorship accounts 

3. Revenue accounts 



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PRINCIPLES OF ACCOUNTING 



Every account which falls under the head of property accounts will 
therefore have a number the first digit of which is i, every proprie- 
torship account will have a number the first digit of which is 2, 
and every revenue account will have number in which 3 is the first 
digit. For example, the two main classes into which the property 
accounts are divided will be numbered as follows: 

11. Asset accounts 

12. Liability accounts 

Every account which is classified under the asset group will therefore 
have a number of which the first two digits are 11, and in the same 
way the first two digits of any number indicating a liability account 
will be 12. The same procedure is followed with all the subclasses of 
accounts. Where it is necessary to show a ** valuation '* account, or 
account representing a deduction from another item, it is listed just 
below the item from which it is to be deducted, and its nature is 
indicated by introducing zero before the last digit, the digits used 
being otherwise the same as those used for the account from which 
the deduction is to be made. 

Illustration of the numbering of accounts. With this brief expla- 
nation in mind, it should not be difficult to understand the principles 
of this system as applied to the classification of accounts previously 
given. In illustrating this, it will be assumed that the proprietorship 
accounts are those of a corporation. The illustration follows: 

I. Property accoimts 
II. Asset accoimts 

111. Current assets 
mi. Cash 

1 1 1 2 . Notes Receivable 

1 1 102. Notes Receivable Discoimted 

1 1 13. Accoimts Receivable 

1 1 103. Reserve for Bad Debts 

1 1 14. Merchandise Inventory 

1 1 15. Accrued Interest Receivable 

112. Deferred charges 

1 1 21. Prepaid Advertising 

1 1 2 2. Unexpired Insurance 

1 1 23. Inventory of Current Supplies 



THE CLASSIFICATION OF ACCOUNTS 

113. Fixed assets 

1 1 3 1 . Store Equipment 

11301. Reserve for Depreciation of Store Equipment 

1 132. Delivery Equipment 

1 1302. Reserve for Depreciation of Delivery Equipment 

1133. Office Equipment 

1 1303. Reserve for Depreciation of Office Equipment 

1 134. Buildings 

1 1304. Reserve for Depreciation of Buildings 

1135. Land 
12. Liability accounts 

121. Current liabilities 

1 21 1. Notes Payable — Banks 

1 2 1 2 . Notes Payable — ^Trade Creditors 

1 2 13. Accounts Payable 

1 2 14. Accrued Wages 

121$. Accrued Interest Payable 

122. Fixed liabilities 

1 22 1. Notes Payable (not current) 

1222. Mortgages Payable 

1223. Bonds Payable 

2. Proprietorship accounts 

21. Capital stock 

211. Common Capital Stock v 

2101. Discount on Common Stock 

212. Preferred Capital Stock 

2102. Discount on Preferred Stock 

22. Reserves 

221. Reserve for Addition to Plant 

222. Sinking Fund Reserve ♦ 

223. Reserve for Redemption of Bonds 

23. Capital Surplus 

24. Surplus 

3. Revenue accounts 
31. Income accounts 

311. Operating income 

31 1 1. Merchandise Sales 

31101. Sales Returns and Allowances 

312. Non-operating income 

31 21. Interest on Notes Receivable 

3122. Interest on Securities Held 

3123. Rentals Earned 

3124. Cash Discount on Purchases 



345 






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PRINCIPLES OF ACCOUNTING 



32. Expense accounts 

321. Operating expenses 

321 1. Cost of Sales 

32111. Merchandise Purchases 

321 Id. Purchase Returns and Allowances 

32 1 1 2. Freight, Express, and Cartage Inward 

3212. Buying Expense 

3 2 1 2 1 . Salaries of B uyers 

32122. Traveling Expense — Buyers 

32123. Office Expense y 

3 2 1 24. Other Buying Expense 

3213. Selling Expense 

3 2 13 1. Salaries of Sales Force 

32132. Expenses of Salesmen 

32133. Advertising 

32134. Office Expense 

32135- Packing and Shippmg Expense 
32136. Other Selling Expense 

3214. Delivery Expense 

3 2 141. Wages of Drivers 

32142. Maintenance and Repairs — ^Delivery Equipment 

32143. Depreciation and Delivery Equipment 

32144. Other Delivery Expense 

3215. Administrative Expense 

321 51. Office Salaries 

32152. Office Expense 

32153. Repairs and Maintenance of Buildings 
3 2 1 54. Depreciation of Buildings 

32155- Insurance and Taxes 

32156. Heat and Light 

32157. Other Administrative Expense 

322. Non-operating expenses 

3221. Interest on Notes Payable 

3222. Cash Discount on Sales 

3223. Exchange 

Lack of uniformity in classification and numbering of accounts. 
This scheme of numbering is a simple one and is easily applicable to the 
numbering of accounts in a business as simple in organization as the 
one assumed for purposes of illustration. A more elaborate classifi- 
cation of accounts would soon cause the numbering to become 
awkward and cumbersome, on account of the number of digits 



\m 



THE CLASSIFICATION OF ACCOUNTS 



347 



involved. It is quite possible, however, to modify the numbering 
system to handle a more complex classification without confusion. 

An example of such a classification is to be found in the uniform 
classification of accounts prescribed by the Interstate Commerce 
Commission for the steam railroad companies which fall under the 
regulation of that body. 

The fundamental classification of accounts given in this chapter 
is a threefold one, dividing account into: (i) property accounts, 
(2) proprietorship accounts, and (3) revenue accounts. The difference 
between this threefold classification and a twofold classification of 
accounts into real and nominal accounts is largely one of terminology 
rather than of basic principles. There is, however, a real difference 
in principle involved in the fact that the threefold classification 
recognizes that the "real" or balance-sheet accounts fall into two main 
classes, each of which is co-ordinate in importance with the " nominal," 
"economic," or "revenue" group of accounts. Aside from this point, 
the classification given here differs very little in purpose and result 
from the classifications given by John R. Wildman, Roy B. Kester, 
Thomas W. Mitchell, and other well-known modern writers on the 
subject of accounting. 

QUESTIONS FOR CLASS DISCUSSION 

1. What real distinction, if any, is to be made between a classification 
of accounts into "red" accounts and "nominal" accounts, and their 
classification into "property" accounts, "proprietorship" accounts, 
and "revenue" accounts ? Is either basis of classification more logical 
than the other ? Discuss. 

2. Make as long a list as you can of factors which might affect the classi- 
fication of the accounts of any business. 

3. The Gross Shoe Company has retail stores in five different cities. In 
each they own the building in which they operate, as well as all the 
equipment used in carrying on the business. The home office is in 
Chicago, but each store is in charge of a local manager. The merchan- 
dise is all purchased by the central organization, and supplied by it to 
the various branches. Do these facts suggest to you the desirability 
of any further sub-classification of the accounts than is shown in the 
illustrations in chapter xxix? Answer this question with regard to: 
(i) the asset accounts, (2) the liability accounts, (3) the proprietorship 
accounts, (4) the income accoimts, (5) the expense accoimts. 



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PRINCIPLES OF ACCOUNTING 



4. What groups of accounts, if any, would need to be rearranged or classi- 
fied in more detail than that shown in chapter xxix to serve the report- 
mg requirements of a department store ? a manufacturing business ? 

5. In the illustrative classification given m chapter xxix, the operating 
expense accounts are divided into five groups. Can you suggest any 
further division that might be made of the operating expenses of a 
business? What purpose might be served by a more elaborate 
classification of operating expenses according to the type of service 
performed ? 

6. Various members of the managerial staff of a large department store 
require analyses of sales for different purposes. In order to satisfy 
these various requirements, the accounting department must prepare 
a sales analysis on each of the following bases: 

a) Sales analyzed by departments 

b) Sales analyzed by terms of sale 

c) Sales analyzed by method of sale 

d) Sales analyzed by method of delivery 

e) Sales analyzed as between rush and normal deliveries 
/) Sales analyzed by salesmen 

What purpose should you expect to be served by each of the foregoing 
analyses ? What member of the managerial staff would be apt to be 
interested in each ? 

7. Should you consider it necessary or desirable to provide an analysis 
of purchases on each of the foregoing bases? on any of them? 
On how many of these bases should sales deductions be analyzed? 
Discuss. 

8. Should you consider it desirable to attempt to mamtain in the ledger 
accounts all the classifications suggested m Question 6 ? If not, which 
ones should you mamtain in the accounts? Suggest the means by 
which each of the classifications not provided by the ledger accounts 
might be made available. 

REFERENCES FOR FURTHER STUDY 
WiLDMAN, J. R., Principles of Accounting, chap, xi, pp. 128-29. 
Dickinson, A. L., Practice and Procedure, pp. 36, 56-62, 154, 162. 
Paton, W. a., and Stevenson, R. A., Principles of Accounting, chaps, 
vi and vii. 

EsQUERRE, Paul- Joseph, Applied Theory of Accounts, chap. xii. 



CHAPTER XXX 
FINANCIAL REPORTS 

Nature and purpose of financial reports. It has been repeatedly 
stated in the preceding chapters that the end and aim of the account- 
ing process is furnishing information for reports which will be of aid 
in the conduct of the business. It is the purpose of this chapter to 
consider somewhat more carefully the method of presentation to be 
employed when the necessary data are available. The reports which 
may be prepared from the accounts are all of a financial nature; 
that is to say, they deal with facts about the business which may be 
expressed in terms of dollars and cents. They may therefore be 
properly referred to sls financial reports. It is quite likely, as has been 
suggested, that in many businesses statistical data will be gathered 
by means of supplementary records having no direct connection with 
the accounting system proper. Some of this information may be of a 
financial nature, and some of it may be in terms of non-financial units. 
An illustration of such statistics is furnished by the operating statistics 
of a railroad, which show among other things the number of "ton- 
miles" of freight hauled during an operating period, and the number 
of **passenger-miles" as well. A manufacturing company may keep 
records of production of individual workmen and individual machines 
in terms of units of product. A department store may keep records 
concerning deliveries of goods from its departments and to different 
sections of the territory it serves, these facts being expressed in 
non-financial terms. The discussion of non-financial statistics and 
reports, however, which may be as important in their way as the 
financial ones, cannot be given a place in this text. 

This chapter will be devoted to the more generally used forms of 
financial rejx)rts (more or less conventional in their form) prepared 
from the information furnished by the ledger accounts. This will 
involve the explanation of some modifications of methods of presenta- 
tion already shown, and the introduction of certain additional reports. 

The conventional financial reports. Throughout the discussion 
of accounting reports in the earlier chapters, two forms of report, the 

.' 349 



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PRINCIPLES OF ACCOUNTING 



balance sheet and the statement of profit and loss, have been used as 
typical of all such reports. Accountants and business men formerly 
thought that these were the only reports necessary. In fact, in many 
cases they failed to realize that it was possible to prepare any other 
reports from the information furnished by the accounts of the business. 
In recent years, however, as business problems have become more 
complex, and as a higher grade of managerial skill has developed to 
meet these problems, managers have come to realize the need of 
information in addition to that furnished by these two conventional 
statements. 

The attempt which accountants have made to furnish such 
information has taken two forms: (i) the modification, rearrangement, 
and improvement of the conventional accounting reports; (2) the 
preparation of additional accounting and statistical reports: (a) re- 
ports showing the results of business operations in the period or 
periods past, (b) estimates of various phases of future operations, 
based on the records of past operations and designed to aid the 
management in planning for the future. 

Any consideration of the subject of estimates must be omitted from 
this text, though it constitutes a very important part of accounting 
for managerial purposes. Some consideration will be given, however, 
to the modern forms of the conventional accounting reports, and to 
certain additional reports which are now in wide use. 

Exhibits. The reports prepared by the accountant which set 
forth the basic facts of the financial condition of a business are usually 
termed exhibits. An exhibit, in accounting, may be defined as a 
summarized statement of facts with regard to the financial condition 
of a business. The exhibits which are usually prepared by the 
accountant are three in number, and are as follows: (i) the balance 
sheet, generally designated as "Exhibit A"; (2) the statement of 
profit and loss, generally designated as "Exhibit B"; (3) an analysis 
of the surplus account, generally designated as "Exhibit C." 

The present tendency in the preparation of these fundamental 
reports is to condense the information shown by them to such an 
extent as to free it from a great deal of detail, thereby making it more 
readily readable. Such a statement is designed to present almost at a 
glance the salient facts concerning that particular phase of the finan- 
cial condition or operations of the business. The exhibits are intended 



FINANCIAL REPORTS 



351 



to present to the manager, owner, or other interested party a "bird's- 
eye view" of the financial condition of the business. This does not 
mean that the reader is to be left in the dark with regard to the 
individual items which make up the more important totals shown by 
these reports. This detailed information is presented in separate 
statements, accompanying and supporting the exhibits. These 
supplementary statements are discussed below. 

Schedules. The supplementary statements which furnish infor- 
mation with respect to detail composing the more important items 
shown in the exhibits are known as schedules. A schedule, in this 
sense, is a detailed list of the individual items composing the total of 
some item which appears in an accounting report. Thus schedules 
may be prepared in connection with the balance sheet. They are 
designated numerically, as "Schedule No. i," "Schedule No. 2," etc. 
Schedules may be used to show detail with regard to the cash balance, 
the notes receivable and payable, the accounts receivable and payable, 
the buildings or equipment owned by the business, the reserve for 
depreciation maintained for each, the securities owned, or any other 
item on the balance sheet which may be of sufficient importance. 
When any item on the balance sheet is supported by a schedule it is 
customary to indicate that fact by giving a reference to the schedule 
in connection with the statement of the item on the exhibit. Thus, 
taking for illustration the item of "Cash," which would ordinarily 
appear first on the balance sheet, this item would be shown in the 
balance sheet as a single item, as follows: 

Cash (Schedule No. i) $22,350.00 



SCHEDULE NO. 1 

The Cash Balance 

Continental and Commercial Bank 
Illinois Trust and Savings Company . 
Home Office Cash Fund . . . . 
Milwaukee Branch Office Cash Fund . 



$ 8,250.00 

13,300.00 

300.00 

500.00 



Total $22,350.00 - 

Each item on the balance sheet which represents a combination of 
several items, and which is considered sufficiently important to justify 
a detailed report as to its component items, is supported by some such 
schedule. 



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352 



PRINCIPLES OF ACCOUNTING 



Analytical statements. The statement of profit and loss will also 
contain certain items which represent a condensation of more detailed 
information furnished by the accounts. In order to make available 
a knowledge of the detail composing such items, supplementary 
statements are necessary here also, as in the case of the balance sheet 
items. A number of accountants make no differentiation between 
the nature of such statements and that of the schedules prepared in 
support of the balance sheet items, calling them all "schedules." 
But the analysis of some class of income or of expense seems to differ 
somewhat in its nature from the mere listing of the assets or the 
liabilities which make up a certain group total as shown on the balance 
sheet. For this reason many accountants make it a practice to differ- 
entiate between the type of supplementary statement which shows an 
analysis (called an analytical statement) and the type which is merely 
a list of certain items composing a total. Such analytical statements 
are typically presented in connection with items appearing in the 
statement of profit and loss. "Buying expense" may be used to 
illustrate the analytical statement. On the statement of profit and 
loss, in order to avoid making this statement too long and compli- 
cated, the buying expenses would be summarized as follows: 

Buying expense (Analytical Statement No. i) . . $5,300.00 

Analytical Statement No. i, which will accompany the statement 
of profit and loss, will appear as follows; 

ANALYTICAL STATEMENT NO. 1 
Analysis of Buying Expense 

Salaries of buyers $3,600.00 

Traveling expenses of buyers . . , 1,200.00 

Office expense — buying 300.00 

Miscellaneous buying expense . . . 150.00 

Total buying expense . . . . $5,300.00 

Similar statements would be prepared for each important group 
of expenses and in some cases for operating income. As already 
explained, these supplementary statements are sometimes called 
schedules and treated as a continuation of the series of schedules 
begun in connection with the balance sheet. However, the differ- 
entiation adopted and illustrated above is a logical one, and represents 
acceptable accounting practice. 



FINANCIAL REPORTS 



353 



The comparative balance sheet. The form of " exhibit " to which the 
most attention is usually given is the balance sheet. The information 
furnished by such a statement is very important, showing as it does 
the status of the business investment at the end of the operating 
period. It may be even more significant if the statement furnishes 
a basis for comparing the facts revealed by the balance sheet at the 
end of the current period with the facts shown by the balance sheet 
at the end of the preceding period. Such a comparison may even be 
profitably extended over several previous periods. Such a basis of 
comparison is furnished by the comparative balance sheet, an 
illustration of which is presented on page 354. 

None of the changes which may be noted as taking place in the 
various items of this statement between the end of the preceding 
period and the end of the current period appears at all startling. 
Some of the changes, however, will be seen to be rather significant 
with regard to the company's financial policy for the year. The 
first thing to be noted is the change in the company's net proprietor- 
ship. A glance at that section of the comparative balance sheet shows 
that the total proprietorship as shown by that group of accounts has 
increased from $193,835 to $222,345, a net increase of $28,510. This 
would seem at first glance to indicate that this figure represented the 
amount of the company's net income for the year. This would be 
true, provided there had been no contributions made to capital during 
the year, and that no distribution of surplus had been made in the 
form of dividends or otherwise. As a matter of fact, the situation is 
seldom so simple. In order to understand the changes that have taken 
place in the various proprietorship accounts, the comparative balance 
sheet must be supplemented by another statement, accounting for 
these changes. 

The analysis of the surplus account. This form of statement was 
mentioned in a previous paragraph as one of the three chief financial 
statements usually prepared at the end of a fiscal period, and is 
usually designated as "Exhibit C." It is designed to show the 
analysis of the debits and credits which have been made to the general 
surplus account, and so to account for the changes that may have 
taken place in the balance of this account and the balances of the 
proprietary reserve accounts, which represent appropriated surplus. 



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PRINCIPLES OF ACCOUNTING 

TAYLOR, JOHNSON AND COMPANY 

Comparative Balance Sheet, Decembes 31 



Assets 


1919 


xpao 


_ Current Assets 
Cash 


43,150 
400 


00 
00 

00 
00 


30.60c 
33,40c 

42.750 

53.80c 
70 


100 
>oo 

00 

00 
00 

00 

00 

00 
00 

00 
00 
00 
00 


50,300 
500 

13.900 
5.700 


00 
00 

00 
00 

00 
00 
00 
00 

00 
00 


M1^ 

49,700 

45,500 
135 




Notes Receivable .' 


00 


Accounts Receivable 


00 


Less Reserve for Bad DebU ..'.'.'.'.'. 


00 


Merchandise Inventoiy 


13,800 
3,100 




Accrued Interest Receivable '.' 


00 




00 


Total current assets 


138,630 


144,485 






00 


Fixed Assets 
Dehvery Equipment 


9.700 

13,700 

3.750 

104,000 
40,000 


8,300 

ZI,IOO 

3,090 

106,600 
40,000 




Less Reserve for Depreciation 


00 


Store Equipment 


15.500 

3,800 

4,500 

750 


00 
00 
00 
00 

00 
00 


15,500 
4,400 
4.800 
1,710 




Less Reserve for Depreciation." ! '. '. 
Office Equipment 


00 


Less Reserve for Depreciation. .... . 


00 


Building 


115.000 
11,000 


130,000 
13,400 




Less Reserve for Depreciation.'.*.! .' '. 
Land 


00 




00 


Total fixed assets 


170.150 


158,990 






00 


Total assets 


308,735 


306.765 






00 


LiabiUUes 


X919 


1930 


Current Liabilities 
Due to Contractor 




3,000 

ISO 

350 

30,500 

13.000 

19,000 


00 
00 
00 
00 
00 
00 


« 


130 

18,500 
7,500 

x8,ooo 




Accrued Interest Payable. . . . 


■ 


Wages Accrued 


00 


Notes Payable— Banks 


00 


Notes Payable— Trade Creditors. .'. '. 
Accounts Payable 


00 
00 




00 


Total current liabilities 


64,900 


00 

00 
00 


44,420 






00 


Fixed LiabUitus 
Bonds Payable 


50,000 


40,000 






00 


Total liabilities 


114,900 


84,430 






00 


Proprietorship 


1919 


! ! 

1930 


Common Capital Stock 




100,000 
50,000 
X 3,000 
10,500 

3IJ35 


00 
00 ■ 
00 
00 
00 

00 

00 




100,000 

50,000 

12,500 

5,500 

54,345 




Preferred Capital Stock 


00 


Reserve for Redemption of Bonds 

Reserve for Addition to Building 

Surplus 


00 
00 

00 




00 


Total proprietorship 


193,835 


333,345 






00 


Total liabilities and proprietorship 


308,73s 


306,76s 


00 


1 




II 






• 1 







FINANCLU. REPORTS 



355 



In the case of Taylor, Johnson and Company the changes which 
afiFected these accounts were as follows: 

1. January 3, 1920, dividends of 2 J per cent on the common stock, and 
3J per cent on the preferred stock, were declared and paid. 

2. July 6, 1920, another dividend of the same amount as the above was 
declared and paid on both common and preferred stock. 

3. January 3, 1920, it was voted to appropriate $10,500 more as an 
addition to the reserve for redemption of bonds. 

4. July 2, 1920, $10,000 of the company's bonded indebtedness was 
retired. This amount was transferred from the reserve account back to the 
general surplus* account. 

5. November 12, 1920, an improvement to the building, costing $5,000 
was completed and paid for. That amount was transferred from the 
account with reserve for addition to building back to the general surplus 
account. 

6. Net income for the year, as shown by statement of profit and loss, 
was $27,010. 

The proprietorship accounts affected by these changes, as they 
would appear at the end of the year after the appropriate entries had 
been made and posted, are shown below: 

SURPLUS 



1920 
Jan. I 
Jan. 3 

July 6 


Dividends 
Reserve for re- 
demption of bonds 
Dividends 


4,250 

10,500 
4,250 


00 

00 
00 


1920 
Jan. I 
July 2 

Nov. 12 

Dec. 31 


Balance 

Reserve for re- 
demption of bonds 
Reserve for addi- 
tion to building 
Profit and loss 


31,335 
10,000 

5,000 
27,010 


00 

00 

00 
00 



RESERVE FOR REDEMPTION OF BONDS 



1920 
July 2 



Surplus 



10,000 



00 



1920 
Jan. I 
Jan. 3 



Balance 
Surplus 



12,000 
10,500 



00 
00 



RESERVE FOR ADDITION TO BUILDING 



1920 
Nov. 12 



Surplus 



S,ooooo 



1920 
Jan. I 



Balance 



10,50000 



In this case the statement showing the analysis of the surplus 
account would appear as follows: 



i 
i 



3S6 PRINCIPLES OF ACCOUNTING 

TAYLOR, JOHNSON AND COMPANY 
Analysis of Surplus Account for the Year Ended December 21, 1920 
Balance, January i . . * 

Add: «3i,33S.oo 

Reserve for redemption of bonds 

utilized and transferred back to 

„^^^Pl"s $10,000.00 

Reserve for addition to building 

utilized and transferred back to 

^/^^^^^ S,ooo.oo 

Net mcome for fiscal year . . 27,010.00 42,010.00 

Total . . . " i 

Deduct: 

Appropriated for dividends . . 8,500.00 
Appropriated to reserve for redemp- 
tion of bonds .... 10,500.00 ,9,000.00 

Balance, December 31, 1920 $54,345.00 

With the information furnished by the comparative balance 
sheet, supplemented by that furnished by the analysis of surplus 
account, it is possible to draw some fairly definite conclusions with 
regard to the financial policy of the company during the year 1020 
It may be noted first that the net income of $27,010 represents a 
return of about 12 per cent on the net investment at the end of the 
year a satisfactory rate of return. It will be noted next that the 
total of the current assets has increased from $138,620 to $144 485 
a change of $5,865. This is a comparatively insignificant increase! 
but It IS to be noted at the same time that the total of the current 
habihtes has decreased from $64,900 to $44,420. This means that 
the working capital," which is the difference between the current 
assets and current liabiHties, has increased from $73,720 to $100 oo< 
an mcrease of $26,285, or more than 35 per cent. It also means that - 
the ratio of the current assets to the current liabilities has changed 
from a httle more than two to one to a little more than three to one 
bmce two to one is the ratio usually considered by the banks as safe 
It IS apparent that the present ratio is a satisfactory one. An exam-' 
ination of the current assets and current liabiHties in detail furnishes 
some further indications with regard to the trend of the company's 



FINANCIAL REPORTS 



357 



financial policy. Thus it appears that the merchandise inventory 
has been reduced by $7,300, while at the same time cash, notes 
receivable, and accounts receivable have increased in amount. This 
would seem to* indicate that the company was reducing its inventory 
in the expectation of a period of falling prices at the same time that 
they were selling more than in the previous year, if the trade receiv- 
ables are to be taken as a guide. This seems to indicate that they are 
liquidating their current assets as far as is consistent with successful 
operation, either to be prepared for a contraction of credits by the 
banks or to take advantage of the expected fall in merchandise prices, 
if not for both reasons. The considerable reduction that has been 
effected in the current liabilities seems to point to the same conclusion. 

An examination of the fixed assets seems to indicate that the 
normal rate of depreciation has been charged off. An addition of 
$1,100 to the amount of delivery equipment would seem to indicate 
that an increased volume of sales had caused the need of additional 
equipment of this type. This surmise can be verified only by refer- 
ence to the comparative statement of profit and loss, which appears 
on a later page. A slight increase in office equipment also appears, 
which would seem to indicate some increase in the volume of business. 
A $5,000 item of addition or improvement to the building also points 
to a progressive policy on the part of the company. 

The redemption of $10,000 of the outstanding bonds of the com- 
pany, together with the further appropriation of surplus for the 
redemption of bonds, seems to indicate that the company is following 
the policy of retiring its bonds in yearly instalments, either by pur- 
chasing them on the open market or by calling them in accordance with 
the terms of the contract with the bondholders, or by paying them 
serially, as they mature. Thus the bonds might have been issued 
with different maturities, so that the $10,000 would mature each year 
until they had all been redeemed. 

The amount of the proprietorship in relation to the amount of 
assets seems very large, and indicates that the business has been quite 
prosperous. It also indicates that the company is in excellent finan- 
cial condition, and should be in no great danger of embarrassment 
from falling prices or from financial stringency. For that matter, 
the showing made by their comparative balance sheet should entitle 
them to preferential treatment in applying to the banks for credit. 



i! 



358 



PRINCIPLES OF ACCOUNTING 



One of the important uses of such a statement is to serve as an aid to 
the busmess m securing credit from the banks, since it furnishes the 
banker with just the type of information that he requires with ref- 
erence to the finarxial soundness of the borrowing concern. Also 
this form of report, with the analysis of surplus account and the com- 
parative statement of profit and loss, furnishes information of very 
great value to the owners or managers of the business, enabling them 
to judge the success of the operations of the current period, and 
also, m the light of the knowledge thus acquired, to plan for the 
operations of the coming period. 

The comparative statement of profit and loss. It has been demon- 
strated that there are certain advantages in presenting the balance 
sheet m the comparative form. Any statistical data, in order to be of 
the highest significance, must be presented in such a way as to show 
comparison or relationship between facts. This appUes to the facts 
shown by the balance sheet, and it applies even more to the statistics 
regarding the operations of the business, shown by the statement of 
profit and loss. This statement is supposed to present the leading 
statistical facts with regard to the period's operations, and so to offer 
a basis for judgment on whether these operations have been efficiently 
conducted, as weU as to suggest how they may be most efficiently con- 
ducted during the coming period. Also, the matter of efficiency is 
a relative one. The fact that the net income of Taylor, Johnson 
and Company for the year 1920 was more than 12 per cent on the 
capital mvested shows that the management could hardly have been 
entirely inefficient. But if this represents a lower rate of return on 
investment than that secured in the previous year, the showing of this 
fact will lead to an inquiry whether the management has been less 
efficient or whether the lower rate of return is due to other causes 
A form of report which presents a comparison of income and expenses 
of the current year with income and expenses of one or more previous 
years may not only raise questions of this nature but may in some 
cases also indicate the answers. 

Such a comparison is still further facihtated if each of the im- 
portant items in the statement of profit and loss for each year is 
expressed m terms of its percentage of some other item on that 
statenient which is taken as the base figure. This base figure may 
be either gross sales or net sales. In the iUustration which follows 



FINANCIAL REPORTS 



359 



gross sales is used as 100 per cent for purposes of establishing compari- 
sons between various items of expense and income for thv-^ same 
period, and between the ratios that such items have to sales in the 
different periods. 

As indicated previously in the discussion of the comparative bal- 
ance sheet, the comparative statement of profit and loss is also of 
considerable value in interpreting certain items appearing on the for- 
mer statement. A comparative statement of profit and loss for 
Taylor, Johnson and Company for the two years ending December 
31, 1920, is shown below: 

TAYLOR, JOHNSON AND COMPANY 

Comparative Statement of Profit and Loss for the Two Years Ending 

December 31, 1920 





19x9 


Per. 
centage 


1920 


Per- 
centage 


Cross sales 


165,300 
4,850 


00 
00 

00 

00 

00 
00 

00 
00 

00 
00 
00 
00 
00 


242,400 0( 
4,630 o< 


> 100 

) 1.9 

> 98.1 

64.7 
33-4 

2.6 

71 
2.7 
2.3 

5-3 

19.9 

•o 13s 
» 2.17 

>o 15.67 
>o 1.9 

» 17. 57 


182,745 
5,420 


00 
00 

00 

00 

00 
00 

00 
00 

00 
00 
00 
00 
00 


263,500 
6,250 


00 
00 

00 

00 
00 

00 

00 
00 

00 
00 


100 


Less sales deductions 


2.4 


Net sales 


237,770 o< 
157.050 


257,250 
186,150 


97.6 


Cost of goods sold: 

Gross Durchases 




I<rss purchase deductions. . 




Net Durchases 


160,450 
1,750 


177,32s 
1,525 




Freight, express, and cart- 
ase in 








Add inventory, Jan. i 


163,200 

47,650 


178,850 
52,800 




Less inventory, Dec. 31 . . . 


2og,8so 
52,800 


231,650 
45,500 




Cost of goods sold 


6,250 

17,300 

6,500 

5,250 

12,650 


5,300 
15,420 

6,215 

4,810 

12,350 


70.8 


Gross profit on sales 

Operating expenses: 

Buvine exoenses 


80,720 

47,950 c 

32,870 c 
5,220 c 


71,100 

44,085 

27,015 
4,475 


26.8 
2.1 


Selline expenses 


5.8 


Delivery expanses 

Credit and collection expenses 
Administrative expenses .... 


2.4 
1.8 

4.4 


Net profit on sales 

Non-operating income 






16. 5 

10.2 
1.7 


Gross income 


28,090 c 
4,620 c 


31,480 
4,470 


II. 9 


Other deductions from income . 


1.7 


Net income 


33,470 c 


27,010 


00 


10.2 







This statement of profit and loss is somewhat condensed. Some 
of the items, such as sales deductions, different groups of operating 



36o 



PRINCIPLES OF ACCOUNTING 



FINANCIAL REPORTS 



361 



expenses, non-operating income, and other deductions from income, 
might well be supported by analytical statements if so desired, but 
for purposes of comparison it is doubtful if many of the parties who 
make use of this report would ever refer to them. For the purposes 
of this illustration these supplementary reports are omitted, although 
a business of the size of the one indicated by the foregoing state- 
ments, might do well to have such reports prepared. 

A study of the comparative statement of profit and loss shown in 
the foregoing illustration will reveal several significant facts with 
regard to the financial condition of the company and with regard to 
its operating policy during the year 1920. In the first place, it will be 
seen that the facts revealed with regard to the operations of the cur- 
rent year bear out the conclusion drawn from the facts in the com- 
parative balance sheet, to the effect that the company was reducing 
its inventory in anticipation of a period of falling prices. It also 
indicates that the company sold more goods than in the preceding 
period, but at a lower gross profit. Thus not only is the percentage 
of gross profit lower but also the actual amount of gross profit is less. 
Assuming that the trade is entering into a period of falling prices, 
this would seem to indicate a wise policy, in accepting a reasonable 
profit on the goods now on hand and thereby reducing their inventory, 
with the expectation of replacing them on a falling market. Another 
point to be noted is that the company has apparently depended on 
lower prices as an inducement to its customers to purchase rather 
than by increasing its selling and other operating expenses. This 
is indicated by the fact that the operating expenses have been reduced, 
not only relatively, as indicated by the percentages, but absolutely as 
well. The net profit is considerably lower in 1920 than in the preceding 
year, both absolutely and in terms of its ratio to sales. It is still quite 
satisfactory in amount, however, and does not necessarily indicate 
that the management has been inefficient. It i^ probable that the 
profits for the past few years have been unusually high, owing to the 
rising market, and it would seem that the management is exercising 
excellent judgment in protecting the company as far as possible from 
heavy losses which might result if a period of falling prices should 
find them with a heavy inventory of goods. Also, it is not unlikely 
that the company may have created good will among its customers by 
the price concessions which it has made, thus building up future trade. 



There are other comparisons for which such a statement furnishes 
the basis, but the foregoing discussion should furnish a sufficiently 
clear idea of the uses which may be made of such a statement, as weU 
as the advantages of expressing the important items on such a 
statement in terms of percentages of gross sales. 

The statement of receipts and disbursements. Another form of 
report which may well be presented is a statement of cash receipts 
and disbursements. As explained in the chapters dealing with the 
cash records, information of this nature is usuaUy analyzed in sufficient 
detail in the cash journals, so that a glance at the footings of their 
columns would yield rather complete information. This does not 
mean, however, that a report of this nature may not be worth while 
to the management, who can hardly be expected to draw their 
information from the books of original entry. 

Such a statement would not be at all complex in form, and does 
not require any lengthy discussion. It would ordinarily be prepared 
monthly, and would be more valuable if presented in comparative 
form. Such a form might well provide the basis of comparison 
between receipts and expenditures for the current month with those 
of each previous month in the current year, and possibly with those of 
the same month in one or more previous years. For purposes of 
illustration the form may be shown for a single month. Such an 
illustration follows: 

WILSON AND COMPANY 

Statement of Receipts and Disbursements for the Month Ended 

January 31, 1920 

Balance, January i, 1920 $24,275-00 

Receipts: 

Accounts receivable 

Cash sales .... 



Notes receivable . 
Loans secured from banks . 
Sale of mortgage bonds 
Interest on notes receivable 
Miscellaneous 



Total receipts 
Total accountability 



$78,500.00 

24,700.00 

8,500.00 

10,000.00 

50,000.00 

350.00 

1,200.00 



$173,250.00 
$197,525-00 






3^2 



PRINCIPLES OF ACCOUNTING 



Disbursements: 
Accounts payable 
Notes payable 
Interest on notes payable 
Operating expenses 
Non-operating expenses 
Purchase of delivery equipment 
Paid contractor (new building) . 

Total disbursements . 
Balance, January 31, 1920 



$63,000.00 

32,500.00 

1,300.00 

9,800.00 

2,750.00 

1,75000 
27,000.00 



138,100.00 
$ 59,425.00 



A few transactions are purposely assumed to have occurred in this 
month which would not occur every month, or in the ordinary course 
of operation. Thus the company is assumed to have received money 
from the sale of its bonds and to have applied part of this in paying 
the contractor who is constructing their new building, for the con- 
struction of which the bonds were presumably issued. This and the 
purchase of some additional delivery equipment are the only items 
which do not represent the regular monthly routine business 
operations. 



QUESTIONS FOR CLASS DISCUSSION 

1. What is an "exhibit" in the accounting sense of the word ? Name the 

exhibits usuaUy prepared and explain the use of each. Discuss the 
importance of each with relation to the others and with relation to 
other forms of reports that might be prepared. 

2. Businesses today maintain more elaborate accounting systems than they 
did a few years ago, so that there is considerably more data available 
with respect to the financial condition and operations of the typical 
business now than there was formerly. But the balance sheets and 
statements of profit and loss pubUshed now are considerably more brief 
than those published a few years ago. How do you account for this ? 
Does It mean that there is less information available in the published 
reports of businesses now than formerly ? 

3. Assume that every item shown by the reports of Taylor, Johnson and 
Company were five times as large. Would this make desirable any 
modifications in the forms of the "exhibits" prepared for that com- 
pany? On the basis of the foregoing assumption, what "schedules" 
and analytical statements " should accompany the three "exhibits " ? 



HNANCIAL REPORTS 



363 



4. Who are the interested parties to be served by the reports of Taylor, 
Johnson and Company, as outlined by you in answer to Question 3 ? 
Would the information furnished by these reports be all that is required 
by the government for purposes of the Federal Income Tax ? Would 
it be all that is required by a banker to whom the company is applying 
for a loan ? Would it completely answer the requirements of the sales 
manager ? the treasurer ? Discuss. 

5. Should you expect the stock of this company to be quoted on the 
market on December 31, 1920, at a higher or a lower figure than on 
December 31, 1919 ? Give reasons for your answer. 

6. Do you agree with all the conclusions stated in the discussion given 
above in connection with the comparative balance sheet of Taylor, 
Johnson and Company ? Can you point out anything of significance 
which was omitted from that discussion ? 

7. Suppose you are a banker and are asked to pass on the application 
of Taylor, Johnson and Company for a $30,000 loan for sixty days. 
Would you grant it ? Give reasons for your answer. 

8. Define or criticize the policy followed by the company mentioned above 
during the year 1920, as indicated by the three reports given above. 

REFERENCES FOR FURTHER STUDY 

Greendlinger, Leo, Financial and Business Statements, chaps, iii and iv. 
WiLDMAN, J. R., Principles of Accounting, chap. xlvi. 
Dickinson, A. L., Accounting Practice and Procedure, chaps, ii and iii. 
Hatfield, H. R., Modern Accounting, chaps, iii and xv. 
EsQUERRE, Paul-Joseph, Applied Theory of Accounts, chaps, xxxv, xxxvi, 
and xxxvii. 



I 




CHAPTER XXXI 

THE GRAPHICAL METHOD OF PRESENTING 

ACCOUNTING FACTS 

Diversified reports required by management. In chapter xxx it was 
pointed out that the need of the management for information could 
not be satisfied by the balance sheet and the statement of profit and 
loss alone, or even by the additional financial reports discussed in that 
chapter. With the growth in size of the average business unit, and 
with the increased specialization of managerial functions, there has 
arisen the need for additional special reports for managerial use. 
An example of the need for such diversification of reports is found in 
the reports which are drawn up to show sales analysis. These reports 
must be so prepared as to show sales analyses on several bases, each 
such basis of analysis being determined by the kind of questions 
which some one of the functional managers wants answered. Thus 
the merchandise man, or purchase manager, might want a report 
classifying sales by commodities. The sales manager might desire 
reports classifying sales by territories, by salesmen, or on both these 
bases. The treasurer, whose problems are financial in their nature, 
might desire a report which would classify sales on the basis of the 
credit terms on which they had been made. And not only are reports 
of this sort needed, but also statements which make possible the 
comparison of such facts, as between branches or departments of the 
business, and as between different periods of time. 

The use of statistical method. If these reports are to give the 
managers for whom they are prepared the information most desired 
by them, and in the most available form, it will be necessary for the 
accountant to call to his aid methods of presentation which are ordi- 
narily termed statistical methods. The statistical method, in the 
best meaning of the term, implies the gathering, in numerical terms, 
of the information needed for answering a certain question or revealing 
a certain tendency, and the presentation of this information in as 
clear a manner as possible. 

364 



■ 



GRAPHICAL METHOD OF PRESENTING ACCOUNT FACTS 365 

Thus if the sales manager of a large wholesale establishment 
wishes to know the ratio between expenditures incurred for adver- 
tising in a certain territory during a certain period of time, and the 
amount of the sales made in that territory during the same period, 
the answering of his query in a satisfactory manner will involve the 
use of statistical method. Assuming that the records of the business 
have been properly kept with a view to answering such a question, 
and that the information needed is therefore available, it might appear 
from these records that the sales made in X territory during November 
amounted to $72,000, while the advertising expense incurred during 
that month amounted to $6,000. Given this information, there are 
several methods by which it may be presented to the sales manager. 
Some possible methods of such presentation are: 

1. A simple memorandum to the effect that the sales made in X 
territory during November amounted to $72,000, with an advertising 
expense of $6,000. This is a mere statement of facts with no attempt 
at interpretation. For this reason, if similar information is furnished 
in this form for all the sales territories, the full significance of the 
comparisons involved would not become evident to the executive 
without the expenditure of some time and energy on his part in study- 
ing the relationships expressed by the figures submitted. 

2. A report to the effect that the sales made in X territory for 
November were twelve times the advertising expense incurred for 
that territory during that month. This is stating the answer in the 
form of a ratio^ and is more suggestive than the first method, because 
a comparison between the two items is indicated. 

3. A report to the effect that the advertising expense for X terri- 
tory during November was 8J per cent of sales. This method is not 
very different from that of expressing the relation in the form of a 
ratio, but is preferable for the reason that it is somewhat easier to 
understand the meaning of percentages taken on a common base, 
the base here being the amount of sales. Thus if the sales manager 
desired also a comparison between sales and salesmen's salaries for 
the same territory and period, as he probably would, and the sales- 
men's salaries amount to $9,000, it would be better to report that 
advertising expense was 8J per cent and salesmen's salaries 12^ per 
cent of sales than to report that sales were 12 times the first item and 
9 times the second, since the percentage method affords not only a 



I 



366 



PRINCIPLES OF ACCOUNTING 



comparison between sales and each of the two expense items but also 
a basis of comparison between the two items of expense. 

4. A chart or graph indicating a comparison between the two 
Items. Such a comparison might be expressed by means of two bars 
of equal width, the respective lengths of which would indicate the 
relationship between the two amounts in question, as foUows: 



CHART I 



S72,CXXD 



l6,ooo 

a, Sales in X territory — November 
6, Advertising expense for X territory— November 

This last method of presenting statistical data is known as the 
graphic method, and is particularly suitable for the presentation of 
certain types of information, as will presently appear. 

Further illustration of the statistical method. To illustrate further 
the presentation of statistical data concerning business operations, 
It may be assumed that a certain department store keeps records 
which furnish the following information concerning the operations of 
each department: (i) gross sales; (2) sales returns and allowances; 
(3) net sales; (4) cost of goods sold; (5) gross profit on sales; (6) sales 
salaries; (7) advertising expense; (8) deUvery expense; (9) general 
overhead expense (pro-rated to die department); (10) net operating 
profit. 

Assuming further that the records are kept in such a manner as 
to make this information available by months, the information concern- 
ing the operations of a given department for a year may be tabulated 
to show each of these items for each month of the year, thus making 
it possible to compare different items for the same month, and also to 
compare the amount of a given item for one month with the amount 
of the same item for any other month. Such a tabulation, showing 
the facts with regard to Uie operations of Department A for the 
year ended December 31, 1919, is shown on page 368. 

There are several comparisons which may be made on the basis 
of the information furnished by tiie foregoing tabulation, as weU as 



GRAPHICAL METHOD OF PRESENTING ACCOUNT FACTS 367 



several ways in which such comparisons may be presented. For 
example, if it is reported that gross sales for January were twenty 
times the amount of advertising expense, for February thirty-one 
and one-tenth times that item, and so on for the remaining months, 
this would be expressing comparisons between these two items for 
different months of the year in terms of raiios. These ratios could 
then be shown for each month to afford a comparison of the ratios 
for different months of the year, as follows: 

RATIO OF GROSS SALES TO ADVERTISING EXPENSE, 

DEPARTMENT A 







For Year Ended December 31, 


1919 ( 


[By Months) 




Jan. 


Feb. 


Mar. 


April 


May 


June 


July 


Aug. 


Sept. 


Oct. 


Nov. 


Dec. 


For Year 


31 


331 


SO. 3 


30 


as 


40.2 


50 


258 


21.3 


26.3 


32-7 


17 


27 



Assuming that gross sales is taken as the basis of comparison, a 
comparison between this item and any other of the items previously 
mentioned may be shown by the method just indicated. For example, 
the ratio of gross sales to cost of goods sold, or to sales salaries, may 
be shown for the year, and for each month in the year. 

Another method by means of which different items may be 
compared for any one month is the use of percentages, as indicated 
in the earlier discussion. Thus, taking the gross sales for the month 
as the base figure, or 100 per cent, it is possible to show other items 
for that month in terms of their percentages of gross sales. This 
method of comparison may be illustrated by a table showing gross 
sales, sales returns and allowances, net sales, cost of goods sold, and 
gross profit on sales, for the first three months of the year, expressed 
for each month in terms of the percentage of each item of the amount 
of gross sales for that month. In practice such a table would probably 
be extended to include all the items listed in the table given and to 
cover all of the twelve months of the year. The method employed, 
however, is sufficiently well indicated by the partial tabulation shown 
on page 369. 

The graphic method illustrated. Still another and very useful 
method of presenting statistical information is by means of charts. 






ll 



368 



C/5 

X 

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M 
O 

CO 
C/3 



PRINCIPLES OF ACCOUNTING 



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GRAPfflCAL METHOD OF PRESENTING ACCOUNT FACTS 369 

DEPARTMENT A 

Percentages to Gross Sales of Returns and Allowances, Net Sales, Cost 

or Goods Sold, and Gross Profit on Sales, for the First Three 

Months of the Year Ended December 31, 1919 



Gross sales 

Sales returns and allowances 

Net sales 

Cost of goods sold 

Gross profit on sales 



Percentages 



January 



loo.o 

5-9 
94.1 
65.2 
28.9 



February 



lOO.O 

5 03 
94.07 
68.0 
26.07 



March 



lOO.O 

4.6 

95-4 
70.1 

25 -3 



curves, or graphs, in such a way as to appeal directly to the eye. 
This method may be illustrated first by the use of what is known as 
the curve. Several types of curves are employed by statisticians and 
for different purposes, but the curves which will be made use of in the 
following illustrations are of a very simple type, and all deal with the 
same sort of data after the same manner. » 



CHART II 



S12QP00 



lOOjOOO 



80JOOO 



eaooo 



40000 



ZOjOOO 




JAN FEB MAK APR MAY JUN JUL AUG SEP OCT NOV DEC 



Department A— Curve showing Gross Sales (by months) for the year ended 
December 31, 1919. 



370 



PRINCIPLES OF ACCOUNTING 



|i > 



The foregoing illustration shows a curve for the gross sales of 
Department A, plotted by months, for the year 1919. An exami- 
nation of this curve indicates that sales in this department were high 
during the January and February sales, lower in March, climbing 
again in April and May, high in the August sales, higher still in 
September, after which they fall off somewhat, but reach their peak 
during the holiday season. 

This curve, showing the comparison of sales by months for a 
single year, at once suggests several other interesting comparisons. 
Thus it would evidently be interesting to see how the sales of the 
preceding year, plotted by months, on the same base and to the same 
scale, would compare with those of the current year. To prepare 
such a curve, however, it would be necessary to assume a considerable 
amount of additional data. It will therefore be omitted, though with 
a full recognition of its value for purposes of comparison. 

Comparison of gross sales with net sales. In the tabulation pre- 
viously given of the more important data concerning the operations 
of Department A for the year, it will be noted that the gross sales 
and the amount of sales returns and allowances are given for each 
month, and that the amount of net sales for the month, which is the 
difference between the two, is shown as the third item. The manager 
is apt to be concerned with the fluctuations of the sales returns and 
allowances in relation to the gross sales, and the relations between 
gross sales and net sales for each month. Two curves may be plotted 
for his inspection, the first showing a comparison between gross sales 
by months and sales returns and allowances by months, the second 
showing a comparison between gross sales and net sales, both by 
months. The second would to some extent serve the purposes of 
both, since the variations that will be shown by this curve between 
gross sales and net sales from month to month will serve to indicate 
fairly well the fluctuations in the amount of sales returns and allow- 
ances. The first chart suggested will be omitted here, and only the 
second one shown for purposes of illustration (Chart III). 

Comparison of gross sales and cost of goods sold. Another signifi- 
cant comparison that can be made on the basis of the data furnished 
by the table on page 368 is one between the gross sales by months 
and the cost of goods sold, also by months. Such a comparison is 
shown by the two curves on Chart IV, both of which are plotted on 
the same base and to the same scale. 



GRAPfflCAL METHOD OF PRESENTING ACCOUNT FACTS 371 



CHART III 



^ 




> 


^ 














^ 


^ 


^ 


"^ 




— - 


^ 












































































• 

















Sl20/)00 



100000 



80000 



60000 



40000 



20000 



JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC 
Department A— Chart showing comparison between Gross Sales and Net 
Sales (by months) for the year ended December 31, 1919. 

CHART IV 
S120000 

100000 



80000 



60000 



40000 



20000 



JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC 
Department A— Chart showing comparison between Gross Sales and the 
cost of the goods sold (by months) for the year ended December 31, iQig- 



L 







372 



PRINCIPLES OF ACCOUNTL\G 



An examination of the two curves shown on this chart shows a 
tendency toward a fably close correspondence in the movements of 
the two lines. However, it is to be seen that the margin between 
the two fluctuates somewhat from month to month, not only in its 
amount but also in its relation to the amount of gross sales. Another 
valuable comparison would be shown by a chart on which was plotted 
the curves for net sales and cost of goods sold, both by months. In 
this case the margin between the two would represent the amount of 
gross profit on sales. Such a chart would reveal, for instance, that 
a high percentage of gross profit was realized in April, in September, 
and in December, as compared with that realized in the other months 
of the year. 

Comparison of gross sales and advertising expense. It is altogether 
probable that the sales manager will desire a comparison between 
gross sales and the advertising expense incurred in making these 
sales, by months. Such a comparison is presented by the two curves 
shown on the following chart: 



Sisaooo 



100000 



60000 



60000 



-WjOOO 



20000 



CHART V 




JAN FEB MAf\ APK MAY JUN JUL AUG SEP OCT NCV DEC 

Department A— Chart showing comparison between Gross Sales and Adver- 
tismg Expense (by months) for the year ended December 31, 1919. 



GRAPfflCAL METHOD OF PRESENTING ACCOUNT FACTS 373 

It is at least evident from this chart that advertising expense 
has not been charged to this department on the basis of sales, since the 
fluctuations of the two curves are not always in the same direction. 
Thus in April the advertising expense is seen to be lower than in May, 
while the sales in April were higher than the sales for May. 

Comparison of gross sales and operating expenses. Another desir- 
able comparison is one between total sales and total operating expense. 
A chart showing such a comparison is given below. 



CHART VI 



$120000 



lOOOOO 



60000 



60000 



'lOOOO 



90000 




JAN FEB MAP. APf\ MAY JUN JUL AUG SEP OCT NOV DEC 



Department A— Chart showing comparison between Gross Sales and Total 
Operating Expense (by months) for the year ended December 31, 1919. 

Inspection of the two curves reveals that in every month an in- 
crease in sales has been accompanied by an increase in operating 
expense and vice versa, though not always in the same proportion. 
Any questions which may be raised by a study of this chart will 
require a reference to the table in which the analysis of operating 
expense by months is shown, and will probably require an investiga- 
tion which will demand information of an even more detailed 
nature. 



374 



PRINCIPLES OF ACCOUNTING 



Comparison of gross sales and net profit. A comparison of gross 
sales by months with net operating profits by months is shown in 
the following chart; 

CHART VII 
S12Q000 

lOOjOOO 



6CX000 



60000 



40000 



20000 




JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC 



Department A— Chart showing comparison between Gross Sales and Net 
Operatmg Profit (by months) for the year ended December 31. 1919. 

The amount of net operating profit fluctuates more sharply from 
month to month in proportion to its size than does the amount of 
gross sales. This is quite to be expected, and may be explained by a 
study of the fluctuations in the amounts of the various items which 
were to be deducted from the amount of gross sales before arriving 
at the net operating profit. 

Other methods of graphical presentation. Another means of showing 
a comparison between figures graphically is by the use of bars or 
rectangles of similar width, whose length furnishes the basis for 
comparison. A case in which this method might well be employed 
IS found m the comparison of total sales for the current year with 
total sales for the preceding year. Assuming gro^s sales for the pre- 
ceding year to have been $1,011,000, and ascertaining the sales for the 
current year to total $1,208,100, such a comparison is shown by the 
following chart: 



GRAPHICAL METHOD OF PRESENTING ACCOUNT FACTS 375 



CHART VIII 



1918 



1919 




$1,011,000 



$1,208,100 



Department A — Chart showing comparison between total sales for year 
ended December 31, 1919, with total sales for year ended December 31, 1918. 

The rectangle or bar can also be used as a device for showing a 
comparison of parts with the whole which they make up. For ex- 
ample, if the gross sales for January are taken as the whole with which 
its parts are to be compared, a rectangle may be drawn to scale to 
show by its length the amount of this total. This rectangle may then 
be divided into cross-sections, the length of each representing the 
amount of one of the deductions which must be made from gross 
sales before net profits can be ascertained. The last remaining cross- 
section will represent the amount of such net profits. Still another 
basis of comparison is furnished if similar rectangles are drawn for 
the other months of the year, all drawn to the same scale and divided 
in a similar manner. This use of the bar or rectangle in graphic 
presentation is illustrated by the chart which follows: 



CHART IX 






234 



234s 



H 



Jan. 



Feb. 



Mar. 



2345 



Department A — Chart showing relative amounts of gross sales, deductions 
from sales, operating expenses^and net operating profit (by months) for the first 
three months of the year ended December 31, 1919. 

1. Net operating profit 5. Sales salaries 

2. General overhead expense 6. Cost of goods sold 

3. Delivery expense 7. Returns and allowances 

4. Advertising expense 



376 



PRINCIPLES OF ACCOUNTING 



m 



Advantages of the graphic method. A few simple illustrations have 
been presented and discussed in this chapter. These illustrations of 
the graphic method of presenting business statistics are perhaps not 
numerous or varied enough to be really representative, but they do 
serve to reveal certain advantages, as well as certain weaknesses, of 
this manner of presentation. The more obvious advantages may be 
listed as follows: 

1. The graphic method of presenting facts appeals directly to the 
eye, and is sure to command attention. 

2. It brings out comparisons or tendencies in a more striking 
manner, and renders the facts shown easier of interpretation than do 
other methods. 

3. A busy executive can review in a given time a much greater 
amount of information presented in this form than if this information 
were presented in some other form. 

4. By the use of curves it is easier to show a continuity of certain 
tendencies over a period of time than it is to show such continuity 
by other methods. 

Limitations of the graphic method. From a careful consideration 
of the illustration?, given in the preceding pages of this chapter, it 
should become aj.parent to the student that the graphic method has 
not only its advantages but also certain limitations. The limitations 
of the use of the graphic method which most readily suggest them- 
selves are as follows: 

1. Only a very limited range of information can be presented to 
advantage on one chart. This can be readily seen by comparing the 
information presented by any one of the several charts illustrated 
above, or by all of them, with the amount of information furnished 
by the single table upon which- they are all based. 

2. While showing certain tendencies very clearly, the chart does 
not usually furnish exact information in such a form as can be readily 
stated in terms of definite numbers. In other words, a chart cannot 
be easily quoted. Graphic presentation of facts is usually not suffi- 
cient in itself, but needs to be supplemented by figures. Thus, in the 
last preceding illustration there is shown comparisons of: (i) totals, 
and (2) the parts into which those totals may be divided. A little 
study of this chart will show that it will be much more enlightening 
if each section of each bar there shown is also marked to indicate the 



GRAPHICAL METHOD OF PRESENTING ACCOUNT FACTS 377 

number of dollars represented by such section, and also the percentage 
of the whole which such section represents. 

3. The amount of training and caution necessary for the proper 
use of the graphic method. This is necessary: 

a) On the part of the one submitting the report. A variation in 
the base, the scale, or the basis of comparison may create a very 
different impression with regard to a given set of facts, and if not 
wisely and honestly done may be very misleading. 

b) On the part of the one to whom the report is submitted for 
inspection and interpretation. If such reports are drawn in a fashion 
tending to be misleading, they are more misleading than almost any 
arrangement of the actual figures could be. Only one who is trained 
in the use and interpretation of statistics would know enough to avoid 
reading a wrong meaning into charts which are carelessly, ignorantly, 
or dishonestly prepared. 

Summary. In rendering reports with regard to various phases 
of business activity to the managers and other interested parties, the 
accountant should make use of the most scientific methods of pre- 
senting such information available for his use. This means that the 
successful accountant must have a working knowledge of statistical 
method. One very useful way of bringing information to the attention 
of those for whose use it is collected is by means of "graphs " or charts, 
which present such information graphically or pictorially. This 
method possesses certain very evident advantages, but it must be 
used with understanding and with caution. Where the graphic 
method of presentation is employed, it should generally be used in 
connection with and supplementary to statistics which are tabulated 
or otherwise reported in such a manner as to show the exact quantities 
involved, thus retaining the good features of both methods of 
presentation and avoiding so far as is possible their dangers. 



■I 



M 



QUESTIONS FOR CLASS DISCUSSION 

I. Assume that you are sales manager of the Way Sagless Spring Com- 
pany, a manufacturing concern turning out three lines of product. 
The company advertises nationally, and sells to dealers all over the 
United States. Sales are made by salesmen and by mail, by means of 
catalogues. The sales teritory is divided into five parts, with a sub- 
ordinate sales manager for each territory. Outline the information 



378 



PRINCIPLES OF ACCOUNTING 



which you should expect the accounting department to furnish you 
each month. 

2. How much of the information shown in your outline could be advan- 
tageously shown in graphic form ? Make a list of such charts as you 
would ask to have prepared. What use could advantageously be made 
of percentages ? 

3. Assume that you are traffic manager for the Way Sagless Spring Com- 
pany. What statistical data would be useful to you in planning your 
work ? Can you suggest any charts that would be useful to you in this 
capacity ? 

4. To what member of the organization would each of the charts shown in 
chapter xxxi probably be most useful ? Prepare a memorandum to 
accompany each of the charts there shown, calling attention to what 
you consider the most significant thing shown by each such chart. 

5. You are appointed head of the accoimting department of a ^wholesale 
hardware business which has six departments and makes sales in fifteen 
states. You wish to employ an assistant who is an expert statistician, 
but this represents an innovation and the general manager is rather 
doubtful as to its wisdom. Prepare a memorandum to the general 
manager, in which you attempt to justify your proposal to employ 
such an assistant. 

6. Assume that you have succeeded in getting your statistician, and that 
he has been supervising the preparation of tables and charts for the use 
of various members of the staff. The sales manager finds the charts 
very helpful, and suggests that it would be a saving of his tune if the 
reports intended for him should be presented in graphic form exclu- 
sively. Should you accede to this suggestion ? Prepare a memoran- 
dum on the subject, addressed to the sales manager. 

REFERENCES FOR FURTHER STUDY 

Greendlinger, Leo, Financial and Business Statements, chap. ii. 
CoPELAND, M. T., Business Statistics, chap, i, and pp. 254-61, 267-72, 
381-86. 

Frankun, B. A., Cost Reports for Executives, chap. vii. 



APPENDIX 

W. C. Harvey's business has been expanding at such a rate that he 
considers it desirable to have a considerably larger capital, and also to have 
another person associated with him in its management. He therefore enters 
into an agreement with H. P. Simmons to form a co-partnership imder the 
name of Harvey and Sinunons for the purpose of dealing in hardware and 
house furniture. 

It is agreed between them that the capital of the partnership is to be 
$30,000. In view of the successful start made by Mr. Harvey, and the 
desirable relations already established by him, Mr. Simmons agrees to 
accept Harvey's present investment at its book value, and to allow him to 
include in the statement of his assets an item of good-will sufficient to bring 
his investment up to $10,000.00. Harvey is to contribute an additional 
$5,000.00 in cash, and Simmons is to contribute $15,000.00, half of which 
must be in cash, and the remainder in cash or high-grade collateral. 

The articles of co-partnership subscribed to by the two parties to the 
agreement are as follows: 

ARTICLES OF CO-PARTNERSHIP 

These Articles of Agreement, made and entered into this first day 
of June, one thousand nine hundred and eighteen, by and between W. C. 
Harvey, of the city of Chicago, party of the first part, and H. P. Simmons, of 
the same place, party of the second part, 

WITNESSETH, as follows: 

1. The said parties above named agree to become partners in the retail 
hardware and furniture business, located in the city of Chicago, under the 
firm name and style of Harvey and Simmons, said partnership to continue 
for five years from the date hereof. 

2. The capital of the said partnership shall consist of thirty thousand 
dollars ($30,000.00), contributed as follows: W. C. Harvey to contribute 
his present retail hardware and furniture business, conducted by him 
him at 6540 Kinzie Avenue, said business to be valued at ten thousand dol- 
lars ($10,000.00), including the good-will, and five thousand dollars ($5,- 
000.00) additional in cash; H. P. Simmon to contribute fifteen thousand 
dollars ($15,000.00), seven thousand, five hundred dollars ($7,500.00) of 
this to be in cash, and the remainder in cash or collateral which shall 
prove acceptable to W. C. Harvey. The said contributions are to be em- 
ployed as a common fund in the conduct of the business, for their mutual 
benefit and advantage. 

379' 






38o 



PRINCIPLES OF ACCOUNTING 



APPENDIX 



381 



3. During the continuance of the partnership herein mentioned, each 
of the partners shall give his time, skill, and attention to the business, 
and exert his best powers for their joint interest, profit, benefit, and advan- 
tage, and truly buy, sell, and trade with their jomt stock, and the increase 
thereof in the said business. 

4. The partners shall bear, pay, and dicharge between them all expenses 
of the business; all losses and all gains arising from the conduct of the 
business shall be borne and divided between them equally, share and share 
alike. 

5. For the time, skill, and attention given to the business W. C. Harvey 
shall receive the sum of two hundred and twenty-five dollars ($225.00) per 
month, and H. P. Simmons the sum of two himdred dollars (S200.00) per 
month, said sum in both cases to be charged to the salaries account. 

6. Each of the partners shall be credited with interest at 6 per cent 
per annum on his capital investment, the amount of said investment to be 
taken as of the first of each month. The amount of such interest accruing 
to each partner shall be credited to that partner's personal account at the 
end of such month. 

7. No withdrawals in excess of salary, interest earned, and profits 
may be made by either partner without written consent of the other. 
Upon such withdrawals, if made, the partner making them shall be charged 
6 per cent per annum until such deficit shall be made good. 

8. All the transactions of the partnership shall be truly entered in 
double entry books of account, and the same are to be audited periodically 
by a certified public accountant. On the thirty-first day of December of 
each year the books shall be closed by a certified public accountant, and 
the net profit or net loss for the year ascertained and apportioned. 

9. The said parties hereby mutually agree that during the continuance 
of the said partnership neither of them shall indorse any note, or become 
surety for any person, without the written consent of the other partner. 

10. And it is finally agreed that at the termination of the said partner- 
ship the sai4 partners, each to the other, shall and will make a true, just, 
and final account of all things relating to their said business, and in all thmgs 
truly adjust the same; and all the stock, as well as the gains and increase 
thereof, which shall appear to be remaining, either in mon^y, goods, wares, 
fixtures, debts, and otherwise shall be equitably divided between them. 

In Witness Whereof, the parties hereto have hereunto interchange- 
ably set their hands, the day and year first above written. 

W. C. Harvey (L.S.) 
H. P. Sinunons (L.S.) 



Nffiv features to he employed in the accounting for June. Owing to the 
rapidly expanding volume of the business, you have advised the partners 
to make use of certain more advanced methods in keeping the records of 
their business. They give you a free hand in the matter, and ask you to 
instal any new features that you consider desirable. You make the 
following modification in the system as at present existing: 

1. Provision for further analysis in the sales journal. 

2. Inclusion in the purchases journal of all purchases on account, 
whether of merchandise or not. 

3. The employment of a petty cash fund, to be kept by the Imprest 

System. 

4. The use of the cash disbursements journal to record only checks 
issued. All payments in currency are made from the petty cash fimd. 

5. The use of sales and credit slips as a basis for entries and also in 
posting to customers' accounts, and the use of the purchase invoices and 
other vouchers for posting to creditors' accounts. 

6. A slight modification in the columns used in the cash receipts journal. 
I. Additional analysis of the sales journal. It is desired to show in the 

sales journal not only the total of the sales for each department, but also 
the amount of cash sales for each department and of credit sales for each 
department. Since, as will be explained below, posting to the customers' 
accounts will now be done directly from the sales tickets, the posting from 
the sales journal will be only through the footings of columns. The col- 
umns required will therefore be as follows: (i) Date, (2) Explanation, 
(3) Accounts Receivable, Dr., (4) Cash, Dr., (5) Charge Sales Hardware, Cr., 
(6) Charge Sales Furniture, Cr., (7) Cash Sales Hardware, Cr., (8) Cash 
Sales Furniture, Cr., (9) Total Hardware Sales, Cr., Total Furniture Sales, Cr. 
This arrangement is made for the purpose of obtaining more analysis. 
As regards the posting to the ledger accounts, only three of the colimms 
will be posted. They are (a) Accounts Receivable, Dr., (ft) Hardware Sales, 
Cr., (c) Furniture Sales, Cr. The debit to cash will be made in the cash 

receipts journal. 

5. Modification of purchases journal. All purchases on accoimt, 
whether of merchandise or not, will henceforth be recorded in the purchases 
journal. Accounts Payable being debited for all such credit purchases. The 
columns in the purchases journal will be as follows: (i) Date, (2) Name, 
(3) Address, (4) Terms, (5) Invoice Number, (6) Folio, (7) Accounts Payable, 
Cr., (8) Hardware Purchases, Dr., (9) Furniture Purchases, Dr., (10) 
Sundry Accounts, Dr., (a) Name, (6) Folio, (c) Amount. 

The posting from this book is all done through the footings of columns, 
except the debits to such ledger accounts as are not provided for by special 
coliunns, and which are entered under "Simdry Accounts, Dr." 






APPENDIX 



382 



383 



PRINCIPLES OF ACCOUTfTING 



The credits to individual creditors' accounts will be posted direct from 
the purchase invoices, and for purposes of this exercise this posting may be 
taken for granted and ignored. 

3. Use of the imprest system for petty cash fund. All cash received 
by the business is to be deposited and to be disbursed only by check. This 
necessitates some device by which staiall currency payments may be made. 
This matter is to be taken care of by means of a petty cash fimd. This 
fund will be established by drawing a check for the amount of the fund, 
entering the amount of such check in the cash disbursements journal as a 
debit to petty cash. This check will be cashed by the custodian of petty 
cash, who will disburse the money as required, taking a voucher for each 
disbursement, and keeping a record of all such disbursements and the 
accounts to be debited in a subsidiary journal known as the petty cash 
book. When the fund needs replenishment, the petty cashier will present to 
the proper authority a statement of the amount disbursed, analyzed 
according to the accounts to be debited, and accompanied by all the vouch- 
ers for such disbursements, and a check will be drawn for the amount 
necessary to bring the petty cash fund up to its original figure. The entry 
in the cash book will be a debit to each of the accounts shown on the state- 
ment submitted by the petty cashier, and a credit to cash. Thus in this 
system the petty cash book will not be used as a posting medium, and the 
petty cash account will be neither debited nor credited after the first entry 
setting up the debit for the amount at which this account is to be maintained. 

The student is expected to keep a record of petty cash expenditures and 
to make the record for the replenishment of this fund whenever it runs low. 

The petty cash book may have the following columns: (i) Date, (2) 
Name and Explanation, (3) Receipts Check No., (4) Disbursements 
Voucher No., (5) Petty Cash, Dr., (6) Petty Cash, Cr., (7) Office 
Expense, Dr., (8) Delivery Expense, Dr., (9) Other Selling Expense, Dr., 
(10) Sundry Accounts, Dr., (a) Name, {h) Amount. 

4. The cash disbursements journal. The form of cash disbursements 
journal used in this exercise is the same as the one used in Exercise 33, 
and in posting from this book the same procedure will be followed as in that 
exercise. 

5. The use of sales and credit slips. As stated above, in this system 
neither charge sales nor cash sales will be entered by individual transactions, 
but will be entered at the close of each day's business as totals, the amounts 
being arrived at through the sorting and adding up of the sales tickets. 
These tickets will be sorted and entered on the basis indicated above in the 
discussion of the analysis of sales. The total debit to cash from cash sales 
will also be entered in the cash book each day. The posting to the custo- 
mers' accounts will be made from the sales tickets themselves. 



Similarly, all credits to customers will be entered on the books of 
original entry at the close of the day's business by means of a sunmiary 
of the day's credit slips, while the posting to the credit of individual cus- 
tomers will be made directly from the credit slips themselves. Thus the 
total credits to customers for collections made will be entered in the cash 
book, while credits for returns will be sunmiarized in the sales returns and 
allowances journal. 

It will be left to the student to design a form of sales returns and allow- 
ances journal that will show the same analysis of sales returns and allowances 
that is shown for sales in the sales journal. The only accounts to be posted 
from this journal are: (i) Accounts Receivable, (2) Hardware Sales Returns 
and Allowances, and (3) Furniture Sales and Allowances. However, the 
management desfres to have the same analysis made in the book of original 
entry that is made of sales in the sales journal. 

The form of purchase returns and allowances journal which was used 
last month will serve equally well for this month. 

6. Form of cash receipts journal. It has been agreed upon that dis- 
coimts will be granted the purchasers of certain classes of furniture for 
payment within a specified number of days, and provision therefore must 
be made in the cash receipts journal for cash discount on sales. In addition 
to this change in its arrangement, certain other slight changes are thought 
desirable, so that the new form of this book shows the following columns: 
(i) Date, (2) Account Credited, (3) Explanation, (4) Folio, (5) Sundry Ac- 
coimts, Cr., (6) Notes Receivable, Cr., (7) Cash Sales, (8) Accounts Receiv- 
able, Cr., (9) Cash Discount on Sales, Dr., (10) Interest, Dr., (11) Cash, Dr. 

The method of posting from this book is the same as that employed 
in posting the form used last month, except that the credits to customers 
are no longer posted from the cash book, but directly from the credit slips. 

The student will not be required to keep a customers' ledger in con- 
nection with this exercise, and will not be given the information which would 
enable him to do so. The creditors' ledger may also be omitted from the 
exercise, though the student may find it necessary for his own use to keep 
some memoranda concerning the amoimts due to individual creditors. 
Only the summaries of sales and collections and other credits to customers 
will be furnished in this exercise. 

TRANSACTIONS FOR JUNE 

June I (^Saturday) 

W. C. Harvey deposits a check for $5,000.00 to the credit of the new 
firm of Harvey and Simmons. Simmons makes his contribution to the part- 
nership capital, as follows: (a) $3,000.00 in American Telephone and Tele- 
graph 6 per cent gold bonds, valued at par plus accrued interest (from April i) ; 



384 



PRINCIPLES OF ACCOUNTING 



(b) $4,000 oo in Swift and Company's two-year 6 per cent gold notes, at par, 
plus accrued interest since April i ; (c) The remaining part of his $i 5,000 . oo 
investment is in the form of a certified check on the Com Exchange Bank. 
Charge sales: hardware, $95 00; furniture, $75 .00. Cash sales: hardware, 
$63 . 00; furniture, $40 . 00. Received from customers on account, $145 . 00. 
Paid pay-roll as follows: bookkeeper, $25.00, one sales clerk at $30.00, 
and one at $25 .00, a driver at $25 .00, and a boy for general work, $18 .00. 

June 3 
Paid H. Flanagan rent of store for May, $125.00. Drew a check for 
$50.00 to set up a petty cash fund. Received invoice from American 
Furniture Company, Milwaukee, for furniture, $1,200.00, 2/10/60. Paid 
freight on this shipment, $60.00. Collections on account, $105.00. 
Charge sales: hardware, $78.00; furniture, $1 10 . 00. Cash sales: hardware, 
$65.00; furniture, $25.00. Petty cash disbursements: mending office 
chair, $3 .00; new ribbon for typewriter, $1 . 25. 

June 4 
Received invoice of hardware from Sinunons Hardware Company, 
$1,350.00, 2/10/30. Received invoice from Muskegon Motors Company 
for new motor truck, $950.00, n/15. Sold the old truck for $345.00. 
Paid W. D. Allen Company's invoice of May 25, less discount. Collections 
on account, $95 . 00. Charge sales : hardware, $1 2 5 . 00 ; furniture, $ 105 . 00. 
Cash sales: hardware, $97.00; furniture, $40.00. Petty cash disburse- 
ments: towels, $4.50; drinking water, $2.25; carfare for deliveries, $0.75. 

June 5 
Purchased, from Ackley Brothers, tuilding and lot at 6375 Kinzie 
Ave., for $14,000.00. (Buildmg $10,000.00, lot $4,000.00.) Borrowed 
$8,000.00 from Chicago Realty Loan Company on our note for five years 
at 6 per cent, secured by a first mortgage on the property. Gave Ackley 
Brothers a certified check for $14,000 . 00. Collections on account, $145 . 00. 
We have adopted the policy of allowing cash discounts as an inducement to 
prompt settlement on purchases of furniture on account. Customers are 
at this time credited with $4.00 for such discoimts, making the total credit 
$149.00. Charge sales: hardware, $107.50; furniture, $115.00. Cash 
sales: hardware, $82.60; furniture, $45.00. 

June 6 

Returned unsatisfactory goods to American Furniture Company, 

being credited by them with $145.00, the invoice price, and also for 

$6.00 freight paid by us on the goods. The following bills were paid: 

Chicago Telephone Company, rent of telephone for June, $6.00, and 



APPENDIX 



385 



for telegrams, $12.70; Commonwealth Edison Company, light, $7.42; 
Marquette Garage, for care of car, $35.50. Customers are credited for 
$135.00, $131.50 of this being for cash and $3.50 for cash discounts. 
Paid Western Supply Company's invoice of May 23. Petty cash disburse- 
ments: office supplies, $8.50. Charge sales: hardware, $78.50; furniture, 
$1 10 . 00. Cash sales: hardware, $87 . 00 ; furniture, $35 . 00. 

June 7 
Charge sales : hardware, $98 . 50 ; furniture, $1 7 5 . 00. Cash sales : hard- 
ware, $87 . 20 ; furniture, $2 2 . 50. Credited customers for a total of $149 • 00 ; 
$142.00 for cash, and $7.00 for cash discount on sales. Petty cash dis- 
bursements: mending office clock, $3 .00; new waste baskets, $2 . 50. 

June 8 
Paid salaries the same as last week. Harvey drew $60.00 for personal 
use. Sinunons drew $50.00. Received invoice of hardware from Butler 
Brothers, $500.00, 2/10/30. Petty cash: stamps, $20.00. At this point 
the petty cash fund should be replenished. A voucher will be made out for 
the amount expended since the fund is established, and showing the dis- 
tribution to the accounts to be debited. A check will be drawn for that 
amount. Charge sales: hardware, $150.00; furniture, $112.50. Cash 
sales: hardware, $85.00; furniture, $75.00. 

Note. — ^In order to simplify the problem, and relieve the student of unneces- 
sary routine work, all sales and collections will be hereafter stated in totals at the 

end of each week. 

June JO 

Gave check to Red Cross for $40.00. Purchased an adding machine 

from the Burroughs Company, $350.00, giving them our check for the 

amount. James Freeman paid his note of April 10 for $200.00, with 

interest at 6 per cent. Paid Fred Hanson $125.00 for certain repairs on 

our newly purchased building, these repairs being necessary before the 

building could be occupied. Petty cash: express on goods shipped to a 

customer, $3.00. 

June II 

Received invoice from Boutell Furniture Company, $950.00, 2/10/30. 
Cash refund to H. A. Howard, a customer, for furniture returned, $55.00. 
(Voucher and draw check.) Paid the Commercial Lithographing Com- 
pany $75 .00 for advertising material. Paid, from petty cash fund, $2 . 25 

express on this material. 

June 12 

Paid balance due on American Furniture Company's invoice of June 
3, less discount on all except $145.00, the invoice price of the goods re- 
turned. The freight allowance counts as a cash payment. Received invoice 



386 



PRINCIPLES OF ACCOUNTING 



from W. D. Allen Company, $1,200.00, 2/10/30. Paid Pennsylvania 

Railroad Company's freight bill of $49.50, $32.00 in-freight on furniture, 

and $17 . 50 being for in-freight on hardware. Petty cash: stamps, $10.00; 

brooms, $3 . 00. 

June 13 X 

Paid William Bums, contractor, $750.00 for work done on our newly 
purchased building to adapt it to our purposes. It is now ready for occu- 
pancy. Received, vouchered, and paid invoice from Western Safe Company 
for an office safe, $150.00. James Thompson, a customer who owed us 
$65.00 on account, has disappeared, leaving a number of unpaid bills, but 
no address. 

June 14 

Paid Simmons Hardware Company's invoice of June 4, less discount. 
Received invoice of furniture from Grand Rapids Chair Company, $1,100.00, 
1/10/60. We are engaged in moving to the new building, and the store is 
closed today and tomorrow (Friday and Saturday). 

June 15 

Paid weekly pay-roll, same as last week. Each of the partners drew 
$50.00. Collections for the week were as follows: cash received, $487 . 20; 
cash discounts taken by customers, $16.40; total credit to customers, 
$503.60. During the week past we conducted a special sale preliminary 
to moving. Sales for the four days were as follows: charge sales, hardware, 
$724.00; furniture, $986.00. Cash sales: hardware, $662.00; furniture, 
$752.00. Paid Hamilton Transfer Company $150.00 for moving our 
stock and furniture. It is estimated that the work done by our own 
delivery truck in moving saved the firm $30 . 00. 

June 17 

Received notice from the Woodlawn Trust and Savings Company, 
with whom we discounted C. E. Pierce's thirty-day note for $300.00, with 
interest at 6 per cent, that this note has been dishonored at maturity, 
and has been protested. Sent them a check covering the face of the note, 
the interest, and a protest fee of $3.00. We notify John Fry, whose 
name appears on the note as indorser. We were successful in securing a 
tenant for the old store building, and received his check for $62.50, the 
rent for the second half of Jime. Paid the Smith Advertising Agency 
$250.00 to cover the cost of advertising for last week's sale. 

June 18 

Received John Fry's check to take up C. E. Pierce's note, including 
pa)nnent of interest and the protest fee. Paid Muskegon Motors Com- 
pany's invoice of Jime 4, net. Received invoice from Barrett-Christie 



.\PPENDIX 



387 



Company, hardware, $850.00, 1/10/30. Petty cash: advertkmg, $6.50; 
stationery, $8 . 00 ; stamps, $10 . 00. Paid Butler Brothers, invoice of June 8, 

less discount. 

June 19 

Furniture returned to us for credit, $65.00. Received invoice from 
Webster Manufacturing Company, furniture, $1,250.00, 2/10/60. Paid 
in-freight on this shipment, $35.00. Petty cash: new desk pads, $1.00, 
supplies for trimming window, $3 . 50. 

June 20 
Received invoice from Huron Supply Company for store supplies; 
$150.00, n/30. Hardware returned for cash, $8.50. This was paid out 
of the petty cash fund. Received credit memo from Grand Rapids Chair 
Company, noting a credit to us for furniture returned, $200.00. 

June 21 
Paid Boutell Furniture Company's invoice of June 11, less discount. 
Bought of Chicago Office Supply Company, for cash, filing cases, $65.00. 
Received invoice from Allegheny Coal Company for coal, $525.00, n/30. 
This represents our coal supply for next winter, put in in advance. . 

June 22 

Paid W. D. Allen Company's invoice of June 12, less discount. Pay- 
roll for the week vouchered and paid. Each of the partners drew $50.00. 
Charge sales: hardware, $514.20; furniture, $705.50. Cash sales: hard- 
ware,' $428 . 60 ; furniture, $374 . 80. Credits to customers : cash, $3 1 2 . 50 ; 

cash discount on sales, $13 . 50. 

June 24 

Our thirty-day note which was discounted by the Woodlawn Trust and 
Savings Company on April 25 was not paid at the date of maturity, May 
25, but was renewed at that time, the old note being cancel^, and a new one 
made for $500.00, the amount of the old note, the new note being for 
thirty days, and bearing interest at 6 per cent. Through an oversight, no 
entry was made on the books at that time. The new note, which falls 
due today, is paid with interest. William Bums, contractor, has com- 
pleted the constmction of a garage on our lot back of the store building. 
We give him our check for $1 ,500 . 00 to cover its cost. Paid $60 . 00 insur- 
ance premium to cover insurance on our new garage for the next two 
years. Paid balance due on Grand Rapids Chair Company's invoice of 
June 14. 

June 25 

Received invoice from Muskegon Motors Company for eqmpment for 
the garage, $85 .00. Sent them our check for the amount. Henry Peters, 



l-H 



3^ 



PRINCIPLE&^OF WWECOUNTING 



convenience this is paid him out of petty cash. -,rr. — ^.;. ^^. 

funt 20 
^^-^MW^ fnv'oiaa'^frotf ^i S^feakr^r 03 Co&pany for' Kira^are, 
|?&JoorW6)^^^ 



5f»r*rr/«mj^<- «• 



T* •**»»'crfr'*p 



H. F. Lucas, the grocer whosft stfM^ adjoins ours, has contracted for 
f9^'?*M^.'^ m^^^ fW^pa^^tV^jratft^ I^.PQ a jpoaU)l< He 
m^bm ^ ^f^^^% '^f ^ JI)!,:a^^^i|«$,4ft.l)iB4,^.*arg^^.„ Ajidreji^ 

a bankrupt^i^4^p^,ha§ ^eft^WJta ^\§ftr,teJhpr<cl^TOu,ai;^i'ji;pJia8 
left the city. 

imf^sil^ I99JI IlUnQifii r PdBts^loli,ailr^dqCQmpai^; <,^l4rcigfat) ohardware, 
$di3.?l«$ iii»ire%)toi^f\HBMtiHre, I*a5r^*> >I^JBttH?0tt4:hiifiiae <)<?i^^ 
inY^'«f4!i|d)ej«8b ifi^i^iiul^.^o iJoIxa ;fia^a^m 4^^^ 4^ 
turned 4»«jr|»fli&»tifSfai|t<N^. ^^V^uche^.^and vd$%Wo ^^chedLp^^Patyo.casb: 
stamps, $io . CO telegrams, $2 . 30. 

ro ^^d,<f»M^ag^iUU,fp^libQAioi^]«to P^ 

]EMfsaiarMs,fa«PDe a^Ja^^^l^,Jl^^uhe ii^ .pP5»d>anc«L to Heiuy ^^tersw 
^c^T^i ,Uii^:,pa^^4Mirs»,dj;e»% l^o-oo. (:ka^^;»saiesi;JMUKlware94|3Q^; 
furniture, $342.60. Cash sales: hardware, ^1,5,.^ 5i>(|uauturep4»g*4.^^ 
Credits to customers, for cash, $a>i5^s«f for cash discount, $18.90. 

**''MK^elitf6fil^'a'WrtMa'nfe^g'^^S^^ '•*fi£rd^iStftr''ls -jAi 00: 

'7 TO&ae&^fe^cif£if?^S'ir^^aife^'^^^ m^^rii {^^M^c3St^6f <^'A^ 
lffid^S^tSteW'\fie^-rciii2rn(fe'f. "^It 1? ^l^ated-^liat x>£^\lnlB'<^ffic 








motor truck, 24 per cent annually. 

Figure depreciation for the rfibn^^'bn the total of each fixed asset as 

^''^t^cal^'durtif^tiftiMdrffft ffht^ehiff^^ >*< f^r'*^?'*? 



APPENDIX 



389 



Inventories of expense items are as follows: prepaid advertising, 
$10.00; auto supplies, $17.00; store supplies, $32.50; office supplies, 
$22.00. 

Advertising payable is accrued, $30.00. 

Make all necessary adjustments for interest and for insurance premiimis 
used and unused. 

Credit each of the partners' personal accounts with his stipulated 
salary. It is estimated that Harvey spends three-fifths of his time in 
administrative work, and two-fifths in selling. Simmons is supposed to 
spend one-third of his time in the administrative work, and two-thirds in 
selling. 

Instructions. Post to the ledger all entries for the month's transactions, 
and take a trial balance (preliminary trial balance). Then, with the aid 
of the data given above, prepare 

1. A working sheet 

2. A statement of profit and loss 

3. A balance sheet 

When this is done, make your adjusting entries in the journal, and post 
them to the ledger accounts. Then draft the closing entries in the journal, 
post, and rule up the accounts closed. 



i 



INDEX 



Acceptance, 169, 207; trade, 207. 

Account, 53-63; adjusting, loi, 305; 
balance of, 57; classification of, 335, 
346; closing, 109, 326; construction 
of, 56; form, 56; interpretation of 
balance, 58; numbering of, 343; 
purpose of, 53. 

Accounting: for trade acceptances, 210; 
function of, 2, 10; information 
furnished by, 3, 10; process, 186, 191; 
relation to proprietorship, 13, 21; 
reports, 3, 18, 186; terminology of, 
29, 60. 

Accoimts with: Accounts Payable, 71, 
266; Accounts Receivable, 69,. 254; 
Administrative Expense, 86; Buying 
Expenses, 83; Cash, 67, 253; Cash 
Discounts, 292, 302; Creditors, 70, 
266; Debtors, 68, 254; Delivery and 
Drayage Expense, 84; Depreciation 
Reserves, 74, 75, 259; Fixed Assets, 
71,259; Interest, 291,302; Merchan- 
dise, 81, 82, 288, 206; Notes Pay- 
able, 70, 267; Notes Receivable, 68, 
256; Notes Receivable Discounted, 
257; Notes Receivable Dishonored, 
259; Operating Expenses, 83, 295; 
Proprietorship, 76, 273, 270; Pro- 
prietorship Reserves, 280; Purchase 
Deductions, 297; Sales Deductions, 
290; Selling Expenses, 84. 

Accruals and deferred items, 305; 
accrued exi)enses, 308; accrued in- 
come, 305; deferred charges to 
expense, 310; deferred credits to 
income, 313. 

Adjusting entries, loi, 152, 318, 328; 
Merchandise Inventory, 102; Need 
of, loi, 318. 

Administrative Expenses account, 86. 

Advantages of controlling accounts, 251; 

of the graphic method; 376. 
Analysis of cash disbursements, 227; of 
» cash receipts, 223; of sales by depart- 
ment, 216; of surplus account, 353. 
Analytical statements, 352. 
Arrangements of accounts in ledger, 86. 
Assets, 17, 253-60. 



Bad Debts, Reserve for, 255. 
Balance of an account, 57, 325, 353. 

Balance sheet, 25-33, 48, 263, 325, 350, 
353; comparative, 353; form, 26; 
function of, 25; heading, 31; sub- 
titles, 31; terminology, 29; use by 
manager, 48. 

Balancing the accounts, 114. 

Bank statement, 182. 

Basis of business management, 13. 

Bill of lading, 179. 

Bonds Payable, 269! 

Books of original entry, 118, 132, 147, 
188, 212, 223, 237; Cash book, 140, 
215, 223; Journal, 118, 147; Pur- 
chases journal, 135, 219; Sales jour- 
nal, 138, 214. 

Buildings account, 262. 

Business practice and procedure, 193, 
202; handling cash disbursements, 
203; handling cash receipts, 202; 
methods of handling Notes Receiv- 
able and Payable, 206; methods of 
handling Purchases, 193; methods of 
handling Sales, 197; petty cash funds, 
204; shipping or delivering merchan- 
dise, 199; trade acceptance, 207. 

Business vouchers and forms, 159, 174, 
i8q; classification, 160; forms used 
in bank transactions, 180; merchan- 
dise invoice, 160; miscellaneous 
forms, 176; negotiable instruments, 
162; purp>ose, 159. 

Buying Expense account, 63. 

Capital stock, 277. 
Cash account, 67. 

Cash book, 140, 223; form, 141; 

illustrations, 141, 142, 226, 228, 229, 

244, 24s; information shown by, 

142; posting, 143. 
Cash Disbursements journal, 228, 229, 

241, 245. 

Cash Receipts journal, 225, 226, 239, 
244. 

Cash, recording of, 223-28. 

Cash Sales, 215. 



391 



392 



PRINCIPLES OF ACCOUNTING 



Cashier's check, 169. 

Charges to capital versus charges to 
revenue, 260. 

Check, 184. 

Classification of accounts, 334-46; of 
expenses, 44, 295 ; of income, 288; of 
vouchers and forms, 160. 

Closing an account, 114, 115; entries, 
153, 326. 

Comparative balance sheet, 353; State- 
ment of Profit and Loss, 358. 

Comparison by graphic method: Gross 
Sales with Advertising Expense, 372; 
Gross Sales with Cost of Goods Sold; 
370; Gross Sales with Net Profit, 374; 
Gross Sales with Net Sales, 370; 
Gross Sales with Operating Expenses, 

373- 
Construction of accounts, 60, 67, 81, 
253, 266, 273, 288, 295. 

Controlling accounts, 237-50. 

Conventional financial reports, 349. 

Cost of Goods Sold, 43, 296, 298. 

Creditors, 8, 28, 70. 

Current accounts, ruling of, 115; 
entries, 149; liabilities, 266. 

Debits and Credits: determination of, 
63; equality of, 63; relation to the 
account, 60. 

Debtors, accounts with, 68. 

Debts owed to creditors, 28; by 
customers, 27. 

Deductions: from Income, 301; from 
Purchases, 221, 297: from Sales, 217, 
290. 

Deferred Charges to Expanse, 310; 
Credits to Income, 313. 

Delivery Equipment, 75, 105; Expense, 
84. 

Departmental analysis: in Purchases 
journal, 220; of Purchase Deduc- 
tions, 221; of Sales, 216; of Sales 
Deductions, ?i7. 

Deposit ticket, 181. 

Depreciation: balance sheet, 31, 73: 
entries necessary for, 105, 321; 
method of showing accounts, 74, 75, 
262-64, 301 ; necessity for showing, 30. 

Dewey decimal system for numbering 
accounts, 343. 

Discount on Stock, 278. 



Discounts for Cash on Purchases, 292; 
on Sales, 302. 

Diversified reports required by manage- 
ment, 364. 

Drafts: accepted, 169; bank, 166; 
commercial, 166. 

Effect of special journals on general 
journal, 147. 

Entries, journal: adjusting, 152, 318; 
closing, 153, 326; current, 149; 
opening, 147; post-closing, 328. 

Equality of debits and credits to ac- 
counts, 63. 

Exhibits, 350. 

Expense accounts: accrued, 308; esti- 
mated, 300; kinds of, 83, 288; 
prepaid, 310. 

Express money orders, 170. 

Financial reports, 349; analysis of 
surplus, 353; analytical statements, 
352; comparative balance sheet, 353; 
Comparative Statement of Profit and 
Loss, 358; conventional reports, 349; 
exhibits, 350; nature and purpose, 
349; schedules, 351; Statement of 

. Receipts and Disbursements, 361. 

Fixed Assets, accounts with, 259. 

Fixed Liabilities, accounts with, 268. 

Form: account, 56; balance sheet, 26; 
Cash book, 141, 225, 228; Journal, 
122; merchandise invoice, 160; pro- 
prietorship, 18-20; Purchase journal, 
135, 220; Sales journal, 137, 214; 
Statement of Profit and Loss, 41. 

Forms used in transactions in the bank, 
179; bank statement, 182; check, 
184; deposit ticket, 181; passbook, 
182; signature card, 182. 

Freight, Express, and Cartage, 298. 

Function of balance sheet, 25. 

Fundamental classification of accounts, 
33 5 ; property accounts, 336; pro- 
prietorship accounts, 337; revenue 
accounts, 338. 

Fundamentals of accounting same tor 
all classes, i . 

Graphical method of presenting ac- 
counting facts, 364; advantages, 376; 
illustrations, 366-76; limitations, 
376; use, 364. 

Gross profit on sales, 10^. 



INDEX 



393 



i 




Handling of Notes Receivable and 
Payable, 206; of Purchases, 193; 
of Sales, 197. 

Heading of balance sheet, 31; of 
Statement of Profit and Loss, 46. 

Illustrations (see List of Illustrations, 
page xxi). 

Importance of accounting process, 191. 

Imprest system for petty cash, 204. 

Income accounts, 288; kinds, 288; oper- 
ating, 288; non- operating, 291. 

Indorsement of negotiable instruments, 
174-76. 

Insurance, 311. 

Interest, 291, 302, 313-15; on Notes 
Payable, 302; on Notes Receivable, 
291; Unearned, 313. 

Interpretation of the account balance, 

Inventory account, 82, 102. 
Investment, 14. 
Investors, 7. 
Invoice, 160-67. 

Journal: defined, 121; modem use, 
147-53; special forms, 132-43, 212- 
28; standard forms, 122; subdi- 
visions of, 212. 

Kinds of expense accounts, 295; of 
income accounts, 288; of negotiable 
Instruments, 166. 

Lack of uniformity in classification of 

accounts, 346. 
Ledger, 60; appearance after closing, 

113; arrangement of accounts in, 86; 

content, 60; need for record other 

than, 118. 
Liabilities, 70, 266-71. 
Limitations of graphic method, 376. 
Long-term notes, 271. 

Management: accounting an aid to, 6; 

basis of, 13; diversified reports 

required, 364. 
Means of classifying business data 

needed, 53. 
Merchandise creditors, 28; inventory, 

82, 102; invoice, 160; shipping or 

delivery of, 199. 



Method: graphic, 364-79; of handling 
Notes Receivable and Payable, 206; 
of handling purchases, 193; of 
handling Sales, 197; of taking a trial 
balance, 92; of determining valua- 
tion of certain assets, 30. 

Miscellaneous business forms, 176. 

Money orders, 170. 

Mortgages Payable, 269. 

Nature* of books of original entry, 120; 
of Cash book, 142; of reports 
affected by functional organization, 
6; and purpose of financial reports, 
349- 

Need of adjusting entries, loi, 318; 
for record other than ledger, 118; 
for special books of record, 132. 

Negotiable instruments, 162; cashier's 
checks, 169; drafts, 166; express and 
postal money orders, 170; indorse- 
ment, 174; kinds, 166; requisites of, 
165. 

Net operating profit, iii. 

Non-operating income accounts, 291. 

Note accounts, ruling of, 115. 

Notes: long-term, 271; Payable, 70, 
206, 267; Receivable, 68, 206, 256; 
Receivable Discounted, 257; Receiv- 
able Dishonored, 259. 

Numbering of accounts, 344. 

Object of business operations to increase 
proprietorship, 16. 

Office Furniture, 73, 105. 

Opening entries, 147. 

Operating expenses, 83, 295-99; in- 
come, 288; profit, 1 11; and non- 
operating expenses, 44. 

Other methods of graphic presentation, 

374. 
Owners, reports required by, 7. 

Partnership, 19, 275. 

Partner's capital account, 273; drawing 
account, 275. 

Passbook, 182. 

Percentages: use in Comparative State- 
ment of Profit and Loss, 358; use to 
express comparisons, 369. 

Petty cash funds, 204. 



394 



PRINCIPLES OF ACCOUNTING 



§^ 




^ 

K^:. 



Postal money order, 1 70. 

Post-closing entries, 328; trial balance, 

329- 
Posting: from the Cash book, 143, 240; 

from the Journal, 126; from the 

Purchases Journal, 137; from the 

Sales journal, 140. 

Prepaid Insurance account, 312. 
Profit and Loss account, iii. 
Property accounts, 336. 

Proprietorship, 15: accounts, 76, 273- 
80; classification, 338; in the cor- 
poration, 277-80; in the partnership, 
275; in the single proprietorship, 76, 
273.338; defined, 17; forms, 18-21. 

Purchase deductions, 221, 297; Dis- 
count account, 292; invoice, 196; 
other than merchandise, 220; order, 
195; requisition, 194; Purchases 
account, 81, 296; Returns and 
Allowances journal, 221. 

Purpose of books of original entry, 212 ; 
of closing entries, 109; of financial 
reports, 349; served by the accounts, 
334; of the trial balance, 92; of the 
voucher, 159. 

Receipt, 178. 

Recording cash disbursements, 228; 

cash receipts, 225; cash sales, 215; 

purchases, 219; retail sales, 217; 
sales, 214. 

Reports: accountant's task to prepare, 
10; accounting, i86; affected by 
functional organization, 6; may be 
of different types, 3; required by 
creditors, 8; required by owners 
and investors, 7; useful to various 
parties, 3. 

Requisites of negotiable instruments, 
165. 

Requisition, purchases, 194. 

Reserve for Bad Debts, 255; for 
Depreciation on Delivery Equip 
ment, 75; on Office Furniture, 74. 

Reserves, proprietorship, 280. 

Revenue accounts, 340. 

Ruling of current accounts, 115. 

Sales, as; account, 82, 288; analysis 
by departments, 216; deductions, 
217; discounts on, 302; for cash, 215; 



gross profit on, 109; invoice, 199; 
journal, 138, 214; journal posting, 
140, 239; methods of handling, 197; 
order, 197; recording, 214; retail, 
217; returns and allowances journal, 
218; ticket, 163. 

Schedules, 35. 

Selling Expense account, 84, 299. 

Shipping or delivery of merchandise, 

199. 
Signature card, 182. 
Source of ledger entries, 118. 
Special colunms in books of original 

entry, 213, 237; forms of the journal, 

132, 212. 

Statement of account, 177 

Statement of Profit and Loss, 39, 322; 
a type of accounting report, 48; 
comparative form, 358; form, 41; 
heading or title, 46; needed to sup- 
plement balance sheet, 39. 

Statement of Receipts and Disburse- 
ments, 361 

Statistical method in accounting, 364. 

Subdivisions of journal, 212. 

Subtitles of balance sheet, 31. 

Surplus account, 279; analysis of, 353. 

Title of balance sheet, 31: of Statement 
of Profit and Loss, 45. 

Trade acceptance, 207: accounting for, 
210. 

Trial balance, 92 ; method of taking, 92; 
post-closing, 329; purpose, 92; use 
as a report, 97. 

Types of accruak and deferred items, 
305- 

Use of controlling accounts, 242; of 
special columns, 213, 237; of statisti- 
cal method, 364; of terms debit and 
credit in relation to accounts, 60; of 
trade acceptance, 207. 

Usefulness of reports, 3. 

Valuation accounts, 262, 263; of assets, 
30, 254, 259. 

Vouchers, 159-84, 189; classification, 
160; purpose, 159; relation to 
accounting process, 189. 

Working sheet, 319. 







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Date Due 



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JUL 2 8 1994 




COLUMBIA UNIVERSITY LIBRARIES 




0041391373 



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